Returning to fundamentals: principles of international law applicable to the resolution of sovereign debt crises.

Authorde Jonge, Alice

    Sovereign insolvency has early precedents. (1) Philip II of Spain had to declare moratoriums on the repayment of Spanish debt in 1557, 1560, 1575, and 1596, largely due to the rising costs of various military enterprises. (2) Many other sovereigns have defaulted on the payment of international debts since that time. On each occasion, almost without fail, extensive debate over the legal and economic aspects of sovereign debt crises have followed, just as they have followed recent financial crises in Iceland and Greece. Given the likelihood that such crises, and such debates, will continue in the future, there is an evident need for the world to reach agreement on a coherent set of guiding principles and procedures to facilitate the resolution of such crises. The establishment of an agreed mechanism for handling sovereign debt crises is essential if the world is to avoid the kind of political impasse that, at the time of writing, is causing such harmful delay in bringing about a resolution of the Greek debt crisis.

    In its 2010 report to the Hague Conference of the International Law Association (ILA), the ILA Sovereign Insolvency Study Group identified four broad policy pathways forward when it comes to handling sovereign debt crises. First, there is the option of doing nothing, so sovereign debt defaults or financial difficulties continue to be dealt with exclusively by voluntary negotiation, and agreement between creditors and debtor state. This has happened for at least the last one thousand years. Second, a minimal layer of legal rules to govern the conduct of the insolvency could be created in the form of a limited provision for creditor voting on a debt restructuring plan. Third, a more comprehensive layer of legal rules could be put into place, which would reflect relevant aspects of private sector insolvency reorganization regimes. The rules would not have any mandatory application, and in many cases would not be used. This occurs in the corporate arena when financial difficulties are dealt with by way of private agreements, or "workouts." The sovereign insolvency reorganization regime would provide a background against which debtor-creditor negotiations would take place. Fourth, a different style of insolvency regime could be designed which would emphasize stronger creditor rights, and in which debtor protections would not be the kind of feature they are in domestic insolvency regimes. Again, the legal regime would exist as a background against which negotiations would take place. (3)

    This paper explores the international law principles that should be taken into account when choosing among these policy options, and in reaching agreement on a global mechanism for resolving sovereign debt crises. The principles explored are those of general international law. In asking what international law has to say about the way in which sovereign debt crises should be handled, I turn to the various sources of international law as recognized in article 38 of the Statute of the International Court of Justice: international conventions, whether general or particular; international custom, as evidence of a general practice accepted as law; the general principles of law recognised by civilized nations; and judicial decisions and the teachings of the most highly qualified publicists of the various nations. (4)


    Examining international custom, both state practice and opinio juris, this paper briefly outlines the history of approaches to handling sovereign debt crises. Examining state practice is particularly important given the lack of internationally accepted codifications relating to this area of international relations. This paper then examines general principles relevant to the handling of sovereign debt crises which can be found in widely accepted treaties and other instruments of international law.

    Since the earliest days of Westphalian sovereignty, (5) nations have dealt with international debt crises in a variety of different ways. Indeed, responses to sovereign debt crises, by both debtor states and their creditors, have been as diverse as the many paths leading to such crises in the first place. While numerous calls have been made for the establishment of a single set of consistent principles for dealing with sovereign debt crises, (6) so far the world community has not been able to agree even on the need for such a set of principles. So, sovereign debt crises continue to end up in default, either partial or total (e.g., Argentina, Mexico, Peru and other South American states in the 1980s), (7) bailout (e.g., Greece in 2010-2012), and/or one of a variety of approaches to sovereign debt restructuring. (8)

    1. Debt Moratoriums, Exchange Controls, and Bailouts

      1. Debt Moratoriums

        One common response to impending or actual sovereign insolvency has been the unilateral declaration of a debt moratorium by the debtor state, sometimes, but not always, following consultation with creditors. A debt moratorium is a delay in the payment of debts or obligations. It may take the form of a complete cessation of debt payments, either permanently or for a limited period of time, or a partial cessation. (9) A debt moratorium can usually be seen as a unilateral attempt by a debt-burdened state to bring about a restructuring of its debt. (10)

        A state-declared suspension in the payment of international debts can be the by-product of wars, revolution or civil conflict. Turkey, Bulgaria, and Austria-Hungary suspended debt payments to enemy-country creditors at the beginning of World War I. Italy, Turkey, and Japan did the same at the beginning of World War II. Mexico (1914), Russia (1917), China (1949), Czechoslovakia (1952), and Cuba (1960) repudiated their debts after revolutions or communist takeovers. Some countries, such as Austria (1802, 1868) and Russia (1839), defaulted after losing wars. Others, such as Spain (1831) and China (1921), defaulted after enduring major civil wars. (11) However, a majority of sovereign defaults and debt restructurings that have occurred since the early nineteenth century--including almost all that have occurred since the late 1970s--do not in fact belong to this category, but reflect more subtle interactions between domestic economic politics and shocks to the economy, including changes in the external environment. (12) Sturzenegger and Zettelmeyer have noted the way in which defaults of this type are bunched in temporal and sometimes regional clusters, corresponding to boom-bust cycles in international capital flows. (13) A number of Latin American countries defaulted or restructured debt when the post-World War I lending boom ended in the bust of the 1930s. The mid-1980s saw another cluster of defaulting states, including Argentina, Cuba, Dominican Republic, Ecuador, Mexico, Panama, and Venezuela in 1982, and Brazil, Chile, Costa Rica, Peru and Uruguay in 1983. This cluster of defaults followed the 1970s boom in bank lending to developing countries. (14) Elsewhere in the world, capital flows to Africa in the 1970s were triggered by African decolonization and independence, which were followed again by defaults and/or restructurings throughout that continent: Liberia in 1980; Madagascar, Senegal, and Uganda in 1981; Malawi in 1982; Morocco, Niger, Nigeria, Senegal, and Zambia in 1983; and Tanzania in 1984. (15)

        Debt moratoriums typically have been partial in nature, aimed at significantly reducing rather than stopping debt payments altogether. In 1985, Peruvian President Alan Garcia implemented the so-called "Ten Per Cent Solution," refusing to allow more than ten percent of export earnings to be used for debt payment. (16) Other states have similarly reduced the amount of interest they were willing to pay: Serbia in 189517; Portugal in 189218; and Greece in 1893. (19) A unilaterally declared debt moratorium also may affect only a percentage of the creditors of the debtor country, leaving some unaffected. On November 14, 2008, Ecuador entered a technical moratorium on its foreign debt. (20) In December 2008 and March 2009, President Rafael Correa stopped payments on $3.2 billion in bonds due 2012 and 2030, saying the securities were "illegitimate" and "illegal." (21) Ecuador did continue payments on its 2015 bond, however, thereby minimizing the reputational costs of a more comprehensive default. (22)

        A moratorium on sovereign debt payments conceivably might be suggested or offered by or on behalf of creditors. In 2010, following devastating floods in Pakistan, Reverend Tim Costello called for creditors to allow a two-year moratorium on its debt in order to allow it to assist those displaced by the floods. (23) He noted Pakistan was spending three times as much servicing its debt as it was spending on health services for its own people, (24) Such proposals are rare though, and the role of creditors is usually restricted to trying to reduce their overall potential losses and maximizing the gains to be achieved from negotiating a restructuring of debt. This was seen when the debt of Pakistan was rescheduled in 2001. (25)

        Proponents of debt moratoriums argue they are sovereign decisions made by the government for the welfare of its citizenry. (26) A number of commentators called for Iceland (2009) and Greece (2010-2012) to unilaterally declare a debt moratorium rather than impose harsh austerity measures as part of a debt rescheduling arrangement. (27)

        Even putting aside questions about their legality, unilaterally declared sovereign debt moratoriums present obvious problems. Debtor nations who default on their debt, even if only partly, must bear the reputational costs of such default, which may make access to finance difficult for many years to come. (28) Even when fresh finance is accessible, there also is the likelihood that the risk of future default will be priced into the cost of credit, to the...

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