New IMF Debt Rules Draw Praise, Criticism

Bankruptcy is the procedure in the United States (and many other nations) that allows a debtor who is no longer able to pay back a debt to come to some form of resolution with his or her creditors, typically allowing for a different repayment term or the discharge (or erasure) of some or all of the debt. In fact, every country has some similar process. When addressing international debts between nations, however, no such procedures exist.

Bankruptcy is the procedure in the United States (and many other nations) that allows a debtor who is no longer able to pay back a debt to come to some form of resolution with his or her creditors, typically allowing for a different repayment term or the discharge (or erasure) of some or all of the debt. In fact, every country has some similar process. When addressing international debts between nations, however, no such procedures exist.

To address this problem, the International Monetary Fund (IMF) has drawn up new rules. As IMF Chief Economist, Olivier Blanchard, explains it, a country in need of IMF assistance is either “illiquid” or “insolvent.” When “illiquid,” the nation simply cannot mobilize funds in order to satisfy its obligations. It simply needs funding in order to see it through this low point in liquidity, and will likely be able to repay its bailout in time.

“Insolvent” nations, on the other hand, need to have their debt restructured, as they will have a difficult time emerging from their own debt spiral otherwise. Such restructuring will likely need to be similar to the process of bankruptcy in the US, with portions of the debt either reduced or deferred.

Unfortunately, it is very difficult to look at a nation in financial crisis and determine whether it is “illiquid” or “insolvent.” Of course, the IMF is under immense political pressure at the same time to bail that nation out, regardless of which bucket its debts fill.

The IMF’s new rules suggest that if a nation’s debts fall into the bucket of “insolvency,” any bailout funds tend to go to repaying creditors who should have participated in the resolution and trimmed a portion of their own profits on those debts in order to reduce the likelihood of default. An excellent contemporary example of this problem is Greece.

When it first began receiving bailout funds, the initial money went to pay off creditors. By the time the IMF and the European Union banks began discussing debt restructuring for the clearly insolvent Greece, many of the creditors had already been paid and had no interest in restructuring any of their portions of the debt.

Blanchard suggests that the new IMF rules will help prevent just such a situation. According to the new rules, if there is doubt as to a nation’s solvency, its debts can be put on temporary hold (though, not erased or reduced). This may pressure creditors to offer debt reductions on their own.

Economists, however, are divided on the potential efficacy of these new measures. The biggest problem is the IMF’s inability to bind a nation’s creditors to any kind of restructuring plan in the way a bankruptcy court can in America. As a result, many of the rules suggest that nations tempt default if they wish to receive funding from the IMF.

Some feel this is an excellent use of extra-judicial pressure to reach bankruptcy-like effects for distressed nations. Others suggest that because there are no real teeth to these measures, they merely serve as a means of refusing aid to nations in desperate need of assistance, leaving them stuck in the middle between their creditors and the IMF.

Until these rules have been given practical use, it will be difficult to determine which view will prove most true. These provisions, however, may be but the first step on a path to addressing the bigger problem of international debt that could lead to a new body of treaty law regarding the bankruptcy of nations and their debts.