To make sovereign debt restructuring smoother, not to dictate the terms -- Interview with Anne Krueger, First Deputy Managing Director, IMF

February 18, 2002

To make sovereign debt restructuring smoother, not to dictate the terms
Anne Krueger
First Deputy Managing Director
International Monetary Fund
Le Monde Economie
February 18, 2002

Français

Can you describe your proposal on restructuring sovereign debt? Is it due only to the current crisis in Argentina?

We have been motivated neither by recent events in Argentina nor by dissatisfaction with the debate on private sector involvement. Rather, we have been motivated by the lack of adequate incentives to bring countries together with their creditors to resolve unsustainable debt problems in a timely and orderly way.

Much has been done to strengthen the international financial system in recent years, but there is still considerable weakness in this area. When a country finds itself shouldering a truly unsustainable debt burden, one way or another its debts will have to be restructured. Unfortunately, governments in this position frequently try to delay the inevitable.

As well as being reluctant to confront the unavoidable political and economic disruption involved, there are daunting logistical and legal barriers. In large part this reflects the fact that countries have increasingly borrowed by issuing bonds as well as taking loans from banks, and in so doing have turned increasingly to the use of complex financial derivatives. Bondholders are more numerous and difficult to coordinate than banks. Many bond contracts also lack provisions that allow a majority to alter their financial terms, allowing free riders to hold out and sue debtors to collect their claims.

This makes it difficult to secure an agreement among creditors on a restructuring, even if almost all of them would benefit.

The fear that restructuring will be unnecessarily messy and painful unduly discourages debtor governments from starting the process. Our approach in no way seeks to make restructuring an easy option. But better incentives to encourage a debtor and its creditors to resolve these problems of their own accord would help the country get back on its feet, lay the basis for a resumption of debt servicing, and limit the depth of the crisis it faces.

Our goal is to propose a framework that will serve as a catalyst for voluntary agreements, without the need for formal activation. The formal element would potentially require dissenters to accept a restructuring agreement once it has been approved by a large majority of creditors. To maximize the value of most creditor claims and minimize the costs to the debtor, this system would offer debtor countries legal protection from their creditors while they negotiate debt restructuring. The debtor would in turn be prevented from paying out its reserves to favored or particularly litigious creditors, and would also be required to negotiate in good faith and adopt sound policies.

What would be the benefits of this new approach for the debtor countries, for the investors, and for the international financial institutions themselves?

Both the debtor country and its creditors stand to gain from the restructuring of unsustainable debts before the country has exhausted its reserves and condemned itself to a deep economic downturn. At present, the fear that these debt problems will be resolved in a disorderly way also depresses the price of a country's bonds on the secondary market when it gets into trouble. True, some investors take advantage of such situations to buy distressed debt more cheaply, but most should welcome a framework that can help maintain the value of their claims, preclude payments to favored creditors, and provide for more equitable restructuring.

This more orderly framework will also help investors distinguish between good and bad risks, and it will therefore become easier for countries with sound economic policies to borrow on the capital market. Countries with weaker policies will have greater incentive to strengthen them and will be less likely to build up unsustainable debts as a result of imprudent private sector lending. These factors should promote the strength and stability of the international financial system and move us away from a situation where debt problems have to be resolved either by hugely disruptive defaults or the bailing out of private creditors with official funds.

Your approach seems to raise the question of sovereignty, and at the same time it might put the IMF in a situation of conflict of interest, being both creditor and debtor. How do you resolve this problem?

The approach we are discussing leaves the debtor country and its creditors in the driving seat. Our aim is to make the process of reaching agreement on a necessary restructuring smoother, not to dictate the terms. The Fund has a crucial role to play as the forum through which the international community can reach a judgment on the sustainability of a country's debt and the appropriateness of its economic policies.

But there are other points—such as resolving disputes among creditors—on which our executive board could indeed face a conflict of interest. These could be entrusted to a legally ringfenced body, inside or outside the Fund.

The creation of an international bankruptcy procedure will need the approval of the whole membership of the IMF. Is this possible?

It is certainly true that any new approach to sovereign debt restructuring will have to enjoy very broad support in the international community. If we were to implement it through an amendment of the IMF's Articles of Agreement, for example, it would need the approval of three-fifths of our 183 members, together representing 85 percent of the total voting power.

Securing such a consensus will not be easy, but I believe that there is widespread dissatisfaction with the way things work at the moment and a genuine willingness to examine alternatives. Indeed, since the issue was raised last year, I have been delighted with the support we have received from a number of industrial and developing countries, plus various parts of civil society.

Your proposal and other initiatives along the same lines have been received with strong skepticism by market participants. Do you expect a change of attitude?

Views among market participants in fact vary a lot. Many recognize that the current system does not work as well as it should and that the value of their claims on emerging market countries suffers more than it needs to when those countries get into difficulties. They want a more orderly and predictable process, but also one where they can be confident that debtors will not abuse the legal protection available to them.

Some are less enthusiastic, of course, but they need to understand that the international community is not prepared to throw large sums of money at countries with unsustainable debts to ensure that their creditors are repaid. Unsustainable debts have to be restructured, one way or the other. The only question is how painfully. A more orderly process will be to almost everyone's benefit, and I think that market participants are increasingly coming round to that view.

Interview conducted by Serge Marti





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