Can capital flows be made more user friendly? Dealing with sovereign debt restructuring

• Author: Shang-Jin Wei/Haizhou Huang/Olivier Jeanne
• Position: IMF Research Department
• Pages: 369-372

Page 369

IMF economists and researchers from outside the institution gathered at the IMF's Third Annual Research Conference on November 7-8. The conference had an overarching theme of capital flows and global governance but also dealt with an eclectic array of other issues that economists at the IMF and elsewhere are exploring.

Nowadays, as IMF Managing Director Horst Köhler noted in opening the conference, the line between interesting research and important day-to-day operational work is blurring, as it should be. As former U.S. President John F. Kennedy once said, "Too often we enjoy the comfort of opinion without the discomfort of thought."

Köhler suggested that the IMF needs the "discomfort of thought" to arrive at fresh and balanced views that are useful for policy discussion.

In that spirit, a number of papers focused on the IMF's stepped-up efforts to figure out an orderly way for countries in financial distress to restructure their debts. Two approaches are being studied simultaneously: a statutory approach-a possible new international legal regime in which debt restructuring is mandated-and a purely marketbased approach in whichPage 370 debt contracts are encouraged to include renegotiation-friendly clauses.

Insights from corporate bankruptcies

A presentation by Princeton University Professor Patrick Bolton looked at what sovereign debt restructuring efforts could learn from corporate bankruptcy practices. After comparing bankruptcy regimes across a number of countries, he concluded that the U.S. regime is perhaps the most relevant for the international system. Interestingly, despite its acceptance today, the U.S. regime was very controversial in the nineteenth century. At least seven attempts were made to introduce some sort of bankruptcy code between 1789 and 1898, each attempt prompted by a major economic crisis. Laws were passed in 1800, 1841, and 1898, but the first three were repealed within a few years of their enactment. Perhaps there is a lesson here for the quest for an international bankruptcy procedure, Bolton suggested.With patience, a system with merit may eventually earn acceptance, even respect.

Bolton also presented some arguments in favor of a statutory approach.A market-based approach, he said, might lead to debt that is excessively difficult to restructure for several reasons, some of which have been developed in the corporate finance literature. For example, creditors may insist on high restructuring costs mainly as a way of guaranteeing that their loans take priority over those of other lenders.Another problem is that the administrations that build up debt are typically no longer around when the time comes to repay, and thus, they may not fully internalize the future costs of financial distress.

But there is a limit to the similarities between corporate and sovereign debt restructuring, Bolton cautioned.

In particular, creditors' ability to collect collateral is more limited in the...