Gabriel Sterne is head of EM macro at Oxford Economics and a former senior economist at the IMF. Here he argues that the Fund’s governance badly needs an overhaul.
Despite the IMF’s “lived experience” of 66 years of crisis resolution, its policy response to the biggest breaking wave of sovereign debt crises since the 1980s is falling short of being timely, efficient, and fair for debtors and creditors alike.
When it receives a loan request from a stricken country, the Fund should respond according to the golden guidelines of crisis resolution:
1. Establish the resource envelope through a debt sustainability analysis (DSA).
2. Distribute haircuts fairly across creditors, commensurate with debt exposure.
3. Use the IMF’s lending into arrears (LIA) policy to deal with holdout creditors. That means the Fund can pursue a lending program to a country in default, as long as the country continues to engage in good-faith negotiations with that creditor.
A couple more crucial points should ensure the resolution process minimises the pain and best allows debtors and creditors to move on from the debacle. A case-by-case approach has long been appreciated as the best way to deal with the complexities of circumstances (and, of course, resist costly procrastination).
Some creditors are more equal than others
Which creditors are most likely to be the main obstacle to crisis resolution nowadays? Probably not bondholders any more. Market discipline does most of the job — a bond price of 50 per cent below par (for example) is normally ample to get most private creditors to accept a 20 per cent haircut — and clauses in bond contracts can nowadays generally mop up any unreasonable resistance. Restructuring private sector debt does still present some challenges, for example when debt has been collateralised. But hopefully that’s an issue lawyers can sort out.
Still, one key deficiency in the crisis resolution toolkit appears impossible to resolve. Namely, the IMF’s role of honest broker crumbles whenever the world’s biggest economies have a stake in the game.
It looks like simply a matter of bad governance: a few major creditors have undue influence over the institution charged with ensuring fair treatment of all creditors and the debtor. How could that possibly work? Specifically, the US, China, and the eurozone are the largest shareholders at the Fund and have a virtual veto over IMF board decisions, which they are willing to use whenever it suits them.
And now its China’s turn to be treated too softly by the IMF.
Don’t mention China!
The IMF set out its stall on crisis resolution in sponsoring the Common Framework, launched in November 2020. It was a much-trumpeted initiative. Given the tools already at the Fund’s disposal though, it looks more like a solution in search of a problem. And it probably reflects the IMF’s attempt to never waste a good crisis to achieve its own longstanding objective of getting China’s massive EM lending programmes to be more in line with the Paris Club of mainly western government creditors.
But it may go down in the annals of history as the latest attempt by the IMF to placate a key shareholder (China) at the expense of crisis resolution best practice.
Currently, the dollar-denominated debt of around 25 emerging market sovereigns is trading at yields of more than 1000 bps, and most of these distressed economies have significant shares of their debt in loans from China.
Sure, the involvement of China has sometimes led to policy procrastination even before requests for help arrive in the IMF’s inbox. China’s inclination has been to provide IMF-lite emergency funding to the likes of Sri Lanka, without any of the policy adjustment traditionally demanded by the Fund. In Sri Lanka’s case that only made the inevitable more painful. The IMF has little or no influence over this stage of procrastination.
But once a stricken country enters a Fund-supported program, it needs a strong backbone to stand up to holdout creditors; and China’s loans present a major challenge to efficient crisis resolution. A brilliant study of China’s secretive loan contracts by Anna Gelpern, Sebastian Horn, Scott Morris, Brad Parks and Christoph Trebesch highlights clauses that would appear objectionable to many observers — such as seniority to the Paris Club and termination of diplomatic relations in the event of default, to name two.
These clauses may have more bark than bite. It’s possible they may serve (in legalistic terms) expressive purpose — in other words, to dissuade the debtor from taking steps adverse to the creditor’s interest. As such, the clauses may not be legally enforceable and perhaps wouldn’t torpedo the IMF’s lending into arrears (LIA) policy should China strive to become a holdout creditor.
A fully-independent IMF would have made it clear it stood ready to implement LIA, which enables it to lend to stricken countries even when they are in arrears to holdout creditors. But politically it is way easier for the Fund to use its LIA policy to deal with private sector holdouts rather than major governments who are its main shareholders.
In May the Fund’s revamped its guidelines for “lending into arrears to the official sector” (LIOA). These may have gone slightly under the radar, but are important because they lay out the cryptic compromises the Fund needs to make in dealing with an unreasonable official lender. The two main criteria under which the IMF can lend when there are arrears to China or any other non-Paris Club bilateral creditor are:
If the official creditor (eg China) consents! There are some circumstances in which this is less ludicrous than it sounds. The IMF lent to Iraq after its debt restructuring, even Iraq was in arrears to Kuwait. Having been invaded by Iraq many years previously, Kuwait could tolerate arrears but providing debt forgiveness was too much.
If the bilateral creditor (eg China) doesn’t consent but the IMF Board decides the decision to provide financing despite the arrears would not have an undue negative effect on the Funds’ ability to mobilise official financing packages in future cases.
For most readers, the latter criteria wouldn’t be an issue. After all, if the IMF is to function properly, you’d think it would actively discourage financing from a creditor inclined to delay the IMF mobilising official financing packages.
But to those familiar with the Fund, the drafting could be enough to provide China an effective veto over IMF lending where there are arrears to the Chinese state, and therefore drive the Fund to risk solutions such as the Common Framework, which appear prone to procrastination risk.
No wonder progress has not been timely, efficient or fair.
The IMF has called for the framework to be stepped up. But the fact it doesn’t attach any blame to anyone in particular suggests to me that stepping down the framework might be just as valid a solution. Just get on with it. More restructuring will happen anyway — if the borrower can’t pay, then at some point they won’t.
It’s encouraging that Zambia finally appears on the road to a restructuring package, and Sri Lanka appears close. But much more needs to be done to ensure other sovereigns are able to move on from crisis.
During the Greek shambles I argued in FT Alphaville for a Transparency Revolution at the IMF. No surprise that it never happened. And the Fund, despite writing so much on crisis resolution since then, has never had the courage to reflect deeply on its own governance as a barrier to efficient solutions.
China has not made crisis resolution easy, but there is a bigger issue. Every creditor tries to secure the best deal for itself, and the governance should be in place to squash such attempts.
But unless the IMF reflects publicly about its own governance issues — and demonstrates a willingness to stand up to its own major shareholders — its legitimacy as a trusted vehicle for crisis-resolution will continue to be undermined.