A PIECE OF INTERNATIONAL FINANCIAL

ARCHITECTURE IS STILL MISSING:

Why We Need More Work on a Sovereign Insolvency Mechanism

 Barry Herman

Statement at Congressional Briefing on Sovereign Debt of Developing Countries

United States Capitol, Washington, DC

November 6, 2013

In different spurts of activity over more than one hundred years, important governments have come together to devise processes for cooperatively dealing with sovereign defaults. The current approach to resolving sovereign debt crises is breaking down, while countries continue to slip into debt crises. It is time now to make another effort to devise an international debt workout mechanism.

 Under United States leadership, the Hague Conventions of 1907 introduced an arbitration alternative to European “gunboat diplomacy” in the Americas. In “gunboat diplomacy” some governments had helped their bondholding investors collect on defaulted sovereign debts by blockading ports and collecting customs duties on behalf of the bondholders (e.g., Britain, Germany and Italy blockaded Venezuelan ports in 1902). Arbitration was indeed used to settle disputes in a number of cases, notably a 1923 case in which Great Britain sought payment from Costa Rica for obligations incurred by a previous regime (Tinoco); the arbitrator was William Howard Taft, then Chief Justice of the United States Supreme Court.

 Arbitration was not the only sovereign insolvency mechanism. The Group of 8 major powers developed an initiative for debt relief for a group of heavily indebted poor countries (HIPCs). It was implemented starting in 1996 by the International Monetary Fund and the World Bank. The HIPCs were mainly indebted to other government and multilateral creditors, but also to private creditors, mainly banks. Although the HIPC relief process had to be amended a number of times, it ultimately wiped out virtually all the foreign debt obligations those countries had accumulated. Additional international mechanisms have been considered by governments at one time or another but not agreed, such as at the 1933 Pan American Conference in Montevideo and at the International Monetary Fund in 2001-2003 (“Sovereign Debt Restructuring Mechanism”).

 In my view, and I think in the view of a growing number of observers as well, it is time to try again. The reason to make such an effort is twofold. First, countries still fall into painful sovereign debt crises, and not only developing countries, as Greece showed. Second, the existing means for resolving sovereign debt crises are increasingly unsatisfactory. Ultimately, sovereign debt crises are resolved, but not necessarily in a timely, effective or fair way. Let me address these reasons in turn.

 The state of developing country debt

 While many developing countries have learned from past crises and have managed their external debt situations successfully in recent years, other countries have not been so successful or lucky. In the latter countries, whether buffeted by natural catastrophes like hurricanes or loss of earnings from disappointing export-oriented industries, such as tourism, or unfortunate policy management, as highlighted by Greece, the poor and working people in the countries pay for it.

 The logic of visiting deprivation on the local people in a sovereign debt crisis is easy to understand. It is every politician’s priority not to fail and that means not to have to recognize when insolvency has arrived under his or her leadership. So, the government of a State facing an impending debt crisis will squeeze funds out of the budget for continued debt servicing as long as possible, usually at the expense of the poor, who do not have a strong lobbying voice in making national policy. As creditors become increasingly nervous, they charge higher and higher interest rates on loans of shorter and shorter maturity until the game is up. Credit is then cut off and the government defaults.

 The country then usually comes to the IMF, which represents the international community in this regard, and seeks to dig itself out of the hole in which it finds itself. An excessive debt build-up results from excessive government budget deficits. That is just arithmetic. The only solution when your creditors will no longer lend is to shrink the deficit. But, the policy question is “how fast?” Quick deficit contraction only worsens the economic situation in the country, as total demand will perforce shrink, reducing output, income and jobs. IMF and sometimes other institutions and some governments will help by lending to a government in arrears to its foreign creditors. This prevents the deficit having to drop virtually to zero almost immediately. However, IMF and the other official creditors rarely lend in amounts sufficient to protect the poor from the hardships imposed by the initial loss of credit or to bring unemployed people back into the productive economy. The outcome is inevitably reduced income and employment, reduced tax revenue and a disappointing reduction in the deficit, especially measured as a percentage of gross domestic product.

 I hope major country policy makers do not emphasize austerity as the proper first response to a debt crisis because they think that somehow suffering is ennobling. I hope that the citizens of the debt-crisis country are not meant to be punished for their government’s failure to avoid default. I do know that IMF Staff have publicly had second thoughts about how tightly they have turned the austerity screws in some cases. When government debts are too high to be sustained, they have to be reduced and the burden of reducing the debt has to be shared in some proportion between the people of the indebted country and the creditors, or at least some of them. Usually, a disproportionate share of the burden (and sometimes all of it) is placed on the local population.

 Is this a theoretical argument? I do not think the people of Greece think so, nor the people of Belize, nor Grenada, nor Jamaica, nor St. Kitts and Nevis, each of which sought to restructure its government debt in 2012-2013. Moreover, there are other countries at risk. The IMF, in collaboration with the World Bank, prepares a monthly update of estimates of the sustainability of the external debt situations of the group of mainly low-income countries that are eligible to draw loans from a concessional “window” at IMF (the Poverty Reduction and Growth Facility). The most recent update on the Fund’s website is dated October 3, 2013. It classifies 15 countries as at “high risk of debt distress” (or already in debt distress for two of the cases, Sudan and Zimbabwe). It also reports that 29 countries are at “moderate risk” of debt distress. These figures are too high.

 Disappointing recent debt workouts

 Probably the most frustration experienced by members of the global creditor community has been in the treatment of the debt of Greece. Most likely, the losses imposed on the bondholders could have been lower had the 2012 debt workout instead taken place in 2010 when there was less debt to restructure. However, the official creditors of Greece should also be disappointed. To some measure their lending to Greece paid for the exit of private creditors who could cash in their maturing bonds at face value pre-default. I am not expert enough to say if Greek debt restructuring is now done or whether another round will be needed, but by all accounts the debt burden remains extremely high and economic recovery has yet to take hold. In short, one would be hard pressed to say the current process for sovereign debt crisis workouts has succeeded in Greece.

 How about the debt workouts in the Caribbean? Actually, Grenada had defaulted nine years before. Belize had defaulted six years before its latest crisis in 2012. And Jamaica’s 2013 default took place only three years since its last debt crisis. It seems easy to infer that these countries exited from their previous debt crises with too much debt still on their books. Creditors in those first rounds apparently received too sweet a deal. That is another indication that the existing debt workout processes are not working well enough.

 Finally, there is the case in the New York courts involving the effort of certain Argentine bondholders to collect the face value of the bonds they hold after over 90 percent of the other bondholders accepted to swap their original bonds for lower-valued bonds. No one doubts that Argentina needed to severely reduce its debt obligations when it defaulted at the end of 2001. The problem now in the courts is in part one of inter-creditor equity. The hedge funds suing Argentina claim it is depriving them of their “creditor rights” to full repayment. However, theirs is a strange argument. On the one hand, Argentina can afford to pay off these aggressive and speculative hedge funds because the other creditors took their losses earlier. On the other hand, it seems that the way the hedge funds would take their payment if it were made is out of the funds that Argentina would send through international commercial banks to service its current bonds. One might judge that the creditors who took the exchange that Argentina offered in 2004 and again in 2010 would have a higher order claim to repayment. But that is an ethical argument and one does not look to Wall Street to watch principles of equity in action.

 My point is not to delve into the details of the Argentine case but only to cite it as evidence that the debt workout processes at hand today are not fair to creditors, let alone the debtor. I cite the Caribbean cases to show that the workouts are not effective, as those countries should not have had to return for additional relief, in one case after only three years. And as the Greek case demonstrates, the workout processes do not deliver a timely resolution of the problem.

 Who will take the first step to debt workout reform?

 I do not want to argue here for any particular debt workout reform proposal. There are many of them. In a book I co-edited with José Antonio Ocampo and Shari Spiegel, we reviewed quite a few of them (Overcoming Developing Country Debt Crises, Oxford, 2010). One that we discussed, a kind of mediation service, is being revised and revived by its author, Richard Gitlin, in Canada at the Center for International Governance Innovation (CIGI). The IMF itself has returned to the subject in certain papers by the staff, which the Executive Board discussed last May. And the United Nations both in New York (Department of Economic and Social Affairs) and in Geneva (United Nations Conference on Trade and Development) is working at the expert level on prospective debt workout reforms. Jubilee, of course, has been a proponent of an international debt tribunal for well over a decade, as have other debt campaigners in developing and developed countries.

 The need at this time, rather, is to send a political signal that there is good reason to think again about reform of the way sovereign debt workouts take place. It is time to encourage international organizations, government officials and academic policy analysts to take up the matter and work toward a solution. The status quo is just not good enough.

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  1.  Recent political developments

           a.    global

  • Heat is up in the IMF

As a consequence of its failure to provide sustainable debt relief in the case of Greece the IMF finally seems to take the need for reform seriously. After the publication of a major paper by a working group at the Brookings Institution, which called for the establishment of a compulsory redebt restructring scheme under the IMF Article’s of Agreement binding power (see below), the Fund now seems set to not let itself be dragged into another round of crisis financing. The Brookings proposal of binding any fresh financing from the IMF for a debtor in (potential) distress to an obligatory debt restructuring, seems to be the baseline of anything the Fund leadership will be prepared to accept in the future. See an article in last Tuesday’s New York Times, including the links to reports about recent experts meetings: http://www.nytimes.com/2013/11/27/business/international/imf-plan-for-next-crisis-would-split-the-bill.html?_r=0

  • UNCTAD Sovereign Debt Workout Mechanism Experts Group

The next experts group meeting will take place on Jan. 12th in Geneva. Bodo Ellmers of EURODAD and Aldo Caliari of the Washington-based Center of Concern will represent the NGO community.

       b.    regional

  • Two governments, which have been supportive of a fair debt workout mechanism through the last years have been voted out of office in last month’s elections in Norway and Germany. Norway continues to be committed to debt relief as an aim of its development policy. In Germany efforts by like-minded parliamentarians to put a commitment towards a sovereign debt workout mechanism into the coalition treaty, were lost between the millstones of conservative and Social Democrat party politicking.
  • The final rejection by the US Supreme Court to re-hear the Argentine/NML case may jeopardize sovereign debt management as it is. Find JubileeUSA’s comment on the case, including links to various amici briefs here. At a recent EURODAD debt strategy meeting particpants wondered, whether this defeat for Argentina may turn out to become a blessing in disguise, as it makes the need for a comprehensive process based on legal security and the rule of law even more obvious. The appeals court judge went a long way to express that Argentina would not set any precedence at all. Like ourselves, private investors who already discuss follow-up cases in their internet fora, do not seem convinced.
  • The Conference of Churches in Grenada organised a workshop last week on debt sustainability, which was attended by the Ministers of the Economy and other cabinet members, the IMF, UNDP, JubileeUSA, the co-ordinator of the incipient Caribbean Debt Network and erlassjahr.de. Below is the short final declaration, which summarizes the process quite well.

The Conference of Churches in Grenada, its local and international partners, met with Minister Oliver Joseph and members of the government on 1-2 October 2013 to discuss the country’s urgent debt situation. The workshop welcomed the participation of Grenada Civil Society Organisation, the Caribbean Debt Network, Jubilee Germany, Jubilee USA and the United Nations Development Programme.

The Conference of Churches in Grenada emphasises the importance of a people-centred resolution to the debt crisis.

We make the following recommendations to the Government of Grenada:

  1. We urge the government to push for a reduction in Grenada’s debt stock to a maximum level of 50% of GDP due to the harmful effects of debt above this level on economic growth. This will require, in practice, an upfront debt stock reduction of approximately two-thirds. It is essential that debt restructuring in Grenada restore long-term debt sustainability and support a return to economic growth.
  2. The debt restructuring process should involve all external creditors, namely commercial, multilateral and bilateral. This will ensure fairness between creditors and mean that each creditor is subject to a lower ‘haircut’ on its claims. This will also be an incentive for all creditors to take part. We encourage the government to explore options for a comprehensive solution. These include an independent debt sustainability assessment, external mediation and a creditors’ conference.
  3. We appreciate that the government wishes to resolve the current debt situation in a timely manner and secure access to new sources of external finance to meet the country’s needs. This is likely to involve an IMF-supported economic adjustment programme. Before the government signs any programme, it must seek consensus with the people on the package of reform measures the country will undertake. This will ensure that the programme respects the priorities of the local people. We therefore insist that the government share all documents with the Committee of Social Partners and the public with ample time for review and debate before any agreements are signed
  4. Looking forward, it will be essential for Grenada to reduce the risk of future debt crises. We insist that the government strengthen legal and administrative structures to ensure greater transparency, accountability and participation. Specifically, we insist that the government commits to a mechanism which monitors and evaluates new debt commitments. This mechanism must involve the social partners. There is also a need to improve debt management capacities. These reforms will help put in place the tools to reduce the risk of future debt crises.

________________________________________________________

Rev. Dr. R. Osbert James – Chairman, Conference of Churches in Grenada

 

  • Upon a parliamentary initiative by a liberal Swiss MP, the Helvetian government has published a report on the desirability and feasibility of a sovereign debt workout mechanism. The desirability is being acknowledged, but the feasibility is considered questionable by the government. The sponsoring MP is not happy with the report, nor are members of Alliancsud of Swiss NGOs. A parliamentary hearing in the little chamber’s Foreign Affairs commission is therefore being organized (probably on Jan. 21st in Berne).

 

Upcoming events

  • CIGI proposal’s Co-author Brett House is touring capitals in order to promote the proposal he has produced together with Richard Gitlin. A one-day seminar in Berlin organized by weed, Bread for the World, erlassjahr.de and the Heinrich Boell Foundation on either January 22nd or 23rd will be open to everybody, who is interested in joining us for the presentation and subsequent discussions with local parliamentarians and ministry officials. Invitations are to be sent out shortly. For further info contact: Eva Hanfstängl at: eva.hanfstaengl@brot-fuer-die-welt.de
  • FTAP Conference Call. If you have not yet participated in the monthly Euro IFI conference calls, but would like to be part of the information exchange and contribute wisdom as well as questions, please E-mail Kristina Rehbein at k.rehbein@erlassjahr.de and find yourself invited to the next doodle.

 

New reading stuff

  • The Committee on International Economic Policy and Reform at the Brookings Institution has produced a proposal to bind future IMF crisis lending to critically indebted countries upon a compulsory debt restructuring: Revisiting Sovereign Bankruptcy. October 2013; http://www.brookings.edu/events/2013/10/03-sovereign-bankruptcy. Anybody who finds 50 plus pages too much to read can also get the main message from a webcast of the document’s presentation mid-October. It comes with nice music and a transcript: http://www.brookings.edu/events/2013/10/03-sovereign-bankruptcy. The English version of an NGO commentary on the paper is about to be published by EURODAD. See www.eurodad.org
    • The Canadian ThinkTank Center for International Governance Innovation (CIGI) has produced a new version of the “Sovereign Debt Forum” (SDF) proposal, which co-author Richard Gitlin had already presented ten years ago as an alternative to the IMF’s SDRM. See: Gitlin,R. and Brett House: The Sovereign Debt Forum: Expanding our Toolkit for Handling Sovereign Debt Crises. Center for International Governance Innovation Policy Brief; http://www.cigionline.org/publications/2013/8/sovereign-debt-forum-expanding-our-tool-kit-handling-sovereign-crises
    •  The standard reference of the FTAP proposal by FES/erlassjahr.de has been updated: Kaiser,J.: Resolving Sovereign Debt Crises; 2nd edition October 2013; FES: Dialogue on Globalization; http://www.erlassjahr.de/news_1/resolving-sovereign-debt-crises.html
    • Celine Tan of the University of Warwick has produced two concise papers, which are excellent tools for political dialogue and educational purposes towards a debt management reform: Tan,C.: Time to rethink Sovereign Indebtedness; University of Warwick; http://www2.warwick.ac.uk/knowledge/culture/life-before-debt-time-to-rethink-sovereign-indebtedness  and Tan,C.: 4 reasons why we need a new international framework for dealing with sovereign debt; at: http://www2.warwick.ac.uk/knowledge/business/4-reasons-why-we-need-a-new-international-framework-for-dealing-with-sovereign-debt
    • A new EURODAD report lays out the present challenges from an ongoing global sovereign debt crisis: Ellmers,B and D.Hulova: The new vulnerabilities. 10 reasons why the debt crisis is not over. EURODAD Oct. 2013; on the web at: http://www.eurodad.org/Entries/view/1546060/2013/11/11/The-new-debt-vulnerabilities-10-reasons-why-the-debt-crisis-is-not-over

 

Further News:

The “Academics Call for a Sovereign Debt Workout Mechanism” has been supported by eleven first signatories. It is now being sent out to the broader academic community, inviting academics from the economic, legal, political and ethics fields to support the call. Contact: Wilfried Neusel at: wilfried_neusel@t-online.de

 

Jürgen Kaiser, erlassjahr.de, Nov. 29th 2013

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