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. Last Updated: 07/27/2016

IMF Draws Up Sovereign Bankruptcy Program

WASHINGTON -- The International Monetary Fund on Monday unveiled groundbreaking plans to develop an international system to allow troubled countries to file for bankruptcy protection when their debts become unsustainable.

IMF First Deputy Managing Director Anne Krueger said the plan would fill a "gaping hole" in the world's financial system that offers troubled nations no formal bankruptcy mechanism.

The proposal would offer countries the type of bankruptcy protection enjoyed by companies in many countries, but would take years to put in place, meaning there would be no benefit for nations like Argentina, which is fighting to avert the world's biggest sovereign- debt default.

The plan, to be discussed by the IMF's board in December, would make the IMF the gatekeeper of the new bankruptcy system with the lender being arbiter of whether to grant nations a "stay" on their debts to negotiate an orderly restructuring.

Krueger unveiled the plan during a dinner speech to the National Economists Club and said four of the Group of Seven leading industrialized nations, including the United States and Britain, were "strongly in favor" of the idea. Three of the seven nations, which also include Japan, Canada, Germany, France and Canada, had yet to take a position, the former academic said.

The issue has been raised before, but little happened due to opposition from the United States. But with Washington seeking a way to reduce the need for IMF bailouts, the idea has resurfaced.

"At the moment, too many countries with insurmountable debt problems leave it too long, imposing unnecessarily heavy economic costs on themselves, and on the international community that has to pick up the pieces," Krueger said.

Krueger said the system would be built on four principles:

that creditors could not disrupt negotiations by seeking recourse in their own national courts, as happened in 1997, when a creditor held Peru ransom.

that countries would have to negotiate in good faith and not give favor to certain creditors, something that would require guarantees of sound economic policies.

that creditors be encouraged to lend new cash to the debtor nation by receiving seniority over earlier claims.

that agreement be reached through settlement with the majority of creditors and not by unanimous approval.

The economist said she hoped a formal bankruptcy mechanism would encourage nations and their creditors to settle their problems on their own, without the help of the IMF and others.

Krueger said the IMF would be central to the system, deciding when to approve a country's request for protection. But, she said, some independent judicial system would be needed to adjudicate disputes between debtors and creditors.

To force countries to negotiate in good faith, the standstill on debts would last just a few months and would require IMF approval to be extended. Further IMF cash would be restricted to help rebuild foreign-exchange reserves and pay for essential services and imports with no extra aid to help pay creditors on the restructured debts.

Krueger said the plan would include temporary foreign exchange controls to avoid currency speculation.

Private companies may also need protection since they could not pay money owed to foreign firms or investors due to the temporary capital controls. But, the IMF's No. 2 in command said, those firms would pay those monies into an escrow account to be payable once the capital controls were lifted.

Since the Asian financial crisis of 1997 to 1999, the IMF has worked hard to shore up myriad problems in the global financial system. That crisis started with a botched devaluation of the Thai baht before ripping through the region and as far afield as Russia and Brazil. Despite improvements since then, there has been little progress on what to do when countries are suffocating under a mountain of debts.

That problem has never been more evident. Argentina has been on the brink of defaulting on $132 billion of debt despite a $40 billion IMF package given last December and another $8 billion in IMF support in August.