trade and development report, 2001

TRADE AND DEVELOPMENTREPORT, 2001

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

UNITED NATIONS

Global trends and prospects

Financial architecture

131Crisis Management and Burden Sharing

There is a growing body of opinion that ef-fective management of financial crises in emergingmarkets requires a judicious combination of ac-tion on three fronts: a domestic macroeconomicpolicy response, particularly through monetaryand fiscal measures and exchange rate adjustment;timely and adequate provision of international li-quidity with appropriate conditionality; and theinvolvement of the private sector, especially in-ternational creditors. With benefit of hindsight, itis now agreed that the international policy re-sponse to the Asian crisis was far from optimal,at least during the initial phase. An undue burdenwas placed on domestic policies; rather than re-storing confidence and stabilizing markets, hikesin interest rates and fiscal austerity served todeepen the recession and aggravate the financialproblems of private debtors. The international res-cue packages were designed not so much to protectcurrencies against speculative attacks or financeimports as to meet the demands of creditors andmaintain an open capital account. Rather than in-volving private creditors in the management andresolution of the crises, international intervention,coordinated by the IMF, in effect served to bailthem out.1

This form of intervention is increasingly con-sidered objectionable on grounds of moral hazardand equity. It is seen as preventing market disci-pline and encouraging imprudent lending, sinceprivate creditors are paid off with official moneyand not made to bear the consequences of the risksthey take. Even when the external debt is owedby the private sector, the burden ultimately fallson taxpayers in the debtor country, because gov-ernments are often obliged to serve as guarantors.At the same time, the funds required for suchinterventions have been getting ever larger and arenow reaching the limits of political acceptability.Thus, a major objective of private sector involve-ment in crisis resolution is to redress the balanceof burden sharing between official and privatecreditors as well as between debtors and creditors.

For these reasons, the issues of private sectorinvolvement and provision of official assistancein crisis management and resolution have beenhigh on the agenda in the debate on reform of theinternational financial architecture since the out-break of the East Asian crisis. However, despiteprolonged deliberations and a proliferation ofmeetings and forums, the international commu-

Chapter VI

CRISIS MANAGEMENT AND BURDEN SHARING

A. Introduction

Trade and Development Report, 2001132

nity has not been able to reach agreement on howto involve the private sector and how best to designofficial lending in financial crises. As acknowl-edged by the IMF, “While some success has beenachieved in securing concerted private sector in-volvement, it has become increasingly clear thatthe international community does not have at

its disposal the full range of tools that wouldbe needed to assure a reasonably orderly – andtimely – involvement of the private sector” (IMF,2000f: 10). This chapter seeks to address this prob-lem by defining the state of play, examining theissues that remain to be resolved and assessingvarious options proposed.

B. Private sector involvement and orderly debt workouts

Private sector involvement in financial cri-sis resolution refers to the continued or increasedexposure of international creditors to a debtorcountry facing serious difficulties in meeting itsexternal financial obligations, as well as to ar-rangements that alter the terms and conditions ofsuch exposure, including maturity rollovers anddebt write-offs.2 In this con-text, it is useful to make a dis-tinction between mechanismsdesigned to prevent panics andself-fulfilling debt runs, on theone hand, and those designedto share the burden of a crisisbetween debtors and creditors,on the other. To the extent thatprivate sector involvementwould help restrain asset grab-bing, it would also reduce theburden to be shared. For in-stance, debt standstills and rollovers can preventa liquidity crisis from translating into widespreadinsolvencies and defaults by helping to stabilizethe currency and interest rates. In this sense,private sector involvement in financial crises isnot always a zero sum game. It can also help re-solve conflict of interest among creditors them-selves by ensuring more equitable treatment.

Market protagonists often argue that foreigninvestors almost always pay their fair share of the

burden of financial crises in emerging markets.According to this view, international banks incurlosses as a result of arrears and bankruptcies, whileholders of international bonds suffer because thefinancial difficulties of the debtors affect the mar-ket value of bonds, and most private investorsmark their positions to market (Buchheit, 1999: 6).

Losses incurred in domesticbond and equity markets arealso cited as examples of bur-den sharing by private inves-tors.3

In assessing creditorlosses, it is important to bearin mind that, so long as thevalue of claims on the debtorremains unchanged, mark-to-market losses may involveonly a redistribution among

investors. On the other hand, net losses by credi-tors are often compensated by risk spreads onlending to emerging markets. For instance, on theeve of the Asian crisis, the total bank debt ofemerging markets was close to $800 billion.Applying a modest 300 basis points as the aver-age spread on these loans would yield a sum ofmore than $20 billion per annum in risk premium,compared to the estimated total mark-to-marketlosses4 of foreign banks of some $60 billion in-curred in emerging-market crises since 1997.

A major objective of privatesector involvement in crisisresolution is to redress thebalance of burden sharingbetween official and privatecreditors as well as betweendebtors and creditors.


Foreign investors are directly involved inburden sharing when their claims are denominatedin the currency of the debtor country and they rushto exit. This hurts them twice, by triggering sharpdrops both in asset prices and in the value of thedomestic currency. For this reason, countries thatborrow in their own currencies(or adopt a reserve currency astheir own) are expected to beless prone to currency and debtcrises since potential losseswould deter rapid exit andspeculative attacks.

However, the denomina-tion of external debt in the cur-rency of the debtor countrydoes not eliminate the so-called collective action prob-lem which underlines self-ful-filling debt runs and providesthe principal rationale for debtstandstills; even though creditors as a group are bet-ter off if they maintain their exposure, individualinvestors have an incentive to exit quickly for fearof others doing so before them. The consequent de-clines in domestic asset prices and in the value ofthe currency not only hurt creditors, but also haveserious repercussions for the debtor economy. Insome cases, there could be a run for the strongforeign-owned domestic banks as well, placing aparticular burden on locally-owned and smallerbanks and other financial institutions. It is for thesereasons that governments of debtor countries areoften compelled to take action to prevent a rapidexit of foreign investors from domestic capitalmarkets. Such actions may go beyond monetarytightening. In Mexico, for instance, market pres-sures in 1994 forced the Government to shiftfrom peso-denominated cetes to dollar-indexedtesebonos in the hope that removing the currencyrisks would persuade foreign creditors to stay.However, this did not prevent the eventual rushto exit, the collapse of the peso and hikes in inter-est rates. Thus, even when external debt is denomi-nated in domestic currency, arrangements to in-volve private creditors through standstills androllovers can play an important role in efforts toachieve greater financial stability.

As discussed in detail in TDR 1998, the ra-tionale and key principles for an orderly debt

workout can be found in domestic bankruptcy pro-cedures. Although chapter 11 of the United StatesBankruptcy Code is the most cited reference, othermajor industrial countries apply similar principles.These principles combine three key elements:(i) provisions for an automatic standstill on debt

servicing that prevents a “grabrace” for assets among thecreditors; (ii) maintaining thedebtor’s access to the workingcapital required for the con-tinuation of its operations (i.e.lending into arrears); and(iii) an arrangement for thereorganization of the debtor’sassets and liabilities, includingdebt rollover, extension of ex-isting loans, and debt write-offor conversion. The way theseelements are combined de-pends on the particularities ofeach case, but the aim is to

share the adjustment burden between debtor andcreditors and to assure an equitable distributionof the costs among creditors.

Under these procedures, standstills give thedebtor the “breathing space” required to formu-late a debt reorganization plan. While, in principle,agreement is sought from creditors for restructur-ing debt, the procedures also make provisions todiscourage holdouts by allowing for majority –rather than unanimous – approval of the creditorsfor the reorganization plan. The bankruptcy courtacts as a neutral umpire and facilitator, and whennecessary has the authority to impose a bindingsettlement on the competing claims of the credi-tors and debtor under so-called “cramdown”provisions.

Naturally, the application of national bank-ruptcy procedures to cross-border debt involves anumber of complex issues. However, fully-fledgedinternational bankruptcy procedures would not beneeded to ensure an orderly workout of interna-tional debt. The key element is internationallysanctioned mandatory standstills. Under certaincircumstances, it might be possible to reach agree-ment on voluntary standstills with creditors but,as recognized by the IMF, “… in the face of abroad-based outflow of capital, it may be diffi-cult to reach agreement with the relevant resident

While debtor countrieshave the option to imposeunilateral paymentsuspension, without astatutory basis such actioncan create considerableuncertainties, therebyreducing the likelihood oforderly debt workouts.


and nonresident investors ...” (IMF, 2000f: 10).On the other hand, while debtor countries havethe option to impose unilateral payment suspen-sion, without a statutory basis such action can cre-ate considerable uncertainties, thereby reducingthe likelihood of orderly debt workouts. Further-more, debtors could be deterred from applyingtemporary payment standstills for fear of litiga-tion and asset seizure by creditors, as well as of last-ing adverse effects on their reputation.

Standstills on sovereign debt involve suspen-sion of payments by governments themselves,while on private external debt they require animposition of temporary exchange controls whichrestrict payments abroad on specified transactions,including interest payments. Further restrictionsmay also be needed on capital transactions of resi-dents and non-residents (suchas acquisition of assets abroador repatriation of foreign capi-tal). Clearly, the extent towhich standstills would need tobe combined with such meas-ures depends on the degree ofrestrictiveness of the capitalaccount regime already inplace.

Since standstills and ex-change controls need to be im-posed and implemented rap-idly, the decision should restwith the country concerned,subject to a subsequent review by an internationalbody. According to one proposal, the decisionwould need to be sanctioned by the IMF. Clearly,for the debtor to enjoy insolvency protection, itwould be necessary for such a ruling to be legallyenforceable in national courts. This would requirea broad interpretation of Article VIII(2)(b) of theArticles of Agreement of the IMF, which couldbe provided either by the IMF Executive Boardor through an amendment of these Articles so asto cover debt standstills. In this context, Canadahas proposed an Emergency Standstill Clause tobe mandated by IMF members (Department of Fi-nance, Canada, 1998).

However, as argued in TDR 1998, the IMFBoard is not a neutral body and cannot, therefore,

be expected to act as an independent arbiter, be-cause countries affected by its decisions are alsoamong its shareholders. Moreover, since the Funditself is a creditor, and acts as the authority forimposing conditionality on the borrowing coun-tries, there can be conflicts of interest vis-à-visboth debtors and other creditors. An appropriateprocedure would thus be to establish an independ-ent panel for sanctioning such decisions. Such aprocedure would, in important respects, be simi-lar to GATT/WTO safeguard provisions that allowdeveloping countries to take emergency actionswhen faced with balance-of-payments difficulties(see box 6.1).

For private borrowers the restructuring ofdebts should, in principle, be left to national bank-ruptcy procedures. However, these remain highly

inadequate in most developingcountries (see chapter IV, sub-section B.6). Promoting an or-derly workout of private debt,therefore, crucially dependson establishing and develop-ing appropriate procedures.Ordinary procedures for han-dling individual bankruptciesmay be inappropriate and dif-ficult to apply under a morewidespread crisis, and theremay be a need to provide gen-eral protection to debtors whenbankruptcies are of a systemicnature. One proposal that has

been put forward is “… to provide quasi automaticprotection to debtors from debt increases due to adevaluation beyond a margin …” (Miller andStiglitz, 1999: 4). Clearly, the need for such pro-tection will depend on the extent to which stand-stills and exchange controls succeed in prevent-ing sharp declines in currencies. For sovereigndebtors, it is difficult to envisage formal bank-ruptcy procedures at the international level, butthey too could be given a certain degree of pro-tection against debt increases brought about bycurrency collapses. Beyond that, negotiations be-tween debtors and creditors appear to be the onlyfeasible solution. As discussed below, these maybe facilitated by the inclusion of various provi-sions in debt contracts, as well as by appropriateintervention of multilateral financial institutions.

While the internationalcommunity has increasinglycome to recognize thatmarket discipline will onlywork if creditors bear theconsequences of the risksthey take, it has beenunable to reach agreementon how to bring this about.


Box 6.1

GATT AND GATS BALANCE-OF-PAYMENTS PROVISIONSAND EXCHANGE RESTRICTIONS

The balance-of-payments provisions of Articles XII and XVIIIB of GATT 1994 al-low a Member to suspend its obligations under the Agreement, and to impose importrestrictions in order to forestall a serious decline in, or otherwise protect the level of,its foreign exchange reserves, or to ensure a level of reserves adequate for implemen-tation of its programme of economic development.1 The provisions of Article XVIIIB(part of Article XVIII dealing with governmental assistance to economic develop-ment) are directed particularly at payments difficulties arising mainly from a coun-try’s efforts to expand its internal market or from instability in its terms of trade.Permissible actions include quantitative restrictions as well as price-based measures.In applying such restrictions, the Member may select particular products or productgroups. The decision is taken unilaterally, with notification to the WTO Secretariatand subsequent consultations with other Members in the Committee on Balance-of-Payments Restrictions. Restrictions are imposed on a temporary basis, and are ex-pected to be lifted as conditions improve. However, the Member cannot be requiredto remove restrictions by altering its development policy.

Similar provisions are to be found in Article XII of the General Agreement on Tradein Services (GATS), which stipulates that, in the event of serious difficulties in thebalance of payments and in external finance, or a threat thereof, a Member may adoptor maintain restrictions on trade in services on which it has undertaken specific com-mitments, including on payments or transfers for transactions related to such com-mitments. Again, such restrictions are allowed to ensure, inter alia, the maintenanceof a level of financial reserves adequate for implementation of the Member’s pro-gramme of economic development or economic transition. The conditions andmodalities related to the application of such restrictions are similar to those in theGATT 1994 balance-of-payments provisions.

Clearly, these provisions are designed to avoid conditions in which countries areforced to sacrifice economic growth and development as a result of temporary diffi-culties originating in the current account of the balance of payments, particularlytrade deficits. Even though they may not be invoked directly for the restriction offoreign exchange transactions and the imposition of temporary standstills on debtpayments at times of severe payments difficulties arising from the rapid exit of capi-tal – and a consequent capital-account crisis – resort to such action in those circum-stances would be entirely in harmony with the provisions’ underlying rationale.

1 For more detailed discussion, see Jackson (1997, chap. 7); and Das (1999, chap. III.3).


Despite its potential benefits to both debtorsand creditors, private sector involvement in crisisresolution has proved to be one of the most con-tentious issues in the debate on reform of the in-ternational financial architecture. While the inter-national community has increasingly come to rec-ognize that market discipline will only work ifcreditors bear the consequences of the risks theytake, it has been unable to reach agreement on howto bring this about. According to one view, avoluntary and case-by-caseapproach would constitute themost effective way of involv-ing the private sector in crisisresolution. Another view isthat, for greater financial sta-bility and equitable burdensharing, a rules-based manda-tory approach is preferable.This divergence of views is notsimply between debtor andcreditor countries, but alsoamong the major creditorcountries.

The main argument in favour of a rules-basedsystem is that a case-by-case approach could leadto asymmetric treatment – not only betweendebtors and creditors, but also among differentcreditors. It would also leave considerable discre-tion to some major industrial powers, which havesignificant leverage in international financialinstitutions, to decide on the kind of interventionto be made in emerging-market crises. Privatemarket actors, as well as some major industrialcountries, are generally opposed to involuntarymechanisms on the grounds that they create moral

hazard for debtors, that they alter the balance ofnegotiating strength in favour of the latter, thatthey delay the restoration of market access, andthat they can be used to postpone the adjustmentsneeded.5

The recent debate within the IMF on privatesector involvement in crisis resolution appears tohave focused on three mechanisms. First, it isagreed that the Fund should try, where appropriate,

to act as a catalyst for lendingby other creditors to a coun-try facing payments difficul-ties. If this is inappropriate, orif it fails to bring in the pri-vate sector, the debtor coun-try should seek to reach anagreement with its creditors ona voluntary standstill. Finally,it is recognized that, as a lastresort, the debtor country mayfind it necessary to impose aunilateral standstill when vol-untary agreement is not feasi-

ble. All these measures should also be accompa-nied by appropriate monetary and fiscal tighten-ing and exchange rate adjustment. A report of themeeting of the IMF Executive Board concerningthe involvement of the private sector in the reso-lution of financial crises stated:

Directors agreed that, under the suggestedframework for involving the private sector,the Fund’s approach would need to be aflexible one, and the complex issues involvedwould require the exercise of considerablejudgement. … In cases where the member’sfinancing needs are relatively small or where,

C. Recent debate within the IMF

Current practices leave toomuch discretion to the Fundand its major shareholdersin decisions regarding thetiming and extent of theofficial financing it shouldprovide, and under whatconditions.


despite large financing needs, the memberhas good prospects of gaining market accessin the near future, the combination of strongadjustment policies and Fund support shouldbe expected to catalyze private sector in-volvement. In other cases, however, whenan early restoration of market access onterms consistent with medium-term exter-nal sustainability is judged to be unrealistic,or where the debt burden is unsustainable,more concerted support from private credi-tors may be necessary, possibly includingdebt restructuring …

Directors noted that the term “standstill”covers a range of techniques for reducingnet payment of debt service or net outflowsof capital after a country has lost spontane-ous access to international capital markets.These range from voluntary arrangementswith creditors limiting net outflows of capi-tal, to various concerted means of achievingthis objective.

Directors underscored that the approach tocrisis resolution must not undermine theobligation of countries to meet their debt infull and on time. Nevertheless, they notedthat, in extreme circumstances, if it is notfeasible to reach agreement on a voluntarystandstill, members may find it necessary,as a last resort, to impose one unilaterally.Directors noted that … there could be a riskthat this action would trigger capital out-flows. They recognized that if a tighteningof financial policies and appropriate ex-change rate flexibility were not successfulin stanching such outflows, a member wouldneed to consider whether it might be neces-sary to resort to the introduction of morecomprehensive exchange or capital controls.(IMF, 2000h)6

Clearly, there still remains the possibility oflarge-scale bailout operations. Some countriesapparently attempted to exclude this possibility,but could not secure consensus:

A number of Directors favoured linking astrong presumption of a requirement forconcerted private sector involvement tothe level of the member’s access to Fundresources. These Directors noted that arules-based approach would give more

predictability to the suggested frameworkfor private sector involvement, while limit-ing the risk that large-scale financing couldbe used to allow the private sector to exit.Many other Directors, however, stressed thatthe introduction of a threshold level ofaccess to Fund resources, above which con-certed private sector involvement would beautomatically required, could in some caseshinder the resumption of market access fora member with good prospects for the suc-cessful use of the catalytic approach tosecuring private sector involvement.

Nor has there been agreement over empow-ering the IMF to impose stay on creditor litigationin order to provide statutory protection to debtorsthat impose temporary standstills:

Most Directors considered that the appro-priate mechanism for signalling the Fund’sacceptance of a standstill imposed by amember was through a decision for the Fundto lend into arrears to private creditors …Some Directors favored an amendment toArticle VIII, section 2(b), that would allowthe Fund to provide a member with someprotection against the risk of litigationthrough a temporary stay on creditor litiga-tion. Other Directors did not favor such anapproach, and noted that in recent casesmembers’ ability to reach cooperative agree-ments with private creditors had not beenhampered by litigation.

Considerable flexibility is undoubtedly neededin handling financial crises since their form andseverity can vary from country to country. How-ever, current practices leave too much discretionto the Fund and its major shareholders in decisionsregarding the timing and extent of the officialfinancing it should provide, and under what con-ditions; how much private sector involvement itshould require; and under what circumstances itshould give support to unilateral payment stand-stills and capital controls. The suggested frame-work generally fails to meet the main concerns ofdebtor countries regarding burden sharing in cri-sis resolution and the modalities of IMF supportand conditionality. Nor does it provide clear guide-lines to influence the expectations and behavioursof debtors and creditors with the aim of securinggreater stability.


The above discussion suggests that there isnow a greater emphasis on private sector in-volvement when designing official assistance tocountries facing financial difficulties. The ele-ments of this strategy include the use of officialmoney as a catalyst for private financing, lendinginto arrears to precipitate agreement between debt-ors and creditors, and making official assistanceconditional on prior private sector participation.Some of these policies were, in fact, used for theresolution of the debt crisis in the 1980s, althoughtheir objectives were not always fully met. Forinstance, under the so-called Baker Plan, officiallending to highly-indebted developing countriessought to play a catalytic role, but faced stiff op-position from commercial banks, which refusedto lend to these countries. The practice of IMFlending to debtors that are in arrears on paymentsowed to private creditors dates back to the BradyPlan of 1989, when commercial banks were nolonger willing to cooperate in restructuring thirdworld debt as they had made sufficient provisionsand reduced their exposure to developing countryborrowers. A decision by the IMF Board in Sep-tember 1998 formally acknowledged lending intoarrears as part of the Fund’s lending policy andextended this practice to bonds and non-bank cred-its in the expectation that it would help countrieswith Fund-approved adjustment programmes torestructure their private debt.7

The current emphasis on official assistancebeing made conditional on private sector partici-pation includes a commitment not to lend or grantofficial debt relief unless private markets similarlyroll over their maturing claims, lend new moneyor restructure their claims. This strategy, which

has come to be known as “comparability of treat-ment”, aims not only at preventing moral hazardas it pertains to private creditors, but also at en-suring an acceptable form of burden sharingbetween the private and official creditors. Its un-derlying principle is that public assistance shouldnot be made available unless debtors get somerelief from private creditors, and no class of pri-vate creditors should be exempt from burdensharing.8 In 1999, Paris Club creditors specificallyadvised Pakistan to seek comparable treatmentfrom its private bondholders by rescheduling itseurobond obligations. However, this policy doesnot seem to have been implemented in the caseof recent official assistance to Ecuador, when theIMF did not insist that the country reach an agree-ment on restructuring with the holders of its Bradybonds as a precondition for official assistance (seebox 6.2; and Eichengreen and Ruhl, 2000: 19).

Certainly, the emphasis on burden sharingand comparable treatment between private andofficial creditors constitutes a major advance overthe debt strategies adopted in the 1980s and in themore recent emerging-market crises. During theseepisodes, official intervention was designed pri-marily to keep sovereign debtors current on debtservicing to private creditors and the seniorityaccorded to multilateral debt went unchallenged.However, the emphasis on burden sharing amongcreditors does not necessarily lead to improvedoutcomes regarding the more important questionof burden sharing between debtors and creditors.

In this respect, a key issue is whether a strat-egy that makes official assistance conditional onprivate sector participation could succeed in pro-

D. Official assistance, moral hazard and burden sharing


Box 6.2

RECENT BOND RESTRUCTURING AGREEMENTS

A number of recent sovereign bond restructuring agreements have been widely hailed by the inter-national community for their success “... in puncturing unsustainable expectations of some inves-tors that international sovereign bonds were, in effect, immune from restructuring ...” (IMF,2000f: 10). However, they also show that, under current institutional arrangements, there are noestablished mechanisms for an orderly restructuring of sovereign bonds, and that the process canbe complex and tedious.1 Success in bringing bondholders to the negotiating table does not dependon the presence of CACs in bond documents alone. A credible threat of default could be just aseffective. However, even then, the debtors are not guaranteed to receive significant debt relief,particularly on a mark-to-market basis.

Pakistan restructured its international bonds at the end of 1999 without invoking the CACs presentin its bonds, preferring a voluntary offer to exchange its outstanding eurobonds for a new six-yearinstrument, which was accepted by a majority of the bondholders. Communication problems werenot serious because the bonds were held by only a few Pakistani investors. It is believed that thepresence of CACs and a trustee, as well as the request of the Paris Club to extend “comparability oftreatment” to eurobonds, along with a credible threat of default, played an important role in dis-couraging holdouts.2 However, the terms of restructuring were quite favourable to bondholderscompared to the prevailing market price, and the new bonds offered were more liquid. Accordingto the IMF, there was a “haircut” for the creditors compared to the relative listing price but not tothe relative market value, and although the initial impact of the restructuring on the debt profile ofthe country was somewhat positive, “by 2001 market estimates suggest that debt-service paymentswill be back to levels before restructuring and will be higher for the remaining life of the exchangebond” (IMF, 2000g: 137 and table 5.2).

By contrast, Ukraine made use of the CACs present in four of its outstanding bonds in a restruc-turing concluded in April 2000. Unlike Pakistan, the bonds were spread widely among retail hold-ers, particularly in Germany, but the country managed to obtain the agreement of more than 95 percent of the holders on the outstanding value of debt. As in Pakistan, however, this involved onlythe extension of principal maturities rather than relief, since reorganization was undertaken on amark-to-market basis. Indeed, there was a net gain for creditors relative to market value (IMF,2000g, table 5.2).

From mid-1999 Ecuador started having serious difficulties in making interest payments on itsBrady bonds, ending up in a default in the second half of the year. As rolling over maturities wouldnot have provided a solution, the country sought a large amount of debt reduction by offering anexchange for global bonds issued at market rates, but with a 20-year maturity period. This wasrejected by the bondholders, who furthermore, voted for acceleration. After a number of failedattempts, Ecuador invited eight of the larger institutional holders of its bonds to join a Consulta-tive Group, with the aim of providing a formal mechanism of communication with bondholdersrather than negotiating terms for an exchange offer. In mid-August, bondholders accepted Ecua-dor’s offer to exchange defaulted Brady bonds for 30-year global bonds at a 40 per cent reductionin principal, while the market discount was over 60 per cent. This resulted in a net gain for thecreditors relative to market value.3

1 On these restructuring exercises, see De la Cruz (2000); Eichengreen and Ruhl (2000); Buchheit (1999);and IMF (2000g, box 5.3).

2 For a different view on the impact of the Paris Club’s request, see Eichengreen and Ruhl (2000: 26–28).3 For an assessment of the Ecuadorian restructuring, see Acosta (2000).


moting orderly debt workouts with private credi-tors. The rationale for this strategy is that, if theFund were to stand aside and refuse to lend to acountry under financial stress unless the marketsrolled over their claims first, private creditorswould be confronted with the prospect of default,which would encourage themto negotiate and reach agree-ment with the debtor. Themain weakness of this strategyis that, if the default is not verycostly, creditors will have lit-tle incentive for restructuringtheir claims. On the otherhand, if it is costly, the IMFwill not be able to stand by andlet it happen, since the threatto international financial sta-bility, as well as to the countryconcerned, would be serious.The insistence on IMF non-intervention would beno more credible than an announcement by a gov-ernment that it will not intervene to save citizenswho have built houses in a flood plain.9 This di-lemma provides a strong case for explicit rulesprohibiting the building of houses in flood plainsor a “grab race” for assets.10

Thus it appears that a credible strategy forinvolving the private sector in crisis resolutionshould combine temporary standstills with strictlimits on access to Fund resources. Indeed, such astrategy has received increased support in recentyears.11 According to one view, access could belimited by charging penalty rates. However, sincesuch price-based measures are unlikely to succeedin checking distress borrowing under crisis con-ditions, quantitative limits will be needed. A recentreport by the United States Council on ForeignRelations (CFR) on reform of the international fi-nancial architecture argued that the IMF shouldadhere consistently to normal access limits of100 per cent of quota annually and 300 per centon a cumulative basis, and that countries shouldbe able to resort to unilateral standstills when suchfinancing proves inadequate to stabilize marketsand their balance of payments. The amounts com-mitted in recent interventions in emerging-marketcrises, beginning with the one in Mexico in 1995,far exceeded these limits, being in the range of500 per cent to 1,900 per cent of quota.

However, in setting such access limits, itshould be recognized that IMF quotas have laggedbehind growth of global output, trade and finan-cial flows, and their current levels may not pro-vide appropriate yardsticks to evaluate the size ofIMF packages. According to one estimate, adjust-

ing quotas for the growth inworld output and trade since1945 would require them to beraised by three and nine times,respectively (Fischer, 1999).In an earlier proposal – madein an IMF paper on the eve ofthe Mexican crisis – to createa short-term financing facilityfor intervention in financialcrises, 300 per cent of quota wasconsidered a possible upperlimit (see TDR 1998, chap. IV,sect. B.4). Such amounts ap-

pear to be more realistic than current normal ac-cess limits.

Fund resources are not the only source ofrescue packages, and in many cases bailouts relyeven more on the money provided by some majorcreditor countries. This practice has often in-creased the scope for these countries to pursuetheir own national interests in the design of res-cue packages, including the conditionalitiesattached to lending. It is highly probable that ma-jor creditor countries will continue to act in thismanner whenever and wherever they see their in-terests involved, and some debtor countries mayeven prefer to strike bilateral deals with themrather than going through multilateral channels.However, limits on access to Fund resourcesshould be observed independently of bilaterallending under crisis. Furthermore, it is desirableto keep such ad hoc bilateral arrangements sepa-rate from multilateral lending in order to reducethe scope for undue influence over Fund policiesby some of its major shareholders.

A key question is whether such access limitsshould be exceeded under certain circumstances.For instance, while arguing for strict limits, theCFR report suggested, “In the unusual case inwhich there appears to be a systemic crisis (thatis, a multicountry crisis where failure to intervenethreatens the performance of the world economyand where there is widespread failure in the abil-

A credible strategy forinvolving the private sectorin crisis resolution shouldcombine temporarystandstills with strict limitson access to Fundresources.


ity of private capital markets to distinguish cred-itworthy from less creditworthy borrowers), theIMF would return to its ‘systemic’ backup facili-ties …” (CFRTF, 1999: 63). It proposed the crea-tion of a facility to help prevent contagion, to befunded by a one-off allocation of special drawingrights (SDRs),12 which would replace the existingIMF facilities for crisis lending (see box 6.3).

While the concerns underlying different lend-ing policies for systemic and non-systemic crisesmay be justified, in practice exceptions to normallending limits could leave considerable room forlarge-scale bailout operations and excessive IMFdiscretion. One possible implication is that coun-tries not considered systemically important couldface strict limits in access to Fund resources, but

Box 6.3

RECENT INITIATIVES IN IMF CRISIS LENDING

The IMF has recently taken steps to strengthen its capacity to provide financing in crises, thoughthis capacity still falls short of that of a genuine international lender of last resort.1 The Supple-mental Reserve Facility (SRF), approved by the IMF’s Executive Board in response to the deepen-ing of the East Asian crisis in December 1997, was designed to provide financing without limits tocountries experiencing exceptional payments difficulties, but under a highly conditional stand-byor Extended Arrangement (IMF, 1998b: 7). However, the SRF depends on the existing resources ofthe Fund which, recent experience suggests, are likely to be inadequate on their own to meet thecosts of large interventions.

The Contingency Credit Line (CCL), created in Spring 1999, is intended to provide a precaution-ary line of defence in the form of short-term financing, which would be available to meet balance-of-payments problems arising from international financial contagion (IMF, 1999). Thus, unlike theSRF, which is available to countries in crisis, the CCL is a preventive measure. Countries can pre-qualify for the CCL if they comply with conditions related to macroeconomic and external finan-cial indicators and with international standards in areas such as transparency, banking supervisionand the quality of banks’ relations and financing arrangements with the private sector. The pres-sures on the capital account and international reserves of a qualifying country must result from asudden loss of confidence amongst investors triggered largely by external factors. Moreover, al-though no limits on the scale of available funds are specified, like the SRF, the CCL depends on theexisting resources of the Fund. Originally, it was expected that the precautionary nature of theCCL would restrict the level of actual drawings. However, in the event, no country has applied forthis facility. It is suggested that, under the initial terms, countries had no incentive to pre-qualifi-cation because fees and interest charges on the CCL were the same as under the SRF. In addition,access was not automatic, but subject to the Board’s assessment of policies and risks of contagioneffects. The IMF Board took steps in September 2000 to lower charges as well as to allow someautomatic access with a view to enhancing the potential use of the CCL (IMF, 2000j), but thereappear to be more serious design problems. In particular, countries seem to avoid recourse to it forfear that it will have the effect of a tocsin in international financial markets, thus stifling access tocredit.2

1 For a discussion of these facilities, see IMF (2000i). For a discussion of the issues involved in establish-ing an international lender of last resort, see TDR 1998 (chap. IV, sect. B.4), and Akyüz and Cornford(1999).

2 For an earlier assessment along these lines, see Akyüz and Cornford (1999: 36). For a more recentassessment, see Goldstein (2000: 12–13).


would have the option of imposing unilateralstandstills. However, for larger emerging marketsbailouts would still be preferred to standstills.Recent events involving defaults by Pakistan andEcuador (see box 6.2), but rescue operations forArgentina and Turkey (see chapter II) bear this

out. In the latter cases, difficulties experiencedwere largely due to the currency regimes pursuedrather than to financial contagion from abroad.However, there is wide concern that if these cri-ses had been allowed to deepen, they could havespread to other emerging markets.

E. Voluntary and contractual arrangements

As noted above, considerable emphasis isnow being placed on voluntary mechanisms forthe involvement of the private sector in crisis man-agement and resolution. However, certain featuresof the external debt of developing countries renderit extremely difficult to rely on such mechanisms,particularly for securing rapid debt standstills androllovers. These include a wider dispersion ofcreditors and debtors and the existence of a largervariety of debt contracts associated with the grow-ing spread and integration of international capitalmarkets, as well as innovations in sourcing for-eign capital. As a result, the scope of some of thevoluntary mechanisms used in the past has greatlydiminished.

Perhaps the most important development,often cited in this context, is the shift from syndi-cated bank loans to bonds in sovereign borrowing,since, for reasons examined below, bond restruc-turing is inherently more difficult. Sovereign bondissues were a common practice in the interwaryears when emerging markets had relatively easyaccess to bond markets. During the global finan-cial turmoil of the late 1920s and early 1930s,many of these bond issues ended up in defaults.There was little recourse to bond financing byemerging-market governments prior to the 1990s.The share of bonds in the public and publicly guar-anteed long-term debt of developing countries

stood at some 6.5 per cent in 1980, but rose rap-idly over the past two decades, reaching about21 per cent in 1990 and almost 50 per cent in 1999(World Bank, 2000). This ratio is lower for pri-vate, non-guaranteed debt, but the increase in theshare of bonds in private external debt is equallyimpressive – from about 1 per cent in 1990 to some24 per cent in 1999. According to the Institute ofInternational Finance (IIF), from 1992 to 1998,of a total of about $1,400 billion net capital flowsto 29 major emerging markets, 23 per cent camefrom commercial banks and 27 per cent from otherprivate creditors, mainly through bonds (IIF, 1999,table 1).

A second important development is that in-ternational lending to emerging markets has beenincreasingly to private sector borrowers. The shareof public and publicly guaranteed debt in thetotal long-term debt of developing countries ex-ceeded 75 per cent in the 1980s, but stood at lessthan 60 per cent in 1999. The increased impor-tance of private sector borrowing has meant a rapidincrease in the dispersion of debtors. While animportant part of private borrowing consists ofinterbank loans, direct lending to corporations isalso important in some emerging markets. In In-donesia, for example, such borrowing accountedfor more than three quarters of the total privatedebt. Furthermore, in developing countries, an


increasing proportion of the private sector’s ex-ternal bank debt is in the form of bilateral ratherthan syndicated lending, implying also a greaterdispersion of creditors. The creditor base is furtherbroadened as a result of repackaging arrangementsand credit derivatives, whereby economic inter-est in the original loan is passed on to third parties(Yianni, 1999: 81–84).

Various developments regarding emerging-market debt have also increased the scope for rapidexit and creditor runs, thereby reducing the roomfor cooperative solutions. Perhaps the most im-portant of these is the shift in bank lending towardsmore short-term loans. In the mid-1980s, bankloans with a maturity of less than one year ac-counted for around 43 per cent of total bank loans,but they increased to almost 60 per cent on theeve of the Asian crisis, and dropped to about50 per cent thereafter. Similarly, the widespreaduse of acceleration and cross-default clauses andput options in credit contracts has increased thescope for dissident holdouts, making it difficultfor debtors and creditors to reach rapid agreementon voluntary standstills and workouts.13

A number of proposals have been made fordesigning mechanisms to facilitate voluntary in-volvement of the private sector in crisis resolution.In discussing these mechanisms, it is useful tomake a distinction between bond covenants andother contractual and cooperative arrangementsdesigned to “bind in” and “bail in” the privatesector.

1. Bond restructuring and collectiveaction clauses

As already noted, the notion that sovereignbonds as well as bank loans may need to be re-structured has only recently been accepted by theinternational community (though not necessarilyby all segments of financial markets). The emerg-ing-market sovereign debtors that had issuedbonds in the 1970s and 1980s generally remainedcurrent on such obligations during the debt crisisof the 1980s while rescheduling and restructuringtheir commercial bank debt – a factor that appearsto have played an important role in the rapid ex-

pansion of bond financing in the 1990s relative tobank lending. As a result of this rapid increase,together with the increased frequency of virulentfinancial crises, bond restructuring has gainedin importance, particularly for sovereign borrow-ers.

However, there are serious difficulties inbond restructuring compared to rescheduling andrestructuring of syndicated credits. First of all,there are collective representation and collectiveaction problems, which are more acute with bondsthan with loan contracts. These arise from com-munication difficulties between the bond issuerand holders; in general bondholders are anony-mous and more diverse and include a variety ofinvestors, both individual and institutional. Thecommunication problem is further aggravated bytrading in secondary markets. Moreover, there arelegal impediments to the establishment of com-munication mechanisms between issuers andholders, as well as to dealing with non-participat-ing holders, that vary according to the legislationgoverning bonds. Again, as legislation for bondcontracts varies, it becomes difficult to applyuniform procedures in restructuring. Current ar-rangements also encourage holdouts and litigationby bondholders since, unlike the practice duringthe interwar years, sovereign issuers are often re-quired to include a waiver of sovereign immunity.Thus, sovereign debtors do not enjoy the protec-tion accorded to private debtors under domesticbankruptcy and insolvency procedures that oftenoverrule holdouts and eliminate free riders.

Quite independently of the contractual andlegal provisions governing a bond, a sovereignissuer facing serious financial difficulties alwayshas the option of making an offer to exchange itsexisting bonds with new instruments containingnew terms of payment. However, the problems ofcommunication and holdouts render such ex-change offers difficult to implement effectively.Thus, since the Mexican crisis, emerging-marketborrowers have been increasingly urged to includeso-called collective action clauses (CACs) in bondcontracts in order to improve communication withbondholders and facilitate bond restructuring.14

Such clauses appear to be particularly desirablefor sovereign borrowers, who do not benefit fromnational bankruptcy codes. There are basicallythree types of CACs:


• collective representation clauses, designed toestablish a representative forum (e.g. a trus-tee) for coordinating negotiations betweenthe issuer and bondholders;

• majority action clauses, designed to empowera qualified majority (often 75 per cent) ofbondholders to agree to a change in paymentterms in a manner which is binding on allbondholders, thereby preventing holdouts;and

• sharing clauses, designed to ensure that allpayments by the debtor are shared amongbondholders on a pro-rated basis, and to pre-vent maverick litigation.

It should be noted that the inclusion of CACsin bond contracts, where allowed by law, is op-tional – not mandatory – and often depends onmarket convention. Issuers generally adopt thedocumentation practices prevailing in the juris-diction of the governing law. In general, collectiverepresentation clauses are not contained in bondsgoverned either by English law or New York law.Majority action clauses are routinely included inbond contracts governed by English law, but notin those issued under New York law, even thoughthe latter does not precludethem from sovereign issues.Similarly, bonds governed byGerman and Japanese laws donot generally contain majorityaction clauses. In these cases,any change to the terms ofpayment requires a unanimousdecision by the bondholders.This is also true for Bradybonds, even when governed byEnglish law. It appears that theinclusion of a unanimity rulewas a major reason for theBrady process to be imple-mented through loan-for-bondexchanges rather than throughamendments to the existing loancontracts (Buchheit, 1999: 9).Sharing clauses are routinely included in syndi-cated bank loans, but are uncommon in publiclyissued bonds since they are often viewed by mar-kets as a threat to the legal right of creditors toenforce their claims.15 The absence of sharing

clauses, together with the waiver of sovereignimmunity, leaves considerable room for bondhold-ers to hold out against restructuring and to enterinto a “grab race” for assets through litigation.

According to available data, about one thirdof total bonds issued by emerging markets duringthe 1990s were governed by English law; the shareof bonds issued under New York law was lower,but still exceeded a quarter, followed by those is-sued under German law (just under one fifth) andJapanese law (around 13 per cent). It appears thatAsian, and particularly Latin American, emerg-ing markets have made greater use of New Yorklaw than English law in their issues. Japanese lawis seldom used in Latin American issues but gov-erns about a quarter of Asian issues, while theopposite is true concerning the use of German law.Between 1995 and 2000, there was an increase inthe proportion of bonds governed by New Yorklaw, but it is not clear if this is linked to the in-creased frequency of financial crises in emergingmarkets (Dixon and Wall, 2000: 145–146; Eichen-green and Mody, 2000a, table 1).

It is estimated that about half of all outstand-ing international bond issues – including thoseissued by industrial countries – do not include

CACs, and this proportion iseven greater for emerging-market bonds. A major con-cern of emerging markets isthat the inclusion of CACswould curtail their access tomarkets and raise the cost ofborrowing because it wouldsignal a greater likelihood ofdefault. They thus insist thatsuch clauses be introducedfirst in sovereign bonds of in-dustrial countries. Some in-dustrial countries, such asCanada and the United King-dom, have recently decided toinclude or extend CACs intheir international bond andnote issues in order to encour-

age a wider use of such clauses, particularly byemerging markets. International private sectorgroups find majority voting acceptable, subject toa threshold in the order of 90–95 per cent, but theyprefer voluntary exchange offers, and are opposed

A major concern ofemerging markets is thatthe inclusion of collectiveaction clauses would curtailtheir access to markets andraise the cost of borrowingbecause it would signal agreater likelihood of default,but the empirical evidenceon the impact of suchclauses on the cost ofinternational bond financingis inconclusive.


to making CACs mandatory in bond contracts(IMF, 2000g: table 5.2; Dixon and Wall, 2000: ta-ble 2).

The empirical evidence on the impact ofCACs on the cost of international bond financingis inconclusive (BIS, 1999; Eichengreen andMody, 2000b; Dixon and Wall, 2000). Indeed,CACs can have two opposite effects. On the onehand, their inclusion can raise the default prob-ability in the eyes of investors since they maycreate moral hazard for thedebtor, leading to a higher riskpremium. On the other hand,in the event of a default, suchclauses help recover the claimsof investors by facilitatingbond restructuring. The neteffect depends on how CACsaffect the perceived defaultprobability and the expectedrecovery rate. For countrieswith high credit ratings, the latter effect coulddominate, so that the inclusion of CACs may, infact, lower the cost of bond financing. For lower-rated bonds, however, such clauses may well leadto sharp increases in the perceived risk of default,thereby raising the spread on new issues.

It is not clear if the introduction of CACs inbond contracts could make a major impact on debtrestructuring, since experience in this respect ishighly limited.16 In any case, even if such clauseswere rapidly introduced by emerging-market bor-rowers in their new bond issues, the initial impactwould be limited because of the existence of alarge stock of outstanding bonds without CACs.On the other hand, CACs have been rarely usedby emerging markets for bond restructuring evenwhen they are present in bond contracts, partlybecause of the fear that bondholders’ meetingscould be used to mobilize opposition against at-tempts to restructure bonds and to take a decisionfor acceleration (which typically requires the con-sent of 25 per cent of bondholders). Clearly, suchrisks can be serious, since the ultimate decisionon restructuring lies with bondholders, and thesovereign debtor does not have the means of ob-taining court approval for its restructuring plan,as provided, for instance, under the “cramdown”provisions of the United States Bankruptcy Codefor corporate borrowers.

In assessing the potential role of CACs ininvolving the private sector in crisis resolution, itis important to distinguish between standstills andfinancial restructuring. The existing practice re-garding bond issues leaves little scope for securinga rapid standstill on a voluntary basis.17 Such astandstill requires representational bodies, such astrustees or bondholder committees, as well as pro-hibition of litigation by individual bondholdersand/or sharing clauses. As already noted, there isstrong resistance by private investors to the in-

clusion of such clauses acrossalmost all jurisdictions, andthey are not likely to be intro-duced on a voluntary basis.Majority action clauses alonecannot secure rapid voluntarystandstill and “cramdown”on dissident bondholders, be-cause invoking such clauses isa tedious process and leavesample time and opportunities

for rogue bondholders to impose a financial stran-glehold over the debtor.

Private investors often point out that themajor financial crises in emerging markets werenot precipitated by a rapid exit of holders of sov-ereign bonds through litigation and a “grab race”for assets, but by short-term hot money (Buchheit,1999: 7). This is certainly true for East Asia, wheresovereign bond debt was generally negligible.However, with the rapid growth of the bond mar-ket, granting bondholders unmitigated power oflitigation and asset attachment is potentially a se-rious source of instability. As already discussed,the current emphasis in official lending on pri-vate sector participation is unlikely to generateadequate incentives for voluntary standstill androllover of private debt at times of crisis.

The consequences of unilateral suspension ofpayments on bonds could be more serious thandefaults on bank debt because the effect would beimmediately transmitted to secondary markets. Asharp increase in the risk premium and a declinein bond prices would then create considerableopportunities for profit-making by litigious inves-tors (the so called “vultures”), who could acquiredistressed debt at substantial discounts and pur-sue a “grab race” for assets.18 On the other hand,as some recent bond restructuring exercises show,

The existing practiceregarding bond issuesleaves little scope forsecuring a rapid standstillon a voluntary basis.


even when unilateral defaults lead to an agree-ment on restructuring, the process tends to bedisorderly and does not always guarantee signifi-cant relief for the debtor (see box 6.2).

Thus a possible solution would be to combineinternationally sanctioned mandatory standstillswith majority action clauses in order to prevent a“grab race” for assets and facilitate voluntaryrestructuring. One proposal (Buiter and Silbert,1999) favours a contractually-based approach tostandstill, which would require all internationalloan agreements to include an automatic univer-sal debt rollover option with a penalty (UDROP).However, such a clause is unlikely to be intro-duced voluntarily and would need an internationalmandate. Another proposal is to empower theFund to impose or sanction standstills on bond-holders at the outbreak of a crisis (see, for exam-ple, Miller and Zhang, 1998). This could be com-bined with IMF lending into arrears, when needed,in order to alleviate the liquidity squeeze on thedebtor country and encourage a rapid restructur-ing. Debt restructuring should be left to a volun-tary agreement between the bondholders and theissuer, subject to provisions in the bond contracts.It is neither feasible nor desirable to empower theIMF or any other international authority to im-pose restructuring of sovereign debt, such as theone practised under the “cram-down” provisions of chapter 11of the United States Bank-ruptcy Code. Nevertheless, theFund could still exert consid-erable influence on the pro-cess through its policy of con-ditionality on lending.

It has been argued thatproposals such as CACs andstanding committees “… areappropriate if it is one’s judge-ment that most countries thatexperience crises have prob-lems with fundamentals that require debts to berestructured in the absence of a bailout. ...UDROPs and internationally sanctioned standstillsare appropriate if one instead believes that mostcrises are caused by creditor panic, and that allthat is required to restore order to financial mar-kets is a cooling-off period” (Eichengreen andRuhl, 2000: 4, footnote 4). However, the consid-

erations above suggest that both instruments areneeded in the arsenal of measures since resolu-tion of most crises requires both a cooling-offperiod and debt-restructuring. Even when the un-derlying fundamentals are responsible for a crisis,debtors need breathing space, as markets have atendency to overreact, and this leads to overshoot-ing of asset prices and exchange rates, therebyaggravating the financial difficulties of the debt-ors. Under such circumstances, standstills wouldallow time to design and implement cooperativesolutions to debt crises.

2. Restructuring bank loans

For the reasons already discussed, it is gen-erally believed that debt workouts are easier forinternational bank loans than for sovereign bonds,as they allow greater scope for voluntary and con-certed mechanisms. Furthermore, the experiencein the 1980s with restructuring of syndicatedcredits, and the more recent negotiations androllover of bank loans in the Republic of Koreaand Brazil, are often cited as successful examplesof debt workouts with banks.19 However, a closerlook at these experiences shows that there are con-

siderable weaknesses in theprocedures followed, and theoutcomes reached appear tobail out – rather than bail in –the private sector.

A main factor, whichfacilitated negotiations withcommercial banks in the1980s, was the existence ofadvisory or steering commit-tees consisting of representa-tives of banks selected mainlyon the basis of their exposureto the debtor country con-

cerned. Clearly, this helped solve the representa-tion problem by providing a forum for nego-tiations. Furthermore, the presence of sharingclauses in syndicated loan contracts, together withsovereign immunity, deterred litigation againstdebtor countries. However, agreement required theunanimous consent of committee members, whowere also expected to strike a deal that would be

A possible solutionwould be to combineinternationally sanctionedmandatory standstills withmajority action clauses inorder to prevent a “grabrace” for assets andfacilitate voluntaryrestructuring.


acceptable to non-participating banks. This, in ef-fect, allowed considerable room for holdouts byindividual banks, in much the same way as bondcontracts without majority action clauses. Suchholdouts resulted in protracted negotiations, lead-ing to frictions not only between debtors and credi-tors but also among creditors themselves. As notedby an observer of sovereign debt reschedulings inthe 1980s: “From the borrower’s perspective, theunanimous consent method translated into alwaysbeing negotiated down to the minimum commondenominator, one acceptable to all members of thecommittee based on consultation with their respec-tive constituencies. Namely, one bank had theability to prevent an entire package from beingadopted if it disagreed with any one of its fea-tures” (De la Cruz, 2000: 12).

The primary strategy of these negotiationswas to avoid default and to ensure that the debtorhad enough liquidity to stay current (i.e. to con-tinue servicing its debt). The money needed wasprovided by the creditor banks as part of the re-scheduling process as well as through officiallending. In this way banks could keep these as-sets in their balance sheets without violatingregulatory norms regarding credit performance.Maturities were rolled over as they became due,but concessional interest rates and debt cancella-tion were not among the guiding principles ofcommercial debt workouts.

Thus, as described in TDR 1988, the processinvolved “concerted lending”, whereby each bankrescheduled its loans and contributed new moneyin proportion to its existing exposure, the aggre-gate amount being the minimum considered nec-essary to avoid arrears. The IMF also made itsprovision of resources to debtor countries – to keepthem current on interest payments to commercialbanks – contingent upon the banks’ making thecontributions required of them. Thus, official in-tervention amounted to using public money to paycreditor banks even though it was designed to bindthe banks in. Developing countries saw their debtgrowing, not only to commercial banks, but alsoto the official creditors, as they borrowed to re-main current on their interest payments (TDR1988, Part One, chap. V).

The negotiated settlements also resulted inthe socialization of private debt in developing

countries when governments were forced to as-sume loan losses, thereby, in effect shifting theburden to the tax payers. For example, in the caseof Chile, it was noted that “private debts have beenincluded in debt rescheduling being negotiatedbetween the Chilean State and the foreign bankadvisory committee for Chile. Apparently theChilean Government caved in under pressure fromthe bank advisory committee … To make theirviewpoint absolutely clear, foreign banks appar-ently tightened up their granting of very short-termcommercial credits to Chile during the first quar-ter of 1983, a technique reportedly used with somesuccess 10 years earlier vis-à-vis the same coun-try. The International Monetary Fund, also activein the debt rescheduling exercise, has not publiclyobjected to this threat” (Diaz Alejandro, 1985: 12).For Latin America as a whole, before the outbreakof the crisis in 1982, around two thirds of the lend-ing by United States banks was to private sectorborrowers. In 1983, the first year of debt restruc-turing, the share of publicly guaranteed debt roseto two thirds, and eventually reached 85 per centin 1985 (UNCTC, 1991).

This process of protracted negotiations be-tween banks and debtors, with the intermediationof international financial institutions (a strategywidely described at the time as “muddling through”),continued for several years without making a dentin resolving the problem and removing the debtoverhang. Highly-indebted developing countriesincreasingly questioned the rationale of engagingin such Ponzi financing – whereby they had tokeep on borrowing in order to service their debt –which eventually pushed some of them into de-fault on interest payments and led to legal battleswith the banks. On the other hand, creditors toobecame highly sceptical of the merits of “puttinggood money after bad”, and started to dispose ofsuch debt in secondary markets as they accumu-lated adequate provisions. Through the BradyPlan, the resolution of the crisis eventually in-volved the private sector, but only after costingthe debtors a lost development decade.

In more recent episodes of financial crisis inemerging markets, creditor banks were again ableto organize themselves into groups to conductnegotiations with the debtors – with the Republicof Korea in January 1998, and with Brazil inMarch 1999. Again, in both cases negotiations and


agreements came only after the deepening of thecrisis. In the case of Brazil, banks were unwillingto roll over debt in late 1998 and agreement wasreached only after the collapse of the currency.The Government of the Republic of Korea hadalready suspended payments at the end of Decem-ber 1997 and, as recognized by the IMF, “… theagreement to stabilize interbank exposure toKorea was struck … when it was generally rec-ognized that reserves were almost exhausted andthat, absent an agreement, a default was inevita-ble” (IMF, 2000f: footnote 26). A number of bankshad already left, which contributed to the turmoilin the foreign exchange market.

While the rescheduling of debt providedsome breathing space in both cases, the impactwas far less than what could have been achievedwith timely standstills. As theGovernment of the Republicof Korea noted in its subse-quent report to the G-20, “Manyof those who have analysedKorea’s 1997–1998 crisis con-tend that Korea could havesolved its liquidity problemssooner had a standstill mecha-nism been in place at the timeit requested IMF assistance”(Ministry of Finance andEconomy, Republic of Korea,1999: 13), that is, at the endof November 1997.20 In Indonesia, restructuringcame even later than in the Republic of Korea(eight months after the first IMF programme) andmade very little impact on stabilizing the econo-my.21

More significantly, such debt restructuringexercises can hardly be portrayed as examples ofthe private sector bearing the consequences ofthe risks it had taken. In the restructuring in theRepublic of Korea, private debts were effectivelynationalized via a government guarantee. Thiswas also the case for subsequent reschedulingsby Thailand and Indonesia. Moreover, creditorsended up better after the rescheduling; there wasno debt write-off but simply a maturity extension,with new loans carrying higher spreads than theoriginal loans. Although the maturity extensionspreads were considered to be relatively low, par-ticularly compared to the IMF’s Supplemental

Reserve Facility (SRF), such a comparison over-looks the fact that the original bank loans alreadycarried a risk premium.22

Problematic as they are, it is found that suchrestructuring exercises cannot be replicated inmany other countries. According to the IMF, “thesuccess of the Korean operation reflected two spe-cific features, which are unlikely to apply to othercases. First, Korea maintained a restrictive capi-tal account regime that forced a high proportionof imported foreign saving to be channelledthrough domestic banks … Second, at the onsetof the crisis, the sovereign external debt burdenwas very low. As a result, the extension of a sov-ereign guarantee … did not place excessive bur-den on the sovereign” (IMF, 1999: 41–42). It isthus recognized that debt restructuring with for-

eign banks can run into seri-ous difficulties when debtorsare widely dispersed and thecapital account is wide open.The latter feature could indeeddiscourage creditor banksfrom entering into restructur-ing since it would allow otherinvestors to exit at their ex-pense. It is also recognized thata concerted rescheduling of in-ternational private bank debtin emerging markets wouldrequire sovereign guarantees –

a practice inherited, as noted above, from the1980s – though this is not consistent with the es-tablished principles of orderly workouts of pri-vate debt.

A further difficulty with such concerted re-scheduling operations is that they require theexertion of moral suasion by the supervisory au-thorities of creditor banks. This gives considerablediscretionary power to major industrial countries,that may not apply it in a predictable and equita-ble manner to different episodes of crisis. Asrecognized by the IMF, “supervisory authoritiesare likely to be reluctant to exert moral suasionover the commercial decisions of the banks undertheir supervision except in the most extreme cir-cumstances, especially in the context of debtorsthat do not pose a systemic threat to the nationalor international banking system” (IMF, 1999:41–42). Again, this means that “non-systemic

“Many of those who haveanalysed Korea’s 1997–1998 crisis contend thatKorea could have solved itsliquidity problems soonerhad a standstill mechanismbeen in place at the time itrequested IMF assistance.”


countries” would have no option but to imposeunilateral standstills.

Thus it appears that, for international bankloans, too, there are serious difficulties in reach-ing orderly and timely workouts on a voluntaryand concerted basis in order to stem self-fulfill-ing debt runs and ensure that the creditors bearthe consequences of the risks they take. As in thecase of bonds, certain ex ante contractual arrange-ments can help facilitate orderly workouts. One

possibility would be to introduce call options ininterbank credits lines that would provide an au-tomatic rollover under certain conditions, such asa request for IMF assistance by the debtor coun-try. However, unless all debt contracts incorporatesuch automatic standstill clauses, including themin interbank lines alone can be counterproductiveas it can trigger capital flight as soon as a debtorcountry runs into financial difficulties and entersinto negotiations with the IMF. But such clausesare unlikely to be introduced voluntarily.

F. Conclusions

It thus appears that an effective and viablestrategy for private sector involvement in finan-cial crises in emerging markets would be tocombine voluntary mechanisms designed to fa-cilitate debt restructuring with internationallysanctioned temporary standstills to be used whenneeded. These arrangements need to be accompa-nied by the provision of international liquidityaimed primarily at helping debtor countries tomaintain imports and economic activity, ratherthan to maintain open capital accounts and allowprivate creditors and investors to escape the cri-sis without losses. In general, normal access toIMF facilities, appropriately adjusted to allow forthe expansion of world output and trade, shouldmeet such needs. While in some cases additionalfinancing may be required, it should also be rec-ognized that, once exceptions are allowed ongrounds of preventing global spillovers and sys-temic instability, they could easily become therule, thereby aggravating the moral hazard prob-lem. In this respect, the minimum strategy shouldbe to require private participation, once officialfinancing is raised above the normal lending lim-its – or a threshold level – as suggested by someof the Directors at the IMF Board.

Much has been written on the pros and consof officially sanctioned payment standstills in theresolution of financial crises in emerging markets.There is strong resistance by some major creditorcountries as well as private investors to a manda-tory temporary stay on creditor litigation on thegrounds that it would give rise to debtor moralhazard and weaken market discipline. That thisneed not be the case has been argued forcefullyby the Deputy Governor of the Bank of England:

Some have argued that articulating a clearerrole for standstill may perversely alterdebtor incentives, by weakening the pre-sumption that debtors should pay their debtsin full and on time. But an orderly standstillprocess should support, not supplant, mar-ket forces and market disciplines. Corporatebankruptcy law grew up as it became clearthat market forces delivered losers as wellas winners and that some orderly means wasneeded of dealing with the losers. In thisway, bankruptcy law supports the marketmechanism.

The situation is no different in a sovereigncontext. A well-articulated framework fordealing with sovereign liquidity problems


should reduce the inefficiencies and ineq-uities of the current unstructured approachto standstills. It would support the interna-tional capital market mechanism. It wouldbe no more likely to induce debtors todefault than bankruptcy law is to induce cor-porate debtors to default. (Clementi, 2000)

Another concern is that the threat of a stand-still could accelerate capital outflows, therebyaggravating the crisis. Indeed,that is why standstills and ex-change controls need to be im-posed rapidly, and why thedecision to do so should restwith the country concerned.Furthermore, as noted above,the threat of suspension ofpayments could provide an in-centive for creditors to engagein voluntary solutions, particu-larly for sovereign debt, there-by avoiding the need to im-pose standstills.

It is also argued that standstills could makeit difficult for the debtor country to regain rapidaccess to international financial markets, forcingit to make painful trade adjustments or to continueto rely on official financing. But that is preciselywhy such decisions can be expected to be takenwith prudence. After all, countries that may needto impose temporary stand-stills are likely to be those thatare closely integrated with in-ternational financial marketsand would stand to lose if thedecision was not exercisedwith care and prudence. In thisrespect, the recent Malaysianexperience holds some usefullessons. The measures adoptedby Malaysia included tempo-rary and selective paymentsstandstills, which sought toprevent the deepening of thecurrency crisis and widespreadinsolvencies. There was nosignificant outflow of capitalwhen the controls were lifted in September 1999,and the country enjoyed an upgrading of its for-eign currency credit in December of the same year

as well as the normalization of relations with in-ternational capital markets.23

There is concern among policy makers insome emerging-market countries that the inclu-sion of internationally sanctioned standstillsamong the arsenal of measures for managingand resolving financial crises and the tying of theprovision of large-scale emergency financingto greater involvement of the private sector

would limit their access tointernational capital marketsand would also reduce privatecapital flows to their econo-mies. Such concerns are par-ticularly widespread in mid-dle-income countries with lowsaving and investment ratesand uneven growth perform-ance, and with only limitedsuccess in attracting greenfieldFDI in tradeable sectors andachieving a stronger exportbase. Such countries are heav-

ily dependent on financial inflows to meet cur-rent-account deficits that tend to increase rapidlyas soon as domestic demand picks up.

The measures advocated here will almost cer-tainly somewhat reduce aggregate financial flowsto emerging markets by deterring short-term,speculative capital. However, this outcome would

have a beneficial side, sincesuch capital flows add littleto the financing of develop-ment, while provoking signifi-cant instability and leading toa stop-go pattern of growth(see TDR 1999, chap. V, andTDR 2000, chap. IV). In thissense, arguments in favour ofsuch measures have a ration-ale similar to those in favourof regulation and control ofshort-term, speculative capitalinflows. There is often a temp-tation for countries to rely onsurges in financial inflows,while paying insufficient at-

tention to their longer-term consequences. However,it is difficult to attain rapid and sustained growthwithout undertaking the reforms needed to address

The threat of suspension ofpayments could provide anincentive for creditors toengage in voluntarysolutions, particularly forsovereign debt, therebyavoiding the need toimpose standstills.

The measures advocatedhere will almost certainlysomewhat reduceaggregate financial flows toemerging markets bydeterring short-term,speculative capital.However, this outcomewould have a beneficialside.


structural and institutional impediments to capitalaccumulation and productivity growth – reformswhich will reduce dependence on financial inflows.

As noted above, the risk of spillovers andcontagion to other emerging markets seems to bethe main reason for the reluctance of internationalfinancial institutions to encourage standstills incountries that are consideredimportant for the stability ofthe system as a whole. Variouschannels of contagion havebeen mentioned in this context,including cutting exposure toother countries, liquidating as-sets held in other markets inorder to meet margin pay-ments, or a general withdrawalof funds from emerging mar-kets (IMF, 2000f: 22). How-ever, the introduction and useof standstills as part of stand-ard tools in crisis interventionwould influence investor andcreditor behaviour and portfo-lio decisions, which could re-sult in reducing such potentially destabilizinginterdependences. More importantly, as notedabove, such orderly debt workout mechanisms arequite different from messy unilateral defaults intheir impact on the functioning of internationalfinancial markets.

Perhaps one of the most important potentialbenefits of binding in and bailing in the privatesector is the possible impact on policy-making inthe major creditor countries. Interest rate and ex-change rate policies in these countries exert a sig-nificant influence on the competitiveness, balanceof payments and capital flows of debtor develop-ing countries, which cannot always be counteredwith domestic policy adjustment. Indeed, mostmajor financial crises in emerging markets have

been associated with sharp swings in exchangerates, interest rates and market liquidity in themajor industrial countries. The latter have notalways paid attention to the global repercussionsof their policies, mainly because adverse spilloversto their financial markets from emerging-marketcrises have been contained, thanks largely tobailout operations. Nor has the IMF been able to

deal with unidirectional im-pulses resulting from changesin the monetary and exchangerate policies of the UnitedStates and other major OECDcountries, in large part becauseof shortcomings in the exist-ing modalities of multilateralsurveillance (Akyüz and Corn-ford, 1999: 31–33). Burdensharing by creditors in emerg-ing-market crises can thus beexpected to compel policymakers in the major industrialcountries to pay greater atten-tion to the possible impact oftheir policies on emergingmarkets. Indeed, it appears

that the potential for adverse spillovers from thecrisis in the Russian Federation played a crucialrole in the decision of the United States FederalReserve to lower interest rates in late 1998, eventhough, on the eve of the Russian default, the Fedwas widely expected to move in the opposite di-rection. As is well known, the default caused con-siderable losses to Western investors and credi-tors, and threatened to set a precedent regardingcompliance of emerging markets with their exter-nal obligations. Thus, it can be expected that ef-fective mechanisms designed to involve the pri-vate sector in the resolution of emerging-marketcrises could bring a greater global discipline topolicy-making in the major industrial countries –something that multilateral surveillance has so farfailed to achieve.

Effective mechanismsdesigned to involve theprivate sector in theresolution of emerging-market crises could bring agreater global discipline topolicy-making in the majorindustrial countries –something that multilateralsurveillance has so farfailed to achieve.


1 For an analysis of the policy response to the Asiancrisis, see TDR 1998 (chap. III), and TDR 2000(chap. IV).

2 A wider use of the concept includes greater trans-parency in standards of policy-making and improveddata dissemination, as these measures are seen tobe essential for markets to appropriately assess andprice risks (IMF, 2000g, chap. V).

3 According to the Institute of International Finance,losses incurred by private investors since 1997 inemerging- market crises have amounted to $240billion for equity investors, $60 billion for interna-tional banks and $50 billion for other privatecreditors on a mark-to-market basis (Haldane,1999: 190). Losses incurred by foreign banks in theAsian crisis are estimated at some $20 billion (Zonisand Wilkin, 2000: 96).

4 Losses resulting from daily adjustments to reflectcurrent market value, as opposed to historic account-ing (or book) value.

5 On the private sector position, see IIF (1999), andIMF (2000g).

6 Unless stated otherwise, all quotations that followin this section are from the same source (i.e. IMF,2000h). For a more detailed discussion, see IMF(2000f). Temporary suspension was proposed in anearlier Working Party report to the Group of Ten:“… in certain exceptional cases, the suspension ofdebt payments may be a necessary part of the crisisresolution process” (Group of Ten, 1996: 3). Sub-sequently, it was supported by the Council on For-eign Relations Task Force (CFRTF); see CFRTF(1999).

7 This was also first proposed by the G-10 WorkingParty: “Such lending can both signal confidence inthe debtor country’s policies and longer-term pros-pects and indicate to unpaid creditors that their in-terest would best be served by quickly reaching anagreement with the debtor” (Group of Ten, 1996: 3).

8 On the “comparability of treatment” principle andits recent application, see Buchheit (1999); De laCruz (2000); and IMF (2000g).

9 For this so-called problem of “the inconsistency ofoptimal plans”, see Kydland and Prescott (1977).

10 See Miller and Zhang (1998). The same argumentsabout the ineffectiveness of official assistance policyin securing private sector involvement in crisis reso-lution were used in favour of the introduction ofcollective action clauses in bond contracts in orderto facilitate restructuring (see Eichengreen and Ruhl,2000).

11 A notable exception to calls for smaller IMF pack-ages is the so-called “Meltzer Report” (see Interna-tional Financial Institutions Advisory Commission,2000). For a discussion of the debate on IMF crisis-lending, see Goldstein (2000).

12 In creating this facility all Fund members wouldagree to donate their share of the allocation to thefacility and there would also be agreement that onlydeveloping countries would be entitled to draw onthe facility. This clearly differs from another pro-posal, which is to allow the Fund to issue reversibleSDRs to itself for use in lender-of-last-resort op-erations - that is to say, the allocated SDRs wouldbe repurchased when the crisis was over. See Ezekiel(1998); United Nations (1999); and Ahluwalia(1999).

13 Acceleration clauses allow creditors to demand im-mediate repayment of unpaid principal following adefault. Under cross-default (or cross-acceleration)clauses, creditors are entitled to bring forward theirclaims if the debtor has defaulted on other debts.Put options allow creditors to demand repaymentahead of the scheduled contract date, under certainconditions.

14 See, for example, Group of Ten (1996). This recom-mendation has been reiterated following the Asiancrisis (see Group of Twenty-Two, 1998). For a dis-cussion of problems in bond restructuring andCACs, see Eichengreen and Portes (1995); Dixonand Wall (2000); and Buchheit (1999).

15 In the case of English-law bonds issued under a trustdeed, the trustee represents the interest of all bond-holders and shares any proceeds recovered on a pro

Notes


rata basis. However, trustees rarely exist for sover-eign issues (Yianni, 1999: 79–81; Dixon and Wall,2000, box 1).

16 For some recent experiences of bond restructuringby emerging markets, see box 6.2.

17 This is also recognized by the IMF (2000f: 16).18 The Bulgarian case of 1996–1997 is cited as an ex-

ample of such market breaks leading to litigations(Miller and Zhang, 1998: 16).

19 See, for example, IMF (1999: 41–42; and 2000b,chap. V); and Eichengreen and Ruhl (2000: 5, foot-note 7).

20 For support of this position based on a study of theMalaysian capital controls, see Kaplan and Rodrik(2000, particularly pp. 27–28).

21 For a description of the East Asian restructuring seeRadelet (1999: 66–67).

22 The deal included a total debt of $21,740 millionowed to 13 banks, and the maturities were extended

from one to three years, involving spreads between225 and 275 basis points. The spread on SRF was300 basis points – lower than the maximum spreadon maturity extension mentioned in the previousnote (Ministry of Finance and Economy, Republicof Korea, 1999: 14).

23 See TDR 2000, box 4.1. This situation was also rec-ognized by the IMF: “They [Malaysia’s controls]do not appear to have had any significant long-termeffect on investor behavior” (IMF, 2000f, foot-note 28). While it is suggested that “capital controlsmay have contributed to a decline in FDI” comparedto the Republic of Korea and Thailand (ibid.: 24),it is quite likely that an important aspect of thestronger recovery of FDI in those two countries in1999 was the spate of fire-sale investments andtakeovers associated with the collapse of asset pricesand exchange rates.

trade and development report, 2001

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