External debt sustainability and development: Lessons learned from debt crises and ongoing work on sovereign debt restructuring and debt resolution mechanisms
Ms. Shamshad Akhtar Assistant Secretary-General for Economic Affairs Department of Economic and Social Affairs
23 April 2013, New York
Your Excellency Ambassador Nestor Osorio,
Secretary-General Mr. Supachai Panitchpakdi,
Today’s meeting hopefully will be a step forward in the discussion of the General Assembly Resolution on external debt sustainability and development. This resolution calls upon countries to promote and contribute to the discussions for a structured framework for sovereign debt restructuring and debt resolution mechanisms.
In sharing my thoughts on this issue today I would like to:
- Highlight key gaps and perverse incentives in sovereign debt markets and restructurings;
- Discuss selected issues illustrating that it takes too long from debt distress to default and from default to debt restructuring;
- Underscore other benefits that a debt restructuring framework could bring to the table;
- Conclude by suggesting a strong focus on international cooperation to develop workable options to reduce the inefficiencies observed in sovereign debt markets.
From distress to default: Too long?
The global financial and economic crisis and the recent distress in Europe have shown deep vulnerabilities at the core of the international financial architecture. Regulations and policies are being devised to safeguard economic and financial systems. Up until now, policymakers have avoided, as much as possible, declarations of default and debt restructuring from distressed sovereigns. So far only in Greece and Iceland there have been “haircuts” to bondholder claims.
Systemic risks in the European case remain high and thus it is understandable that any decision in a particular country has to be carefully considered in the context of the union. Yet, delayed defaults, as well as repeated restructurings, have been identified in the past as characteristics of the sovereign debt markets. While economic models have the tendency to assume default occurs too early or too often, in most cases politicians and policymakers go to great lengths to postpone what seems like unavoidable defaults.
Defaults are costly, especially in political terms, and even more so if the exposure of the domestic banking system is significant. Incentives to gamble for resurrection are high and the costs typically are even higher for all involved when the bet eventually does not pay off. Additional debts have been typically incurred and have to be repaid. The economic costs in terms of GDP have been exacerbated by prolonged uncertainty. A framework for sovereign debt restructuring could provide incentives to avoid these additional costs.
From default to debt restructuring: too long?
After default is declared, protracted debt renegotiations can erode confidence even more. Even in cases where negotiations facilitated voluntary debt exchanges, the economic and social costs associated have been high. For example, the cumbersome and protracted negotiations that began in 2010 “culminated” with the Greek voluntary debt restructuring in April 2012. However, a further debt reduction operation was needed just six months later.
Thus market based or voluntary solutions have generally not provided sufficient debt relief and debtor countries do not always succeed in bringing themselves back to a debt sustainability path. Creditors have incentives to give up as little as possible and debtor governments in a weak negotiating position may have to settle for less relief than they need. Rules in debt restructuring could allow faster and more equitable burden distribution, ensuring a return to debt sustainability and sustainable and inclusive growth.
The perverse incentives that the lack of a “bankruptcy” procedure in sovereign debt entails affects lending and makes it a highly inefficient market from the point of view of both creditors and debtors. It intrinsically affects both the cost and the extent of borrowing. Yet this is an inherently difficult problem to solve, as sovereignty issues are at the core of the international order. A judgment against a sovereign is not necessarily enforceable. And yet, claims against sovereigns are not uncommon, even after debt exchanges. As Lee Buchheit, eminent lawyer involved in many debt negotiations, states, “Sovereigns are both uniquely vulnerable and uniquely protected”.
In most recent cases, litigation and holdouts have not been an impediment for debt resolution negotiations. Yet, the case of Argentina has shown the legal limits of debt exchanges and it is clear that the implementation of any verdict from NY Courts, be it for or against the plaintiff, will most likely raise serious uncertainties about the outcomes of future sovereign debt restructurings. Uncertainty still remains as the plaintiff rejected Argentina’s offer over the weekend. In this regard, a system that would provide rules and procedures would benefit both sovereigns and creditors, diminishing risks and eliminating incentives for vulture funds to gamble in sovereign debt markets.
What other benefits could a mechanism for debt restructuring provide?
A mechanism for sovereign debt restructuring could help in:
- Improving coordination and fair representation of the debtor and all dispersed creditors;
- Establishing priority rules among the whole range of official and private creditors;
- Provide an early response to debt distress, allowing for breathing space to find a solution and protect from litigation;
- Provide a space and procedures for dispute resolutions
I am sure the discussion today will refer to these issues and to proposals to implement them. Let me touch on two of them: Early response and coordination.
There is need for a process through which there is early engagement of debtors and creditors to frankly address unsustainable debt situations on a timely basis. This would reduce overall uncertainty in affected economies, as well as offer a framework for creditor consultation and structures for engagement with debtors.
Unlike in the 1980s when the main creditors were large commercial banks, today’s bonds are held by numerous disperse bondholders. Because of this, one of the issues that needs to be addressed is collective action problems amongst creditors. However, developments in contract technology, such as collective action clause provisions that establish a super majority, are not sufficient. The issue of aggregation across bond issues, let alone across different types of debt, does not make collective action clauses, which are written on specific bond issues, very effective for creditor coordination. A voluntary code of conduct and the principles of stable private capital flows and fair debt restructuring have not resulted in more efficient outcomes either.
The way forward
History is replete with frustrating experiences that give reason to want to set up a practical and fair architecture for sovereign debt restructuring. The way forward is to develop rules, procedures and processes that can offer effective solutions for today’s global economy. UNDESA has organized a series of expert group meetings to garner ideas on what can be done ex-ante to provide a more stable, fair, and efficient system and identify the options. In the last expert group meeting there was near consensus (with only two dissenting voices from the private sector) on the deadweight losses due to the gaps in debt restructuring.
IMF has launched work on debt sustainability and sovereign debt restructuring in light of the emerging developments. This move should enhance debates in this area and help move towards an acceptable international approach to sovereign debt resolution.
I thank you.