Lee Buchheit is a professor of law (Hon.) at the University of Edinburgh.
A modern sovereign debt restructuring can be expected to unfold more or less as follows:
• The debtor country approaches the IMF for a program.
• The Fund staff prepares a Debt Sustainability Analysis (DSA).
• If the DSA pronounces the country’s debt as “unsustainable,” the IMF staff will insist that it promises to restructure its financial liabilities in order to meet specified “Debt Sustainability Targets” (such as an average annual gross financing needs target; a target debt-to-GDP ratio; a cumulative debt service reduction target, etc.).
• The IMF staff and the country then negotiate the terms of an IMF adjustment program, with the terms memorialised in a “staff level agreement” (SLA).
• But the Fund staff will not take the draft program to the IMF’s Executive Board for approval unless and until the country’s bilateral and commercial creditors provide the Fund with assurances that they will restructure their debts in a manner consistent with the program. In IMF-speak, these are called “financing assurances.”
The ostensible justification for the IMF’s insistence on receiving financing assurances from a country’s existing creditors is to be found in the Fund’s Articles of Agreement. FTAV’s emphasis below:
Section 3. Conditions governing use of the Fund’s general resources
(a) The Fund shall adopt policies on the use of its general resources, including policies on stand-by or similar arrangements, and may adopt special policies for special balance of payments problems, that will assist members to solve their balance of payments problems in a manner consistent with the provisions of this Agreement and that will establish adequate safeguards for the temporary use of the general resources of the Fund.
As an institution that lends fresh money into visibly distressed situations, it is entirely understandable that the IMF would want the debtor country’s existing lenders to agree to moderate their claims against the borrower before the new money is disbursed. After all, the IMF should not wish to see its money bleed out to pay existing creditors in full.
Of equal importance, the Fund wants to ensure that its programs will have a reasonable change of succeeding. When the country is assessed as carrying an unsustainable debt load, that success will require an adjustment to existing liabilities.
The pig-in-a-poke dilemma
The problem is not that the Fund seeks financing assurances from existing lenders. No commercial lender into a distressed corporate situation would do otherwise. The problem resides in when and how those financing assurances are sought.
Let’s start with the when. The IMF staff asks both bilateral and commercial creditors to provide financing assurances before the staff will take the proposed program to the Fund’s Executive Board for approval. The IMF’s financing assurances policy took this form in the early 1980s at the commencement of the Latin American debt crisis.
In that era, bilateral sovereign creditors were members of the Paris Club and commercial bank lenders were represented by a Bank Advisory Committee. Back then, it was thus a relatively easy task to seek assurances from both groups that they would provide the debt relief needed to fill any financing gaps projected in the Fund’s adjustment program for the country. By 1989, however, it had become clear that commercial banks were using the Fund’s financing assurances requirement as leverage to secure concessions from the sovereign debtors.
As it related to commercial creditors, the Fund therefore substantially diluted its financing assurances policy. Financing assurances from commercial creditors are now satisfied if the sovereign borrower commits to negotiate in good faith with its commercial lenders. In other words, a promise by the debtor to negotiate with its private sector lenders is deemed an assurance from those creditors that they will accept the results of that negotiation, whatever it may be. The Fund continues to insist, however, on receipt of affirmative financing assurances from bilateral creditors.
Over the last twelve years the Paris Club’s share of bilateral lending has been dwarfed by non-Paris Club bilateral lenders, principally China. Financing assurances must now be solicited from two bilateral creditor groups — Paris Club and non-Paris Club bilaterals like China. And if receipt of financing assurances is a precondition to the Executive Board’s consideration of a program, a bilateral creditor like China that may not relish the prospect of a debt restructuring can forestall that event — pretty much indefinitely — simply by withholding its financing assurances to the IMF staff.
Now for the how
The lenders asked to give these financing assurances are never told exactly what they are, in principle, signing up for. The debt sustainability targets contained in the DSA will be expressed as being applicable to the entirety of the country’s debt stock. The Fund’s sensibilities forbid it from indicating in the DSA or in the program how much of the required debt relief should be borne by each class of lender; the Fund insists that this is a matter to be worked out between the country and its various creditors.
The phrase “financing assurances” might suggest that each creditor group is being asked to confirm that it will contribute a quantum of the prescribed debt relief proportionate to its share of the overall debt stock. But this is only an implied meaning. Financing assurances could just as easily connote an undertaking to provide debt relief commensurate with a creditor group’s share of the debt stock and sufficient to cover any deficiency in the debt relief provided by other creditors.
Moreover, some lenders may feel that other creditors should provide a disproportionate share of the debt relief. Scratch a Paris Club creditor, for example, and just under the surface you will probably discover a profound belief that bilateral creditors — lending at below market interest rates — should be given preferential treatment in any debt restructuring with the lion’s share of any needed debt relief coming from those irredeemably avaricious commercial lenders. What then is a bilateral creditor so minded really saying when it assures the IMF that it will provide appropriate debt relief?
Finally, what does the phrase “financing assurance” mean in the context of a country like Sri Lanka or Ghana, where roughly half the debt stock is comprised of domestic (local currency) obligations? Everyone knows that great caution must be exercised in seeking debt relief from local creditors for fear of destabilising domestic financial institutions, pension funds and insurance companies.
In a country with a sizeable slug of domestic debt, does “financing assurances” therefore mean debt relief commensurate with each external creditor group’s share of the foreign currency debt stock plus some portion — how much? — of the domestic debt stock?
There is an obvious solution. Instead of asking lenders to give financing assurances as a condition to taking a program to the IMF’s Executive Board, let the Board approve the program but withhold any significant cash disbursements until existing lenders have agreed to provide the needed debt relief.
This would (i) adequately safeguard Fund resources, (ii) put pressure on the debtor and the existing lenders to come to definitive terms on the debt restructuring or risk a cancellation of the program and (iii) deny to any one large creditor or creditor group the ability to stymie the process by withholding its financing assurances.
Moreover, the IMF has well-established policies (called “Lending Into Arrears”) that address the problem of recalcitrant legacy creditors after the Board approves a program for the country.
The potential timing delay inherent in the Fund’s current practice regarding financing assurances is more than just an inconvenience.
At the time of signing a Staff Level Agreement, the debtor country authorities are often asked to implement “prior actions” before the program goes to the IMF’s board for approval. Some of those prior actions, such as raising taxes, can be politically toxic.
It can therefore leave the authorities in an uncomfortably exposed position if the country swallows some bitter medicine but finds that one creditor can in practice still indefinitely delay the program by withholding financing assurances.