The debt problem… again

by Carmen C. Seekatz

This article presents an introduction to global indebtedness and to some of the proposed solutions to the problem. Here, a long-term global perspective is needed to allow the design of adequate policies. Among the vulnerabilities seen is the level of debt, including public debt, which has increased significantly in the global economy since the financial crisis at the end of 2007. The debt of the emerging countries has seen important growth, and the debt related to oil and gas companies saw an annual rate of increase of 15% from 2006 to 2014 – a substantial portion of the debt being represented by public petroleum companies.

 

ABSTRACT In 2016 the Bank for International Settlements, BIS, was already indicating that the falling tendency in economic growth; the downward revision of economic projects, especially in the emerging markets; the significant changes in foreign exchange rates; and the decrease in the price of basic materials occurring at that moment, were all an expression of the realignment, over the longer term, of the economic and financial forces associated with the anticipated change in global monetary forces. The Bank affirmed that such facts are part of a wider movement which requires a long-term global perspective in order to detect the vulnerabilities that the financial markets and the global economy face, so allowing the design of adequate policies to overcome them. Sovereign debt default is not beneficial for any of the parts involved. It is for this reason that some experts have been working on several proposals that are related to a change in debt profile that would preserve the value for both parts. For the creditors a default is not beneficial, and neither is it for the debtors, since they are penalized, access to the bonds market is closed, they have to pay high litigation costs, and they lose reputation. If the debt is unsustainable there is no other option than its renegotiation, from a perspective that preferably preserves the value for debtors and creditors, keeping in mind the effects of the softest forms, of debt liberation, such as extensions to the maturity term and reduction of interest rates on growth and credit qualification. The changes in debt profile (reprogramming and restructuring) are a complex problem. On the other hand, debt default could take approximately eight years to be resolved, and generally leaves the country more indebted than when it entered into default. This suggests the need for a theory of debt renegotiation in order to avoid delays in the indebtedness profile change, as well as correcting the deficiencies in the present system, which creates a series of inequities and inefficiencies. In addition, the lateness of the debtors in identifying the problems leads the country to what the IMF calls “very little, very late” registering, initially, a high amount of loan, and later a lot of suffering, of which Greece is the most recent case. The fact that the present system lacks the mechanisms that assure an ordered restructuration means that it is perceived as costly and that the political leaders try to postpone its execution. Consequently, inefficient delays are registered that make the recessions more persistent and which could drag down with them the countries with which commercial relations are sustained.

 

1: GENERAL CONSIDERATIONS

Longer-term realignment

In 2016 the Bank for International Settlements, BIS (1), was already indicating that the falling tendency in economic growth; the downward revision of economic projects, especially in the emerging markets; the significant changes in foreign exchange rates; and the decrease in the price of basic materials occurring at that moment, were all an expression of the realignment, over the longer term, of the economic and financial forces associated with the anticipated change in global monetary forces.

The Bank affirmed that such facts are part of a wider movement which requires a long-term global perspective in order to detect the vulnerabilities that the financial markets and the global economy face, so allowing the design of adequate policies to overcome them.

Amongst such vulnerabilities are seen the level of debt, including public debt, which has increased significantly in the global economy since the financial crisis at the end of 2007.

With regard to this point, the IMF in its publication “Global Debt Data” compiled a series of data about public and private debts registered since the end of World War II, the Debt/GDP top being 225% versus 213% in 2009.

The average Debt/GDP relation, for this last-mentioned year, of the Eurozone was 60% which exceeds that prescribed in the European Union Stability and Growth Pact (2), and even though Greece is the most recent and extreme case there are others whose debt increased significantly after 2008.

The debt of the emerging countries has also seen important growth. In the case of the private sector the debt/GDP ratio relation has increased from 75% to 125%, and from 2003 Brazil and China surpassed that of the advanced countries. (3)

Oil & Gas companies

Furthermore, the debt related to petroleum and gas companies deserves to be mentioned. This passed from US$455 thousand million in 2006 to US$ 1.4 trillion in 2014, which meant an annual rate of increase of 15%. On the other hand, the energy companies became indebted to the sum of US$1.6 trillion, which represented an inter-annual rate of 13% starting from the base of US$600 thousand million in 2006 (4).

It should be emphasized that a substantial portion of the debt is represented by public petroleum companies. For example, in the case of the Russian company the annual increase was 13% per annum, that of China 31% and that of the other emerging countries 17% (5).

Levels of debt not easy to manage

Associated to the above, C. Reinhardt (6), in 2013, had indicated that the economic dynamic would suggest that in the coming years new restructurings of sovereign debt would be registered, particularly in the countries on the periphery of Europe, and she suggested that the problems associated to the levels of debt which, already for that date, had affected some of the industrialized countries would not disappear soon, nor would be easy to manage.

In connection to the indebtedness of the emerging countries recently, Rogoff (7) affirms that the latest exchange rate and indebtedness problems in Argentina and Turkey could be considered early signs of deeper weaknesses in the levels of debt related to the normalization of interest rates in the United States.

Furthermore, he alerts about the negative effects that could be derived from a possible financial crisis, cybernetic attacks (especially by state actors), pandemics, and a temporary deceleration in China. Such occurrences would put even the United States in danger if an adequate policy for debt reduction were not designed.

Also, related to indebtedness we must point that after several increase in interest rate in USA, the last semester of 2018, in January this year the Fed announced a pause, and now looks to be extended until the end of the year, moreover, the Fed has signaled that “quantitative tightening”, the process of allowing treasuries and mortgage-backed securities to roll off its balance sheet, will continue only through September.

US recession?

Those facts create optimistic, but cautious, expectations regarding emerging markets because recently another risk has been raised – which is the expectation of a US recession, which could be severe because of the low level of interest rate as well as the high amount of budget deficit, which give little space for fiscal stimulus.

Moreover, a US recession would interact with other risks, among which it is possible to expect those linked to the corporate debt of China and its negative effect on international economic expansion.

High levels of debt predictors of debt crisis?

Regarding the above, one has to indicate that some research appears to favour the point of view where high levels of debt do not necessarily cause low rates of economic growth nor are they immanent predictors of debt crisis, but the actual levels of debt in developed and emerging countries, in the present context and expectations, suggest that which C. Reinhardt, explained in 2013, and that we cited before, in the present article, could be right.

Stiglitz, on the other hand, sustains that the probability of a country entering into severe difficulties on facing high indebtedness depends on a variety of economic conditions (8) but also on the actions of the debtor regarding how the situation of the debt may be resolved at the risk of losing access to the financial market if it falls into default (10).

He adds that the absence of clarity of a company or country in acting to resolve situations that may be obstacles to the payment of their obligations could lead them into chaos. This would open up periods in which, if the demands were not met, their businesses would not proceed or they would do so, but not in the most desirable form.

2: DEBT RESTRUCTURING AND REPROGRAMMING (11)

Correlated with the Greek debt crisis in the year 2103, the Executive Board of the IMF held a series of discussions on the processes of sovereign debt restructuring and their legal aspects and implications with regard to policy design, also holding more discussions in September of 2018 with respect to the solution of problems, associated to the high international levels of indebtedness, in the framework of the conference “Sovereign Debt: A Guide for Economists and Experts”. Since 2005 the said institution had not held discussions on this subject.

General Aspects

Sovereign debt default is not beneficial for any of the parts involved. It is for this reason that some experts have been working on several proposals that are related to a change in debt profile that would preserve the value for both parts. For the creditors a default is not beneficial, and neither is it for the debtors, since they are penalized, access to the bonds market is closed, they have to pay high litigation costs, and they lose reputation.

According to C. Reinhart, in contrary to the opinion of some intellectual circles, debt restructuring (14) has been used by the advanced countries, accompanied or not, with others such as financial repression, conversions and capital control in face of important debt problems (15) (the period previous to World War II). This is to say, that not only is it not the first time that it has been used, neither has it been uniquely used by emerging countries, as some sustain.

Presently, the size of the problem of indebtedness, in the case of the more advanced countries, suggests the need for restructuring particularly in the countries on the periphery of Europe. Above all because in these countries, in the framework of a growth sustained below the average, it suggests that fiscal austerity is not sufficient even if accompanied by financial repression.

What has just been mentioned, added to what has been cited from Rogoff, with respect to emerging countries leads one to pay attention to some opinions with respect to the processes of restructuring that would allow their optimization, in as much as currently the debtor is wrapped in a process of negotiation with numerous creditors with different interest, in the framework of legal regimes that can result conflictive between themselves and generate tensions.

Differences between restructuring and reprogramming sovereign debt 

Generally, one speaks of debt restructuring (16), however Consiglio A. and Starvos A. (17) have introduced a variant that they have named “sovereign debt profile modification”. This consists in incorporating changes in the terms, such as extension of maturity dates, renegotiation of the rate of interest, and reduction in nominal value that allow the debtor the continuation of the payment of his service.

Moreover, when such modifications do not imply losses in the nominal value of the debt one speaks of “debt reprogramming” whilst the word “restructuring” is used in those cases where such losses have been registered (18).

That is to say, according to the said authors, a change in the indebtedness profile could involve, or not, losses in the present value that would allow, the debtor, to move concentrations of payments in specific years.

Likewise, they add that the changes in debt profile should be framed in denominated risk managements that go further than static analysis of debt sustainability and require that policy makers elaborate possible scenarios and develop measurements of risk that assure a high probability of debt sustainability.

According to studies from the previously cited authors, when considering both modes of debt crisis solution, debt reprogramming has been the most common and has prevailed over restructuring (19).

They conclude such affirmation from the evaluation of cases of debt crisis resolution in advanced and emerging countries, which have much in common in spite of their being registered with a difference of half a century. In both cases, they resorted to default and restructuring in difficult times and the magnitudes of debt condonation were comparable. The extension of the said crisis amounted to almost ten years.

On the other hand, according to C. Reinhart’s (20) analysis both categories of countries used “soft”(21) and “hard”(22) ways of crisis resolution. In the 20s (twelve cases of advanced countries) debt reprogramming involving new loans, extension of maturity term and interest rate reduction were registered, whilst in the 80s debt was reprogrammed and debt roll-over applied in 100 cases of emerging countries, failing in both opportunities to resolve the problem so leading to indebtedness. Overcoming the crisis was only attained with the reduction of the face value of the debt, which was put into practice in the case of the advanced countries after 1934 and in the emerging countries with the Brady initiative in 1990. Nevertheless this did not imply that the importance of fiscal restrictions, structural reforms, financial repression and inflation were not recognized.

The losses in debt nominal values, which restructuring involves, could later be transformed into important results such as improvements in economic panorama of the country, risk qualification and the sustainability of the debt (23).

In relation to the softer forms of crisis resolution, such as debt reprogramming, temporary suspension of payments and bridging loans, they did not translate into the previously mentioned results, and were not fruitful, for years, in the solution of the crisis associated to indebtedness.

Anyhow, if the debt is unsustainable there is no other option than its renegotiation, from a perspective that preferably preserves the value for debtors and creditors, keeping in mind the effects of the softest forms, of debt liberation, such as extensions to the maturity term and reduction of interest rates on growth and credit qualification.

It should be emphasized that some studies cite the Brady plan as a case where creditors and debtors benefitted from debt liberation. For example, the share markets of the Latin American countries that were involved in that framework appreciated 60% in real dollar terms.

Problems associated to changes in debt profile

The changes in debt profile (reprogramming and restructuring) are a complex problem. On the other hand, debt default could take approximately eight years to be resolved, and generally leaves the country more indebted than when it entered into default.

According to Stiglitz, amongst the aspects of a general character in which the majority of the countries that enter into restructuring programmes coincide, one may note the following:

• The said countries find themselves in a particularly weak situation, which obliges them to accept conditions that affect their long-term interests.
• In those cases in which the country does not find solutions to the obstacles that led it to default it could face a chaos whose seriousness would be in function of the extension of the period in which it remains in that situation, given that it would not be able to undertake transactions nor investments so limiting the normal development of its economy.

In this sense, solutions are required that give incentives to debtors and creditors to seek formulas, at the moment of the contracting of the credit, that would lead to efficiencies, as well as to the solution to the appearance of possible crises.

This suggests the need for a theory of debt renegotiation in order to avoid delays in the indebtedness profile change, as well as correcting the deficiencies in the present system, which creates a series of inequities and inefficiencies. In addition, the lateness of the debtors in identifying the problems leads the country to what the IMF calls “very little, very late” registering, initially, a high amount of loan, and later a lot of suffering, of which Greece is the most recent case.

On the other hand, the fact that the present system lacks the mechanisms that assure an ordered restructuration means that it is perceived as costly and that the political leaders try to postpone its execution. As a consequence, inefficient delays are registered that make the recessions more persistent and which could drag down with them the countries with which commercial relations are sustained.

There are various factors that are obstacles to the efficiency of the present system, and these will be dealt with in greater detail in a future article. However, the following may be briefly mentioned:

Credit Default Swaps… The opacity of this market overshadows the intentions of those who form the negotiation team, delaying restructuring. (The information will be amplified at a later date).

CACs (Collective Action Clauses)… These are legal clauses that allow changes in the emission of bonds through two options: Majority Enforcement and Majority Restructuring.

• “Majority Enforcement” provides the norm for the “Acceleration” of shares, including that which refers to the minimum percentage of bondholders that the rights claim would have to approve, that come from the law that shelters the debt once the moratoria has been declared. In this sense, the totality of the placements, realized under New York law, adopted 25% as the minimum number of votes to activate it.
• With regard to the necessary percentage for the contesting of such actions, variations were registered amongst the countries.
• For their part, the placements realized under the Laws of the United Kingdom and Japan contemplated a series of provisions or clauses that allow, to a qualified majority of bond holders, the modification of relevant financial clauses of their contracts which would facilitate the taking of decisions of all the bond holders pertinent to a determined emission, obliging a minority to accept what has been approved by the majority.
• The bonds whose debt contracts are emitted under German jurisdiction and subjected to this legal regime do not generally include CACs.
• The legal regimes mentioned can result conflictive between themselves and generate tensions.

Aspects related with economic policy… Amongst these the following should be emphasized:

The actors that execute indebtedness policy do not necessarily coincide with those that have to apply the sovereign debt restructuring process (SDR) which generally only takes into account short-term effects.

The fact that the costs of elaboration of the restructurings are perceived as very high leads governments to postpone their execution whilst the lenders prefer to undertake them in the short-term. This leads, amongst other consequences, to difficulties in reaching less favorable restructuring agreements and conditions.

On the other hand, the fact that many of the sovereign debt bonds are assumed to be collateral determines that a fall in their prices drags with it that of the instruments that they are supporting, with onerous results for the new emissions of those that serve as guarantors and that of other emitters of similar credit qualification.■

BIBLIOGRAPHY

Caruana J. Credit, Commodities and Currencies. Lecture at LSE. London, 5 February 2016.

Cecchetti G. Mohanty M. and Zampolli F. The Real effects of debt. 2011 BIS Working Papers No 352

Consiglio A., Starvos A. Risk Management Optimization for Foreign Restructuring. 2016 August, 2014 revised March 2015, December 2015. Working Paper 14-10 The Wharton Financial Institutions Center. The Wharton School, University of Pennsylvania, PA

Jorda O, Schularick M y Taylor A. When Credit Bites Back. Federal Reserve Bank of

San Francisco. Working Papers Series.2013.

Mody A. Saving the IMF. Project Syndicate. April 2016.

Reinhart C. Growth in a Time of Debt. American Economic Review. Papers and       Proceedings. 2010

Reinhart C. Rogoff K. Debt, Growth and the Austerity Debate. Abril 2013

Reinhart C. Financial and Sovereign Debt Crisis: Some Lessons Learned and Those Forgotten. IMF Working Papers 13266. December 2013

Reinhart C. Rogoff K. Dealing with Debt. Revised version of paper presented at the NBER International Seminar on Macroeconomics, Riga, Latvia, June 27-28, 2014.

Reinhart C. This time is different: Eight Centuries of Financial Folly. Princeton,

N.J: Princeton Universisty Press.

Rogoff, K. Are Emerging Markets the Canary in the Financial Coal Mine? June 2018. Project Syndicate.

Schadler S. Does the level of public debt matter? CIGI, Policy Brief. April 2016.

Stiglitz J, M. Guzman, D. Lombardi, J.A. Ocampo (editors). Fixing Sovereign Debt Restructuring. Journal of Globalization and Development, 6(2):181–213, February 2016. Special issue on sovereign debt restructuring,

Zetlemeyer J. Trebesch Ch., Gulati M. www. Duke Law Scholarship Repository 2013

 

REFERENCES

1. Caruana J. Credit, Commodities and Currencies. Lecture at LSE. London, 5 February 2016.
2. Zetlemeyer J. Trebesch Ch., Gulati M. www. Duke Law Scholarship Repository 2013.
3. Caruana J. Credit, Commodities and Currencies. Lecture at LSE. London, 5 February 2016.
4. Idem.
5. Idem.
6. Reinhart C. Financial and Sovereign Debt Crisis: Some Lessons Learned and Those Forgotten. IMF Working Papers 13266.December 2013.
7. Rogoff, K. Are Emerging Markets the Canary in the Financial Coal Mine? June 2018. Project Syndicate.
8. Of the discrepancy between expectations about the future capacity for repayment and the realization that determines actual repayment capacity.
9. Also of the disposition of the creditor to actions Such as roll-over.
10. Stiglitz J, M. Guzman, D. Lombardi, J.A. Ocampo (editors). Fixing Sovereign Debt Restructuring. Journal of Globalization and Development, 6(2):181–213, February 2016. Special issue on sovereign debt restructuring,
11. Consiglio A. y Starvos. A, have introduced a variant that they have named “modification of the sovereign debt profile”.
12. Bredenkamp H., Hausmann R., Pienkowski H, Reinhart C., Challenges Ahead. September 2018. IMF.
13. Non-compliance of a promise of payment, when it has been agreed, after the expiry of any period of grace.
14. Classified as a heterodox method of debt reduction by C.Reinhart.
15. Reinhart C. and Rogoff K. Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten. 2013. IMF.
16. The word restructuring is used sometimes to encompass all types of modifications of the initial conditions of the debt contract, but in our case we use it strictly to refer to the cases where there is loss in the nominal value of the debt.
17. Consiglio A., Starvos A. Risk Management Optimization for Sovereign Restructuring. 2016
18. Idem.
19. At the end of 2013 the IMF recognised that the decision not to impose losses on creditors in 2010 was an error.
20. Reinhart C. and Trebesh C. Sovereign Debt Relief and Its Aftermath. Journal of European Economic Association. February 2016.
21. Negotiated.
22. Unilateral.
23. Capacity of a country to confront its payments.

 

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