The IMF is taking a fresh look at sovereign debt restructuring, with a robust work agenda on this issue in the coming months, said Hugh Bredenkamp, Deputy Director of the IMF's Policy, Strategy, and Review Department. In an interview with the IMF Survey, Bredenkamp noted that sovereign debt is back at the center of economic policy debate as a result of the global crisis, prompting the IMF to develop a new work program on the topic.
Sovereign Debt Restructuring-Recent Developments and Implications for the Fund's Legal and Policy Framework looks at the experience with restructurings in recent years and identifies issues that have emerged, Bredenkamp said. Serving as the starting point for future IMF work on the topic, the study also outlines the range of policy proposals that have been made to address these problems, he added. In this interview, Bredenkamp discusses the new IMF study and why it is important to encourage a more efficient approach to sovereign debt restructuring.
Why has the IMF decided to review its sovereign debt restructuring policies and practices?
The IMF has not looked at the topic of sovereign debt restructuring in a comprehensive way since 2005. A lot has happened since then, including the global financial crisis, so it was time to take stock. Greece executed the largest debt restructuring in history in February 2012. A number of other countries have recently launched restructurings, including Belize, Jamaica, St. Kitts and Nevis, and Grenada. There is also ongoing litigation between Argentina and its creditors, which could have major implications for how future sovereign debt restructurings are done.
The debate on debt restructuring is already going on actively outside the IMF in various international fora. We are joining in this discussion.
What is the Fund's current approach and framework for supporting sovereign debt restructuring?
To understand the Fund's role with regard to debt restructuring, you have to go back to the IMF's lending mandate. Our Articles of Agreement require that, when we lend to a country, we do so to help that country resolve its balance of payments problems within a timeframe that allows it to return to medium-term viability and repay the Fund. Because of this mandate, the IMF cannot lend in situations where debt is assessed to be unsustainable. As a result, the IMF often becomes, in effect, the trigger for a decision by a country to restructure. When a country has lost market access or has very restricted access, it has no choice but to restructure if we are unable to lend to it. Once that happens, the IMF's debt sustainability analysis effectively determines the parameters of that restructuring by indicating how much debt relief is needed.
We don't micromanage how debt restructuring is done. But since restructurings typically are done in the context of an IMF-supported program, where we require assurances of sufficient creditor support and the restoration of debt sustainability, we have an important role.
In light of recent experience with sovereign debt restructuring cases, what are the main issues identified by the paper?
In this paper, we look at the nine new restructuring cases that have taken place since the last comprehensive review in 2005. There are two main findings that come out of that review. First, it appears that debt restructurings often come too late and are too limited to really restore debt sustainability. This can be very costly. When a country is laboring under an excessive debt burden, this debt overhang hinders market access and growth. It damages confidence and deters investment. So the economic recovery that the country needs may not materialize.
Also, if it's apparent to us that the debt is unsustainable before it's restructured, it's likely to be apparent to the markets, too. So investors will be in the process of exiting. What happens then is that while the official sector-including the IMF-is trying to support the country, our money is going in while the private creditors' money is going out. This is inconsistent with the IMF's lending principles-we're putting money into a situation where we're not actually solving the problem, and the country is just exchanging one type of debt for another. That is the first main finding that we need to think about and consider whether it warrants a change in our policies.
The second finding is that the current contractual, market-based approach to debt restructuring may be becoming less potent in overcoming collective action problems. In recent years, debt restructurings have been done through a market-based approach that is increasingly based on collective action clauses built into debt contracts. The purpose of these clauses is to reduce the incentive for individual creditors to hold out and not to participate in a restructuring in the hope that they can get paid in full. Obviously, if you have too many people doing that, it undermines the whole restructuring operation. This market-based approach has been working reasonably well, but there are signs in some recent cases that it may be becoming less effective in overcoming collective action problems.
How do you see the IMF's role in sovereign debt restructuring going forward?
It's clear that the IMF will remain centrally involved in sovereign debt restructuring because of our "lender of last resort" role. But the question is, how should the IMF best exercise that role? The IMF needs flexibility in sovereign debt restructuring cases, but we should not be so accommodating in our lending policies that we encourage undue procrastination. On the other hand, we need to be able to provide large amounts of financing in a really critical situation. So it's difficult to set a rigid framework of rules. In order to strike the right balance between flexibility and consistency, we could potentially set better defined criteria that would guide the IMF's discretion on these issues. That's what we will consider in the next phase of the work.
As regards the collective action problem, one way to solve it would be through a statutory approach like the sovereign debt restructuring mechanism we discussed in 2003. But there is not sufficient support in the international community for this type of approach. Our work in the coming months will therefore focus mainly on strengthening the contractual approach.
What are the next steps for the IMF's work in this area?
When the IMF's Executive Board discussed this paper earlier this month, it agreed that the staff should do further work on these issues. This will include a more extensive study of the case histories-not only of countries that went through debt restructurings, but also of those that were able to work their way out of debt difficulties without a restructuring. Our plan is to have a two-stage work program that would begin with issues related to the timeliness and adequacy of debt restructurings and collective action problems, followed by the framework for official sector involvement and the lending-into-arrears policy in later stages. We will be doing follow-up papers with further analysis and outlining policy options for each strand of work, based on thorough, objective assessments of the pros and cons of each option, and drawing on a broader set of recent country examples.
We envisage that it could be a year or so from now before the IMF's Board is ready to consider possible modifications to Fund policies in this area.