Tread with Care: Benefits and Costs of Domestic Debt Restructurings

Summary

With increasing debt vulnerabilities, domestic debt may become an important-though still distinct--part of debt restructurings. This paper aims to contribute to the discourse by examining the factors that precipitate domestic debt restructurings (DDRs) and their implications for macro-fiscal outcomes. We find that: (i) DDRs are less effective than external debt restructurings (EDRs) in reducing public debt and interest payments; and (ii) they entail deeper, more persistent costs to output and domestic credit. Still, well-designed DDRs can be critical for restoring macroeconomic stability and sustainability, regardless of costs. Their impacts depend on design, instruments, sovereign-bank nexus, concurrent fiscal consolidation, and financial development. Finally, the paper shows that gross international reserves and the presence of an IMF-supported program can mitigate the costs associated with DDRs while preserving their debt relief benefits.