Donnerstag, 20. Februar 2003

FTAP working against debtor countries?

Some remarks on counterarguments raised by those who are to benefit

Prominent among counterarguments raised against a Fair and Transparent Arbitration Process (FTAP) appears the suggestion that such a reform might actually put the sovereign debtor into a less favourable position, because such a procedure might make it more difficult to access capital markets. This argument is not particularly new. When, during the eighties, the main question regarding debt relief was not yet about an adequate amount of relief, but essentially whether it should be granted at all, this point was already a standard argument for private as well as official creditors, who apposed any relief. It was, in fact, not that much used among experts on the topic, who were familiar with the day-to-day practice of write-offs in private credit relations, but rather in public debates towards a less informed audience which tended to be more receptive to a suggested implicit parallel with personal credit relationships: Who would actually continue to give credit to a friend, whom he once had once helped out to pay the bill in the bar and who subsequently failed to settle that debt?

More recently the fear that a comprehensive process to restructure and eventually cancel partially sovereign debt could weaken the position of emerging market economies in international markets has been behind statements of the G24, the group representing the emerging markets within the broader G77 within the International Financial Institutions: „Ministers note the ongoing discussions on sovereign debt restructuring. They reiterate their preference for voluntary, country-specific, and market-friendly approaches to such restructuring. They remain open-minded about recent proposals for incorporating collective action clauses into bond contracts, while being sceptical of those proposals entailing amendments to the IMF's Articles of Agreement. They note that any proposal should be framed in a way that does not impair the volume and conditions of developing country access to financial markets.„ ([1])

Are those fears justified?

In order to explore whether Emerging Market governments are rightfully sceptical, one needs to make an important distinction. erlassjahr.de holds that passing through an FTAP will not enhance credit costs or make market access more difficult. There is some logical substance to this, which will be laid out in the next paragraph. However, an empirical test cannot be undertaken, simply because there has not yet been any debt renegotiation which would have matched the standards of an FTAP. Occasionally erlassjahr.de cites the example of the mediated Indonesian debt relief of 1969 in order to highlight the potential of mediated solutions. However, while this case implies some key elements of an FTAP, but not the full concept. Therefore, its evidence regarding the FTAP’s eventual effects is also a limited one.

What can, however, be tested empirically, are the consequences which historical debt relief has had on the market access for the countries it benefited. As the above quoted counterargument also strongly focuses on the effect of the relief as such and less so on the questions how it has been brought about, it does indeed make sense, to explore the effects of historical relief efforts, even if they have been brought about in the traditional unfair and intransparent procedures of the Paris Club or the Brady Plan. In that sense the evidence produced below certainly contains a message, but its limitations regarding the effects of an FTAP need to be clearly acknowledged.

These limitations underline the need to see the two elements of this brief analysis as a coherent whole: the analysis of the logical substance of the counterargument that credits might become more expensive and scarce, and the empirical evidence.

1. The logical substance

Normally private investors make their lending decisions on the basis of two criteria: first profitability, i.e. which income can be reasonably expected from the investment over which timeframe? Second security, i.e. the probability that payments agreed with the debtor are not going to be made due to incapacity or unwillingness to pay on the part of the debtor. While profitability can be calculated with a considerable degree of certainty, security remains very much subject to the assessment of the debtor by the creditor. As future ability and willingness to pay can logically not be foreseen, the creditor needs to take other factors into account: the likely development of the sovereign debtor’s economy, political stability, reliability of projected income, and, of course, the debtor’s behaviour towards his creditors in the past.

If in the past the debtor has failed to meet his payment obligations, this can have been for either of two reasons: either he was unwilling, though he had the necessary resources available; in that case the above mentioned pub-logic would be fully applicable, and any creditor would be well advised to think twice before extending a new loan. Or he has been unable to pay up ([2.]). In that case the potential future creditor is confronted with a completely different set of questions: First of all he would have to ask whether the reason for the debtor’s insolvency is still there or not. This in turn means: Debt relief would in that case not be an impediment to the extension of new loans, but, to the contrary, an explicit prerequisite. National insolvency procedures reflect this logic, when they pave the way to renewed market access by eliminating an old debt overhang. After such an operation investors will not have to fear any more that the fresh money they bring into the country will be consumed for servicing old, unproductive debt, instead of spurring growth.

The majority of countries, for which over the last twenty years solutions have been sought via either the Paris Club under or the multilateral HIPC initiative, were clear cases of inability and not unwillingness to pay. Consequently write-offs were agreed upon – even if more often then not these turned out to be insufficient. As an FTAP would be clearly designed for cases of insolvency, it makes sense to also assume the second of the above mentioned situations: debt relief via an FTAP will not endanger access to credit markets, but will rather serve to restore it, when it is already extremely limited or even nonexistent. Thus the logic for dealing with insolvent sovereigns tends to be very different from the one we find in the pub round the corner.

2. Empirical Evidence

How have debt cancellations over the past twenty years affected the indebted sovereign’s creditworthiness?

It is not easy to isolate the effects of debt cancellation on access to capital markets from other influential factors. Thus, the following is just a rough evaluation of the effects which the most important debt relief programme since the outbreak of the modern debt crisis, i.e. the Brady-Plan of the of the nineties, has had. Evidence suggests that at least a systematic rise in borrowing costs for countries which have received a Brady-style restructuring and NPV reduction of their debt stocks, has not materialized. There is, moreover, some evidence supporting erlassjahr.de’s hypothesis, that debt reduction enhances borrowing opportunities, namely the strong rise in new loans extended to post-Brady countries as opposed to the five years immediately before the restructuring.

The following table compares interest rates, which Brady countries have paid in the five years before and after the restructuring. In nine out of thirteen cases interest levels were lower than before. On unweighted average of all thirteen countries interest was some 10% or 0.7%-points lower than in the years before the respective agreements.

If one takes the development of the international reference interest rate LIBOR into account, however, the slight positive change is reduced to zero. With a spread over LIBOR which is enhanced by +0.32% as compared to pre-relief levels, the affected countries do nearly pay the same spread as before. A far more positive result is found when we look at the amounts which have flown to the countries before and after the Brady relief.

It strikes that not only have creditors obviously followed on average the logic outlined in part (1), when considering to provide fresh money. Moreover, the eventual objection that the public sector, which had given considerable political backing to the Brady reschedulings, had stepped in with fresh money at favourable conditions while private market participants remained reluctant, is obviously unfounded. Particularly private non-guaranteed lending has grown nearly five-fold after the write-off. But also regarding publicly-guaranteed lending, private market participants have not only considered the respective countries as more creditworthy than before; they have even done this to an extent, way beyond the improved perception by the public sector.

Here again it needs to be taken into account that we have been looking into the consequences of an insufficient debt relief organised and managed by the creditors. Those experiences can therefore be supplemented by Raffer’s argument, who has pointed out that after the one single historical case which in a way comes close to an impartial process for a sovereign, namely the Indonesian relief of 1969 has re-established the sovereign’s creditworthiness to such extent that only five years after that generous write-off, the country faced a new debt crisis triggered by the extensive debts, which the public oil company PERTAMINA had accumulated.

Finally mention should be made of the argument brought forward by the IMF’s vice managing director Anne Krueger in a statement in December 2002 in Brussels ([3]). She reacted to fears that through its SDRM proposal credit costs for Southern sovereigns would eventually rise. First she pointed out that an orderly process would be most likely to be faster and thus less expensive than existing mechanisms with their potential of mutual blockade between various creditor groups. Then she recalled the experiences with national insolvency frameworks: „U.S. bankruptcy procedures, for instance, were an outgrowth of attempts to deal with numerous railroad failures in the 1850s at a time when there were no formal bankruptcy institutions. It was obvious that liquidating the railroad, and giving each creditor a piece of the track, was not a solution that would get anyone anywhere. So procedures evolved that tried to maintain a railroad's going-concern value during the restructuring process. This required, among other things, new funds to keep the railroads running and pay suppliers; (...)

A second source of evidence is the anecdotal and more systematic empirical evidence on the impact of collective action clauses on borrowing costs. CACs have already existed in British trust-deed bonds, and there is no evidence that they raise borrowing costs.“

[1.] COMMUNIQUÉ of the INTERGOVERNMENTAL GROUP OF TWENTY-FOUR ON INTERNATIONAL MONETARY AFFAIRS AND DEVELOPMENT September 27, 2002

[2.] It should be mentioned that there is still a third alternative, namely that the debtor is solvent, but unwilling to pay for a good reason, f.i. because the claim needs to be considered illegitimate as it has f.i. been taken out by an illegitimate government; this odious debts doctrine which surprisingly enough has recently been invoked by the US government in the case of Iraq’s foreign debt, shall be left out of the picture, because this paper focuses on the consequences of a debt relief after an arbitration process.

[3.] Anne O. Krueger: Sovereign Debt Restructuring Mechanism-One Year Later; Presented at the European Commission Brussels, BelgiumDecember 10, 2002