Some sovereign debtors and private creditors have been attempting to develop voluntary Principles of stable capital flows and fair debt restructuring in emerging markets , but progress has been slow.

Sovereign obligations, such as bonds, are commonplace in the capital markets, and demonstrate strong investor demand and confidence.

Beban Utang Tersembunyi pada Negara negara Emerging Market

The US sovereign debt market shows no similar evidence of having reached a limit yet. But bond markets do not issue many early warning signals witness the sudden run up of yields in Italy and Spain a year ago.

The Coming Emerging Market Debt Squeeze

Permanent debtor creditor dialogues, the provision of transparency, and information on emerging market debt would be ensured through the creation of a permanent international debt framework secretariat.

The broader message of the Greek move is that coordination has so far been a code word for almost total control by creditors (sometimes together with the ECB). The attempt to impose a benevolent creditors dictatorship is now being met by a debtors revolt.

Nonetheless, Argentina s latest debt trauma shows that the global system for sovereign debt workouts remains badly in need of repair. Deepening domestic debt markets and perhaps change along the lines proposed by the IMF is sorely needed.

Sovereign debt restructurings with private creditors

On international financial markets, the war in Georgia has rendered Russian debt and bonds toxic. Interest rates on Russia s bonds have risen by 2 3 percentage points, and many Russian creditors no longer have access to international capital markets.

(b) Debtor creditor dialogue to explore alternative market based approaches for dealing with debt service difficulties in order to avoid defaults

At the very least, it renders non viable all debt restructurings under the standard debt contracts. In the process, a basic principle of modern capitalism that when debtors cannot pay back creditors, a fresh start is needed has been overturned.

Moreover, some debtor countries which have gone through debt restructurings soon resumed their access to capital markets.

Recognizing the current debate on sovereign debt restructuring, especially the efforts led by sovereign debtors and private creditors to develop a voluntary code of conduct, and stressing that modalities for sovereign debt restructuring should be voluntary, market friendly and flexible, with due consideration of the specific circumstances of individual countries, and should result from the participation of all relevant stakeholders,

Some might assume that bond markets are shielded from the effects of climate change, ecosystem degradation, and water scarcity. With more than 40 trillion of sovereign debt in global markets at any given time, that is a very high risk game.

The critical policy mistakes were those committed at the outset of the crisis. It was already clear in the first half of 2010, when Greece lost access to financial markets, that the public debt was unsustainable.

How Scary Is the Bond Market?

Table 3 Recent sovereign debt restructurings with private creditors main features

For both borrowers and creditors, the risks and costs are enormous. The borrower is cut off from international markets, and essential imports can no longer be purchased, while large scale defaults threaten to plunge creditors into insolvency.

How to Default on Sovereign Debt

Sovereign Debt at Square One

However, that strategy resulted in increased contractual debt obligations, contributing to a further deterioration in markets sentiment regarding debtors creditworthiness and continued delay in the eventual restoration of their access to capital markets.

The CDO market, however, was concentrated six or seven issuers controlled most of the market, and this market ended up representing 50 of the entire revenues to be gained through ratings. All of a sudden, issuers had much more influence on the rating agencies, which, like any good seller, were ready to bend a little not to alienate important customers.

When the US housing market started to turn south, the biggest underwriters (such as Countrywide) did not go bankrupt right away, because they had sold the vast majority of their loans to the CDO market. Eventually, however, the uncertainty created by these CDOs nearly brought down the entire US banking system.

A New Approach to Eurozone Sovereign Debt

The Root of All Sovereign Debt Crises

In addition, the ECB could purchase EIB bonds on secondary markets, which would help to keep funding costs low or even reduce them. More important, purchases of EIB bonds would enable the ECB to undertake quantitative easing without triggering the degree of controversy implied by intervening in 18 separate sovereign bond markets, where concerns that ECB purchases would affect the relative pricing of sovereigns are very real.

Moreover, financial markets underpriced private and sovereign credit risks, in the implicit belief that no one would fail, and that all debts would somehow be made whole, implying weak market discipline on borrowers.

Griesa, for his part, showed no compunction about upending a financial order in which market based exchanges of old bonds for new ones are used to restructure the debts of countries unable to pay. By making it impossible for sovereigns to restructure, he effectively rendered them unable to borrow in the United States.

15. Reiterates the importance of the orderly resolution of sovereign debt crises, notes the increasing voluntary use of collective action clauses in international sovereign bonds, and takes note of the efforts led by sovereign debtors and private creditors to develop a voluntary code of conduct for the resolution of sovereign debt crises

Until the euro crisis, it was generally believed that problems servicing sovereign debt occurred only in emerging markets and the least developed countries. The US Supreme Court s decision on Argentina adds a new wrinkle, and may well further increase the risk attached to holding sovereign debt and this to the cost of issuing it.

Sovereign debt for sustained development

The answer is to emulate the response to sovereign debt crises in Uruguay, Pakistan, Ukraine, and many other emerging market economies, where orderly exchange of old debt for new debt had three features an identical face value (so called par bonds) a long maturity (20 30 years) and interest set well below the currently unsustainable market rates and close to or below the original coupon.

Europe s Time to Learn

When a sovereign decides that its foreign debt is unsustainable, the government and its creditors have had to negotiate among themselves about what to do. For sovereign bonds held by other sovereigns, the Paris Club of creditor countries has developed procedures for handling the debt.

That way, formal haircuts on the face value of debt can be avoided via new bonds that include only a maturity extension and an interest rate cap that is set below today s unsustainable market rates. Waiting to restructure unsustainable debts would only lead to disorderly workouts and severe haircuts for some private creditors.

In 1989, the Brady Plan was announced with unprecedented official commitment, most particularly from the United States of America, Japan and the Bretton Woods institutions, to support debt reductions in line with debt prices on the secondary market.6 For many indebted countries, this market based approach allowed a reduction of external debt at a significant discount.

The fair value of a liability instrument shall be determined on the basis of the market situation of the day when it is acquired or issued and the current market situation, or the current market interest rates of other similar liability instruments (namely, having a similar remaining period, mode of cash flow, pricing currency, credit risks, basis of guarantee and interest rate, etc.).

The simplest solution is to treat official funding no differently from private debt best achieved if official lenders buy sovereign bonds as they are issued (possibly at a predetermined yield) and agree to be treated on par with private creditors in a restructuring. As the country regains market confidence, the official funding can be reduced, and eventually the bonds can be sold back to the markets.

(a) To simplify debt sustainability analysis18 and fully involve debtors in determining sustainability criteria (debtors ownership of debt sustainability analysis)

This would include, at a minimum, reforms of labor rules, pension systems, and anti growth provisions of tax codes. It would also include an aggressive attempt to reduce the sovereign debt overhang that remains a major impediment to growth and continues to threaten some European banks.

So the only realistic and sensible solution is an orderly and market oriented but coercive restructuring of the entire Greek public debt. But how can debt relief be achieved for the sovereign without imposing massive losses on Greek banks and foreign banks holding Greek bonds?

In the insolvency of a non grantor debtor, the creditor is an unsecured creditor with an unsecured claim against the non grantor debtor.

On 29 June 2005, the Paris Club creditors announced their agreement to enter into negotiations with Nigeria on a comprehensive exit debt treatment, which would include debt reduction up to Naples terms on eligible debts and a buy back at a market related discount on the remaining eligible debts.

Where the credit risks of the debtor and the applicable credit risk agios remain unchanged after the issuance of the liability instrument, the benchmark interest rate may be adopted to estimate the interest rate of the current market so as to determine the fair value of the liability instrument.