RISK & NO REWARD

Make odious debt too risky to issue (Michael Kremer and Seema Jayachandran, May 8 2003, Financial Times)

The way to prevent lending to illegitimate regimes without jeopardising legitimate borrowing is to make clear in advance which loans will be considered odious rather than nullifying them after the fact. Retroactively, there is a temptation to apply the odious label liberally and nullify legitimate loans as a way of transferring money from the rich to the poor.

A declaration that a particular government is odious and that future lending to it will be considered illegitimate would constitute a new and better form of sanction - a "loan embargo" that cuts off the flow of funds to targeted countries. Profiteers have strong incentives to evade trade embargoes, but creditors would not want to flout a loan embargo because they would risk not being repaid. Creditors would stop issuing loans to odious regimes, not because such loans are illegal or immoral but because they would be more likely to be unprofitable.

For example, suppose the UN Security Council declared that any future borrowing by another dictatorship - be it Syria, Zimbabwe or Burma - would be the regime's responsibility, and not that of the citizens or any future government of the country. When the regime went to the debt market to borrow, this sanction would discourage creditors from lending to it. Even if the US imposed the sanction on its own, creditors in other countries would abide by it. The US would need only to vow that it would give political and financial backing to any successor government that repudiated new loans issued to the current regime.

If the international community added a loan embargo to its tool kit of economic sanctions, creditors would know the rules of the game in advance and would not risk nullification of their loans. Accordingly, legitimate governments would be able to borrow at lower interest rates. Most importantly, governments deemed illegitimate would find it much harder to borrow in world markets and use the funds to finance repression; and it would become impossible for them to saddle their ill-treated people with debt.

A decision by the postwar Iraqi government to renounce Mr Hussein's debt would be greeted with dismay in some quarters; but that might also spur the creation of a system that prevents lending to such repressive rulers the first place.

Odious debt is an idea whose time has come. Posted by Orrin Judd at May 9, 2003 8:55 AM