Global Policy Forum

By Michael M. Phillips

With financial instability rippling through Latin America, momentum appears to be building for an international plan to make it easier for developing nations to declare bankruptcy and renegotiate their foreign debts. The Bush administration, which recently has found itself forced to support big money rescue loans for some crisis-wracked developing countries, has given the International Monetary Fund a spring deadline to draw up terms of a global treaty allowing nations to restructure debts more smoothly. Top economic officials from the IMF's 184 member nations are likely to give the plan a boost when they meet here at the end of the month.

"Today, with no clear process for sovereign-debt restructuring in place, when a nation is on the brink of financial collapse we have two stark and uninviting options - unwarranted lending or sending the troubled nation off a cliff into a catastrophic default," Treasury Secretary Paul O'Neill said in a recent speech.

Growing support for the plan is a sign of official concern about recent financial crises in the developing world. Argentina has defaulted on much of its $141 billion in government debt. Uruguay has been caught up in a run on its banks. And the IMF has promised $30 billion to help restore flagging investor confidence in Brazil. While there is enormous pressure to aid countries whose problems might infect their neighbors, economic officials worry that such large rescue packages sometimes simply put off an inevitable default. Instead, the world's wealthy nations have agreed to look at two proposals that would create a process by which countries that are truly insolvent - not just short of cash - could reduce their debts and stretch out payments.

The Bush administration has thrown its weight behind the idea of urging borrowing governments to include clauses in future bond contracts that would allow a majority of creditors to agree to a restructuring and force less-willing bondholders to go along with them. That would keep vulture funds and other holdout creditors from turning to the courts to block a restructuring. Investors and bankers, acting through trade associations, are crafting model language for such clauses, but no developing country has used one yet.

A second proposal, created by IMF First Deputy Managing Director Anne Krueger, would essentially make those majority-action contingency clauses retroactive, applying to the hundreds of billions of dollars in emerging-market debt that are in circulation. Under the IMF proposal, a country would declare itself bankrupt, halt all repayments to foreign private creditors, and negotiate a restructuring with the majority of its creditors. Minority creditors would have no choice but to go along with the majority.

IMF member nations would rewrite its articles of agreement to give the plan force of law worldwide. The U.S. Congress would have to approve such a change.

The IMF plan has alarmed investors, who oppose altering the terms of existing debt contracts. "We continue to believe this is not a productive way forward, and that at a time of extreme risk-aversion in emerging markets, when capital flows are falling, that approaches such as this add further to uncertainty and investor anxiety," said Charles Dallara, head of the Institute of International Finance.

European governments argue that the IMF proposal is central to insulating the world financial system from the shock of defaults. "I would like this to move very fast," said Caio Koch-Weser, Germany's deputy finance minister.

But the key to making the plan a reality is the position of the U.S. government, the most powerful voice on the IMF board. Mr. O'Neill has said both the IMF and Treasury proposals are "necessary and important." John Taylor, Treasury undersecretary for international affairs, acknowledged that he has been more forceful in pushing the U.S. plan. "The time for action is here," he said. But he stressed that Treasury supports movement on both plans.

For months, however, U.S. allies have complained of mixed messages and behind-the-scenes obstructionism from Treasury on the international-bankruptcy issue. The U.S. has blocked attempts by other members of the Group of Seven major industrialized nations to issue stronger words of support, complained one senior G-7 official. "The support by the U.S. has been lukewarm at best," the official said.

Now that perception is changing. At a recent private lunch, Mr. O'Neill asked IMF Managing Director Horst Koehler to draw up language -- by the IMF's April meetings -- to amend the articles of agreement to permit the plan to go into effect. Although Treasury didn't commit to supporting such an amendment, IMF officials came away from lunch convinced that the U.S. is warming to their idea.

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