(2014), German Council of Economic Experts (2015). Restructuring the Sovereign Debt Restructuring Mechanism Rohan Pitchford University of Sydney Mark L. J. Wright University of California, Los Angeles ABSTRACT Sovereign defaults are time consuming and costly to resolve. since the ECB announcement concerning Outright Monetary Transactions. From the Autumn 2022 edition of The Bretton Woods Observer. She was awarded the 2022 Society of International Economic Law (SIEL)-Hart Prize in International Economic Law for her doctoral research on the political economy foundations of international sovereign bankruptcy law. It should strive to create Another limitation of collective action clauses as a coordination solution is that while they may mitigate coordination problems among heterogeneous bondholders, they would fail to address differences across different classes of debt holders, such as claimants on syndicated bank loans. Desperately seeking a mechanism for sovereign debt restructuring. The assessment seeks to evaluate the level of country risk and the risk of a debt crisis, in both cases measured on the grounds of quantitative indicators. Liquidity is the key to understanding the structural causes of sovereign debt crises. The third type of clause specifies the terms for launching restructurings. This makes a country more prone to exchange rate instability created by international liquidity booms-and-busts, increasing the likelihood of a sovereign debt crisis. The investors would then punish that country with inferior credit terms. Second, even though the cost of requesting a restructuring will be reduced by a workout mechanism, restructurings still will be sufficiently disruptive and costly to ensure that debtors will not enter into them if they can be feasibly avoided. this feature of a sovereign debt restructuring mechanism would be similar to the majority restructuring provisions of domestic insolvency laws, which aggregate the claims of all eligible creditors (irrespective of the nature of the instrument) when determining whether there is adequate support by a majority to make an agreement binding on all The IMF's role in sovereign debt restructurings 4 Executive summary This report focuses on the international architecture for sovereign debt restructurings (SODRs), as seen through the lenses of the International Monetary Fund and with a special attention to the role that the Fund can play in facilitating orderly restructuring processes. The cooling-off period is envisioned to last about 60 days (Taylor 2002). We are now almost one year into the renewed debate on the resolution of sovereign debt crises that began with a speech last November by Anne Krueger proposing the creation of a sovereign debt restructuring mechanism (SDRM). However, the IMF has been reluctant to support a statutory mechanism for the collective reorganisation of sovereign debt since the withdrawal of its proposal of a Sovereign Debt Restructuring Mechanism. Finally, there is the issue of adjudicating disputes. Such factors are said to result in the sovereigns inability or unwillingness to honour its financial obligations, leading to defaults. Over the 1990s, public and private international borrowers shifted the composition of their external financinginstead of relying primarily on loans from a syndicate of a few banks, they turned to issuing bonds. Stakeholders in this process have repeatedly failed to reach an agreement that would set up a rules-based sovereign debt restructuring mechanism. Conference on Sovereign Debt Workouts: Hopes and Hazards? Institute for International Economics, Washington, DC. the auction-based debt restructuring process. As a result, the fulfilment of sovereign debt contracts from peripheral currency states is significantly affected by global movements that lie beyond their fiscal rules. If, all else equal, one third of the missing revenue was collected, Italys budget deficit would virtually disappear and the debt ratio would fall sharply. Given the higher propensity of investors to dispose of their assets denominated in peripheral currency during bursts in the liquidity cycle, the ability of peripheral central banks to make sovereign debt safe by acting as a LOLR is limited compared to core central banks. If it felt that it did not, the IMF could withhold further financing. "Redesigning Sovereign Debt Restructuring Mechanisms. The IMF has raised it without taking any formal stance on this point, merely stating that judgments about sharing the burden between domestic and foreign creditors would need to be made on a case-by-case basis that incorporates the impact of such decisions on the domestic financial market. One advocates a decentralized approach, and it is currently associated with policymakers in the U.S. Treasury. This Paper. Despite their differences, the proposals are not mutually exclusive, and at this point it appears that a set of new policies on debt restructuring will include elements of both proposals. This implies that core currency states can access unlimited, non-conditional reciprocal swap arrangements with an ILOLR, while most peripheral currency states are left with the IMF as their only source of international liquidity. From its inception in 1964, UNCTAD Ministerial Conferences placed core emphasis on developing country debt and debt service problems (e.g. 2002. Presented in 2001 and abandoned in 2003, the proposal included a debt standstill during the restructuring process and a cramdown whereby the agreement of a supermajority of creditors with the terms of the restructuring would have a binding effect on the minority. ZEW discussion paper No. Once the debt relief has been granted, the sovereign borrower is generally free to spend or misspend the . However, global liquidity is unevenly available to states, due to asymmetrical levels of monetary power. The SDRM would create a new international legal framework for sovereign defaults, similar to bankruptcy proceedings in the private sector. Over the past two decades, emerging market developing economies have seen their share of sovereign domestic debtlet's call it "domestic debt" for shortincrease from 31 to 46 percent of their total sovereign debt. 2019, IMF 2020b), the process starts by determining a sustainable debt service-profile. In the absence of a fundamental change in the geopolitics of global money, an equitable shorter-term mechanism is needed to stave off a new wave of sovereign debt crises. and pay only $8.25 each, Buy 500 or above Contrary to mainstream assumptions on fiscal fundamentals, the solvency of states is critically determined by their monetary power: The ability to issue debt in their own currency and the degree to which such currency performs the functions of money internationally. The review found that recent restructurings of sovereign debt had been much smoother . Krueger has to construct a convincing case that the SDRM would be more effective than alternative approaches to sovereign defaults. Another issue is the treatment of domestic creditors. Hence the proposed New York law approach is unexpected and the lack Students must weigh the advantages and disadvantages of different approaches to sovereign defaults. But when things are going badly, it is the poor who are hurt the most. Anne O. Krueger of the International Monetary Fund (IMF) is proposing a new approach to sovereign defaults: the Sovereign Debt Restructuring Mechanism (SDRM). Admittedly, a structural reform of such type would require a major change in the geopolitics of global money that may not be viable in the current circumstances. Countries have been reluctant to give up power to supranational rules or. See ESM (2012). sovereign debt restructuring is a careful analysis of the problems that such a mechanism should address. sovereign debt restructuring treaty or model law has not been favoured at this time. FUET, Economics Foundation, University of Rome Tor Vergata, Rome, Italy, 2017 Springer International Publishing AG, Barbieri Hermitte, R. (2017). Currency hierarchy is equally critical in establishing the level and conditions under which a state can access an ILOLR. The Future of European Government Bonds Markets, 2 May 2016, Weber A, Ulbrich J, Wendorff K (2011) Safeguarding market stability, strengthening investor responsibility, protecting taxpayers. Collective Action Clauses and Sovereign Debt Restructuring Frameworks: Why and When is Restructuring Appropriate. But these costs also improve borrowing incentives ex ante. Download Download PDF. During this period, the debtor would negotiate a rescheduling or a restructuring, with IMF approval, with its creditors. She is particularly interested in the role of financial and monetary arrangements in development and environmental sustainability strategies. A serious flaw in conventional sovereign debt restructurings is the absence of any effective mechanism for the creditors providing debt relief to monitor or enforce how the sovereign debtor uses the savings that flow from the debt relief. Ms. Dauchy was a contributing author to Understanding Sovereign Debt: Options and Opportunities for Africa. This is, of course, a highly controversial issue. and pay only $8.50 each, Buy 50 - 499 But in today's world, the emergence of new and more varied creditors has made the process more difficult, pointing to the need for a new global facility. The case provides information on some major sovereign defaults (the crises in Latin America, Mexico, and Asia) and on the existing institutions and processes that creditors and debtors turn to in sovereign defaults. The main thesis is that the formal introduction of sovereign insolvency procedures into the ESM Treaty would make the mechanism too rigid and potentially destabilizing. Finally, creditors would be bound by the terms agreed upon by the super-majority through collective action clauses. Mimeo, Treasury Department, Ministry of Economy and Finance, Rome, Italy, You can also search for this author in Publication Date: Sovereign insolvency should be conceived not as a states inability or unwillingness to pay its debts, but rather as inability to continuously ensure or otherwise access liquidity. To do so, the IMF should rely upon its institutional memory to reinstate its support for an international sovereign debt restructuring mechanism. Historically, debt accumulation by sovereigns has been a pressing issue. 1 short forms of Sovereign Debt Restructuring Mechanism. The IMF reviewed the institutional mechanisms that address sovereign debt restructurings in 2020 policy paper, The International Architecture for Resolving Sovereign Debt Involving Private-Sector CreditorsRecent Developments, Challenges, And Reform Options. The most recent stress test is reported in EBA (2016). The risk that entire countries could go bankrupt has become inevitable post COVID. The sovereign debt crises threatening states in the Global South are less about fiscal mismanagement and more about monetary power in the global currency hierarchy, and until that issue is addressed, these states will continue to be vulnerable to debt crises and their punishing consequences. Those dynamics, while seldom discussed outside of specialist circles, have significantly contributed to the unequal recovery from the pandemic (see Observer Summer 2020). Ecuador and Venezuela each defaulted ten times between 1800 and 2010, and Greece defaulted five times between its war of independence (1821-1830) and 1932. . (2013), Fuest et al. The IMF has acknowledged that it would be difficult for its Executive Board to adjudicate disputes of this kind. Research Library All rights reserved. Second, debtor behavior would need to be constrained during the negotiation period to ensure protection of creditor interests. no. WASHINGTON, DC When the economy is going well, the poor benefit more than others. One advocates a decentralized approach, and it is currently associated with policymakers in the U.S. Treasury. For such debt governments have the means to resolve collective action problems. The sovereign debt crises threatening states in the Global South are less about fiscal mismanagement and more about monetary power in the global currency hierarchy. by By Dr Karina Patricio Ferreira Lima, University of Leeds. 1 This is usually called Zdebt restructuring [ as opposed to Zdebt rescheduling [ which consists of amending the . 2002. VoxEU, Zettelmeyer J (2016), Sovereign debt restructuring in the euro area: an introduction to the debate. CEPR Press, EBA (2011) EU-wide stress test results, European Banking Authority, 15 Jul 2011, EBA (2016) EU-wide stress test results, European Banking Authority, 29 Jul 2016, ECB (2012) Technical features of outright monetary transactions, European Central Bank, 6 Sept 2012, ESM (2012) Treaty establishing the European stability mechanism, ESRB (2016) Adverse macro-financial scenario for the EBA 2016 EU-wide bank stress testing exercise, European systemic risk board, 29 Jan 2016, European Finance Committee (2012) Common terms of reference for euro area collective action clauses, Fuest C, Heinemann F, Schrder C (2014) A viable insolvency procedure for sovereigns (VIPS) in the Euro Area. Crucially, a states ability to guarantee the performability of its sovereign debt contracts while maintaining macroeconomic stability depends on the hierarchy of its currency. Eichengreen, Barry, and Ashoka Mody. The problem is that, if investors saw that one country was leading the way in including such clauses, they might think this country is abnormally concerned with debt renegotiation procedures and assume that it perceives a higher than average probability of finding itself in a renegotiation. Market . Throughout most of the issues raised above, there is a tension between the stance that decisions are to be left in the hands of a super-majority of creditors and the perceived need for a rapid and orderly workout that disrupts the domestic economy as little as possible. At an international level, this view is reflected in the IMFs Debt Sustainability Assessment (DSA), which guides all the IMFs surveillance, lending, and disbursement monitoring activities. One could envision a scenario where a government that failed to include such clauses could find itself in economic difficulty after the fact. The DSAs primary policy preference to pursue sustainability is to generate primary fiscal surpluses and reduce the debt-to-GDP ratio, notably through fiscal adjustment. Clear rules for creditor participation in case of overindebtedness would strengthen market discipline and enhance the effectiveness of crisis assistance. In: Paganetto, L. (eds) Sustainable Growth in the EU. Sovereign debt crises represent an increasing problem in the world economy and an obstacle to development. . Second, a states fiscal capacity is critically influenced by the position of its currency in the global hierarchy. Sovereign debt crisis solution: African countries trading more with each other. A new judicial group within the IMF would oversee the SDRM, and it would be implemented through international treaties. The concept of monetary power, as employed here, includes both the ability of a state to issue sovereign debt in its own currency and the degree to which a national currency is able to perform the functions of money as a unit of account, medium of exchange, and store of value internationally. This publication is edited by Sam Zuckerman and Anita Todd. The Report on Tax Evasion recently released by a committee appointed by the Italian government (MEF 2016b) estimates a tax gap (including social security contributions) equivalent to 6.84% of GDP in 2013, the most recent year for which a complete set of figures is available. To tackle the increasing risks of disorderly defaults and the crisis of multilateralism, the International Monetary Fund must reckon with the monetary determinants of sovereign debt crises and support the creation of an international sovereign debt restructuring mechanism. However, countries typically issue debt in a number of legal jurisdictions, so there is no guarantee that such a clause would be interpreted the same way across jurisdictions, even if it were worded identically. Please send editorial comments and requests for reprint permission to This is especially true in the case of the COVID-19 pandemic, which has hit poor countries - and the poorest people within . The stock of sovereign debt in the hands of the private sector and of foreign central banks has fallen by an equivalent proportion. Banks exposures were reported in EBA (2011). Most recently, members of the German Council of Economic Experts proposed a Sovereign Insolvency Mechanism for the Euro Area . Second, the system would be designed to spread the burden of balance of payments adjustment equally between deficit and surplus countries, thereby incentivising balanced flows internationally. These figures are based on the latest estimates for 2016 by the European Commission as reported in the AMECO online database at the time of writing. Guaranteeing involves the state, typically through its central bank, acting as a LOLR in the government bond market to ensure the performability of sovereign debt contracts. 1 of 10 Ad. 14 ICMA has also proposed a new form of standard pari passu clause for sovereign debt securi- ties, responding to concerns that existing pari passu clauses are undermining Argentina's debt-re-structuring efforts. Download Citation | American States and Sovereign Debt Restructuring | When States Go Broke collects insights and analysis from leading academics and practitioners that discuss the ongoing fiscal . Subscribe It is important that policymakers including at the IMF recognise that such crises are not necessarily the product of bad luck or bad decisions by individual governments, but rather a systemic feature of the current international monetary system. Recent financial crises in Latin America, Asia, Russia, and the Middle East hve resulted in widespread restructurings of sovereign debt. Ultimate approval of the terms of the restructuring could remain in the hands of a majority of a super-majority of creditors, across a broad range of credit instruments, and the sovereign debtor. While the IMF welcomes the inclusion of collective action clauses in bond issues as a fundamental component of addressing problems in sovereign borrowing (see, for example, Krueger 2002), it has argued that a policy based solely on the inclusion of such clauses is not sufficient. As long as the international monetary system is built upon a global currency hierarchy, such crises will not disappear. Sovereign Debt Restructuring Mechanisms (SDRMs) have been the subject of a considerable volume of working papers and policy proposals since the eruption of the Euro area sovereign debt crisis in 2010. The author wishes to thank, without implicating them, Jeromin Zettelmeyer, Eugenio Gaiotti, Carlo Cottarelli, Ottavio Ricchi and Alberto Cagnazzo for helpful discussions on this subject. In the speech, she proposed a "sovereign debt restructuring mechanism" and her idea garnered enormous attention in international policymaking circles. and pay only $8.00 each. Desai, Mihir A., Christina Pham, Julia Stevens, and Kathleen Luchs. Consequently, there would be no stigma against any individual nation doing so. Treasury proposes that decisions be made on an issue-by-issue basis through majority voting, with inconsistencies across different types of debt claims to be handled through an arbitration process (Taylor 2002). Register as a Premium Educator at hbsp.harvard.edu, plan a course, and save your students up to 50% with your academic discount. The importance of currency hierarchy as a structural determinant of sovereign debt crises is three-fold. Nations have borrowed unsustainably, and the heavy burden of the loans is now coming to bear. Finally, currency hierarchy determines the states capacity to guarantee the safety of its sovereign debt contracts by acting as a lender of last resort (LOLR), or otherwise, by accessing financing from an international lender of last resort (ILOLR). EUROPEAN FINANCIAL INFRASTRUCTURE IN THE FACE OF NEW CHALLENGES, ed. While fiscal misfortunes and mismanagement have some explanatory power, such a viewpoint tends to neglect the monetary factors at the root of sovereign insolvency. Under those circumstances, it may be hard for the IMF to resist providing assistance to a country that is taking positive steps to address its financial difficulties. However, there are still some issues that need to be solved. The challenging debt landscape of DEEs amidst the prospect of further fragmentation of multilateralism is bringing the legal governance of sovereign debt crises to the centre of the stage. Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.
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