Sovereign debt:

Many developing countries face renewed debt difficulties

Possible mechanisms for coping with debt crises and preventing them from occurring need global scope and a careful balancing of issues related to sovereignty and the functioning of the international financial order, experts told a seminar jointly sponsored by UNCTAD and Columbia University.

The seminar titled ‘The Resolution of Debt Crises: The Policy and Research Agenda’, was held in Geneva recently.

It was co-hosted by UNCTAD and Columbia University’s Initiative for Policy Dialogue (IPD).

UNCTAD Secretary-General Supachai Panitchpakdi and IPD co-President Jose Antionio Ocampo opened the debate with a review of the current situation relating to sovereign debt, which has seen many developing countries face renewed debt difficulties in the wake of the global financial crisis.

Three views emerged at the seminar on the issue of a possible sovereign insolvency mechanism. The first holds that the current ‘non-system’ is inefficient and inequitable and that a well-designed mechanism for dealing with sovereign insolvency could help in reducing the costs of debt crises and minimise any negative consequence in terms of access and cost of financing.

The second view was that rather than being characterised as a non-system, the current situation should be described as a fragmented system which, even if it is not perfect, generally has the instruments for dealing with most sovereign-insolvency cases.

The third view acknowledged that, while there are many theoretical arguments in favour of creating mechanisms for dealing with sovereign insolvency, the implementation of such a system could face challenges, including issues related to national sovereignty and the difficulty of differentiating liquidity from solvency problems.

While there was no agreement on the desirability of creating a new mechanism for the resolution of debt crises, many participants agreed with that if such a mechanism were to be created, it should have a global rather than a regional reach.

Participants and panellists also discussed the role of Credit Default Swaps (CDS) and debt buybacks in the field of sovereign debt. There was agreement that whatever other merits they may have or problems they may generate, the presence of an active market for credit default swaps was not a serious obstacle to restructuring sovereign debt. Overall the panellists and participants said that any discussion on resolution of debt crises should be linked with discussions on how to avoid such crises. On this subject, there are many open issues. The first has to do with contingent liabilities. Many debt crises originate from problems in the banking system.

Policymakers should find ways to isolate the credit of the sovereign from the sometimes reckless behaviour of the financial sector, the speakers said. A second issue relates to the link between the behaviour of capital flows and financial crises. Time and again, debt crises are preceded by international lending booms (either to the private or public sectors) and large misalignments of the real exchange rate, participants said.

Some argued that the ‘non-system’ now in effect relates not only to the resolution of debt crises but to the overall international financial order.

Having a system aimed at avoiding excessive capital flows, large current account imbalances and exchange-rate misalignments is a necessary condition to avoid future crises, the speakers said. The current solution in which each country tries to deal with these problems on its own is clearly inefficient and a global solution is needed, the participants said.