Presentation by Kunio Saito
Director, Regional Office for Asia and the Pacific
International Monetary Fund
Given at the APEC Financiers Group Meeting
Bandar Seri Begawan, September 9, 2000

Thank you Mr. Chairman, I am pleased to be here, etc.

This morning, I have been asked to speak on the subject of private sector involvement in crisis prevention and resolution or PSI. This subject has been discussed intensively over the last few years in various international fora, and discussion continues. In that sense, the subject is continually being renewed and redefined. But the notion of PSI, or at least some elements of it, is not new. I say this from my own experience of being with the Fund for the last 30 years, working on Asian countries. Our work on Asian countries experiencing external payments difficulties involved, at times, what may now be called concerted efforts to involve the private sector in crisis management. Those efforts included rollovers of private bank credit, debt exchanges, and other forms of rescheduling and refinancing debts, as well as more general efforts to promote dialogue between countries and creditors and maintain close relationships at both good and bad times.

In my presentation this morning, I will try as best I can, to highlight the key features of the ongoing discussion on PSI—what it is about and where it is going. I will try to be as comprehensive and as objective as I can. But this is not easy, as discussion is still continuing, and views differ widely on some issues. I must stress at the outset that, in many respects, my presentation will represent my own views and interpretations, and will be biased by my experience of working on Asian countries that I just mentioned.

I will address three broad topics/questions:

i) What motivated the PSI discussion?
ii) What has been agreed so far? and
iii) What are the remaining issues?

What motivated the PSI discussion?

Let me start with the first question—what motivated the PSI discussion? And why are some people so insistent on PSI? I think there are two sets of arguments to answer this question—"bail-in" arguments and "burden sharing" arguments.

Proponents of "bailing-in" the private sector start from their concern about the consequences of large official financial packages provided to countries in crisis—such as Korea, Thailand, Indonesia, Russia, Mexico etc. They argue that large official packages have been used to bail-out private creditors and investors who should have been left to deal with the consequences of their investment choices. In addition, they argue that, even when official funds are not used for unjustified bail-outs, expectations exist among at least some creditors and investors that they will be bailed out at times of crisis. The proponents of bailing in the private sector also point out that the availability of official funds, and the associated actual and expected bail-outs, causes moral hazard—it discourages thorough and careful risk assessment, and encourages imprudent and unsustainable lending and investments which can increase the potential magnitude and frequency of future crises. The logical consequence of these arguments is to bail-in the private sector and it is for this reason that these proponents insist on implementing PSI. I might add that these "bail-in" arguments have sometimes been advanced with an emotional tone, amid criticisms of private sector behavior, and have been perceived as coercive or punitive by some private sector participants.

I do not fully agree with the arguments forwarded by the proponents of bailing in the private sector. For one thing, I associate myself with those who argue that there has never been a wholesale bail-out of private creditors in recent crises and that private creditors have also been victims of those crises. In this regard, there is a widely quoted estimate by the Institute for International Finance (IIF) that private creditors and investors lost some $350 billion in the recent Asian and Russian crises. Nevertheless, I think it is fair to say that some investors, a small sub-group of the total, did probably escape the full negative consequences of their unwise investment decisions. To this extent, therefore, I agree that there is some truth to the "bail-in" arguments, especially regarding the expectation of official bail-outs by some investors and the associated moral hazard.

The second set of arguments, the "burden-sharing" arguments, are perhaps more widely accepted. According to this view, the burden of crisis resolution—and in particular the burden of providing financial resources to the country suffering from the crisis—should be shared equitably between the official and private sectors. I share these views and would add an observation based on my own experience that, equitable or otherwise, private sector contributions have been an essential part of successful financing packages. There will inevitably be cases where, for example, banks have to tolerate a delay in principal and interest payments for a relatively short period to give time for an IMF program to be completed and the country's foreign exchange flows to be normalized. In most cases, the banks have understood this and have agreed voluntarily to provide such a breathing space to allow the negotiations on an IMF-supported program to be completed. More generally, banks have often agreed that, if and when an IMF-supported program is in place, they will roll-over short-term credits, reschedule and refinance debt, and so on. I do not want to suggest this process is easy. In fact, there have been cases where, even after an IMF-supported program had been put in place, private capital outflows have continued—short-term credits were not rolled over as had been hoped, and debts previously thought medium- or long-term became short-term as all possible options were exercised. So, in my view, there have been some collaborative mechanisms between official and private sectors to help countries in payment difficulties, but these mechanisms need to be strengthened through a better framework for PSI, and through better burden sharing.

What has been agreed?

Against the background I just described, PSI has recently been discussed intensively in various official international fora, including the Fund's International Monetary and Finance Committee (IMFC), the Fund's Executive Board, the G-7, APEC etc. Private sector participants have also joined in the discussion—you may recall Mr. Charles Dallara of IIF and Mr. William Rhodes of Citicorp expressing their views on this topic. It is fair to say, I think, that a wide range of views from both official and private sectors have been advanced during these discussions, and that for this and other reasons, including the complexity of the issues involved, progress has been slow.

Nevertheless, a few areas of agreement have been identified. These were set out in the G-7 Finance Ministers report to the Köln Summit in June 1997 and the communiqués adopted at a series of IMFC meetings.

One basic area of agreement, although it is not explicitly stated in any of those documents, is that the international community recognizes the need for PSI, and that it is seeking to advance—or at least continue—the PSI debate, despite the complexity and difficulty of the issues involved. There is also agreement that the IMF will have to continue to play a key role in whatever arrangements come out of the discussions.

Beyond these basic areas of agreement, a number of broad principles for PSI have been established. These are:

First, prevention is better than cure. This is obvious and uncontroversial. The operative message, I think, is that any PSI proposal must include measures for crisis prevention.

Second, contracts must be honored, and any PSI proposal must not undermine the obligation of countries to meet their debts in full and on time. Nobody would disagree with this, but at the same time everybody would note that PSI becomes an issue when contracts are in danger of not being honored.

Third, creditors must bear the consequences of the risks they take. Private creditor decisions should be based on thorough risk assessment, and not on the expectation that creditors will be protected by official actions.

Fourth, as a recapitulation of the principles mentioned so far, there should be no presumption of an automatic bail-out either of countries or of lenders. The primary responsibility, the first line of defense against crises, must be the sound policies implemented by borrowing countries and solid risk assessment by lending institutions.

Some of the agreed principles are of more practical relevance to the operation of any scheme or framework that may come out of the PSI discussions. These are:

First, all categories of creditors should be treated equally. No one category of creditors should be regarded as inherently privileged relative to others in a similar situation.

Second, a framework for PSI—or any PSI proposals—should provide flexibility to address diverse cases. Wherever possible, proposals should aim to achieve cooperative solutions based on voluntary participation.

Third, notwithstanding what has just been mentioned, solutions should not be seen as arbitrary. Although it may not be possible to devise a "one-size-fits-all" approach, there need to be broad guidelines that can be applied consistently across cases to avoid the perception of uneven treatment of creditors or countries.

Based on these principles and recent experiences in a number of countries, the international community has developed and agreed on a framework for PSI, which involves two alternative approaches.

The first is the IMF's traditional catalytic approach, which is to be applied to cases where the country's financing requirements are small and its prospects for a return to the markets are good.

The second is a more concerted approach, which may be required when financing requirements are large and prospects for a return to the markets are poor.

It is obvious, at least to me, that, in the case of crises of the sort we increasingly see today, the second, more concerted, approach is more likely to be relevant than the first, more traditional, approach. The more concerted approach would aim at putting in place a broad spectrum of actions by private creditors. These include actions that will prevent them from exiting in the midst of a crisis—by reaching collaborative agreements for the maintenance of exposure, or a de facto voluntary standstill. Possible actions could also include a comprehensive debt rescheduling and refinancing, including debt exchanges and restructuring of international sovereign bonds.

There is also broad agreement, embodied, for example, in the G-7 report of June 1999, that the use of IMF funds should be linked to the authorities' commitment and efforts to negotiate these actions with private sector participants—that is, no IMF money should be made available without successful PSI negotiations. Subsequently, this element has been introduced in a number of recent IMF-supported packages with, I believe, considerable success.

The last area of agreement in PSI discussions that I want to mention is the emphasis that has been placed on the importance of regular and close contacts between country authorities and private creditors at both good and bad times. Various efforts are being made to this end, including through the IMF.

What are the remaining issues?

Having listened to what I have been saying so far, some of you might say that this is not what you thought PSI was all about. To some people, especially those who approach PSI issues from the viewpoint of bailing-in and moral hazard arguments, PSI is about establishing a more rules-based system. Consequently, PSI discussions have covered such topics as standstills, collective action clauses in bond contracts, and some quantitative norms for PSI. Let me now touch briefly on these issues.

First, on standstills. If the voluntary, concerted techniques I mentioned earlier are put in place promptly and successfully, countries benefit from a de facto voluntary standstill, as banks rollover maturing credits and maintain their exposures. However, if there is a delay in agreeing concerted actions, which is quite likely to be the case during a crisis, countries may have no choice but to impose a unilateral standstill—by introducing exchange controls and/or defaulting on sovereign obligations. These considerations have led to a proposal for enabling a third party, namely the IMF, to introduce a standstill in a more orderly fashion in certain extraordinary circumstances. This proposal entails many legal and technical challenges, including the need to amend the IMF's Articles of Agreements. A related question is whether a super-national institution like the IMF can be empowered to intervene in private businesses directly—without going through national authorities. Consequently, as far as I know, the proposal has received only limited support.

Second, on collective action clauses in bond contracts. These clauses could enable rescheduling with the consent of a predetermined majority, rather than requiring unanimous consent as is the case in many countries at present. The international community has agreed to this approach and is encouraging countries to adopt it. However, countries are not forced to do so, and only a few countries, like the U.K. which has traditionally had such clauses in corporate bond contracts, have adopted collective action clauses.

Third and finally, arguments have been advanced for establishing an understanding, but not necessarily a requirement, that, if access to Fund resources exceeds a certain level, some concerted means of securing PSI must be made mandatory for the country. Proponents of this argument point out that such an approach would provide greater clarity and predictability. It would also help limit moral hazard and the use of IMF and other official resources. Other people point out the associated difficulties, including, most importantly, establishing the thresholds that would apply to various cases. Discussions continue on this and other related issues.

Conclusion

Mr. Chairman, I would now like to conclude by reiterating what I said at the beginning—that is, there is wide recognition about the need for, and the importance of, establishing mechanisms for PSI in crisis prevention and resolution. To this end, borrowing countries and lending institutions are now encouraged to engage closer dialogue even at good times. There is also agreement for applying a concerted approach—or a set of principles and techniques—to facilitate creditor involvement and coordination in assisting countries in crises. This approach will be based on collaboration between countries, creditors, and the IMF and on voluntary participation of creditors. Some people have criticized this approach as a mere codification of existing practices, but in my view, it provides a clearer and better-defined framework for PSI. It has been used in a number of recent cases with considerable success.

Some people are content with these agreed principles, techniques, and approaches, and feel, I think, that this is as far as PSI discussion can go usefully, at least at this stage. However, some others argue that there should be a more formal rules-based system for PSI, involving such elements as standstills and collective action clauses, which will be mandated by international agreements and enforced by some super-national institutions. This is an area where views differ widely, and where PSI discussion currently focuses on.

Mr. Chairman, I have tried over the last half an hour or so to outline the key features of PSI discussion—what it is about, and where it is going. This has been a difficult task for me, and I must admit that it is quite frustrating to disentangle some of the issues and find ways to present them succinctly. I am not sure if I did a good job in my presentation, but I hope that it will be helpful to your deliberation of this important subject.

Thank you.