Sean Hagan served as IMF General Adviser from 2005-2018; he is currently a practice professor at Georgetown Law
Over the years, efforts to improve the sovereign debt restructuring process have focused on tackling collective action among private creditors. That has changed.
There is now a consensus that a major obstacle to this process – including the one started by the so-called “Common framework” — ensures collaboration between officially creditors, with much of the focus on the largest among them, China.
Opinions differ about the changes in international architecture needed to tackle this problem. But I think more attention should be paid to consistent application of the existing frame.
More specifically, the IMF’s major shareholders would simply be a robust application of overdue borrow policy.
The relevance of the IMF to this debate is not surprising. The IMF has always played a central role (for better or for worse) in guiding the debt restructuring process. A country will generally only initiate debt restructuring if and when the IMF determines that it is no longer willing to provide financing in the absence of restructuring.
In addition, when restructuring is required, the financial parameters of an IMF-supported program determine the total amount of debt relief needed to restore debt sustainability. An important challenge has always been the next step: ensuring adequate cooperation from creditors.
On the one hand, the IMF is reluctant to postpone the approval of financial aid until the ink of the restructuring agreement has dried. On the other hand, it cannot approve a program until it has sufficient assurances that creditors will in fact provide relief consistent with the program’s assumptions.
The IMF’s approach to obtaining these guarantees from creditors (commonly referred to as its “funding guarantees” policy) has evolved. During much of the debt crisis of the 1980s, the IMF would not approve a program unless a critical mass of private creditors expressed their willingness to provide the necessary debt relief. Over time, however, creditors began to drag on and as a result, the IMF’s financial support to countries was unnecessarily delayed.
The IMF therefore introduced one of its most consistent policies: the “provide delinquent” policy: in the absence of creditor support, the IMF obtained funding guarantees by assuming that if — during the life of the program — the debtor does not agree with its creditors, the necessary funding for the program would be obtained through the accumulation of arrears.
An important aspect of this policy is that it can be relied upon even when there are no arrears, in other words, in a pre-default context. In these situations, the financial parameters of the program assume that payments will no longer be made in accordance with the original contractual terms. While the first best-case scenario is that these parameters will be met through a consensual restructuring that avoids default, the IMF can assume that, even in the worst-case scenario, these parameters would be observed by the accumulation of arrears. Essentially, the policy can be used as a backstop.
Unsurprisingly, the introduction of this policy was unpopular with private creditors: they no longer had the power to hold back an IMF program. Moreover, to avoid default, they had no choice but to grant debt relief on terms consistent with the IMF’s program.
As originally conceived, this muscular approach was: limited to private creditors. Through the Paris Club process, the bilateral government creditors continued to provide the IMF with early assurances that they were willing to provide the necessary debt relief on a consensual basis.
Over time, however, exclusive reliance on this consensus approach broke with the emergence of new official bilateral creditors unwilling to join the Paris Club, including China. Faced with this challenge, the IMF decided in 2015 to a policy that allows it to make delinquent loans to official bilateral creditors.
Importantly, the policy on administrative backlogs is less flexible than the policy on private backlogs. While two of the criteria to be met also apply to private arrears (namely, the urgency of IMF support and the existence of good faith efforts by the sovereign), the third criterion is specific to official claims: the policy cannot be applied as it would have an “unnecessarily negative effect on the Fund’s ability to mobilize official funding packages in future cases”.
Because arrears from a particularly large creditor — or a group of creditors — increase this risk, the policy states that the Fund would “normally” be unwilling to make delinquent loans when the aggregate value of the official creditor(s)’ claims ) in question represented a “majority of the total financing contributions required from official bilateral creditors during the program period”.
Despite these limitations, the 2015 policy remains an important policy tool, both in the pre-default and post-default context. In particular, the term “normal” provides flexibility and, in line with policy, could allow the IMF to lend to a large creditor that does not have a proven track record of providing debt relief.
Unfortunately, the IMF has generally been reluctant to implement this aspect of the policy. This reluctance undoubtedly reflects the concern of the IMF board, which represents the interests of traditional Paris Club creditors.
There may be a concern that even if a country falls into arrears with a major official creditor during the program period, the creditor in question will be able to use its influence to restore the full value of the claim after the program ends , addressing both sustainability issues and equity between creditors. While this is undoubtedly a risk, there may be ways to mitigate it, including through the type of ‘most favored creditor’ provision recently proposed by Lee Buchheit and Mitu Gulati.
In any case, this recovery risk must be weighed against another risk: a creditor vetoing the approval of an IMF program. This is precisely the risk that the loan delinquency policy was designed to address.