29 Oct, 2012

Harvard Professor: Sovereign Debt Defaults by U.S., Japan, Germany “A Real Worry”

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United Nations, 25 Oct 2012, (UN Department of Public Information) – Any international plan to combat the risks of sovereign debt default must be capable of handling a potential crisis in one of the world’s largest economies, the Second Committee (Economic and Financial) of the 67th UN General Assembly heard today.

Delivering the keynote address during a panel discussion on “Sovereign debt crises and restructurings: Lessons learned and proposals for debt resolution mechanisms”, Kenneth Rogoff, Professor of Public Policy and Economics at Harvard University, said that while most debt-resolution mechanisms concentrated on resolving problems in developing countries, the euro zone crisis clearly underlined that defaults by larger economies were the “real worry”, and that it would be “folly” to build a mechanism that could not handle a default by the United States, Japan or Germany.

Opening the special event were Vuk Jeremić, President of the General Assembly, and Supachai Panitchpakdi, Secretary-General of the United Nations Conference on Trade and Development (UNCTAD). With Second Committee Chair George Wilfred Talbot (Guyana) presiding, the discussion featured the following panellists: Arvinn Eikeland Gadgil, State Secretary for International Development, Norway; Maria Kiwanuka, Minister for Finance, Planning and Economic Development, Uganda; Adrián Cosentino, Secretary of Finance, Argentina; Otaviano Canuto, Vice-President, Poverty Reduction and Economic Management Network, World Bank;, Shamshad Akhtar, Assistant Secretary-General for Economic Development, United Nations Department of Economic and Social Affairs; and Martin Khor, Executive Director, South Centre.

Mr. Rogoff warned that, although sovereign debt crises had been in existence since countries had been borrowing money, and although defaulting on external debt was much less frequent today than it had been for much of the last 200 years, that was unlikely to last. A new structure was needed to deal with any potential deterioration. Recalling that various plans for an international bankruptcy regime had been tabled over the years, he said they included the “international debt commission” proposed by the “Group of 77” in 1979, intended to concentrate on official debt and the development problems of the poorest countries. Another proposal had called for transforming the International Monetary Fund (IMF) from a lender of last resort into an international bankruptcy court.

The eventual IMF proposal for a sovereign debt restructuring mechanism had been met with “tremendous hostility” by creditor countries, the private sector and even some successful borrowers, he continued. However, the debate had had positive effects, including the establishment of the collective action clauses contained in many current loan contracts. If an international bankruptcy court were to be established, it would need to be kept separate from the IMF in order to be considered an “honest broker”, he stressed, pointing out the difficulty of a regulator proposing a new regulatory structure and placing itself at its centre.

He called on the United Nations to make the decision and then direct IMF’s restructuring, if that proved to be the plan. Any new regime would address the problem of “holdouts” while also establishing the principle of creditor seniority. The latter, in particular, must be tackled in a meaningful way so as to establish that some debt, like that owed to official creditors like IMF, for example, must be paid before others.

While accepting that creditors might oppose an international court because it would be too debtor-friendly, he said experience with collective action clauses showed that they had made restructuring easier without pushing up interest rates. It had smoothed the process, with the result that there had been fewer crises, and made accidental defaulting much less frequent. The regional level sovereign debt reduction mechanism being established in Europe was a good proving ground for the idea, because if it failed to take hold in the European Union, it was highly unlikely to gain any traction on the international level, he said.

Mr. Eikeland Gadgil said that a new international mechanism should be designed to react quickly in order to ensure that defaults were not prolonged. Saying he was looking forward to long-term debt-resolution mechanisms that would cover all sovereign debt, including private and commercial debt, he said such a mechanism should also be able to follow the process from the time of default to the delivery of relief. Emphasizing the importance of fairness and justice, he called for an end to the regime that placed debt sustainability above all else. Debt was not only technical, it was also political, he said, adding that the international community was required to examine the underlying causes of the problem and establish an independent mechanism to handle debt in a neutral way.

UNCTAD had brought principles and values to the debt crisis because it examined the situation from the perspective of both the lender and the borrower, he said, adding that more of the international community should follow that innovative approach. Norway was planning a full debt audit to find debt that could be considered illegitimate, he said, encouraging others countries to emulate his country and offering to share some of its experiences and knowledge in that area.

Ms. Kiwanuka said there was high pressure on sovereign States to incur debt in order to meet the financial demands of socio-economic policy obligations, such as the Millennium Development Goals or increasing investment in infrastructure. With Africa needing to invest $93 billion to address its infrastructure deficit, the current situation was like that of the debt pressures on the housing market, which had contributed to the current global financial crisis, she said. Without established practices for resolving sovereign debt crises, a coherent and consistent international framework of policies and regulations was needed to govern the behaviour of sovereign countries and their lenders.

She went on to say that standard procedures were also needed to regulate or guide decisions on debt acquisition and management. They should address increased systemic risk and the difficulties of debt restructuring, while seeking to prioritize short-term social obligations. If accepting a loan could jeopardize the fulfilment of social obligations, it might be necessary to reconsider, she said. The use of such a framework with three of Uganda’s biggest creditors had facilitated debt relief packages under the Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief initiatives, which had led to a 50 per cent reduction in the total national debt. Uganda had used the increased fiscal space to solidify future debt-absorption capacity and generally improve debt sustainability, she said.

Mr. Costentino, echoing the call for macroeconomic sense, described Argentina’s recovery path from macroeconomic instability, saying it had required a steady and comprehensive plan. In dealing with the current global financial and economic crisis, the international community should implement an open and honest approach that would define priorities and objectives first and foremost, he said. The task required recognizing available resources and then working on a package of proposals, a process that was often inverted, he noted, adding that it was counter-productive not to take basic macroeconomic rules into account. Such negligence was responsible for the debt crisis, he said.

It had taken Argentina three years to establish the environment necessary for a recovery plan to be implemented, with a serious scaling back, or “haircut”, taking effect in 2005, he recalled. The Government had indexed its debt security to gross domestic product (GDP), thereby improving its ability to repay its debt. Out of a total of $80 billion, 76 per cent had been accepted and Argentina had avoided default, though more work had been needed to manage the debt because even where restructuring had been successful, the small remaining holdout had led to enormous problems. From 2005 onwards, Argentina had continued to work on a liability strategy aimed at clearing non-performing liabilities. Today, the country had active claims on less than 3 per cent of its original default figure, he said.

Argentina had not only restructured most of its debt, but had also implemented a policy to focus on growing from within, using national resources, he said. Emphasizing that he was not urging other countries to follow Argentina’s recovery path, he said that he wished to shed light on the legal vacuum that allowed countries to be placed in situations where sustainability could not work. With the euro zone facing liability restructuring, lessons learned implied a focus on sustainability levels and macroeconomic order, he said. While such an exercise was time-consuming, it was a basic condition for finding a sustainable and long-term solution.

Mr. Canuto said debt restructuring tended to be disorderly and prolonged. Official intervention could help, but it could also make things worse depending on implementation and circumstances. Fiscal fundamentals played a crucial role, internationally, as well as domestically. The Latin American debt crisis of the 1980s had been overcome through a voluntary approach, but official intervention in the Russian Federation and Argentina had not helped at all, he noted. In the current case of Greece, a major risk was contagion spreading to the core of the European Union. That remained the most important economic problem in the world today, he warned. Only Ukraine and Pakistan had restructured debt in an orderly fashion and they were small in size and comparatively isolated.

Official intervention would only be effective if there was a clear distinction between insolvency and liquidity, he said, stressing that procrastination would lead to growing debt levels. He called for private creditors to receive a “haircut”, vulnerable systemic banks to be protected and official loans to be made on the basis of their seniority. The risk of moral hazard on the part of the debtor country had been overestimated, he said, stressing that a resolution mechanism that could smooth debt restructuring would certainly improve things for everyone, as long as procrastination was avoided. Such a positive outcome would benefit all stakeholders, including those responsible for official debt intervention.

Ms. Akhtar, focusing specifically on the euro zone crisis, placed responsibility for it on weak governance and a lethal combination of problems rather than on the timeliness of the intervention. Within the euro zone, laws, policies and institutional mechanisms remained fragmented and not conducive to strong governance in economic policymaking, she said, while stressing that sovereign debt reflected symptoms, not root causes. Solutions must address the root causes, while also resolving the symptoms.

She said the debate had long been in existence, with each major sovereign debt crisis teaching important lessons. However, no changes were made to the static international financial architecture, and there was no consensus on how, or how far, to change that architecture. As soon as the heat of crises cooled, political will became diluted. The current debt crisis was different from others in that, among other ways, it concerned sovereigns in developed countries. It was also complicated by the rules surrounding monetary union, which made dealing with sovereign debt more complex, despite the fact that 80 per cent of the debts issued between 2003 and 2010 had been issued under local laws. The exchange rate could not be used as a tool to combat the crisis, which further limited the adjustment tools on offer, she said.

Mr. Khor, taking up the idea of seeking solutions, said new efforts were needed to find an institutional solution, describing such an institution as the missing pillar in the international financial architecture. Its features should include a temporary standstill on the servicing of external debt to provide breathing space for planning formal debt-restructuring and servicing. The debtor country should be in unilateral charge of that decision, but an independent panel of experts should agree on the decision, he said, emphasizing that creditors, including IMF, should not be involved at all due to their conflict of interest.

The standstill should bring an immediate end to any attempts at litigation, in a similar way to how the World Trade Organization (WTO) allowed the installation of tariffs in balance-of-payments crises. Debtors should be prepared to carry out selective exchange controls to prevent capital flight, or the whole exercise would be defeated, he warned. New loans should then be provided, lending into arrears to keep the sovereign debt a “going concern”, and those new loans should conform to the principle of seniority to facilitate new creditors.

In his opening remarks, Assembly President Jeremić noted that for the first time, a debate on enhancing sovereign debt restructuring and debt resolution mechanisms was taking place had under the auspices of the General Assembly. Hopefully, the exchange would be helpful in shaping the planet’s “material destiny”, he said, pointing to the far-reaching implications of current events in the euro zone. It was encouraging that many the foreign currency reserves of developing countries still surpassed their external debt levels, despite the global economic crisis, he said, pledging to enable the General Assembly to build more meaningful relations with international financial institutions, such as the World Bank and IMF, as well with as the G-20.

Also making opening remarks, Mr. Panitchpakdi noted the absence of enforceability in sovereign debt issues, saying that the lack of a structured approach had led to calls for a formal mechanism. While some argued that that would make it easier for debtors to default, thereby raising the cost of borrowing, such a mechanism could work with the correct safeguards. The issue was due for a return to the centre of international debate, he stressed.

In the ensuing dialogue, the representative of Greece asked Mr. Rogoff why he had reversed his stance on Greek membership in the euro zone, having recently called for the country’s exit and for a devaluation of its currency to boost exports and tourism.

Mr. Rogoff said he had never favoured euro zone membership for Greece and, looking narrowly at its national interest, the country had a good argument for using its own currency and deeply restructuring its debt.

Ms. Kiwanuka, responding to a question about Uganda’s special knowledge, derived from its own experiences with debt restructuring, said that after two decades of restructuring through HIPC, her country was now incurring debt only on infrastructure projects and those that enhanced agricultural productivity. For social initiatives, it was looking more towards bilateral grants and soft financing, she said, adding that debt was out of the question because solving social problems did not generate income.

Mr. Eikeland Gadgil replied to a question about vulture funds by saying that attempts had been made to regulate them, but a strategic debt reduction mechanism remained the key.

Also participating in the interactive dialogue were representatives of Iceland, Nigeria, United Republic of Tanzania and Cameroon. Representatives of Latindad and the European Bank for Reconstruction and Development also took part.