## A New Approach to Sovereign Debt Restructuring -- Address by Anne Krueger, First Deputy Managing Director, IMF

_IMF News, November 26, 2001_

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## Bibliographic details
- Published: November 26, 2001

---

### I. Introduction
- Occasion: Given at the National Economists' Club Annual Members' Dinner, American Enterprise Institute, Washington DC.
- Date: November 26, 2001.
- Central problem identified:
  - There is a "gaping hole": no mechanism to give incentives for prompt, orderly restructuring of unsustainable sovereign debts.
  - The only available mechanism currently effectively requires the international community to bail out private creditors.
- Proposal purpose:
  - Create a catalyst — a framework offering a debtor legal protection from obstructive creditors in exchange for obligations to negotiate in good faith and implement preventive policies.
  - Model analogy: domestic bankruptcy court; better thought of as an international workout mechanism.
- Timing:
  - Management and staff of the IMF are discussing the approach and plan to discuss with the Fund's Executive Board next month.
  - Even with unanimous political support, implementation would take "at least two or three years."
- No immediate implications for current negotiations (examples cited: Argentina and Turkey).

### II. Reforming the Architecture
- Context:
  - Growth of private international capital flows has benefits but increased frequency and severity of crises.
  - Affected countries have generally not retreated from global capital markets; instead they used corrective policies: "fiscal adjustment, financial sector strengthening, and more flexible exchange rate regimes."
- Crisis-prevention advances (three main elements):
  - Strengthened IMF surveillance of national economic policies and international markets.
  - Encouraged better communication between IMF, members, and private investors and lenders.
  - Created the Contingent Credit Line facility (public "seal of approval" to bolster reserves at very low cost).
- Crisis-management advances:
  - Adjustment programs now stress resolving balance-sheet problems in financial and corporate sectors as central.
  - Creation of the Supplemental Reserve Facility in 1997: advances large amounts for relatively short periods at penalty interest rates; lending requires agreement on economic policy measures.
- Constraints and moral hazard:
  - The Fund cannot print money; resources limited to quotas and borrowing agreements.
  - Reluctance of members to see resources used to bail out private creditors creates moral hazard concerns.

### III. Involving the Private Sector in Crisis Resolution
- Definition and necessity:
  - Concerted involvement: encourage private creditors to roll over commitments and limit demands for repayment during crises when private capital is unavailable.
  - When a country has a large debt, stock (not just flows) matters; refusal to roll over stock creates persistent problems.
- Differences from 1980s restructuring:
  - 1980s: commercial banks dominated, steer committees worked (approximate example: "steering committee of maybe 15 people holding perhaps 85 percent of the debt"), incentives to cooperate existed.
  - Today: bond issues have grown faster than syndicated bank loans; creditors are more numerous, anonymous, harder to coordinate; debt instruments and derivatives add complexity.
- Creditor heterogeneity and holdout problem:
  - Bondholders include opportunistic secondary-market purchasers who may seek litigation rather than cooperation.
  - Individual bondholders have greater legal leverage than banks and are less vulnerable to regulatory pressure.
- Case examples and implications:
  - Pakistan, Ukraine, Ecuador: litigation fears turned out to be unduly pessimistic.
  - Peru case: Elliott Associates bought $20m of commercial loans guaranteed by Peru in 1997; demanded full repayment instead of Brady bonds; in June 2000 obtained a judgment for $56m and an attachment order against Peruvian assets used for commercial activity in the US; Peru settled rather than be pushed into default on its Brady bonds.
  - The Peru episode highlights the power of holdout creditors and a missing element in current approaches.
- Current IMF-endorsed approach:
  - Favors voluntary, market-oriented solutions; official financing limited; encourage voluntary creditor agreements where possible.
  - Fund should be prepared to give "implicit support to a temporary standstill" (lend to a country even though it is in arrears to private creditors) if the country implements a sensible adjustment package and negotiates in good faith.
  - Implicit support does not prevent holdouts from disrupting restructuring; thus inadequate as sole incentive.
- Need for a new, formal mechanism to address holdouts and coordination failures.

### IV. A New Approach to Sovereign Debt Restructuring — Outline
- Core design concept:
  - A country could request a temporary standstill from the Fund during which it negotiates rescheduling/restructuring with creditors, with the Fund's consent.
  - Standstill likely to be "some months in duration"; debtor would have to provide assurances (e.g., temporary exchange controls) to prevent capital flight.
  - Primary objective: create incentives so indebted countries and creditors reach voluntary agreements "in the shadow of the law."
- Benefits:
  - Reduces secondary-market price drops by resolving collective action problems.
  - Outcome remains determined by debtor and creditors; holdouts restrained but final terms are negotiated by the majority of creditors.
  - Could contribute to a more stable international financial system and lead to more prudent assessment of risk by lenders and borrowers.
- Four key features the mechanism must be built on:
  - First: Prevent creditors from disrupting negotiations by seeking repayment through national courts (avoid "grab race").
  - Second: Provide creditors guarantees that the debtor will act responsibly (appropriate policies, good-faith negotiations, nonpreferential treatment).
  - Third: Encourage private lenders to provide fresh money, possibly by granting providers of new money some guarantee of repayment ahead of existing private creditors (a form of preferred creditor status).
  - Fourth: Bind minority creditors to a restructuring agreement once agreed by a large enough majority, preventing rogue creditors from leveraging attachments on assets.

### V. Practical Questions Raised (six discussed)
- First — Legal basis:
  - To restrict creditors' enforcement in national courts the mechanism must have force of law universally; laws in a few leading countries would be inadequate because creditors would use favorable jurisdictions.
- Second — Who should operate it:
  - The Fund's involvement is essential: it can judge debt sustainability, economic policies, and balance-of-payments prospects.
  - Some functions (adjudicating disputes among creditors, verifying claims, confirming voting integrity) are not well suited to the Fund's existing institutional structure.
- Third — Activation criteria:
  - Standstill activated if a debtor's request is endorsed by the Fund.
  - Fund would agree if, given limitations on official finance, the member's debt profile was unsustainable and it had little prospect of accessing private capital in the foreseeable future.
  - Formal activation may be necessary even when there is broad agreement, to bind potential holdouts.
- Fourth — Ensuring debtor discipline during protection:
  - Analogous to IMF conditionality: standstill could be endorsed for limited periods and renewed following reviews of policies and creditor relations.
  - A maximum period for the stay beyond which continued protection would require approval of a required majority of creditors would encourage good-faith negotiation.
- Fifth — Scope of Fund financing:
  - After restructuring, Fund financing should be limited to amounts necessary to rebuild reserves and pay for essential services and imports.
  - "There should be no extra support to help finance payments to creditors on the restructured debt."
- Sixth — Types of debt covered:
  - Complex issues include sovereign debt owed to domestic residents and foreign debts owed by domestic residents other than the sovereign.
  - Reasons to include sovereign domestic debt:
    - Balance-of-payments problems can arise from flight of domestic investors in absence of capital controls.
    - Domestic debt may impose an unsustainable fiscal burden as crises depress activity.
    - External creditors less likely to accept reductions if domestic investors are repaid in full.
  - Treatment of foreign debts owed by nonsovereign residents:
    - Exchange controls can prevent companies from paying overseas creditors, exposing them to litigation.
    - Alternative: extend legal protection to these enterprises if they place payments they would have made into escrow accounts to be paid once exchange controls are lifted and the stay is terminated.

### VI. Conclusion — Incentives and Political Dimension
- Incentives for debtor countries:
  - The approach would reduce restructuring costs and encourage earlier restructuring when debts are unsustainable.
  - It would not make restructuring an "easy option"; severe economic costs and risks to the banking system remain.
- Incentives for creditors:
  - May appear unattractive if they prefer bailouts, but official financing is limited.
  - The real choice is between orderly restructuring and disorderly restructuring; most creditors prefer the certainty of orderly processes.
  - Secondary-market values of claims are likely to be better preserved under an orderly framework.
- Overall promise:
  - The proposed approach offers a "fairer and more efficient process" that encourages prompt, orderly resolution of unsustainable debts, improving both crisis prevention and crisis management.
- Political imponderable:
  - Whether members are prepared to constrain their citizens' ability to pursue foreign governments through national courts in exchange for a more stable international economy is ultimately a political decision for member countries.

*Address by Anne Krueger, First Deputy Managing Director, International Monetary Fund, Given at the National Economists' Club Annual Members' Dinner, American Enterprise Institute, Washington DC. November 26, 2001.*

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## References

- [Peru and the IMF](http://www.imf.org/external/country/PER/index.htm)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp112601_