Sovereign Debt Restructuring: Red Herrings Swimming in a Sea of Confusion

You may have read about those radical plans by the International Monetary Fund (IMF) to force governments to default on their debts as a condition of IMF support. Debates over the place of sovereign debt restructuring in a financial crisis are getting more muddled and acrimonious, in no small part because no one wants to face the underlying governance challenge: political pressure to lend public money to contain the crisis, even if it means paying private creditors in full and adding to a sky-high pile of sovereign debt. As this year of public debt drama draws to a close, it is useful to separate fact from fiction before considering the way forward.

The IMF said publicly last spring [pdf] that it would revisit its sovereign debt restructuring policies, prompted by its recent experiences in Greece and Argentina. The prevailing narrative holds that in Greece, [pdf] the IMF came under political pressure from its biggest shareholders (member states) to finance a hopelessly over-indebted government, initially without demanding sacrifice from private creditors. IMF and EU money paid off private claims on the Greek government. The result was a bigger Greek debt stock dominated by public creditors and impaired IMF credibility. The Fund came off as captured by Europe, which was looking out for its banks, which had foolishly invested in risky Greek debt. Meanwhile, US federal court rulings against Argentina and a copycat lawsuit against Grenada had convinced the official sector that holdout creditors were resurgent, threatening to disrupt future sovereign workouts.

Partly responding to criticism of its Greek programs, the IMF has already revamped [pdf] the way in which it evaluates distressed countries’ debt burdens and has begun to release more information about its analysis to the public. In this way, Fund staff may better insulate itself from political pressure to fudge sustainability assessments and avoid debt restructuring. More ambitiously, the Fund is reviewing its lending policies to address burden-sharing with private creditors. Responding to holdout litigation, IMF staff suggests debt contract reform to neutralize holdouts, focusing on clauses that let all of a sovereign’s private bondholders hold a single aggregated vote to restructure the debt (paragraph 42 of the IMF paper). [pdf] A supermajority could then impose new terms on everyone.

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