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Ukraine's Odious Bonds: Part II



In an earlier post, I suggested that the United Kingdom should refuse to enforce $3 billion in English-law Ukrainian bonds sold to Russia just before President Viktor Yanukovych fled the coop. This debt is special for two reasons. First, it came about as a lifeline to an unsavory government. Second, it was blatantly political lending trying to gain repayment advantage by masquerading as plain-vanilla private eurobonds.

It is Russia's sovereign prerogative to prop up friendly kleptocrats. Getting its money back by dressing it up as private contracts is another matter. The Paris Club of government-to-government creditors should use the case of Yanukovych bonds to promote a broader ban on selling government claims into the private markets.

The Paris Club is a forum of government creditors that have regularly met in Paris since the 1950s to renegotiate their claims on other governments. Although it started as a place for First World creditors to coordinate their dealings with Third World debtors, it has grown to include new members—including former debtors, like Russia, though not China or most of the oil-exporting states in the Middle East.

Debts renegotiated in the Paris Club is mixed-motive debt—part political, part commercial. Export credits to help the debtor buy the lender's exports might look more like private bank loans. Agricultural loans and foreign aid might reflect a mix of domestic subsidies, humanitarian objectives, and political patronage. As recent overtures to the new Ukrainian governments attest, politicians bring all kinds of loans as gifts to political summits. At the extreme, there are the US agricultural credits to Vietnam in 1971, which were really disguised military aid in the face of congressional skepticism about the war—and which Vietnam refused to repay when it settled with the Paris Club in 1993.

While governments and private creditors alike might underwrite corruption and oppression, their ways and motives are qualitatively different. Governments rarely enforce their debts in court, and are often willing to lend at a loss for long periods of time, so long as they get military or political dividends for it. In crisis, official and private creditors renegotiate their claims separately, though Paris Club rules try to prevent other creditors from free-riding on taxpayer concessions.

The Paris Club would look rather different if its members traded their debts freely to private creditors. On any given day, you might find a distressed debt fund across the table where Russia used to sit—or worse, Russia would still be there, but having sold off its economic interest in Ukrainian debt under discussion. Its negotiating position would be very different from the other countries', but no one would know.

Paris Club debt trading is very rare. Germany securitized its Paris Club loans to Russia in 2004 to comply with European Union budget targets. Poorer governments that are not permanent members of the Paris Club are more likely to sell their claims. In 1999, a private investor bought twenty-year-old agricultural equipment loans to Zambia from Romania, which sought to escape writing off this debt in the Paris Club. The investor sued, won, and got millions from Zambia on debt that had been unenforceable in Romania's hands.

After the lawsuit against Zambia, some Paris Club members committed in 2007 not to sell their claims against heavily indebted poor countries to creditors who would not grant them debt relief. This had little practical impact within the Paris Club but sent an important message to all government creditors. The initiative should now be revived and expanded. As the Zambian loan and Yanukovych bonds illustrate, chances of abuse go up when official and private credits cross-dress.

Some might object that a claims trading ban would deprive poor creditors like Romania of much-needed revenue. But the practice is so rare that it is unlikely to be a significant source of funds. Unlike private creditors, governments do not lend in a liquid market. They do not make credit decisions in the expectation of trading out of their exposure. On the other hand, diverse and obscure government accounting practices seem to make claims trading particularly vulnerable to corruption.

A broad claims trading ban would take time to negotiate and take hold. It is unlikely to help Ukraine in the near term because Russia would not sign up. The Yanukovych bonds were designed with the private market escape hatch in mind—but the blatant way in which this was done could help shift international lending norms in the right direction. The time to act is now, when pictures of the Putin-Yanukovych signing ceremony, followed immediately by pictures of troops running over Crimea, are still fresh in public memory. Using the Paris Club forum to put governments on notice that they cannot launder loans to dictators and kleptocrats in the capital markets might make them think twice before lending.

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