Policy Research in Macroeconomics

Sovereign Debt Crises – for China’s People’s Daily.

First Published in China’s People’s Daily on 29 May, 2015

Sovereign debt can be uniquely complex, from both a financial and political perspective. It is covered by private law, yet there is no international law equivalent to insolvency law for sovereign states. Unlike individual and corporate debtors, who can appeal to the law of bankruptcy to draw a line under their debt, the citizens of poor countries remain infinitely liable for debts incurred by their governments. This is the case even if their exchange rate has collapsed and the debt has a far higher value than when incurred. 

There are welcome recent efforts by the G77 and China to put in place a fair international process for sovereign debt crisis resolution. By contrast, the IMF is pursuing a far more limited path of improving the technical wording of bonds, to enable collective action clauses that enforce organized write-down or restructuring of debt more easily. While making some improvements, this does not resolve the root problem.

Underlying most recent sovereign debt crises is the fact that, under today’s global financial architecture, there is no adequate management of exchange rates and of cross-border capital flows. These footloose, de-regulated and often short-term speculative flows encourage excessive borrowing, reckless lending and risk-taking. With increased regularity they cause financial crises.

Greece and Ukraine

At a time of rising geopolitical tensions, two European sovereign debt crises are adding to global economic and financial instability. The crisis in Greece exposes a deepening divergence within the European Union, and that in Ukraine has opened a dangerous gulf between western states and Russia.

While Ukraine’s total external debt is (optimistically) projected to peak at 158% of GDP in 2015,[1] Greece’s €312bn debt represents nearly 175% of the country’s 2014 GDP. [2] Most of Greece’s debt is now owed to official creditors: the European Union, the European Central Bank and the IMF. Ukraine’s external debt is largely owned to private creditors, with a significant debt owed to Russia.

Recently Ukraine’s parliament voted to grant the government power to stop foreign debt payments to both private and official creditors. This implies that Ukraine may default on a $3bn bond obtained from Russia because – according to the parliament – this and other debts incurred by the previous government of Viktor Yanukovich were “odious” and “wasted in vain”.

As I write, Greece is still in protracted, painful negotiations with her official creditors. The country is desperately short of funds, and her Finance Minister, Yanis Varoufakis, has accused Europe’s creditor powers of “trying to force his country to its knees by ‘liquidity asphyxiation’”.  There appears to be a very real chance that Greece will involuntarily default, and in so doing exit the Eurozone.

A Greek exit from Euro could have a wider destabilizing impact on global capital markets. As Mr. Varoufakis argued recently in Washington: “The euro is fragile, it’s like building a castle of cards. If you take out the Greek card the others will collapse.”  

Argentina and the US Legal System

The case of Argentina highlights major problems under the current non-system.  After a disorderly default in 2001/2 due to economic collapse, Argentina negotiated a ‘haircut’ of 70% of the debt with over 90% of her creditors.

Less than 10% of creditors, the “hold-outs” including some notorious ‘vulture funds’ declined to accept this deal.  The latter are speculative investors that buy up sovereign debt on secondary capital markets at, say, 20 cents in the dollar and then use aggressive US legal techniques to get 100% payment on the debt – plus compound interest.

Argentina refused to pay the excessive demands of the vulture funds. Argentine bonds were, however, issued under New York law and American courts then interpreted the standard terms of the vulture funds’ bonds in a way that overturns long accepted international understanding of the law. This interpretation favours a small group of billionaire vulture funds over Argentina – and its people – as well as other creditors.

In addition, US courts extended the long arm of American extra-territorial law enforcement to ban any payments to the ‘haircut’ creditors, unless the vulture funds are paid 100% of the face value of the bonds – plus compound interest!

This is a highly unjust legal result with strong political undertones.

What is the cause of sovereign debt crises? 

Since the 1960s, the gradual de-regulation of international capital markets has led to excessive lending and borrowing across borders by both private and official creditors and debtors. This frequently culminated in sovereign debt crises.

Sovereign debt differs in many ways from private debts. Investors that lend to countries normally face few risks, as governments can normally draw on predictable income from taxation and exports to repay debts. On the other hand, private investors do not have recourse to a fair, international legal framework if a sovereign debtor defaults.

Sovereign government debtors also face risks, not limited to public debt. Private corporate and individual borrowers may take on too much foreign currency debt, exposing the government, the central bank and ultimately innocent taxpayers or citizens to risk. Exchange rate movements can increase (as well as decrease) the cost of debt to be repaid in foreign currency. 

What we can do to guard against debt crises?

 The G77 and China group of states have played an important role in putting sovereign debt resolution, and reform of the international financial architecture, on the high-level international agenda.  In June 2014, at the group’s 50th anniversary session in Bolivia, The Declaration of Santa Cruz, called for

“reform of the international financial architecture so that we have a financial and monetary system that reflects the realities of the twenty-first century, including a properly regulated international financial sector that reduces and discourages speculative investment, in order for capital markets to be mobilized to achieve sustainable development and play a constructive role in the global development agenda.”

It further called for

“an effective, equitable, durable, independent and development-oriented international debt resolution mechanism”.

This initiative was swiftly followed up at the UN.  In September 2014, a General Assembly Resolution backed by the G77 and China (and overwhelmingly supported) called for “a multilateral legal framework for sovereign debt restructuring  processes..”  The UN noted that vulture funds “pose a risk to all future debt restructuring processes, for both developing and developed countries.”

However, the 11 votes against this Resolution include most of the main western creditors, so the struggle for a fair independent legal process will need to be sustained and determined.

If proper regulation of the international financial sector were to be put in place, and if such regulation were to be complemented by a “new international legal framework for sovereign debt restructuring” – then the world could begin to end the global imbalances between sovereign debtors and their creditors; limit sovereign debt crises, and restore global financial and economic stability and justice.

The absence of the discipline imposed by an international insolvency framework, encourages reckless lending and borrowing. At the same time this void in international law prevents the resolution of debt crises in ways that are fair to both debtor and creditors.


[1] Source: IMF Press Release, March 11, 2015.  https://www.imf.org/external/np/sec/pr/2015/pr15107.htm

[2] Source: Greek Public Debt Agency, 31 March, 2015. http://www.pdma.gr/index.php/en/public-debt-strategy/public-debt/level-of-debt-en

One Response

  1. Nice article.
    In fairness to Argentina though, they’re now serving a solid example for why taking ‘USD’ denominated debt is not without its risks. The country thought it could walk away from its obligations and the ‘vultures’ stepped in to enforce ‘creditor’ justice.
    The vultures might well be leeches, but they serve a valuable function in the overall financial ecosystem, much like the real vultures in real life.

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