IMF approves reform to change its current policy on arrears that should promote more efficient resolution of sovereign debt crises in the future (IMF logo)
SOVEREIGN DEBT REFORM
The new policy, approved on December 8, would allow the IMF, in certain carefully defined circumstances, to provide financing to a country even when it has outstanding arrears to official bilateral creditors. This reform should help promote more efficient resolution of sovereign debt crises in the future.
As a general rule, the IMF encourages all countries to maintain sound finances and does not condone payments arrears (i.e., where a country gets behind on its debt obligations). Indeed, until now, the IMF’s policy barred it from providing financing to a country that was in arrears to official bilateral creditors. This was the general policy except in two circumstances: where a restructuring agreement in the Paris Club (a longstanding forum of official bilateral creditors) exists—in which case all other creditors were assumed to restructure their claims on similar terms; or, where in the absence of such an agreement, each creditor provided its consent.
However, as IMF staff had highlighted in a May 2013 paper, this policy could, in some circumstances, allow an official bilateral creditor to block IMF assistance to a debtor country by refusing to participate in a restructuring. This could result in bigger losses for all creditors and damage to the international financial system. The 2013 staff paper had also pointed out that reliance on Paris Club processes could give rise to unfairness in cases where the Paris Club only accounted for a minority of the official claims on a particular country.
The need for this new policy, therefore, has been evident for some time now. In the following interview, Sean Hagan, the IMF’s General Counsel, and Hugh Bredenkamp, Deputy Director of the IMF’s Strategy, Policy, and Review Department, talk to the IMF Survey about the new reform and what it means.
IMF Survey: What motivates this reform?
Bredenkamp: There were two main issues to address. The first relates to the IMF’s exclusive reliance on the processes and practices of the Paris Club when it is considering financial support to a country that is in arrears to its official creditors. This approach worked well in a context where the Paris Club creditors accounted for the bulk of official financing.
However, over the last decade or so, there has been an evolving structural shift in the range of countries providing official finance to other sovereigns. Creditors such as China, Brazil, India, and Saudi Arabia, who are not members of the Paris Club, have become increasingly important lenders, providing the majority of new official financing in some parts of the world.
This shift brought to the fore an important gap in the IMF’s arrears policy. The old policy effectively allowed the IMF, in its financing decisions, to ignore any arrears to non-Paris Club official creditors, so long as the country’s Paris Club creditors had reached agreement on a debt restructuring, even if that agreement represented a small fraction of the needed contributions.
When we flagged this issue in 2013, the Board agreed that it called for a rethink of the policy, and asked the staff to consider the issue in the context of our broader work program on strengthening the framework for sovereign debt restructuring.
Hagan: The second problem we highlighted with regard to the old policy was that it could give rise to situations in which official creditors holding a minority of the claims on a country could block or delay IMF support to that country, even when the majority was willing to restructure or refinance their claims. Knowing that they had this potential veto power over IMF financing, individual creditors could feel emboldened to “hold out” from any restructuring or refinancing agreements amongst other official creditors, in the hope that they could get better terms from the debtor. These holdout creditors could essentially attempt to “free-ride” on the negotiated settlement.
When creditors act in this manner, it creates delay in resolving the debt crisis and could potentially result in a default, raising costs to all parties. Such coordination problems are particularly acute in a pre-default setting where time is of the essence and creditors know they have greater leverage on a debtor desperate to avoid default.
IMF Survey: Could you explain how the policy has now changed?
Bredenkamp: The new policy seeks to address the two issues we have just talked about, i.e., the need to explicitly allow for situations where non-Paris Club creditors account for a majority of the contributions; and the need to effectively mitigate the holdout problem. The new policy does this by setting out clearly defined circumstances under which the IMF would be able to provide financing to a sovereign debtor that owes arrears to other official bilateral creditors.
In approaching this, we were very mindful of the special role that official bilateral creditors play in supporting the IMF-financed programs. These creditors often contribute financing in the context of IMF-supported programs when other sources of funding—notably, from private investors—have dried up. It was important, therefore, to ensure that the new policy would provide appropriate safeguards to official creditors, and seek to avoid situations in which a decision by the IMF to provide financing notwithstanding outstanding arrears could send such a negative signal to the community of official bilateral creditors at large that it would impair our ability to mobilize official support for future IMF-supported programs.
Against this backdrop, the key features of the new policy are as follows.
First, if there is a Paris Club agreement that is “adequately representative” (i.e., Paris Club creditors account for a majority of the required contributions from official bilateral creditors over the program period), the IMF would be able to move ahead and provide financing on the assumption that the debtor will negotiate an agreement with non-Paris Club official creditors on terms comparable to those provided by the Paris Club. In other words, if there is a Paris Club agreement that represents the majority, we can still use our traditional approach.
If, however, there is no adequately-representative Paris Club agreement, and the debtor has been unable to reach agreement with one or more official bilateral creditors to clear its arrears, the IMF Board could nevertheless approve financing for that country if the following three criteria are satisfied:
(i) there is a need for prompt IMF support (that is, waiting until all creditors have reached an agreement with the debtor would be too costly);
(ii) the debtor is making good faith efforts to reach an agreement with the creditor(s); and
(iii) the decision to provide financing, given the circumstances, would not have an undue negative effect on the IMF’s ability to mobilize official financing packages in future cases.
The new policy specifies various factors, among others, that would be taken into account in assessing whether the second and third criteria, in particular, are met. It is important to emphasize that, while staff will provide analysis and recommendations, the ultimate judgments here would be made by the IMF Board. Hence, both the debtor and the official bilateral creditors would have an opportunity to voice and discuss their particular concerns as part of the decision-making process.
I would also highlight the fact that the policy leaves open the possibility for those official bilateral creditors who are owed arrears to give their consent to IMF financing, as before. In other words, the Board would only need to make judgments about whether the three criteria are satisfied if there are official bilateral creditors to whom the debtor owes arrears who have not provided consent for IMF financing to proceed.
IMF Survey: Who will the reform benefit most?
Hagan: In broad terms, all parties stand to gain from this reform. By strengthening incentives for collective action among official bilateral creditors and removing impediments to the IMF’s financing role, the reform will promote more efficient resolution of sovereign debt crises and generate significant benefits for creditors, debtors, and the international financial system more broadly.
As regards official creditors, it is important to recognize that the policy only applies when a debt restructuring has already been deemed to be necessary—it does not imply any increase in the frequency of restructurings. Where the decision has been made that a restructuring is needed, timely IMF support offers the best chance for maximizing the value of creditors’ claims (or minimizing their losses). Because the reform reduces the ability of a holdout creditor to block or delay IMF support, collective action will be more likely, so official bilateral creditors, as a group, will benefit from the reform.
The reform also protects non-Paris Club official creditors who, under the current policy, have no leverage whenever there is a Paris Club agreement, regardless of whether that agreement is representative of the contributions required under the program. Under the new policy, non-Paris Club creditors would only be bound by the terms of a Paris Club agreement when the latter is adequately representative.
The reform will also benefit debtor countries, as it will be more difficult for holdout creditors to block timely IMF support to those members.
IMF Survey: Why did the IMF enact this change now? Did it have anything to do with Ukraine’s recent difficulties in obtaining a restructuring of its debt to Russia?
Bredenkamp: The need for this reform has been evident for some time now. IMF staff first raised concerns about the risks inherent in the institution’s policy on non-toleration of arrears to official bilateral creditors back in 1989, when IMF rules with regard to private creditors were amended. These concerns were reiterated in the May 2013 paper, before the Russian loan to Ukraine even existed. On both occasions, staff argued that protections under the policy should not automatically extend to non-contributing creditors and that the policy needed to be reformed to strengthen incentives for collective action among official bilateral creditors.
