I am putting down some notes regarding what might be an emerging socially-informed principle for a policy on handling sovereign liquidity problems in developing countries that could strike a somewhat familiar chord with some veteran debt campaigners. The notes reflect what seems implicitly some new thinking in international policy circles, albeit thinking that could be snuffed out in the end (wont be the first time). I started thinking again about these issues when I was asked to make a presentation at a debt workout discussion in Berlin and I attach the short paper for that meeting for those who are not following the recent discussions, which go beyond the points I want to make here.
In other words, I recently noticed that the Paris Club has now defined a class of rescheduling treatments called "Exceptional treatments in case of crises" (http://www.clubdeparis.org/sections/types-traitement/reechelonnement/traitements) that covers cases of natural catastrophes (Honduras, Nicaragua, Indonesia and Sri Lanka), peace building (Liberia), and "rocketing" import commodity prices (Togo). Also, the IMF staff produced a paper last spring that proposed refinancing of obligations to private creditors falling due during a period of an IMF program for countries that had already reached a certain degree of debt vulnerability and that might thus also face a solvency problem, especially if they were to borrow a lot during the liquidity crisis (It was not clear to me if the proposal was supposed to apply to bilateral official debt servicing as well). The IMF Board asked the Staff to prepare a follow up report for discussion in early summer. Finally, there seems renewed interest in countercyclical forms of private sovereign financing, which a decade ago were discussed in the form of GDP-linked bonds, as adopted in Argentina's bond exchange, or the commodity-price linked.Brady bonds of an earlier. era. The newest variant is the Bank of England proposal for contingent convertible bonds ("cocos"), which would automatically extend maturities and give liquidity relief during a Fund-supported adjustment program (http://www.bankofengland.co.uk/research/Pages/fspapers/fs_paper27.aspx),
These proposals step away from the usual presumption in sovereign and also private finance, which is that repayment obligations are fixed and unalterable, except in dire emergencies (why we have insolvency regimes, if only for non-sovereigns). This is the fundamental distinction with equity finance (or Islamic finance, as I understand it) in which the provider of funds shares in the risk faced by the recipient of the funds. If there is a temporary need for additional funds, the debtor is meant to borrow them and repay when the need eases. If the private creditors fear the borrower will have difficulty repaying, then the interest charge and the tenor of the additional loans will be disadvantageous and/or the borrower will have difficulty arranging private financing, even just to roll over maturing claims. In the case of the sovereign debtor, the next step is to visit the IMF and get official funds and an adjustment program (in the 1970s, the Fund offered virtually unconditional "compensatory financing" to help meet externally caused temporary liquidity needs, but that is another story). The debt-management strategy (and legal principle: "pacta sunt servanda") is to squeeze other government expenditures so as to maintain debt servicing as government revenues and borrowing options fall.
This is what is being challenged. Financial specialists phrase the new approach as not "bailing out" the existing creditors with public money, which is precisely what official financing during a liquidity problem does. This reflects unhappiness at the tender treatment of banks and bankers in recent crises. The argument ought to be made as well in terms of the creditors already collecting a risk premium on their loans to cover potential interruption in debt servicing and thus they should actually face such a risk. A different argument has been made by NGOs in regard to debt relief for poor countries, in that government priority should be first to meet domestic social safety net obligations and then pay debt servicing (the proposal is more detailed; see Henry Northover, "Human Development.Advocacy for Debt Relief, Aid, and Governance," in me, José Antonio Ocampo and Shari Spiegel, eds., Overcoming Developing Coutnry Debt Crises (Oxford, 2010). It took much of a decade from the start of the HIPC Initiative to the MDRI, but that view -- or at least that principle -- carried the day in the end in the sense of redirecting BWI and AfDB debt servicing to MDG outlays. Can such a perspective be resurrected?
Julien J Studley Graduate Program in International Affairs
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