Tread with Care: Benefits and Costs of Domestic Debt Restructurings

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.