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Illegitimate Debt

ALTERNATIVES TO DEBTORS' PRISON: Developing a framework for international insolvency - Jubilee Australia Report, October 2011

A business is insolvent when it can’t pay off its debts. So what is international insolvency? How do countries go broke? Why does it keep happening? Who should bear the cost? The sovereign debt crises in Greece, Spain and Ireland have emphasised the urgency of the issue, but the phenomenon of countries repeatedly going broke has a long history. Alternatives to Debtors' Prison: Developing a Framework for International Insolvency answers the questions above by examining this history and the key patterns that have emerged. The paper makes the case for an independent arbitration mechanism, that would give priority to governments’ obligations to meet the essential needs of its citizens, introduce a modicum of accountability to financing decisions, and elevate debt renegotiation decisions to a neutral and legitimate forum. 

Introduction to Illegitimate Debts

Very few countries have developed after incurring international debts in a foreign currency that they then had to repay. Yet over the past half century, the IMF has consistently required the opening up of less-developed countries to overseas investment as a quid pro quo for being granted access to foreign aid.


And despite being aware by the mid-1960s that these countries were over-borrowing and may never be able to repay the loans, the World Bank has continued to encourage a pattern of profligate lending by donor countries, which peaked with the petrodollar boom in the mid-1970s.

Since at least the early 1980s, less-developed countries in Asia, Africa and Latin America have seen recurring sovereign debt and financial crises disrupt their economies and cause suffering to their people. Yet when nations have unsustainable debts they typically must repay them. Though effectively broke, the debts can be paid by virtue of the fact that countries can always increase taxes, take on more debt, or reduce spending on health, education and infrastructure. As Citicorp Chairman Walter Wriston famously said in the 1970s, 'Countries never go bankrupt'. 

Jubilee's Australia's critical perspective of debt is not the simplistic belief that all debt is bad: rather, it is the more nuanced position that borrowing to facilitate development should be done selectively and with great caution, lest it lock less-developed countries into a subordinate relationship to lending countries and financial institutions, reduce democracy and violate human rights.

An entire new source of loan-based development financing is potentially opening up, with some multilateral institutions manoeuvring to make much-needed climate change adaptation financing available to vulnerable countries in the form of loans. Needless to say Jubilee Australia wholly rejects the use of loans to confront the climate crisis.

 

Investigating the origins of debt

The legitimacy of many past loans, often pushed onto nations by overenthusiastic commercial bankers or governments, and often associated with bribery of officials in the borrowing nation, is questionable.

The appalling human suffering that has resulted from less-developed countries prioritising foreign debt repayment while citizens forgo their basic human rights, including access to clean water and sanitation, basic healthcare and housing, is thoroughly documented.

A fundamental agreement of international debt campaigners is that debts found to be illegitimate should be cancelled immediately and without conditions. Such a position arises from the contention that those governments and institutions lending to less-developed countries, often in the name of ‘development’, should share responsibility for self-interested or poorly conceived loans and should pay the outstanding costs of the illegitimate debts created.

Critical civil society and campaigns like the international Jubilee network see themselves as existing to demonstrate that there is much more to the story of the ‘debt crisis’ than the simplistic interpretation of rich-country charity being carelessly squandered. Corruption and waste in indebted nations has regularly left a well-worn trail back to institutions and actors in industrialised countries like Australia. In particular, the competitive trade policies of developed countries and the debt accumulation of less-developed countries are inherently linked. Yet Norway is still the only country to have acknowledged this in practice by cancelling debts shown to have arisen from loans that were made more for the purpose of boosting domestic exports than to serve the development needs of the recipient country.

The narrative of illegitimacy is still very challenging to people both inside and outside of government, and much of Jubilee’s advocacy work surrounding the debt crisis remains very sensitive. People’s default assumption seems to still mirror the story projected by many in government: that the debt crisis is the fault of corrupt and venal third world officials and that, in contrast, industrialised nations have been generally well-intentioned in their dealings with developing countries.

In 1996, 1999 and again in 2005 the G7/G8 announced commitments to cancel up to US$155 billion in debt owed by the ‘heavily indebted poor countries’ (HIPCs) to the major multilateral institutions such as the World Bank and IMF, intended to reduce the debt burdens to “sustainable levels”. Whilst viewed by many as the panacea for the debt crisis, these initiatives were donor-centric. In other words, wealthy creditor countries and institutions play the role of judge and juror. There is no space for governments or citizens to raise questions about the legitimacy and legality of the original loans.

For this reason, debt audits are now seen as a key strategy for countries to pursue. Comprehensive debt audits initiated by the government and citizens have exposed the culpability of all the actors in loan and debt contraction and ascertain what constitutes illegitimate or odious debt. Citizen’s audits are underway in the Philippines and Indonesia amongst other countries. A comprehensive public audit in 2008 encouraged President Correa to default on some of Ecuador’s most unjust debt, eventually leading to a write-down by some of its creditors. As these audits uncover failure and often criminality surrounding loans, the calls for countries to repudiate (to refuse to pay) grow stronger.

 

Moral hazard of lenders

Moral hazard describes the incentive for irresponsible behaviour when, for one reason or another, actors are insulated from the implications of their deeds.

For every bad credit decision there are two culpable parties: the borrower and the lender.  Yet the existing international framework for sovereign lending and borrowing focuses exclusively on the role of the borrower in a sovereign debt crisis, and places the responsibility for making the situation right squarely at the feet of the indebted country and its people. This happens while the culpability of the creditor is ignored, and risky lenders are freed from taking responsibility for their poor decisions. 

Developed governments for decades vigorously resisted all calls for unconditional debt relief on the basis that such an act would rescue recalcitrant countries from the consequences of their errant behaviour, and thereby increase moral hazard.

As Secretary of the U.S. Treasury, Donald Regan, said in the early 1980s:

“I don’t think we should just let a nation off the hook because we are sympathetic to the fact that they are having difficulty. As debtors, I think they should be made to pay as much as they can bear without breaking them. You just can’t let your heart rule your head in these situations.”

Yet one of the root causes of the ‘third world debt crisis’ was unquestionably poor quality ‘development’ finance, often extended for strategic geopolitical purposes or self-interest. And the absence of an international bankruptcy or debt arbitration system means that even the most bogus of loans is expected to be repaid, despite ample evidence of overly-enthusiastic and even reckless lending by private banks, international institutions and governments.

Further, local elites in recipient countries have manipulated the system in a number of ways. First, many have been adept at skimming a proportion of the aid funds flowing into the country for their own uses. Second, they have also profited from setting up joint ventures with foreign businesses attempting to penetrate their country with new products and services, serving their own needs rather than the needs of the country at large.

Jubilee Australia is recommending the Government support in international fora the proposals for loans to sovereign states to be subjected to a much higher level of transparency and accountability than has historically occurred. This would enable populations in countries who are supposed to be the beneficiaries of such loans to be able to track whether the supposed economic benefit has taken place, that would justify the public debt that their government has taken on. A concrete list of such criteria has been provided by EURODAD with its Responsible Financing Charter.

 

An independent debt court

“Countries never go bankrupt”

Charismatic and influential U.S. banker and chairman of Citicorp, Walter Wriston, famously declared this in the 1970s.

In theory, a country can always repay its debts by virtue of the fact that the government can increase taxes and reduce spending on health, education and infrastructure. But at some point the reductions in spending make it impossible for governments to fulfil the basic human rights of their citizens: including rights to water and sanitation, food, health, adequate housing and education.

National insolvency laws for corporate business and individuals were introduced to fairly and efficiently divide the assets of the insolvent debtor between creditors, while ensuring the debtor is left with enough resources for survival and dignity, forbidding creditors from having access to the debtor’s basic resources. These rules of insolvency operating within countries like Australia, are mandated by law; access to an impartial judgement is a legal right.

Yet notoriously absent from the modern insolvency process are sovereign debtors (nations), who rather than experiencing any form of legal protection, have been forced to bear the brunt of unsustainable debts (often the legacy of brutal dictators) as their countries face long term economic stagnation and social disruption.

When capital is in surplus in rich countries, too much money flows to poorer countries because commercial banks know that poor country governments can always reduce social services and/or increase taxes to continue to service their debts. These excessive capital flows have been one of the major contributors to the debt crises in poorer economies; and recent developments in Greece suggest we may be about to see similar crises in Southern European countries.

Introducing an international insolvency regime would be an important step toward an international financial system that is more predictable, fair and conducive to development. The procedure for resolving debt payment difficulties would be fundamentally different from existing mechanisms in that it would: 1) give priority to a governments’ obligations to meet the essential needs of its citizens; 2) discipline imprudence on behalf of both lenders and borrowers; and 3) elevate debt restructuring decisions to a neutral and legitimate forum.  

Jubilee Australia is recommending the Australian government support international proposals for establishment of an independent decision-making body (debt court or tribunal) to fairly determine outcomes when a country cannot afford to repay its debts (international insolvency mechanism).

 

Vulture funds

Vulture funds are private investment firms that prey on the world’s poorest countries. These commercial bankers circle developing countries on the lookout for debts that the country is struggling to repay. Then they swoop down, purchase the debt on the secondary market for a cheap price, and sue the poor country to recover the full value of the debt, plus interest, penalties and legal fees.

In November last year, for the first time the Australian legal system was exploited by a Vulture Fund. New York investment firm FG Hemisphere, came to the NSW Supreme Court to pursue a debt claim against the Democratic Republic of Congo (DRC).

Congo is a heavily indebted poor country (HIPC). It had finally completed the long and tough process required to receive debt relief. Congo’s debt was due to be cut by over $7,000 million. The IMF, World Bank and African Development Bank had agreed to cancel 100 per cent of pre-2004 debts. Other creditors like the UK having committed to do the same.

However a Vulture Fund had been circling the DRC. Just as it reached HIPC completion point, FG Hemisphere swooped. Having bought one of the African nation’s debts cheaply on the secondary market, it refused to participate in the debt relief scheme, and instead began pursuing repayment of $100 million for this debt - $80 million more than the country would have been expected to pay for the debt under the HIPC process.

FG Hemisphere scoured the world in search of foreign assets belonging to the DRC. When it found that the government owned shares in an Australian mining company operating in Congo, the Vulture Fund filed a case in the NSW Supreme Court, and in November 2010 was successful in forcing the DRC government to sell the shares and transfer the $30 million (plus $2 million in legal costs and court-imposed fines) to itself.

This reprehensible vulture fund is not a one-off. Between 1998 and 2008, 54 court cases were instituted by vulture funds against 12 heavily indebted poor countries. National income that is earmarked for poverty reduction and basic social service provision is diverted to settling the legal claims of vulture funds. The lawsuits are grinding down poor countries in cycles of litigation for up to 10 years and costing the equivalent to 18% of spending on health care and education.

The good news is that this practice of vulture funds can be stopped by introducing legislation to ban such entities from profiteering in Australian courts. In April last year the UK government passed a landmark Debt Relief (Developing Countries) Act which does just that.

Jubilee Australia is recommending the Australian government enact legislation to outlaw the practice of Vulture Funds collecting debt in Australia that has been purchased cheaply from highly indebted poor countries (HIPC).

 

Climate debt

Wealthy governments intend to allocate a significant proportion of their funds for climate change adaptation through the World Bank, in many cases against the wishes of less-developed countries. What is more worrying, the majority of these funds given to enable less-developed countries to cope with the impacts of climate change will have to be paid back, despite developed countries like Australia admitting to being historically responsible for the majority of greenhouse gas emissions that are warming the globe. The already costly debt burdens of less-developed countries will be further increased in the name of climate change.

While the World Bank is issuing new loans to help less-developed countries mitigate and adapt to the impacts of climate change on behalf of industrialised countries like Australia, loans for coal-fired power stations by the World Bank, which produce massive carbon emissions that contribute to climate change, have increased 40 times over the past five years to hit a record US$ 4.4 billion in 2010. If the multilateral development banks, including World Bank and Asian Development Bank, are serious about alleviating poverty and promoting sustainable development, they should be investing their billions of dollars into carbon-safe, clean ways of generating energy, such as solar and small-scale hydroelectric, and biomass projects which can help avert climate chaos and deliver clean energy directly to vulnerable people to help lift communities out of long-term poverty.

Jubilee Australia will shortly release a report including recommendations to the Australian government on how climate change finance would be most effectively and equitably governed. 

 

Australia as a creditor nation

Notwithstanding its membership of international lending agencies, including the World Bank and International Monetary Fund (IMF), Australia is a relatively small player when it comes to the debt of the two-thirds world. Compared with countries like the United States, Japan, the United Kingdom and Germany, Australia is a minor creditor with little outstanding bilateral debt. This is in part because of the way that Australian development assistance has been delivered. With a couple of notable exceptions, the Australian aid program has provided bilateral assistance only in the form of grants.

Despite a relatively minor role as a lender to the two-thirds world, the Australian Government joined with the others creditor countries in supporting the 1996 introduction of the Heavily Indebted Poor Country (HIPC) Initiative, an official debt relief scheme coordinated by the World Bank and the IMF. The HIPC Initiative and the subsequent 1999 Enhanced HIPC Initiative were a response to the calls of Jubilee 2000 campaigners worldwide for the cancellation of the ‘unpayable’ debts of the poorest countries by the year 2000 and a reaction by G7/G8 creditors to the growing fear that an unprecedented rise in the incidence of sovereign debt defaults could destabilise the world economy. In 1998 the Australian Government announced $30.5 million in additional aid funding as a contribution to the HIPC initiative. Then in April 2000, influenced by the announcements made by the G8 and the public pressure exerted by Australian Jubilee 2000 campaigners, Australian Treasurer Peter Costello announced that the Government would provide 100 per cent bilateral debt forgiveness to those countries which met the HIPC requirements.

As of March 1999, Australia was owed an estimated total of $4 billion in sovereign debt by less-developed countries. Of the 41 countries deemed eligible for possible debt relief under HIPC, Australia was owed money by four – Vietnam, Ethiopia Nicaragua and Laos. Given the aforementioned grant-based nature of the Australian aid program, this $90 million of debt was almost exclusively generated through export finance loans and insurance by the Export Finance and Insurance Corporation (EFIC). EFIC is the wholly Government-owned entity established to provide finance and insurance products to Australian exporters where they cannot be sourced through commercial channels. 

Along with Indonesia, Australia's largest debtor, there are a number of low and middle income countries still represented on Australia’s debt list: Egypt, Zambia, Philippines, Sri Lanka and Vietnam among them. 

 

Australia's first debt-for-development exchange

Debt-for-Development exchanges are a tool for financing development projects, involving an agreement by a creditor government to cancel foreign debt of another country in exchange for the country investing freed up resources into a particular development initiative.

For many years the Australian government was resistant to including such exchanges in its overseas development policy, so it was a significant achievement when in 2010 the ALP government signed with Indonesia its first ever debt swap agreement.

Jubilee Australia first proposed a debt-for-development exchange in October 2002, coinciding with the Indonesian government’s formal request for Australia to consider such exchanges 'as a way of addressing the bilateral debt between the two countries'. Though unfavourably received, Jubilee Australia continued making such recommendations to parliamentarians and treasury officials for a number of years.

In late November 2006 representatives of The Global Fund to Fight HIV/AIDS, Tuberculosis and Malaria were hosted by Jubilee Australia to meet with government officials with a specific proposal for Australia to join the German government in their to date successful program to eradicate Tuberculosis in Indonesia through the Debt2Health initiative.

Jubilee's advocacy on this Debt2Health proposal was supported by Make Poverty History coalition, and in partnership with RESULTS Australia and the Lowy Institute for International Policy. Such a collaborative effort was able to pique the interest of then Shadow Parliamentary Secretary for Overseas Development Assistance, Bob McMullan. In June 2007, this translated to a pre-election commitment to officially support the Debt2Health initiative that became government policy as the ALP won office later that year.

After nearly three years of sustained work – negotiation between the Australian and Indonesian governments, the Global Fund and their Indonesian civil society partners – the final Debt2Health agreement was signed by the Australian and Indonesian governments in July 2010.

Given the institutional capacity gained in AusAID and DFAT from the implementation of this first exchange, there are new opportunities for further bilateral debts with Indonesia, or other countries. However potential exchanges must be thoroughly assessed from lens critical of the debt-development model to ensure that illegitimate debts are cancelled rather than 'legitimised' through debt-for-development exchanges.

take action:

1. Tell G20 Chair, French President Sarkozy to support a fair and independent debt court.
2. Write to your local MPto Stop Debt Vultures from using Australian courts to profiteer off the poor.

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