The problem of collective action
In most cases, the IMF can help countries overcome balance of payments problems that arise without the pressure on creditors to act against their will. The financial agreement for a moderate and a convincing program of economic adjustment and reform often enough so that private lenders and investors regain confidence, and thus able to restore the country’s access to private capital abroad. The program recently agreed with Mexico, Bulgaria and the Baltic countries are a good example of this “catalyst”. In these cases the private sector contributes to the solution of the crisis on a voluntary basis, simply defending their own interests.
But what if the country needs in the short term a significant amount of foreign currency (which goes beyond what the IMF and other official lenders are willing to provide) and are unlikely to get quickly through the private sector ? In that case may need to ask the creditors to limit their demands for repayment. Knowing when to do so is not easy. For example, in the cases of Brazil and Korea, the economic policy programs supported by the IMF initially failed to restore the confidence of creditors. The banks that had granted loans did not feel safe and continued asking the repayment of their loans. The central banks of industrial countries and the authorities later persuaded them to moderate their demands and renewed loans.
The creditors will also limit the demands of repayment if the country faces a debt burden truly unsustainable, ie an insolvency crisis rather than a lack of liquidity in the short term. In these cases will ultimately inevitable restructuring of the debt of a country.
As in situations of failure of one entity, creditors tend to judge that they should collectively contribute to solving the financial crisis to exercise restraint in their demands for payment. The reason for that might be involved, the official sector to encourage or require such restraint is in-you want to avoid the “problem of collective action”, namely that for each creditor separately provides the incentive to charge as soon as possible or to try to block a plan to restructure the debt, and thus take advantage at the expense of other creditors. Some private institutions, to which is known as “vultures” – they specialize in precisely this tactic of blocking. The problem of collective action could worsen because, individually, it is likely that creditors have very imperfect information about the real intentions and other creditors who are in the same situation.
The problem of collective action is clearly manifested in the 1998 film entitled Waking Ned Devine, as Steven Schwarcz, Faculty of Law, Duke University. In the story, a man without heirs named Ned wins ? 6.7 million in the Irish national lottery and died because of the emotion received. Its 52 neighbors in the village where he lived decide which one of them was run by Ned, copper and share the prize with all the ? 130,000 that would apply to each. For the money, all you have to do is say to the administration of the fake lottery winner is Ned. Unfortunately, a woman of the people want greater involvement and threatens to uncover fraud if you do not give you more money.
Another dimension of the problem of collective action is the incentive that is submitted to creditors to act as “stowaways”. An agreement for the restructuring will improve a country’s ability to service that part of the debt whose original conditions remain unchanged. Consequently, there is an incentive for creditors to refrain from participating in the agreement and simply take advantage of the best prospects for repayment.
So, in practice, what is done to limit the actions of creditors that they are free or to persuade them to act with restraint? The approach has varied depending on the case and was caused by several factors. A crucial aspect is the type of debt and creditor.
Bank debt
In cases where the debt is bank loans, the method of creditors to provide a concerted often facilitated by the fact that it is a rather small number of creditors. For example, in early 1999 was relatively easy to get the banks to agree to maintain open lines of credit to borrowers in Brazil, after the announcement of a program negotiated with the IMF initially fail to halt the outflow of capital. The lenders were interested in cooperating in order not to jeopardize trade relations with long-established Brazil. But those circumstances may not occur in other countries.
In late 1997 it took a much tougher approach in the case of Korea. The country’s official reserves were almost exhausted after being used to pay loans from Korean banks abroad. Planning the threat of imminent default. The authorities of the major industrial countries that make up the Group of Ten pressured banks in their countries to renew the debt against the Korean banks, instead of demanding its cancellation. The maneuver worked, but the Group of Ten was willing to employ this method only because of the potential impact of a Korean default on the stability of the global financial system. It is doubtful that the initiative was repeated in the case of a country less important for the system. It could also be dangerous to use this method regularly, as banks were forced to keep open lines of credit in a country could decide to rebalance their loan portfolios and request the cancellation of debts in other countries. The only fear of being subjected to such pressure could be enough to encourage them to request cancellation.
Sovereign bonds
The most visible trend of international capital flows in recent years, apart from the rapid pace of growth has been the advance of the issuance of bonds versus bank loans. Since 1980, the gross issuance of bonds by emerging market countries has grown as a source in an average of 25% annually, four times the rate recorded by syndicated bank loans. This means that private creditors have become increasingly numerous, anonymous and difficult to coordinate. It is also less likely to maintain commercial relations with the countries they lend. However, that said, recent experience with regard to the restructuring of its debt by issuing bonds has been less difficult than many expected.
Following the Russian moratorium in 1998 and although it had reached agreement on an economic program with IMF, Ukraine was unable to raise funds from private investors while the repayment profile of its debt was highly concentrated. Several of the payments falling due in 1998 and 1999 were rescheduled slowly before he could reach an agreement in early 2000 for the restructuring of government bonds. Three of the emissions that are not restructured widely dispersed, so it was relatively easy to reach a collaborative dialogue with the owners. One of the investors the possibility of litigation to demand the full repayment, but others felt that the offer of exchange of securities was attractive enough to be accepted. So the swap was completed successfully and there was no dispute.
Pakistan also reached an agreement for the restructuring of its foreign debt in early 2000. Previously, in late 1998, there was an acute liquidity crisis when the increase in short-term debt coincided with the collapse of the flow of foreign officials because of the nuclear tests that began the country. The restructured debt include deposits held in financial institutions Pakistanis, bonds issued by national authorities and bank lending to government and public corporations. Pakistani bonds were largely held by financial institutions and individuals in the Middle East. The authorities were able to contact the owners of 40% of the debt and negotiated an acceptable offer of redemption.
In the case of Ukraine as for Pakistan, the prognosis for restructuring the bond debt would be frustrated by disruptive litigation was too pessimistic. This might be due to several factors: extensive informal contact between creditors and debtors; credible threat of failure if no agreement was reached; clear understanding that the countries facing serious balance of payments problems and foreign exchange shortages, and assurances that IMF was insisting on significant economic reforms. Marginally, can that many clauses in the contracts signed for the bond issue, which limited the extent that dissenting creditors might prevent an agreement, have helped to avoid litigation. Ukraine is used in such clauses, but not in Pakistan.
When Ecuador experienced difficulties in 1999, the prospects for restructuring seemed much less promising. In September of that year, Ecuador was the first country that failed to pay Brady bonds, some titles created to restructure the bank loans to non-payment of the eighties. Attempts to normalize relations with creditors Ecuador were largely hampered by the confusion of political events. But in May 2000, the Ecuadorian authorities announced they were willing to restructure the whole of the U.S. $ 6650 million of international bonds and Brady, and stressed that no agreements with separate groups of creditors.
The exchange offer for new bonds to 30 and 12 years was launched on July 27, requiring a 85% acceptance for its entry into force. The announcement led to a rise in the price of Ecuadorean debt on the secondary market, indicating that the market believed that the offer was relatively good. In the end, 98% of bond holders accepted the offer. In this case, litigation can be avoided partly due to innovative use of the so-called “exit consent”. This allows, by simple majority of the holders of the bonds, modifying the terms of the original bond not directly related to the refund. It is therefore less attractive for creditors to keep dissidents titles.
This does not necessarily mean that the threat of disruptive litigation is no longer a problem. Peru has recently had to pay a company to “vulture”, Elliott Associates, because the company had achieved in June 2000 a Brussels court issued an order that would have meant that Peru fails to pay interest on the Brady bonds, leading to company to a costly bankruptcy. The legal basis on which Elliott Associates defended his controversial case, but the success forced Peru to pay might encourage other holders of bonds to withstand future restructuring.
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