A long-awaited overview paper on sovereign debt restructuring from the International Monetary Fund (IMF) is here, the first since 2005. And it does not revive the Sovereign Debt Restructuring Mechanism (SDRM) proposal, which died in 2003 at the hands of the United States and the big emerging markets. As the new paper explains politely, SDRM "failed to command the majority needed ... due to the members' reluctance to surrender ... sovereignty" a decade ago. It then takes great pains to establish that the core political reality has not changed, even though SDRM would have solved many of the problems with sovereign debt restructuring that have arisen in the interim.
Within its crystal-clear political constraints, the Fund goes on a measured march across sovereign debt restructurings from 2005 to 2012, or from Argentina to Greece, through Belize, Jamaica, and St. Kitts and Nevis. I came away thinking that the paper was not particularly radical, but that it was generally constructive and refreshingly precise. But it does point to potential changes.
Perhaps the most drastic of these (previewed in the Financial Times on May 23) could be to condition IMF lending programs on an early debt rescheduling, to lock in the private creditors while official sector creditors debate the liquidity/solvency diagnosis. In a solvency case, more creditors would stick around to share the pain. This innovation would effectively institutionalize what happened in Latin America in the 1980s—except that it was not planned that way, took many years, and caused a huge amount of pain. Thirty years later, the Fund reacts to Europe's recent habit of letting public money finance private creditor exits: by the time officials decide to administer haircuts to creditors, the barbershop has cleared out.
The rest of the paper is a mix of policy refinement, contractual incrementalism, and regrets about wrong turns and roads not taken. The core insight driving the IMF's work program is the fact that governments restructure too late (two to seven years by one count), and fail to get enough relief. Preemptive restructuring before default, also prominent in the arguments for SDRM, remains the holy grail. To that end, here are a few more directions for policy change proposed in the report, along with the supporting arguments:
- IMF debt sustainability and market access assessments determine restructuring outcomes, but have come under fire from all sides. To address the criticism, the Fund will continue moving to more standardized, transparent, and rigorous assessments. At the same time, it acknowledges that the result will always be a mix of art, science, and staff judgment. Creditor participation in sustainability determinations is not on the horizon.
- It was a mistake to change the IMF's access policy to give Greece exceptional financing despite its dismal debt prospects, for fear of "international systemic spillovers." The systemic exception may not be long for this world.
- Diversity among private and public creditors is a recurring theme. For private creditors, this leads IMF staff to distance themselves from creditor committees (and, pointedly, from IIF advocacy of these committees). Exchange offers will continue to rule the day.
- For public creditors, diversity means new worries about governments outside the Paris Club playing holdup, and a broader policy review of official sector involvement.
- In a passage that surely would have made it into the briefs of the recent US court decisions on the pari passu clause had it been published sooner, the IMF predicts that those decisions would trigger collective action problems. Collective Action Clauses (CACs) are not the answer, but aggregated voting across the debt stock would help, especially if individual bond issues cannot drop out. Conditioning IMF support on minimum participation thresholds could supplement CACs to promote creditor coordination. Ironically, the paper does not propose changes to the pari passu clause itself.
- To no one's surprise, the Fund's policy on lending into arrears was found wanting and in need of a fundamental rethinking.
The paper is full of useful tidbits from other IMF and academic studies: examples of debt restructuring inside monetary unions beyond Europe; the puzzling case of Turkey, which alone seems to have climbed out of an unsustainable debt hole without restructuring; and a crisp explanation of the difference between Greece's foreign contractual and domestic statutory restructuring.
The Executive Board of the IMF has blessed the paper and the work program earlier this week. This lays the groundwork for papers on restructuring delays and overcoming collective action problems in the next few months. Papers on lending into arrears and dealing with official creditors will come later.
A key part of the IMF overview that could fall by the wayside—but that should be tackled at the outset—is the fear of contagion. The authors recognize both the merits of the argument, and the fact that merits aside, fear is a real driver of delay. In response, they advocate buffers and firewalls—the lessons of Europe—in rather general terms. To my mind, the credibility of all the other reforms spelled out in the paper and between the lines, from better debt sustainability projections to limits on official lending, rests on the Fund's capacity to address the fear of contagion. And here it gets really foggy.
A modified version of this post appeared on CreditSlips.org.