The Role of the IMF
- Anne Krueger
- Published Date:
- April 2002
If appropriately designed and implemented, a sovereign debt restructuring framework would assist in achieving the IMF’s purposes in a number of respects. First, if such a framework facilitates an early restructuring of unsustainable debt, balance of payments viability could more easily be attained in a manner that minimizes the resort to measures that are destructive to national or international prosperity. The achievement of this objective would in turn help the IMF safeguard its resources. Finally, to the extent that a predictable framework assists creditors in their assessment and pricing of risk, it will help to avert future crises, thereby enhancing the stability of the international financial system.
In light of the above, what role should the IMF play in the actual operation of the mechanism? The financial support that the IMF provides for an effective economic adjustment program already shapes incentives that surround the sovereign debt restructuring process and would continue to do so under an SDRM. This section addresses the critical question of whether, under an SDRM, the IMF’s role could be limited to the exercise of its existing financial powers or whether it would need to exercise additional legal authority.
The Role of IMF Finance
In the present environment, decisions by the IMF regarding the availability of its resources already influence all stages of the sovereign debt restructuring process. Specifically:
- The judgment of the IMF about the scale of the financing it is willing to provide in the absence of a debt restructuring and the design of an economic program supported by the IMF both help determine the timing of a sovereign payment suspension. Before a member decides to seek a comprehensive debt restructuring, it typically approaches the IMF for financing (either in the context of an existing or future arrangement) with the aim of avoiding such a restructuring and the associated economic, social, and political disruption. On being approached, the IMF is required to make a judgment whether the member’s debt burden is or is not sustainable. This judgment determines the availability and the appropriate scale of IMF financing. Consequently, decisions about the availability of IMF resources strongly influence a member’s decision as to whether to suspend payments in order to conserve its remaining international reserves.
- After a member has suspended payments, it is currently expected to work with the IMF on the development of an appropriate economic policy framework, and to negotiate a debt restructuring with its creditors. Approval of an IMF-supported program often, but not always, precedes final agreement on restructuring terms with creditors. In this context, the IMF currently makes judgments about the good faith of the member in its negotiations with its creditors in determining whether to lend into arrears on payments to private creditors. The IMF-supported program will specify a fiscal and external adjustment path, which will determine, in broad terms, the amount of resources available for debt service by the sovereign during the program period.
- When deciding whether to support a member that is about to conclude a restructuring of its obligations to private creditors, the IMF currently makes two important judgments. First, it assesses the consistency of the restructuring agreement with the adjustment path in the member’s economic program. The payments stream that emerges from the private debt restructuring should be consistent with the member’s program. Second, it assesses whether the resulting medium-term payments profile is consistent with the requirements for debt sustainability.
Under an SDRM, the nature of the financing decisions that the IMF would need to make before, during, and after a debt restructuring would not change. Consistent with its mandate, the IMF would continue to ensure that its resources were being used to resolve the member’s balance of payments problems without resorting to measures that were destructive of national and international prosperity. Moreover, the IMF would continue to need to ensure that there are adequate safeguards for the revolving character of its resources. Both of these imperatives would require it to continue to condition the availability of its resources on the adoption of appropriate policies and, where necessary, on a debt restructuring that laid the basis for a return to sustainability.
Operating the Framework
In light of the central role that IMF financing plays, one could envisage a framework that empowered the IMF to make key decisions regarding its operation. Bearing in mind the key features described in the previous section, these decisions would include the following:
- First, activation of a stay on creditor action would require a request by the sovereign debtor and IMF endorsement. Such endorsement would be based on the IMF’s determination that the member’s debt is unsustainable and that appropriate policies are being—or will soon be—implemented.
- Second, any extension of the stay would require a determination by the IMF not only that adequate policies continue to be implemented but also that the member is making progress in its negotiations with its creditors.
- Third, IMF approval of a restructuring agreement that had been accepted by the requisite majority of creditors would be a condition for its effectiveness. Such approval would be based on a determination that it provides for a sustainable debt profile.
While the IMF’s involvement in the decision making process, as described above, would help ensure that the framework was not abused, a number of concerns have been expressed regarding the above approach. As a creditor and as an institution whose members include debtors and bilateral official creditors, there are concerns that the IMF would not be perceived as being entirely impartial in exercising this authority. More generally, it is unclear whether the international community would be willing to confer additional powers on the IMF.
In light of these concerns, the remainder of this section discusses the benefits of an approach that would limit the role of the IMF in the operation of the mechanism itself. Under this alternative approach, decisions under the SDRM would be left to the debtor and the majority of the creditors. Accordingly, the IMF would have no power to limit the enforcement of creditor rights. Rather, the IMF would rely on its existing financial powers to create the incentives for the relevant parties to use the mechanism appropriately. How such an approach could be implemented is discussed below for each of the main features of the mechanism.
- Approval of the restructuring agreement—It would be possible to rely exclusively on the approval of the requisite majority of the creditors as a means of making the agreement binding on all creditors, that is, IMF endorsement of such an agreement would not be a condition for its effectiveness. Such an approach would make this element of the mechanism consistent with the majority restructuring provisions found in collective action clauses. The key difference would be that, while majority restructuring provisions only apply to bondholders within the same issuance, an affirmative vote by the requisite creditors under the mechanism would bind the entire creditor body.
This approach carries a risk that the debtor and creditors would conclude an agreement that did not achieve a sustainable debt profile. However, this risk could be addressed, as it is in the present context, if subsequent IMF financial support is conditioned on a judgment that the payments stream in the proposed restructuring was consistent with the adjustment path in the member’s economic program and the requirements for medium-term debt sustainability. If it did not meet these conditions, the IMF would be effectively prevented from lending until the member had taken further steps to ensure debt sustainability, possibly involving a further restructuring.
- Activation of the stay—As an alternative to activating the stay upon the IMF’s endorsement of a request, one could envisage a stay that would be activated only upon a request of the member that had been approved by the requisite majority of creditors. Such an approach would mimic, to an extent, certain provisions of collective action clauses found in many international sovereign bonds. These provisions effectively enable a qualified majority of holders of a single bond issuance to restrict a minority of holders of the same bond issuance from enforcing their claims against the sovereign during the negotiations of a debt restructuring agreement.2 Under this approach, however, the decision would be made a qualified majority of all of the member’s creditors, that is, creditor claims would be aggregated across instruments for voting purposes. Reliance on such an approach would serve to highlight the extent to which the problem being addressed by the mechanism is that of collective action.
A shortcoming of this approach is that, even if the requisite majority of the creditors were amenable to approving a stay that would be binding upon the entire creditor body, it could take considerable time to put one in place. In the context of a single bond issue where provisions exist that enable the majority of creditors to prevent enforcement by a minority, the process of ascertaining the will of the majority is relatively straightforward, although even that takes time. In contrast, a vote by all creditors (all bond issuances, bank debt, trade credit, certain official claims) as envisaged under the mechanism would need to be preceded by a verification of claims process that might take several months to complete.
There are several different ways in which the above shortcoming could be addressed.
- First, the mechanism could enable the sovereign to activate the stay unilaterally and enjoy the resulting legal protection for a limited 90-day period. At the end of that period, claims would have been verified and creditors would vote as to whether the stay would be extended and, if so, for how long. Although the IMF would not have a legal veto, in most cases a member would likely only activate the mechanism in consultation with the IMF, that is, after the IMF had determined that the debt burden was unsustainable and that further financial assistance would not be forthcoming in the absence of a restructuring. But a key question would be whether the ability of the sovereign to activate the mechanism for a limited period unilaterally might be abused by members whose debt was not judged to be unsustainable.
- Second, IMF approval of the stay could be necessary for it to be effective for the initial 90-day period. Any extension of the stay beyond this limited period would require the consent of the majority of the creditors. This approach would be designed to protect against the possibility of debtors’ abuse of a purely unilateral stay prior to a creditors’ vote. It would, however, entail IMF involvement in the decision-making process, albeit in a limited manner.
- Third, one could accept that a stay would not be in place until an affirmative vote of the creditors had taken place and focus instead on ways to limit the delay between a member’s request and the creditors’ vote. For example, as a means of accelerating the verification of claims and voting process, a standing organization could be established whose role would include registering claims against the sovereign and facilitating the organization of creditors in the context of a restructuring.
It should be noted that a brief delay between the member’s suspension of payments and the activation of the stay would not leave a sovereign helpless in the event that the suspension gave rise to capital flight. Under certain circumstances, capital controls to stem outflows might be a necessary—but temporary—feature of an IMF-supported program. This is discussed further below.
- Maintenance of the stay—Just as a qualified majority of creditors might be given the authority to activate a stay, the majority of creditors might be given the authority to determine whether to extend the stay beyond the initial 90-day period. By that time, the claims of creditors would have been verified, and creditors would be in a position to vote on the issue. If the member was already in a position to submit a restructuring plan for approval at the expiration of this initial period, the creditors would vote on the proposal, and an affirmative vote by the requisite majority would bind dissenting creditors. If, however, more time were needed for negotiation, creditors would decide (again by a vote of the requisite majority) whether the stay should be extended and, if so, for how long.
The IMF’s decisions regarding the availability of its resources would have a major impact on whether an extension would be approved by creditors. Specifically, the requisite majority of creditors would normally only be willing to extend the stay beyond the initial period if they had some assurance that the member was adopting policies that were being supported by the IMF. When making a decision to extend the stay, the majority of creditors would be in a position to judge whether the member was negotiating with them in good faith and their interests were protected.
Would such an approach give creditors too much leverage in the process? The concept of a stay being imposed upon all creditors through a decision by a majority is roughly analogous to the majority enforcement provisions that are found in many international sovereign bonds. Such provisions limit the ability to initiate litigation without the support of a given percentage of the bond issue. But while such provisions bind the bondholders within the same issuance, an affirmative vote by the majority under the proposed statutory framework would bind the entire creditor body.
There may be a risk that creditors would withhold an extension of the stay in the hope that the IMF would provide more financing or call on the member to make additional adjustment efforts. For example, even in circumstances where the member is implementing good policies and negotiating in good faith, creditors may refuse to extend the period of the stay as a means of persuading the member to turn to the IMF for financing that could enhance the terms of any restructuring. The creditors could threaten to lift the stay to force the debtor to agree to more adjustment than contemplated under the IMF-supported program. Such risks could be reduced, however, by the resolute application of the IMF’s policy of lending into arrears, under which it signals its willingness to continue to support a program, even if the member has interrupted payments to its creditors.
- Priority Financing—As noted in the previous section, an SDRM could provide incentives for new financing by providing an assurance that any new financing in support of the members program extended after the introduction of the stay would be senior to pre-existing private indebtedness. This could be achieved by giving a qualified majority of private creditors the power to subordinate the claims of all private creditors to claims arising from financing provided after the effectiveness of the stay.