Ukraine is struggling to negotiate a deal with its creditors, which the International Monetary Fund demands as a condition for further financial support. Russian aggression has taken a terrible toll on the economy of the new Ukraine, making its $19 billion in foreign debt unsustainable. Talks to renegotiate the country’s debt are currently under way in San Francisco.
Unfortunately, Ukraine doesn’t have recourse to bankruptcy. There is no chapter 11 for sovereign borrowers to establish a cease fire between lenders and borrowers, decide which debts should be reorganized, and mediate negotiations between the two sides. Ukraine and its private lenders are left to negotiate in a setting in which “might makes right.”
In such a setting, Ukraine’s only negotiating leverage is to threaten to default unless its gets debt relief. I am sure that, in return, bondholders are warning Ukraine that if it defaults, no one will invest in the country for a very long time..
Sovereign defaults are costly. But they have lasting effects mainly when lenders drag out the battle, as they did in Latin America in the 1980s or in Greece today. When a country and its lenders can reach a speedy deal, even one that imposes losses on lenders, the country is usually back in the market in a year or two. Moreover, it is not the default that briefly keeps the country out of the markets but the economic problems that caused the default in the first place.
Former U.S. Treasury Secretary Nicholas Brady understood this when he unveiled the Brady Plan in 1989, which urged banks to accept debt relief, at least for those Latin American countries pursuing sensible reforms. Mr. Brady understood then that savvy investors would look to the future rather than to the past when considering whether to lend to a country that had just defaulted.
Today, Mr. Brady is the chairman of Darby Overseas Investments, the private-equity arm of Franklin Templeton, Ukraine’s largest bondholder. Franklin Templeton is pressing hard against debt relief. It is difficult to reconcile Mr. Brady’s position in 1989 with Franklin Templeton’s position today.
The Ukrainian government is fighting heroically for the kinds of structural reforms that the Brady Plan called for in 1989: rooting out corruption, reforming the judicial system, weaning the country from Russian gas, integrating the economy into the European Union, boosting agriculture, cleaning up the banking system, and more. If debt relief can be a fillip to these reforms, then investors ought to demand it (as the IMF is doing) and ignore the argument that writing off debt spells doom. If going into default is the only way to get debt relief, then investors will applaud, not condemn, Ukraine for doing it.
Recent efforts by policy makers and academics to revive the idea of a sovereign-debt restructuring mechanism, along the lines of chapter 11, are liable to founder, just as they have in the past. This is unfortunate for countries like Ukraine, because the argument that default ruins a country’s reputation runs against the logic behind the U.S. bankruptcy code, which allows companies to “reorganize” their debts—often by imposing haircuts on their creditors—so that they can revive their fortunes. Chapter 11 assumes that forcing a heavily indebted company to pay its debts in full is bad for business, and that making debt relief easier can be good for business.
For Ukraine’s bondholders, there is no shame in admitting that they oppose debt relief, whether through haircuts or in any other way. They loathe losing money on their investments as much as I do. Why not admit this rather than try to convince Ukraine that debt relief is bad for the country? This would at least be sincere and have the advantage of being true. To say that debt relief and even default is not in Ukraine’s best interest is disingenuous and false.