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Debt Conversion Program: Guidelines for Bulgaria


Debt Conversion Programs are no panacea for a country's debt or development problems. They should be viewed as useful but limited vehicle for debt reduction and for the attraction of new investments. However, in certain circumstances, they can make a substantial contribution both by encouraging foreign capital inflows at a time when it is scarce and in alleviating the debt service burden. Some countries have used these programs as an incentive for capital flight reversal.

The underlying concept is simple. Sovereign external debt is exchanged for local currency and the respective amount of debt is canceled. The debt titles are repurchased with the provision (restriction) that the proceeds in local currency are used to purchase domestic assets, equities or other investments, which are specifically designated by the country's program. In practice, each country formulates its own program, with its own regulations and procedures.

Debt conversions cover a wide range of applications. They impose some costs on the economy and have implications depending on whether they are applied primarily for debt reduction or investment promotion purposes. The extent to which debt equity swaps will actually occur depends on the attractiveness of the availability and quality of assets in which to invest. Privatization can improve on all these conditions, since many government assets are large companies with many attractive features. In the case of Bulgaria the swaps could be used as part of the privatization efforts. When a debt-equity swap is used to finance purchase of all or part of a state enterprise, there is no need for local currency funding. In this kind of transactions, the government would give up assets in return for canceled debt. The mere process of privatization improves the business climate by opening up the local markets and offering opportunities for growth and expansion to the private sector. Privatization will almost certainly lead to the conversion of higher proportions of the external debt into equity, thus promoting "market" solutions to the debt problem.

Any country considering such a program must weigh very carefully the costs and benefits that it can expect. The government policy orientation and its long-term economic strategy are crucial for its success or failure. Sometimes the establishment of such program can become a very political issue.

Debt-for-equity swaps or debt conversions (debt-for-nature, debt-for-social programs, etc.) are very specific programs. In the case of Bulgaria, they can have favorable impact on the privatization process as part of the overall market-oriented adjustment strategy.

Although the legal framework for privatization is in place for some time, no substantial results have been achieved so far. One major obstacle to foreign participation was the external debt overhang. The regularization of the relations with the commercial banks provided a favorable background for the design and preparation of a debt conversion program, focusing on ownership restructuring through debt-equity swaps.


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