Almost 20 years ago, Anne Krueger, then Deputy Managing Director of the IMF, proposed an institutional mechanism for restructuring sovereign debt – a global bankruptcy regime for over-indebted governments. The controversial initiative was a response to a cascade of financial collapses in emerging economies in Asia, Mexico and Argentina.
While the proposal died a quiet death, the issues it aimed to address have only grown in importance. It was just at the right time that the fund relaunched the idea. As its annual meetings approach next week, its current leader Kristalina Georgieva called for a new “international debt architecture” to allow orderly sovereign restructuring.
Well Named. The extent of the economic shock of the Covid-19 pandemic has severely weakened the often already fragile public finances of many poor and emerging countries. While welcome steps have been taken to avert immediate liquidity crises, including emergency IMF lending and suspension of debt service by creditors, the protracted nature of the pandemic means that we are only one at the beginning of the financial problems that she will leave behind.
For all but the most resilient debtors, liquidity problems tend to develop into solvency problems. For poor and emerging economies, weak public finances all too easily trigger balance of payments crises that worsen the damage to the economy, in turn leading to further decline in tax revenues. The problem is not confined to poor and middle-income countries either. As the debt crisis in the euro area has shown, even advanced economies can be threatened. Many have entered this crisis with more debt than last time.
Previous efforts at multilateral sovereign debt management reforms have failed with opposition, including from the United States, to a supranational authority. As long as this resistance is not overcome, there are other ways. Much progress has been made since the global financial crisis in designing debt contracts with “collective action clauses” – provisions that make it easier for creditors themselves to agree on lighter terms for a debtor who would otherwise have. struggling to honor the initial conditions.
After all, the rationale behind all bankruptcy proceedings is precisely this: it may also be in the interest of creditors to restructure payment obligations when changed economic circumstances make them more onerous than expected. When debts are totally unpaid, insisting on full repayment only diminishes debtors’ ability to collect – and their chance to offer creditors the best realistic return.
The functioning of financial markets also benefits from the certainty offered by a well-designed restructuring regime. IMF research suggests that “pre-emptive” restructuring is cheaper, in terms of lost production, investment and availability of capital, than waiting for a default to make it inevitable.
Building on the advantages of modern CACs offers an avenue for reform. The euro zone should complete the current update of its CACs in order to make it more difficult for the “refractories” to paralyze a majority of creditors wishing to restructure. The IMF, for its part, rightly underlines the risk of sovereign debt, which takes alternative forms to traditional bond contracts and thus escapes the reach of CACs. Much of the government-to-government debt is also hidden or owed to countries, like China, that are not part of traditional debt negotiation groups. All debt must be made public and all official creditors must join multilateral forums for debt negotiations.
Mrs Georgieva has established an interesting program for finance ministers to resolve these problems. Using next week’s meetings to make progress might soon feel like time well spent.
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