A Critique of sovereign bankruptcy initiatives: the IMF and G7 should curb financial assistance to countries in trouble

Business Economics, Jan, 2003 by Arturo C. Porzecanski

Top International Monetary Fund (IMF) and U.S. Treasury officials have put forth proposals designed to make it eventually easier for governments and bondholders to go through a debt-workout process. Their intent is to enable the C7 governments to scale back their multi-billion-dollar bailout programs for countries in financial difficulty on the theory that, if the road to default was paved rather than bumpy, more of them would choose to take it rather than seek large-scale financial support. Experience strongly suggests, however that the absence of better bankruptcy procedures has not impeded several debt workouts; that in cases when the bankruptcy option was available, it was nevertheless avoided; and that even if the IMF and Treasury initiatives had been in place in 2001, the tragedy in Argentina would not have been prevented. The best way for the G7 and the IMF to extricate themselves from the current morass is by curbing sharply the financial help that they offer to countries in trouble.

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During the past year-and-a-half, policymakers in Washington and other G7 capitals have been advocating that the functioning of the world's financial markets must be improved by making it easier for insolvent governments, especially in the "emerging" markets, to obtain debt relief from their bondholders. Two high officials appointed in late 2001 have made this project their top priority: Anne Krueger, First Deputy Managing director of the IMF, and John Taylor, Under Secretary for International Affairs at the U.S. Treasury. In fact, the IMF's supervisory committee (the IMFC) has instructed the Fund's management to come up with a concrete plan for a statutory mechanism to facilitate the bankruptcy of nations by April 2003.

Official rationale and proposals

The IMF's rationale for this plan was summarized in a press release April 2002, issued after two days of Executive Board discussions on sovereign debt restructuring: "An important shortcoming in the international financial system is the absence of a framework for the predictable and orderly restructuring of sovereign debts.... The upshot... is that debt restructuring is often delayed, prolonged and disorderly, depleting asset values of creditors and imposing severe hardship on the debtor country. This is damaging not only to the debtor and its creditors, but it is also disruptive to international capital markets and to the trading partners of the debtor country." (l)

According to a speech delivered by Krueger at the time, encouraging the orderly and timely restructuring of unsustainable sovereign debts would have several benefits: help private investors distinguish between good and bad risks, help countries with good policies attract capital more cheaply, and help prevent countries with weak policies from building up excessive debts that might leave them vulnerable to a major crisis. (2) All in all, she said, facilitating sovereign debt restructurings "would result in a better allocation of global capital and make the international financial system stronger, more efficient and more stable."

Treasury Under Secretary Taylor, for his part, argued in a presentation given contemporaneously that: "A more predictable sovereign debt restructuring process for countries that reach unsustainable debt positions would help reduce... uncertainty. It would lead to better, more timely decisions, reducing the likelihood of crises occurring and mitigating crises that do occur." (3) But Taylor was much more forthcoming about why the G7 governments are so keen on lubricating the world's financial system by improving sovereign bankruptcy procedures: "Limiting official sector support when countries reach unsustainable debt situations is also a key element of our emerging markets strategy. . . . The uncertainty that currently exists leads to pressures for large [official] support packages. Reducing this uncertainty will reduce such pressures." In other words, by facilitating sovereign defaults on bonded debt and negotiations on the postponement of interest payments and the forgiveness of principal obligations, the G7 and the IMF will no longer need to put together large packages of official support for presumably insolvent governments.

Krueger's earliest proposal (November 2001) called for the amendment of relevant legislation in all countries to permit qualified majorities of bondholders to restructure all new sovereign bond issues under the aegis of the IMF. It contemplated that debtor governments could appeal to the Fund for a temporary stay on debt-service payments and that the IMF would play the role of a benign bankruptcy judge, managing the process whereby a restructuring proposal is negotiated that would be binding on all bondholders. Since none of the abrogation of bondholder rights is envisioned under any current national laws, particularly in the jurisdictions of choice to issuers and investors (New York State and the UK), the proposal would have required uniform amendments to all domestic legislation. Whatever the inherent justification and merits of this proposal, it was--to say the least--exceedingly impractical.