22 January 2013

IMF Working Paper: You never give me your money? Sovereign debt crises, collective action problems and IMF lending

This paper reviews the impact of the global financial crisis, and its spillovers into the sovereign sector of the euro area on the international "rules of the game" for dealing with sovereign debt crises.

The rules of the game rest on two main pillars. The most important is the IMF’s lending framework (policies, financing facilities, and financial resources), which is designed to support macro-economic adjustment packages based on the key notion of public debt sustainability. The complementary pillar is represented by such contractual provisions as Collective Action Clauses (CACs) in sovereign bonds, which aim to facilitate coordination among private creditors in order to contain the costs of a debt default or restructuring. The authors analyse the most significant changes (and their consequences) prompted by the recent crises to the Fund’s lending framework, not only in terms of additional financial resources, new financing facilities (including precautionary ones), and cooperation with euro area institutions, but also as regards the criteria governing exceptional access to the Fund’s financial resources.

The authors highlight a crucial innovation to these criteria, namely that, for the first time, they now explicitly take account of the risk of international systemic spillovers. Finally, the authors discuss how the recent crises have provided new political support for a broader dissemination of CACs in euro area sovereign bonds. Importantly, in the first case involving an advanced economy, CACs were activated in the debt exchange undertaken by Greece in spring 2012.

The recent crises originated at the very heart of the global financial system, provoking  unparalleled risks of global financial meltdown and spillovers on a worldwide scale. In addition, their management was further complicated by the initial lack of effective intervention tools in the European camp. Such tools had to be developed hand in hand with  the complex build-up of a more robust and credible system for regional macro-economic  surveillance. Thus, these crises posed distinct and unprecedented challenges, which required major adaptations to the existing management and resolution framework in order to tackle systemic risks effectively. 

As far as IMF financing is concerned, the design of a comprehensive lending framework, with the right mix of constraints and discretion, is by its very nature a complex endeavour, one that requires laborious learning and adaptation processes. The authors have underscored the comprehensive overhaul of the Fund’s lending toolkit since March 2009; they have also emphasised how the Greek programme of May 2010 was another landmark moment in terms of: cooperation between the Fund and European institutions; (large) size of euro area countries’ financing needs and related burden sharing; programme design (conditionality) and monitoring. The authors have also taken special care to illustrate the equally significant impact of the crises on the rules governing exceptional access to Fund resources, in order to determine their implications for the key objective of ensuring greater predictability set by the international community in the early 2000s.

On this latter point, the authors believe that the net effects of recent EAP changes appear somewhat difficult to gauge in a forward-looking perspective. On the one hand, the reforms adopted in March 2009 have certainly strengthened the rule-based nature of the EAP, by resolving the asymmetric treatment of capital versus non-capital account crises and by clarifying that both actual and potential BoP needs are covered under the policy. On the other hand, the  introduction of a systemic clause to justify exceptional access to the Fund’s resources in case of a “high risk of international systemic spillovers” has broadened the scope of application of the EAP, but at the same time may have to some degree expanded the room for discretion.

In any case, the authors emphasise that the introduction of a systemic clause is a consequential development. In their view, new lending rules to address explicitly the risks of systemic crises are a necessary (and desirable) response by the Fund to the evolution of the global financial landscape, where the greater size, interconnectedness, and sophistication of international capital markets amplify the potential for pure contagion and international spillovers (including those stemming from countries that do not necessarily meet the commonly-accepted definition of systemically-important economies on the basis of size).

The authors  believe that the growing relevance of cross-border interdependencies has magnified problems of collective action and time inconsistency deriving from the higher potential for  systemic crises at the global and regional levels. Recent experiences have dramatically confirmed the fact that, like coordination failures among creditors, systemic factors do raise the costs (if not the likelihood) of sovereign debt crises, as they may more easily affect other countries via contagion. As a result, while it would be appropriate (and rational) strictly to enforce market discipline and institutional rules ex ante (i.e. before a crisis), and thus let countries default if their debts are truly unsustainable, this option may not appear preferable in practice ex post, once contagion and risks to systemic stability triggered by the above threats of default materialise.

In principle, one can argue that the combined effects of a higher potential for systemic crises (including those originated in non-large countries), on the one hand, and the introduction of a  systemic clause, on the other, may increase the risk that, under new egregious failures in crisis prevention, the Fund might be faced with more cases of exceptional access to its resources than before. This scenario has a number of important consequences for the Fund, including in terms of: the analytical requirements for surveillance and lending; the adequacy of financial resources; and burden-sharing and cooperation with regional financial arrangements.

Full paper

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