A Contribution to an Online Discussion on Sovereign Debt Restructuring--A Letter by Thomas C. Dawson, Director, External Relations Department, IMF

February 7, 2002

A Contribution to an Online Discussion on Sovereign Debt Restructuring
Moderated by the European Network for Debt and Development
A Letter By Thomas C. Dawson
Director, External Relations Department
International Monetary Fund
February 7, 2002

Thanks to Eurodad for setting up this forum and to the various contributors for putting forward their views. As you know, we are at an early stage in the discussion of new approaches to sovereign debt restructuring, with the Fund's executive board holding its first substantive discussion of the topic next week. Ms. Krueger's speeches have outlined our current thinking (and these are available on the Fund website at www.imf.org/cgi-shl/create_x.pl?mds), but we do not yet have a detailed proposal to put to our members. Indeed, at the moment we have almost as many questions as answers, and so we look forward to hearing ideas from all interested parties in coming months on how we should proceed. Your thoughts are very helpful.

It would take up a lot of bandwidth to respond to all the points that have been raised on the forum, so let me pick up on just five:

1. The ideas discussed by Ms. Krueger focus on the problems of countries that have borrowed from the private sector, as well as from other governments and international institutions. In other words, it addresses the difficulties faced by emerging market countries rather than the poorest with no access to capital markets. The international community is tackling the debt problems of the poorest countries through the HIPC initiative. There is of course a debate over whether that initiative should be more generous or differently structured, but that is a separate question from the issue raised by Ms. Krueger.

2. Several contributors ask what if any role the Fund itself should play in a new sovereign debt restructuring mechanism. This is a complicated question, and would depend on the precise proposal that is finally put on the table.

One element of the new approach would be to decide whether a country's debts are truly unsustainable and what policies are required to stop the problem reoccurring. This is difficult enough when companies get into trouble, and even more so when countries do. Ultimately, it is a matter of judgment on which the international community needs to take a collective view, rather than leaving it to technocrats or unaccountable judges. The IMF's executive board is an appropriate body: it is representative of the international community – both debtor and creditor nations – and has appropriate expertise through its ongoing surveillance and lending activities. And, of course, the debtor country itself is represented on the board. It is worth noting that the Fund's Board has performed this role for many years. The approach suggested by Ms. Krueger would not change the Fund's role in this area.

However, in most cases the Fund will be a creditor of the country seeking help and therefore faces an apparent conflict of interest. This is true, for example, of sorting out disputes among different creditors or arranging votes on whether to accept particular debt restructuring terms. It would probably not be appropriate for the board to take decisions on these matters. Some legally ring-fenced body could be created to do the job, either inside or outside the Fund.

At the end of the day, the crucial point to remember is that the Fund would not decide the terms of any debt restructuring. In other words, neither the amount of relief the country receives nor the size of the hit the private creditors take. That is for the debtor country to sort out with its creditors. The aim of the new approach is simply to make the process of getting to an agreement easier, which should benefit both the debtor country and most of its creditors. The heart of the approach is a framework for making a restructuring that is accepted by a qualified majority of creditors binding on all creditors, not to give greater legal authority to the Fund. This would be similar to the "cram-down" mechanisms incorporated in most bankruptcy regimes.

3. A related question is whether debts owed to the Fund should be restructured along with those owed to the private sector. The key point to remember here is that the Fund is not a commercial organization seeking profitable lending opportunities. We lend at precisely the point at which the private sector is reluctant to do so – and at interest rates well below those that would be charged by private creditors. Countries that come to us for help are by definition in painful economic positions, but by lending we help them avoid having to resort to policies that would do further unnecessary harm to themselves, their private creditors, and other countries. This is a public good that benefits all concerned and it would not therefore be appropriate to lump outstanding loans to the Fund with commercial claims in a workout. To do so would limit our ability to be able to help other countries in trouble in future.

4. Some critics argue that the mechanism would reduce the amount of private capital flowing to emerging market countries. But remember that by making the process of restructuring unsustainable debts more orderly, the mechanism would help private creditors distinguish between good and bad risks. Countries with good policies should find it easier and cheaper to attract capital. Countries with weak policies might find it more difficult to obtain capital, because creditors know that the Fund will not be waiting on the sidelines to bail them out. But that would be no bad thing. It would make debt problems less likely to build up and would encourage countries to strengthen their policies. It should be recalled that nonsovereign credit markets operate within a framework for court supervised workouts, and so there is little reason to believe that an efficient mechanism for resolving sovereign debt difficulties would have a major impact on private capital flows.

5. What about the argument that the system is working perfectly well as it is? If the new approach comes to fruition, then it will alas be too late to help Argentina in its current difficulties. But Argentina is a good example of a country where underlying problems could well have been addressed earlier and in a less painful way if it had been in place. Like a toothache sufferer delaying a visit to the dentist until the last possible moment, governments frequently try to put off the inevitable. The result is that the citizens of the defaulting country experience greater hardship than they need to, and the international community has a tougher job helping pick up the pieces. In the end, unsustainable debts have to be restructured. The only question is how painfully.


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