Sovereign debt (re)structuring-Where do we stand?

Abstract

Argentina’s debt default in 2001 moved the international community to launch initiatives to develop procedures for the orderly restructuring of unsustainable sovereign debt. These initiatives come against the backdrop of the increase in public debt in emerging market economies over the last decade, of large-scale fi nancial crises linked to the level or structure of sovereign debt and, a recent development, of several cases of sovereign default on international bonds. These developments pose two challenges. Firstly, the complexity of sovereign debt dynamics makes it necessary to strengthen international institutions’ assessment capacity. The International Monetary Fund (IMF) has thus launched initiatives to improve the assessment of debt sustainability and balance sheet weaknesses. Secondly, the developments have prompted the re-examination of IMF facilities for managing debt crises. The absence of a clear framework in this area could create a moral hazard risk, as the international community could be tempted to avoid necessary restructuring by granting substantial fi nancial assistance. In practice, defining such a framework is complex, given that reforms in the area of restructuring influence the way in which debts are structured. In fact, the features of sovereign debt aim to reconcile two requirements: first, ensuring that the sovereign debtor honours the terms of the debt contract if it has the means to do so (ex ante efficiency); second, making sure that the cost of default is not excessive when the sovereign debtor is effectively unable to pay back (ex post effi ciency). The international community currently favours a market-based approach. Its first pillar is a result of the development and spread of collective action clauses (CAC), following the Quarles Report by the Group of 10. Incorporated into debt contracts, CAC aim to reduce the problems arising in inter-creditor co-ordination, by defi ning, in advance, the decision rules applicable in the event of re-negotiation. The “Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets”, whose defi nition was fostered notably by the Governor of the Banque de France and the Group of 20, form the second pillar. They supply guidelines for the parties involved to steer the exchange of information and facilitate co-ordination between debtors and creditors. The market-based approach is not exclusive of a formal regime, e.g. the IMF’s Sovereign Debt Restructuring Mechanism (SDRM), where such a regime is feasible. In the market-based approach, the IMF acts as an expert via the supply of information and analyses, and also as a “monitor” via the negotiation and monitoring of programmes. The provision of loans, which is in principle limited, aims mainly to facilitate renegotiation by giving credibility to the sovereign’s policy. By contrast, a more formal regime would suppose limiting IMF involvement, so as to guarantee the independence of the mechanism. Whatever the case, the efficiency of the overhauled restructuring framework, which is built on contractual provisions and general principles rather than on a formal regime, will depend on the Fund’s capacity to fully perform its three functions.