“T.HE PROCEDURE for solving an international debt crisis, ”wrote Alexis Rieffel, a former Treasury official in 1985,“ resembles a three-ring circus ”. In the first ring, the bankrupt country negotiates with him IMFwho have to decide how much the country can repay and what tightening of the belt it has to endure. In the second ring, the country is asking for leniency from other governments it owes money to. And in the third case, a “comparable” deal is sought by private lenders.
However, the circus sometimes struggles to hold it all together. For example, after Argentina defaulted in May, the IMF could not play his usual role in the first ring. It was unable to provide new oversight and funding as the country was still affected by its predecessor’s failure IMF Rescue operation. The second ring also suffered from some absent performers. Over the past decade, China has become a far larger lender to poor countries than other governments combined (see Figure 1). However, it is not a member of the Paris Club overseeing debt renegotiations between countries and their official creditors. As for the third ring, when the Latin American debt crisis erupted in the early 1980s, it took commercial lenders (and their governments) nearly seven years to come up with a permanent solution. The juggling went on and on.
Many fear that another series of default settings is imminent. In many poor countries, government and export revenues have declined (although efforts by the US Federal Reserve to calm the financial panic have reduced its borrowing costs). On November 13, Zambia became the sixth country that year to default on its bonds. Eight spend more than 30% of their tax revenue on interest payments, estimates Fitch, a rating agency, more than they did in the early 2000s, when Bono and other debt relief activists were at their best. Fitch gives 38 states a rating of B + or worse, where B. denotes a “significant” risk of default (see Figure 2). According to his projections, governments with a junk rating –BB + or worse – may soon outperform investment grade companies.
Will the circus handle a new crisis better than it did in the 1980s? In some ways his job is now even more difficult. Poor countries owe a wider variety of liabilities to a wider range of creditors. In many emerging markets, bonds have dwarfed bank loans. And loans themselves are anything but uniform. Some are hedged against government assets such as stake in a public company or oil revenues; The creditor might prefer to seize the collateral rather than write off the debt. Others are syndicated or spread across many banks, meaning that no single creditor can make the loan at their own discretion.
This gnarled mix of instruments is accompanied by an equally entangled group of believers: public, private and everything in between. For example in April G20th A group of large economies called on member governments to give the world’s poorest countries loan repayment leave. China was unhappy that private creditors did not participate in the effort. Others complained that the state owned and run China Development Bank, but not equivalent to the Chinese government, did not participate.
However, progress has also been made. On 21.-22. November G20th The heads of state and government will sign a “common framework” for renegotiating debt with the world’s poorest countries. The framework practically extends the principles of the Paris Club to these G20th Members who have not yet joined expand the second ring of the circus. It only applies to countries with unsustainable debt and to all borrowers who receive EU relief G20th must seek a similar deal from other creditors. With all lenders to do their bit, little depends on whether they are classified as official or private. Perhaps that is why the China framework has met with little resistance.
Progress has been made with both contracts and clubs. After Argentina defaulted in 2001, it offered to swap its non-payable bonds for new securities on simpler terms. Some bondholders rejected the deal and instead moved for full payment in the New York courts. That made life harder for Argentina and its other creditors. As of 2003, most of the bonds issued under New York law contain “collective clauses” that force all bondholders to join a majority-accepted deal. Such clauses have helped Ecuador resolve its default this year with “barely any real grumbling,” notes Clay Lowery of the Institute of International Finance, a banking association. They also helped Argentina reach a deal with its main bondholders in August (albeit with “quite a bit of grumbling”).
A review of the “architecture” for solving sovereign debt published by the IMF considered other contractual innovations in September that could facilitate future restructuring. Lenders could insist on the wider use of negative pledge clauses, which prevent a borrower from pledging important assets as collateral for other creditors. Syndicated loans can add provisions that allow a lender to be excluded from the syndicate if they block a deal. The fund is also redesigning “contingent” debt, which is more sensitive to the ups and downs of poor countries. For example, Barbados has issued bonds that will pay back less in the event of an earthquake or tropical cyclone.
An idea suggested by Ben Heller and Pijus Virketis from HBK Capital Management, a mutual fund, is “Bendy Bonds”. In most cases, these would behave like ordinary bonds. In a crisis, however, the issuer could extend the term and defer interest for a few years in order to pay additional interest at the end of the bond’s term. The issuer could benefit from the G20thApril initiative without the help of the great powers. As the long history of debt rescheduling shows, “fixed-rate” liabilities are often anything but. Solemn obligations to pay in full and on time cannot always be met. Lenders and borrowers might therefore appreciate tools that determine in advance when and how fixed income securities become more flexible. ■
This article appeared in the Finance & Economics section of the print edition under the heading “Roll up, roll up and write down”.