2024-08-23 03:00:17
The Caribbean nation of Grenada has triggered a “hurricane clause” on its government bonds for the first time, drawing attention to calls for more countries to suspend debt payments when hit by natural disasters.
Grenada told investors in its $112 million bonds this week that it would suspend $12 million in interest payments over the next year as it recovers from Hurricane Beryl, which hit its outer islands last month.
Grenada incorporated the world’s first disaster “standstill clause” into its debt nearly a decade ago, and the triggering of that clause will serve as a test case for the effectiveness of these tools. Even other small island nations hit by hurricanes have largely refrained from adopting similar clauses, despite growing encouragement from official lenders.
“Grenada provides us with the opportunity to test the value of this type of contractual innovation in helping a country and its people recover from a devastating disaster, which cannot be underestimated,” said Shakira Mustafa, head of research at the Disaster Protection Center.
At the same time, she added, there needs to be “clear articulation” of the financial relief such provisions entail, as well as how their triggers should be designed, since disasters such as droughts or floods are more difficult to model than earthquakes or hurricanes.
The moratoriums are seen as an alternative to what UN climate chief Simon Steele has called “an endless cycle of governments borrowing to rebuild only to face another climate disaster,” while touring the damage on his home island of Carriacou in Grenada in July.
As hurricanes and other threats become more frequent and destructive, countries are often faced with costly post-disaster emergency borrowing or prepaying insurance premiums.
“Climate change cannot be insured,” said Avinash Persaud, special adviser on climate change at the Inter-American Development Bank. “The frequency of this event used to be called once in a thousand years, but it actually happens every few years… so it has to be different from insurance.”
Grenada’s Prime Minister Dickon Mitchell said in July that damage from the earliest severe storm on record in the Atlantic hurricane season could ultimately be equal to a third of the country’s GDP.
Countries from Mexico to Jamaica have also obtained insurance through investors buying catastrophe bonds arranged by the World Bank, but these measures are relatively complex and, in Jamaica’s case, the insurance was not triggered by Hurricane Beryl.
Grenada began suspending up to two interest payments after an insurance claim by the Grenadian government exceeded a threshold of $30 million.
“The interest saved is then added back to the principal of the debt. So in effect, it’s a source of liquidity at a non-emergency rate. And it’s automatic.” [with] There is no need to go through a cumbersome process to try and get it,” Persaud added.
The World Bank is now offering a two-year suspension of disaster loans to island nations and other small economies at no extra cost, one of the biggest moves yet by officials to push through such provisions.
In a report this month, the IMF also detailed how such clauses should be treated alongside other climate change-related bonds when analyzing countries’ debt sustainability. “The reduced need to borrow when natural disasters occur would mitigate the impact of negative shocks on debt burden indicators,” the fund said.
Still, standstill clauses have not caught on in bond markets so far. After Grenada, only Barbados has included standstill clauses in its international bonds, including debt restructured in 2018.
“It’s a no-brainer for both issuers and bondholders, but surprisingly we haven’t seen widespread adoption,” said Sebastian Espinosa, managing director of consultancy White Oak, which helped Grenada restructure its sovereign debt in 2015 and added hurricane clauses.
“There have been calls for private sector lenders to include these clauses in their contracts, but that’s not really how the bond market works,” Espinosa said. “It really comes down to whether the issuer and its advisers insist on these clauses.”
In Grenada’s case, “the clause in the restructuring was accepted by bondholders because it made sense for a small country like Grenada to have that flexibility,” said Carlos de Sousa, portfolio manager at Vontobel, an investor in Grenada bonds.
But other countries, including larger ones, may be reluctant to include standstill clauses in regular bond sales for fear they would be hit with extra borrowing costs by triggers that may never be used, Mr de Sousa added.
He said governments might have to test the waters by, for example, issuing two bonds that are identical except for one with a standstill clause. “Without that counterfactual, it would be difficult for a country to assess the actual cost of issuing that clause.”
Persaud said the clauses should not incur additional costs because they limit the number of times an issuer can trigger them during the life of the bond, such as three times for Grenada’s bonds.
The price of Grenada’s bonds, which mature in 2030, fell slightly after Beryl as investors factored in the possibility of triggering the clause. Grenada’s fiscal position was improving before Beryl hit. In June, the International Monetary Fund forecast a budget surplus of 9.5% of GDP this year.
The move is partly due to a surge in sales of Grenadian citizenship, which allows investors to use their passports to obtain U.S. investment visas and visa-free travel to a number of countries. Bondholders will also receive a portion of the citizenship sales proceeds as part of the restructured debt.
“From a financial perspective, they don’t necessarily have to trigger that clause, but they have the power to do so and I don’t think anyone would criticise triggering it,” Mr De Sousa said.
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