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

The time has come to scale back the official financial support made available to errant nations, and a decision along these lines need not await improved sovereign bankruptcy procedures. As a necessary first step, the G7 should get the IMF out of the business of providing huge packages of aid measured in many multiples of a country's quota. Although re-establishing as low a relative ceiling for aid as prescribed by the IMF's founders would emasculate the Fund needlessly, the objective should be for access levels to be consistent only with the provision of seed money for economic and policy turnarounds on as objective a basis as possible. It is patently unfair that some governments should be lavished official aid, and others should be starved, when the IMF is a co-operative to which its member governments should be able to turn for fairly automatic, albeit limited, help. Scaled-back official intervention on behalf of countries in trouble will likely encourage governments and their bondholders to consider much more seriously the implications of falling into the abyss of bankruptcy--regardless of whether or not either of the current G7 initiatives ever yield some fruit.

Outlook

In sum, the U.S. Treasury has joined its G7 counterparts in giving top priority to finding ways of facilitating a bankruptcy process for heavily indebted nations, including via an expanded role for the IMF. It has done this even though recent experience does not justify it: the absence of said procedures has not impeded several landmark debt workouts; in instances when the bankruptcy option was available it has been avoided; and the existence of an orderly process would not have prevented, for instance, the debacle in Argentina. In our view, the Treasury's and IMF's persistent advocacy on this issue has started to alienate the already limited investor base for sovereign bonds that are rated below investment grade, except in the case of those countries deemed to be "protected" because they are of strategic interest to the G7 (such as Colombia and Turkey). Pushing a sovereign bankruptcy process may also encourage reform fatigue and reduced fiscal discipline in some of the weakest sovereign credits--including Ar gentina--because of the allure of an eventual "fast track" to debt forgiveness. Besides, if the real purpose behind the initiatives is to extricate the G7 countries from the big bailout business, the best way to accomplish this is by reintroducing limits to the rescue packages that the IMF is allowed to put together.

The less harmful of the options being pursued involves the voluntary adoption of collective action clauses in bond covenants, which would facilitate a renegotiation of terms and conditions should circumstances warrant it. At present, most emerging-market issuers and investors are loath to introduce such clauses for fear of signaling that they contemplate or countenance an eventual default--something akin to the chilling effect that talk of a prenuptial agreement tends to have on a marriage. In any case, even if such clauses were to be introduced voluntarily in new issues, the stock of outstanding bonds would still be governed by preexisting legal covenants, such that their practical effect would be absolutely marginal for many years to come.