By Roy Culpeper
North-South InstituteJanuary 9, 2002
Recent debate on Argentina's $132 billion debt crisis has focused on its rigidly fixed exchange rate system and other economic policy choices that the country has taken, rightly or wrongly. The fact of the matter is that Argentina's debt is not going to be repaid wholly or on time. Missing from the discussion is the glaring failure of the international financial system, which has been increasingly prone to such debt crises, to prevent or remedy them. The task of "rebuilding the global financial architecture," embraced by the G-7 industrial countries in 1997 at the onset of the last crisis, has been virtually abandoned.
In terms of preventing debt crises, the onus has been put on borrowing countries to avoid over-indebtedness through tightening up supervision of their financial sectors. In contrast, there has been no effort to tighten up the rules to prevent private sector creditors from over-lending. As for crisis resolution, there has been much talk, but little action, with regard to getting foreign creditors to accept a larger share in the costs of resolving crises, which are largely borne by the debtor countries. However, it seems alternative solutions are now being considered, such as an international bankruptcy procedure that will require debtors and their creditors to restructure the outstanding debt on mutually acceptable terms.
In a keynote speech on November 26, Anne Krueger, number two at the International Monetary Fund in Washington (and recently appointed to that post by the Bush Administration) talked about the need to develop an "international workout mechanism" modeled on domestic bankruptcy courts. Her proposal sent a strong signal that the IMF (backed by the Bush Administration) no longer has the desire, let alone the required funding, to bail out creditors to Third World countries when financial panic sends them all racing for the exits.
Essentially, the mechanism would involve new ground rules, supervised by the IMF, under which debtors and creditors would be required to work out compromises with concessions on both sides. Although such rules are common in domestic jurisdictions, in the international sphere there is no parallel, although deals have been struck on a case-by-case basis. The problem is that rogue creditors pose a growing threat to such ad hoc solutions. (Ms. Krueger explicitly alluded to the recent exploits of Elliott Associates, a "vulture fund", in the Peruvian debt market.) By demanding 100 cents on the dollar plus accrued interest, and by threatening legal action to seize the debtor country's bank accounts and other assets domiciled in the U.S. or elsewhere, such financiers seriously undermine the willingness of other creditors to cut a deal.
There are many challenges to be addressed if this mechanism is to see the light of day. The principal stumbling-block will be the need for countries around the world to agree on and enact national rules to prevent rogue creditors from disrupting orderly workouts for debtor countries. In fact, Ms. Krueger predicted such new rules will take two or three years to be put in place, so they will come too late to help debtor countries currently in crisis such as Argentina and Turkey.
The fundamental flaw in this proposal, however, is that it puts far too much faith in the self-regulating capabilities of the global capital market. It also does little to prevent future crises beyond taking away an assurance to lenders that they will be bailed out in the crunch. A basic lesson of the last 20 years is that much of the private capital flowing to developing countries, far from seeking long-term productive investments, has been footloose and vulnerable to panic, causing disruption on world markets and exacerbating the poverty of host countries in times of crisis. The bankruptcy-type proposal also assumes roughly equal power between debtor countries and their creditors, which may be true only for the largest debtors such as Brazil and Argentina. Most other debtors will have a hard time getting a fair deal.
Therefore, an international bankruptcy mechanism, if one ever materializes, needs to be complemented with a range of other measures to help prevent future crises by encouraging more stable, long-term foreign investment while discouraging volatile and speculative capital flows. Such measures include financial and currency transactions taxes (the so-called "Tobin tax"), border taxes on short-term foreign borrowing like those employed by Chile and Colombia, and more effective regulations for international banks to discourage short-term lending.
Given the uncertainties facing the IMF's proposed workout mechanism, there may in the final analysis be little alternative to a "condoned default"—essentially a debt-reduction formula imposed by the international community, such as that crafted for the poorest debtor countries in 1996. This solution simply accepts that it is better for acutely distressed debtor countries to meet the needs of their people rather than to service all their obligations on time.
Roy Culpeper
President
The North-South Institute
FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Policy Forum distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C § 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.
