Solution sought for bankrupt countries

Argentina's woes have concentrated minds

by Andrew Walker BBC Economics Correspondent

The debt problems of Argentina and Brazil have loomed large over the annual meetings of the International Monetary Fund and the World Bank.

And they have made some progress on ideas for how to prevent countries suffering all the economic consequences of a default on debts owed to the private sector.

The second in command at the IMF, Anne Krueger has put together outline proposals for a new system that is sometimes likened to a bankruptcy process for countries.

There's no question that the near collapse of the Argentine economy over the course of the year has really focused minds.

One element in the country's problem was a debt burden that it couldn't cope with.

It eventually gave up trying to cope towards the end of last year and announced a default in December.

Order needed

Ms Krueger's ideas are intended to allow this kind of situation to be resolved in a more orderly way.

Ms Kruger is seeking a better way of dealing with debt default

There would be a forum which countries could go to if their debt burden became impossible.

They would then negotiate with creditors. If a majority agreed, the debt would be restructured.

In practice it would mean creditors taking a loss. And it would be binding on them all, including those who voted against.

In previous debt crises, there have been agreements between lenders and borrowers.

But Ms Krueger says the lack of formal procedure makes the process messy and drawn out.

Government bonds

It is a much more difficult process than in the 1980s, when a country's creditors were mostly a fairly small number of large banks who could be persuaded to get round a negotiating table.

Now middle income developing countries - the likes of Brazil or Mexico - borrow more by selling bonds.

They are traded in financial markets, and by the time a debt crisis comes along there may be thousands of bondholders.

The fact that developing country bonds can be traded can also lead to a particular problem that Ms Krueger calls 'hold-out' creditors.

These are creditors who demand full payment of what they are owed while others are negotiating new payment terms.

It doesn't happen very often, but she says is it is getting to be more of a problem.

Vulture funds

There is a type of investment institution, known as vulture funds, that buys up debts owed by companies or countries in financial difficulty for a deep discount, and then tries to get full payment.

In one recent case, she says the Democratic Republic of Congo, emerging from a wrenching civil war, was sued successfully for full payment of $17m in a US court.

In another well know case in the 1990s, a New York Fund, Elliot Associates, paid £11m for Peruvian debt with a face value of nearly $21m.

Peru had a debt problem and agreed a restructuring with most creditors.

Elliot however sued for full payment and was eventually awarded over $55m by a US court.

And Elliot then went on to use a court in Belgium to disrupt the reduced payments negotiated by Peru with its other creditors.

That was enough to persuade Peru to pay up in full.

Opposition

Mr Krueger's proposals are meeting some opposition.

Many creditors - not just the vulture funds - don't like the idea of an official agency interfering in their relations with countries which owe them money.

Some of them warn that if there is a system which might force them to take a loss, it will be bad news for the developing countries - they will end up paying higher interest rates when they borrow.

Some development lobby groups say that there should an opportunity for the population of affected countries to participate in the negotiations.

The idea of some sort of formal process for dealing with debts to the private sector has been around for many years.

It was given a new lease of life after the Asian financial crisis of 1997, but even then the idea seemed to flounder.

So if there is going to be progress this time it will be too late to be much help to Argentina - or Brazil for that matter, which some people in the financial markets think is perilously close to default as well.

But perhaps it will be some help to the next country that gets into the same kind of difficulty.