Riding Out the Storm

• Author: Inutu Lukonga
• Position: Senior Economist in the IMF's Policy Development and Review Department

Dealing with crises more effectively

Given that it is unrealistic to think that all financial crises can be prevented, where are we on efforts to at least reduce their number and severity? The IMF continues to place top priority on surveillance and macroeconomic and structural policy reforms, including appropriate exchange rate regimes, better debt and reserve management, sound budgets that leave room to maneuver in difficult times, and efficient and diversified financial sectors. However, crises can still occur if sufficiently large shocks hit a country or if it is unwilling or unable to implement sound policies. The remedial policy actions a country pursues will depend on its situation. But when countries amass unsustainable debts and have no feasible macroeconomic policy options to resolve the crises, the IMF is recommending restructuring sovereign debt-to the consternation of some developing countries and market participants.

At the IMF-World Bank Annual Meetings in Prague in September 2000, the international community backed a new framework for involving private sector creditors in crisis resolution. The framework relies on market-oriented, voluntary approaches but makes room for debt restructurings when absolutely necessary. The IMF's proposed sovereign debt restructuring mechanism (SDRM) has no doubt captured the most attention, both flattering and unflattering. However, it is only one part of a multifaceted strategy to tackle the crises that began with Mexico in 1994. Other measures include strengthening the assessment of debt sustainability, improving the predictability of access to exceptionally large sums of IMF financing, revamping current lending facilities, and clarifying rules on IMF lending to countries that are behind on payments to private creditors-known as lending into arrears.

Working with the private sector

In most cases, the IMF can help countries overcome balance of payments problems without their putting pressure on private creditors to act against their will. Modest financial assistance and agreement on a convincing economic adjustment and reform program are normally sufficient to rebuild the confidence of private investors and lenders and thereby restore a country's access to foreign private capital.

But what if a country faces a large short-term need for foreign currency (beyond that which the IMF and other official lenders are willing to provide) and has little chance of securing it quickly enough from the private sector? And what if a country faces a genuinely unsustainable debt burden-a solvency crisis rather than a short-term liquidity problem?

In such extreme situations, private creditors might need to share the burden of restructuring by limiting their demands for repayment or even agreeing to reduce the real value of their claims. However, rather than face the unpalatable consequences of approaching their creditors, country authorities almost invariably gamble for redemption through less credible policy measures. Individual creditors, too, have an incentive to get out as soon as they can, before other creditors preempt them-the so-called collective action problem. The difficulties of achieving an agreement on how to allocate losses equitably may also prolong the process. As a result, both debtor countries and their creditors pay dearly in terms of lost economic activity and income to the country, economic hardships for the citizens, and lost value of claims for creditors. Often, uncertainty about how the situation in one country is going to be resolved hurts the value of other developing country debt.

To speed up needed reschedulings of unsustainable debts and to help countries tackle these problems at an early stage, the IMF is seeking a more orderly and transparent framework for restructuring sovereign debt. It is considering two complementary and mutually reinforcing approaches-both of which involve coordinating a group of scattered and diverse creditors who are able to seek enforcement of their rights in different legal...