Changing Rules of the Game of Global Finance: Glimpses from a Sovereign Debt Restructuring Episode

Sovereign debt restructuring refers to debt workout procedures for sovereigns which involve reduction in the nominal value of the old debt instruments when the debt burden of a country becomes unsustainable. Debt restructuring is required in any debtor-creditor relationship since any financial contract has to take the possibility of default into account. As far as corporations are concerned, the idea that the debt burden of the corporations may become unsustainable and in which case it may require restructuring is not new. Corporations in the US have access to legal remedies if they want to restructure their debts or go for liquidation. But when it comes to sovereigns, the international financial architecture lacks any mechanism to take care of the “debt overhang” of sovereigns. Literature in this area has tried to model the incentives which would lead the sovereign debtor towards repayment. The two main incentives are direct punishments (such as trade embargoes) and reputation concerns (fear of loss of access to international capital markets). The basic assumption in all these models is that creditors only have limited powers to enforce repayments since the sovereign debtor cannot be ordered to repay by the courts of the creditors‟ country of origin because of the sovereign immunity laws. The focus of this paper is on the recently concluded Argentine debt restructuring where the sovereign debtor was forced to make repayments to the “vulture funds” after an order for repayment was passed by the US courts, thus making the assumption of non-enforceability of sovereign debt untenable. This is a real threat because 70% of the sovereign bond documentation is under the US law at present and many debt restructuring exercises are on in countries around the globe. The paper also looks at two different sovereign debt crisis resolution episodes from history – the first one is the Barings‟ Crisis of 1890 when Britain was the centre of international finance and the other episode is from the inter-war period when USA had overtaken Britain. The attempt is to see if history has some lessons to offer for an orderly debt workout.