Though the words debt restructuring repeatedly come up during discussions on the Greek crisis, the priority remains to implement the EU-IMF stabilisation package that can foster domestic efforts in Greece. However, Bruegel director Jean Pisani-Ferry and Senior Fellow André Sapir warn that the European Union needs to stay ahead of the curve and prepare a debt resolution mechanism in the event that a eurozone member has to tackle unsustainable debt. The authors argue that a European debt restructuring mechanism - on the lines of a sovereign debt restructuring mechanism, a suggestion that came up in the context of the Argentinean crisis - could be a realistic option. Questions about institutional coordination in activating an EDRM could pose a challenge.
Solvency has become a big issue for Greece because of a cocktail of high current debt levels, large primary fiscal deficits, high interest rates and negative growth prospects. There are serious reasons to doubt that the country will be able to repay its debt entirely, even if it implements in full the large and protracted budgetary adjustment now on the table, and regains competitiveness. Other eurozone countries face difficulties of a similar nature if not of similar acuteness. The issue has a strong European Union‐wide dimension as public debt is largely held by residents of other EU countries. So the question arises: how should the eurozone deal with debt restructuring by one of its members?
Although the question is starting to be openly recognised, it is generally considered too early to contemplate restructuring Greek debt, because of a risk of contagion to other EU countries and because partner countries want first to see thorough action on the part of Athens. What is regarded as the best strategy for now is to implement a stabilisation package, with EU and International Monetary Fund support, which would accompany and foster domestic efforts.
With or without debt restructuring, Athens has to cut spending aggressively, raise revenue and redirect both spending and revenue to foster growth for years to come. But the EU should not run the risk of again being behind the curve. Given the likelihood of debt restructuring down the road, it should waste no time in designing a European debt resolution mechanism to help members with unsustainable debt to resolve it with their creditors in an orderly way. This should go hand in hand with reform of the crisis prevention regime, which is sorely in need of repair.
The issue of sovereign debt restructuring last gained prominence nearly 10 years ago when a number of emerging countries, particularly Argentina, faced severe public debt crises. The situation led to an intense debate about how to manage and resolve such crises. A central issue then – as potentially now – was that sovereign debt restructuring with an internationally diverse and diffuse creditor community poses co‐ordination and collective action problems.
Two solutions were suggested. Some proposed contractual reforms, making it easier for the private sector to restructure debts by imposing collective representation clauses. This idea was eventually adopted in 2003 when Mexico first issued bonds with collective action clauses. The other solution, originally proposed by Anne Krueger, the then IMF first deputy managing director, was more ambitious: a sovereign debt restructuring mechanism that would provide a statutory framework for debt crises. Bruegel ©2010
According to its proponents, the SDRM would have bound together all countries, superseding the diverse and conflicting provisions of private debt agreements. The mechanism, when activated, would have allowed a temporary stay on litigation followed by talks on a restructuring between creditors and debtors. Decisions, by a specified super‐majority, would aggregate across instruments and be binding on all.
The SDRM never saw the light of day because of Wall Street’s adamant opposition, the lack of perceived shared economic interests among IMF members and twitchiness about supranational solutions. There are two reasons, however, why the EU should take inspiration from it.
First, the absence of a mechanism for orderly debt reduction is no guarantee that debt reduction will not take place. Rather, it makes a messy outcome more likely as each creditor country stands behind its banks and insists for too long on full repayment. This is what happened in Argentina in 2002. No one wants to see such a scenario in the eurozone.
Second, the EU is a community of law. Despite different economic interests, member countries are more likely to accept the kind of supranational statutory mechanism rejected at global level. Shared interests, be it in terms of the single market or single currency, should hopefully prevail, and make the EDRM more realistic.
The most difficult question is institutional: who could and should be entrusted with the power of decision and arbitration? The spirit of the EU treaty suggests that, as for the stability and growth pact, the final say in fiscal matters must belong to the European Council, which groups national governments. But it should act only on the basis of proposals by the three institutions in charge of preparing assistance programmes: the European Central Bank, with prime responsibility for the stability of the euro, the European Commission, which represents the common European interest, and the IMF, whose role is to ensure consistency between European and global practice.
The writers are director and senior fellow with Bruegel, the Brussels‐based European think‐tank
A version of this op-ed was published by Financial Times.