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Impact of the Global Crisis on Emerging Economies Lorenzo Giorgianni Chief of the Emerging Markets Division Strategy, Policy and Review Department International Monetary Fund Yerevan, Armenia July 7, 2009 Outline I. Origin of the global crisis II. Impact of crisis on Emerging Economies III. Global crisis response IV. Emerging Economies’ crisis policy response V. Conclusions I. Origin of the Global Crisis Global warming (output) 2006 Heating economy—above trend growth Cooling economy—below trend growth Global cooling (output) 2009 Heating economy—above trend growth Cooling economy—below trend growth Root of crisis The period of high growth and low interest rates masked market as well as policy failures: Financial regulation: perimeter, procyclicality Macroeconomic policies: asset prices, capital inflows Global architecture: coordination, warnings, insurance Propagation of crisis 1. Financial centers Complexity of assets led to mispricing of risks (subprime lending) Realization of risks with fall in U.S. house prices 2. Advanced countries Globalization spread risks across assets, institutions, and countries Counterparty risks led to further tightening of banking standards and cross-border flows 3. Emerging market countries Increase in EM spreads and sudden stop turned the financial crisis in advanced countries into a full-fledged global economic crisis Feedback loops from EMs to advanced country banking systems Feedback loops: Eastern Europe to Western banks Losses from 20 percent loss on loan portfolio in CEE (in percent of GDP) First Round (from East to West) High ( 5%-14%) Reduction in claims of international banks (in percent of recipient country GDP) Second Round (from Belgium and Austria) High ( 5%-24%) Medium (1% -5%) Medium (1% -5%) Low (0-1%) Low (0-1%) II. Impact of Crisis on Emerging Economies EMs hit by multiple shocks 1. Sudden stop in capital flows 2. External demand shock 3. Terms of trade shock for commodity exporters 4. Drop in remittances 1. Deleveraging in advanced countries… Private Sector Credit Growth 20 15 (q/q, seas. adj. annualized, 4 quarter moving average, percent) United Kingdom United States 10 5 Euro Area 0 -5 1989 1994 1999 2004 2009 …led to a sudden stop in capital flows to EMs, notably Emerging Europe… Private capital inflows 6 (percent of PPP GDP) 5 CEE 4 3 2 Middle East 1 0 Asia Latin America -1 -2 -3 2000 2001 2002 2003 2004 Source: IMF, World Economic Outlook 2005 2006 2007 2008 2009 …where stronger financial linkages amplified the shock transmission. 1800 1600 Europe, America, and Asia: Cross Border Claims on Emerging Economies, 2008:Q3 (Billions of U.S. dollars) 1800 1600 1400 1400 1200 1200 1000 1000 Emerging Europe Emerging Asia Emerging America 800 800 600 600 400 400 200 200 0 0 Europe Asia America Deleveraging means not only less availability financing, but also higher borrowing costs. 2. An external demand shock worse than in past crises… Volume of Imports by G3 160 G3 imports (2008 = 100) 140 G3 imports during past crises (100 = start of crisis) Index 120 100 80 60 40 1999 2001 2003 2005 2007 2009 2011 2013 …is leading to severe output contractions.. Industrial Production, monthly, 2006-2010 (weighted by PPP-GDP, 2006) 115 Index (Jun-08 = 100) 110 105 100 95 90 85 80 75 G3 EM non-crisis EM crisis Past crises 70 Jan-2006 Jan-2007 Jan-2008 Jan-2009 Jan-2010 …which tend to be amplified by strong trade linkages… 30 30 Intraregional Trade, 1997–2007 (Percent of GDP) 25 25 20 20 Africa Middle East Western Hemisphere Asia Europe EU 15 10 15 10 2007 2006 2005 2004 2003 2002 2001 2000 0 1999 0 1998 5 1997 5 …as in Armenia’s case Armenia: Exports by Recipient Country, 2008 (in percent of total exports) Other, 19.7 Russia, 20.2 UK, 3.8 USA, 4.9 Germany, 17.2 Bulgaria, 5.7 Georgia, 7.7 Belgium, 8.5 Source: DTS. Netherlands, 12.2 3. Fall in commodity prices hitting commodity exporters very hard Annual Percentage Changes in Exports and TOT, 2008-09 0 Commodity Exporters Change in Exports -5 Manufacturers -10 -15 COL -20 EGY -25 PER CHL ECU -30 DOM ISL JAM ARM -35 ALG -40 VEN SER KAZ RUS -45 -50 -40 -30 -20 -10 0 Change in Terms of Trade 10 20 30 4. Lower incomes in advanced countries also means lower remittances to some EMs Top 10: Projected decline in private current transfers (in percent of GDP) 0 -1 -2 -2.3 -1.6 -1.5 -1.4 ELS GTM ARM -1.2 -1.2 -1.1 MOR BIH EGY -2.2 -3 -4 -3.8 -5 -6 -7 -7.0 -8 MDA LBN JOR VNM Emerging Europe and CIS hit worst Real GDP Growth Projections 15 Armenia 10 5 CIS CEE Emerging Markets Advanced Economies 0 -5 -10 2006 2007 Source: IMF, World Economic Outlook 2008 2009 2010 Increase in CDS (bps, 2007-2009, median) But, are EMs innocent by-standers? Vulnerabilities explaining market spreads… EM Credit Default Swaps 1000 LVA 900 800 LIT EST 700 ROM 600 BGR EGY IDN 500 SAF 400 SER VNM CRO HUN PER KOR POL PAM COL PHL BRA THA TUR 300 200 100 0 0 20 40 60 80 100 External debt (end-2007, % of GDP) 120 140 …and cross-country differentiation in recessions Real Effective Exchange Rate (Since Sep 2008, percent) GDP decline, 2009 proj. (Proj., percent) LVA Peg LIT Peg EST Peg External and Public Debt (Percent of GDP, 2008) UKR Public Debt ARM External Debt MDA ROM Peg BGR HUN RUS CZE BLR BIH Peg KAZ GEO POL -20 -15 -10 -5 0 -30 -20 -10 0 10 0 50 100 150 II. Global crisis response Global crisis requires global response A. Coordinated G-20 policy response B. IMF reforms: resources and lending framework C. IMF lending A. G-20 fiscal response Source: IMF Fiscal Affairs Department Note: Discretionary stimulus (average, 2009-10, based on measures announced through early March) plus automatic stabilizers (average, 2008-10) A. G-20 Monetary policy easing A. Liquidity injections/asset purchases since January 2008 Liquidity Injections/Asset Purchases (percent of GDP) 0 to 5 5 to 10 10 to 15 > 15 No data A. Banking recap since January 2008 Recapitalization (percent of GDP) 0 to 2 2 to 5 5 to 10 > 10 No data B. IMF Reforms—Increase in resources Size of war chest in relation to potential needs Triple lending resources to $750 billion Raise $500 billion in bi-/multi-lateral agreements Commitments so far over $400 billion General SDR allocation of $250 billion Boosts country reserves by 75% of quota Some $100 billion of liquidity to EMs and LICs Later, quota increase B. IMF Reforms—More effective lending IMF as first port of call for EMs in stormy weather More flexible lending: large, frontloaded, contingent access to deal with all financing needs Conditionality better tailored to countries’ circumstances to reduce stigma Flexible Credit Line (FCL) High Access Stand-By Arrangements (HAPAs) C. Increase in IMF lending 160 152 US dollar billions 140 120 100 88 86 FCLs 80 60 Traditional programs 40 14 20 0 1998 2002 2006 May 2009 C. Fund financing can play useful role Reduces need for adjusting to liquidity shock Allows orderly adjustment to solvency shock It does so by increasing reserves and catalyzing private lending bailing-in the private sector (Vienna initiative) creating room for spending reserves to (i) ease private sector’s FX liquidity constraints, (ii) recap banks, and (iii) ease budget financing constraints Caveat: to safeguard Fund resources, policies need to be consistent with capacity to repay IV. Emerging Economies’ Policy Response (as seen through the lens of the recent Fund-supported programs) EMs policy response often constrained Exchange rate regime Degree of dollarization Fiscal sustainability and credibility Bank solvency Institutional weaknesses Social considerations Political, electoral cycles Focus: fiscal policy in crisis Much emphasis has been placed on fiscal stimulus to counter effects of global financial crisis But many EMs face stricter constraints on their fiscal space than advanced economies: Financing constraints Debt levels (for some) Credibility issues Accommodating bank recapitalization costs (for some) Strictures of Euro entry criteria (for some) Reflecting these constraints, fiscal deficits were allowed to widen, but not fully… Fiscal Adjustment in program cases average fiscal balance, % of GDP (excl.Latvia, Mongolia and Seychelles) 0 -1 latest program projections -2 -3 -4 -5 fiscal adjustment in programs implied overall fiscal balance w /o adjustment -6 -7 2003-07 2008 2009 …given the stock of public debt and other initial conditions Public Debt (2008) and Primary Balance (2009) % of GDP 2 Belarus 1 Hungary Primary Balance (2009) Pakistan 0 -1 Guatemala -2 Costa El Rica Salvador Serbia y = 0.07x - 4.17 R2 = 0.58 Armenia Ukraine -3 Georgia Romania Latvia -4 Mongolia -5 0 10 20 30 40 Public Debt (2008) 50 60 70 80 Even so, fiscal programs are being flexibly adapted to evolving macro conditions 2009 Overall Fiscal Balance (% GDP) 0.0 0.0 -1.0 -2.0 -1.8 -2.5 -3.0 -2.8 -3.0 -4.0 -3.8 -3.9 -4.0 -4.0 -4.2 -5.0 Program -5.6 -6.0 Latest Rvw -6.5 U kr ai n e a Se rb i n Pa ki st a ry ga un H eo rg ia G Ar m en ia -7.0 Conclusions Global crisis spreading from advanced countries to EMs Required a coordinated global response fiscal and monetary stimulus where feasible emergency measures to support financial sectors The Fund has played a central role hit Armenia and other CIS/CEE countries particularly hard endowed with more resources; overhauled lending framework launched substantial lending programs across the world New programs have had to adapt to the new crisis Exchange and monetary policies according to country circumstances Accommodative fiscal stance as possible given financing/sustainability issues; attention to social safety nets Focus on maintaining financial sector health Thank you Back-Up Slides Crises are costly, come in waves; and require strong, comprehensive response Fiscal and Output Costs of Banking Crises in Advanced and EM Countries (Size of bubble represents gross fiscal cost as percent of GDP) Output cost: Minimum real GDP growth during crisis (percent of GDP) 25 ERM crisis Debt crisis 20 Tequila crisis Current crisis Asian crisis 15 10 Israel 1977 (fiscal cost: 30%) Norway 1991 (fiscal cost: 3%) Sweden 1991 (fiscal cost: 4%) 5 Japan 1997 (fiscal cost: 14%) US 2008 (fiscal cost: 51%) 0 -5 US 1988 (fiscal cost: 4%) -10 -15 Spain 1977 (fiscal -20 1975 Finland 1991 (fiscal cost: 13%) 1980 1985 1990 1995 Starting date of crisis Korea 1997 (fiscal cost: 31%) 2000 Source: Laeven and Valencia (2008); FAD-MCM: Public Interventions in the Financial Systems. 2005 2010 When will markets normalize? Expected duration of market pressures in EM universe ≤1 year, 5 countries 1-2 years, 28 countries >2 years, 16 countries Measured as number of quarters in which probability of exiting from the crisis reaches 0.5. Duration model is estimated in Mecagni et al "Duration of Capital Crises-An Empirical Analysis, " IMF Working Paper 07/258. Recent IMF lending in context Change in Output for Program Cases 15 10 ARG ARG TUR RUS Percent change in real GDP 1/ 5 0 -5 TUR COL IDN BRA BRA MEX PAK BRA PHL UKR ARG COL IRQ HUN COL KOR BLR ARM MEX ROM UKR URY TUR -10 THA IDN ISL IDN -15 Size of bubble = access in percent of quota ARG LVA -20 -25 Dec-96 Dec-98 Dec-00 Dec-02 1/ Maximum cumulutive decline in three years from program inception Dec-04 Dec-06 POL Dec-08 Large Access, Short Duration Access in Percent of Quota (size of bubble) and Program Duration 50 Turkey 40 Korea Uruguay Latvia Duration (in months) Brazil Argentina Brazil Armenia Argentina 30 Serbia Turkey Pakistan Iceland 20 Mongolia Guatemala Belarus Hungary Brazil 10 Colombia El Salvador Mexico Indonesia Argentina Poland 0 Jan-93 Oct-95 Jul-98 Apr-01 Jan-04 Program approval Oct-06 Jul-09 Apr-12 Access is large and front-loaded Access, in percent of quota Access, in percent of 2009 GDP 1200 16 1000 14 12 800 10 600 8 400 6 4 200 2 0 0 Average 200 Armenia Georgia Romania Ukraine Access, in percent of 2009 short-term debt at remaining maturity Armenia, 1257 percent before augmentation and 1823 percent total 150 100 50 0 Average Armenia Georgia Romania Ukraine Average Armenia Georgia Romania Ukraine First purchase in percent of total access 45 40 35 30 25 20 15 10 5 0 Average Armenia Georgia Romania Ukraine Structural Conditionality Number of structural conditions in initial programs 20 Non-core 15 Core 10 5 0 Asian crisis Argentina, Brazil, Turkey 2001-03 Current programs Core measures: financial/monetary, exchange rate and fiscal policy Issues in crisis management Early diagnosis is key (liquidity vs. solvency) Deal with uncertainty (size of output gap?): adapt plans; develop contingencies (abandon peg?) Secure legal authority to act Ensure good interagency coordination Premium on coherent communications Ensure adequate safety nets for disadvantaged Plan exit strategy Evolving circumstances: downgrade in growth projections GDP growth in 2009, percent Sep 2008 WEO projections 8 6 4 2 0 -2 -4 -6 -8 EM average AM average Ukraine Armenia Moldova Romania Bulgaria Croatia Macedonia Bosnia Israel Cyprus -12 Georgia -10 Montenegro Jul 2009 WEO projections Exchange rate policy Should pegs be abandoned in crisis? Keeping pegs can lead to severe loss of competitiveness with respect to floaters Regaining competitiveness (or correcting overvaluation) under peg imposes harsh deflationary adjustment—plus it seldom happens in crisis (only Hong Kong and Panama) However, negative balance-sheet effects of depegging could be large when liability dollarization pervasive (although deflation in the context of peg also leads to insolvencies) Regional contagion is another risk of depegging Presence of a credible exit strategy from peg, including plans to join monetary union, is another important consideration Role of capital controls? Exchange Rate Policy (continued) To what extent should a country with flexible ER intervene in the FX market? Appropriate to offset disorderly conditions, counter currency overshooting, and provide FX liquidity to banks However, to be effective, needs to be accompanied by rate hikes/active mopping up of domestic currency liquidity and be part of credible policy response Trade off use of reserves today with potential demand for reserve use tomorrow Exchange rate developments in programs Step changes Pegs/tightly managed 10 10 0 5 -10 0 -20 -5 -30 -10 -15 -20 Jul-08 BIH COS ELS GTM LVA approval dates Sep-08 -40 -50 Nov-08 Jan-09 Mar-09 May-09 -60 Jul-08 ARM BLR GEO SYC approval dates Sep-08 Nov-08 Gradual depreciations 0 -10 -20 -30 -40 -50 Jul-08 HUN ISL PAK ROM SER UKR approval dates Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jan-09 Mar-09 May-09 Monetary Policy in Crisis Considerations for appropriate monetary policy stance (flexible exchange rate regimes): Inflation pressures Inflation-fighting credentials of monetary authority Trade-off between (i) growth benefits from lower interest rates and weaker currency and (ii) costs of currency depreciation on unhedged balance sheets Trade-off between (i) LOLR function in face of deposit runs and (ii) avoidance of exchange rate overshooting/loss of monetary control Monetary Policy Instruments Policy interest rates: The reduction in interest rates in advanced markets has provided space for reduction in nominal interest rates in EMs, although country risk premiums have risen. Quantitative measures: Especially useful when the transmission mechanism from policy rates to the rest of the economy may be impaired by non-functioning credit markets. Inflation pressures to persist, especially for floating currencies Inflation Projections vs Maastricht 16 14 Czech Republic Hungary 12 Romania Poland Bulgaria 10 Estonia Latvia 8 Lithuania Imputed Maastricht Criterion 6 4 2 0 2005 2006 2007 2008 Source: IMF, World Economic Outlook 2009 2010 2011 2012 Fiscal policy: automatic stabilizers operating in Western Europe… Change in fiscal balance 2009 over 2008 1 0 -1 -2 -3 -4 Advanced Europe -5 -6 y = 0.8361x - 0.5989 R2 = 0.7149 -7 -8 -12 -10 -8 -6 -4 GDP growth in 2009 Source: IMF, World Economic Outlook -2 0 2 …but less evident in Emerging Europe… Change in fiscal balance 2009 over 2008 1 0 Emerging Europe -1 -2 -3 -4 -5 y = 0.0858x - 1.4215 R2 = 0.0497 -6 -7 -8 -12 -10 -8 -6 -4 GDP growth in 2009 Source: IMF, World Economic Outlook -2 0 2 el an un eo rg an ia ia Pa ki st an G a ry ga Se rb i om R e in ol ia on g H M kr a U us Be la r ia or va d La tv Po la nd en ia Ar m m al a ua te El Sa l G ex ic o M a ic a R s d el le om bi ta ol C os C Se yc h Ic …despite fiscal easing in 2009... Change in Primary Balance from 2009 to 2008 % of GDP 4 Tightening 2 0 -2 -4 -6 Loosening -8 -10 Further Fiscal Policy Considerations Automatic stabilizers are preferable over discretionary measures to achieve fiscal easing Need to make room for stabilizing financial sector More timely, better targeted (e.g. unemployment benefits), and more credibly reversed than discretionary measures Government support for recapitalization with safeguards Investment expenditures and transfers targeting the unemployed or poorer households (which have higher propensity to spend) are effective stimulus measures Subsidies to specific industries and hard-to-reverse expenditures are not recommended debt and deficit limits more respected in emerging Europe, despite worse growth Performance against Maastricht criteria unweighted averages, percent of GDP 0 "Excessive" debt -1 2008 Fiscal balance -2 2008 Emerging Europe -3 -4 2009 Advanced Europe 2010 2009 -5 "Excessive" deficit -6 2010 -7 20 30 40 50 Public debt 60 Source: IMF, World Economic Outlook 70 80 Financial sector policies in crisis Preserving soundness of financial systems key for: domestic financial stability and economic growth stability of interconnected countries effectiveness of monetary policy transmission Financial sector policies in crisis— lessons from previous crises 1. 2. 3. 4. 5. 6. Avoid piecemeal approach Secure confidence of creditors/depositors Ensure upfront loss recognition Facilitate recapitalization Remove nonviable institutions Do not delay debt restructuring Coordination issues from diversified financial links through parent banks Concentration of Emerging Europe Exposure to Western Europe, H1 2008 (Percent) 100% 80% 60% 40% 20% 0% BA BY AL Austria SK Italy HR RO Germany MD CZ France UA HU Sweden BU RU Switzerland PL MK LV Netherlands LT EE Other Source: Bank for International Settlements, Quarterly Review, June 2008. Note: Country names are abbreviated according to the ISO standard codes. 1/ Emerging Europe exposure to western European banks is defined as the share of the reporting banks in each western European country in the total outstanding claims on a given emerging European country (both bank and nonbank sectors). For example, about 42 percent of Croatia's exposures to Western European reporting banks is owed to Austrian banks, 38 percent to Italian banks, 13 percent to French banks, etc. For the Baltic countries, 85 percent or more of exposures to the reporting banks is owed to Swedish banks. Phase 1 – Contain Crisis Establish credible macroeconomic policies Provide needed liquidity All countries have done this Short maturity, collateral, penalty rates but need for flexibility Open market operations successful in sterilizing injections Protect depositors Most countries have done this Blanket guarantees successful but may be costly Depends on size of financial hole and restructuring alternatives Cover all liabilities except subordinated debt and equity Announce medium-term restructuring program Phase 2 – Restructure Banks Diagnosis, focus on medium-term viability Recognize losses upfront Preserve viable, undercapitalized banks: request time-bound recap/restructuring plans close oversight and prompt corrective actions Resolve insolvent, unviable banks: not all institutions to be rescued close/merge and liquidate assets Use of Public Money for Recap Rationale: To encourage private sector contributions (investor of last resort) Principles and safeguards: All losses recognized/absorbed by existing shareholders Match private injections with government funds Government shares could have preferred status Government representation in Board Require operational restructuring/asset workouts Sweeteners (option to buy back government shares) Allow convertibility of state contribution to Tier 2 capital into Tier 1 capital if CAR falls below given ratio Phase 3 – Manage Impaired Assets Resolution of debt overhang needed to restart supply and demand of credit Corporate debt restructuring often neglected Issues in institutional framework speed versus value centralized versus decentralized legal reforms (bankruptcy/foreclosure) out-of-court debt restructuring (London approach) Phase 4 – Exit from Crisis Mode Exit from blanket guarantee if applied Exit from government ownership of banks Sale of assets taken over Overhaul of regulations to not repeat mistakes Continue corporate restructuring to avoid “secondwave crisis” Flexible Credit Line (FCL) Flexibility to draw or treat as precautionary Qualification: Very strong fundamentals/policies No conditions after approval Access upfront, no cap expected not to exceed 1000 percent of quota Renewable arrangements, 6 months or 1 year (with mid-term review), repurchases same as SBA Safeguards: Board scrutiny, transparency, PPM 3 users so far: Colombia, Mexico, and Poland FCL – Qualification Criteria Very strong fundamentals, policies, and policy track records Positive assessment from recent Article IV Qualification criteria (Annex 1 SM/09/69) Strength of external position, market access, sound fiscal position, low/stable inflation, absence of systemic bank problems, effective bank supervision, data transparency/integrity Not all criteria need to be met, but offsetting reasons needed High Access Precautionary SBAs HAPAs for members not eligible/do not request FCL All BOP needs—credit tranche terms No hard caps, but exceptional access policy applies Phasing: can move to 2 instead of 4 purchases a year, in relation to members’ strength/need Review frequency: at least two a year Length: flexible (up to 3 years) Need to solve “blackout” problem Access Normal access limits doubled 200 percent annually, 600 percent cumulative Exceptional access procedures modified Both precautionary/nonprecautionary use Same treatment in current/capital account crises Eliminate ambiguities (debt sustainability criterion Simplifying Surchages and Maturities Figure B: New Surcharge Schedule Figure A: Old Surcharge Schedule (in basis points) 600 500 500 400 400 SRF 300 (in basis points) 600 300 > 300% of quota SBA/SLF/EFF, > 300% of quota 200 200 SBA/SLF/EFF, 200-300% of quota 100 100 0 0 t t+12 t+24 t+36 t+48 Time (in months) t+60 t t+12 t+24 t+36 t+48 Time (in months) t+60 Eliminate time-based repurchase expectations (effective immediately) Remove 100 bps surcharge for credit of 200-300% of quota Keep 200 bps surcharge for credit above 300% of quota Introduce a 100 bps surcharge when outstanding credit is above 300% of quota for more than 3 years Issues in crisis management Early diagnosis is key (liquidity vs. solvency) Deal with uncertainty (size of output gap?): adapt plans; develop contingencies (abandon peg?) Secure legal authority to act Ensure good interagency coordination Premium on coherent communications Ensure adequate safety nets for disadvantaged Plan exit strategy Exchange rate policy Should pegs be abandoned in crisis? Keeping pegs can lead to severe loss of competitiveness with respect to floaters Regaining competitiveness (or correcting overvaluation) under peg imposes harsh deflationary adjustment—plus it seldom happens in crisis (only Hong Kong and Panama) However, negative balance-sheet effects of depegging could be large when liability dollarization pervasive (although deflation in the context of peg also leads to insolvencies) Regional contagion is another risk of depegging Presence of a credible exit strategy from peg, including plans to join monetary union, is another important consideration Role of capital controls? Monetary Policy in Crisis Considerations for appropriate monetary policy stance (flexible exchange rate regimes): Inflation pressures Inflation-fighting credentials of monetary authority Trade-off between (i) growth benefits from lower interest rates and weaker currency and (ii) costs of currency depreciation on unhedged balance sheets Trade-off between (i) LOLR function in face of deposit runs and (ii) avoidance of exchange rate overshooting/loss of monetary control Financial sector policies in crisis Preserving soundness of financial systems key for: domestic financial stability and economic growth stability of interconnected countries effectiveness of monetary policy transmission Financial sector policies in crisis— lessons from previous crises 1. 2. 3. 4. 5. 6. Avoid piecemeal approach Secure confidence of creditors/depositors Ensure upfront loss recognition Facilitate recapitalization Remove nonviable institutions Do not delay debt restructuring