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

To begin with, the governments of Ecuador, Pakistan, Russia, and the Ukraine have all been able to restructure their bonded debt in recent years, without recourse to or even in the absence of collective-action clauses--never mind favorable legislation at the national or international level. Substantial debt-service relief and even sizeable debt forgiveness were obtained through the use of exchange offers, sometimes accompanied by so-called exit consents that encouraged the participation of as many investors as possible in take-it-or-leave-it settlements. In the case of Romania, the original cash flow and private-sector involvement objectives were attained via the placement of a new bond issue rather than a potentially traumatic restructuring of past obligations. Experience has demonstrated that neither the threat of litigation nor actual cases of litigation have obstructed these various emergency financial operations. Although it is true that one lone creditor was able to use the New York and Brussels courts to collect payment from a formerly bankrupt government (Elliott Associates vs. Peru in 2000), the amount involved was relatively small, the favorable judgments took years to be obtained, the government would have been likely to prevail upon appeal, and most importantly the country's debt restructuring under the Brady plan was neither obstructed nor invalidated.

Beyond this experience from the recent past, it would behoove the G7 governments to ponder whether the recent tragedy in Argentina would have been avoided if either the Krueger or Taylor approaches to sovereign bankruptcy had been in place in 2001. It is possible that the G7 governments would have slammed the door on Argentina earlier than in the final two months of that year: they might have refused to put together a medium-size package of financial support in late 2000 or might have refused to augment it modestly in August 2001 if an elegant sovereign bankruptcy mechanism had been available. Yet, the absence of a smooth debt-restructuring process did not stop G7 officials from slamming the door on Russia in mid-1998, despite potentially catastrophic worldwide economic consequences. It did not stop the G7 from forcing unwilling Ecuador (in 1999) into the first-ever default on Brady bonds and the first-ever default on sovereign Eurobonds issued in the second half of the twentieth century. It did not stop the G7 governments from insisting that Indonesia, Pakistan, and the Ukraine restructure their obligations to bondholders or commercial banks (falling due in 1999-2002) to obtain IMF financial support or debt relief from official creditors via the so-called Paris Club.

Similarly, it is possible that the Argentine authorities would have decided to declare a moratorium on debt payments much earlier than in December 2001 if they had had greater certainty about the bankruptcy process. Yet, the final outcome--an economic depression--would have been exactly the same. Since a substantial proportion of the Argentine government's debt obligations were held by local banks, pension funds, and insurance companies, any announcement of a payments stand-still with the intention to seek massive debt forgiveness would have triggered a stampede of bank depositors and a collapse of the pension and insurance industries. This would have led to a run on the central bank's official reserves, precipitating a devastating currency devaluation and thus the same economic implosion, political fallout and popular discontent that we witnessed in 2002. The only difference is that it would all have unfolded several months earlier, with no benefit accruing to anyone--except the G7 and the IMF, which would s urely not have made the eleventh-hour disbursement they made in September 2001. But then, they might have been more generous with Argentina earlier on.