THE PARIS CLUB has gone through fundamental change over the past year. First it agreed to an enormous debt reduction for Iraq, then it started to allow debtor nations to buy back their debts. Most recently, it came to a long-awaited and ground-breaking agreement with Nigeria that involved elements of both debt reduction and buyback.
At the same time, the official creditors’ association’s members are generally avoiding bilateral lending in favour of granting credits through multilateral institutions. Many private-sector creditors remain critical of the Paris Club’s opacity and high-handedness. But the future of the Club seems clear: more debt reduction, more buybacks, and less lending mean that it could be reforming itself out of relevance.
That would by no means be a bad thing. The Paris Club is almost unique among creditors in never wanting to roll over its debt; also, of course, it has a lot more political clout than the average bank or bondholder. For those reasons, most countries would rather not borrow from it. And for their part, Paris Club members, most of them in tough fiscal situations of their own, have no particular love of lending to other nations.
They have also, over the past decade, seen outright debt forgiveness move from being a bad thing fiscally to being a good thing politically. Middle-income countries have had increasingly large chunks of their debts forgiven, following the precedents set by Egypt and Poland in the 1990s.
“The Paris Club is becoming more pragmatic than it was before,” says Jean-Pierre Jouyet, who was the Club’s chairman until June and is now chairman of Barclays in France. “Since around 2000 and the HIPC [heavily indebted poor countries] initiative, debt forgiveness has risen higher on the political agenda.”
The Paris Club rules have changed to reflect this new approach. After Egypt, Poland and Serbia all got roughly half of their outstanding debts forgiven, in 2003 the Club formally adopted what it called the Evian approach.
Evian put an end to the sequence of increasingly generous restructuring terms that Paris Club members were willing to give to the poorest and most indebted countries: the Toronto terms of 1988, Houston terms of 1990, London terms of 1991, Naples terms of 1994, Lyon terms of 1996, and Cologne terms of 1999.
Under Evian, by contrast, the exact amount of debt relief to be granted is worked out on a case-by-case basis. Countries no longer needed to prove a certain level of poverty or indebtedness before receiving debt relief: if the political will exists, in theory any country is allowed to receive whatever the Club’s members are willing to offer.
Evian, in effect, ratified the politically motivated deals that had been done for middle-income countries in the past. Egypt was rewarded for its actions during the first Gulf war; Poland was rewarded for playing nice with the EU in general and Germany in particular; and Serbia got its debt reduction very shortly after Slobodan Milosevic was turned over to the war crimes tribunal in The Hague.
The Evian approach arrived just in time for Iraq, which approached the Paris Club at the end of 2003. Iraq’s case was the most difficult ever to appear before the Paris Club: normally, countries don’t even bother turning up if there isn’t a large degree of agreement between the creditor countries as to what kind of deal should be done.
Without Evian in place, it’s hard to imagine that the Paris Club member nations would have signed off on a deal as nakedly political as Iraq’s. Iraq really needed flow relief, not stock relief: although it can’t repay anything now, it is sitting on roughly $10 trillion in oil reserves, as well as hundreds of trillions of cubic feet of natural gas. In the end, though, 80% of Iraq’s debt was forgiven.
In turn, Iraq arrived just in time for Nigeria. Part of the groundwork had already been laid by Argentina, which set a precedent for debt relief of the order of 70% for a middle-income country. But that debt was from the private sector, not Paris Club. From the Paris Club point of view, the key precedent in Nigeria’s case was Iraq, another middle-income oil-producing nation that received a large amount of outright debt forgiveness.
Nigeria had long been something of an embarrassment for the Paris Club. The equation ran something like this: 19–11=31. Paris Club member nations lent Nigeria a total of $19 billion. Nigeria has repaid those member nations a total of $11 billion. And the total amount that Nigeria has outstanding in Paris Club debts is $31 billion. By the time the debt process has finished, the Paris Club will have been repaid a total of $23 billion on its $19 billion in original lending; it will have forgiven $18 billion more.
It seems almost usurious – that rich Paris Club countries should ask for repayment of $22 billion in interest and arrears on $19 billion in principal. And in fact arguments to that effect did help a deal get done. Lex Rieffel, a visiting scholar at the Brookings Institution in Washington, DC, says that “the Nigeria case demonstrates the ability of the Paris Club to modify its rules when the reasons to do so become compelling”.
But the compelling reasons ultimately had little to do with lenders’ remorse over how much interest they were charging. Much more important was the emphasis placed on debt relief for Africa at the G8 summit in Gleneagles in July. After the summit, Africa’s HIPC countries were left with a commitment to wipe out completely both their bilateral and their multilateral debt. Nigeria, meanwhile, with tens of billions in debts and a per capita income lower than that of the average HIPC nation, was not included in that deal. Given that it is the most populous country in Africa, something had to be done about its debt.
Cynical reasons There were cynical reasons for doing the deal, as well. Historically, Nigeria’s oil wealth has been more of a curse than a blessing, creating a kleptocracy that is consistently at the bottom of Transparency International’s corruption perceptions index. (In 2004, it came in 144 out of 146 countries, with only Bangladesh and Haiti reckoned more corrupt.) But now, for what might be the first time ever, windfall oil profits for Nigeria happened to coincide with a relatively clean government, and a spotlessly clean finance minister.
The Paris Club, on this view, basically jumped at the chance of getting its hands on a chunk of Nigeria’s oil revenue before anybody in the country could steal it – $12 billion today is much better than $31 billion never.
The official structure of the deal is fairly complex. Nigeria’s Paris Club debt totals somewhere between $30 billion and $31 billion, depending on international exchange rates: most of it is not dollar-denominated. Of that, some $6 billion is considered to be arrears by the Paris Club, and Nigeria is paying that sum in full. That leaves about $24 billion. The Paris Club then gives Nigeria Naples terms, or a 67% debt reduction. That leaves Nigeria owing $8 billion to the Paris Club. Finally, Nigeria is going to buy back that remaining debt at a “market discount” – meaning that it will pay roughly another $6 billion to clear its Paris Club debts once and for all.
Ultimately, Nigeria is paying $12 billion in cash to be done with the Paris Club once and for all. Rieffel says: “The deal, pure and simple, is a buyback of $30 billion of debt for $12 billion, which represents a discount of 60%.”
Whichever way you look at the deal, however, Nigeria is buying back either $30 billion or $8 billion of its debt below par. And it is the buyback aspect that is probably the most exciting and important part of the Nigeria deal.
Unbending rules Until this year, no country was allowed to buy its debt back from the Paris Club at all. The reasons for this were never entirely obvious, but the rule was considered so unbending that Germany, in July 2004, went to enormous expense to securitize its Russian Paris Club receivables rather than simply sell the debt back to oil-rich Russia.
The Aries deal, as it was called, made almost no sense on any level other than as a mechanism for generating hefty fees for its lead managers, Deutsche Bank and Goldman Sachs. Germany got much more expensive funding than its triple-A credit rating would warrant; Russia’s outstanding bonds were devastated on the international capital markets as they were diluted by the unexpected new issuance; and bond investors were left trying to understand and arbitrage an unfamiliar new instrument, which did nothing for the emerging-market asset class as a whole.
When Russia approached the Paris Club with a proposal to buy back $15 billion of its debts, then, the Club was well disposed to agree. The buyback would be open to all Paris Club creditors, rather than benefiting only one; it would take place at par, rather than at a market discount; and no new quasi-sovereign bonds would wreak havoc in the markets. The buyback was agreed in May, leaving $25 billion Russia is expecting to be mopped up by similar operations in the future.
Russia, like Nigeria, is buying back its Paris Club debt using windfall oil profits. But it’s not just the unexpectedly rich that are taking advantage of the new rules. Peru realized this year that its long-term bonds were trading at such tight levels that it made sense to swap its Paris Club debt for new bonds. In June it agreed a $2 billion Paris Club buyback, at par, to be paid for largely out of new bond issuance.
The Paris Club hasn’t given a free blanket call option to all its debtors. Any buyback has to be negotiated, under the Evian umbrella, on a case-by-case basis. Russia and Peru negotiated buybacks at par; Nigeria negotiated a buyback below par; and in the future it’s entirely conceivable that buybacks might even happen above par. But there is now a powerful brand-new debt-reduction mechanism in the Paris Club’s arsenal, which has been used successfully three times and is surely certain to be used again.
The buyback is a great leap forward for an institution that has historically moved extremely slowly. It was founded in 1956, as a forum where debtor countries could have a combined negotiation rather than a number of separate ones with bilateral creditors. The country in question sits in a small meeting room at the French treasury, while representatives of the various creditor countries sit in a larger conference room. Intermediaries go back and forth between the two sides until an agreement is reached.
The whole process can last many days and nights, with Russia in 1996, Serbia in 2001 and Iraq in 2004 going down in Paris Club lore as particularly gruelling and inhumane negotiations. “It’s an exercise in sleep deprivation as much as anything else,” says a veteran negotiator who has endured more than his fair share of cold pizza and consecutive all-nighters.
In that sense, nothing has really changed since 2000, when a UK official told Euromoney that the Paris Club approach to negotiations was “hopelessly out of date”.
Other aspects of the Paris Club, however, have changed out of all recognition. Buybacks are one; a series of regular meetings with the private sector is another. There is also a bit more transparency – the Club now boasts a fairly comprehensive website that lists every agreement it has ever entered into, along with its size, terms and status (www.clubdeparis.org).
As far as debtors are concerned, the biggest change is the Club’s willingness to enter into stock restructurings. Historically, creditor countries held bilateral obligations on their books at par, even when there was obviously no way that they were ever going to be repaid in full. So they tended to push out maturities and add ever-increasing grace periods rather than bite the bullet and grant any kind of debt relief. That way they could maintain the accounting fiction that the debt was not decreasing in value, and did not have to take any kind of fiscal hit.
Today, however, most of the Paris Club member countries have changed their accounting principles, and have to write down the value of non-performing debt. It is therefore now possible to grant debt relief to a country in default and actually get a positive budget receipt while doing so. Nigeria was a major beneficiary of this approach, as was Iraq.
But the one thing that hasn’t changed is the Paris Club’s insistence on comparability of treatment – the single most controversial aspect of Paris Club agreements, and one area where the Club shows no sign of budging.
Although the exact wording of the provision changes from agreement to agreement, the general rule is that whenever the Club grants debt relief, the debtor country must seek comparable relief from all its other creditors – preferred creditors such as the IMF and World Bank excepted.
Comparability is a rule honoured often in the breach: for the first 40 years of the Club’s existence, for instance, it never asked for a bond restructuring in the wake of one of its own reschedulings. Yet the provision has been a part of every agreement since the very first, for Argentina in 1956, and has become an omnipresent, unique and unpredictable part of the international financial architecture.
In 1999, for instance, the Paris Club decided that the provision did apply to bonds, and forced Pakistan to restructure its bonded debt; subsequent bond restructurings, such as the one made by the Dominican Republic this year, have similarly been driven largely by Paris Club comparability requirements.
At the same time, however, the provision is frequently ignored. Nigeria’s Paris Club deal, for instance, seems to carry no comparability provision at all – or at least not one with teeth. That makes a certain amount of sense, since Nigeria’s traded debt has already been restructured, when the London Club of commercial creditors accepted a 60% haircut in 1992. Moreover, Nigeria’s commercial debt is small in relation to its bilateral debt.
But the Paris Club could very easily have asked for comparability regardless.
Indeed, Nigeria notwithstanding, the Club seems to be getting more strict, not less, about comparability of treatment even as its deals are becoming more political and less economically justifiable.
Rieffel has a theory why that is. He has decades of experience with the Paris Club, having worked for the US Treasury between 1975 and 1994, and he has seen changes over the years that no-one has been able to explain to him.
“There’s a cost to the Paris Club not being institutionalized: its institutional memory is weak,” he says. “Every few years you get a complete turnover of the people at the French treasury who do this stuff. One factor contributing to problems in the 1990s was the loss of institutional memory.”
Specifically, Rieffel says, something called the non-discrimination clause has disappeared from Paris Club agreements. The Club used to make a distinction between non-Paris Club bilateral debt on the one hand, and commercial debt on the other. The non-discrimination clause applied to other bilateral creditors, and essentially forced upon them identical terms to those granted by Paris Club creditors. The comparability of treatment clause was reserved for commercial creditors, and was generally interpreted more flexibly.
But in the 1990s, the non-discrimination clause disappeared, and the comparability of treatment clause started having to do double duty, applying not only to commercial restructurings but also to other bilateral creditors. As a result, the strict application of comparable treatment was extended to banks and bondholders as well.
As a result, says Rieffel, there has been “a move from loose comparable treatment to strict comparable treatment, which doesn’t make sense. It never has, and it never will.”
And the more political Paris Club agreements become, the less sense the comparability of treatment provision makes. If the Paris Club wants to write off the debt of a middle-income country such as Iraq or Nigeria, that’s all well and good – but its political reasons for doing so simply don’t apply to private-sector creditors.
Yet it seems that the Paris Club has never been as evangelical about the comparability of treatment provision as it is in Iraq – possibly the most political deal it ever did.
For one thing, Iraq has agreed that private creditors must receive comparable treatment not only in haircut terms but in net present value terms too: even 80% forgiveness would not be enough if Iraq were to start paying market interest rates on the remaining 20%.
The penalties for sweetening any deal with Iraq’s private creditors are harsh – in theory. It has not been made public by the Paris Club, but Euromoney obtained a copy of the agreement. Regarding the comparability of treatment clause, it says that “if the Participating Countries determine that these conditions are not substantially fulfilled, the provisions of the present Agreed Minutes will become null and void. If the Government of the Republic of Iraq has not met its payments obligations under this Agreed Minutes, the Participating Creditor Countries may decide to suspend the present Agreed Minutes”.
Iraq takes the threat seriously. No such suspension of a Paris Club agreement has happened in the past, its representatives admit, but then again no Paris Club agreement has ever been as unpopular among many Club members as this one is. Given half a chance, there is more than one creditor country that could easily be seen jumping at the opportunity to go back to square one and try to extract more money from Iraq.
So Iraq has offered its smaller private-sector creditors just 10.25 cents on the dollar, and its larger creditors a choice of bonds or loans worth roughly the same amount. That, say Iraq’s representatives, is what the Paris Club deal is worth.
Creditors would be stupid to reject the deal, say the representatives: Iraq enjoys bulletproof protection from litigation thanks to a UN Security Council resolution, and the next Iraqi government is likely to be less keen to pay off Saddam-era creditors than this one is.
The creditors, on the other hand, are less convinced. Iraq’s Paris Club agreement came together at head-of-state level, and it seems improbable that such an unprecedented scuppering could be quite as easy as Iraq’s representatives like to suppose it might be.
“Iraq says it’s worried that the referee is going to give it a red card and render the Paris Club deal null and void, but the referee has never given a red card to anyone,” says Daniel Lucich, a lawyer at Akin Gump in Washington who represents Hyundai, which is owed more than $1 billion by Iraq. “To undo this deal would be to undo a high-level political deal. It’s a bogeyman, but it’s not credible.”
What’s more, many creditors have been waiting 15 years to get their money back: they’re used to playing the long game, and might well be willing to wait a bit longer rather than settle for a mere 10 cents on the dollar. “The Paris Club countries did a politically negotiated deal among themselves, which is their prerogative. But private creditors don’t see why they should go along with it, because they aren’t political actors,” says Lucich.
In any case, a certain amount of damage has already been done. Former Club chairman Jouyet says that “even if you are politically minded, all the decisions in the Paris Club are based on debt sustainability calculations made by the IMF, and we are very strict on this point.” But it’s very easy to be sceptical about the Fund’s debt sustainability analysis for Iraq, not least because it’s based on an oil price of $26 a barrel. The combination of extreme fuzziness on debt sustainability with extreme strictness on comparability of treatment is a particularly nasty one for private-sector creditors.
And one meeting in Dubai in May notwithstanding, Iraq has essentially refused to negotiate with those creditors. Rather, it has decided to take a leaf out of Argentina’s book and issue a unilateral, take-it-or-leave-it offer.
Whether or not Iraq’s approach works will emerge over the next few months, as creditors’ claims are officially reconciled and Iraq starts to announce the results of its offer. But a recent lawsuit by Italian creditor Banca Nazionale del Lavoro does not bode well for Iraq: it’s suing Iraq for $1.38 billion, plus interest, that it says it is owed. The lawsuit, which was filed after Iraq made its offer to private-sector creditors, is not the sort of thing that one would expect from a creditor inclined to take the country up on its offer.
In any event, there seems to be no chance that Iraq is going to budge from its ultra-orthodox interpretation of comparability any time soon – a fact that the Paris Club will probably welcome and private creditors bemoan.
Even as the Paris Club’s total stock of debt is falling, it seems to have no compunction dictating terms to the private-sector creditors that now provide the overwhelming majority of all sovereign finance.
Paris Club deals like Nigeria’s and Iraq’s are rare: a huge number of different planets needed to line up for them to happen. In Nigeria’s case, there was a long-standing commitment by the UK government to debt relief for Africa, which combined with the UK’s chairing of the G8, which combined with high oil prices, which combined with an unusually savvy and well-connected finance minister with decades of experience in Washington, which combined with a renewed focus on the Millennium Development Goals, which combined with a democratic government in Nigeria making successful economic reforms, which combined with a general political feeling in the G8 that it wouldn’t look at all good to ignore pleas from the largest Muslim country in Africa. And even then coming to a deal was very hard.
So it’s difficult to see how the Paris Club can justify jumping on its financial high horse at the end of one of these deals and decree that whatever deal was scraped together in Paris must set the bar for all other deals with all other creditors.
It would seem that there’s a new moral hazard in the markets, and this one works against private creditors. In the past, bondholders would pay close attention to the relationships between indebted countries and the richest nations in the world, in the expectation that if a crisis hit, the rich nations might bail the poor ones out – and save private-sector creditors in doing so.
Today, however, such close relationships might not be quite as positive. Any middle-income country seeking exceptional treatment at the Paris Club needs a sponsor – a rich country that can represent its case in the conference room. In Nigeria’s case it was the UK; in the cases of Pakistan and Iraq it was the US. If the relationship is particularly strong, the debtor country might get an exceptionally good deal. The risk then is that instead of bailing out the private creditors, the Club is likely to try to bail them in instead.
