Experts debate merits of IMF bankruptcy idea

by Emad Mekay

WASHINGTON: Analysts remain divided over whether an International Monetary Fund (IMF) proposal to help insolvent countries avoid litigation by private bondholders will quell the financial jitters associated with international bankruptcy.

The proposal, outlined in the week of 26 November by the Fund’s number-two official, Anne Krueger, would allow trouble-stricken countries to reschedule sovereign debt and call a temporary standstill in the interim. The process, modelled on US private bankruptcy procedures, would be designed to ease pressure on debtors, creditors and the IMF, which traditionally has had to step in with bailout funds for governments to use to pay private holders of sovereign debt instruments.

As with other IMF packages, the Fund’s support would be contingent upon a country’s implementation of “a sensible economic adjustment package” and on the country’s readiness to “negotiate with its creditors in good faith,” said Krueger. The Fund would signal its support by being prepared to lend to the country even though it was in arrears to its private creditors.

“The idea is to create incentives for debtors and creditors to reach agreement of their own accord, so the mechanism would rarely need to be used,” she added.

Left-wing and right-wing critics of traditional bailouts have long urged some kind of global bankruptcy mechanism. At the same time, the IMF and some governments have sought ways to “bail in” private investors - that is, make them share in the costs of financial stabilization - rather than simply rescue them at borrowing governments’ expense.

Fund critics - and a number of agency staff members - long have complained that bailing out private investors simply encourages “moral hazard”, the repetition of the same rash gambles in expectation that the IMF also would soften any future falls.

John Williamson of the Institute for International Economics, a think-tank here, said he favours the Fund proposal as “a way of sorting things out when debt proves unsustainable on the contracted terms.”

“There is no question but that it will be difficult,” he acknowledges, “but countries do sometimes get into debt difficulties however hard they try to avoid them, and it will be better for creditors as well as debtors if there is an orderly way for these to be sorted out.”

Carol Graham, a senior fellow at the Brookings Institution, welcomed the proposal but warned that “the devil will be in the details.”

“It is hard to predict what the impact on world financial markets would be in the future, but certainly the intent is to limit the high costs associated with countries carrying unsustainable levels of indebtedness - to both borrowers and lenders, and particularly to the citizens in borrowing countries, who usually bear the brunt of the costs,” she said.

Not everyone agrees.

“Standstills correct the world financial system the same way banging your head with a hammer will correct a headache,” said Gary Hufbauer, a trade expert at the Institute for International Economics and co-author of the book World Capital Markets: Challenge to the G-10.

Hufbauer argued that standstills would significantly depress capital flows to emerging markets, regardless of their creditworthiness.

“Standstills should only be a last resort,” he said. “Before more debtor countries get in the bad situation of Argentina or Turkey today, or Russia a few years ago, the G-10 countries should take strong proactive measures to dampen imprudent flows of foreign capital to those emerging countries.”

Krueger, however, tried to ease private creditors’ fears about doing business without the cover they have come to expect from bailouts and with the prospect that repayments could be suspended pending a  debt  workout. A  methodical restructuring, she emphasized, would help keep  the  value  of their debt instead.

“The value of their claims on the secondary market is unlikely to fall anywhere near as much as it does now when a country starts to get into trouble,” she said.

Williamson played down concern that the proposal would strengthen debtors’ hand against bondholders and thus dampen the flow of capital.

“I see a real danger that the initial reaction of investors will be very negative but if the mechanism is well-designed to keep a fair balance between the interests of debtors and creditors, the long-run impact could be very positive,” he said.

Graham agreed. “If well crafted, this should facilitate rather than curb the flow of private money to the emerging markets and at the same time discourage irresponsible creditor behaviour,” she said.

The plan, which has yet to be put to the IMF’s board of directors, would require a change of laws and political will on the part of shareholder countries, who would have to constrain their citizens from suing foreign governments, as private investors have done with Peru and Ecuador, for example.

Even assuming total political support for the proposal, implementation would take at least two to three years, meaning the new system would not be in place in time for Argentina or Turkey, said Krueger. Both countries, in the throes of crisis, are embroiled in tortuous negotiations with the Fund. (IPS)