Thirty Years After the Outbreak of the 3rd World Debt Crisis: The Need for a New Deal on Debt

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    Debt relief is like putting out a fire: It is absolutely necessary, but it does not guarantee that the house won't be on fire again. This is, why a deliberately one-off relief scheme like HIPC has necessarily been an insufficient answer to a systemic crisis. As crises can arise any time and sometimes in places which have been considered as fire-proof for long, you need to have a fire-brigade, i.e. a mechanism, which makes sure that an appropriate crisis response can be found, whenever it is needed.

    A brief look at the history of sovereign debt relief can reveal how far we are still away from such a functioning fire-brigade.

    No success story at all

    By the end of the 1980s it was already clear that the debt, at least of the poorest countries, would need a complete or almost complete cancellation – something in the range of what was implemented through the Multilateral Debt Relief Initiative (MDRI) as the culmination of the HIPC process 20 years later.

    However, this debt relief was not provided; rather, the Paris Club sent countries down a 15 year long road of ever insufficient debt reschedulings, flow reliefs and partial write offs. From the Toronto Terms to the Cologne Terms, countries constantly received too little debt relief too late. This is why each of these frameworks had to be reformed, re-drafted, amended or abolished altogether.

    As a consequence, countries were bleeding off scarce resources through an unaffordable debt service, while creditors pretended to be generous. People in the indebted countries were deprived of their right to have a functioning state. Some of the poorest were literally dying because states were unable to fulfil their duties regarding food security, health or public safety – thanks to creditors' unshakable belief that even out of poor, failing states one could squeeze 67%, 50% or 20% of contractual debt service.

    And even when finally nearly total debt cancellation was provided after 2005, it was financed to a large extent by development aid budgets – so to say, by the developing countries themselves.

    No thing of the past

    For an illustration, we tend to point to Senegal who is the leader of the pack with 14 Paris Club reschedulings since 1980, including three final ones.

    What is even more worrying to us is that creditors seem not to have learned anything from those 20 years: presently, 16 Low Income Countries have a high risk of (renewed) debt distress. Seven of them are post-Completion Point HIPCs. However, nobody on the creditors side, who for so long have set the tone on sovereign debt, has any clue, how one of these countries could negotiate any post-HIPC debt relief, as other creditor categories are of importance today.

    One of these high-risk countries is Burundi. The East African nation should have received a topping-up of its HIPC relief, but was denied it, because the World Bank did not consider its own calculation errors as an "external shock", which in the eyes of the Bank and the International Monetary Fund (IMF) is the sole reason for anybody to obtain relief beyond what the International Financial Institutions (IFIs) have calculated as necessary.

    Burundi has continued to be a high risk country ever since. Still the Bank and the Fund boards have just agreed to waive their non-concessional borrowing policy for Burundi, thus allowing for an 80m US-$ dam project, that EximBank of India wants to finance at insufficiently concessional terms.

    That dam may turn out to be a good investment. But it also may not. And if all of a sudden the roof is on fire again, there is still no fire brigade out there, since the HIPC was a one-off cancellation and since India is not a even a Paris Club member. So no one could say whether India would, in case of project failure, be bound by any reschulding, or - like about half of official bilateral creditors - just will not care about any Paris Cub decision.

    One can also look at the Eurozone for an illustrative example. Everybody knew that the 109bn Euro haircut for Greek private investors early this year was insufficient in order to restore debt sustainability. Still, it was treated like a solution. And today we speak of the need for another haircut, which would necessarily also involve those claims that have come as public rescue financings.

    For everybody who has been working on the so called third world debt debt crisis for a while, the way Europeans and the Troika at large treat the sovereign debt crisis in the European periphery is a striking déja vu: You bail out private investors with bilateral and multilateral public money at first; you fail to restore debt sustainability, because debt levels are already way past that point; and you have to write-off the public rescue money in the end.

    Why is that so?

    One essential difference between a somehow functioning private debt-workout in our domestic contexts and the way sovereign insolvencies have been handled is the "independent expert" who does the assessment of the need for debt relief.

    In the domestic context, it is, of course, not the banks that define the haircut that creditors of an insolvent corporate or private debtor need to accept in order to restore debt sustainability. This expertise needs to come from a neutral institution. Otherwise you have a classical conflict of interest and a recipe for exactly the process we have seen in the Paris Club from the 1980s to 2005.

    There was no lack of insightful expertise in the 1980s. It pointed to the fact that something in the range of the "full cancellation", something that we have seen from 2005 onwards, was actually necessary. The problem was that these suggestions had no chance of being listened to as long as the World Bank and IMF held the monopoly on assessing the debt situation. The IFIs was where debt relief was actually decided. The situation was akin to the local savings-and-loan deciding what could be taken out of indebted individual's home.

    What would actually happen to this poor person's rights and human dignity? Easy to figure out, and that is exactly what happened to indebted sovereigns between 1982 and 2005: They fell prey to a harsh and senseless austerity, which only timidly started to be reformed in the last decade – and is still alive and kicking as one can see for instance in the critically indebted countries in the Caribbean today.

    Not only the assessment

    Of course, an independent assessment does not help you a great deal when it is your creditors that do the interpretation. Handing the role of an independent expert to an institution, which is neither debtor nor creditor, is only one essential element of a reform that we need if we are to avoid the next debt crisis to drag on like the last one. We also need to put the ultimate decision making into the hands of a neutral body.

    A lot of proposals have been made for this, from UNCTAD’s pioneering work in the Trade and Development Report of 1986, building on proposals by academia, through the IMF's own Sovereign Debt Restructuring Mechanism, the Dutch proposal for a debt chamber at the Permanent Court of Arbitration and NGO proposal for a Fair and Transparent Arbitration Process on Debt (FTAP). The latter is no less than an emulation of the chapter 9 of the US insolvency code (which deals with the insolvency of “municipalities”), and which has been serving that nation well for nearly a century.

    These proposals are not pies in the sky. An independent assessment has actually been key to solving Indonesia’s debt problem in 1969/1970. The Paris Club had been unable to agree on a restructuring of Indonesia’s unsustainable debt, which was still a low income country in the range of 200 US-$ per capita at the time, and whose most important creditor was the Soviet Union, which had no interest in supporting a regime that had just slaughtered half a million communists.

    When a disinterested party – in this case a German private banker with no stakes of his own in that country – made the realistic proposal of a full repayment of the principal and the (nearly) complete cancellation of interest, which would amount to an Net Present Value reduction of around 50%, that was acceptable for everybody, because it restored Indonesia’s fiscal viability. Additionally it treated creditors uniformly and thus allowed for a nearly universal acceptance.

    Some governments like Germany, Argentina and Norway have committed to work towards such a comprehensive, fair and rules-based debt workout mechanism. More are invited to join the bandwagon, and we hope Belgium is going to be one of them. Quite a bit of literature on the various proposals is available. And the further work of UNCTAD is likely to provide a focus for a real political reform process.

    Jürgen Kaiser is Political Coordinator at

    This article was published in Great Insights Volume 2, Issue 1 (January 2013)


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