November 2004

Oscar Ugarteche

Responses to the comments are made to Prof Raffer, Kitazawa, Round, Kaiser, Eurodad with the contributions from UNAFISCO and Jubilee South

With many thanks to all, the issues that the Eurodad paper raises are if some countries should have a certain treatment different from others. In principle the answer is no if we are to take into account the arguments made in my paper and developed fully below. Debt cancellation for the poorest countries in this approach should be immediate and unconditional given they have no payback capacity and that conditions placed on them have further damaged their capacity to have economic development, even less to work their way towards the MDG. Negative resource transfers from countries with income levels of under 1,000 dollars per capita with a Ppp of about the same or less, a substantial percentage of the population with AIDS, and with massive undernourishment does not seem to speak of serious bargaining on the side of the creditors but on the exertion of power. If there was any evidence that HIPC conditions lead to better income levels, they might be considered, but there is nothing of the sort. HIPC conditions seem to confuse the issue that if Governments spend more on social sectors, they are advancing, much the same as is more exports per se led to more GDP growth, which it does not.. HIPC could be taken seriously into account if income per capita in terms of constant Ppp was improving, which it is not substantially. Nicaragua. Honduras and Bolivia are cases in point. It is not only too little too late, but inadequate.

It is correct that 100% of multilateral debt cancelled, but it should be expanded to all the rest of categories until the negative net resource transfer becomes cero or positive, and the conditionality should be related to economic, social and cultural rights, like for the rest of the countries. The MDGs is one step in that direction.

We agree with Eurodad on creditor co responsibility, an issue that has been going around but never quite managed by the G7 in its full magnitude. The first time the point came up was at an Organisation of American States conference on external debt, meeting in Caracas, September 7, 1983 which concluded with a declaration under the name Bases para un entendimiento where shared responsibility was brought forward in view of high US interest rates, inflexible conditions and a short leash policy of debt renegotiation. At the Latin American Conference of Heads of State held in Quito, January 9 to 13, 1984 the concept of co responsibility was recognised as a major issue at the political level and where they demanded that IFIs, international private banks and leading Governments take their share of their co responsibility as the same time as Latin American and Caribbean countries at the time made their best efforts to keep their payments to date. James baker, U.S. Secretary of the Treasury in 1985 said in Seoul at the IMF meeting made a debt management proposal which was recognition of co responsibility. The Catholic Church made its first report on debt and called for co responsibility through Un Informe Etico de la Deuda Internacional made by the Commission Pontificia in Roma in 1986 which then led to the Jubilee movement in 2000. The G7 made the same recognition in 1988 when it discussed the Toronto terms of debt management. The meaning of co responsibility does not seem to be clear. Eurodad demands that IFIs “need to publicly acknowledge the roles they played in exacerbating indebtedness in poor countries”. This is true not only for the poor countries but for all developing nations.

Finally Eurodad explicitly demands that the British Government take further steps into a much needed reform within the international debt architecture, with which we can all but agree. Specifically on the subject of an arbitration mechanism Eurodad mentions the FTAP as part of that new architecture The Halifax Initiative on this subject brings out the odd situation of IFIs as they have found in a survey amongst seventeen nations that

a national institution with limited public accountability should be co responsible for a multilateral public one marks an important accountability gap. This gap will probably expand as the trend towards increased central bank autonomy from Government expands. (14)

Halifax finds that there is a contradiction between the concept of development institutions and banks. On the second point they are profit motivated, on the first they are not. This means that the Ministry of Finance is responsible for it in most countries but Development Ministries are responsible in two. The contradiction found is that an institution with a mandate of a “world free of poverty” is overseen by individuals concerned first with fiscal prudence. The representatives at the IFIs are not approved by national Parliaments but are named directly except for the US. They are political appointees drawn from the senior ministries without any transparency. They render accounts to no one. The executive directors, un turn, are autonomous mostly, for leading countries. They consult exceptional matters only. The Scandinavians have a more democratic approach. From 2005 on, reports will be supplied to Parliaments in some countries related to the use of public monies by IFIs. The new international financial architecture requires more democratic IFIs in this view. Indeed this is required but regional IFIs are easier to monitor and have less power making negotiations possible between debtors and them. The idea of a world policy based bank, however democratic, does not seem reasonable nor does it lead to global governance. Policies must be supported by public opinion to be effective, which is something IFIs have against them today in view of persistent failures. It is true that democratising IFIs the role of “political party” they now hold would disappear, or they might become democratic political parties rather than parties with democratic centralism, that decide for the debtor governments what is good for them, and in that process makes the same decision for donor countries. With Halifax we share the view that “the declining authority of national democracies has not given way to democratic decision at the multilateral level, however.”(7) The world is becoming increasingly less democratic at a time of the search for more democracy. Ifis as well as the UN system, Halifax argues, “are either unable or unwilling to respond adequately to the challenges posed by an increasingly integrated world”. (7) “One hundred forty seven nation states have ceded vast authority over trade to the WTO yet it remains one of the most secretive and unaccountable bodies in the world. The IMF dictates policies to over 100 country ‘members’, yet is effectively governed by a handful of industrialised country governments.”(8) I understand there is complete agreement on this. Except, to the best of my knowledge, for Eurodad no one else has raised these issues so clearly. The new international financial architecture must be more democratic in various ways, which they present later in the paper. Their diagnosis on the increasing role of the Bretton Woods institutions is unquestionable as these really pave the way for economic policies under “an offer cannot be refused”.

The IBASD mechanism in itself is discussed by Prof Raffer and certain points remain unclear. The issue of debtor protection, which seems to be the last bone of contention pending with Prof Raffer is presented in our paper as a request via the secretariat due essentially to the matter that today, there is no debtor country protection and that this RIGHT as he puts it, is not recognized by anyone. In my modest understanding of things, if (the secretariat) as a UN agency (or whatever it is called) demands it, UN member countries will abide. Given I am not an international public lawyer and that this is a technicality, it might be worth inquiring into who seeks debtor protection. Up to now, debtor countries are sued, tried and blocked regularly as the Argentine case is showing us today. Domestically debtor protection is simple. Internationally it is unknown because there has never been such a precedent. Normally the debtor should seek its protection, but where, under what jurisdiction? Each and every one of them, domestically? Most private loans are hired via financial havens using New York or London law, mostly. Government bonds have these features. It is unclear to me who should seek, or demand, and where, the debtor protection. If debtor protection was available today, Argentina’s accounts would net be blocked around the world. The worst block is that in the Euroclear system which happens in New York under New York State Law, but there are others in every country. One initial role of the IBASD secretariat, or working group, could be to demand an immediate standstill and debtor protection world wide.

In order to have the right to debtor protection, the IBASD convention would have to be established first. I understand that this is a G7 member agreement, initially. I also understand the US is not interested in this at all as it is trying to build a bilateral board of arbitration for debtor countries under the FTA with the Andean countries and with the Central American nations. The international financial code is a long term aspiration that will support and international financial authority much as the UNCITRAL supports the WTO.

The reason for the secretariat’s role is that as an international body it would have the power to make sure that the debtors right is honoured and guaranteed and have the capacity to coerce those who do not comply. E.g. Argentina has no weight to coerce anyone into respecting its debtor protection rights.

In the IBASD model, the IBASD orders the universal standstill after the panel verifies the debtors arguments for filing for the insolvency procedure. This is a unique procedure as so far standstills are national in scope. Under the US law, under the British law, etc. This does not worsen the debtor’s position,. It only makes clear that the standstill will be applied by all creditors at the same time everywhere, which today is inexistent.

I do not see why crisis prevention is such an issue. For debtor nations, a sudden rise in international interest rates as occurred in 1980-1981 when it jumped from ?3.2 to + 26% is more than a reason to go and prevent what is an imminent balance of payment crises. While it is true that developing country surpluses covered the US external deficit of the 1980’s, it is also true that we lost a decade, and now it seems that two decades, of economic growth. In personal loans, insurance is available in case the debtor dies, for example. In international loans, there is no insurance against unreasonable jumps in interest rates generated by the monetary policy of any particular leading nation. Attempts have been made at indexing bonds to GDP growth with no success for the reason Raffer suggests. It is better in the name of risk aversion and stability from the debtor side to borrow less, have higher tax pressures, and be willing to pay more for the money borrowed that to borrow cheaply and when, the US goes into a binge, the sky is the limit for interest rates.

As far as the option between refinancings and reschedulings, they are options the Board would choose depending on the costs and possibilities. I am opening doors rather than narrowing the scope. On the whole, complete payment reprogramming is less costly and will be even less so using the DSA, understanding “costly” as the national capacity to pay over time in terms both of the national budget and the balance of payments.

The reason to have one time debt reductions is that the board must have a good analysis of the DSA when it recommends the new payback schedule. Done using reasonable MDG objectives and with a long term view, the reduction would hold. Otherwise, what we would be doing is squeezing the debtor little by little until the full reduction is made. My impression of negotiations is that the creditor has all the power and does not want to let go. This is shared by the Jubilee South movement. In the reverse, if debtors have the capacity to demand a one time major debt reduction, the ‘bleeding” is reduced. Jubilee South includes the ecological; debt as a demand that would annul the debt given the ecological debt is larger than the entire foreign debt, in principle. The issue there is how to quantify it.

If we look a the various terms agreed upon at G7 meetings, it is evident that what seemed to be impossible in 1988, when the Toronto terms were agreed, was totally unrealistic and useless by the time the Evian non terms were signed in 2003. Fifteen years of financial bleeding to no end other than the exertion of power from the debtors angle. A one time reduction forces the G7 to think correctly at what is feasible. If this is unrealistic, I take it back. Raffer and I agree that continuous refinancing is not good for the debtor. It is wonderful for the creditors because the cost of the debt increases and ensures net resource transfers abroad. Since 1998, again developing countries are exporting capital de the G7 via the debt. With major debt reductions some creditors “loose” in the end, but how much suffering is inflicted on the debtor nation’s population until this happens? Is this necessary?

I have not said that OPEC is responsible for anything, so all Raffer’s reasoning after that line of thought must be set aside.. What I have said is that banks “lent to debtor nations that had no oil, because thy had no oil and major deficits appeared, and to those who had oil, because they had oil, that is t say, bankers lent to anyone because there was a lot of cash going around”. The explanation for the excess liquidity, in my view, is related to the deregulation of the currency and gold markets in August of 1971 under the Smithsonian Agreement, which then led to a major devaluation of the US dollar between 1971 and 1973. The interest rate jump in the early 1980’s was generated by Reaganomics. Indeed there is no mention of OPEC because in none of my work has that been the issue starting from my first paper published in 1976. In Estado Deudor, la economia politica de la deuda de Peru y Bolivia 1968-1984 published in 1986 and available at the Library of Congress in Washington, the entire first part is dedicated to how the Euromarkets developed. OPEC is not on my list. With Raffer we share the view that the laxity of lending is at the bottom of the story. We differ with the bankruptcy argument. I still insist that countries do not go bankrupt the way private firms go bankrupt. In this sense I would argue that a national cease payment is not a bankruptcy because assets cannot be liquidated, the firm put out of business nor management substituted. In that sense I am closer to Wriston’s 1976 view. Because there is no real bankruptcy is that the moral hazard problem we observe, happen. This issue is irrelevant to our current discussion on IBASD.

The discussion on the use of bonds in order to have a long run, one time reprogramming, was held in Latin America not only by Bresser, but was a major part of the discussion held amongst Latin American academics as to how to come out of an entangled system that was that depressing us. In every major debtor country someone was speaking of bond conversions using the XIXth century history of debt crises solutions. In the US, Prof. Kennen from Princeton I recall brought the point up in the early 1980’s. There was a consensus in Latin America by the time the Baker plan was designed in 1985, that only a long payback period with a return to the original amount owed would make the debt payable. That is why Baker failed in 1985. This led to the consensus amongst debtors that very long term bonds were the only reasonable answer. The Brady Plan in 1989 caught on quickly for that reason. It was when the creditors listened to the debtors that things changed and became manageable for all, but certainly it was not enough. Debt reductions were nowhere near in proportion to the debt increase caused during the decade by continuous refinancings and the unusually high US$ interest rates.

To start a procedure from the DSA is to believe that the debtor Government does not have the capacity to recognize when it can or cannot meet its payments. Creditors have little or no leeway in face of the fact that a debtor finds it cannot meet its payments. If there is to be a consensus on the DSA instrument, there should need to be agreement on its use in order to decide when to suspend payments and proceed to go to the IBASD. Particularly when what is at stake is the management of the national budget and spending in education and health in order to meet the MDG. It must be kept in mind that Government wages have been reduced substantially in developing economies over the past three decades in order to make ends meet while the foreign debt is fully paid, and that this has had a negative impact that is not counteracted by the MDG under existing tax revenue restrictions. So far, the DSA revised do not take wage stability into account.

What has happened so far is that creditors refinance, or reprofile bond debt, pressing the debtor Government to use up as much of the national budget as possible athe the expense of Government wages. The income side of the fiscal balance sheet remains intact and MNC as well as new private investors pay little income tax as a result of the investment promotion policies. The 1980’s saw how Governments exported more than half of national savings at the cost adjustment policies which reduced Government wages, education and health expenditures, thus disorganizing the Governments bureaucracies and overall creating conditions leading to a loss of governance. This has not been reversed during the 1990’s after the reforms were in place.

China is a member of both the IMF and the World Bank, is a major international creditor holding over 1 bn dollars in external assets, and has the same voting rights at the IMF as Canada.

Currently, with the fall in tax income ?not only? in developing countries as a result of investment promotion mechanisms, and the imminent raise in the US Dollar interest rates as a result of the US Dollar devaluation, we are facing a situation where leading debtor countries are going to face payments problems.

The DSA becomes useful during the negotiations as a model where certain expenditures can be incorporated and certain suppositions of export and GDP growth included so that a reasonable payback period can be properly calculated, supposing stable wages...

No debtor Government will want to use the IBASD until it is in place because, as some foreign ministers told me two years ago when we were pushing with Acosta the initial IBASD idea, debtor Governments don’t want to appear as having problems in order “not to frighten the market”. Most South American ministers of foreign affairs responded this when we sought support at the UN system. This is how we ended at Parlatino, the Latin American parliament. Kaiser is right in his observation that it is fruitless to pursue something that Governments do not want to use. However, given the world scenario, the problems in the world economy will continue evolve towards debt payment problems. Ecuador, Argentina and Paraguay are the tip of an iceberg that will be better seen as the US interest rates go up and we enter the seventh year of negative net resource transfers from the South to the North. In fact, the Latin American nations have been working at Innovative Market based instruments after the Cuzco meeting of the G8 countries in 1992. This has so far failed. Recently President Lula of Brazil met in London with Jacques Chirac, Ricardo Lagos from Chile and Koffi Annan and made an announcement that includes the following point

We recalled that the Monterrey International Conference on Financing for Development and the Johannesburg World Summit on Sustainable Development provided important parameters for building coalition and support towards a global partnership. Such efforts call for a prompt implementation of commitments and actions from both developing and developed countries, including through partnerships with NGOs and private companies. We also highlighted that adequate funding must be provided to the UN agencies. In addition, innovative sources of financing should be explored.

The carbon financing mechanism in one such. This is meant to counter the negative net resource transfer problem but does not solve the payments problem in face of rising interest rates and negative net resource transfers, much alike the early 1980’s. Countries will see the need with time.

So far the mechanism to reach our goal must be multilateral in the political sphere. Multilateralism was stressed in that announcement once again. The SELA in Latin America responding to the demands of the Parlatino is the path chosen for our lobby so far. Parlatino has already taken it up and should pressured to send it to SELA at some point. It would be inconsistent and suicidal to look into G7 controlled IFIs to advance an institutional change. The G7 will be convinced on time. So far only Germany and Britain seem to be on our side given the work done by Kaiser and his team and the post Jubilee work in Britain. France, Canada, Japan, the us are flat set against any change. IFIs are change averse by definition. The SELA and then ECLA route sounds more reasonable from the debtor civil society side. The discussions held at the UN on intermediate nations is a proper space for debate over the next couple of years and must be used as well..

IBASD is strongly related to SDRM and to the Chapter 9 mechanism also proposed in the FTAP. It owes to all of them and has as a major difference the elimination of creditor preferences. No creditor in this proposal is exempt from a global rescheduling. The idea being that Governments don’t have any reason to give debt relief that will benefit the payback capacities to other creditors. This is the situation now with the exception of HIPCs. Middle income debtor countries are full of creditor free riders that benefit from the debt reduction schemes of G7 Governments. The most important free riders are the IFIs.

The convergence of IBASD with the other mechanism lies in the creation of a board of arbitration that will work out a feasible debt repayment calendar. This is related to the DSA considerations.

The SDRM is only for bondholders and private creditors while IBASD includes all. FTAP considers all willing creditors.

The SDRM considers using the IMF a window to place the demand for a debt restructuring mechanism. Both the FTAP and the IBASD, seek a non IMF window. The FTAP is into an ad hoc mechanism, the IBASD believes it should be a permanent mechanism, with a permanent window who calls for boards to get organized but that has a permanent status within the UN system. The IBASD attempted using the Paris International Chamber of Trade system but it has turned out that it would only deal with private creditors, which has brought IBASD even closer to FTAP in terms of the UN system. A permanent secretariat at UNCTAD or at the Secretary General’s Office level could be a start. This has not been discussed yet by neither.

IBASD tries to construct a global rule of law for all creditors under a procedure similar to the one used for the creation of an international trade law. Raffer agrees with this point. SDRM does not touch it.

The SDRM touched upon the collective action clauses (CAC) and suggested them in the emission of Mexican bonds during 2002 after the Elliot Case scandal broke out with Peruvian paper. We are all in agreement that collective action clauses are essential to prevent free riders within bondholders. Mexico was warned that including CAC would increase their spread but in reality it was not substantial to any significant degree.

Much as in the personal treatment of bank debts, the capability of debt paybacks under a long term calendar and fixed interest cost is the base. The distribution of the weight of the debt in time is the definition of debt sustainability in its original Withers definition of 1927. This distribution should be such that the debtor is able to meet the payments. If there is agreement that debt should not be more than X percent of the national budget, and that in order to meet the MDG there must be budget considerations for health, education, sanitation and infrastructure, that should be the base, considering a certain wage level. Otherwise those expenditures are kept at the cost of depressing Government wages.

Using very long term instruments with fixed interest rates is the second step.

Debt reductions should be done accordingly to fit both criteria. Indeed the Argentina calendar will look differently from the Ethiopia calendar, one will require substantial debt reductions, the other, not. The criteria should be the same. It is one mechanism, one world and one system. It would be a matter of proportions.

The responsibility for the debt crisis must be bourne in the shape of debt reductions, it is a matter of proportions and possibly of the underlying elements the fed into the specific national crisis. We all know that debt crisis are recurrent and universal, but the external side has an internal counterpart that must also be taken into account. Additionally, as the IMF role in the 2001 Argentina crises shows, IFIS also have a responsibility that must be accounted for and paid.

Odious debt has its doctrine and that must be respected. Any loans given to a dictatorship to harm its people or to keep itself in power is odious debt. The conventional definitions of political science as to what constitutes a dictatorship must be considered and the odious debt doctrine followed. The FTAP and IBASD agree on this point. Southern Governments don’t want to hear about it except for the Iraq case where it has been agreed. So far the odious debt doctrine has only worked when the US has wanted it to work, most recently in Iraq.

There is a side to this referring to the legitimacy of the debt. Indeed this is an issue that has had much discussion over the past five years and about which there is no disagreement. There is a clear conscience amongst civil society organizations, expressed in the Conclusion of the International Workshop on Debt Auditing held in Brasilia November 9-11, 2004 organised by UNFISCO and Jubilee South that corruption is present and must be detected from outside the Governments. There is an agreement that it is

“The State’s obligation to render accounts to the citizenry. It is also a reflection of our right to be informed, to participate in the decision making on policies that affect us, and to exercise control and vigilance over Government action”.

IN this sense, a condition for any IBASD procedure could be to demand an audit of the loans using all of the criteria detailed in the document’s conclusions, in the event that this has not been done by the proper domestic authorities in its time with the results presented to its citizens.

The result of this procedure would lead to a recognition that certain loans hired in some cases decades before the audit are corrupt. Raffer suggests that this leads to a declaration that they are “null and void”. I go along with this idea but legally it would require further elaboration, in my understanding. The international penal court, not yet designed for international corruption would be one such place, domestic courts would be another. Are corrupt loans null and void by definition? Or should an international agreement be held and included in the international financial code in this sense. The greater problem is that of debt conversions, particularly from commercial paper into Brady bonds. Brady bondholders are not lenders of the original corrupt loans and this presents a problem. This issue is not present however in bilateral or multilateral loans

Ecological debt, a matter taken up by President Kirchner at the inaugural speech of the World Climate Summit held in Buenos Aires a the end of 2004, is a political argument that must be calculated and put in numbers with the assistance of environmental economists. The definitions made by Martinez Allier are clear and the next step is to make the calculations in order to reduce the NPV of debts by type of creditor by nation. There are attempts at financial innovation through Clean Development Mechanisms but as long as the numbers are not put over the table and the fact that global warming, the melting of the Andes snow, climate changes, etc are the responsibility of those high energy using country governments that do nothing t reduce their contamination and to the added fact that in the process of extraction of raw materials, wastage is left at the same time that we trade more highly value added goods, leaving the waste and contamination in the developing countries. Clean industries in lading economies are done at the expense of ecological hubris in the rest of the world.

An agreement should be made as to whether this type of ecological debt is paid by creditor governments, or the private sector through an international tax. This must be worked through. A simple proposal is to estimate the ecological damage done in the past 40 years by energy and other pollution in the north, and deduct from Governmental debt the amounts that result. If it is larger than the creditor Government loans, then the left over should be used for IFI debt reduction... A fair amount of the debt intermediate countries pay today have the 1970s as their point of origin. The argument here is not the oil prices of the 70’s are responsible for the lending and borrowing but that real interest rates at the time where ?3.2% making it very reasonable to borrow. The fact that real interest rates went from ?3.2% to +26% in 1982 helps to explain why we all fell into the dame ditch at the same time. The cause for that to happen were Reaganomics and the massive US budget deficit.

Our problems arose from a global injustice, one Government was allowed to do what no other Government can, hold a massive budget deficit, thus absorbing resources from around the world through debt payments. This is a major reason to argue for a World Central bank or World Financial Authority. Currently it is happening again.

The IMF should be turned into an International Monetary Authority with the role of coordination of economic policy amongst all members. Today, the international system is divided into the G7 that do their coordination amongst themselves allowing counter cyclical policies, and the rest of the world (180 countries) that cannot have counter cyclical policies but that are pushed into deeper crisis when they are forced to use pro cyclical policies at times of slowdowns and world problems.

On the other side, the World Bank has turned since 1986 into a political party that pushes an economic doctrine, lends the money and supplies the professionals to the borrowing Governments. It has a high disregard for democracy as we can see in Iraq, were it entered at the side of a military invasion, or in the case of Peru, where it became the lead lender to the Fujimori dictatorship, to name two. When it changed from project based lending to policy based lending, it bypassed the concept that for policies to work correctly in a democracy they must be legitimate, and in order to be legitimate they must be considered by the population where they are going to be applied, This basic element of political science 101 was bypassed in all the economic reform process everywhere creating governance problems for which it bears no responsibility. In the Andean region this is obvious. My suggestion is to reinforce regional development banks for environmentally friendly infrastructure loans. Redesigned regional banks could be financed by the CTT with a much larger stake held by civil society organizations in their boards.