Patricia Adams: IMF should back, not belittle, odious debt regime

International Monetary Fund (IMF), Finance and Development, Vol. 42, No. 2

June 1, 2005

Read the following letters on the publisher’s website

In his haste to dismiss the international legal Doctrine of Odious Debts and my arguments in favor of it, Raghuram Rajan (“Odious or Just Malodorous” December 2004) missed the long legal history in which the doctrine’s principles have been used to establish the responsibilities of creditors (or borrowers), and thus their rights to repayment (or repudiation).

This time-honored legal principle holds that debts not used in the public interest are not legally enforceable: in 1898, the U.S. repudiated the “Cuban debts” after the Spanish-American War on the grounds that the money was spent contrary to the interests of the Cuban people; in 1919, the Reparation Commission refused to apportion debts under the Versailles Treaty to newly liberated Poland that had been incurred by the German and Prussian governments to colonize Poland; in 1923, Chief Justice Taft, sitting as arbitrator, ruled against the Royal Bank of Canada’s claim to repayment for monies it lent to a Costa Rican dictator. The list of precedents goes on.

Not only is the doctrine well-rooted in international legal custom, it is also grounded in the rich jurisprudence of common and civil law: the principle of “unjust enrichment” undermines an odious creditor’s rights to repayment and strengthens a legitimate creditor’s rights torepayment; and the law of domestic agency governs the way in which agents can create legally binding obligations for those they represent, thus putting a dictator’s creditor at risk.

The private sector has had no trouble grappling with the law and figuring out how to “odious debt—proof” its loans: in much lending and project finance today the lenders know the purpose of the loan and an elaborate set of representations and warranties binds the borrower. If a lender doesn´t exercise the due diligence to establish whether the steel imported is used for cannons rather than cradles, or for guns to shoot innocent civilians rather than criminals, as Rajan warns, then I say, as the American commissioners to the Spanish-American War peace conference said: “The creditors, from the beginning, took the chances of the investment.” Already, private sector financiers are careful to establish their due diligence and evidentiary basis to defend today´s loans in future.

The IMF should champion this application of the rule of law, rather than disparage it. While an odious debt regime might not stop all dictators “in their tracks,” it would stop many and it would isolate as pariahs those who survived by selling off their nation´s assets. By giving creditors—public and private—an incentive to lend only for purposes that are transparent and of public benefit, the IMF would change the culture of international lending and reduce the moral hazard that has destabilized international finance for the past 60 years. It would also promote sound investment and growth, starve tyrants of their ability to finance themselves against their people, and thus better serve the cause of world peace.

Patricia Adams
Executive Director, Probe International
Author of Odious Debts: Loose Lending, Corruption, and the Third World’s Environmental Legacy
(London: Earthscan, 1991)

Dictators and debt: Let’s clarify the rules

In “Odious or Just Malodorous” (December 2004), Raghuram Rajan
discusses proposals to restrict odious debt such as the one we proposed
in F&D two years ago (“Odious Debt [anotherPDF here] ,”
June 2002). Rajan raises the concern that as an unintended consequence
of restricting loans to odious regimes, legitimate governments might
also find it harder to borrow. If a legitimate government borrows and
an odious regime subsequently takes power, under the new system the
odious regime will be both less able and less interested in repaying
the debt it inherited, he argues.

An odious regime will be less able to repay inherited debt if new loans
are needed to fund ongoing and new projects that generate the country’s
cash flow. While we agree that countries often grow themselves out of
debt, it seems unlikely that odious regimes are really borrowing for
this purpose. It would have to be the case that both being able to
borrow enabled a dictator to expand the economy and, crucially, that
the dictator spent the gains for the benefit of the country. If
borrowing by a dictator is indeed in the interests of the citizens, we
agree that it should not be blocked. The truly odious dictators,
however, probably don´t borrow to grow the economy and, in any case,
don’t pass the gains on to the people.

Rajan also points out than an odious regime will be less interested in
repaying debt because it no longer has the carrot of being able to
continue to borrow as long as it repays. One solution to this problem
is to roll over the inherited debt until the next legitimate government
comes to power. The country would still be responsible for paying the
debt plus arrears, and the creditor would expect to receive payment in
time.

Rajan is right to point out that, because there are many possible
debt-market equilibria, we should be cautious of unintended
consequences of a system that restricts odious debt. However, the
benefits of eliminating odious debt are potentially enormous, so it
would be unfortunate and premature for the proposal to be put in cold
storage, as he suggests. If loans to odious regimes were restricted,
people in poor countries would be saddled with less debt. Their rulers
would have less incentive and ability to misspend. And there is another
potential benefit: legitimate governments could find it easier to
borrow. Currently, there is a movement to nullify some debt on the
grounds of odiousness, but it is hard for creditors to anticipate which
loans will be considered odious in the future. If the rules of the game
were known in advance, lending to legitimate governments would be less
risky and interest rates for legitimate governments would fall.

Seema Jayachandran
Assistant Professor, Department of Economics
University of California at Los Angeles

Michael Kremer
Gates Professor of Developing Societies
Department of Economics, Harvard University