Brady's plan .. What is the role of the IMF to resolve debt crises?

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Brady's plan .. What is the role of the IMF to resolve debt crises?

13 May 2019 05:51 PM
Editing: Sally Ismail

Mubasher: The 30th anniversary of the Brady Plan, launched in response to the Latin American debt crisis of the 1980s, was resolved in March.

A report published in the IMF blog discusses Brady's plan, named after US Treasury Secretary Nicholas Brady, after nearly three decades.

The plan allowed countries to exchange commercial bank loans against Treasury-backed bonds.

The move has put an end to a turbulent period that threatened potentially disastrous consequences for the global banking system at the time.

Banks then agreed to provide required debt relief, averaging 35 percent debt write-off in exchange for risk-free and tradable instruments.

The IMF played a crucial role in line with its authority to assist Member States in resolving their balance of payments problems and restoring their viability.

The role of the International Fund is not limited to overseeing countries' economic reform plans and providing financing for debt repurchase and secured payments in bonds exchanged.

But it also provides a forum for negotiations between creditors and the city, as well as better coordination among creditors through a change in its own policies.

Prior to the Brady plan, any private creditor could have disrupted IMF funding by refusing to restructure.

This situation changed, however, with IFAD adopting a "lending in default" policy in 1989, under which a country could be loaned to private creditors as long as the debtor was in good faith negotiations with the creditors.

Brady's deals have changed the landscape of sovereign finance in two fundamental ways forever.

First , sovereign bonds, held directly or indirectly by a variety of thousands of potential creditors, have become the preferred financing instrument for countries, replacing many of the sovereign banks' loans.

Second , the formal sector plays a major role in the restructuring of sovereign debt.

This shift left new challenges for the IMF, requiring the adoption of IFAD policies to meet the growing needs of its membership.

Coordination between creditors

First, with a large and diverse base of creditors increasingly, coordination among creditors is more difficult, as individual bondholders have the option of rejecting the restructuring agreement and demanding full debt repayment, an option primarily for debt relief by others.

Initially, the IMF considered a corporate bankruptcy or SDRM approach to address this problem but ultimately supported the market-based approach in 2003 by endorsing the CEC .

Such clauses allow a qualified majority of bondholders to agree to the terms of debt restructuring and have the same changes in terms of terms imposed on all bondholders of the same class.

In 2014, the IMF approved the main features of a revised version of CICS that allows a qualified majority of bondholders in all bonds to bind the minority to the agreement, which is the market standard now in use.

Growing debt levels and increasing market interdependence

Second, as debt levels increase dramatically, currently accounting for about 225 percent of global GDP and increasing market interdependence, sovereign difficulties in refinancing debt can create sovereign debt crises.

Often, the IMF intervenes at such moments with funding, yet support risks creating "moral hazard" if creditors expect the fund to bail them out and thus drive them to risk more.

The International Fund responded to this concern early in the first decade of the twentieth century by recognizing that there were circumstances in which the private sector should contribute to the financing of economic reform programs of States.

It also revised its lending policies to require a high probability that debt would be sustainable (the ability to meet debt and its benefits) whenever large funding was needed or a sharp restructuring would be necessary.

When the euro zone crisis occurred, this situation proved to be very strict.

Fears that a debt restructuring in Greece would undermine market confidence elsewhere in the euro zone would also trigger the introduction of a formal exemption in 2010.

This exemption allowed lending to move forward in cases where debt was considered sustainable but not highly probable, and there was a high risk of side effects.

However, with Greece's public debt still very high, by 2012 the process of restructuring private debt is inevitable.

Against this background, in 2016, the IMF revised its lending framework to remove systemic waivers and introduce more flexibility to help maintain private-sector financing in situations where debt is sustainable but not highly probable.

UNFPA is also reviewing its analytical framework on sustainable debt analysis for countries with market access, in order to enhance its assessment of the future debt sustainability of States.

This will help to adjust the timing and conditions under which debt restructuring is necessary to ensure sustainability in the context of IMF funding.

Official sector finance

Third, an increasing share of formal sector financing is now provided by non-traditional creditors in emerging markets.

This has posed challenges to the IMF policy on official arrears, which is directly linked to the Paris Club, the long-term coordination mechanism for traditional official creditors.

In 2015, the IMF amended this policy to remove the link with the Paris Club, as the group's participation in the financing of the program has not accounted for the majority of formal sector funding.

The revised policy also allows the IMF to lend arrears to the formal sector if certain conditions, including bona fide negotiations by the debtor, are met.

Transparency of debt

Fourthly, there are increasing concerns about transparency, as the terms and conditions of sovereign borrowing are increasingly invisible to the public.

In addition, borrowing countries have benefited from new and non-traditional forms of financing, such as bond purchases through sovereign wealth funds.

The IMF is promoting enhanced sovereign debt management practices, reporting data through its members and reviewing the debt ceiling policy, including the outlook for secured debt.

Given the rapid development of the financial and technical landscape today, it is impossible to predict the new challenges in sovereign debt that will arise during the next 30 years following the Brady plan.

However, the report expects that the principle of coordinated international response represented by the Brady Plan will continue to be necessary to prevent and resolve sovereign debt crises.

The IMF is expected to continue to play a central role in this context given its funding authority and will adapt to new realities based on lessons learned from the past.