The Role of the Official Sector in Sovereign Debt Workouts

I. INTRODUCTION As tar babies go, few have proven stickier for the official sector than the plight of private sector lenders trying to recover their bad loans to foreign governments. Inevitably, these lenders have looked to their own governments for succor and protection against defaulting sovereign debtors. At several points and in several ways over the last two centuries, the official sector has tried to detach itself from this problem, only to discover how relentlessly adhesive it can be. The motivations for the official sector to involve itself in the affairs of private lenders have changed over this period. During the nineteenth century, the governments of countries in which the private lenders were located ("Creditor Governments") would occasionally champion the cause of their citizen debtholders in response to domestic political pressure from those citizens. In some cases, the Creditor Governments' motives were less benign. Protecting private debtholders, for example, was the ostensible justification for certain Creditor Governments assuming what one scholar has called "the orderly administration of the debtor's fiscal affairs, as by the United States in the Caribbean and by England or the great powers in Egypt, Greece, Serbia, Turkey, and elsewhere." In this context, of course, "orderly administration" meant running all or a portion of the debtor country's finances. After the First World War, and accelerating with the establishment of the Bretton Woods institutions following the second World War, official sector lenders had another reason to promote orderly workouts of private sector claims against distressed sovereign borrowers-the official sector was often itself a lender to those same borrowers. Official sector credits were sometimes extended bilaterally (government-to-government), sometimes multilaterally (through the International Monetary Fund ("IMF"), World Bank and other international financial institutions), and sometimes both. But, in all cases, failure by the sovereign debtor to reach a satisfactory arrangement with its private sector lenders could jeopardize the recovery of those official sector credits. Finally, the integration of the world's financial and trading markets has forced the official sector to view a sovereign debt problem in one country as a potential source of disruption elsewhere. The financial and geopolitical consequences of an unmanageable debt crisis can no longer be neatly contained in a single country, or even a single region. The official sector's search to find a satisfactory method of resolving private sector claims against distressed sovereign borrowers, right down to the IMF's proposal in 2002 for a Sovereign Debt Restructuring Mechanism ("SDRJVI"), can only be understood in light of this history. The official sector is searching for a sovereign debt restructuring policy that will achieve each of the following objectives: 1. Result in an orderly and expeditious readjustment of the claims of private (and bilateral) lenders against financially distressed sovereigns; 2. Ensure that any new funds advanced by the Bretton Woods institutions to a debtor country will be recoverable; 3. Minimize the risk of financial contagion in other debtor countries; 4. Encourage fiscal prudence on the part of the debtor and sound credit decisionmaking on the part of the lenders; 5. Promote, or at least not impair, private credit flows to emerging market borrowers generally; and 6. Shield the official sector from blame for having suffered the existence of rogue creditors or rogue sovereign debtors. It is a tall order and has not yet been filled. As the motivations for official sector intervention have changed, so too have the means. The establishment after the second World War of the Bretton Woods institutions (the IMF, the World Bank, and the regional development banks) gave Creditor Governments an entirely new instrument through which to influence the behavior of sovereign debtors. …