IMF Sheds No Tears for Argentina

It is good to kill a country from time to time, pour encourager les autres, as Voltaire might have said. That, at least, seems to be the message the international community is trying to send to debt burdened countries in its handling of the crisis in Argentina.

The seven leading industrialised countries have announced an end to the increasingly large international bailouts needed to rescue countries which have got into difficulties with their creditors. In the words of one senior group of seven official, International Monetary Fund bailouts had become "a welfare system for Wall Street" with the money flowing straight from the Fund's coffers into the waiting hands of western bankers.

At their meeting in Washington last weekend, the G7 countries agreed to limits on future IMF loans, and to ram home that message, they took a tough line with Argentina's finance minister, Jorge Lenicov, who attended the gathering to plead for help for his imploding country. He went home empty handed, and two days later resigned.

The G7 is worried that IMF bailouts encourage reckless lending to developing countries by the private sector because the banks know that in the end, the Fund will step in to rescue any country which gets into financial difficulties. As one commentator observed several years ago, " the costs of inaction - a severe economic contraction, an extended interruption to capital market access, and a lengthy and difficult restructuring -are too painful for the official community to bear".

That, at least, used to be the assumption. Now the G7 is trying to prove that it is tough enough to stand aside and watch a country suffer and unfortunately for Argentina, it has become the guinea pig.

Limiting big bailouts is a necessary reform, but there is as yet no alternative system in place for dealing with sovereign bankruptcies. Last weekend G7 finance ministers discussed a twin-track approach, however, with changes to bond contracts and a new international legal framework for dealing with bankrupt countries.

The US is keener on the pursuing the first approach, which it sees as more market orientated. In future, all bond contracts will contain collective action clauses allowing for a majority of creditors to agree to a restructuring deal. Such clauses are common in bonds issued in London but not in the New York market, with the result that so-called rogue creditors can hold out for full payment. In some cases, by threatening legal action, they have been able to secure a better deal for themselves at the expense of other lenders. One such creditor, Elliott Associates, a New York hedge fund, recently held up the restructuring of Peru's debts with a court challenge.

As the IMF's deputy managing director, Anne Krueger, argues, however, new arrangements in bond contracts are not enough to tackle the problem of insolvent countries.

Collective action clauses apply to all the creditors in a particular bond contract - but an indebted country may have many different bonds outstanding as well as bank loans and official debts. Agreement still has to be secured between different classes of creditors.

Ms Krueger has called for an international legal framework which uses some of the features of domestic bankruptcy systems. Countries would be able to declare a payments standstill while they negotiated a restructuring deal with creditors.

Litigation would be prohibited while the deal was being worked out. It would only be able to be used if a country's debt burden were clearly unsustainable.

The idea of an international bankruptcy system is as old as Adam Smith and most recently was proposed by the debt campaigners, Jubilee 2000. While Jubilee would prefer to see a UN appointed body adjudicate over restructurings, Ms Krueger proposed that the IMF should be in the driving seat.

Neither idea was received with any great enthusiasm by the US. Unsurprisingly, the private sector is not a big cheerleader for reform either, although the official representatives of the banking sector seem to have accepted that it is inevitable.

Privately, British officials are optimistic about the chances of progress this time, after years in which reforming the international financial architecture has been on every G7 agenda. Previously the discussion was deadlocked, with the Europeans insisting that fundamental reforms were necessary so that the private sector had to take some of the pain of debt writedowns and the previous US administration preferring to take a case by case approach to crises.

Last weekend's communiqué reflected real unanimity on the need for reform, according to British officials who believe their own approach of "constrained discretion" has won out. As some observers noted, the G7 has left itself an enormous escape clause. Future IMF lending is to be limited except "when circumstances justify an exception".

You could call this the Turkey exemption if you were a cynic. Turkey received the largest handout last year from the IMF of any country since the Asian crisis.

Defenders of the package would no doubt argue that the country has stuck to the IMF's tough conditions more successfully than Argentina, at considerable economic cost. Cynics might note that the country is an EU accession candidate with an overwhelmingly Muslim population, and an important ally in America's war on terror.

The moral of the story seems to be, no bailouts except for countries which are strategically or economically important. Poor old Argentina is neither.