Public Information Notice: IMF Executive Board Discusses Involving the Private Sector in the Resolution of Financial Crisis
September 19, 2000
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On September 5, 2000, the Executive Board discussed Involving the Private Sector in the Resolution of Financial Crises — Status Report and Standstills: Preliminary Considerations. Following is the summing up of the discussion by the Chairman of the Executive Board. The staff paper on which the discussions were based will be posted on the IMF website shortly.
Executive Board Assessment
Executive Directors agreed that good progress has been made in developing a framework for involving the private sector in forestalling and resolving financial crises, and welcomed the convergence of views on many topics evident in the discussion. They agreed that valuable experience has been gained with securing the involvement of the private sector in the resolution of individual cases, with lessons learned by debtors, private creditors, and the official sector. This experience has highlighted the strengths, as well as the limitations, of the tools currently available to the international community for securing concerted private sector involvement. Notwithstanding the recent progress, Directors concurred that more needs to be done to operationalize policies in this area, in order to strike the right balance between the clarity needed to guide market expectations, and operational flexibility anchored in a clear set of principles needed to allow the most effective response to each crisis situation. They also considered it important that the official sector discuss the implications of the emerging framework openly with the private sector and, in this connection, welcomed the recent establishment of the Capital Markets Consultative Group. In this context, Directors welcomed the Managing Director’s statement and his intention, based on the discussion, to report to the IMFC.
Directors stressed that prevention remains the first line of defense against a financial crisis. They noted that the adoption of consistent macroeconomic and exchange rate policies, sound debt management, and effective supervision over financial systems are all critical elements of a policy framework designed to manage and reduce vulnerabilities and the frequency and severity of crises. Directors emphasized that the primary tool available to the Fund in support of prevention is surveillance. They noted that, beyond the traditional policy areas, surveillance is now focusing on improving the environment for private sector decision-making through measures to improve the transparency of members’ policies, the development and strengthening of standards, and the assessment and reduction of members’ vulnerability to financial crises. Directors emphasized the value to borrowing countries of establishing regular procedures for a dialogue with their private creditors. They called on the staff to follow up on this matter in Article IV consultation discussions with emerging market countries, and to report back to the Board on progress in this area.
Resolving Balance of Payments Difficulties
Directors agreed that, despite the adoption of preventive measures, members may at times face serious stresses in their external accounts. In some cases, a member may be able to address these stresses through the prompt adoption of corrective measures without financial support from the official community. In other cases, a member may complement the adoption of corrective measures with an arrangement with the Fund. In yet other cases, the difficulty in financing its external accounts may become severe, and the member may face a loss of access to international capital markets, at least on terms broadly consistent with a return to external viability and sustainable growth. In such circumstances, the member needs to work with all its creditors to ensure continued financing. However, Directors noted that if this is not successful, concerted private sector involvement may be required to achieve an orderly resolution of the crisis.
Directors agreed that, under the suggested framework for involving the private sector, the Fund’s approach would need to be a flexible one, and the complex issues involved would require the exercise of considerable judgment. They called on the staff, in bringing program documentation to the Board, to be clear about the financing that is expected to come from the private sector for the member’s program. In cases where the member’s financing needs are relatively small or where, despite large financing needs, the member has good prospects of regaining market access in the near future, the combination of strong adjustment policies and Fund support should be expected to catalyze private sector involvement. In other cases, however, when an early restoration of market access on terms consistent with medium-term external sustainability is judged to be unrealistic, or where the debt burden is unsustainable, more concerted support from private creditors may be necessary, possibly including debt restructuring. Directors agreed that the assessment of a member’s prospects for regaining access to international capital markets in the near future was a critical element of the framework. They broadly agreed on the factors that would be relevant to making this judgment; these include the characteristics of the member’s economy, including the profile of debt service and debt stock, and the strength of the fiscal accounts and the financial system; previous levels of market access and market indicators; the strength of macroeconomic and structural policies; the authorities’ commitment to sustain the implementation of the reform program; the level of reserves and availability of financing; and the stage of the crisis and experience with creditor-debtor relations. Directors called on the staff to continue its work on the analytic issues involved, with a view to strengthening the ability to assess both the pace and magnitude of a resumption of market access by countries emerging from crisis.
A number of Directors favored linking a strong presumption of a requirement for concerted private sector involvement to the level of the member’s access to Fund resources. These Directors noted that a rules-based approach would give more predictability to the suggested framework for private sector involvement, while limiting the risk that large-scale financing could be used to allow the private sector to exit. Many other Directors, however, stressed that the introduction of a threshold level of access to Fund resources, above which concerted private sector involvement would be automatically required, could in some cases hinder the resumption of market access for a member with good prospects for the successful use of the catalytic approach to securing private sector involvement. They also noted that a trigger of this sort could increase the volatility of international capital markets at a time of tension. Some Directors pointed to the presumption of continued private sector involvement in financing the balance of payments of members drawing on the Supplementary Reserve Facility.
While there remain differences among Directors, I believe, nevertheless, that there has been welcome progress toward a convergence of views concerning the circumstances in which the use of Fund resources would be conditioned on action to secure private sector involvement. All Directors agreed that Fund operations should, to the extent possible, limit moral hazard, and that the availability of Fund financing is limited. Directors also agreed that reliance on the catalytic approach at high levels of access presumed substantial justification, both in terms of its likely effectiveness and of the risks of alternative approaches.
Directors acknowledged that the range of tools available to assure a reasonably orderly and timely involvement of the private sector was limited. Most Directors stressed the importance of promoting the use of existing tools, including through the introduction of collective action clauses in international sovereign bonds issued by both industrial and emerging market members, and the use of contingent lines of credit. Directors noted that, in some cases, it may be possible to reach collaborative agreements with banks and other specific creditors for the maintenance of exposure or agreements on the restructuring of international sovereign bonds. In other cases, however, it may not be possible to contain capital outflows without using additional measures, the possible negative effects of which on the country itself, and on other countries, would need to be considered.
Directors encouraged the staff to examine issues concerning the process of debt restructuring and the relative treatment of different types of debt against the background of the principle that no one category of private debt should be regarded as inherently senior relative to others in a similar position. Some Directors noted that the treatment of sovereign bonds in a restructuring compared with other types of long-term credits, including the claims of Paris Club and other official bilateral creditors, required further consideration. Directors noted that decisions adopted in this area could affect the willingness of long-term private investors to hold emerging market sovereign debt.
Directors welcomed the opportunity to have a preliminary discussion of issues associated with the possible use of standstills, and considered the staff paper to be very helpful as a first step. They noted that, as there is little empirical evidence concerning the effects of standstills, the staff’s analysis and this discussion were inevitably somewhat speculative. Directors noted that the term “standstill” covers a range of techniques for reducing net payment of debt service or net outflows of capital after a country has lost spontaneous access to international capital markets. These range from voluntary arrangements with creditors limiting net outflows of capital, to various concerted means of achieving this objective.
Directors agreed that, when creditors are reasonably homogenous and have an interest in maintaining a long-term relationship with the borrower, voluntary agreements to contain private capital outflows may be feasible. This might be the case when exposure is predominantly due to commercial banks or suppliers, particularly if these creditors are satisfied that their commercial interests would be protected through a standstill. They concluded that, since the interests of nonbank investors who hold sovereign claims tend to be less homogeneous, it may be more difficult to secure agreement on voluntary standstills when payments due on such indebtedness are significant.
Directors underscored that the approach to crisis resolution must not undermine the obligation of countries to meet their debt in full and on time. Nevertheless, they noted that, in extreme circumstances, if it is not feasible to reach agreement on a voluntary standstill, members may find it necessary, as a last resort, to impose one unilaterally. Directors noted that, while a standstill limited to payments on sovereign obligations might be sufficient to stabilize the balance of payments, there could be a risk that this action would trigger capital outflows. They recognized that if a tightening of financial policies and appropriate exchange rate flexibility were not successful in stanching such outflows, a member would need to consider whether it might be necessary to resort to the introduction of more comprehensive exchange or capital controls. More generally, Directors recognized that exchange or capital controls would need to be tailored to the specific characteristics of the individual member, with the feasibility of imposing controls rapidly depending upon the existence of an established control infrastructure. All Directors emphasized that controls were no substitute for strong adjustment policies and should be considered only in exceptional circumstances.
Some Directors thought that, in some circumstances, a standstill could serve the best interests of both the member and its creditors; even so, they stressed that, as a general rule, a standstill should be maintained for the shortest possible period. These Directors noted that a standstill may be a useful tool for halting runs and could provide a breathing space to enable a member to put in place corrective policies, and—if necessary—to negotiate a restructuring agreement that would help pave the way toward a return to medium-term viability. Some Directors noted that bond exchanges had successfully followed some recent standstills. Many Directors, however, warned that the threat of a standstill could precipitate outflows and thus be destabilizing.
Some Directors noted that the use of standstills could cause concern about debtor moral hazard. Other Directors considered, however, that a compulsory standstill would still impose such significant costs on the member, including in the form of lost output, that the argument was not compelling. Directors stressed that the rights of creditors needed to be protected in a standstill.
Directors stressed that the imposition of a standstill by one systemically important country could lead to substantial spillover effects on the external accounts of other emerging market countries. They noted, however, that the strength and duration of these effects would depend on circumstances in the international capital markets and the relative importance of the transmission mechanisms, which are likely to vary over time.
Directors agreed that the impact of the imposition of a standstill in the medium term would depend on both the nature of the standstill and the risk preferences of investors. The imposition of exchange or capital controls is likely to reduce the availability of private capital over the medium term, because of the re-evaluation by both domestic and foreign investors of the extent of default and transfer risk. However, to the extent that the corrective policies adopted by a country and the extent of its cooperation with creditors indicate that the future resort to a standstill would be less likely, this effect may dissipate over time.
Most Directors considered that the appropriate mechanism for signaling the Fund’s acceptance of a standstill imposed by a member was through a decision for the Fund to lend into arrears to private creditors. Under the established policy, the Fund can lend in such circumstances when it is essential for the success of the member’s adjustment program, and the member is making a good-faith effort to reach orderly agreement with its creditors. Some Directors favored an amendment to Article VIII Section 2(b) that would allow the Fund to provide a member with some protection against the risk of litigation through a temporary stay on creditor litigation. Other Directors did not favor such an approach, and noted that in recent cases, members’ ability to reach cooperative agreements with private creditors had not been hampered by litigation. Irrespective of the actual mechanism applied, some Directors considered that Fund support of standstills could help reduce financing costs by assuring creditors that standstills are being implemented as part of an orderly and comprehensive approach to crisis resolution. These Directors were of the view that greater clarity and predictability in this area could lead to more stable capital flows to emerging markets. Other Directors expressed a concern that Fund endorsement of standstills could increase the price and reduce the availability of private capital flows to emerging market economies.
Some Directors noted that a clear framework for the circumstances in which a standstill would be invoked could encourage capital markets to limit the build-up of vulnerabilities. On the other hand, some Directors noted that a move toward a clearer framework for imposing a standstill could provide an incentive for creditors to position themselves to be the first to exit through a shortening of maturities of their instruments. Investors may also develop complex financial structures that could frustrate the efforts to impose a standstill.
Directors noted that the complex operational issues that standstills raise warranted further consideration.
In sum, I believe that Directors agree that these staff papers and the discussion, which draw on our recent experience and build on the guidelines provided to us in the April IMFC Communiqué, represent a very useful step toward the refinement of our strategy for private sector involvement.
This discussion has also highlighted a number of areas in which further work is required. In the period ahead, our work program in this area will include:
- The promotion of a constructive dialogue between members and their creditors.
- The strengthening of the basis for assessments of the pace and magnitude at which countries in crisis can regain market access.
- The strengthening of the basis for assessments of medium-term viability, and whether or not there is a need for debt restructuring.
- Further work on debt restructuring, and in particular, the relation between the treatment of Paris Club and private sector claims.
- Further work on assessing the extent of moral hazard.