Global financial system ripe for change

IT is being bravely predicted that Argentina's sovereign debt default last week will not matter to the global financial system. After all, it is argued, the South American country has been locked out of capital markets for the past 13 years. So the latest dispute with two US hedge funds whose refusal to accept a write-down on debt Argentina defaulted on in 2001 would have consequences only for its own economy.

Certainly, the country may have to devalue its currency to preserve its foreign currency reserves and that could trigger a rise in inflation that is already projected to hit 40 per cent. Even so, few expect that there will be anything like the riots and civil unrest that gripped the country in 2001, when it first defaulted on US$95 billion debt. Since then, the country has been paying its restructured debt instalments to 93 per cent of its bondholders. Its debt-to-GDP (gross domestic product) ratio is now about 40 per cent, well down from the 166 per cent it endured in 2001.

However, unless the International Monetary Fund (IMF) comes up with an international treaty on sovereign debt defaults, there will be consequences for the global financial system, certainly over the longer term. As the IMF's chief economist, Olivier Blanchard, said: "There's much more uncertainty as to how we'll be able to restructure debt for other countries in the future. So this really tells us that we need to work on improving resolution mechanisms." Indeed, the IMF proposed an international debt restructuring mechanism in 2003 but the plan had to be abandoned as the United States, the institution's largest stakeholder, was against it. As things stand, settlement of defaulted international loans depends on the vagaries of US and, to a lesser extent, European legal systems.