Lee Bouchett is Professor of Law (Honours) at the University of Edinburgh.

accident Sovereign debt restructuring It is expected to unfold more or less as follows:

• The debtor country is approaching the International Monetary Fund to obtain a programme.

• Fund staff prepares a Debt Sustainability Analysis (DSA).

• If a country’s debt is declared “unsustainable” by the Public Debt Law, IMF staff will insist on their promise to restructure its financial obligations in order to meet specified “debt sustainability targets” (eg average annual total financing needs; target debt relative to gross output domestic; cumulative debt service reduction target, etc.).

• The IMF staff and the country then negotiate the terms of the IMF Adjustment Program, with the terms stated in a Staff Level Agreement (SLA).

• But IMF staff will not take the draft program to the IMF’s Executive Board for approval unless and until the country’s bilateral and commercial creditors provide assurances to the Fund that they will restructure their debt in a manner consistent with the programme. In IMF talk, these are called “Financing guarantees.“

but why?

The ostensible justification for the IMF’s insistence on receiving financing guarantees from the country’s existing creditors is found in the Fund’s Articles of Agreement. FTAV focus below:

Section 3. Terms of use of the general resources of the Fund

(a) The Fund shall adopt policies regarding the use of its general resources, including policies relating to stand-by or similar arrangements, and may adopt special policies for special balance of payments problems, which will assist Members to resolve their own balance of payments problems in a manner consistent with the provisions of this Agreement and which will establish Adequate guarantees for the temporary use of the general resources of the Fund.

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As an institution that lends new money in clearly distressed situations, it is quite understandable that the IMF would want the debtor country’s existing lenders to agree to settle their claims against the borrower before disbursing the new money. After all, the IMF should not want to see its money hemorrhaged to pay existing creditors in full.

Equally important, the Fund wants to ensure that its programs will have reasonable change for success. When a country is assessed as having an unsustainable debt load, that success will require an adjustment to existing liabilities.

The dilemma of the pig in the goose

The problem is not that the fund is seeking financing guarantees from existing lenders. No commercial lender in a distressed company situation would do otherwise. The problem is when and how to request these financing guarantees.

Let’s start with when. International Monetary Fund staff is asking bilateral and commercial creditors to provide financing guarantees Before Staff will submit the proposed program to the Fund’s Executive Board for approval. The IMF’s financing guarantee policy took shape in the early 1980s at the onset of the Latin American debt crisis.

In that era, the bilateral sovereign creditors were members of the Paris Club Commercial bank lenders were represented by an advisory committee to the bank. At the time, it was relatively easy to seek assurances from both groups that they would provide the debt relief needed to fill any projected funding gaps in the country’s IMF adjustment programme. But by 1989 it had become clear that commercial banks were using the Fund’s financing guarantee requirements as leverage to obtain concessions from sovereign debtors.

With respect to trade creditors, the fund has considerably relaxed its financing guarantee policy. Funding guarantees from commercial creditors are now met if the sovereign borrower commits to negotiating in good faith with the commercial creditors. In other words, the debtor promised to negotiate With Its private lenders consider it collateral From These creditors that they will accept the outcome of those negotiations, whatever they may be. However, the fund continues to insist on receiving positive financing assurances from bilateral creditors.

Over the past 12 years, the Paris Club’s share of bilateral lending has dwindled compared to non-Paris Club bilateral lenders, particularly China. Funding guarantees must now be sought from two groups of bilateral creditors – the Paris Club and non-Paris Club bilateral countries such as China. and if receipt of funding guarantees is a precondition for consideration by the Executive Board of the programme, a Bilateral creditor like China that may not relish the prospect of debt restructuring could prevent this event – largely indefinitely – simply by Withhold their financing guarantees staff of the International Monetary Fund.

Now how

Lenders who have been asked to provide these financing guarantees have not been told exactly what they are, in principle, signing up for. The debt sustainability targets contained in the debt sustainability analysis will be expressed as applicable to the entire stock of a country’s debt. The sensitivities of the Fund prevent him from indicating in the DSA or in the Program how much debt relief is required to be charged by each class of lenders; The fund insists that this is a matter to be resolved between the state and its various creditors.

Sentence “Financing guaranteesIt may indicate that each creditor group is required to confirm that it will contribute an amount of prescribed debt relief proportionate to its share of the total debt stock. But this is merely an implication. Funding guarantees could just as easily refer to a promise to provide debt relief proportionate to With the share of the creditors group in the debt balance And the Sufficient to cover any shortfall in debt relief provided by other creditors.

Furthermore, some lenders may feel that other creditors should offer a disproportionate share of debt relief. Scratch a Paris Club creditor, for example, and you’ll likely discover beneath the surface a deep belief that bilateral creditors — lending at below-market interest rates — should be given preferential treatment in any debt restructuring with the lion’s share of any debt relief needed. Coming from those incorrigibly greedy commercial lenders. What does a bilateral creditor say when the IMF is assured it will provide adequate debt relief?

Finally, what does “guarantee funding” mean in the context of a country such as Sri Lanka or Ghana, where almost half of the debt stock is made up of domestic liabilities (in local currency)? Everyone knows that great care must be taken when seeking debt relief from local creditors for fear of destabilizing local financial institutions, pension funds and insurance companies.

In a country with a large amount of domestic debt, does “financing guarantees” thus mean debt relief in proportion to each external creditor group’s share of the foreign currency debt stock Plus Portion – how much? – From the balance of the domestic debt?

deadlock

There is an obvious solution. Instead of requiring lenders to provide financing guarantees as a condition of taking a program to the IMF’s executive board, have the board approve the program but withhold any large cash payments until existing lenders agree to provide the required debt relief.

This would (1) adequately protect the fund’s resources, (2) put pressure on the debtor and existing lenders to come to specific terms on debt restructuring or risk canceling the program and (3) deny any creditor or large creditor group the ability to thwart the process by Withhold their financing guarantees.

Moreover, the IMF has Established policies (called “lending to arrears”) that addresses the problem of recalcitrant creditors After, after The council approves a program for the country.

The potential time delay inherent in the Fund’s current practice of financing guarantees is more than an inconvenience.

At the time of signing the Staff Level Agreement, the debtor country’s authorities are often required to implement “prior actions” before the program goes to the IMF’s board for approval. Some of these prior actions, such as raising taxes, can be politically harmful.

So it could leave the authorities in an uncomfortably exposed position if the state swallows some bitter medicine but finds that in practice a creditor can still delay the program indefinitely by withholding financing guarantees.