Debt Reprofiling
In the wake of the euro zone crisis, and in the midst of the Argentina litigation, a number of new proposals for handling sovereign debt restructuring have been advanced, including the IMF’s recent proposal to reform its own lending framework. All of these proposals build on, or break from, the established statutory-versus-contractual dichotomy.
The IMF and Debt Reprofiling
As mentioned, the outbreak of the euro zone crisis, combined with the legal saga surrounding Argentina’s debt obligations, has put sovereign debt restructuring at the top of the IMF’s agenda. In June 2014 the IMF released a staff report considering a new approach to Fund’s “exceptional access” lending framework as it relates to sovereign debt restructuring. The report identifies key deficiencies in the Fund’s current lending framework – brought into stark relief during the euro zone crisis – and outlines a new, potentially improved, institutional approach to managing sovereign debt crises.
Established in 2002 and amended in 2010, the current framework stipulates that in cases where there is a “high risk of international systemic spillover effects,” a member’s debt sustainability does not have to be assured with high probability to gain exceptional access to IMF resources (IMF 2010: 20). The wisdom of introducing this “systemic exemption” in 2010 has since been scrutinized, as critics argue that it undermined the framework’s ability to constrain IMF lending decisions to the ultimate detriment of the Fund’s legitimacy and ability to manage future crises (Schadler 2013). More generally, others called on the Fund to restore the “credibility and consistency of the policies underpinning its crisis-driven lending” (Boughton et al. 2014: 1). Whether or not the Fund heeded such criticism, the first major recommendation of the June 2014 staff paper is to eliminate the “systemic exemption.”
Once the “systemic exemption” is removed, the Fund is left with its 2002 framework, which states that in order to be granted exceptional access to IMF resources, a rigorous and systematic analysis must indicate with “high probability” that a member’s public debt will remain sustainable in the medium term. If debt sustainability can be assured with high probability, the Fund will rely on its traditional approach: provide money to repay creditors with maturing debt obligations (i.e., to bailout creditors) as long as the borrowing country agrees to an economic adjustment program.
If a country’s debt sustainability cannot be assured with high probability, however, it must undergo a debt restructuring sufficiently deep to restore sustainability before it can receive IMF assistance. As a consequence of this approach, “debt restructuring will be required not only in cases where there is a high probability of unsustainability, but also where it is not clear with a high probability whether the debt is sustainable or unsustainable; i.e., in cases where there is uncertainty” (IMF 2014: 9).
The problem with this approach is that, despite the increasing sophistication of the Fund’s debt sustainability analyses (DSAs), there are many cases in which considerable uncertainty exists; in these cases, requiring a deep debt restructuring, which imposes steep costs on creditors and debtors, may be an unnecessary and suboptimal outcome. As such, in cases of uncertainty, where neither the sustainability nor the unsustainability of a member’s debt can be established with “high probability,” Fund staff advocate an approach that relies on reprofiling debt rather than restructuring it.
Under a reprofiling, there would be an extension of maturities on existing sovereign debt, but no change to the interest or principal. According to IMF staff, in cases of genuine uncertainty, reprofiling sovereign debt would be a more effective than the current crisis management strategy for at least four reasons: (1) it would be less disruptive to financial markets and less costly to debtors and creditors than a potentially unnecessary debt restructuring; (2) it would be more effective and fair than allowing creditors with maturing claims to “exit” if a debt restructuring does indeed prove necessary; (3) it would buy more time to implement necessary policy adjustments, better assess debt sustainability as those policies go into effect, and, in turn, reduce the likelihood of needing a restructuring in the first place; and (4) since Fund resources would not have to be used to service maturing debt obligations, the IMF could support a more growth-friendly (i.e., less austerity-based) adjustment program with a greater chance of restoring debt sustainability (IMF 2014).
In addition to genuine uncertainty, reprofiling would be conditional upon a member country already having lost market access; that way, reprofiling would follow, not trigger, a loss of confidence or certainty in country’s debt sustainability. Fund staff also note the importance of securing broad creditor support for a reprofiling, and thus the need to implement reprofiling in a way that, if possible, avoids a payment default.
Overall, the Fund is seeking a broader range of economically potent and politically acceptable policy tools for managing severe sovereign debt crises. Compared to the status quo, argue IMF staff, providing a greater role for debt reprofiling in the IMF’s exceptional access lending framework will allow the Fund to better tailor its policy actions to the specific circumstances of a given country and crisis. Even if the IMF adopts these proposals, however, there is no guarantee that the reprofiling option will be invoked. As Brett House (2014) notes, there is still a great deal of stigma associated with seeking the IMF’s help.
The IMF’s proposal is far from the only new idea for how to improve the handling of severe sovereign debt crises. In fact, the last few years have seen several new and innovative proposals. The following summarizes the most noteworthy of these.