Ms. Shamshad Akhtar Assistant Secretary-General for Economic Affairs Department of Economic and Social Affairs
In sharing my thoughts on this topic, I would like to:
- First, discuss the changing dynamics of sovereign debt restructuring.
- Second, illustrate that despite the changing course and complexity of sovereign debt restructuring, the enabling policy, legal and institutional environment for debt resolution has adapted slowly and suffers from a number of shortcomings.
- Third, highlight my perspective of selected recent debt resolution cases.
- Finally, offer some concluding remarks by laying out a way forward.
The book “This time is different: Eight Centuries of Financial Folly”1 offers compelling evidence that sovereign debt crises have been occurring for a long time indeed. In the past, sovereign debts – largely direct government borrowings –were raised to finance frequently unsustainable macroeconomic imbalances and deal with consequences of abundant credit.
This round of sovereign crises is different and unprecedented. One the size, scale and spread of sovereign debt crises is large and engulfs developed countries. Two, in many countries unabated growth in public borrowing has violated debt sustainability principles and benchmarks. Three, the over-leveraging of both the financial and corporate sector, and the intertwined nature of debt crises hampers the ability of sovereigns to rescue their banking systems. Fourth, recourse to private sector participation in bank rescues has been backed by sovereign, given the risk perception and spreads, and in a number of cases the hair cuts have extended to senior creditors and even depositors.
Driven by a complex set of developments, the present sovereign crisis emerged as a result of a combination of factors:
- The breakdown of fiscal, financial and corporate governance and especially complex governance issues associated with monetary unions.
- Credit booms and busts, aggravated by rising cross border private flows, combined with pervasive and unregulated financing engineering in national markets, mutually inducing volatility.
- The use of instruments of sovereign debt borrowing in which the risks go beyond institutions to individual bondholders geographically dispersed; and
- Excesses of corporate and financial institutions and the traditional excesses and mispricing of risks and returns from sovereigns.
Yet, the international community has continued to go along with business as usual. The gaps in debt restructuring architecture and framework persist. There is no centralized dispute resolution mechanism and there is no attempt to develop international law governing international bankruptcies. This implies that a judgment passed in one jurisdiction is not enforceable in another jurisdiction. Furthermore, there is no provision:
- To offer “breathing space” to find a solution and protect against litigation.
- For enforceable priority rules for creditors.
- For organized representation of all stakeholders.
- To harmonize the laws, policies and institutional mechanisms.
Protracted debt renegotiations erode confidence and debtor countries do not always succeed in bringing themselves back to debt sustainability path is worrisome.
Even in cases where negotiations facilitated voluntary debt exchange, recently including the use of collective action clauses, the economic and social costs associated have been high. This is especially true when large magnitudes of distressed sovereign debt are involved: the cumbersome negotiations that culminated with the Greek voluntary debt restructuring in April 2012, are a distinct example. Although the debt exchange finally reached high private sector participation, with the activation of Collective Action Clauses, the economic and social costs, as well as the underlying and persistent risks to global financial stability, are too high to ignore.
In most recent cases, litigation and holdouts have not been an impediment for debt resolution negotiations.2 Yet, the case of Argentina has shown the legal limits of past 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 have important repercussions for future sovereign debt restructurings. In this regard, a system that would provide enforceability and clear rules would benefit both sovereigns and creditors, diminishing risks and eliminating incentives for vulture funds to participate and gamble in sovereign debt markets.
The case of Cyprus illustrates, in turn, not only the need for “breathing space” but also the crucial benefits of enforceable priority rules. In effect, the risks to the banking systems of making depositors cover part of the bailout cannot be underestimated. With depositors now included, and deposit guarantees less iron-clad, any hint of weakness in a bank could lead very rapidly to deposit flight and insolvency. The final deal reached last month regarding Cyprus protected most insured deposits, observed the seniority ranking of creditors and imposed losses only on uninsured depositors and creditors of restructured banks and did not set a levy on all deposits—except for an increase in the existing levy on all bank deposits from 0.11% to 0.15%. Yet, Cyprus had to impose extensive controls on capital movements and banking transactions. The combination of a wealth shock and extensive disruptions to banking and payment transactions would lead to a much sharper GDP decline this year.
In conclusion, history is replete with frustrating experiences to set up a practical architecture for sovereign debt restructuring. Tackling the root cause of past failures, the way forward is to develop a solution relevant for today’s global economy. FFDO, UNDESA has organized expert group meetings to garner ideas on what can be done ex-ante to provide a more stable system and identify the options under the voluntary and statutory approach or some middle-ground approach.
There is a need for addressing the gaps highlighted before, and also for a process through which there is early engagement of debtors and creditors to reduce uncertainty, as well as for a framework for creditor consultation and structures for engagement with debtors.
The case of Belize demonstrates that it is possible to set out criteria for a creditor committee allowing for successful coordination. Is the lesson that the structure and format of the creditor committee should be set forth by the debtor? Or is it time to set ex-ante structures and frameworks for creditor committees? If implemented, these should be open and transparent, with an oversight body so that it the creditor committee can swing into action when needed? Or maybe the format could even be a permanent creditor committee? These are some of the international community should be asking in this regard.
We must recognize that rules alone will not be a solution to the problem. There is an important role for responsible borrowing and lending, improved debt management practices and counter-cyclical lending policies. UNCTAD “Principles on Promoting Responsible Sovereign Lending and Borrowing”3 , and IIF “Principles for Stable Capital Flows and Fair Debt Restructuring”4 are important contributions in this regard. The use of new instruments such as GDP linked bonds can also play an important role as these instruments would more accurately reflect debtors’ capacity to repay and they would do so in a counter-cyclical way.
1Reinhart, Carmen M. and Kenneth Rogoff (2009), This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
2IMF (2012), IMF Working Paper, WP/12/203, “Sovereign Debt Restructurings 1950–2010: Concepts, Literature Survey, and Stylized Facts”, Monetary and Capital Markets Department. Available at: http://www.imf.org/external/pubs/ft/wp/2012/wp12203.pdf, Table 8, page 49.
3United Nations Conference on Trade and Development, Principles on Promoting Responsible Sovereign Lending and Borrowing,http://unctadxiii.org/en/SessionDocument/gdsddf2012misc1_en.pdf
4Institute of International Finance, Principles for Stable Capital Flows and Fair Debt Restructuring. More information available at http://www.iif.com/emp/principles. 1. These have been amended to incorporate the new developments associated with debt restructuring and were presented to the G20 recently. The original Principles were endorsed by the G20 in Berlin in 2004.