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International Monetary Seminar, Banque de France, Remarks by Ms. Anne O. Krueger, First Deputy Managing Director, IMF
May 13, 2003
Introduction
1. Good afternoon Ladies and Gentlemen. Let me start by thanking the Banque de France for inviting me to speak at this seminar. I am sorry that I cannot be with you in person—and am unable to enjoy a visit to the Banque. Unfortunately, a range of prior commitments forces me to limit my participation at this distinguished gathering to a video hook-up.
2. The past year has witnessed a vigorous and constructive debate regarding the need to improve arrangements for the resolving of financial crises, and in particular the tools for restructuring sovereign debt. To be sure, this remains a controversial topic. But the debate has served to help define the issues, and to build understanding on possible ways to strengthen the international financial system. In particular, how to address the hopefully rare cases in which sovereign debtors and creditors must confront debt burdens that have become unsustainable. At times, however, the intensity of the discourse may have tended to mask the extent to which there has indeed been a convergence of views regarding the nature of the problem, and the desirability of taking actions to strengthen the system.
3. Today I would like to step back from the fray and look at the convergence of views on the diagnosis of the problem, and at some of the factors that will have to be part of the solution.
Importance of policies as crisis prevention tools
4. A first point on which there is general agreement concerns the importance of the sustained implementation of sound macroeconomic policies. And the critical importance of buttressing these with efforts to reduce vulnerabilities to crises. Strengthening tools for resolving crises and the debate about how to improve mechanisms for sovereign debt restructurings must never be allowed to detract from the critical need to persevere with reforms that could reduce the frequency, and mitigate the severity, of crises. In this regard, substantial progress has been made in recent years. In many respects, the world economy is now more resilient to shocks. Moves toward more flexible exchange rate regimes, strengthening of domestic financial systems (particularly through enhanced banking supervision), and rebuilding official reserves have contributed to making economies more robust and less vulnerable to crises. We should not forget that the crises in Asia, Russia, and Brazil of the late 1990s were typically associated with pegged exchange rates, a mix of monetary and fiscal policies that attracted short-term capital hoping to benefit from high domestic interest rates, and generally inadequate banking supervision. But we should not lose sight of the fact that there are a number of emerging market countries that have high debt burdens and continue to experience fiscal pressures.
5. Of course, through bilateral and multilateral surveillance, we are engaged in a continuous dialogue with our members, which focuses on the implementation of sound policies. But in recent years, the Fund has put enormous emphasis on prevention. Beyond working on strengthening macroeconomic policy frameworks, we have worked closely with our members to help them assess and manage vulnerabilities, strengthen surveillance over financial systems, and improve debt management. We have stressed the importance of remaining vigilant to developments in capital markets, re-orienting and re-designing policies where needed. For instance, it is important that financial supervision be kept in line with increased integration into global capital markets. Moreover, with the aim of improving the environment for private sector decision taking, we have promoted transparency, and have disseminated—and encouraged adherence to—standards and codes.
6. Of course, we must avoid complacency, and recognize that despite best efforts at prevention, crises will still occur. The 15 or so years since the resolution of the 1980s, debt crisis have witnessed large-scale capital flows to emerging market borrowers. But we are now moving into a period in which an increasing number of emerging markets have become mature borrowers—by which I mean countries that regained access to capital markets have allowed their debts to increase to levels at which future net borrowing needs be kept strictly in line with their growth in their payments capacity. This has a number of implications.
Resolution of financial crises
7. However, in a hopefully very limited number of cases, countries may experience rising debt or other capital account pressures—including unanticipated external shocks—which may develop into full-blown crises.
This suggests that the resolution of individual crises will need to be tailored to the diversity of situations that our members may confront.
8. In any event, there is typically at least a brief period between the recognition that a member has a building capital account or an acute debt problem and the outset of a full-blown crisis. But in such circumstances, time is the friend of neither country authorities nor private investors. Nevertheless, there is likely to be a window of opportunity for taking corrective actions that offer the prospect of resolving crises in a fashion that limits the scale of economic dislocation and preserves assets' economic value. The challenge confronting policy makers is to utilize the window, and thereby to avert an even worse outcome.
The Fund's access policy
9. The Fund, through its role both as an advisor and as a lender, will continue to play a key role in the resolution of financial crises. And so access policy—the conditions under which the Fund is willing to extend support for a member's adjustment program, and the scale of such support—will remain an important parameter in the resolution of crises. The scale of potential financing needs has increased as a result of the increasing integration of countries into the global economy, and with it the risk of abrupt changes in market sentiment and reversal of capital flows.
10. In some cases, it may be appropriate for the Fund to provide large-scale access in support of a forceful adjustment program. This would be done with the expectation that, as policies take hold and confidence builds, this support will have a catalytic effect in facilitating a return to national and international capital markets. But it would only be appropriate for consideration to be given to large-scale access to the Fund's resources in cases where:
11. In other cases, however, these conditions may not be satisfied, and so it would not be appropriate for the Fund to provide exceptional access to its resources. Accordingly, in such cases the resolution of crises must entail some form of concerted refinancing or restructuring of the claims on sovereign and/or nonsovereign debtors.
Strengthening the arrangements for resolving sovereign debt difficulties
12. Now let me turn to efforts to strengthen arrangements for resolving sovereign debt difficulties. The debate surrounding the Sovereign Debt Restructuring Mechanism (SDRM) served as a useful platform to consider avenues for improving the debt restructuring process. While we do not now have the high level of support that would be required to make the adoption of the proposed mechanism feasible, the analytic work and broad discussion has been extremely helpful in helping to develop our thinking on where the main shortcomings lie.
13. The focus of our current efforts is on promoting the inclusion of collective action clauses (CACs) in debt contracts, and, more generally, on finding ways to improve arrangements for sovereign debt restructuring within the existing legal framework.
Process of debt restructuring
14. Let me first address ways in which the process of debt restructuring could be improved. A number of commentators have highlighted, in particular, the absence of procedural clarity regarding the conduct of debtors and creditors.
15. These concerns have contributed to calls for a voluntary Code of Good Conduct. The various proposals that have emerged—including, importantly, from the Banque de France—are constructive, and could, in our view, help provide greater predictability to the restructuring process under any legal framework.
16. Recent adaptations in Fund policies could be complementary to a Code. Last year the Fund's Executive Board adopted a modification of the lending into arrears policy—the policies that govern the circumstances under which the Fund can provide financial support for a member's adjustment program during the period in which it has arrears to private creditors, and is attempting to reach agreement on a restructuring. This policy establishes expectations regarding the behavior of debtors that are receiving financial support from the Fund in such circumstances:
17. The debtor should engage in an early dialogue, which should continue until the restructuring is completed:
18. In addition, in cases in which creditors have organized a reasonably representative committee on a timely basis, there is an expectation that the member would negotiate with such a committee. Our policy suggests a number of principles that should guide the debtor's conduct during negotiations. In formulating these principles, we have drawn on the expertise of workout specialists reflected, for example, in the report by the Council on Foreign Relations (CFR), and efforts by International Federation of Insolvency Professionals (INSOL) to distill best practice for nonsovereign workouts.
Collective action difficulties
19. Let me add a few words concerning the motivation behind initiatives to promote the inclusion of CACs. An important shortcoming of the existing arrangements for the restructuring of sovereign debt relates to the failure of collective action. It complicates the process of reaching agreement on a restructuring. There is a danger that individual creditors will decline to participate in a voluntary restructuring in the hope of recovering payment on the original contractual terms, even though creditors—as a group—would be best served by agreeing to a restructuring.
20. But we should not fall into the trap of believing that default is a good solution to collective action difficulties. Of course, there is no doubt that following default, agreement on a restructuring would eventually be reached. But default—and the associated uncertainties regarding creditor-debtor relations—tends to be associated with widespread economic dislocation. Proposals for strengthening arrangements for debt restructuring are intended to increase the likelihood that early agreement can be reached on restructuring that can restore viability. They are also intended to see that neither debtors nor their creditors must bear costs that are unduly large.
21. But I am pleased to be able to say that progress is being made! I would like to take this opportunity to applaud Mexico, Brazil, and most recently, South Africa for the inclusion of CACs in their recent bond issues governed by New York law. These are very important steps. If this leads to the establishment of a new market standard, it could go a long way toward a more orderly and efficient process for debt restructurings. The Fund's role in this area is to promote the voluntary use of CACs through its surveillance, as recently mandated by the International Monetary and Financial Committee (IMFC).
Dealing with banking system crises
22. In addition to the work on improving the sovereign debt restructuring process, there is also a need to develop further our thinking on a number of other issues arising in the context of a crisis. One is how best to assist members in addressing systemic banking crises, particularly in cases in which the system is highly-dollarized, and/or cases in which systems that are highly exposed to sovereign debt.
23. With highly dollarized banking systems, issues arise regarding the extent to which liquidity assistance can be sustained in the event of a crisis, where that assistance has to be provided in a currency that the government does not have the ability to create. The inability of a central bank to serve as a credible lender of last resort in these circumstances may end up fueling a run and leading to greater economic disruption. In this context, questions may arise as to the extent to which it would be appropriate for the official sector may need to step in with additional financing to boost the central bank's lender of last resort capacity, which in turn raises several issues regarding debt sustainability and the adequacy of macro policies.
24. As the recent cases of Argentina and Uruguay illustrate, the combination of a highly dollarized banking system and a rigid exchange rate regime can result in vulnerabilities are difficult to manage. In this context, severe liquidity losses stemming from a bank run will quickly feed into a currency crisis and eventually necessitate a sharp exchange rate adjustment. The adjustment in relative prices may in turn induce an unsustainable debt profile and severe balance sheet problems in the corporate sector. These problems will be further compounded when the banking system is largely exposed to the sovereign's unsustainable debt, and as restructuring will unavoidably amount to a further deterioration in banks' balance sheets. Thus, measures to stem the effects of debt restructuring on the banking system also need to be considered in greater depth.
Conclusion
25. In conclusion, let me summarize the five key areas where there appears to be broad agreement.
Thank you very much.
1 See, for example, "A Balance Sheet Approach to Financial Crisis," by Mark Allen; Christoph Rosenberg, Christian Keller, Brad Setser; Nouriel Roubini. WP/02/210, 2002.
http://www.imf.org/external/pubs/ft/wp/2002/wp02210.pdf
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