An Exit from Debt Crises
The Need for Fair and Transparent Arbitration of
Sovereign Debt
Greece’s dramatic debt crisis drew attention to the absence of a orderly, fair, and transparent way to
deal with sovereign debt crises within the current international financial architecture. Yet, Greece’s
problem is not new. Many poor countries struggle under crushing debt burdens, risking default or
paying debts at the expense of critical domestic needs. A new framework is urgently needed.

International debt relief efforts have produced positive results. Since the Heavily
Indebted Poor Countries (HIPC) Initiative in 1999 and the Multilateral Debt Relief Initiative
(MDRI) in 2005 substantial progress has been made in debt relief for developing countries.
Through a combination of partial debt relief and strong economic growth, key indicators of
indebtedness have been reduced considerably in several countries. In a few non-HIPC
countries, individual agreements on debt cancellation have also led to considerable
improvements (for example Iraq and Nigeria).

However positive, these relief initiatives have been short-term and fragmented, and
failed to address odious debts. The HIPC and MDRI relief schemes were deliberately
designed and run as one-time deal by one group of creditors, with other creditors only
reluctantly participating, if at all. Thus, newly over-indebted countries today face the same
problems countries faced when the debt crisis began in 1982. There is still no comprehensive
mechanism to reduce a country’s exposure to all its creditors in a fair, orderly, and pre-defined
way.

Low-income countries face renewed risks of debt distress. Even before the global
financial crisis took effect on the poorest countries, the World Bank acknowledged in 2008 a
"high risk of debt distress" in 4 low-income countries and a "moderate" risk in an additional 10.
In early 2010 the IMF reported a "high risk" in 16 low-income countries and 11 countries in
debt distress. Countries at high risk of debt distress increased.

Middle-income countries and developed countries also face potential debt crises. In
addition to countries that have already received debt relief through MDRI, some countries,
which never really managed to get out of the debt crisis of the 1980s and 1990s, risk being
pushed over the edge by the global economic slowdown. According to research by Jubilee
Germany, 14 middle-income countries faced critically high indicators and/or high debt
vulnerability. The recent Greek debt crisis, moreover, has demonstrated that even developed
countries are not immune from state insolvency.

Restructuring debt has become more complicated. The spectrum of creditors and lending
instruments has considerably broadened in recent years. Some emerging economies, such as
China, Brazil and India, have become increasingly important lenders to foreign countries.
New debt can come in the form of new types of bonds, through traditional syndicated loans by
commercial banks, through a new wave of aggressive marketing by Export Credit Agencies,
or the greatly expanded multilateral post-crisis-lending. So-called “vulture funds” hold out
from debt restructuring in an attempt to free-ride off of other official creditors. Traditional debt
restructuring therefore is now less effective in dealing with these heterogeneous actors.

Excessive new borrowing may continue. The International Financial Institutions (IFIs) have
tried to control this new borrowing with the help of the World Bank’s Debt Sustainability
Framework (DSF). The framework threatens to punish borrowers with the loss of access to
highly concessional financing if they borrow beyond sustainability limits defined by the Bank.
This approach is not likely to be successful. By only punishing the borrower, the DSF provides
no incentive for a creditor take into account a country’s long-term debt sustainability when
making a loan.

Piecemeal and voluntary instruments are no substitute for a comprehensive
framework. Individual instruments such as Collective Action Clauses (CACs) or Codes of
Conduct for the restructuring of external debt can be useful at times. However, they generally
address only one group of lending instruments or creditors or are non-binding, influencing the
benevolent lenders without consequence for potentially predatory lenders.

Emergency lending from International Financial Institutions may provoke debt distress
down the road. In the wake of the economic crisis, the IMF and other multilateral institutions
engaged in post-crisis lending to help countries avoid a lengthy recession. However, this
threatens to lead the international community down the failed path of defensive lending by
multilateral institutions, something that could start a new debt cycle like the one of the 1990s.

New lending must come with clear rules about how to deal with a potential new debt
crisis. New proposals to strengthen the global financial safety net could entail countries
having to ramp up public borrowing in times of crises. Without a sovereign debt workout
mechanism, this crisis lending may bail out private creditors and leave the burden of the future
debt to workers and citizens. It is therefore essential that new lending and “financial safety
nets” for developing countries be accompanied by a new mechanism that involves all creditors
and is expedient and fair.

Key principles of fairness and transparency are needed. A new framework for sovereign
debt relief needs to differ from existing procedures if it is to address the changed landscape of
new lending. Key principles of an orderly, effective and fair debt workout mechanism are:


One single “insolvency” process which involves all creditors.
Impartiality in decision making, rather than the present creditors' hegemony over the
negotiation process.
 Automatic stay on loan enforcement, once a case has been filed.
 Impartial assessment of the validity of individual claims, as well as the legitimacy of the
loans.
These principles essentially reflect the leading principles of corporate or individual insolvency
laws in civilized nations around the globe.

Governments, UN bodies, and civil society organizations are calling for a new
framework. The UN commission chaired by Nobel Laureate Joseph Stiglitz has called for an
international insolvency procedure. Most recently the governments of Norway, Germany, and
the Netherlands started exploring ways to develop an international insolvency framework, in
cooperation with UN bodies, such as UNCTAD or with the Permanent Court of Arbitration in
the Hague, respectively. The recent Greek debt crisis has triggered a debate on a state
insolvency mechanism in the context of a new European financial architecture.

Some practical proposals for a new framework include:

The "Fair and Transparent Arbitration Process" (FTAP) as an ad-hoc procedure: It has
been developed by the Austrian economist Prof. Kunibert Raffer and heralded by
Jubilee Germany and other civil society organizations. It adds the decision-making
technique of arbitration to the fundamental principles of chapter 9 of the US insolvency
code, which deals with the insolvency of municipalities.

Proposals for a standing debt court: Practical proposals for a standing court have been
worked out by Latin American economists Alberto Acosta and Oscar Ugarteche
(Tribunal de Arbitraje sobre Deuda Soberana - TIADS), the African Network on Debt
and Development (AFRODAD) and by Jurists Christoph Paulus and Stephen Kargman
("Sovereign debt Tribunal").
A fair and transparent sovereign debt workout framework is clearly missing from the
international financial architecture. Instituting such a framework would provide immense
human benefits for poor countries without requiring additional financial contribution from
taxpayers in the U.S. and other creditor countries.
Jubilee USA Network ~ 212 East Capitol Street NE, Washington, DC ~ 202-783-0215 ~ www.jubileeusa.org