STUDY Resolving Sovereign Debt Crises TowardsaFairandTransparent InternationalInsolvencyFramework Secondrevisededition JÜRGEN KAISER October2013 Duetotheglobalfinancialcrisis,externalsovereigndebthasagainbecomeaprob- lemtoabroadrangeofcountries–fromEuropeanhigh-incomecountriestothe pooreststatesonearth–evenaftertheyhadobtaineddebtreliefthroughexisting multilateralinitiatives. Despitelong-standingexperienceswithsovereigninsolvencies,however,nomecha- nismpresentlyexiststodealwiththecomplexdebtstructuresofmanycountriesin acomprehensiveway.Existingdebtworkoutprocedures–suchastheParisClub, HIPC/MDRI,orBrady-styledebtconversion–haveeitherbeenone-offexercisesnot meanttobeappliedasapermanentmechanism,ortheyarereinforcingcollective actionproblemsforbeingpiecemealincharacter. Thisstudythereforearguestoapplyprinciplesandproceduresofdomesticinsolvency tosovereigns,inordertoreachafairandsustainabledebtworkout.Itexplainsthe principlesofanad-hocoraninstitutionalisedframework,anddescribesthepossi- bilitiestoobtainpoliticalsupportandtechnicaladviceforcountriesthatmayfind themselvesinneedofanorderlydebtworkoutprocess. JÜRGEN KAISER | Resolving Sovereign DEbT Crises Contents Introduction: Greece and the Resurgence of Sovereign Debt . 3 1. The Persistence of Sovereign Debt as Systemic Problem in the Global South . 4 2. Debt Management from the Crisis of the 1980s to the Debt Sustainability Framework. 5 2.1 TheParisandLondonClubs. .5 2.2 TheHeavilyIndebtedCountriesInitiativeandtheMultilateralDebtReliefInitiative. 6 2.3 Exceptionalandnon-negotiatedDebtReductions. .8 2.4 TheDebtSustainabilityFramework:PreventingFutureDebtCrisis?. 9 3. Shortcomings of Current Sovereign Debt Management: The Need for Reform. 11 3.1 PayingthePriceforInefficientCrisisResolution. .11 3.2 IncoherencebetweenVariousNegotiationFora. .12 3.3 ConflictsofInterestsontheCreditors’Side. 13 3.4 CreditorsasInsolvencyJudges. 16 4. Main Proposals for International Insolvency Procedures . 17 4.1 PrinciplesforSettlingSovereignDebtDisputes . .17 4.2 Ad-hocArbitrationProcess. 19 4.3 TheSovereignDebtRestructuringMechanismandItsImpactontheGlobalDebate 20 4.4 AnInternationalInsolvencyCourt. .22 4.5 ProsandConsoftheAboveOptions. .24 5. The Political Debate. 25 5.1 FromAdamSmithto»FinancingforDevelopment«:CallsforaSovereign InsolvencyFramework. 25 5.2 ExistingMultilateralandNationalPoliticalCommitments. 28 6. Practical Steps towards Resolving a Sovereign Debt Crisis . 30 6.1 PoliticalandLegalScopeforDebtorGovernments. .30 6.2 AStep-by-StepGuidetoaFairandTransparentDebtWorkoutProcedure. .31 6.3 PoliticalSupportforGovernmentsSeekingaFairandComprehensiveDebtWorkout33 6.4 DealingwithArgumentsagainstanInternationalInsolvencyFramework. 34 Selected bibliography and Internet links . 38 literature . 39 Glossary . .41 list of Abbreviations. .42 1 JÜRGEN KAISER | Resolving Sovereign DEbT Crises between the strong and the weak it is liberty that oppresses and the law that liberates. JeanBaptisteHenriLacordaire(1802–1861; Frenchecclesiastic,preacher,journalist,andpoliticalactivist 2 JÜRGEN KAISER | Resolving Sovereign DEbT Crises Introduction:Greeceandthe toanattitudethatassumesthatnobodyelsebutGreece ResurgenceofSovereignDebt and some other European countries (Portugal, Ireland, Italy,Spain)arereallyatrisk.Inrealitythefactthatstates OnMondaythe12thofJuly2010,GermanFinanceMin- canandeventuallywillgobankruptisneitheranewphe- isterWolfgangSchäubleproposedtohisfellowmembers nomenonnoronethatisconfinedtoEUmembers.The oftheEUTaskForceontheStrengtheningoftheEuro- Europeancrisiscomesontheheelsofmajorsovereign pean Monetary Union the creation of an international debtcrisesinAsia,Africa,andLatinAmerica.Typically, sovereigninsolvencyframework.SuchaninitiativebyEu- developingstatesintheseregionshaveexperiencedthe rope’smostpowerfuleconomywouldhavebeenunim- samecycleofpoliticaltreatment,whichrunsfrom»no aginablejusthalfayearearlier.Thede-factoinsolvency debtreliefinnecessary«,through»nodebtreliefispos- oftheGreekstatehadnotonlyshatteredtheoldconti- sible«,tothegrantingof»exceptional,single,andnever nent’sfinancialandbankingsystem.Ithadalsobrought evertoberepeateddebtrelief«,beforefinallyreturning aboutimportantchangesinsomeofthekeyorientations whereitstarted. ofpolicymakers.Strongdiscontentamongthepopulace aboutthebigbailoutsofstatesaswellasprivateinves- Thispapertriestotracethereasonsforthisastonishing torspushedtheconservative/liberalgovernmentinGer- refusalofpolicymakerstoacknowledgetherealityofsov- manytowardsthesearchforalternatives.Holdinginves- ereigninsolvency.Itfindsthemlargelyinthepowerim- torstoaccountwhenofficialdebtorsrunintodifficulties balancebetweensovereigndebtorsandtheircreditors, isnotjustaninnovativeidea;itisbasicallyinlinewith anditsuggestsreformingthissetupbytakingrecourseto thewayinsolventindividualsorcorporationsarebeing veryfundamentalprinciplesoftheruleoflaw. treatedwithinanyEuropeanlegalsystem. Our intention is to guide governments, parliamentari- Still,ittookEuropeangovernmentsnearlyanothertwo ans,andaninterestedpublicintoday’scriticallyindebted yearstoagreeonapartialdebtwrite-offforGreece;a countriesinsideandoutsideEuropetopossiblealterna- write-off that did not come in the form Schäuble had tivecrisisresolutionmechanisms.Itpresentsandanalyses suggestedinJuly2010,butthroughaquitedisorderly existingmechanisms,theirshortcomings,andtheresult- andad-hocrestructuringenforceduponGreekandin- ingneedforreforminchapters2and3.Subsequently, ternational holders of Greek bonds. Immediately after itoutlinesthebasisprinciplesandoptionsforimplemen- thewrite-offofabout109billioneuro,itbecameclear tation of a sovereign insolvency framework in chapter thatthereliefprovidedwouldnotbeenoughtorestore 4 before highlighting the state of the political debate Greekdebtsustainability.Anothersmalldebtconversion inchapter5.Giventhedynamicofthisreformdebate followedattheendof2012,andasofthewritingofthe withinaswellasoutsideEurope,thepoliticallandscape second edition of this paper,1 international experts in- mayindeedchangeveryquickly.Therefore,linkstosev- creasinglyagreethatanothersubstantialdebtreduction eralonlinemediaintheServicesectionattheendofthe willbenecessary.Politicians,however,aresayingexactly reportcomplementthispart.Chapter6providesabrief, whattheyweresayingaheadoftheMarch2012write- stylised agenda for a state insolvency process through off:nodebtreliefwilleveragainbenecessary,andeven internationalarbitration.This,inturn,isbeingcomple- ifitwere,itshouldnotbegrantedbecauseitwouldac- mentedbylinksandcontactstopossiblesupportingin- tuallyworkagainstthedebtor’sinterest.Moreover,next ternational institutions, like-minded governments, and timeitwouldbetheofficialrescuefundsthatwouldhave NGOsthatwouldbepreparedtolendahandtoanybody to be reduced in value, because the remaining private whotriestoavoidthemistakesofthepast,whilead- claimshaveanoverlyseniorstatusafterthespring2012 dressingthesovereigndebtproblemsoftoday. operation. TheauthorwishestothanktheFriedrich-Ebert-Stiftung AnotherastonishingfeatureoftheEuropeandebateis foritscooperationintheproductionofthisstudy,and thechangefromanattitudethatwouldhaveruledout personalthankstoHubertSchillinger,whohasprovided anystatebankruptcyforcountriesontheoldcontinent extensiveadviceonthestyleandsubstanceofthisstudy. Moreover,theauthoristhankfultoBenYoungandGail 1. August2013. 3 JÜRGEN KAISER | Resolving Sovereign DEbT Crises Hurleyforhelpfuladviceregardingboththesubstance ralandhumanresourcesasthecrisiscontinues.Recent andlanguageofthispaper. analysesinclude: 1.ThePersistenceofSovereignDebtas By mid-2009 erlassjahr.de and the Friedrich-Ebert- SystemicProblemintheGlobalSouth Stiftunganalysedprospectsfor»postcompletionpoint« HIPCsandfoundthatoutof26countriesthathadjust By mid-2008 sovereign debt problems, which had obtaineddebtrelief,13suffered»high«risksofrenewed plaguedmanycountriesintheglobalSouthovermore debtdistress(Kaiser,Knoke,andKowsky2009); thantwodecadessincetheoutbreakoftheLatinAmeri- candebtcrisisintheearly1980s,finallyseemedtobe InJune2013,theIMFupdateditsownoverviewof athingofthepast.Afterthemultilateraldebtreliefini- debtsustainabilityof76low-incomecountries.TheFund tiativesHIPC/MDRI,2someextraordinarydebtreductions concludedthatfromthose76countries,17wereeither forselectedcountriesbeyondtheHIPCgroup,andafter indebtdistressorfacedahighrisk.Only24seemedto sixyearsofnearlyunhamperedglobalgrowth,thedebt bebeyondnewdebtproblems;theremainderwereat indicatorsofthevastmajorityofSoutherncountrieshad »moderate«risk.3 substantially improved. This does not necessarily imply thatallcountriescamesubstantiallyclosertothefulfil- erlassjahr.delookedat108low-andmiddle-income mentoftheirdevelopmenttargets. countriesattheendof2011;65ofthemshowedeither debtindicatorsbeyondcriticalthresholdsorfacedhigh Thisoverallpositivepicturechangedfundamentallywith risksofdeteriorationintheimmediatefuture–orboth therecentglobalfinancialcrisisandtheensuingglobal (erlassjahr.deandKindernothilfe2013). recessionin2008/2009. Inthiscriticalsituation,low-andmiddle-incomecoun- Whiletheoriginsofthiscrisisclearlylayintherichcoun- trieswereprovidedwithaccesstovastlyenhancednew tries’domesticfinancialsystems,notablytheUShousing financing. This included the support from multilateral marketandthebreakneckexposureofEuropean,Japa- lenders,suchastheIMF,whichcountriesobtaininor- nese,andUSinvestorstowardsthosemarkets,thefallout dertostimulatetheireconomies.Italsoincludedanex- oftheworld-widerecessionontodevelopingcountries tendedaccesstonon-concessionaltrade-financingbythe and emerging markets