IMF-run debt standstill?

by Chakravarthi Raghavan

GENEVA: After opposing and resisting for over two decades, the International Monetary Fund is now moving in the direction of international bankruptcy procedures and debt standstills by debtor countries with IMF authorization while the debtor country and private creditors negotiate a sovereign debt restructuring.

The idea, first mooted by the United Nations Conference on Trade and Development (UNCTAD) in its 1986 Trade and Development Report and further developed and advocated in its TDRs of 1998 and  2001, has now been adapted and promoted by the First Deputy Managing Director of the IMF, Anne Krueger, who chose a dinner meeting of the American Enterprise Institute in Washington DC on 26 November to unveil her idea.

While going some way in the direction of critics of the Fund and the international financial system, the proposals outlined in Krueger’s speech, including an authorization for imposing exchange controls for a limited time while an “orderly workout” could be negotiated, may result in merely strengthening the hand of the IMF management and in the application of wrong conditionalities, if the process is controlled and run by the Fund (which, as a creditor itself, has a conflict of interest) rather than by an independent authority to adjudicate the disputes and enable an equitable process.

The idea mooted in Krueger’s speech would appear to have been discussed at the mid-November IMF-World Bank meetings in Ottawa, with no definite opposition from any of the major IMF members but with some questions and critical views from the Latin American region. The opposition to the idea from the region’s economies is perhaps due to their extreme vulnerability, their having opted for neoliberal policies that have in effect made them dependent on foreign funds (whether short-, medium- or long-term) to finance their current account deficits and consumption, rather than productive investments.

Krueger, who holds the second highest position in the Fund and in effect ensures US Treasury control over the international lender, said in her speech that the IMF management and staff are discussing the proposal and that it would be considered at the Fund’s Executive Board in December.

As unveiled in her speech, Krueger’s proposals involve:

   *   firstly, a mechanism to prevent creditors from disrupting negotiations leading to a restructuring agreement by seeking repayments through national courts (and getting attachment orders to seize the foreign assets);

   *   secondly, the mechanism’s providing the creditors with some guarantee that the debtor country would “act responsibly” during the standstill, adopt “appropriate” economic policies and “negotiate in good faith” with creditors, and refrain from treating some creditors more favourably than others;

   *  thirdly, “encouragement” to private lenders to provide fresh money to meet the financing needs of debtors, with the lenders getting the status of preferred creditors, meaning these loans would be repaid ahead of existing loans; and

   *  fourthly, binding minority creditors to the restructuring agreement that would be accepted by a large enough majority of creditors.

Among the “practical” questions needing solutions, the IMF official said, were:

   *  setting up a legal basis for the mechanism so that it would have the effect of a “universal law” and creditors could not get around it by seeking a forum or a country to enforce their claims;

   *  the Fund’s involvement in the control and operation of the system;

   *  activating the standstill by the debtor through endorsement by the Fund; and

   *  ensuring “appropriate behaviour” by the debtor through periodic review and sanction of the standstill by the Fund management (as now under the IMF-supported structural adjustment programmes).

While welcoming the IMF move in the direction of international bankruptcy procedures, Yilmaz Akyüz, the chief author of UNCTAD’s TDRs and acting Director of the UN body’s Division on Globalization and Development Strategies, said the idea would not work and would be quite useless “unless in times of crisis the (debtor) countries impose capital controls.”

Evolution of bankruptcy idea

The idea of “international debt reform” was mooted by UNCTAD in 1986, in an annex to that year’s TDR, as a policy measure to increase world growth, lower world interest rates and increase capital flows, and thus overcome the debt and growth crisis that was enveloping the developing world. The proposal was patterned on the lines of Chapter 11 of the US bankruptcy code.  However, it was ignored and scorned not only by the Bretton Woods institutions and the major industrial countries but even among the developing countries who were heavily indebted to private creditors.

The Fund and others preferred an ad hoc approach: rescheduling of debt and creation of new debt instruments at a heavy cost to the debtor countries, and financial liberalization sought by the private capital holders.

The surge of capital flows was pointed to as showing the validity of this ad hoc, case-by-case approach. The capital inflows were touted as proof that such liberalization was attracting funds that could be used by the recipient countries to fill their savings gap and enable investment without having to face balance-of-payments constraints or rising indebtedness. The capital inflows, or most of them, were described as “non-debt-creating” though in fact the external debt of these countries began to rise in 1990, both in absolute terms and as a proportion of their export earnings.

The dangers of such a policy were brought out in dramatic fashion with the outbreak of the 1997 financial crisis in Asia. The subsequent IMF policies to manage the crisis (in effect forcing Thailand and other South-East Asian countries to devalue, raise interest rates and adopt other adjustment policies, including further financial liberalization and selling assets on the cheap to foreigners) only made matters worse, adding political crisis and bringing down governments on top of the economic crisis. Only Malaysia escaped this ordeal, by disregarding the IMF advice and imposing capital controls.

UNCTAD again proposed international bankruptcy procedures and invoking the use of Art. VIII of the IMF’s Articles of Agreement (under which countries could be asked to impose capital controls to prevent outflows on the capital account). However, the proposal did not get far, since the creditors were more intent on disciplining the debtors than finding durable solutions.

Large bailout packages were put in place instead, often designed to ensure that debtors met current obligations to creditors while keeping their capital account open and adopting tight macroeconomic policies to ‘restore confidence’ and make it attractive to lenders to provide funds. These did little, however, to either prevent the collapse of currencies or prevent recession. The economic and social conditions in many of the countries in fact worsened.

Neither individual country situations nor that of the international financial system has improved; each crisis is being followed by another, with every new bailout package involving more and more funds.

Argentina and Turkey are currently the prime examples of cases where the bailout policies have failed. While Turkey, because of its ‘geography’ and strategic importance to US campaigns in the region, is being favoured with large bailout packages, in the case of Argentina (with its currency board system and free convertibility on a dollar-peso parity basis), where the debt is now mostly held by nationals, there is now a distinct possibility of debt default.

According to Akyüz, a way forward, in terms of the IMF’s coming around to the idea of international bankruptcy models, would be to frame explicit guidelines under  the IMF’s Articles to enable a stay on creditor  litigation and give some statutory protection to the debtor countries imposing temporary standstills.

The decision of whether or not to impose temporary standstill should rest with the debtor country, which should be enabled to get an examination and endorsement of the move by an independent panel. TDR 2001 suggested in this regard a procedure similar to the safeguards procedure of the WTO, and also proposed strict limitations on crisis lending in order to ensure private sector involvement and the private sector’s sharing the burden for its unwise lending. The debtor country should be enabled to initiate restructuring of its private and sovereign debt under international rules formulated on the model of Chapter 11 of the US bankruptcy code. These should enable a rapid but comprehensive debt restructuring - by extending maturities, debt-equity conversions and some debt writeoffs.

Such a move would alter the balance of negotiating strength between creditors and debtors and between developed and developing countries.

It may have some negative effect by reducing aggregate financial flows, mainly short-term speculative flows. However, this has also to be balanced by the fact that for the first time in many years, the developing world has a net outflow of capital, estimated by the IMF to involve an outflow of $1.4 billion.

For the proposals to move forward and gain some  credibility as well as wider public acceptance,  perhaps  an independent commission or group (and not the IMF/World Bank management) would be needed to work out the technical details and practical procedures. (SUNS5021)

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.