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Rules Governing International Debt

“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.” (Secretary of the U.S. Treasury Donald Regan, early 1980s)
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.

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.

An independent debt court

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.

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 fulfill 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). 

Watch this clever mock court scene produced by our colleagues at Jubilee Germany.

Debt according to Law by erlassjahr

learn more 

Read our 2011 Report written in partnership with Ross Buckley, Professor of International Finance Law at UNSW: 

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