How to fix bankrupt sovereign debt

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Fiscal consolidation is the creed — if not necessarily the rallying cry — of most advanced countries today. Sovereign debt crises are no longer a problem just in emerging markets, but a concern in advanced countries as well, particularly in the euro area. The graph above shows the reason: advanced economies tend to have higher debt levels in relation to the size of their economies than emerging ones, according to a new report from the Brookings Institution. “Revisiting Sovereign Bankruptcy” was written by the Committee on International Economic Policy and Reform, a non-partisan, independent group of experts.

Reducing public debt to safe levels is a daunting task for most advanced countries — though one that must be undertaken. However, there are no internationally accepted standard procedures for doing this. Greece’s debt restructuring in February 2012, the largest ever and which nearly brought down the euro, points to the risks of policy mistakes in ad-hoc solutions. Argentina’s devaluation and debt default in 2001 highlights the lack of a standard international legal procedure. Private litigation between Buenos Aires and its hold-out creditors continues more than a decade later, putting the country at risk of a new default.

In its paper Brookings makes the case for a legally and politically recognized procedure for restructuring the debt of bankrupt sovereigns. One proposal could be to have the International Monetary Fund act as a combined lender and debt restructurer for bankrupt sovereigns, “the creation of a Sovereign Debt Adjustment Facility by the International Monetary Fund, which would combine IMF lending with debt restructuring,” the report says. In May the Fund said it would take a fresh look at the issue. Though it would have to overcome the reluctance of countries to yield to supranational rules or institutions, as the Brookings paper hints towards, that time may have come as the need for orderly restructuring procedures is greater than ever.

Watch the discussion on the report here