Sean Hagan is former general counsel of the IMF. He is currently professor from practice at Georgetown Law and an adviser to Rothschild & Co.
A crucial feature of corporate insolvency law is the “trigger” — when should a proceeding begin? Sadly there’s no insolvency law for sovereigns, so for better or for worse it is the IMF that in practice acts as the trigger.
Why? Because when a country cannot service its debts, it will typically ask the IMF for money. That’s not an easy decision for any finance minister. Although they know IMF support will come with painful strings, a default and debt restructuring can result in the loss of hard-earned creditworthiness, kybosh the economy and may very well cost the minister their job.
But the IMF also has to make a difficult decision. It too prefers to avoid a restructuring, given the economic and financial risks. However, if the IMF concludes that the country’s debt burden is so high that it cannot repay creditors in full under any feasible scenario it will make a restructuring a condition for its assistance.
This is why the IMF’s “Debt Sustainability Analysis” is the de facto trigger for government restructurings.
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 capacity 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 surpluses.
This is particularly tricky. There comes a point where tax increases become counterproductive, since it chokes growth. Spending cuts can hit the economy instantly. Also, not all governments have the same political capacity to sustain fiscal surpluses over an extended period. Argentina is not Latvia. Finally, the IMF assesses the country’s overall financing needs and the projected cost of future borrowing.
If all of this seems a bit judgmental, it’s because it is. Notwithstanding the sophistication of the Fund’s DSA methodology, the bottom-line assessments of debt sustainability are, as the economists say, “probabilistic”.
An IMF determination that the debt is not sustainable is pretty 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, it shapes crucial features of the IMF program, including the pace of “fiscal adjustment”. Moreover, because a vital objective of the program is to restore debt sustainability, it effectively determines the size of the “restructuring envelope” — ie, the overall amount of debt relief needed.
At this point, delays are costly. While this may seem obvious for the country — a government “gambling for resurrection” will, in desperation, inflict unnecessary pain on the economy in a futile attempt to service a debt level that is unserviceable — it is also true for creditors.
Why? If the debts are unsustainable and the IMF continues to provide financing to repay maturing obligations, it will effectively be replacing these creditors. Because of the IMF’s preferred creditor status, the remaining creditors will have to contribute more to secure the necessary debt relief.
Unsurprisingly, creditors often argue vociferously over DSAs, which basically dictate how much money they can get back. And admittedly, the IMF’s record on the accuracy of its macroeconomic projections is hardly unblemished. Indeed, some feel that DSAs should therefore be a subject of “negotiation” between the IMF and a country’s creditors.
This would be . . . problematic. As long as DSAs are made in the context of the IMF’s lending decisions, they must be the product of IMF’s independent judgment. The DSA is a crucial anchor of the entire process. Despite its shortcomings, subjecting DSAs to negotiation would compromise their legitimacy. An already uncertain process could become chaotic. As has been noted of the role that Supreme Courts play: 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 approves of the programme and the full documents are published. This is in contrast to other government creditors, who normally receive at least certain important elements of the DSA on a confidential basis at an earlier stage.
This lag creates delays. Private creditors cannot begin negotiations unless they have clarity as to what the restructuring envelope is. As is the case in the corporate bankruptcies, once a sovereign debt restructuring process has been launched, everyone just wants to get it done quickly. The government is anxious to regain market access. Private creditors are eager to see the recovery in the market value of their claims that will occur once the restructuring has been completed and debts are sustainability again.
The IMF should therefore speed up the process by publishing key elements of the DSA when the staff level agreement is reached, so official and private creditors receive this information at the same time.
It’s a small thing, but given the mess the sovereign debt restructuring process is in right now, every little bit helps.
