Why Not Default: A Subaltern Perspective

2 February by Sumanasiri Liyanage


Having read many opinions over the issue about what should be done with regard to the debt crisis in Sri Lanka, I think even a scary task of summarising the argument of a book of 384 pages in 1,000 to 1,200 words column would be a useful endeavour. In my previous columns, although I referred to this book entitled ‘Why Not Default: the Political’ Economy of Sovereign Debt by Jerome Roos, a Fellow in International Political Economy at the Department of International Development of the London School of Economics, the current debate demands a focused attention to the main argument of the book.

Why do countries repay their debts?

The sovereign States have the power and authority to determine their policies. When a country has accumulated debt, the repayment of them would create many issues with regard to the relationship between the Government and its people. Oftentimes, governments have to impose austerity measures on their people as a substantial amount of resources move from the debtor to creditor countries.

Hence, quoting economists at the International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
, Roos referred to the natural preference of the debtor nations in avoiding default “even if that implies running down reserves, shortening the maturity of the debt, and ceding part of their economic policy sovereignty to multilateral institutions.” So, Governments will generally prefer to negotiate an orderly settlement with their creditors over a unilateral suspension of payments.

We may see this logic in operation in Sri Lanka today. Even right-wing think tanks who have so hitherto talked about the Government’s incapacity to fulfil its debt servicing requirement, have started to talk about some kind of debt restructuring and defaulting 500 million dollars international sovereign bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. that is to mature on 18 January 2022.

According to Roos, four explanations have emerged. They are: (1) the borrower’s long-term reputation; (2) legal and trade sanctions; (3) democratic institutions; and (4) spillover costs, respectively. The reputation hypothesis is based on the assumption that creditors usually discriminate between defaulting countries and non-defaulting countries so the countries should be conscious about the timely repayment of debt in order to make sure that necessary resources are available when the need arises.

Roos has shown that there is no clear evidence to support this hypothesis. “Lenders were eager to let bygones be bygones; what mattered was not the historical repayment record of individual sovereign borrowers, but the immediate prospect of easy profits”.

The second hypothesis highlights the main enforcement mechanism as the main reason for debtor compliance. Referring to legal enforcement in a variety of forms, Roos argues that legal sanctions alone do not appear to make for a credible enforcement regime. The third argument that emphasises the presence of a democratic institution as a factor conducive to debtor compliance is based primarily on the experience of the relationship between the state and the private individuals in developed capitalist regimes in the West: may not be applied in the same manner for underdeveloped debtor nations in which the relationship is weak and fragile.

As the book argues, “it usually does not apply to developing or peripheral economies, which (until recently at least) have tended to depend on credit denominated in currencies and contracted under legal systems other than their own—a form of a foreign credit dependence that economists like to refer to as original sin, and that is often considered an important determinant of default”.

The possible spillover cost of default as a reason for debtor compliance is referred to as the fourth explanation. The argument goes like this: “Because it is often difficult for a Government to discriminate between domestic and foreign creditors, the costs of non-payment could spill over into finance, trade, and production at home—not only harming bankers, traders, and industrialists but also affecting the overall economic performance, industrial output and employment”. As a result, the stakeholders within the country would respond by forcing their Governments not to default and it seems to be a strong reason for Governments to comply.

The political economy of debt

Chapter 2 of the book gives the author’s diagnosis of the foreign -debt problem in which he brings in the political and social dimensions of the issue. The conventional literature on debt questions assumes the national state is a unitary agent who weighs positive and negative impacts of debt repayment or default. Nonetheless, the political economy sees nations as an amalgam of different agents with different needs and interests: the decision that a government of the respective country depends on the interaction of varying social forces.

Hence Roos explains: “Yet this approach clearly glosses over a stark social divide between those who stand to lose from the austerity measures required to repay the debt, and those who are more exposed to the financial fallout of a potential default. Wealthy elites, in particular those who hold Government bonds, own capital and/or run credit-dependent businesses, are likely to derive much greater utility from uninterrupted debt servicing than others, giving them a clear interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. in compliance, even if this inflicts harm on the wider economy and on the population at large”.

Roos takes us to an area in which conventional economists are silent. He writes: “One of the principal blind spots of the conventional explanations of debtor compliance is that they generally tend to treat the borrowing country as a singular entity whose different social groups and classes are aggregated into an overarching national interest. Governments, then, are merely “representative agents” that negotiate with foreign creditors on behalf of their country as a whole.

In the process of this aggregation, all conflicts of interest within the debtor country are quietly assumed away; the different stratum of society are simply expected to share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. the same interest in compliance or noncompliance, repay mentor default, and the country’s Government is presumed to apolitically represent this collective set of policy preferences. Yet this approach clearly glosses over a stark social divide between those who stand to lose from the austerity measures required to repay the debt and those who are more exposed to the financial fallout of a potential default.”

Political economists tend to ask a set of very appropriate questions: Why and how this mountain of debt is accumulated? In Sri Lanka this is a fairly recent phenomenon. Who has initiated this? Which social group is responsible? Questions of this nature may also help in finding a solution to the debt crisis. What should be done? What actions can be taken? As the experience of the last 43 years shows that this debt-based model is a necessary corollary of a continuous deficit in the trade balance Trade balance The trade balance of a country is the difference between merchandize sold (exports) and merchandize bought (imports). The resulting trade balance either shows a deficit or is in credit. , heavy expenditure on imports catering to new consumerist demand and unaffordable infrastructure development. Hence, it is totally unjustifiable to blame the lower classes of society. On the contrary, the lower classes, especially women, contributed immensely to getting the country out of this impasse.

Simple arithmetic is adequate enough to find a solution to the debt crisis. Default 2022 debt and cut down the bigger portion of imports of consumer goods that is close to one billion dollars. These two steps save approximately five billion dollars for the country in 2022. Of course, a default that may take three forms, namely, rescheduling, restructuring and moratorium, are not the answer. It is just patching up operation. A paradigm shift of development is necessary and unavoidable for a permanent solution.




Source : Ceylon Today

Sumanasiri Liyanage

is a retired teacher of Political Economy at the University of Peradeniya.

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