Tokyo Panel Discussion on Sovereign Debt Restructuring

October 17, 2012
Development Committee Press Conference at the 2012 Tokyo Annual Meetings of the IMF and World Bank Group (Ryan Rayburn/World Bank).

CIGI, together with the UN financing for development office, hosted a panel discussion on sovereign debt restructuring at the IMF/World Bank annual meetings. The panel featured an impressive group of speakers drawn from academia, the private sector and official sectors. It built on two earlier Expert Group meetings held in May and September, respectively.

The discussion in Tokyo covered a number of key issues. As Barry Eichengreen argued, a fundamental question is how to strike the right balance between ensuring that debt restructuring is sufficiently costly to the sovereign in order to support sovereign lending, on the one hand, and the need to restructure debt when it is clearly unsustainable, on the other. In a sense, this "Goldilocks" challenge (a process that is neither too easy, nor too hard) is about balancing incentives to repay debt (preserve its bonding role) and incentives not to "defect" from the cooperative outcome of strong policy frameworks and the open international trade and payments system that has been constructed over the past 65 years.

This question also frames other issues, including how best to secure the timely, orderly restructuring of sovereign when it is required. This challenge is often presented in terms of voluntary versus statutory (as, perhaps, a euphemism for "coercive") approaches, with the use of collective action clauses, falling under the former, and the IMF's ill-fated Sovereign Debt Restructuring Mechanism (SDRM) of a decade ago, the public face of the latter. As Willem Buiter noted, however, this dichotomy is misleading. By legal convention and statute, sovereigns are not constrained as are private agents. Moreover, the two basic approaches are complementary — in most jurisdictions with well-designed bankruptcy regimes, most so-called voluntary restructurings are held in the "shadow of the courthouse."

What does this mean? Legal frameworks (or rules of the game) provide greater clarity — not certainty — on how a particular restructuring would be dealt with by a disinterested judge. This allows the debtor and its creditor to come to a restructuring agreement sooner, with less loss of value to creditors and lower costs to the citizens of the country from economic disruption. And, even in this felicious case, creditors that "holdout" in an effort to delay the restructuring in order to secure higher returns are subject to a "cram down" through CACs, provided a requisite supermajority of creditors agree to the restructuring.

Rather than the voluntary-statutory divide, a better taxonomy is "conctractual" and "rules-based."

An important issue picked up by Amar Bhattacharya and Jose Antonio Ocampo is the role of the official sector, especially the IMF. The key here is defining when a country's debt burden is unsustainable. Most observers agree that the IMF is best placed to make this determination. The problem is when that "call" is ensnared with substantial amounts of IMF lending. Because the IMF is accorded a preferred creditor status, additional IMF lending has the potential to subordinate private sector creditors, who complain the Fund is conflicted —in effect, they contend, the IMF can judge a debt burden unsustainable, triggering a restructuring, secure in the knowledge that it will remain whole.

At the same time, there is a potential role for the official sector to provide assistance to a country that is prepared to negotiate in good faith with its creditors, but is locked out of capital markets without access to financing. In this regard, the IMF's lending into arrears policy can help prevent a virtigous decline in output that would harm all —private creditors and citizens alike.

Finally, the panel also considered the feasibility of state-contingent contracts to facilitate better risk sharing. Robert Gray noted this a perennial issue in discussions to improve the process by which sovereign debt is restructured.

Personally, I am sceptical of how far state-contingent contracts can go. My doubts do not reflect limitations of contract design, but the issue of monitoring, verification and enforcement. Such contracts are conditional on the measurement and publication of specific states of the world. Now, a government will always want creditors to share in "bad" states; it is not clear that sovereigns will be equally prepared to share in good states, particularly given unlimited demands for scarce, limited resources. We are back to the problem of unenforceable contracts and sovereign immunity.

In this respect, these instruments would very likely be quickly viewed as insurance contracts for the "bad" states; being insurance contracts, investors will price them so as to extract the necessary premium. As a result, they will carry a fairly substantial premium over plain vanilla instruments. My guess is that governments would be unwilling to issue bonds that carry high premiums today to insure against possible bad states tomorrow (particularly when another government might be in charge).

It is possible that governments would agree to third-party verification and enforcement. But the implicit loss of sovereignty that would entail makes this option unpalatable, except perhaps in extremis.

Alternatively, efforts could be made to develop rules on making debt instruments more state-contingent ex post, rather than ex ante. But isn't that what sensible, efficient bankruptcy regimes do?

  "Alternatively, efforts could be made to development...". Thanks again.

*This post was prepared from notes taken by Paul Blustein, a co-moderator of the panel and senior CIGI fellow, who graciously permitted me to draw on them.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

About the Author

James A. Haley is a senior fellow at CIGI and a Canada Institute global fellow at the Woodrow Wilson Center for International Scholars in Washington, DC.