issue 320 - January-February 2000
Deal with debt
Massive debt loads are crippling Third World nations and destabilizing the global economy. Debt cancellation is needed now. But there also needs to be an agreed procedure to ensure that debt-strapped nations are dealt with fairly and given a chance for a new start.
In most parts of the world companies and individuals can declare
themselves bankrupt and start again. Nations have no such luxury.
Wayne Ellwood explains a new mechanism for dealing with debt.
Slowly, too slowly for the millions whose lives have been destroyed, Western nations are beginning to understand that Third World debt is a wasting disease that can’t be cured by standard economic prescriptions.
When debt-strapped nations get into trouble they have had little choice but to turn to big lenders who hold all the cards. In the case of recent massive bailouts for Mexico (1994), Thailand, Indonesia, Korea (1998) and Brazil (1999), no-one but the International Monetary Fund (IMF) could assemble the package needed to do the job – $120 billion alone for East Asia.
But these bailouts don’t really get to the root of the problem. In fact they ensure that the haemorrhage will only get worse in the long run. All policies are geared to earning foreign exchange to keep up payments while the legitimacy of the original debt is never in question. Repayment is the only issue and debtor countries have to return cap-in-hand, again and again.
As the church-led Jubilee campaign has shown, Third World nations are already being bled dry. In 1998 alone developing countries repaid $250 billion while receiving just $30 billion in government aid. And in 1996 sub-Saharan Africa, the poorest region in the world, paid $2.5 billion more in debt service than it got in new loans and credits. The IMF, playing both judge and jury, has siphoned more than $3 billion out of Africa since the mid-1980s. But it doesn’t have to be this way.
The United Nations Conference on Trade and Development (UNCTAD), non-governmental organizations (NGOs) and experts like Austrian economist Kunibert Raffer, all propose a mechanism to deal with financial crises and debt in a more just and equitable way. The solution, they say, is an International Insolvency Court (IIC).
UNCTAD argues that IMF-engineered bailouts pose three big problems:
They protect creditors from bearing the costs of poor lending decisions, putting the burden entirely on borrowers.
They induce ‘moral hazard’: ie lenders are guaranteed repayment so they blithely continue to make imprudent loans.
The funds needed are increasingly large and hard to raise.
Instead, says UNCTAD, an International Insolvency Court would allow cash-strapped countries to suspend debt payments legally and without penalty. This would give debtor nations breathing space to renegotiate loans. And it would prevent a rush to the exits by nervous speculators, which UNCTAD says can quickly turn a ‘minor liquidity problem [lack of cash flow] into an insolvency crisis [inability to pay]’.
Currently, IMF bailout loans mainly benefit speculators who bet against a country’s currency or take advantage of high interest rates on short-term loans. An International Insolvency Court would help ensure that lenders take their share of the losses, which they provoked in the first place through reckless lending. Such a standstill would also enable local companies to remain in production instead of being squeezed into bankruptcy or becoming targets for takeover by bargain-hungry foreign corporations.
Some Western countries already have domestic bankruptcy codes that allow them to deal with ‘bad debts’ without bringing the whole economy to a halt. Society as a whole benefits when businesses stay solvent rather than being forced into liquidation and laying off their employees.
US law is the model that the UNCTAD secretariat has in mind. Under Chapter 11 of that law no receiver or trustee is appointed to manage the debtors’ business and debtors are left in possession of their property.
US law supports an orderly workout in three stages. First, the debtor files a petition and there is an automatic standstill on debt servicing. This prevents a dogfight for assets which is bad for the creditors as a group. The procedure allows the debtor to stitch together a reorganization plan and ensures that creditors are treated equally.
In stage two, the debtor can borrow new working capital to carry on with its operations. New financing granted with court approval does not require permission from the existing creditors. Stage three sees the reorganization of the debtor’s operations. The plan does not need unanimous support by creditors; acceptance by 50 per cent of the creditors and two-thirds in terms of the amount of claims is sufficient. US bankruptcy procedures are also available for some kinds of government debts. Chapter 9 of the US code deals with public debt owed by municipalities and applies the same principles as Chapter 11.
UNCTAD draws a sharp contrast between the way the US responded to its own domestic financial crises in the early 1990s and the harsh medicine that the US Treasury and the IMF doled out to Asian countries. Short-term interest rates were reduced in the US, notes UNCTAD, ‘almost to negative levels in real terms, thus providing relief not only for banks, but also for firms and households which were able to refinance debt at substantially lower costs’. Those policies in the early 1990s made it possible for the US economy to enjoy one of its longest postwar recoveries.
In contrast Asian, African and Latin American countries facing financial crises have no equivalent of US bankruptcy law to hold off their creditors while they renegotiate their debts. Nor can they turn to a benign international central bank to refinance their debts at lower interest rates. Instead they have to seek bailouts from lenders, led by the IMF and the US Treasury, and submit to the IMF’s orthodox ‘adjustment’ programmes – the opposite of America’s own policy of keeping interest rates low and ready cash available to head off a recession.
According to World Bank Chief Economist Joseph Stiglitz, forcing indebted nations like Thailand and Brazil to raise their interest rates, supposedly to win back the ‘confidence’ of foreign investors, actually undercuts domestic demand, triggering numerous bankruptcies and ‘undermining confidence still further’.
International support for an Insolvency Court is spreading. Canada has proposed to the G7 industrial countries that loan agreements contain an ‘Emergency Standstill Clause’ that could be activated by debtor countries. After invoking the clause, creditors would have 90 days to negotiate a debt rearrangement. Unfortunately, the Canadian proposal requires the IMF Executive Board to approve the negotiations, something which other supporters of the idea dismiss as extremely unlikely.
UNCTAD, for example, notes that the Executive Board of the IMF is not a neutral body and that decisions by an IIC could affect its most powerful members. In addition, the IMF may be a creditor as well as a potential source of new loans – an obvious conflict of interest. Instead, UNCTAD suggests that an IIC be established under a treaty ratified by the UN. If no agreement can be reached with creditors, then the Court would be empowered to impose settlements based on legal precedents.
Kunibert Raffer of the University of Vienna calls for a ‘neutral court of arbitration’ to avoid decisions being influenced by the national interests of creditor or debtor countries. The interests of those affected by any renegotiated debt plan would be defended by ‘trade unions, grassroots organizations, NGOs or international organizations like UNICEF’. And, says Raffer: ‘Arbitrators would have to take particular care to ensure that a minimum of human dignity of the poor in the debtor country is safeguarded.’
As Raffer points out, under the US Chapter 9 law ‘creditors are to receive what can be reasonably expected under the circumstances and humane living standards of people living in the indebted municipality are protected’. A bankrupt city government in the US is not expected to stop basic social services in order to pay its creditors; national governments should not have to do so either.
An IIC would also put an end to the double standard practised by the IMF. According to Malaysian activist Martin Khor: ‘On the one hand [the IMF] insists that the [Asian] governments play by strict market rules and not put in money to aid ailing local financial institutions and companies. But on the other hand it wants the governments to pay back all external loans contracted from international banks, including the huge debts of the private sector that have gone sour.’
Others suggest that the mandate of an IIC could be extended beyond immediate financial crises to address the root cause of debt on a country-by-country basis. If much of the Third World’s debt is illegitimate, as Jubilee campaigners and many Third World NGOs claim, then an independent International Insolvency Court needs to be empowered to make that judgment and approve cancellation. The Latin America Jubilee 2000 movement calls for creditors and debtors to appoint an equal number of judges to any debt-arbitration panel, including representatives from a broad range of civil-society organizations.
At the moment it’s all one-sided. Creditors like the IMF and the World Bank remain all powerful. In the words of Raffer, the creditors are ‘jury, bailiff, interested party and witness all in one, and no decent legal system allows deciding one’s own case.’