Policy Research in Macroeconomics

The IMF’s new consultation on an SDRM: reflections on the last SDRM

by Ann Pettifor

Readers will know that I played a role (as part of the Jubilee 2000 movement) in the cancellation of about $100bn (in nominal terms) of debt owed by dozens of low income countries in and around the year 2000. While advocating for debt cancellation (as opposed to ‘relief’) I became increasingly conscious of the imbalanced and unjust relationship between sovereign debtors and their international creditors. It was clear that one-off debt cancellations would not resolve that imbalance – indeed debt cancellation made sovereign debtors more creditworthy in the eyes of international markets, and so creditors (including official creditors) would quickly jump in and burden the sovereign with new debt. In other words, in the absence of an international ‘insolvency’ framework for the resolution of debt crises, neither sovereign debtors or creditors were disciplined for reckless lending/borrowing. Fortunately Prof Kunibert Raffer of the University of Vienna had already given this issue much thought, and had proposed a sound framework for resolving debt crises – the Raffer Proposal.

Back in 2001, the IMF’s Anne Kreuger initiated a consultation on the need for what it defined as a Sovereign Debt Restructuring Mechanism (SDRM). A great conference was finally held in Washington in 2003, and Prof Raffer and I were invited to participate. At the end of the conference, I participated in the Fund’s Press Conference together with Mrs Kreuger. While we supported the IMF’s proposal in principle, Prof. Raffer and I (and many other civil society representatives) were concerned that the IMF, as a major creditor itself, and as agent of the world’s creditors, had given itself unreasonable powers under the SDRM to pre-determine the outcome of the debt-restructuring process.

All these discussions and the IMF’s consultations were in vain, because the proposal for the SDRM was quickly subverted by Wall St. However, recent crises in Greece and Cyprus have prompted the IMF to think again. And so a new proposal for an SDRM is out for consultation – on the IMF’s website here.

Given that the issue is back on the agenda, I thought it timely to reproduce below, an article I wrote for the Carnegie Council for Ethics and International Affairs, September 15, 2003 – on Resolving International Debt Crises Fairly.

I will be reviewing the IMF’s new SDRM proposals in due course, and discussing them on this site.

If global economic justice is to be achieved, debt crises must be assessed within the broader context of the international financial system. This system, which has been largely imposed by a small group of powerful financial agents in the Organisation for Economic Co-operation and Development countries, has led to instability and recurrent financial crises that have severely harmed the interests of poor countries and their people. Responsibility for bearing the costs of debt crises and other negative effects of the prevailing international financial system should therefore be assumed by those who have contributed to bringing them about. At present, however, the burden of economic “adjustments” during debt crises has fallen disproportionately on poor debtor nations, and debates regarding debt management have been dominated by individual, corporate, and official creditors. This essay presents the case for institutional reforms that can better protect the human rights of citizens of sovereign debtor nations during debt crises.

Responsibility, Impartiality, and Accountability

Several principles should guide the design of institutional arrangements that can deal justly with debt. The first is that there should be recognition that it takes two parties to make a loan, and that each of these two parties can be reckless, irresponsible, and delinquent in its actions. Insofar as either party to a loan acts in this way, it ought to shoulder part of the burden of the crises that often ensue. Losses from bad loans and bad debts should not, therefore, fall solely on the debtor. The second principle, based on a fundamental principle of the rule of law, is that no one ought to be judge in their own court. Any courts that are developed to resolve debt crises must be fair and impartial with respect to the parties to the loans in question. The third principle is the principle of accountability. Sovereign debt crises are public, not private, crises involving the use of taxpayer funds. If the resolution of these crises is to be achieved within a framework of justice, and if democratic scrutiny of public funds is to be strengthened, then it will be vital for the process to be open, transparent, and accountable to citizens and taxpayers.

Unlike proposals recently put forth by the International Monetary Fund (IMF) and by private creditors, the Jubilee Framework for resolving sovereign debt crises expresses these three principles. The framework is based on the proposal originally developed by the Austrian economist Kunibert Raffer and is modeled on Chapter 9 of the U.S. legal code, which regulates the bankruptcy of municipal and governmental organizations[i].The particular attraction of the Chapter 9 model is its applicability to governmental institutions and its protection of taxpayer and employee interests in the resolution of municipal and other governmental debt crises.

The Jubilee Framework envisions an independent court that would be representative of all creditors and the debtor nation, and would treat their interests on equal par. The framework rejects a role for the IMF that would discriminate against other creditors by protecting its own claims, and is highly critical of a process in which the Fund would have strong agenda-setting powers. However, it recognizes that the IMF will play an important financing role by providing working capital in loans to the debtor country while negotiations proceed, and that the repayment of these loans will take priority over other loans. It also suggests that the UN should oversee debt sustainability analyses but, in the absence of available resources, recognizes that the UN could only play a marginal role in the process. In this respect, the Jubilee Framework differs from the proposals of other civil society organizations, such as Erlassjahr in Germany 2 and the African Forum & Network on Debt & Development, 3 which reject a role for the IMF and instead see the UN as the main arbiter in negotiations. However, such differences are not fundamental, as most civil society organizations agree on the need for an independent, fair, and transparent process of arbitration.

International Economic Justice

The first objective of any sovereign debt crisis resolution process should be the achievement of international economic justice with respect to the designers of the international financial system—the G-7, its members’ representatives in the Bretton Woods institutions, the Bank for International Settlements, and the central bankers of the economically powerful countries—and its victims—the people in the indebted countries. The Bank for International Settlements has acknowledged that the liberalization of financial systems, led and promoted by the central bankers and finance ministers of the G-7 countries, has

Over the past few decades . . . arguably also increased the scope for pronounced financial cycles. In turn, these cycles can contribute to the amplification of cycles in the macroeconomy, and in the past have all too often ended in costly banking system crises. While both industrialised and emerging market economies have been affected, the damage caused by financial instability has been particularly serious for emerging market countries. At the root of these cycles typically lies a wave of optimism . . . [which] contributes to the underestimation of risk, overextension of credit . . . . Eventually, . . . the imbalances built up in the boom need to be unwound, sometimes causing significant disruption to both the financial system and the real economy. 4

Such admission of fault and responsibility should provide a backdrop to any consideration of how losses arising from the “significant disruption to the financial system” should be shared between industrialized and emerging market countries. Current international practice places the burden of major economic adjustments for losses on the debtor. What is often not taken into account, however, is that the real burden for such adjustments falls not on the actual borrowers—who are often corrupt presidents, finance ministers, and central bankers of debtor governments––but on the taxpayers of current and future generations, including poor people who experience the costs quite acutely. In the absence of a resolution of the Argentine debt crisis, for example, since the default of 2001, the population living below the poverty line has risen to 50 percent. Of these poor people, 33 percent are indigent, forming the most underprivileged sector of Argentine society. Moreover, a system that allocates the costs of repayment of debt to those that did not incur them engenders further misestimating of risk, leading to further bad borrowing and bad lending.

Neither the IMF’s proposal for a sovereign debt restructuring mechanism nor the private-sector alternative reflects any recognition of the role that creditors have played as designers and primary beneficiaries of a financial system that precipitates crises by encouraging reckless lending and borrowing. Both multilateral and private lenders represent the process of dealing with debt as an act of mercy, rather than as a process for restoring stability and economic efficiency on the one hand, and, on the other, as a struggle to mitigate injustices in the current global financial order. As a result, their proposals serve to maintain the status quo.

The IMF’s Sovereign Debt Restructuring Mechanism (SDRM), for example, is not equipped to deal justly with debt because its design does not assure a balanced process in which each interested side is represented on an equal par.5 It violates the principle of the rule of law––allowing a major creditor to be judge in its own cause. The mechanism would be overseen by the Fund’s own executive board, which is dominated by the official creditors of the powerful G-7. The Fund’s proposal would ensure that Fund staff and the executive board would play a preemptive role in shaping the outcome of the debt crisis resolution negotiations by setting the country’s level of debt sustainability, on the basis of which will be determined the necessary debt reduction. In addition, the Fund will continue to play a substantial role in shaping the debtor’s economic policies, by providing technical assistance and advising on fiscal, monetary, and legal policies during the period over which the country is being granted relief. As a result, the IMF will effectively draft the composition plan for restructuring debts and financing their repayment that should rightly be presented, as in domestic bankruptcy law, by the debtor in order to provide the basis for fair and effective negotiations.

By determining the composition plan, the IMF disempowers the debtor, all other creditors, and civil society. The IMF could, and very likely will, set the debt sustainability to a level that does not place its own claims economically at risk, even if they were legally exempt from debt cancellation, in case the debtor transferred all its available resources to the repayment of private-sector debts.6 Indeed, it was even suggested at an IMF conference that took place in Washington, D.C., on January 22, 2003, that if debtors were to agree to solutions that were considered “too generous” by the staff of the Fund, the IMF would penalize the debtor––for example, by withholding funds––thus blocking the solution agreed to by both parties. Above all, this would allow the Fund to play the role of a judge in its own cause––the defense of its own claims. While the Fund might argue that its preferred creditor status enables it to provide crisis financing, much of the outstanding IMF debts do not represent crisis financing but development financing. This is because the IMF has long overstretched its fire-fighting role in international finance and has increasingly engaged in micromanaging economies. The case of Argentina is a striking example of this––the country’s debts have been accrued as a result of sustained lending and failed structural adjustment programs over the course of more than fifty years.

By enshrining the SDRM in its articles of agreement, the Fund would go further. First, it would change the present situation where the IMF and the World Bank together engage in poor country debt management. Second, if the IMF were to enshrine the executive board’s authority to define the behavior of the debtor as a breach of its obligations under the articles of agreement and to determine sanctions against the member country, it would put debtor countries in a situation of coerced choice––since the costs of exiting the Fund are very large. Third, the amendment to the articles of agreement would legally entrench the IMF’s present status of preferred creditor.

The approach preferred by private creditors, that of collective action clauses (CACs), would pit powerful creditors against a weakened debtor in behind-the-scenes negotiations. There may be circumstances in which the debtor is powerful enough to engage forcefully with creditors. Past experience of poor country debtors, however, shows that they lack the resources to hire the legal staff necessary to ensure equality and justice in the negotiations. The imbalance in the relationship between creditor and debtor can only be corrected by a proper legal framework in which both are protected. It is the statutory framework (in this case Chapter 11 of the U.S. legal code) that provides incentives for private creditors to negotiate with the management of defaulting companies like Enron. It is the lack of a comparable framework that leaves them unwilling to do so with Argentina.

A further objective for any framework of debt negotiation should be to reduce and punish the incidence of corruption, fraud, and criminality associated with international lending and borrowing. The only way in which this can be achieved, and indeed is achieved in Western economies like that of the United States, is through mechanisms that ensure public scrutiny of public officials. It is the existence of regulatory authorities, transparent reporting, and the threat of punishment that discourages corruption in financial centers like London, New York, and Zurich.

We have been pleased to note that the IMF’s latest draft of its SDRM proposal calls for much greater transparency in the sovereign debt restructuring process.7 Unfortunately, one major weakness in the IMF’s Sovereign Debt Dispute Resolution Forum remains.8 Although the IMF has consulted the UN Commission on International Trade Law to ensure its independence, the IMF nevertheless denies the Sovereign Debt Dispute Resolution Forum powers to challenge the decisions of the Fund, such as its assessments of the amount of debt reduction that will be needed to resolve a particular debt crisis.

Efficiency, Stability, Development

The second objective of any insolvency framework should be economic efficiency, stability, and development. The main rationale for bankruptcy law is that releasing bankrupt economic agents from debt bondage will encourage them to contribute productively to the economy once again.

There is ample evidence to suggest that the economic policies effectively imposed by foreign creditors over the past thirty years, particularly through the IMF, have failed to return countries to sustainability, or to encourage economic growth.9 Using their influence in the IMF, the G-7 countries have effectively been imposing economic policies on indebted countries in Latin America and Africa since 1982, and over that period economic growth in those continents has been lower than during the period between 1945 and 1980, with a consistent decline in GDP in some cases.10 On the whole, and perhaps logically from the point of view of the creditors who dominate the executive board, IMF policies have been designed to extract and transfer assets from debtors to creditors. One of the most likely and predictable outcomes of the SDRM is that countries would not be returned to sustainability. Just as under the failed Brady Plan of the 1980s, under the SDRM only private creditors would have to reduce their claims. As the IMF’s proposal stands, public creditors like the Fund, the World Bank, and all the regional development banks would have their debts excluded from debt restructuring negotiations. There have been some suggestions in informal talks during meetings and conferences that the Paris Club of sovereign creditors would be included within the SDRM but an official intention to do so has not been confirmed. This would be ineffective and unjust because it fails to ensure that the debtor’s crisis is addressed comprehensively and limits the accountability of official creditors like the IMF and World Bank. Indeed, even relatively generous debt reductions by the private sector might be insufficient to return debtor nations to sustainability. With respect to unsecured creditors, the IMF’s proposal asserts that they would receive a combination of “cash and new securities.”11 If this cash is provided in the form of an IMF loan––because the overindebted country has no hard currency––the principal debt will increase. Furthermore, the debt will rise, because the IMF gives out harder loans, that is, loans that normally have to be repaid over a relatively short period at interest rates that may not be concessional.

Any framework for debt restructuring will involve the assessment of the assets of the sovereign. The institution that provides these assessments must include transparent and inclusive procedures that involve the citizens of the debtor nation. It will also be necessary to develop reasonably precise principles for determining levels of debt sustainability that are consistent with the protection of human rights. We believe that UN agencies such as the United Nations Development Programme and UNICEF are best placed to advise the court on the resources that will be required to ensure that the human rights of the people of the debtor nation are well protected. Indeed, much of the work currently being undertaken by the UN to measure the costs of achieving the Millennium Development Goals could contribute to assessments of a debtor’s sustainability.

The Jubilee Framework calls for an ad hoc, independent debt crisis resolution body, with transparent procedures, representing the interests of both the creditors and the citizens of the debtor country, with an independent judge ruling on the final composition plan. This body can be modeled on the arbitration panels used by the International Chamber of Commerce for the resolution of disputes between corporates and sovereigns. Specifically, all civil society frameworks call for a forum made up of an equal number of representatives from the creditor and the debtor side, who in turn would appoint a third or a fifth person to act as chair, or judge, of the panel. Such ad hoc panels could begin work now––and would be particularly effective in cases like that of Argentina. With time they would build up a body of practice and law, which could later provide the basis for an international statutory agreement.

Bringing the Proposal to Reality

The only process needed for the resolution of a debt crisis and the establishment of an ad hoc panel is political will, on the part of both the debtor and G-7 official creditors (who will in turn require the support of private creditors). In doing so, the G-7 creditors will have to overcome the strong incentive of private creditors to resist any proposals for restructuring debts that limit their current control over the process. At the same time the process must respect the rights of creditors by giving them an equal voice in negotiations with the debtor and by not discriminating among them in a way that benefits some creditors and disadvantages others.

A UN resolution may be required to secure the cooperation of UN staff who would provide the independent oversight of the framework and develop principles for determining sustainability levels. Were the G-7 to implement an ad hoc, independent, and transparent process, it would then be able to mobilize the active participation of the IMF for the provision of working capital, known in the U.S. legal code as debtor-in-possession finance. The IMF would thus have its original mandate restored––to provide financial support in crises, and to correct, rather than precipitate, imbalances, thereby fostering stability and growth in the international economy.

A review of the history of bankruptcy law in the United States reveals that it was only when rich debtors needed protection from their creditors after the major external economic shocks of the late eighteenth century that a body of law began to evolve that respected the rights of the debtor as well as the interests of the creditor.12 So long as rich countries are protected from their creditors through, for example, the power to print the currency in which they repay their debts, so long will they be reluctant to develop a just framework for resolving international debt crises. Indeed, it may be that a rich country needs to encounter a major debt crisis before we can expect a new framework to evolve and justice to be achieved in international financial relations. This is regrettable since just, economically efficient, and effective frameworks for resolving debt crises are both feasible and available.

(Previously published in Ethics & International Affairs, Volume 17.2: Fall 2003)


1 Kunibert Raffer, “Applying Chapter 9 Insolvency to International Debts: An Economically Efficient Solution with a Human Face,” World Development 18, no. 2 (1990), pp. 301–13. See also Professor Raffer’s Web site, mailbox.univie.ac.at/~rafferk5/art.html. [BACK]

2 Erlassjahr, “A Fair and Transparent Arbitration Process for Indebted Southern Countries”; available at http://www.erlassjahr.de/content/languages/englisch/dokumente/ftap_englisch_rz.pdf. [BACK]

3 AFRODAD, “AFRODAD’s Call for a Fair and Transparent Arbitration Court for Debt”; available at http://www.globalpolicy.org/socecon/develop/debt/2002/01arbitration.htm. [BACK]

4 Bank for International Settlements, “71st Annual Report: 1 April 2000–31 March 2001,” p. 123; available at http://www.bis.org/publ/arpdf/ar2001e.pdf. [BACK]

5 International Monetary Fund, “The Design of the Sovereign Debt Restructuring Mechanism––Further Considerations,” November 2002; available at www.imf.org/external/np/pdr/sdrm/2002/112702.pdf.. [BACK]

6 Ibid., paras. 84, 85, p. 25. [BACK]

7 Ibid., paras. 14, 273, and 291, pp. 6–8, 70, and 74. [BACK]

8 Ibid., paras. 28, 230–63, pp. 11–12, 57–67. [BACK]

9 For evidence of the impact of these policies on economic growth in emerging markets, see Ann Pettifor, ed., Real World Economic Outlook, vol. 1 (London: Palgrave, forthcoming, September 2003). [BACK]

10 See Mark Weisbrot, Robert Naiman, and Joyce Kim, “The Emperor Has No Growth: Declining Economic Growth Rates in the Era of Globalization” (Center for Economic and Policy Research Briefing Paper, May 2001); available at http://www.cepr.net/documents/publications/econ_growth_2000_11_27.pdf. [BACK]

11 International Monetary Fund, “The Design of the Sovereign Debt Restructuring Mechanism,” n. 17, pp. 35–36. [BACK]

12 See Bruce H. Mann, Republic of Debtors: Bankruptcy in the Age of American Independence (Cambridge: Harvard University Press, 2003). [BACK]

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