Reducing low-income country debt risks: the role of local currency-denominated loans from international institutions

Low-income countries, already facing significant challenges, now face a dramatic worsening of debt sustainability and the possibility of a widespread debt crisis because of the Covid-19 pandemic. These countries are sensitive to external shocks partly because a large proportion of their debt is held in foreign currency and widespread devaluation of their own currencies has made their debt situation much worse.

This briefing outlines four options as to how low-income country debt risks could be reduced in a way that overcomes challenges, including the institutional rules of multilaterals, political economy problems and issues of moral hazard:

• Multilaterals accept the currency risk themselves.
• Multilaterals hedge lending through another institution.
• Multilaterals borrow from local capital markets and on-lend.
• Multilaterals borrow abroad and on-lend in local currency.