Restructuring Sovereign Debt

Ken Shadlen is a professor of Development Studies in the London School of Economics’ Department of International Development. His research examines how international institutions can create unique challenges for developing countries and, in doing so exacerbate core-periphery inequalities. Writing on the HIV/AIDS crisis, Shadlen has illustrated how intellectual property rules developed by the World Trade Organization threaten to limit the supply of antiretrovirals, with profound implications for patients in the developing world. In his 2017 book Coalitions and Compliance: The Political Economy of Pharmaceutical Patents in Latin America, he finds that countries which had well developed pharmaceutical sectors prior to the WTO’s Agreement on Trade-Related Intellectual Property Rights (TRIPS) did not adopt the sort of maximalist patent regimes that were demanded of less-developed nations. Across his work, Shadlen explores how political blocking and coalition building by developing countries strengthened their influence within the WTO in the late twentieth century.

Alongside international institutions, Shadlen has written on the politics of debt and financial crises in Latin America. Specifically, his writing has considered the evolution of bilateral trade in the region, and explored how decision making operations of multilateral institutions like the IMF, World Bank, and WTO systematically disadvantage countries in the Global South. Today, as the coronavirus crisis is pushing dozens of countries to the brink of default, the need for a mechanism to guide debt restructuring is especially urgent. I spoke with Shadlen about these issues last winter.

An interview with Ken Shadlen

Reece Sisto: What is our operational definition of a sovereign debt restructuring mechanism (SDRM), and what is its history?

Ken Shadlen: Generally speaking, an SDRM refers to a set of rules that would determine how much and under what terms a country pays its creditors when it can’t repay a given debt in full. Whether it slashes interest rates, extends payment timelines, or reduces the overall value of the debt in question, an SDRM is basically a way of establishing a collectively agreed upon set of conditions for what the borrower must do to receive restructuring, and what the creditors must do to make this happen. While there was an effort in the early 2000s to come up with something like this specifically in relation to private creditors, similar mechanisms had been proposed earlier.

RS: Why did the most recent iteration, proposed by Anne Kreuger of the IMF, target private creditors?

KS: Without an SDRM, there’s no structure in place to hold private creditors accountable. Simply put, when we make investments, we incur risks; however, private creditors investing in sovereigns often displace those risks onto others, namely the public. This was plainly evident in the Global Financial Crisis, but has happened many times before. An SDRM would provide a set of rules by which both creditors and debtors are held accountable and not saddle the public with bailouts, potential or otherwise.

RS: Typically I could see why such a proposal might never be realized, but coming from the IMF I would imagine it to be more successful. Why did it fail?

KS: The proposal was rejected because it’s not really clear that anyone within the IMF wanted it other than Anne Kreuger. Creditors and creditor countries like the US didn’t like it for obvious reasons—too much authority delegated to the IMF—and effectively vetoed it. But debtors, who we’d imagine to be the principal beneficiaries of an SDRM, also opposed it. It’s hard to say whether they really didn’t want it or were just scared of coming out as the debtors who were saying, “We really want a system that makes it easier for us to not repay our debts in full.”

RS: These are not only structural barriers to the creation of an SDRM, but instrumental ones; creditors and the states in which they’re headquartered pressure developing states to oppose an SDRM as a demonstration of creditworthiness.

KS: Exactly. The fact of the matter is that we know countries may not repay their debts in full. That’s the reality! Yet we live under this myth that countries will always be able to repay, so any effort to prepare for scenarios where countries can’t repay is viewed with suspicion. It’s like saying that people who buy insurance on their automobile are planning to drive recklessly. You should be able to buy insurance for your automobile because accidents happen and you should be afforded protection against that possibility. Instead, debtor countries were made to feel that if they bought “insurance” they were telling the world that they were planning on “driving irresponsibly.”

RS: Is there space for coalition-building amongst countries in the Global South? Can we overcome this collective-action problem?

KS: Only insofar as there is consent from the US. Substantive changes to the IMF require an 85 percent supermajority from member nations; however, nations don’t have equal votes. Votes are proportionate, ostensibly, to the contributions they make to the fund. The US, for example, has 17 percent of the vote, meaning it has an effective veto power. No US support, no SDRM. Whether developing countries are acting collectively or separately is inconsequential.

RS: Is there the possibility of an SDRM model that exists outside of or otherwise circumnavigates the IMF? Are there other institutional mechanisms to pursue?

KS: I have trouble imagining that. There are certain functions that have to be performed—like calculating and monitoring debt sustainability—and they can only be executed by an authority which is commonly respected within the global financial community. Like it or not, that’s the IMF. However, this is not stopping other international institutions from trying. The UN is trying to create an instrument very similar to an SDRM that doesn’t rely on the IMF.

RS: Let’s talk about Argentina’s most recent debt restructuring. When Anne Kreuger’s SDRM proposal failed, the compromise was a more tempered option: collective action clauses (CACs). Could you talk about how the two differ and what we gain or lose from CACs over an SDRM?

KS: For restructuring to happen, creditors have to accept being paid back less now and more in the future or just less in general. How do you get creditors to agree to that? The SDRM and CACs offer distinct answers to that question. With an SDRM, particularly the one proposed by Kreuger, creditors vote on whether or not a debt should be reduced to a given level and the approach to making that happen. If the requisite proportion say yes, then the decision binds to every creditor. CACs do the same thing, but they do so within the issue of the bond. If a creditor lends a debtor money, they do so knowing that if said debt is deemed unsustainable or unpayable (say, via default), then the contractual obligation within the CAC kicks in and if a supermajority agrees, the debt is restructured for all those who hold bonds with CACs. In the former, there’s no opt-in; it becomes a structural condition of sovereign debt. In the latter, there’s a simple solution if a creditor doesn’t want such terms: don’t purchase bonds that have CACs, lend your money to another country. Creditors obviously preferred the flexibility and choice of the second.

RS: It seems a bit paradoxical to offer a market solution to what is, effectively, a problem inherent to the market itself.

KS: Insofar as CACs can’t be retrofitted to existing debt, I might agree. However, they have their benefits. At first, CACs only applied to each individual bond issue. This wouldn’t work: creditors issue bonds in different currencies, through different banks. If each bond had a correspondingly unique CAC, then CACs wouldn’t do much good. However, about five years ago, a new approach to CACs became standardized. They started appearing in single issue bonds with clauses specifying their application to all issues. These are called “Enhanced CACS.” With these, the CAC in a bond issued by a borrowing country may be triggered even without a supermajority of that particular bond’s owners, provided that there is supermajority support for restructuring across all the country’s bonds. With a good enough lawyer, you can write anything into a contract. Paired with their ubiquity—basically all debt is issued with enhanced CACs these days—CACs are functioning more like an SDRM than initially anticipated.

RS: CACs featured prominently in Argentina’s recent debt restructuring. Some scholars view this restructuring as a success which vindicates CACs. What is your take?

KS: I think you can look at it both ways. The restructuring does vindicate CACs—the last time Argentina defaulted, in 2001-2, the negotiations and restructuring went on for fifteen years. This time, it was a matter of months. Clearly, something worked. But the question is not only whether restructuring happened. What we care about is whether it brought debt down to a level that is sustainable. Did they get enough reduction? Argentina didn’t get as much debt reduction this time as it did last time.

So you might want to say there’s a trade-off here: CACs make debt restructuring easier, more efficient, and quicker, but they also make it less generous. I’ve spent most of my career looking at this issue from the perspective of and with sympathy for the debtors. In this case, I’m not actually sure who got the worst deal. On the one hand, Argentina got really good debt reduction that they imposed, unilaterally, in 2005. But then they spent ten years in litigation and ended up paying a lot of money to end the litigation and to be able to close the chapter on the 2001-2 default. Looking back, the 2005 restructuring isn’t all that successful. This time they didn’t restructure quite as steeply, the level of debt reduction they got is significantly smaller in comparison, but it was done in eight months, and there’s no litigation. It’s hard, even for me, not to acknowledge that there are some upsides to CACs.

RS: What, then, are the implications of that right now? We have close to 100 countries that are about to default on their debt. Are the CACs going to ultimately work in their favor?

KS: The more immediate problem is that many of those countries don’t have CACs. This harks back to the paradox you mentioned: CACs aren’t a structural fix. In Argentina, after litigation, they basically restructured and reissued all of their debt in 2016 and 2017. The government—for reasons the world will someday have to understand—was a darling of the international financial community. Everybody was lending money to Argentina, but with CACs. This other massive number of countries about to go belly-up? They don’t have CACs, sometimes weren’t even offered them, so they’re back to the old problem.

RS: If this brings us full circle, then is this moment one where the realization of an SDRM is more politically feasible?

KS: We will have to see. Like the UN, the G20 is also trying to do something like an SDRM. Their approach at the beginning of the pandemic was not debt restructuring, but suspension—the Debt Service Suspension Initiative (DSSI). It was originally only for bilateral debt and now there is an effort to expand it to include commercial, private debt. Ultimately, though, these are all just ideas. In general, it depends on the appetite of the big creditor countries.

The other issue is that there’s more Chinese debt than ever before. This means that some countries don’t really need the US—they would need a sovereign China debt restructuring mechanism. For many countries (particularly in Sub-Saharan Africa, but also several in Latin American) the Chinese government is the creditor that most matters.

RS: So is it then realistic to imagine an SDRM that exists without consideration for American debt?

KS: I’m not sure about China’s position on debt restructuring, but at the end of the day, we won’t get an SDRM for private, commercial debt that doesn’t include the US and the UK; they hold such a large majority of private debt. Even debt issued by other creditor nations is often based in the US or the UK, and thus subject to American and/or British law. If a given contract needs to be overwritten or suppressed, it must be done in the country of legal jurisdiction, the country that houses the debt—national creditor and debtor courts alike would be subordinate. The US and UK not only lend significantly, but house, legally speaking, an immense amount of sovereign debt.

RS: At the turn of the millennium, there was a political and moral imperative that reframed the issue of debt relief. Do you think there could be a similar cultural or political movement that pushes the US and the UK in this direction?

KS: Yes. The Debt Jubilee at the turn of the century was focused on a group of “heavily indebted poor countries.” At that time, most of these countries owed their money to public creditors, either foreign governments or the multilateral banks. Cultural and political actors built a movement around debt relief that framed the issue for policy makers and politicians and it worked. However, it didn’t apply to commercial debt because those weren’t the countries that owed much to public creditors. The movement focused on pathos, drawing on a portrayal of these poorer nations’ most desperate conditions. This didn’t translate to Brazil and Argentina, middle-income countries that were regarded as big enough and strong enough to fend for themselves (even though middle-income countries house close to, if not an outright majority, of the world’s poor). The question for me is: Can we recreate that sort of “moral movement,” as it has been understood by the academic community, that is not just about poor countries’ and public creditors, but countries’ debt to commercial and private creditors?

I think the answer is yes. The consequence of what happened twenty years ago is that a lot of poor countries got their debt restructured, their economies started doing better, and they started borrowing from private creditors. So many of those same countries that needed their debt restructured twenty years ago because they were too poor to repay the IMF are now too poor to repay Citibank. We are beginning to see exactly what you were talking about: a moral movement to say that creditors’ debt should be forgiven too. However, at this moment, it’s too early to say. What’s going on with the G20 is an effort to have debt restructuring, but only for really poor countries—that would leave out the middle-income countries, recreating the problem of twenty years ago. I wouldn’t suddenly expect the world to change, but there may be reason for cautious optimism.