Should we worry about sovereign debt?
In her recent book “The Deficit Myth” star economist Stephanie Kelton tells us why economists should not worry too much about sovereign debt and deficits. But is that the same for lawyers? And are all countries truly treated equally?
Almost every state in the world borrows – some very little, like Estonia, and some very much, like the United States. Whether or not a country can and should borrow is a topic of perpetual academic and political debate by economic experts, such as Professor Kelton, but as lawyers we are more interested in the legal risks and possible gaps in regulation.
There is currently no truly global regulatory system for problematic sovereign debt – that’s the kind of debt countries can no longer repay. If countries are forced to default on their debt, the ultimate consequence is that they can no longer borrow money from anybody else. If they want to finance their deficit then, they will have to print more money, which leads to inflation. To make matters worse, many lenders are sophisticated financial parties who will use every tool in their box to retrieve their money. If the country did not lend in its own currency and under its own jurisdiction, like many developing countries, the country can look forward to lengthy legal battles in foreign courts. This is what happened to Argentina, and their case lasted for 15 years.
Choice of Law in EU sovereign debt bonds >1yrs (Chamon, Schumacher & Trebesch, 2018)
Most EU countries borrow almost exclusively under their own jurisdiction, with very few (like Estonia, which has one of the lowest debt-to-gdp ratios in the world at below 10%) opting mostly for English law and a few issuing some bonds under New York law. Issuing under their own law means countries can retroactively fit in legal solutions to their problems in their bonds, like Greece did in their historic restructuring (the Greek parliament retroactively fit in Collective Action Clauses – which meant that if 75% of the bondholders agreed on a restructuring, the remaining 25% holdout creditors would be bound by the agreement). It also means that any disputes related to your debt stock are handled by your own courts and on your own terms. This option is not open for all countries and many developing country instruments are governed by the laws of England & Wales and New York.
As the IMF forecasts that debt levels will reach historical levels due to the Covid-19 crisis, the Fund also released a report advocating for the reform of the international debt architecture. In Europe, we are still discussing setting up a European Sovereign Debt Restructuring Mechanism for the euro area – sometimes known as the European Crisis Resolution Mechanism (Gianviti et al., 2010). But the IMF’s latest global proposal, the SDRM, failed to secure the necessary political support (Setser, 2008) and a European proposal would require the transfer of further sovereignty.
That said – with a looming debt crisis around the corner (and not just for the poorest countries in the world), thinking about a global sovereign debt architecture would not be remiss. Whether we’re thinking on a European or more global level, we need to find out how we can tackle the debt fallouts of the future in an orderly, predictable way.
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