June 5, 2002

This brief commentary on the IMF proposal for Sovereign Debt Restructuring Mechanism (SDRM) builds on our earlier reaction to the various speeches Ms. Krueger has delivered on the subject and follows broadly their structure.

1. Introduction At the occasion of this year’s spring meetings the IMF published for the first time a comprehensive version of its proposal for a Sovereign Debt Restructuring Mechanism (SDRM), first launched in November 2001. The little brochure called „A New Approach to Sovereign Debt Restructuring” by the Fund’s Vice Managing Director Anne Krueger contains some welcome clarification, and some improvements over former speeches. But it also reveals some substantial flaws, which in fact put the value of the whole reform process in question. The following brief commentary on the proposal builds on our earlier reaction to the various speeches Ms. Krueger has delivered on the subject since November and follows broadly their structure. In section (2) the positive clarification, where the IMF approach is broadly in line with erlassjahr.de’s and other NGOs’ FTAP proposal, are identified. Section (3) – not incidentally more extensive – discusses the deviations between the two concepts. While the NGO positions on these issues is quite clear as demanding that the IMF and its members take NGO proposals on board, there are some open questions identified in section (4). On these issues a more intensive conceptual debate seems necessary between NGOs as well as with other stakeholders including the IMF.

2. Positive clarifications

2. 1 Statutory vs. contractual approach The paper contains a clear option for the statutory approach, which Ms. Krueger and the Fund staff have been pursuing from the outset of the debate. I.e. the Fund wants a clear legal basis and a statutory framework, which provides security for all the parties involved. This concept must have a legal basis in international law. The shortcomings of the rivalling “contractual approach” which relies on clauses in new loan contracts and is currently supported by the US with the aim of derailing a deeper reform process, is rejected. Strong and convincing reasons are given for this rejection (p. 29) Within the framework of the “statutory approach” promoted by the Fund, at some points there have clear decision been made, either to the good or to the bad. On other issues alternatives are offered –not always the right ones.

2. 2 Recognition of chapter 9 as a conceptual basis On p.13 Ms. Krueger identifies the key elements of an insolvency approach based on the chapter 9 of the US-Insolvency code, i.e. insolvency for entities with governmental power or “Municipalities”. She acknowledges that all of these features could be appropriately integrated into a sovereign debt restructuring mechanism. This is particularly welcome as she explicitly refers to the protection of the sovereign sphere of the debtor. However, her proposal subsequently lacks a recognition of chapter9’s full potential when she completely fails to discuss what this non-interference into the governmental powers and the revenues of the sovereign means in the context of her own proposal (see below).

2. 3 Inclusion of domestic debt The IMF is still having a hard time to acknowledge that a process which is to lead to debt sustainability needs to deal with all claims on the debtor, including Multilateral Debt. However, one big step forward has been made through the acknowledgement that domestic debt, i.e. debt owed to residents of the debtor country needs to be included. The main reason for that is that …nonresident investors may only be willing to agree to provide substantial debt reduction if they consider that adequate intercreditor equity has been achieved – they would be unlikely to be willing to provide such relief if it was seen as enabling other private creditors to exit whole. (p.18) The IMF obviously has still some way to go before it acknowledges that exactly the same goes for external debt owed to Multilaterals.

2. 4 The debtor’s exclusive right to trigger the process Right at the beginning of her paper Ms. Krueger points out that nobody else but the debtor has the exclusive right to trigger an SDRM, “not the IMF or creditors” (p.4.).

3 Flaws in the IMF’s proposal Though the SDRM as it is presented in this document goes quite a long way from the unfair and inefficient mechanisms we are still having, it does not match with some essential requirements for a fair, transparent and efficient procedure, which complies with the high benchmarks set by Ms. Krueger herself in the introduction to the booklet.

3. 1 Incomprehensiveness of the procedure While there is some progress regarding the inclusion of domestic debt into the SDRM, this comprehensiveness is not reflected on the procedural side, as Ms. Krueger seems to advocate a somewhat split procedure, where it is clear that private claims are being dealt with through the SDRM, while, regarding official claims, we would need to ecxplore further whether it would be feasible to include bilateral official debt under an SDRM…. (p.18). She also seems to understand that institutions like the Paris Club are there to stay, although their mere existence contradicts the fundamental principle of comprehensiveness of one single process, which she upholds herself. (p.15)

3. 2 Fundamental principles lacking Ms. Krueger identifies and subsequently discusses four elements of most well developed corporate rehabilitation laws which she also considers essential for the SDRM: · a stay on creditor enforcement during the restructuring negotiations; · measures that protect creditor interests during the period of the stay; · mechanisms that facilitate the provision of new financing during the proceedings; and · a provision that binds all relevant creditors to an agreement that has been adopted by a qualified majority. (p.11) There are two essential elements lacking, for which the Fund at least for the time being does not seem to be prepared, to work out criteria: · The necessity to reduce the debt of the sovereign to a truly sustainable level, and the definition what that actually is; it needs to be underlined that a conservative sustainability threshold is not an element of generosity or social attitude, which creditors might wish to apply or not. Securing that debt cancellation goes deep enough to reduce the overall indebtedness to truly sustainable levels is one basic requirement for a successful SDRM. The HIPC Initiative for the poorest countries has demonstrated how fast an ambitious debt relief program can be discredited, if creditors try to minimize expenses regardless of the debtor’s situation. · The verification of all claims on the debtor, which currently is done on a very technical basis; a fair and inclusive procedure, however, can no more be based on the principle that creditors will not question the legitimacy of each others’ claims. To the contrary: there is a big potential for the avoidance of future irresponsible lending and borrowing in an enhanced verification of claims, which provides space for a transparent examination of any questioning of the rightfulness of particular claims. Bona fide creditors must be in a position to improve their repayment expectations, by questioning the validity of rival creditors’ claims, if these are possibly tainted with fraud or corruption.

3. 3 Independence of decision making Immediately after trying to manoeuvre the Fund into a decision making position in her first (November) speech had earned her fierce critiques from all sides, Ms. Krueger has withdrawn from that attempt. In this paper she relies on two principles for the key question who actually is going to decide upon debt relief within an SDRM: First she assumes that decision making essentially needs to remain in the hands of the parties, i.e. the debtor and a qualified majority of creditors. Secondly she considers a supporting role for a new judicial organ, that would carry out the limited functions of allowing and extending the stay of payments and supporting the process between the two parties. Even if the Fund has refrained from the absurd idea of putting itself into a decision making role, the proposal leaves the parties with an institution which would likely be too weak to resolve difficult issues regarding f.i. the debt sustainability threshold or the verification of claims process. The organ would be more of a facilitator than actually an independent body, which could bind the diverging interests into a comprehensive solution. It is obviously not for lack of fantasy that the IMF does not envisage a truly neutral arbitration panel with far reaching competence over the whole procedure. The proposal Ms. Krueger makes regarding the structure of the new judicial organ – based at the IMF, but completely independent from its board and staff – is worth considering – even if alternatives like institutionalising the organ at the International Court of Justice could be more adequate. Instead, the limited competences of the neutral institution gives the technical expertise of the Fund the more weight, so that in the end it might sneak back into a decision making role which it formally does not strive for.

3. 4 The IMF as a decision maker in disguise While discussing the strengths and weaknesses of a process driven by the parties – as opposed to one driven by the IMF – Ms. Krueger benevolently points to some dangers, which such a process might involve for the debtor. Particularly she sees the danger that the debtor and the creditor would conclude an agreement that did not achieve a sustainable debt profile (p.24). This danger is certainly real, particularly as there is nothing like an established benchmark for true debt sustainability (hence the need for a far-reaching solution, as pointed out above). However, Ms. Krueger obviously considers an IMF assessment as the only imaginable remedy against an unviable solution. Consequently she appeases concerns to the respect by pointing out that the debtor would still be in need of financial support from the IMF, which again would only be delivered on the basis of a sound assessment of the debtor’s viability. Given the fact that the whole SDRM proposal has its offspring in the acknowledgement by strong forces within and without the Fund that the institution’s false positive judgements on the Argentinian debt sustainability and macro economic policy has essentially contributed to the crisis, the idea that the Fund would be an adequate institution to judge over its members’ debt sustainability is a truly bizarre one. Through decades ever insufficient Paris Club arrangements for the poorest countries have been based on IMF balance of payment analyses which regularly and falsely have claimed that the Club’s terms would lead to a sustainable debt burden. As well as a creditor is not suited to make decisions between debtor and creditors (what Ms. Krueger acknowledges on p.24), it must not be the institution, which establishes the database upon which an independent panel then bases its decision.

3. 5 IMF conditionality still in place Parallel to the Funds eventual role in assessing the debtor’s situation it also tries to maintain its grip on its macroeconomic policy by claiming that IMF conditionality is the only safeguard for securing that the debtor is honestly doing everything he can be expected to do to in order to satisfy his creditors claims. This perception is a wrong one from various angles: First a continuation of the Funds monopoly on defining sound macroeconomic policies violates the basic principle that a creditor must not be the one to judge on the debtor. Instead, the neutral institution needs to be the one to define the conditionality, which the debtor has to accept in order to qualify for the restructuring of its claims. The selectivity of Ms. Krueger’s willingness to acknowledge the conflicting roles the Fund has played up to now, is certainly annoying. Secondly the IMF needs to acknowledge that its track record in assessing macro economic policies gives absolutely no reason for superseding the structural contradiction on the basis of an institution having done a good job in the past. As the Fund itself now acknowledges it has contributed to countries’ economic crises through its authoritative “advice” in the past. The question of conditionality thus is certainly a strong point for enhancing the neutral institution’s role beyond the mere technical function it is designed to have under the Fund’s proposal. As with the question of defining debt sustainability, the neutral institution should certainly be prepared to consider facts and proposals provided by the Fund – as well as from other sources. The IMF is still the largest institution established and financed by the international community to produce expertise on macroeconomic issues. The ultimate decision, however, must under any circumstances be made by the neutral institution.

3. 6. Ms. Krueger’s running gag: the exempt creditor status If it were not a real serious issue for the whole new mechanism one could laugh at the stubbornness with which Ms. Krueger tries to uphold the exempt creditor status of the Fund (and less vigorously of other Multilateral lenders). To support this claim she keeps referring to the Fund’s role as a “lender of last resort”, which is providing the essential new financing during the restructuring phase, which no other lender is prepared to give. However, there is no logical relationship between the status of the Fund as an institution and the protection of new loans, which provide the debtor with fresh liquidity during the restructuring period. Nobody denies that such new loans need to be protected from restructuring or write-off. But this goes for any lender of new money (including eventually privates), and has nothing to do with the old claims of the Fund. The simple institution of a cut-off-date provides for the necessary protection. No preferred creditor status whatsoever is actually necessary.

4 One open question Ms. Krueger has rightly pointed out that even if the Fund must not have the authority to trigger an SDRM, its decision to either keep lending to an illiquid member or not, will largely decide whether the member needs to resort to the mechanism . Thus, even if it deliberately does not have any formal decision making power regarding the starting of the process, it will still maintain a lot of it through its core function as a lender of last resort. The same dilemma might be faced in the debate on the conditionality. Even if the contradictions highlighted above are ironed out by reducing the Fund role to its core function as a lender: as any lender rightfully defines the terms of its lending to the borrower, the Fund will have a strong influence on the outcome of an SDRM, which may need to rely on new lending – at least in the incipient phase. Thus there is some need to define the power balance between the Fund as a lending institution and the Neutral Institution driving the SDRM/FTAP process.