Sean Hagan is a former General Counsel of the IMF. He is currently a professor of practice at Georgetown Law and of counsel to Rothschild & Co.
A defining feature of business insolvency law is the “trigger” – when must proceedings commence? Unfortunately, there is no insolvency law for sovereigns, so for better or worse it is the IMF that effectively acts as the trigger.
Why? Because when a country cannot pay its debts, it will typically ask the IMF for money. It is not an easy decision for any finance minister. Although they know that IMF support will come with painful strings attached, a default and debt restructuring could result in the loss of hard-earned credit, kybosh the economy and very well cost the minister their job.
But the IMF also has to make a difficult decision. It also prefers to avoid a restructuring given the economic and financial risks. But if the IMF concludes that the country’s debt burden is so high that it cannot repay creditors in full under one possible scenario, it will make restructuring a condition of its assistance.
This is why the IMF’s “Debt Sustainability Analysis” is the de facto trigger for sovereign restructuring.
To say that DSAs are difficult is an understatement. A company is insolvent when its liabilities exceed its assets. Trying to assess the value of a country’s “assets” is complicated when its taxing power is, at least theoretically, inexhaustible. As a result, the IMF’s assessment involves a number of projections around things like economic growth and the maximum achievable budget surplus.
This is particularly difficult. There comes a point where tax increases become counterproductive as they stifle growth. Cost savings can hit the economy immediately. Nor do all governments have the same political capacity to maintain fiscal surpluses over an extended period. Argentina is not Latvia. Finally, the IMF assesses the country’s overall financing needs and the expected costs of future borrowing.
If all of this seems a little judgmental, that’s because it is. Despite the sophistication of the fund’s DSA methodology, the bottom line assessments of debt sustainability are, as the economists say, “probability”.
An IMF decision that the debt is does not sustainable is quite consequential. A restructuring is no longer a question of “if” – it is now a question of “when” and “how”.
In addition to kick-starting the debt restructuring process, the defining feature of the IMF program, including shaping the pace of “fiscal adjustment”. Moreover, because an important objective of the program is to restore debt sustainability, it effectively determines the size of the “restructuring grant” – i.e. the total debt relief needed.
At this point, delays are expensive. While this may seem obvious to the country – a government “gambling for resurrection” will, in desperation, inflict unnecessary pain on the economy in a futile attempt to service a level of debt that is unworkable – it also applies to creditors.
Why? If the debt is unsustainable and the IMF continues to provide financing to repay past due obligations, it will effectively replace these creditors. Due to the IMF’s preferred creditor status, the remaining creditors will have to contribute more to secure the necessary debt relief.
Not surprisingly, creditors often argue loudly about DSAs, which basically dictate how much money they can get back. And to be sure, the IMF’s record in terms of the accuracy of its macroeconomic projections is hardly flawless. Indeed, some believe that DSAs should therefore be subject to “negotiation” between the IMF and a country’s creditors.
This would be. . . problematic. As long as DSAs are made in the context of IMF lending decisions, they will must be a product of the IMF’s independent judgment. DSA is a crucial anchor in the whole process. Despite its shortcomings, subjecting DSAs to negotiations would compromise their legitimacy. An already uncertain process can become chaotic. As has been noted about the role of the Supreme Court: they are not final because they are right; rather, they are right because they are final.
But the IMF could and should take steps to improve the transparency of the process.
Private creditors typically only see the DSA after the IMF’s Executive Board has approved the program and the full documents have been made public. This is in contrast to other government creditors who usually receive at least certain key elements of the DSA on a confidential basis at an earlier stage.
This delay creates delays. Private creditors cannot start negotiations unless they have clarity on what the restructuring framework is. As is the case with corporate bankruptcies, once a sovereign debt restructuring process is initiated, everyone just wants to get it done quickly. The government is keen to regain market access. Private creditors are eager to see the recovery in the market value of their claims, which will happen when the restructuring is completed and the debt is sustainable again.
The IMF should therefore speed up the process by publishing key elements of the DSA once the staff-level agreement is reached, so that official and private creditors receive this information at the same time.
It’s a small thing, but given the mess the sovereign debt restructuring is in right now, every little bit helps.