Sovereign Debt Restructuring
Notes for the Special Committee on Crisis Prevention and Resolution — Citicorp Center, New York, 2nd December, 2002)


Current proposals for sovereign debt restructuring, both by IMF circles and by the PSAG (Private Sector Advisory Group), seem to neglect or underplay some important differences between private and sovereign default. It is not just a matter of private debtors’ assets being easier to identify and therefore sequester for the satisfaction, at least partial, of creditors’ claims, with respect to government assets — a point well made by Anne Krueger (2002a) Differences between sovereign and corporate default are much deeper.

In any country the net wealth of the state is made up of two major components: the current value of its marketable assets plus the present value of its other future revenues and expenditures. We should remember that:

First, after successive waves of privatization of state assets, even in advanced capitalist countries — let alone emerging economies and, worse, transition economies — there are hardly any gross assets in the hands of the state, that could be tapped to satisfy creditors through a bankruptcy — style procedure.

Second, the present value of government revenues and expenditures, while being subject to economic fluctuations similar to those affecting the wealth of private companies, depends strictly on the government ability to raise taxation and to contain public expenditure. Any assessment about sovereign wealth must depend on judgments about the sustainability or non — sustainability of the government fiscal stance, i.e. it must be “conditional” on the set of government policies, whether these are unilaterally adopted by the sovereign debtor or imposed by the creditors or a third party — such as the IMF — in exchange for additional finance or additional concessions.

Moreover, as mentioned only in passing in Anne Krueger’s report (2002, pp. 11 — 12) there is no question of sovereign governments being “liquidated” at all, let alone automatically, like a bankrupt corporation. Nor can creditors swap their claims for shares in the sovereign state, debt — for — equity swaps extinguishing debt altogether. And even if future fiscal revenues were nominally earmarked for debt service such commitment would not be more credible or enforceable than the underlying sovereign obligation.

It follows that the fundamental question in SDRM is not just, or not so much, a question of encouraging — through contractual or statutory means — collective action and debt restructuring by a qualified super — majority of creditors, for such an action would still require a judgment about debt sustainability and it would do nothing to uncover or determine the sovereign debtor’s ability to repay.

Is the IMF the best judge of debt sustainability? In the Russian crisis of August 1998 the IMF actually contributed to the crisis by supporting a non sustainable policy package of an overvalued ruble exchange rate, high interest rates necessary to prop it up, and a public deficit made non — sustainable precisely as a result of such high interest rates (Kolodko 2000). Is the IMF good at detecting and enhancing debtors’ ability to repay debt? Only insofar as a significant part of debtors’ capacity to service and repay debt depends on IMF funds. By its conditional support for the provision of fresh liquidity the IMF can call the shots, bringing both debtors and creditors to the negotiating table with a view to debt restructuring regardless of contractual or statutory clauses enabling collective action.

This function of providing liquidity in a crisis has been likened to a function as International Lender of Last Resort (ILLR). Apart of the hopelessly small scale of the funds commanded by the IMF relatively to the volume of emerging countries external debt (a proportion of the order of 1:15), this is a misconstruction of the relative roles of Central Banks and the IMF. A Central Bank provides 1) unlimited and 2) unconditional liquidity, 3) in the domestic currency which it issues 4) to domestic commercial banks 5) that are otherwise solvent, 6) against first class liquid assets and 7) at a penal interest rate. The IMF, on the contrary, provides 1) limited liquidity, 2) subject to conditions about macroeconomic and other policies, 3) in foreign exchange which it does not issue itself in any necessary amount 4) to national governments 5) regardless of their solvency, 6) without a counterpart (except for occasional pledging of reserves), 7) at a subsidized interest rate.

Until such a time when there is a single world currency, centrally issued and managed, commercial banks can get their liquidity from their own Central Bank or go bust. What is needed is an IMF — style agency with world — wide regulatory and surveillance functions, but — contrary to current practice — with lending functions exclusively available to solvent governments facing liquidity problems in their international payments, especially if there is a danger that non — sustainability might precipitate into insolvency.

If the regulatory and surveillance functions mentioned here are best centralized in a single, world — wide public institution like the IMF, the function of conditional lending — just before and immediately after default — can very well be shared by the private sector. Contingent credit line facilities can be provided equally by the IMF and by the private sector, with periodic disbursements being subject to verification of the stipulated conditions (as the IMF did monthly in Russia). No coordination would even be necessary between the two, except for agreements with the debtor and other creditors about a stay on legal actions by creditors and about constraints on debtor’s behavior (payments to privileged creditors, reorganization plans, etc.). The emphasis placed on private contingent credit lines by the IIF — WGCR (Working Group on Crisis Resolution) and PSAG (Private Sector Advisory Group) is fully justified.

Collective action clauses are of course desirable — as a response to the switch from syndicated bank loans prevailing in the 1980s to traded securities re — packaged into credit derivatives and re — traded among a large number of diverse creditors today. Any statutory or contractual change will still leave the problem of outstanding debt that is not subject to those new provisions. The questions remain also of possibly diverse interpretation even of uniform new provisions by the courts in different countries, the fair aggregation of diverse creditors’ claims including domestic debt — holders. Unless homogenous and universal, a collective action clause would involve a stigma for the borrower — certainly Poland would not agree to any such a clause unless it was universally compulsory.

Even if collective action clauses were statutorily imposed (as suggested by Krueger 2002) through a possibly doubtful renegotiation of the IMF Articles, the sovereign nature of the debtor would require solutions negotiated between creditors, the sovereign debtor and both the IMF and other conditional new lenders. All parties have something to gain: creditors stand to recover at least part of their claims, debtors stand to retain a better access to IMF resources and to international financial markets than with unilateral default, which is always an option — though past and recent experience shows the short or even totally lacking memory of international financial markets.

The IMF can fulfill its statutory role and new lenders — through the recognition of the higher seniority of their claims — can obtain attractive yields (if they are old lenders, they can also facilitate the recovery of the capital lent in the past). Ultimately it is this element of mutual benefit from an accommodation that will drive crisis resolution, regardless of contractual or statutory obligations difficult to enforce towards a sovereign government. Richard Portes (2002) proposes a new mediation agency independent of the IMF in the debt work out process — an attractive alternative worth exploring.

Among the open questions there remains the status of IMF and World Bank credits (and the related question of a possible conflict of interest with other creditors), the status of official debt with Paris Club lenders, the treatment of domestic debt (however defined, whether by holder nationality, location or currency of issue) and the question of domestic debt — holders representation, voting procedures and verification.

Also, we should not overlook that international financial crises are often caused and always aggravated by the very mobility of capital, i.e. the reversal of short term capital flows self — fulfilling adverse expectations (Kolodko 2002). A contribution to crisis prevention and attenuation could be made by a less favored treatment of short term capital flows (whether through a universal Tobin tax or simply differential tax treatment or capital controls). Finally, there are international financial crises that are unleashed by private sector indebtedness, which ultimately impinge on the financial position of sovereign governments (e.g. the Czech crisis of 1997) but require different safeguards and instruments (capital adequacy ratios, surveillance, etc.).

Anne O. Krueger, “A New Approach to Sovereign Restructuring” , International Monetary Fund, Washington D.C. 2002.

Anne O. Krueger, “New Approaches to Sovereign Debt Restructuring: An Update on Our Thinking” , Institute of International Economics Conference Paper, Washington DC, 1st April 2002.

Grzegorz W. Kolodko, “From Shock to Therapy. The Political Economy of Postsocialist Transformation” , Oxford University Press, Oxford — New York 2000.

Grzegorz W. Kolodko, “Globalization and Catching — up in Transition Economies” , University of Rochester Press, Rochester, NY, 2002.

Richard Portes, “Orderly Workouts Redux: New Mechanisms for Restructuring Sovereign Debt” , Centre for Economic Policy Research, London 2002.