By Rhoda Weeks-Brown and Martin Mühleisen
Last month marked the 30th anniversary of the announcement of the “Brady plan”. In response to the 1980s Latin American debt crisis, this plan, named after then US Treasury Secretary Nicholas Brady, allowed countries to exchange their commercial bank loans for bonds backed by US Treasuries, bringing an end to a tumultuous period with possible systemic consequences for the global banking system at the time. In what was then a novel approach, banks agreed to provide much needed debt relief—the average write down was 35 percent—in exchange for risk-free tradable instruments.
The IMF played a crucial role, consistent with its mandate to help member countries resolve their balance of payments problems and regain external viability.
It not only oversaw countries’ adjustment plans and provided financing to buy back debt and secure payments on the swapped bonds—it also provided a forum for creditor-debtor negotiations and incentivized better creditor coordination through a change in its own policies. Before the Brady plan, any private creditor could hold up IMF financing by refusing to restructure its claim. That changed with the IMF’s adoption in 1989 of its “lending-into-arrears” policy, under which it could lend to a country that was in arrears on financing from private creditors, so long as the debtor was negotiating with its creditors in good faith.
IMF is working to encourage improved sovereign debt management practices and data reporting by its membership.
The Brady deals forever changed the landscape of sovereign finance in two fundamental ways. First, sovereign bonds, held directly or indirectly by a diverse set of possibly thousands of creditors, became the preferred financing instrument for countries, replacing much of sovereign bank loans. Second, the official sector assumed a central role in sovereign debt restructuring.
This shift has presented the IMF with new challenges, requiring frequent adaptions of its policies to meet the evolving needs of its membership.
First, with an increasingly large and diverse creditor base, creditor coordination is more challenging, as individual bondholders have the option to “hold out” of a restructuring agreement and seek full repayment—essentially free riding on debt relief provided by others. The IMF initially considered a statutory approach along the lines of a corporate bankruptcy regime for sovereigns (the “SDRM”) to address this issue, but ultimately supported a market-based approach in 2003 by endorsing collective action clauses (CACs).
Such clauses allow a qualified majority of bondholders to agree to debt restructuring terms and have those same changes in terms imposed on all bondholders within the same series. In 2014, the IMF endorsed the key features of “enhanced CACs” that go further by allowing a qualified majority of bondholders across all bonds to bind the minority. These are now the market standard .
Increasing debt levels, greater market interconnectivity
Second, with debt levels increasing dramatically —now accounting for 225 percent of global GDP—and increased interconnectivity of markets, sovereign difficulties in rolling over maturing debt can trigger sovereign debt crises. It is at these moments that the IMF often steps in with financing. However, this backstop risks generating moral hazard if creditors expect that the IMF will bail them out.
The IMF responded to this concern in the early 2000s by recognizing that there are circumstances where the private sector should contribute to financing countries’ adjustment programs. It also refined its lending policies to require a “high probability” that debt be sustainable whenever large financing is required, or else a sufficiently deep restructuring would be necessary.
This proved too strict when the euro area crisis hit, and concerns that a Greek debt restructuring might undermine market confidence elsewhere in the eurozone led to the introduction in 2010 of a “systemic exemption.” This exemption allowed lending to go ahead in cases where debt was deemed sustainable but not with high probability, and there was a high risk of systemic spillovers. However, as Greek public debt remained too high, by 2012 a private debt restructuring became unavoidable. With this experience as backdrop, in 2016 the IMF modified its lending framework to remove the systemic exemption and introduce more flexibility to help maintain financing from private creditors in situations where debt is sustainable but not with high probability.
The IMF is also reviewing its analytical framework of debt sustainability analysis for market access countries—those that have access to international capital markets—to strengthen its assessment of countries’ future capacity to repay debt. This will help to refine further when—and on what terms—a debt restructuring may be necessary to ensure sustainability in the context of IMF financing.
Official sector finance
Third, an increasing share of official sector financing is now being provided by “non-traditional” emerging market creditors. This posed challenges for the IMF’s policy on official arrears, which linked directly to the Paris Club, the longstanding coordination mechanism for “traditional” official bilateral creditors. In 2015, the IMF amended this policy to remove the link to the Paris Club where this group’s participation in financing a program does not represent the majority of official sector financing. The amended policy also allows the IMF to lend into arrears to the official sector if certain conditions (including good faith negotiations by the debtor) are met.
Fourth, transparency concerns are growing, as the terms and conditions of sovereign borrowing (including collateral and collateral-like arrangements) are increasingly hidden from the public eye. In addition, borrowing countries have taken advantage of new and non-traditional forms of financing such as bond purchases by sovereign wealth funds. The IMF is working to encourage improved sovereign debt management practices and data reporting by its membership and reviewing its debt limits policy, including guidelines for collateralized debt.
With today’s rapidly evolving finance and technology landscape, it is impossible to predict the new challenges in sovereign debt that will arise during the second 30-year period after the Brady plan. We would expect, however, that the principle of a coordinated international response that the Brady plan represented will continue to be indispensable in preventing and resolving sovereign debt crises. The IMF will continue to play a central role in this context, given its unique financing mandate, and will adapt to new realities, building on lessons learned from the past.
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