Select Committee on International Development Minutes of Evidence

Supplementary memorandum submitted by HM Treasury


  Because the risk of financial crisis cannot be completely extinguished, it is essential for the international community to ensure that effective strategies are available for managing and resolving crises when they occur. These strategies are aimed at ensuring the appropriate balance is achieved between domestic adjustment, official sector inflows and private sector involvement. The need for better mechanisms to facilitate sovereign debt restructuring, when countries are faced with an unsustainable debt burden, has been visibly demonstrated by recent crises, where delays in restructuring have caused an excess loss of growth.

  These delays have a number of sources. In the recent past, instances where minority creditors have been able to successfully litigate against sovereigns in default have introduced an additional uncertainty into the process. The mere threat of disruptive litigation by minority creditors creates uncertainty about the restructuring process[10]. In addition to the uncertainty it introduces to the process, these judgments also raise questions of whether all creditors will be fairly treated, making creditor co-ordination problematic, resulting in less orderly restructuring negotiations—a trend that has been reinforced by the shift over the last decade away from direct bank lending and towards bond issues held by a large number of dispersed creditors. Partly because of the lack of a predictable method of undertaking restructurings countries have also tended to value avoidance of a restructuring too highly relative to the potential impact on the domestic economy of default.

  These practical and legal difficulties provide an incentive to governments with unsustainable debt to avoid or delay necessary restructurings, while the delay in turn often results in unnecessarily painful or prolonged domestic adjustment, in addition to a greater loss of value for investors.

The statutory approach

  The Chancellor has been in the lead in calling for more effective mechanisms to address the issues surrounding the current process of sovereign debt restructuring, which are described above. In November 2001, the IMF proposed the establishment of a new Sovereign Debt Restructuring Mechanism (SDRM), with the following main elements:

    1.  To prevent disruptive litigation and creditor coordination problems from undermining agreement, debtors that had suspended payments would be given temporary protection from creditor litigation until a fair, sustainable resolution had been achieved.

    2.  To prevent this protection being abused by the debtor, it would be necessary to establish a mechanism to facilitate debtor-creditor negotiations and ensure that the debtor acts fairly and in good faith.

    3.  To facilitate the provision of new money, seniority would be granted to financing extended during the restructuring period.

    4.  To prevent holdout creditors from deliberately undermining any restructuring agreement reached between the debtor and a majority across all creditor classes of debt, the mechanism would bind minority creditors to the agreement.

  The UK, along with other G7 countries, has pledged its support for further work to develop this proposal and at the Annual Meetings 2002, the IMF was mandated to develop a concrete proposal for an SDRM in time for the IMF Spring Meeting in 2003.

  There are a number of complex technical, legal, analytical and policy issues involved in designing such a mechanism which the international community is currently trying to address, such as:

    —  the appropriate scope of the debt to be covered (i.e. the value and the practicability of incorporating various types of debt into the mechanism);

    —  the nature of any stay on litigation;

    —  the legal changes required to give the mechanism sufficient statutory authority;

    —  the impact the mechanism would have on developing country access to capital; and

    —  the appropriate role of the Fund in such a mechanism.

  In answering these questions the IMF is consulting widely with the interested parties with a view to formulating practical solutions. It is likely that the final shape of any proposed SDRM will be significantly different from the initial outline proposals made in 2001.

  Because of the legal changes required, it may be impossible to establish such a mechanism quickly (although the IMF also plays a non-statutory role in crisis resolution and debt restructuring through its policies of lending into arrears and access, which it is currently refining). Moreover, the mechanism could only ever be one part of a wider framework for private sector involvement in crisis resolution. Only in extremis should a country embark on such a procedure, when it had become clear that the country could no longer service its debts. The procedure could otherwise give rise to serious debtor moral hazard problems, which could raise emerging market borrowing costs.

  However, even if rarely used, the mechanism could considerably improve the overall effectiveness of the official approach to private sector involvement in crisis resolution. By establishing a credible recourse to restructuring, the mechanism could provide the correct incentives for creditors and debtors to find voluntary solutions to sustainability problems at an earlier stage—a phenomenon known as "bargaining in the shadow of the law" in a domestic bankruptcy context.

HM Treasury

December 2002

Letter sent by PSIRU (Public Services International Research Unit) to the Rt. Hon Clare Short MP, Secretary of State for International Development

Dear Secretary of State,


  During your oral evidence to the select committee on 5 November, a member of the committee referred to reports submitted as evidence to the Committee by PSIRU (Public Services International Research Unit). The uncorrected transcript of evidence attributes a number of comments to you, including: "Which [PSIRU] I have never heard of, may I say, which is making false claims, whoever they are"; later, "what they are claiming about the World Bank is false" and finally "The organisation is making absolutely false and untrue claims about Bank policy. I do not respect false claims. There is a lot of campaigning that goes on in development that seeks headlines by making false claims. I profoundly disrespect that so when that is happening I will say it is a false claim."

  The first point is that, as you can see from this letter, we are a research unit in the University of Greenwich, whose work is based on empirical studies on public services, privatisation and restructuring. Our research is respected and well received by the academic community both in the UK and abroad: the most recent example was at the annual meeting of the Development Studies Association on 9 November, where a workshop on PSIRU's work was very well attended, the presentations were received with considerable interest and our work was described by leading members of the DSA as extremely interesting and posing some very important questions. PSIRU staff's work is published in academic journals in a range of disciplines, including development studies, water, energy and health policy and we have presented at a number of academic conferences. We do not seek headlines, we do not issue press releases and we hardly ever get mentioned in the media.

  The second point is that the World Bank itself, which you complain we have misrepresented, has taken our research very seriously. The papers which we submitted to the Select Committee were written last year as critiques of successive drafts of the World Bank's Private Sector Development (PSD) Strategy. The World Bank responded to these positively and with respect for the arguments we advanced. I attended a forum in Washington last year, which was organised specifically to debate our critiques, where Michael Klein, the chief author of the PSD Strategy papers, conceded that he was convinced by our arguments on risk transfer, and indeed the next draft of that policy paper largely abandoned those arguments. In January this year, he attended a meeting here in London, at LSE, where he discussed the later version of the PSD Strategy with two commentators—Professor Robert Wade of LSE and my colleague Kate Bayliss. At no stage did he or anyone else at the World Bank accuse us of making false claims.

  In addition to this engagement with our work on the PSD Strategy, the World Bank's Water Supply and Sanitation Division, in February this year, recognised our work on the water sector by inviting me to give one of the guest lectures to that Division[11], followed by an hour and a half's discussion of PSIRU's work in this sector. World Bank water specialists have independently complimented us on our work and its empirical basis.

  I don't complain that you hadn't heard of us, but I don't think it's justifiable to accuse us of making "false claims", which is a damaging thing to suggest about a research institute. So I hope that on reflection you can reassure the University of Greenwich, and the Select Committee, that you did not mean to suggest that our work is inaccurate or unreliable - only that you have not (yet) been convinced by our arguments.

David Hall


Public Services International Research Unit (PSIRU)

School of Computing and Mathematical Sciences

University of Greenwich

19 November 2002

Letter sent by the Rt Hon Clare Short MP, Secretary of State for International Development, to David Hall, Director, PSIRU

  Thank you for your letter of 19 November 2002 about Public Services International Research Unit's (PSIRU) work, which was raised during my House of Commons' International Development Committee (IDC) appearance on 5 November. I note your positive engagement with the World Bank and its development of policy in both the areas of private sector development and of water and sanitation, but I thought it might be useful to set out why I was unable to agree with some of the points raised with me at the IDC hearing.

  The elimination of poverty in developing countries requires sustained economic growth; this cannot be achieved without the private sector. We need to harness private finance and ensure that it works for the poor. My Department engaged closely with the World Bank in the preparation of its Private Sector Development Strategy earlier this year. We welcome the way it acknowledges the primacy of country driven processes (such as Poverty Reduction Strategies, which we have championed), balances the roles of the state and the private sector, and stresses the need for proper governance and regulatory reforms in the private sector. The Strategy also advocates private provision of services when it is clear that this is the best approach. As I made clear to the Committee, our starting point in considering public or private basic utility and service provision is to ask what will deliver the best service and value for money for the poor. We find the Bank's strategy balanced on this issue, with consideration of the most appropriate supplier in each case, rather than a presumption that the private sector is best. Indeed, we find that the Bank remains very engaged with public sector development.

  On the specific issue of poor countries allegedly being forced to shoulder all the commercial risk for long-term take-or-pay agreements with private power producers, my Department had some initial concerns about this. However, the World Bank has given an assurance that it has processes in place to check the sustainability of any such agreements. We shall remain engaged with the Bank to ensure that these processes are being followed on a case-by-case basis and that developing country governments get the best deals they can.

  Finally, I note from the paper you submitted to the IDC that you see the World Bank's Private Sector Strategy as giving priority to the needs of the private sector which, you believe, will adversely affect social provisions. As I said in my evidence, I simply do not agree that the Strategy is all about privatising the public utilities. During its development, my officials were successful in ensuring that the final version gave significant weight to proposals for improving the investment climate that benefit small, informal and domestic firms—informal operations by the poorest—as well as large firms and foreign direct investment. Like my own Department, the Bank believes that there needs to be an assessment of what is in the best interests of each country. Also, where utilities are privatised it is important to secure proper regulation.

  I am sorry that you received what was probably more than your fair share of my criticism of campaigners who misrepresent the case for private sector engagement in public sector utilities in poor countries. But as I have said, I do not agree with the thrust of your evidence to the Select Committee.

Rt Hon Clare Short MP

8 December 2002

10   While there have been two recent cases of successful creditor litigation involving the attachment of assets: Elliot Associates vs. Peru; and Red Mountain Finance vs. the Democratic Republic of Congo, there have also been many cases of out of court settlements. The precise impact of the threat of litigation about the outcome of the restructuring process may be difficult to quantify. Back

11   See Back

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