APPENDIX 15
Memorandum submitted by Professor Kunibert
Raffer, Department of Economics, University of Vienna, Austria
Justified calls for a fundamental change in
"debt management" by important G7-members, first by
the Secretary of the US Treasury, Paul O'Neill, shortly later
by the Chancellor of the Exchequer, Gordon Brown, and the Canadian
Finance Minister have finally been heeded by the IMF. A publication
by the Bank of England and the Bank of Canada (Haldane & Kruger
2001) had also proposed a standstill arguing that sovereign debtors
need the safe harbour which bankruptcy law provides in a corporate
context. The decision to go on exploring possibilities of sovereign
insolvency is thus a very important outcome of the Autumn Meetings.
The UK played an important and commendable role in changing the
international financial architecture, both by demanding debt reduction
within the Paris Club, and more recently by incorporating clauses
regarding creditor actions into debt contracts in a helpful attempt
to bring about useful changes.
While sovereign insolvency is hardly a new approach—Adam
Smith already advocated it—Anne Krueger's initiative is
laudable. Its merit is finally breaking the taboo at the IMF,
bringing a long needed change in the Fund's own attitude. Unfortunately
it is not going to work. Totally shaped by the IMF's narrow institutional
self-interest it is simply a continuation of unsuccessful debt
management since 1982. Strong reservations are therefore heard
from creditors, including the US Treasury, debtors and NGOs. The
SDRM is likely to become another unsuccessful IMF attempt at debt
management, a Simply Disastrous Rescheduling Mechanism for all
but the Fund. Its results are likely to match those of HIPC I,
HIPC II, "Structural Adjustment", Paris Club Terms,
and the Miyazawa/Brady deals, all characterised by a leading role
of the IMF and the fact that they did not resolve the debt problem.
The fundamental difference between the SDRM
and all earlier proponents of sovereign insolvency (cf Raffer
2001, Rogoff & Zettelmeyer 2002) is that it would make the
IMF the undisputed overlord of sovereign insolvency, also legally
enshrining its present de facto treatment as a preferred
creditor by treaty. And it will not work. The SDRM's main problems
are:
1. The IMF's Executive Board alone determines
sustainability and decides on the adequacy of the debtor's economic
policy. These decisions cannot be challenged. Determining sustainability
the IMF would automatically determine the amount of debt reduction.
This most important decision would be taken by the Fund, a creditor
both in its own right and dominated by a majority of official
creditors. Other creditors have no say. Debtor ownership would
not be encouraged.
The IMF (2002, p8) meanwhile suggests that debtors
may choose which part of debts to include into an SDRM, a choice
to be "influenced" by the Fund, whose conditionality
would "enhance" the "incentives to assure equitable
treatment" of creditors (ibid., p16) The IMF (2002,
p10) suggests the creation of many creditor classes with classification
rules part of the amendment of the IMF's Articles of Agreement,
each class vested with "effective veto power over the terms
offered to other classes". One may safely assume mutual blocking
and the need for good services. It would be a surprise if the
IMF would be unwilling to provide these good services. Considering
the number of cases in the near future might tempt minds more
critical than I to speak of a substantial employment programme
for the Fund.
The Fund is to decide on a temporary standstill.
Activating the stay by creditor decision—as now suggested
as one possibility by the IMF (2002, p6)—is clearly unrealistic,
considering how long it would take for creditor committees to
be formed. The Fund would evaluate relations with creditors, which
raises the question: are creditors themselves unable to judge
whether their relations with a debtor are good? Krueger's (2002,
p4, emph. mine) statement "The Fund would only influence
the process as it does now, through its normal lending decisions"
sums up, in a nutshell, the problem with the SDRM.
2. The whole mechanism is to be enshrined
into the IMF's statutes. The problem of so-called "vulture
funds" is used to claim that the Fund would be necessary
to implement sovereign insolvency as laws barring disruptive litigation
must have the force of law universally. This argument is altogether
flawed. Not all countries and territories are IMF members. If
creditors were actually as eager to shop for jurisdictions without
collective action clauses (which is unlikely) they could still
choose jurisdictions which, not being members of the IMF, offer
this option. When arguing against the Tobin Tax this point has
routinely been used to prove that universal implementation could
not be assured and that this form of taxation would therefore
not work. The same concern holds logically in the case of the
SDRM, even though it is conveniently "forgotten".
Legally it is not absolutely clear whether vultures
would prevail in future cases, but there are several suggestions
how to preclude vulture funds from disturbing the process of bona
fide negotiations. There is one water tight way of doing so
shown by Raffer (2002). Changing sovereign immunity laws in the
very few jurisdictions stipulated by loan agreements by inserting
a clause voiding or suspending waivers of immunity during sovereign
insolvency proceedings would solve the problem of disruptive litigation.
"Vultures" are equally bound by existing contracts,
including clauses stipulating which law applies in the case of
disputes. If the US and the UK changed their laws governing sovereign
immunities by inserting one short sentence vulture funds would
be put out of business in most cases. This sentence could, eg,
read: "Starting international insolvency procedures voids/suspends
all waivers of immunity relating to this case." In the UK
State Immunity Act 1978, Chapter 33, this could, eg, be inserted
in Part I. More elegant formulations than mine are certainly welcome.
If those few "exotic" places whose laws are occasionally
agreed on, such as Frankfurt, followed, disruptive litigation
would be impossible. This small change in sovereign immunity laws
would have the advantage of preserving sensible and tested solutions
in domestic contexts, such as the US preference for excluding
majority action clauses to protect small investors.
From an institutional point of view the statutory
approach is vitally important to the Fund, giving it the sole
mandate on sovereign insolvency, also ending joint "debt
management" of IBRD and IMF and thus the long turf war between
the two about which is in charge.
3. Multilateral debts, especially the IMF's
own claims, remain exempt. The present de facto status
of International Financial Institutions (IFIs) is to be legalised.
This makes the ongoing discussion about "bailing-in"
the private sector—or Private Sector Involvement—particularly
obfuscating. Under various Brady schemes private creditors granted
generous debt reductions, eg 35 per cent in the case of Mexico,
or 45 per cent in Ecuador. These reductions did not solve the
problem as new official money—protected against losses—immediately
increased debts again. In 1999 Ecuador was unable to honour her
Brady bonds, the first undeniable failure of the Initiative demanding
only one group of creditors to "take a haircut". If
all creditors had reduced by 30 per cent commercial banks would
have saved 15 percentage points and Ecuador would in all probability
have been economically afloat again—a prime example of the
necessity of equal treatment repeatedly demanded by the private
sector, of fully bailing in the international public sector.
4. The arbitration mechanism proposed—meanwhile
called Sovereign Debt Dispute Resolution Forum (SDDRF)—is
totally under IMF control. The SDDRF would have no authority to
challenge decisions made by the Executive Board regarding, inter
alia, the adequacy of a members policies or the sustainability
of the member's debt. Claiming that the SDDRF would be "independent"
of the IMF, Krueger (2002, p4) clarifies "The flipside of
this independence is that the role of the dispute resolution forum
should be strictly limited."
While its authority over the IMF and public
creditors is indeed quite limited, its decisions resolving disputes
between the debtor and its creditors or among creditors are binding
irrespective of what creditor "super majorities" might
decide. They could not be challenged (IMF 2002, p28). The panel's
powers over private creditors and debtors would not be limited.
A complicated, clumsy, and unnecessary five-stage
process dominated by the IMF is proposed. Nominees—one per
member country—are vetted by a "neutral" committee
established by the IMF's Executive Board in order to reduce the
roster from 183 names to 21, incidentally a number that would
allow a list exclusively consisting of nominees from Northern
creditor countries. The vetted and reduced list is passed to the
Governors for approval, who can only vote on the entire list as
a package. If approved the Managing Director appoints the members
for a renewable term. The appointed elect a president, who—when
needed—would "impanel" three members of the roster
to form the panel for an actual case. The IMF's weighted voting
structure establishes clear creditor majorities. Creditors would
be able to determine the committee, and to check its proposal.
Once again, debtors would be under the thumb of their official
creditors.
The IMF's model violates the fundamental principle
of the Rule of Law that one must not be judge in one's own cause
In spite of repeated assertions that creditors or creditors and
the debtor should be empowered, the IMF would determine the outcome
down to details. Private creditors already complained about undue
preference.
CHAPTER 9 BASED
DEBT ARBITRATION—A
VIABLE ALTERNATIVE
A mechanism able to solve sovereign debt overhang
problems must comply with minimal economic, legal and humane requirements.
It must respect the fundamental pillar of the Rule of Law that
one must not be judge in one's own cause, and it must incorporate
the principle of appropriate debtor protection. Also, present
preferential treatment of IFIs allows them to profit from their
own errors and negligence. This appalling case of institutional
moral hazard must be abolished.
The Fair and Transparent Arbitration Procedure
(FTAP) proposed by Raffer (1990, 2001) and seconded by Raffer
& Singer (1996, pp.203ff; 2001, pp.243ff) provides an economically
efficient solution with a human face. It is based on the principles
of the US municipal insolvency, so-called Chapter 9 of Title 11
of the US Code, the only procedure protecting governmental powers,
and thus applicable to sovereigns 904 titled "Limitation
on Jurisdiction and Powers of Court" states with outmost
clarity that the court—let alone creditors—must not
"interfere with—
(1) any of the political and governmental
powers of the debtor;
(2) any of the property or revenues of the
debtor; or
(3) the debtor's use or enjoyment of any
income-producing property."
The concept of sovereignty does not contain
anything more than what 904 protects. The court's jurisdiction
depends on the municipality's volition, beyond which it cannot
be extended, similar to the jurisdiction of international arbitrators.
Unlike in other bankruptcy procedures liquidation of the debtor,
receivership or change of "management" (ie removing
elected officials) by courts or creditors is not possible in the
case of US municipalities—nor should it be in the case of
sovereigns.
Public interest in the functioning of the debtor
safeguards a minimum of municipal activities. US municipalities
are allowed to maintain basic social services essential to the
health, safety and welfare of their inhabitants. The affected
population has a right to be heard. The procedure is as transparent
as befits a public entity. The US Chapter 9 provides viable solutions
protecting the governmental sphere of the debtor as well as the
interests of creditors. This is essential, as only a totally fair
mechanism would be universally accepted, and rightly so. Naturally,
only the basic principles not all details of domestic Chapter
9 should form the basis of arbitral proceedings. Evidently, some
important and necessary details of domestic Chapter 9 are unnecessary
and inapplicable internationally.
Respecting the Rule of Law: In contrast
to the SDRM where the IMF, itself a creditor and controlled by
a creditor voting majority, would decide on debt reductions and
other important issues, all civilised legal systems require a
neutral entity without any self-interest to preside legal procedures,
and to decide if and when necessary. It is also economically sensible,
as someone with a vested interest is unlikely to decide objectively
and efficiently. The IMF's role in debt management since the mid-1970s
drives this point home. This minimum of fairness has been denied
to sovereign debtors and their poor so far. Creditors have been
judge, jury, experts, bailiff, occasionally even the debtor's
lawyer all in one—with highly unsatisfactory results. The
SDRM is also unfair vis-a"-vis other creditors forced
to pay for the consequences of wrong or negligent IFI decisions
by losing more money.
In my model the parties—debtor and creditors—would
establish ad hoc arbitration panels. Creditors and debtors would
nominate one or two persons, who in turn would elect one further
member to reach an uneven number, as is traditional practice in
international law. The whole clumsy process proposed by the IMF
is unnecessary and unduly restrictive. Arbitrators would have
the task of mediating between the debtor and creditors, chairing
and supporting negotiations by advice, providing adequate possibilities
to be heard for the affected population, and—if necessary—deciding.
This would be done obeying the main principles of domestic US
Chapter 9, such as protection of the debtor's governmental powers,
the right of the affected population to voice their views, but
also the best interest of creditors. The entities and NGOs representing
the affected population—as the right to be heard could not
be exercised individually in the case of countries—such
as trade unions, entrepreneurial associations, religious or non-religious
NGOs, would present opinions and data, arguing in an open, transparent
procedure before the panel. Sustainability would emerge from the
facts presented and discussed. It would not be determined by the
IMF whose record of estimating sustainability is anything but
good.
The Principle of Debtor Protection: The
basic function of any insolvency procedure is solving a conflict
between two fundamental legal principles: the right of creditors
to interest and repayment and the human right recognised generally
(not only in the case of loans) by all civilised legal systems
that no one must be forced to fulfil contracts if that causes
inhumane distress, endangers one's life or health, or violates
human dignity. In the case of a debt overhang these principles
collide. Although claims are recognised as legitimate, insolvency
exempts resources from being seized by bona fide creditors. Debtors—unless
they happen to be Developing Countries—cannot be forced
to starve themselves or their children in order to pay more. Human
rights and human dignity enjoy unconditional priority over repayment,
even though insolvency only deals with claims based on a solid
and proper legal foundation. A fortiori this is valid for less
well founded claims. By contrast, Malawi—a case discussed
in the Treasury Select Committee on 4 July 2002—was forced
to sell maize from her National Food Reserve to repay loans, which
left seven million of a population of 11 million severely short
of food according to Action Aid. This priority of creditor interest
over survival—nowadays unique to Southern debts—must
be abolished. None of the IMF's papers so far contains the smallest
hint of any debtor protection. My proposal would precisely make
cases such as Malawi no longer possible. The life and the human
dignity of people must be equally respected and protected in the
South.
Besides preserving essential services to the
population my proposal gives the affected population and vulnerable
groups a right to be heard, and exempts resources necessary to
finance minimum standards of basic health services, primary education,
and an economic fresh start. Briefly put: it applies the decent
principles of modern law worldwide. A transparently managed fund
financed by the debtor in domestic currency and monitored by an
international board or advisory council consisting of members
from the debtor country as well as from creditor countries should
administer these exempt resources. Its members could be nominated
by governments (including the debtor's) and NGOs. This fund would
be a legal entity of its own. Checks and discussions of its projects
would not concern the government's budget, which is an important
part of a country's sovereignty.
Multilateral Debts: The most basic rule
of a market system demands that decisions be inseparably linked
with risk. Making those taking decisions accountable this link
promotes economic efficiency. It was severed in the former Eastern
Bloc where largely unaccountable institutions took decisions.
In the case of IFIs the problem is even worse: decisions are not
simply delinked from financial responsibilities, IFIs even gain
financially from their own errors and negligence. Extending new
loans necessary to repair damages done by prior loans increases
their income streams. IFIs insist on full repayment, even if damages
are caused by their staff because of grave negligence or disregard
for minimum professional standards. A high rate of IFI-failures
might therefore render adjustment programmes necessary, which
IFIs administer, just as failed programmes are likely to call
for new programmes, as long as unconditional repayment to IFIs
is upheld. Since prolonged and aggravated crises increase the
importance of IFIs as "crisis managers", there is an
incentive not to solve debt problems. An institutional self-interest
in crises is part and parcel of the present system. If IFIs have
learned in the past, poor countries and vulnerable groups in particular
have paid their tuition (cf. my submission to the Treasury Committee
in 1997, published as Annex 12). Unconditional exemption of the
IMF's own and other multilateral claims as demanded would legalise
this economically and ethically unjustified malpractice. While
private creditors are supposed to grant debt reductions, feeling
the sting of the market mechanism, IFIs could increase their exposure,
knowing that they will be protected.
By contrast my proposal would introduce financial
accountability of IFIs for their own decisions, similar to the
way consultants are accountable. Equal treatment with other creditors
if debtors acting on IFI-advice become insolvent is the easiest
way to do so. The statutes of all multilateral development banks
already foresee default of sovereign borrowers and appropriate
ways of recognising losses. As conditionality was initially not
foreseen loan loss provisions were unnecessary for the IMF. When
conditionality was introduced, no appropriate changes making the
Fund financially accountable were made. It is necessary that a
minimum of market discipline be brought to the IMF. In the case
of HIPCs the need to reduce multilateral claims is already accepted.
The "argument" that IFIs cannot reduce their claims
is no longer upheld.
CONCLUSION
While some form of sovereign insolvency is urgently
needed, the IMF's self-serving SDRM-proposal is no solution. Economic
efficiency, respecting human rights and the Rule of Law, and fairness
to both debtors and all creditors convincingly demand a specific
type of insolvency appropriate for sovereigns—a process
based on the principles of the US Chapter 9. Using existing mechanisms
my proposal can be applied immediately if important creditor countries
agree. It is to be hoped that no further delays imposing unnecessary
costs on debtors and the international community will occur.
Haldane, Andy & Mark Kruger (2001) "The
Resolution of International Financial Crises: Private Finance
and Public Funds", November, (mimeo).
IMF (2002) "Sovereign Debt Restructuring
Mechanism—Further Considerations", (14 August) (mimeo).
Krueger, Anne (2002) Sovereign Debt Restructuring
and Dispute Resolution" (6 June), http://www.imf.org/external/np/speeches/2002/060602.htm
Raffer, Kunibert (1990) "Applying Chapter
9 Insolvency to International Debts: An Economically Efficient
Solution with a Human Face", World Development 18(2), pp.301ff
Raffer, Kunibert (2001) "Solving Sovereign
Debt Overhang by Internationalising Chapter 9 Procedures",
updated version via link on http://mailbox.univie.ac.at/¥rafferk5
Raffer, Kunnibert (2202) "Shopping for
Jurisdictions—A Problem for International Chapter 9 Insolvency?"
(24 January) http://www.jubilee.org/raffer.htm
Raffer, Kunibert & H W Singer (1996) The
Foreign Aid Business: Economic Assistance and Development Co-operation,
E Elgar, Cheltenham (UK) and Brookfield (US).
Raffer, Kunibert and H W Singer ("001)
The Economic North-South Divide: Six Decades of Unequal Development,
E Elgar, Cheltenham (UK) and Northampton (US).
Rogoff Kenneth and Jeromin Zettelmeyer (2002)
"Early Ideas on Sovereign Bankruptcy Reorganisation: A Survey",
IMF Working Paper WP/02/57.
Treasury Committee, House of Commons (1997)
Fourth Report: International Monetary Fund, ordered to
be printed on 5 March 1997, Stationery Office, London.
Professor Kunibert Raffer
Department of Economics, University of Vienna, Austria
Senior Associate, New Economics Foundation, London
October 2002
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