Info Service on Finance and Development (Nov12/03)
22 November 2012
Third World Network
General Assembly special event on sovereign debt and debt resolution
mechanisms - Part 2/2
York, 22 November (Bhumika Muchhala) - A UN General Assembly (UNGA)
event in New York on 25 October, titled “Sovereign debt crises
and restructurings: Lessons learnt and proposals for debt resolution
mechanisms,” outlined some concrete steps that could be taken
toward a viable debt resolution mechanism.
The UNGA has over the last year channeled a greater amount of its
focus on the debate surrounding a sovereign debt resolution mechanism,
which has been particularly timely in the wake of the sovereign debt
crises in many European countries. The most recent discussion in late
October followed the resolution 66/189 on “external debt sustainability
and development,” which was adopted by the General Assembly in February
The above UNGA resolution marks a renewed effort to review ongoing
work on sovereign debt restructuring and debt resolution mechanisms,
and to intensify efforts to prevent and mitigate the prevalence and
cost of debt crises. An overall goal of the UN’s intergovernmental
negotiations on sovereign debt is to guide policymakers in shaping
the future global agenda on international financial system reform.
second part of the day-long panel event included speakers from Argentina’s
Finance Ministry, the intergovernmental organization, the South Centre,
the World Bank and the UN Department of Economic and Social Affairs.
Adrian Cosentino, Secretary of Finance in Argentina, said that
debt rescheduling has to carefully ascertain the sovereign capacity
to pay in a context where sovereign debt complicates the ability of
countries to normalize its economic relationship with the rest of
In the Argentine experience, organizing debt swap offers required
as a reference point an evaluation of debt sustainability, which in
turn looked at fiscal and external surpluses as reference points.
Starting in 2005 Argentina has continuously worked on a debt management
strategy which has vigorously pursued the goal of clearing non-performing
liabilities and solving outstanding problems.
Cosentino said that Argentina has restructured 92% of its total debt
default, where the proportion of holdouts was not even 40%. Argentina
has not only restructured but has also carried out debt reduction
processes based on financial policies that used internal resources.
This allowed Argentina to lower the debt-to-GDP ratio to a present
figure of 43%. Half of the total sovereign debt is held by the public
sector, including public agencies whose financial risk capacities
are very broad. In comparison, the private-debt-to-GDP ratio of 12%.
Cosentino said that unstable macroeconomic policies are a key driver
of debt crises, which has to be taken into account particularly in
the aftermath of the recent global financial crisis. “In Argentina,”
he said, “we have understood that we need to ensure a path to the
use of resources that could otherwise be affected by debt payments.
We have also understood that we have to give priority to building
macroeconomic sustainability, before starting to work on proposals
for debt repayment.”
Perhaps a conclusion we can reach, especially by looking at what is
happening in the Euro region which is facing a liability restructuring
process, is that the lessons learned from Argentina are significant.
One key lesson is to prioritize macroeconomic stability, because debt
default is economically destructive and leads to a protracted debt
resolution process over time.
Another lesson is that fiscal policy has to be very responsible in
its allocation of resources, which requires serious parliamentary
discussion on how this has to be carried out. A central problem that
has emerged from the Argentine experience is that of the “legal vacuum.”
The importance of making progress on dispute settlement mechanisms
cannot be overstated. Such mechanisms must lead to innovations where
rules and procedures place creditors and debtors on an equal footing.
A lot remains to be done, Secretary Cosentino concluded, although
there are many good initiatives which already exists and which will
hopefully quickly become real measures and options that all countries
A day after Secretary Cosentino’s remarks at the UN General Assembly,
on Friday 27 October the Second US Circuit Court of Appeals in New
York declared that Argentina had discriminated against bondholders
who refused to take part in the nation’s two large debt restructurings.
The Court of Appeals said that Argentina’s decision to pay holdout
bondholders later than bondholders who agreed to participate in the
2005 and 2010 debt swaps violated provisions that required the country
to treat bondholders equally.
Argentina vowed to fight the court’s decision, and Secretary Cosentino
told the state news agency Telam, “Today’s ruling is not in any way
the end of litigation” on the relative treatment of bondholders, and
that it had no immediate impact on debt payments. However, prices
of Argentine government debt fell on that day, and the cost of protecting
the debt against default surged higher.
Former Argentine finance secretary Guillermo Nielsen, who helped oversee
the 2005 debt swap, said that the court action “corners Argentina
into a new default, potentially forcing the country to pay holdouts
while it services restructured debt.”
The court proceeding was steered by NML Capital and the Aurelius Capital
Management funds, both holdout bondholders who owned $1.4 billion
of defaulted debt. Earlier in October, NML Capital won a court order
to detain the Argentine naval ship ARA Libertad in a Ghana port, demanding
that it be paid some of what it is owed.
A Reuters report on the case concluded that the court decision against
Argentina could make it harder for other countries to extricate themselves
from sovereign debt crises and fend off angry creditors that may sue
the country from United States courts.
Khor, Executive Director of the South Centre, said there is an
urgent need for an internationally coordinated system of debt workout
today, which is a key missing pillar of the international financial
architecture. The world has now seen all the weaknesses in the present
system and all the ways in which it doesn’t work. The need to make
new efforts for an international solution has never been more important.
What are the features of an international sovereign debt workout system?
Some of the features can be borrowed from the US Bankruptcy Chapter
11 law as well as Chapter 9 relating to public sector municipalities.
Khor outlined six major pillars or elements of such a system:
First, a temporary standstill on external debt servicing which will
provide breathing space for debtor countries to formulate a viable
debt servicing plan. Such a plan should cover all debt servicing,
including those due to solvency problems in which the debt has to
be reduced, or liquidity problems in which the debt has to be rolled
There should also be an automatic stay on litigation during the standstill
in order to avoid problems for both debtor country and creditors,
and in particular to avoid a scenario where creditors are scrambling
for exit or to sue the debtor. The process should be similar to the
World Trade Organization (WTO) feature, in that if there is a balance
of payment difficulty in the country that can be demonstrated, the
country can unilaterally suspend its tariff obligations in the WTO
while receiving assurance that other WTO member states cannot take
it to court.
Second, an independent panel of legal and economic experts should
be established, and independence should be safeguarded by ensuring
that panel members are neither debtors or creditors. The IMF, in particular,
cannot sit on such a panel because the institution is itself a creditor,
which compromises the independence of such a panel.
Third, selective capital controls should be implemented in order to
prevent capital flight. Fourth, new loans should be provided to the
debtor country, in a process of lending into arrears. This enables
countries to continue their trade, and in particular to be able to
import essential items. Possible lenders for new loans are the IMF,
the WB and other donor and lender countries. However, such lenders
should not finance debt payments, which should be discussed strictly
in the debt workout reorganization and mechanisms. If new money is
lent to the debtor in order to repay old creditors, the whole point
Fifth, new debt contracted after the standstill should not be counted
in the original debt amount. If the problem is primarily a liquidity
problem, there should be a rollover of existing loans. If it is a
solvency problem there should be a partial debt writedown. The precise
method of such workouts should be the result of negotiations between
the debtor and the creditor, and the negotiations process should be
guarded by a statutory mechanism. Operationalizing the Collective
Action Clause should be part of the entire exercise. When creditors
and debtors cannot reach an agreement, an independent panel should
Elements of such a process were in the Sovereign Debt Restructuring
Mechanism proposal by the IMF.
Recently, South Korea expressed support for a debt standstill and
restructuring process when it said to the G20 that “Many who have
analyzed Korea’s 1997 and 1998 financial crises have found that Korea
could have solved its liquidity problem sooner had a debt standstill
programme been in place at the time Korea requested IMF assistance
at the end of 1997.”
Khor stressed that the UN can take the lead in the debt restructuring
exercise. In watching the Euro area debt crisis, there is an evolution
of many ideas, especially from political leaders who are recognizing
that there are far more efficient and effective processes and mechanisms
than the ‘muddling through’ process the world is currently witnessing.
What is important for developing countries, especially Least Developed
Countries that have experienced the Highly Indebted Poor Countries
program, is that they do not become complacent when sovereign debt
is low and sustainable, when times are good.
Khor highlighted that many factors indicate that the favorable global
economic conditions that led to high capital inflows and high commodity
prices are going to phase out in the coming years. Most economists
are currently predicting that in the next 3-5 years there are very
difficult times ahead for most developing countries. There may be
shocks to export and remittance earnings, and this may cause difficulties
for debt sustainability.
This is why, Khor emphasized, the current time is an opportune time
to set up a debt restructuring mechanism. When countries are in the
middle of a crisis, it will be much harder to establish a large-scale
internationally coordinated mechanism.
Akhtar, Assistant Secretary-General for the Department of Economic
and Social Affairs (UN DESA) in the United Nations, outlined the proposals,
perspectives and collective wisdom towards a sovereign debt resolution
framework. Parallel to UNCTAD’s “Principles on Promoting Responsible
Sovereign Lending and Borrowing,” the private sector has started
discussing amendments to the “Principles for Stable Capital Flows
and Fair Debt Restructuring.” The private sector’s objective is
to incorporate the new developments associated with debt restructuring
into the capital flows regime.
Meanwhile, UN DESA has launched a range of multi-stakeholder consultations
on sovereign debt restructuring to solicit views of distinguished
experts from academia, policymakers and private sector representatives.
At the October meetings of the World Bank and IMF in Tokyo, experts
acknowledged the virtues of a statutory debt restructuring mechanism
but also recognized the complexity of designing an acceptable and
The magnitude of the recent financial crisis might explain a perceived
general willingness, including among private sector representatives,
to entertain a more rules-based approach. Such an approach, while
constraining private sector creditors, would also protect them from
arbitrary actions by sovereigns, said Akhtar. The hope is that the
recent round of debates might result in a balance etween contractual
and statutory instruments.
Akhtar highlighted that an important and cross-cutting issue is that
of transparency and availability of data. One proposal to enhance
transparency and data access is the creation of an international registry
of debt, reported by creditors and reconciled with debtors. Another
perhaps more ambitious option would be the creation of a neutral Sovereign
Debt Forum, which would help assuage the information and analytical
issues associated with the question of debt sustainability, as well
as provide a space for negotiations and consultations.
In situations of debt distress borrowers would benefit from “breathing
space,” which is not available currently, before identifying a sound
policy framework to promote “sustainable adjustment, preserve asset
values and support growth, to the mutual benefit of both debtors and
creditors.” In practice, sovereigns can impose de facto standstills
through the exercise of ‘force majeure,’ given the absence of credible
means to enforce judgments under sovereign immunity.
A fundamental issue, Akhtar stressed, is whether a more formal process
for the declaration of a standstill, in conjunction with lending into
arrears by the IMF, would enhance the debt resolution framework. Such
a process would provide a stay on all litigation by individual creditors,
preventing a panicked rush to the exits that usually triggers a rollover
crisis and a race to the courthouse.
Two proposals have been discussed in this regard. First, the inclusion
of terms for standstills in bond and loan contracts under the voluntary
approach and second, the amendment of article VIII 2b of the IMF Articles
of Agreement to include capital account transfers under the statutory
Otaviano Canuto, Vice-President of the Poverty Reduction and
Economic Management Network in the World Bank, said that various World
Bank studies have concluded that sovereign debt restructuring tends
to be disorderly and prolonged. Official interventions can sometimes
help, but sometimes it can worsen sovereign debt situations.
This conclusion was consistent across countries with striking similarities
such as fixed exchange rates, open capital accounts, weak growth prospects
and concerns about fiscal solvency. A common sovereign narrative is
that fiscal fundamentals play a crucial role. Even though all these
crises typically involve abrupt economic disruptions, their seeds
were sown over long periods, and reflect policies in national and
global political economy.
A common thread across sovereign debt crises is the rise of a relatively
new set of complications, namely that of private capital flight moving
from the core to the periphery and now back to the core. In the 1980s
there was a proliferation of black market premia for hard currency,
and the rising risks of convertibility have become a serious concern.
However, despite the disorderly nature of some debt writedowns, at
the end of the day there is some acknowledgement for the need to write
Canuto compared the 1980s debt crisis in Latin America, after the
Brady Plan was formulated, to the debt crisis in Russia and Argentina,
where the usefulness of official intervention was questionable. Financial
engineering occurred in the form of voluntary debt swaps and the lesson
was learned that procrastination is costly for all stakeholders.
For any official intervention to be catalytic, Canuto said that private
holders of government debt must get involved, fiscal and structural
reform must take place, and the interest rate must come down after
risk stress declines. “Intuition is simple,” he said, “There is an
understanding that solvency means that the present value of primary
fiscal surpluses must be less than outstanding debt.”
With regard to the Greek debt crisis, bond spreads in the country
continued to rise even as the interest stayed stagnant. The debt had
to be adjusted even higher and a haircut has to come to the fore.
Against this backdrop of recent experiences in the Euro area, there
are many desirable features underpinning any orderly debt restructuring
when a fiscal solvency problem is detected and when the market is
in significantly high default risk.
First, private creditors receive an upfront haircut; second, vulnerable
systemic banks are protected to get back on track; and third, the
official money is loaned at risk-free rates which reflect its senior
status. The question would arise whether an upfront haircut for private
creditors would incur more hazard.
What the data in the World Bank shows, according to Canuto, is that
the supposed moral hazard risk on the debtor country has been overestimated
starting from the various debt crises in the 1980s. The kind of smoothing
required in a debt restructuring mechanism is one that would avoid
the aspects of disorderly and procrastinated debt restructuring.
Nigeria said that defaulting countries are not focusing enough
on the ways in which creditors can behave more responsibly. There
is a lot of discrepancy in the figures presented by the IMF, the World
Bank and the countries themselves.
The international community also has to address the important question
of how these sovereign debts have been amassed by developing countries
in the first place. Has the debt been used for the purpose originally
stated? There are often no proper records, no statements and no evidence
as to the actual use of the debt. For some developing countries, sovereign
debt becomes deeper and deeper because they don’t export industrialized
How will developing countries stimulate exports of higher value added
manufactured and industrial goods? Many African countries have a taste
for imported goods from abroad, and do not put the priority on building
a deeper domestic industrial base. But, Nigeria stressed, if developing
countries have nothing to export there is nothing with which to pay
The International Monetary Fund stated that when discussing
issues countries currently face in debt sustainability, there are
successful examples of how the international community effectively
cooperated to establish the Multilateral Debt Relief Initiative and
the Highly Indebted Poor Countries initiative.
Since the Sovereign Debt Restructuring Mechanism (SDRM) proposal,
the IMF has been involved in many national debt restructuring initiatives,
where the IMF is guided by its policies on debt restructuring and
private sector involvement. The mandate given to the IMF by the international
community is to provide an independent assessment of the economic
reform programme of the government to ensure debt and economic sustainability
The Fund is also mandated to provide financing and more importantly
play a catalytic role to help unlock financing from other countries.
Even though the SDRM discussion was stalled at the IMF’s Executive
Board, the Fund has been involved in a number of sovereign debt restructuring
processes, and within each of these, the IMF has been following international