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The IMF Is Courting New Risks with a Change in Policy on Debt Restructuring

From the Peterson Institute by Douglas A. Rediker:

With surprisingly little public debate, the International Monetary Fund (IMF) is on the verge of confronting one of the most sensitive issues in international finance: how to balance political and economic considerations when a country loses market access and needs to restructure its debt or its economy, or both. In the next several weeks, the Fund is expected to release a follow up to last year’s controversial staff paper on sovereign debt restructuring [pdf], which could dramatically alter how countries borrow and the risks for investors who lend to them.

 

The Fund’s initiative, though well intentioned, is flawed and likely to create more problems than it solves.

 

In its staff paper last year, the IMF floated a new general policy that would impose losses on creditors—whether banks, individuals, or other private lenders—as a precondition for financial assistance to a country in need of rescue. The rationale was that bailouts often take so long that by the time debt restructuring is called for, private investors have already liquidated their holdings and costs to the official sector have increased. The Fund seeks to address a problem they describe as “too little too late.”

 

The three policy goals enunciated by the Fund were “(1) increased rigor and transparency of debt sustainability and market access assessments, (2) exploring ways to prevent use of Fund resources to simply bail out private creditors, and (3) measures to alleviate the costs associated with restructurings.” In the IMF’s view, a more predictable regime for indebted countries would force them to face up to their problems earlier without investors keeping them afloat until it is too late.

 

These goals are laudable, and certain issues raised by the Fund are constructive, timely, and deserving of further exploration.1 But basing significant policy changes mostly on recent experiences in Argentina and Greece and, as a result, increasing the number of potential debt restructurings is misguided.2

 

Instead the Fund should step up its surveillance efforts, perhaps boosting its regular World Economic Outlook and the Global Financial Stability Reports to highlight potential vulnerabilities more effectively. Louder naming and shaming to force policy corrections is a better approach than promoting debt restructurings that could cause sharp and abrupt dislocations in sovereign funding markets and risk spreading contagion in world financial markets.

 

Sovereign debt restructurings requiring investors to accept less than they are contractually entitled to should never be easy or common. After all, a restructuring is a more diplomatic term for a fundamental breach of contract between a country and its lenders. But restructurings sometimes are needed, and, in spite of rhetoric to the contrary, have generally proceeded smoothly over the past decades, as a 2012 IMF research paper studying 60 years of restructurings concluded.3

 

The Fund’s proposals would increase the rigidity and inflexibility of the debt sustainability analysis (DSA), by which the Fund assesses a country’s ability to service and repay debt under a variety of scenarios. Current policy sensibly calls for DSAs not to be “interpreted in a mechanistic or rigid fashion.”4 The new policy would impose greater standardization and limit the Fund’s discretion.

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