Nearly 20 years ago, Anne Krueger, then deputy managing director at the IMF, proposed an institutional mechanism for sovereign debt restructuring — a global bankruptcy regime for over-indebted governments. The controversial initiative was a response to a cascade of financial collapses in emerging economies in Asia, Mexico, and Argentina.
While the proposal died a quiet death, the problems it aimed to address have only grown in importance. It is timely that the fund has revived the idea. In the run-up to its annual meetings next week, its current head Kristalina Georgieva has called for a new “international debt architecture” to allow orderly sovereign restructurings.
Rightly so. The magnitude of the economic shock from the Covid-19 pandemic has badly weakened the often already fragile public finances of many poor and emerging countries. While welcome steps have been taken to avoid immediate liquidity crises, including emergency IMF lending and debt service suspension by creditors, the pandemic’s drawn-out nature means we are only at the start of the financial problems it will leave behind.
In all but the most resilient debtors, liquidity problems tend to turn into solvency problems. For poor and emerging economies, weak public finances all too easily trigger balance of payments crises that add damage to the economy, in turn dragging tax revenues down further. Nor is the problem confined to poor and middle-income countries. As the eurozone debt crisis showed, even advanced economies can be at risk. Many entered this crisis with greater debt than the last time around.
Previous efforts at multilateral reforms of sovereign debt management foundered on opposition, including from the US, to a supranational authority. Until such resistance is overcome, there are other ways. Much progress has been made since the global financial crisis on designing debt contracts with “collective action clauses” — provisions to make it easier for creditors themselves to agree lighter terms for a debtor that would otherwise struggle to honour the original ones.
The rationale for all bankruptcy arrangements, after all, is precisely this: it can be in the interest of creditors, too, to restructure payment obligations when changed economic circumstances make these more onerous than expected. When debts are unpayable in full, insisting on full repayment only diminishes debtors’ ability to recover — and their chance to give creditors the best realistic return.
The functioning of financial markets also benefits from the certainty a well-designed restructuring regime provides. IMF research suggests “pre-emptive” restructuring is cheaper, in terms of lost output, investment, and capital availability, than waiting until a default makes it unavoidable.
Building on the advantages of modern CACs offers a route for reform. The eurozone should complete the pending update of its CACs to make it harder for “holdouts” to paralyse a majority of creditors willing to restructure. The IMF, meanwhile, rightly highlights the risk of sovereign debt that takes alternative forms to standard bond contracts and so eludes the reach of CACs. Much government-to-government debt is also hidden or owed to countries, such as China, that are outside traditional debt negotiation groups. All debt should be brought into the open and all official creditors join multilateral forums for debt negotiations.
Ms Georgieva has set a worthwhile agenda for finance ministers to solve these problems. Using next week’s meetings to make progress could soon look like time well spent.