Time to Rethink Sovereign Bankruptcy: A New Role for the IMF?

Abstract

This chapter is concerned with the issue of how to balance bailouts (or ‘lending into arrears’) with debt reductions (or ‘private sector involvement’) in the resolution of sovereign debt crises. It begins by briefly outlining the core underlying economic and legal problems sovereigns and creditors face in a sovereign debt crisis. It continues with a review of recent proposals to facilitate or regulate sovereign debt renegotiations, in particular the proposal for a statutory approach to sovereign debt restructuring. We do not aim to assess the political feasibility of the proposed institutions for the resolution of sovereign debt crises. Instead, we focus on their likely effectiveness. In addition to defending a sovereign bankruptcy framework we have developed in recent work, we propose a major reorientation of the IMF’s role in sovereign debt crises. The motivation for the discussion can be traced back to the Mexican debt crisis of 1994–5, which gave rise to an International Monetary Fund (IMF) bailout of unprecedented size. Since then, there has been a debate raging on how the IMF should handle sovereign debt crises. Despite the successful resolution of the crisis and the quick repayment by Mexico of all the emergency debt, the sheer size of the intervention raised worries that bailouts could cause significant sovereign debt market distortions. These concerns have led to a gradual shift away from the assumption that the IMF can and should act as the de facto international lender of last resort (ILOLR) by arranging bailouts in response to major sovereign debt crises. As is now widely recognized, the