Following the Mexican devaluation crisis of 1994 and the Asian crisis of 1997, the official sector (the IMF and the G-10 governments) became increasingly uncomfortable with the policy implications of bailing out private bondholders with public funds. The message went out in 1998 that bondholders and bank lenders should not expect to escape future sovereign debt crises without rescheduling their existing claims, lending new money or, when necessary, writing off part of the debt. This was hailed as the new international financial architecture. It lasted for only three years:1998-2000.
During this period, two countries, Pakistan and Ukraine, were forced to reschedule their Eurobonds as a condition of obtaining multilateral and bilateral financial assistance. Russia successfully completed a restructuring of its Soviet-era debt owed to private creditors in August of 2000 and obtained a 36.5% reduction in the size of those claims. After defaulting on its Brady bonds (the first country to do so) and its Eurobonds in late 1999, Ecuador restructured those instruments a year later with approximately a 40% reduction in the size of the affected debt stock.
Even in the heyday of the new financial architecture, however, a few cynics wondered aloud whether the public sector’s insistence on burden sharing by private-sector lenders would apply only to the smaller debtor countries (such as Pakistan, Ukraine and Ecuador), but would evaporate when crises appeared in countries that were thought to pose a systemic risk to the international financial network, or in countries that enjoyed significant geopolitical clout. The cynics were right.
At the end of 2000, Turkey (not on everyone’s list of systemic threats to international finance but enjoying some geopolitical leverage) encountered a banking crisis and associated financial difficulties. The response? A multilateral bailout of the kind that the official sector had so openly forsworn a few years before. Several weeks later, a $39.7 billion bailout package allowed Argentina (the most active emerging-market borrower) to continue normal servicing of its external debt payments in 2001. When the evil day finally arrived, therefore, the official sector’s fear of a contagious financial crisis overcame their policy misgivings about insulating private investors from the consequences of investment decisions.
Investors will glean from these events obvious lessons: lend to a smaller emerging-market country and you will be expected to accept your losses with manly fortitude if the borrower runs into trouble. But lend to a country with the capacity, or perceived capacity, to destabilize the international financial system and no unpleasant reschedulings, restructurings or write-offs will be required. Going forward, we may well find that only larger or geopolitically advantaged sovereigns will enjoy access to international bond markets. Smaller countries will be shunned by international investors, with adverse effects on development programmes.
Apart from the uncertainty created by this thorough muddling of the official sector stance on bailouts, private investors have also come to regard bilateral (Paris Club) creditors with deep suspicion. The Paris Club insists on a principle of comparable treatment of other creditor groups: any rescheduling of Paris Club debt must be matched by comparable reschedulings of amounts owed to other creditors, including the country’s private-sector lenders. Each debtor country approaching the Club is required to commit itself to implement this principle in its dealings with other creditors.
Comparability, it turns out, is not a two-way street. The Paris Club insists that other creditors provide debt relief comparable to Paris Club terms, but it rejects out of hand the suggestion that any deeper debt relief provided by private sector creditors should be matched by Paris Club lenders. Both Russia and Ecuador achieved significant reductions in the stock of their private sector debt in 2000, but both have been rebuffed in their efforts to persuade Paris Club creditors to reciprocate with equivalent concessions.
This Paris Club resistance to reverse comparability triggers two reactions in private-sector creditors, one emotional, the other financial. Here is the emotion. The private sector will not long tolerate a situation in which the cashflow savings resulting from a reduction or rescheduling of claims against a sovereign is then cited by another creditor group (in this case, the Paris Club) as a justification for demanding full payment of their credits. Unless there is a dramatic change in Paris Club policies, sovereign borrowers will be told to settle their affairs first with Paris Club creditors before approaching the private sector for significant debt relief.
The financial argument goes like this: there will no doubt be situations in which a deferral of short-term maturities will be adequate to restore a country to a sustainable external payments position and, in these cases, a simple rescheduling of both Paris Club and private sector debt will be adequate.
But there will undoubtedly also be situations where a sovereign’s external debt stock is simply too large, by any reasonable measure, to be serviced on its original contractual terms without significantly retarding growth and development. In these latter cases, private creditors will consider reducing the size of their claims if, but only if, they believe that the effect of the restructuring will be to enhance the collectibility of the balance of their credits.
Absent this assurance, there is no financial justification for any creditor to forgive any part of his claim. But when another significant group of creditors – the Paris Club – refuses to accept similar debt relief, it is more difficult to reach this judgment about the enhanced collectibility of remaining claims and thus more difficult for private creditors to justify to themselves or to their shareholders accepting a sovereign borrower’s request for debt forgiveness.
The Paris Club’s behaviour in recent sovereign debt workouts has infuriated private lenders. There is a strong suspicion that the official sector has pressured some smaller debtor countries to bail in their private creditors in order to vindicate the principles of the new international financial architecture, but has drawn the line at making comparable concessions on their own loans to these countries. One interpretation of recent events is that the private sector will be asked to subsidize bilateral lenders in cases where no official bailout is forthcoming, in return for being themselves subsidized in countries found eligible for official bailouts.
The solution will require much closer coordination between the restructurings of bilateral and private creditors. Both groups should start from the same set of macroeconomic assumptions and projections (the IMF’s, in most cases) and both should accept similar treatment of similarly situated debt.
If the official sector’s policy is to arrange financial safety nets for distressed sovereign debtors, that policy should apply to any sovereign – large or small – prepared to undertake appropriate economic reforms. On the other hand, if the official sector recants its recent backsliding and returns to its doctrine of burden sharing in sovereign debt crises, that policy too should be applied evenhandedly across all creditor groups, official and private.
