Spain calls for disaster ‘pause clauses’ for developing nation debt

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Spain is pushing other wealthy countries to allow developing nations hit by famines, droughts and hurricanes to suspend debt repayments, as climate change increases the threat from natural disasters.

Paula Conthe, the head of Spain’s Treasury, told the Financial Times that official and private creditors should incorporate emergency so-called pause clauses for natural disasters into all loans to poor countries, after Grenada became the world’s first country to use such a clause last month.

The Caribbean nation was able to suspend payments on a $112mn bond for a year after damage from Hurricane Beryl, which struck in July, triggered a clause in its debt terms agreed almost a decade ago. The interest will be added on to the bond’s principal. However, such clauses are currently rare in debt documents.

The loan clauses that Spain is putting in its own debt documents will pause debt service for 12 months following a trigger event. Conthe said that the Covid-19 pandemic showed how an exogenous shock can threaten a fiscally prudent country’s ability to repay debt in the short term.

More severe and frequent droughts and floods are complicating debt crises, particularly in Africa. Zambia emerged from a bond default this year only to find its finances strained even further by the worst El Niño drought in southern Africa in four decades.

Spain wants to use its clout as a member of the Paris Club of rich-country creditors to push for the wider uptake of similar clauses and across more types of disasters that can befall developing nations.

“Otherwise, they might go into a negative debt spiral where their liquidity problems would turn into solvency problems,” she said.

Madrid also wanted to make the pauses a standard feature of a G20 common framework for lending to poor nations, as well as some middle-income ones, Conthe added. It plans to make these agreements part of all concessional and commercial lending to low-income countries.

Spain carries weight as a member of multilateral development banks active across emerging markets, including the Asian Infrastructure Investment Bank, the Central American Bank for Economic Integration, and CAF, the Development Bank of Latin America and the Caribbean.

Spain has already inserted food crisis-related pause provisions into loans to Rwanda and Senegal this year. The clauses will only be able to offer “true relief” to borrowers if they are widely adopted, Conthe said.

Some analysts say it is very difficult to design pause clauses that derive specific triggers from disasters such as drought, which can be harder to measure. Beyond Grenada, few countries have adopted the clauses even for risks such as hurricanes, which can be quantified relatively easily.

However, Brad Setser, a senior fellow at the Council on Foreign Relations, said that such clauses would be beneficial for both lenders and borrowers, and would not add much to a developing country’s borrowing costs.

“The ability to stop payments for a year in the face of an act of God, so to speak, helps the debtor and helps the creditor. It helps avoid unnecessary default, and means the debtor doesn’t have to worry about coming up with funds during a disaster,” he said.

“All insurance comes with a price,” Setser added, but the likely cost for loan payment suspension clauses done at issuance would be tens of basis points, not in the percentage points, he said.