Chapter 2: The Mexican Crisis and its Implications for Bonded Debt
- Julianne Ams, Tamon Asonuma, Wolfgang Bergthaler, Chanda DeLong, Nouria El Mehdi, Mark Flanagan, Sean Hagan, Yan Liu, Charlotte Lundgren, Martin Mühleisen, Alex Pienkowski, Gustavo Pinto, and Eric Robert
- Published Date:
- September 2018
1. The debt crisis ended along with the 1980s, and 1989 saw interest rates drop and prospects for economic growth brighten. With the 1990s, private capital began flowing again to emerging and developing countries. This renewed interest in investment was bolstered by liberalization of international capital flows and widespread deregulation of financial institutions and capital markets. As the recipient economies found, however, the speculative inflows were subject to sudden capital flow reversals and stops.
2. Following several years of relative economic success, political instability in Mexico triggered massive capital flight and a sharp devaluation of the peso in 1994–95. As foreign investors suddenly pulled their money from the country, Mexico faced a liquidity crisis. Only a large bailout from the United States, the IMF, and other official creditors (both bilateral and multilateral) allowed Mexico to resolve the immediate crisis by rolling over or paying out debts falling due . Significantly, there was no requirement that the private sector contribute to the resolution of the crisis—most short-term bondholders were repaid in full and at the pre-crisis, undepreciated exchange rate.
3. The Mexican crisis exposed a gap in the sovereign debt framework with respect to private sector involvement (PSI) in debt restructurings. This gap was only further highlighted by sovereign debt operations in the late 1990s, where restructurings with private creditors were only achieved either post-default (e.g., Russia, Ecuador) or in the shadow of a default (e.g., Ukraine, Pakistan). The rise of privately held bonds as a primary form of sovereign debt and the stronger linkages among financial markets constituted a break from the bank syndicated loans of the 1980s: contagion could spread more quickly; creditors were more varied and dispersed; bondholders were not “repeat players”—unlike the limited number of major banks in the 1980s that faced multiple London Club restructuring processes—or subject to the moral suasion or supervisory authority of the sovereign; and private bondholders were considered more liable to litigate. A new approach to liquidity crises, further informed by IMF experience with creditors during the Asian Financial Crisis, was required to limit moral hazard and contagion. Supported by IMF analysis, the G-10 Communique of April 22, 1996 recognized this gap and called for a new regime for sovereign liquidity crises that could be applied case by case and that would ensure that debtors and their private creditors would not be bailed out in the future .
4. The series of policy papers prepared by the IMF in response to the Mexican crisis reveal the fundamental impulses of the international community regarding PSI and lay the groundwork for the IMF’s future work on sovereign debt. While the papers of the late 1990s and early 2000s introduce a variety of possible frameworks for PSI, only a few proposals made it into policy, as the general consensus among the stakeholders was that collaborative efforts between a government and its private creditors provide the best prospect to ensure the member’s return to market access. The IMF considered the first line of defense to be prevention through appropriate macroeconomic policies [31, 34, 35, 36].
- Considering ex-ante rules to guide how private sector involvement would be sought in crises to ensure equitable burden sharing [32, 34, 35, 36]. There was an attempt to establish principles on PSI that would be informed by financing needs, the relative sizes of private and official contributions, the Paris Club’s comparability of treatment principle, and the likelihood of the member regaining market access. However, support for a strict framework and hard rules on PSI among stakeholders was limited. Furthermore, staff considered it difficult to develop an approach that would be generally appropriate or even to know when the application of the measures would be warranted.
- Seeking to establish a Sovereign Debt Restructuring Mechanism (SDRM), a treaty-based bankruptcy mechanism for countries . The SDRM was imagined either as incorporated into the IMF’s Articles of Agreement or under a separate treaty. While the initial work, which covered many aspects of the SDRM, was done in the mid-to-late-1990s, the final push was saved for the early 2000s, and the outcome will be discussed in the following chapter.
- Considering other statutory responses to sovereign debt crises, including litigation stays and standstills on debt payments [28, 29, 31, 32]. For the former, while voluntary litigation stays had been agreed in some restructurings, a proposal was made for an amendment to the Articles of Agreement allowing the IMF the power to impose a mandatory stay. This was ultimately rejected. For the latter, discussions focused on ways the IMF could encourage members to impose a standstill, either on specific debt payments or on outflows of private capital more generally. Ultimately, this was also dropped.
- Strengthening the contractual framework for addressing collective action by private investors by endorsing the incorporation of provisions in bond contracts that would enable smoother restructurings [31, 32, 33, 34]. In the absence of consensus around a statutory approach, discussions on possible contractual provisions were wide-ranging, and covered state-contingent debt instruments and clauses addressing moratoria on debt payments and capital outflows, stays on debt litigation, creditor committees and representation, and universal debt rollover options with penalty (UDROP). However, the only provision for which the IMF Executive Board ultimately endorsed inclusion in bond contracts was the collective action clause (CACs). This provision, which is discussed in more detail in the following two chapters, was again revisited in the early 2000s and the 2010s.
- Increasing the flexibility of the Lending Into Arrears (LIA) policy to allow the IMF to lend despite a sovereign’s arrears following a default on sovereign bonds or imposition of exchange controls, while encouraging cooperative solutions with private creditors [31, 32]. The original policy, introduced in 1989, provided for lending into arrears only on debt to foreign commercial banks. In 1998, the IMF Executive Directors extended the policy to cover cases of arrears to sovereign bonds, allowing IMF financing to be provided on a case-by-case basis where (i) prompt IMF support was considered essential for the successful implementation of the member’s adjustment program; (ii) negotiations between the member and its private creditors had begun; and (iii) there were firm indications that the sovereign borrower and its private creditors would negotiate in good faith on a debt restructuring plan . The first two criteria replicated the first two criteria of the 1989 policy, while the third criterion was intended to address specific concerns with regard to bond restructuring. In 1999, there was further discussion on the LIA policy, with a focus on how the heterogeneity of bondholders and divergent interests might delay negotiations following a default . As a result, the second two requirements were dropped in favor of an assessment of whether the member was making “good faith efforts to reach a collaborative agreement with its private creditors.” In 2002, the application of the good faith criterion was reviewed to provide procedural clarity and guiding principles for the dialogue between debtors and their external private creditors .
 Note on an International Debt Adjustment Facility for Sovereign Debtors, EBS/95/90, May 26, 1995; Statement by the Staff, BUFF/95/57, June 21, 1995; Chairman’s Concluding Remarks, BUFF/95/68, July 20, 1995.
 Recent Proposals on International Debt Adjustments, SM/96/25, February 2, 1996; Concluding Remarks by the Acting Chairman, BUFF/96/17, February 26, 1996.
 Note on “Legal Aspects of Standstills and Moratoria on Sovereign Debt Payments and their Effect on Actions by Creditors”, EBS/96/26, February 22, 1996.
 Communique of the Ministers and Governors of the Group of Ten, ICMS/Doc/46/96/12, April 22, 1996.
 Involving the Private Sector in Forestalling and Resolving Financial Crises - Further Considerations, EBS/99/21, February 25, 1999; EBS/99/21, Rev. 1, March 9, 1999; Summing Up by the Acting Chairman, BUFF/99/36, March 17, 1999; BUFF/99/36, Rev. 1, April 9, 1999; BUFF/99/36, Rev. 2, April 14, 1999.
 Involving the Private Sector in Forestalling and Resolving Financial Crises - Additional Considerations, EBS/99/152, August 10, 1999; EBS/99/152, Sup. 1, August 26, 1999; Summing Up by the Acting Chairman, BUFF/99/122, September 22, 1999.
 Involving the Private Sector in Resolving Financial Crises - Experience and Principles, EBS/00/42, March 7, 2000; EBS/00/42, Sup. 1, March 17, 2000; Summing Up by the Acting Chairman, BUFF/00/42, March 27, 2000.
 Managing Director’s Statement to the International Monetary and Financial Committee on Private Sector Involvement in the Prevention and Resolution of Financial Crises, BUFF/00/139, September 21, 2000; Communiqué of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund, September 24, 2000.
 Involving the Private Sector in the Resolution of Financial Crises - Restructuring International Sovereign Bonds, EBS/01/3, January 11, 2001; Summing Up by the Acting Chairman, BUFF/01/17, February 2, 2001.
 Fund Policy on Sovereign Arrears to Private Creditors, SM/98/8, January 9, 1998; Concluding Remarks by the Chairman, BUFF/98/25, March 6, 1998.
 Fund Policy on Arrears to Private Creditors - Further Considerations, EBS/99/67, April 30, 1999; Summing Up by the Acting Chairman, BUFF/99/71, June 18, 1999.
 Fund Policy on Lending into Arrears to Private Creditors - Further Consideration of the Good Faith Criterion, SM/02/248, July 31, 2002; Acting Chair’s Summing Up, BUFF/02/142, September 9, 2002.