Introduction
The recent debate on reforming the international financial system has focused on the need to improve the sovereign debt restructuring process, and in particular on steps that could limit the risk that litigation could disrupt or delay a sovereign debt restructuring. This debate increasingly has focused on the debt restructuring process in those cases where debt reduction is needed to produce a sustainable debt profile. Less attention has been given to those cases where a sovereign lacks the reserves needed to cover its near-term obligations and, absent international support, has a clear need for debt rescheduling to push out near-term maturities.
There is a strong case for seeking to make the sovereign debt restructuring process more orderly, more predictable, and more rapid. There is also a strong case that steps to address collective action problems created by the threat of holdout litigation could help to improve the restructuring process, and give all parties more confidence that there is path that can lead a sovereign from the decision that a restructuring is necessary to its successful conclusion. Moreover, reasonable steps to reduce the risk of holdout litigation would not suddenly dilute the sovereign’s incentives to pay: no rational sovereign would prefer default to payment just because it can restructure with a super- majority vote.
It is therefore important to capitalize on the enormous investment that the international community already has made in thinking through the problems that arise in a sovereign debt restructuring. It would be a shame if the debate that began with the G- 10’s report on Sovereign Liquidity Crises back in 1996 and that gained new prominence after the IMF proposed a new statutory bankruptcy regime did not ultimately result in the implementation of a series of concrete improvements in the sovereign debt restructuring process.
But it is also important to recognize that there are limitations to what likely can be achieved. The legal ability to bind in a minority alone will not significantly lessen the real economic costs of defaults or make it easy to turn down a country’ request for official support. The case for taking steps to limit the risks of holdouts and to clarify the debt restructuring process with a code of conduct should rest on the ability of these steps to make the restructuring process more transparent and the outcome of the restructuring somewhat easier to predict ex ante—not on their ability to change dramatically the incentives facing either sovereign debtors or the official sector.
The first half of this paper is organized as follows: an initial section discusses the problems that arise when a sovereign needs to restructure its debts; the second section discusses the three main proposals that have been put forward to improve the sovereign debt restructuring process (clauses, codes, and statutes), emphasizing the differences between various contractual and statutory proposals as well as the difference between the contractual and statutory approaches; the third section synthesizes this discussion into four broad approaches to moving forward; the fourth section briefly lays out a set of recommended policy steps; and the fifth section suggests broadening the agenda beyond its current focus on steps to facilitate the restructuring of the sovereign’s external debt in debt reduction cases. These five sections constitute a relatively short, self-contained paper that provides an overview of the issues that arise in a sovereign debt restructuring and potential solutions. The second half of the paper provides a more detailed presentation of the case for the recommended set of policy steps, with analysis to help back up the judgments embodied in the proposed course of action.