Debt Exchanges Revisited: Lessons from Latin America for Eastern Europe
Debt Exchanges Revisited
Debt Exchanges Revisited: Lessons from Latin America for Eastern Europe
Ross P. Buckley 0
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Debt Exchanges Revisited:
Lessons From Latin America
for Eastern Europe
As John Kenneth Galbraith wrote in 1987, "[h]istory has a way of
repeating itself in financial matters, because of a kind of sophisticated
stupidity."I The Latin American debt crisis of 1982 was certainly an instance of
such stupidity. The region has had a consistent history of a major debt
crisis about every fifty years; however, crises in the 1820s,2 1870s, 3 and
1930s 4 were insufficient to restrain banks from their Latin lending frenzy in
. Associate Professor of Law, Co-Director, Centre for Transnational Business Law, Bond
University, Australia. The production of this article was supported by an Australian
Research Council Small Grant. I am indebted to Lee C. Buchheit and Michael Pettis for their
helpful comments on earlier drafts. All responsibility is mine.
1John K. Galbraith, Insanity of 1929 Repeats Itself,SUNDAY TIMES, Oct. 25, 1987, at 35,
quoted in FRANK G. DAwsoN, THE FIRST LATIN AMERICAN DEBT CRISIS: THE CITY OF
LONDON AND THE 1822-1825 LOAN BUBBLE X(1990).
2With the exception of Brazil, Latin American countries issued £19 million of bonds in
London in the 1820s. By 1828 all were in default. See CARLOS MARICHAL, A CENTURY OF
DEBT CRISES INLATIN AMERICA 43 (1989). See generallyDawson, supranote 1.
3The 1860s lending boom to Latin America culminated, in the first three years of the
1870s, with close to £75 million of bonds issued. The bubble burst in 1873 as the European
stock markets crashed and worldwide trade declined precipitously. See MARICHAL, supra
note 2, at 94-99.
4The most extensive payment interruption of Latin America's foreign obligations was in
the 1930s in the aftermath of the Great Depression. By the mid-1930s, almost 70% of
national Latin American government dollar denominated bonds and almost 90% of municipal,
provincial and corporate bonds were in default. Debt servicing in most cases was not
resumed until the mid to late 1940s. See Marilyn E. Skiles, Latin American InternationalLoan
Defaults in the 1930s: Lessonsfor the 1980s?, Federal Reserve Bank of New York, Re
search Paper No. 8812, at 1, 15, 17 (1988); MARICHAL, supranote 2, at 212-13.
Debt exchanges in the form of debt-equity swaps, privatizations for
debt, debt-for-nature swaps, and debt buy-backs were employed in the
1980s in response to the Latin American debt crisis.5 Latin American
countries have continued to employ all of these techniques in the 1990s,6
and these techniques are gaining popularity in Eastern Europe and
elsewhere. The principal type of debt exchange in Eastern Europe to date has
been privatizations for domestic debt. As we shall see, such swaps are far
less detrimental for the debtor country than swaps for external (foreign)
debt. However, some Eastern European countries are considering
expanding their debt conversion programs to include external debt. Their
experience with debt exchanges using domestic debt will be a poor guide to the
likely impact of permitting external debt to be exchanged; the history of
debt exchanges for external debt in Latin America is a far better guide.
This article analyses the role and effects of (i) debt-equity schemes, (ii)
privatizations for debt, (iii) debt-for-nature and debt-for-development
swaps, and (iv) debt buy-backs in Latin America in order to determine
whether the expansion of programs in Eastern Europe and elsewhere to
include external debt is likely to be another example of Galbraith's
I. DEBT EXCHANGES TODAY
While the techniques of debt exchanges were developed in the 1980s in
response to the Latin American debt crisis, the use of debt exchanges,
particularly debt-equity schemes and privatizations for debt, has now spread
far beyond Latin America and has served a range of purposes. In the 1990s,
developed countries have often used debt-equity exchanges to enable banks
to convert their non-performing loans into equity stakes in troubled debtor
5 Claudio Milman, Attitudes Towards Debt-Equity Swaps And Privatization of
Owned Enterprisesin Chile, 8 PuB. BUDGETING & FIN. MANAGEMENT 170 (1996).
6Argentina has continued to promote debt-equity swaps in the 1990s and liberalized its
foreign investment regime in 1993 so that foreign investors could invest in Argentina
without prior approval and upon the same terms as local investors. See Bemardo E. Duggan &
Victoria Zoldi, Argentina, Guide To Energy, NaturalResources And UtilitiesLaw Supple
INT'L FIN. L. REv., Apr. 1996
. Brazil has likewise continued to promote debt-equity
swaps. For example, the Central Bank of Brazil issued Resolution 2203 and Circular 2623
to broaden categories of Brazilian public sector foreign debt that could be tendered for
conversion into equity in Brazil's ongoing privatization program. See James Leavy & M.
Cecilia Gaviria, Legal Notes, EMERGING MARKETS DEBT REP., Dec 4, 1995, at 4. Chile
ized its scheme in August 1995
by removing the ten-year lock-in period on capital
repatriation and the limits on repatriation of liquid profits for investments made through
debtequity conversions. The purpose of this change was to increase liquidity in the system and
reduce interest rates and thus inflation. Consistently Sound Performance, CORPORATE
FINANCE FOREIGN EXCHANGE YEARBOOK 59 (1995/96); Chile: Chile Ends
CapitalRepatriation Restrictions, Reuters Econ. News, Aug. 7, 1995. In Mexico, debt-equity swaps have
continued to play a major role. Robert Taylor, Seedily Holds the L
id On, BANKER, Aug.
, at 46.
companies. For instance, the recent restructuring of Eurotunnel, the tunnel
linking England and France, involves a proposed swap of one billion
pounds of debt for equity. 7 In Russia, debt-equity swaps were first mooted
as early as July 1992,8 and have since attracted a considerable deal of
attention,9 even though the swaps have not been implemented. The former
Soviet satellites in Eastern Europe have been quicker off the mark.
Poland implemented an extensive privatization program in 1990 and
had privatized half of all state-owned enterpr
ises by the end of 1994
Debt-equity swaps were introduced
into the Polish process in 1994
principally for use by Polish banks in converting their non-performing loans into
equity stakes in the debtor companies." Foreign debt was not eligible for
use in these Polish debt-equity swaps,12 although there were suggest
and 1996 that it should be.13 Other Eastern European countries, such
as Croatia, 14 the Czech Republic, 15 and Hungary,1 6 have used debt-equity
swaps to enable banks to exchange debt for equity in highly indebted local
companies so that the local banks become shareholders in the companies.
Bulgaria 17 has likewise made extensive use of debt-equity conversions,
7joe Ortiz, Bankers See Debt RestructuringSigned Well Before Year End, Reuters Eur.
Bus. Rep., Jan. 22, 1997, available in LEXIS, Busfin Library, Reueub File; Mary Brasier,
EurotunnelAsks for Debt-Equity Swap, DAILY TELEGRAPH, June 20, 1996, at 19, availablein
LEXIS, News Library, Txtnws File.
8Debt-for-Equity Swap JustAn Idea, RussiA & COMMONwEALTH Bus. L. REP., Aug. 7,
1992, at 15.
9See generallyThomas M. Reiter, The Feasibilityof Debt-Equity Swaps in Russia, 15
MICH. J. INT'L L. 909 (1994); Nigel Stephenson, RussiaAimsfor ForeignDebt/EquitySwap
in 1997, Reuters Fin. Serv., Dec. 13, 1995, availablein LEXIS, News Library, Reufin File.
12New PolishPrivatizationLaw Passed,PRIVATISATION INT'L, Oct. 1, 1996, availablein
LEXIS, Market Library, Iacnws File.
ish Plansfor 1996
, PRIVATISATION INT'L, Feb. 1, 1996, availablein LEXIS, Market
Library, Iacnws File.
14By early 1996, Croatian banks had converted well over DM I billion of
nonperforming loans into equity stakes in local companies. See Pa
inful Peace, BANKER, May
, at 61.
15Jan Lopatka, Czech Truckmaker Tatra Rescued, Reuters Fin. Serv., Feb. 29, 1996,
availablein LEXIS, News Library, Reuf'm File.
16See KH Bank Acquires 39% of Concordia Warehouse Firm, MTI ECONEws, Sept. 18,
FIN. Tmis (London), Feb. 6, 1995, available in LEXIS, News Library, Allnws File;
BulgariaUses $17 Million ofBradys in Privatization,Reuters Fin. Serv., Sept. 12, 1995,
available in LEXIS, News Library, Reufin File; Robert Whitford, Dynamic Debt: Brady Bonds
Can Sweeten BulgarianAcquisitions, Bus. E. EuR., Feb. 19, 1996, at 4. Under Bulgaria's
regulations, Brady bonds can be used to finance up to one-half of the price of a company to
principally of external debt in the form of Brady bonds. 18 In the words of
one commentator, "[d]ebt-equity swaps have become a standard tool for
foreign investment in Bulgaria, as they promise bargain prices for privatised
This section considers debt-equity swaps involving the exchange by a
foreign investor of external debt incurred or guaranteed by a Latin
American sovereign (the government of the debtor country) for an investment in a
private sector company in the debtor country. The foreign investor will
typically be either a multinational corporation, which has acquired the debt
in the secondary market, or less often, a bank holding the debt as a result of
its lending activities. For a multinational corporation making a new
investment or expanding an existing one, a debt-equity swap offers the best
exchange rate through which to make a capital injection into the private
be privatized. Investment GuideforBulgaria,Euao-E., Apr. 23, 1996, availablein LEXIS,
Eurcom Library, Eureas File.
18,,Brady bonds" is the name commonly given to the collateralized bonds issued upon the
securitization of a country's loans pursuant to a restructuring of the country's debt. They are
named after the Brady Plan, a proposal by Nicholas Brady, then Secretary of the United
States Treasury, first outlined in a speech to a joint meeting of the International Monetary
Fund ("IMF") and the World Bank in Seoul, South Korea. See Nicholas Brady, Remarks
before a Conference on Third World Debt (March 10, 1989), in DEP'T ST. BULL., May 1989, at
53-56. Secretary Brady proposed a series of individual market-based transactions in which
(i) creditors would be invited to participate voluntarily, (ii) debt relief would be tied into the
conversion of loans into collateralized bonds, (iii) debtor countries would be permitted to
repurchase their own discounted debt on the secondary market and (iv) debt-equity schemes
would be promoted. The proposal was seen as an expression of increased urgency from the
U.S. government about the resolution of the debt crisis, a strong call for the development of
capital-market-based solutions, and an official acceptance that some debt forgiveness was
essential. See Lee C. Buchheit, The Background to Brady's Initiative, INT'L FIN. L. REv.,
Apr. 1990, at 29-31.
19Whitford, supra note 17. Further afield, Nigeria has operated a debt-equity scheme,
with only a few interruptions, since 1988. See Tunde Obadina, Nigeria to Resume
DebtEquity Swaps Next Week, Reuters World Serv., Mar. 20, 1995 available in LEXIS, News
Library, Reuwld File. Jordan commenced
its scheme in 1996
pursuant to an agreement with its
icial creditors. In April 1996
, the United Kingdom's Export Credit Guarantee Department
arranged to sell 35 million pounds sterling of its Jordanian debt at around 50% of face value
for use in equity exchanges. Jordan:ParisClub Debt/Equity Swap Approved, MIDDLE E.
ECON. DIG., Apr. 29, 1996, availablein LEXIS, News Library, Txtnws File. France reached
a similar agreement with respect to FF 325 million of Jordanian commercial debt. Jordan:
Debt/EquitySwap with FranceApproved, MIDDLE E. ECON. DIG., July 15, 1996, availablein
LEXIS, News Library, Txtnws File. Negotiations with foreign commercial banks for more
extensive conversion schemes were underway at the end of 1996. Jordan Says 96 Budget
Deficit Under 200 million Dinars,Reuters Fin. Serv., Nov. 5, 1996, available in LEXIS,
News Library, Reufin File.
In any debt-equity scheme, there are two methods used to convert debt
into equity. Under the first method, the debt-equity scheme prescribes a set
discount at which the debt may be converted into equity. For example, the
debtor country's central bank may stipulate that it will retain twelve cents
on the dollar so that, for every dollar of debt tendered, the investor receives
local currency to the value of eighty-eight cents. Under the second method,
the conversion rate may be set by an auction so that investors bid for the
right to convert debt into equity and those willing to accept the largest
discounts receive the right to convert their debt.
The attraction of these schemes to investors in Latin America in the
1980s becomes clear upon consideration of a typical example. In late 1986,
Mexican sovereign debt was trading at fifty-seven cents on the dollar, and
Mexico was taking an average redemption discount of eleven percent.20
Allowing three cents on the dollar for the fees of a trader to assemble the
package of convertible debt, an investor would receive eighty-nine cents
worth of pesos for every sixty cents spent - an increase in buying power of
over forty-eight percent.2 1 Debt-equity swaps confer a preferential
exchange rate upon foreign investors. In exchange for such a preference
there are usually limitations. Eligible investment is often limited to certain
industries and restrictions are imposed on the repatriation of capital and the
remittance of dividends.23
Debt-equity swaps were rapidly embraced in the 1980s by most banks
and commentators, and, after a short period, by the U.S. government.24 As
a potential market-based response to the debt crisis, conversions into equity
held out a hope against the spectre of mandatory debt forgiveness. In the
1980s, the major debt-equity schemes were operated in Argentina, Brazil,
2 0RICHARD A. DEBs ET AL., FINANCE FOR DEVELOPING COUNTRIES: ALTERNATIVE
SOURCES OF FINANCE: DEBT SWAPs 23 (1987)
2,This example is modified from the one given by DEBS Er AL., supra note 20, to take
account of the higher trader's fees and transaction costs which, from the author's experience,
were typical in the market at that time.
22DEBS ET AL., supra note 20, at 23. For an analysis of the preferential exchange rate
involved in debt-equity swaps, see George Anayiotos & Jaime De Pinies, The
SecondaryMarket and the InternationalDebt Problem, 18 WORLD DEVELOPMENT 1655, 1657 (1990).
23For instance, under the Ch
ilean scheme, until 1995
, capital could not be remitted in the
first ten years of an investment, and dividends could only begin to be remitted in the fifth
year, and then at a controlled rate. See Claudio Pardo, Remarks at the Heritage Foundation
Center for International Economic Growth Conference on Debt/Equity Conversion: A
Strategy for Easing Third World Debt 45, 48 (Jan. 21, 1987) (transcript on file with the
Northwes2t4eSrneeJoguenrneraalollfyIMntaerrynaWtiiollniaamlLsaown,&CBhuilsei'nseDsse)b. t ConversionProgram: Its Promises and
Limitations, 27 STAN. J. INT'L. LAW 437 (1991); Derek Asiedu-Akrofi, A Comparative
Analysis of Debt Equity Swap Programsin Five Major Debtor Countries, 12 HASTINGS
INT'L & COmp. L. REv. 537 (1989)
Chile, and Mexico 25 with less significant volumes of debt converted in
Costa Rica, the Dominican Republic, Ecuador, Jamaica, Nigeria, Poland,
the Philippines, Uruguay, and Venezuela.2 6
A. Potential Advantages of Debt-Equity Schemes
The potential advantages generally identified in the literature of
debtequity schemes for the debtor country include the following:
The preferential exchange rate afforded by a debt-equity program may
serve as an incentive for extra investment in the debtor country. Increased
foreign direct investment is the most commonly cited advantage of
2. Recapture ofSome of the SecondaryMarket Discount
In virtually all debt-equity schemes, a portion of the secondary market
discount is recaptured for the benefit of the debtor. Under Chile's auctions
in the 1980s, between ten percent and fourteen percent of the face amount
converted would generally go to the debtor. In the early 1990s, investors
were prepared to pay substantially higher premiums to participate in
con25Between 1985 and 1993, these four Latin American countries were responsible for
79% of debt converted worldwide. Milman, supra note 5, at 170. The figure would have
been much higher than 79% for the period 1985-89 considering that in excess of $2 billion of
Chilean companies' external debt was converted through its formal program in 1987 and
over $2.6 billion was so converted in 1988. See Williamson, supra note 24, at 490, Table 3
(1991); see also Asiedu-Akrofi, supra note 24, at 537. Argentina variously promoted and
suspended its scheme throughout this period. However, once the price on Argentina's debts
had fallen to the 20% range in 1988 and 1989, conversions became very attractive to the
country because of the large amounts of debt erased by the conversions. Mexico's program
was suspended in October 1987 amid concerns about its inflationary impact and effect on the
allocation of new investments. Asiedu-Akrofi, supranote 24, at 560; see also Peter Truell,
Brazil Could Cut ForeignBank Debt By $19 Billion By 1994, Study Says, WALL ST. J., Aug.
23, 261M98i8c,haate6l. Chamberlin, et al., Sovereign Debt Exchanges, 1988 U. ILL. L. REv. 415, 417
n.17 (1988); Martin W. Schubert, A Debt Strategy for International Commercial Banks in
1988, Address at Bankers' Association for Foreign Trade Conference (Jan. 24-26, 1988) (on
file with the Northwestern Journal of InternationalLaw and Business); Peter Truell &
Charles F. McCoy, Third World CreditorsGive Debt-EquitySwaps a Try, WALL ST. J., June
11, 271L98e7e, aCt.6.Buchheit, Debt Equity Conversion ProgrammesFrom the Debtor Country's
Perspective,in GUIDE TO DEBT EQUITY SwAps: SPECIAL REPORTNo. 1104 33, 34 (Steven M.
Rubin ed., 1987) [hereinafter GUIDE TO DEBT EQUITY SwAPs]; Elali, Debt-Equity Swaps and
the Alleviation of the LDCs Debt Problem, 5 INT'L J. COM. & MGMT. 49, 64 (1995); Jay H.
Newman, Trends in the Marketfor Developing CountryDebt andDebt Equity Conversions,
in GUIDE TO DEBT EQUITY SwAps, supra, at 14; Lotfi Maktouf, Some Reflections on
Debtfor-Equity Conversions,23 INT'L LAW. 909, 910-915 (1989); Michael K. Phair, Debtfor
Equity: A PortfolioInvestment Approach, in GUIDE TO DEBT EQUITY SwAps, supra,at 80.
versions, but, overall, the proportion of the secondary market discount that
Latin American debtors were able to appropriate remained small.28
As the debt converted into equity is extinguished, the repayment of
interest and principal no longer burdens the debtor's economy and foreign
exchange reserves.29 Offsetting this benefit, however, is the immediate
burden of repaying the external debt in local currency and the long-term
drain on foreign exchange of dividends and capital repatriation on the
equity investment.30 In most debt-equity schemes, remittance of dividends
and capital is restricted for a period of years, but eventually this outflow of
foreign currency has to be permitted.3' This outflow will exceed the interest
that would have been due if the investments were successful as was the
case, for the most part, in Latin America. 2
4. Encouragementofthe RepatriationofFlight Capital
The preferential exchange rate afforded by a debt-equity swap made
the repatriation of flight capital by local investors more attractive,
particularly as the typical limitations on repatriation of principal and payment of
dividends did not affect local investors. 33 The return of flight capital is a
commonly cited benefit of debt conversion programs.34 However, this also
heightened local criticism of the programs, which were seen as rewarding
locals who had previously broken the exchange control laws by sending
their money abroad.
28Buchheit, supranote 27, at 34-35.
29 1d.; Elali, supranote 27, at 62.
30 ROBERT R. BENCH, REMARs BEFORE THE EUROMONEY DEBT/EQUITY CONFERENCE:
THE REGULATORY ENVIRONMENT FOR DEBT-EQUITY SwAPs (1987), reprintedin 6 0CC Q.J.
17 (311987); Williamson, supranote 24, at 475-77.
Argentina, Brazil, Chile, Mexico, and the Philippines each imposed restrictions on
capital repatriation and profit remittances in their debt-equity schemes. Asiedu-Akrofi,
supranote 24, at 571.
32 1f the investment is in a field that does not generate foreign exchange, these dividend
payments will deplete the country's foreign exchange reserves. See Tina Hofmann,
InternationalDebt: Debt-to-EquitySwaps, 28 HARV. INT'L L.J. 507, 513 (1987). The success of
these investments was made more likely because the prices paid for them were set in a
period of extreme economic hardship. See Ricardo A. Lagos, Debt-EquitySwaps and the
Consequences for Chile, in THIRD WORLD DEBT: MANAGING THE CONSEQUENCES 139, 148
(Stephany Griffith-Jones ed., 1989) [hereinafter THRD WORLD DEBT: MANAGING THE
33This remained true only if local investors were prepared to keep the funds in their
cou3n4tSrye.e Asiedu-Akrofi, supranote 24, at 569; Elali, supranote 27, at 64; Lagos, supranote
32, at 143.
Facilitating the privatization of state-owned companies that were a
burden to the economy has been identified by some commentators as a
benefit of debt-equity programs.3 5 Chile and the Philippines, in particular,
used their36debt conversion programs to facilitate extensive privatization
B. Potential Disadvantages of Debt-Equity Schemes
The generally identified potential disadvantages
schemes include the following:
The most widely criticised aspect of debt-equity schemes has been its
effect on economies that typically were struggling to limit inflation. In the
words of Jeffrey Sachs, "[t]he problem with a debt-equity swap is that it is
highly inflationary, exactly [when] the government is desperately
attempting to control inflation., 37 When a debtor country's central bank prints cash
to fund conversions of the national debt, the impact is highly inflationary.
More commonly, a country will issue bonds domestically in local currency
to fund the conversions. The demand generated by such bonds puts upward
pressure on local interest rates, which potentially increases the
government's cost of funds and crowds out private investors.38 Furthermore, since
these local currency bonds are short-term, the bonds are so similar to money
that their issuance fuels inflation directly by adding to the monetary
supply.39 In general, whenever credit to the economy is allowed to expand to
fund conversions of debt, the result has been strong inflationary pressures.40
For instance, Mexican officials calculated that for every $100 million of
DEV3E8LMOiPcIhNaGelCOBUlNacTkRwYeDllEB&T ISMiPmLoEMnENNToIcNeGraT,HTEhCeONImSEpNaScUtS oxfxDxieib(1t9t8o7)E.quity Conversion,
FINANCE & DEVELOPMENT, June 1988, at 17; Elali, supranote 27, at 65; Lagos, supra note
32, at 148; Reiter, supranote 9,at 960 (1994); Williamson, supra note 24, at 479.
39 Sachs' Testimony, supranote 37, at 370.
40Shilling & Toft, supranote 37. Blackwell and Nocera calculated that the conversion of
only 5 % of the outstanding debt could have led to an increase in the money supply ranging
from 33 % for Brazil and the Philippines to 59 % for Mexico. Blackwell & Nocera, supra
note 38, at 16.
debt converted to equity in the years 1986 and 1987, inflation increased by
between three percent and five percent. This is a substantial increase
considering that $100 million is a modest amount of debt.41
2. Substitutionfor FreshInvestment
Investment by way of debt-equity conversion does not result in extra
foreign exchange and capital for the debtor economy as do other forms of
foreign investment. Accordingly, if debt-equity conversion schemes are
merely subsidising investments that would have been made anyway, the
conversions are positively detrimental to the host country,42 as the
investments would have been made at more favorable exchange rates and
accompanied by an injection of precious foreign currency.
3. Short Term Costs andBenefits
In the short term, a debt-equity conversion saves the debtor economy
the interest payments over the few years following the conversion at the
cost of paying around ninety percent43 of the face value of the tendered debt
in local currency immediately.44 As local interest rates were usually higher
than the interest rates on the foreign currency in which the external debt had
been denominated, 45 and local currency denominated bonds were usually
issued by the government to fund the conversions, debt-equity conversions
typically resulted in significantly increased budgetary burdens on Latin
American debtor governments. As Buchheit wrote in 1987, "[s]ome
countries therefore see these transactions as amounting to the immediate
tender of 100 cents worth of local currency in return for seven or eight cents
(at present interest rates) of debt service relief in each of the next few
41See Steven M. Rubin, GUIDE TO DEBT EQUITY SWAPS, supra note 27. However,
inflation should be unaffected in the unusual case in which a sovereign funded the conversion
from its internal resources. Shilling & Toft, supranote 37.
42See Blackwell & Nocera, supra note 38, at 17; Buchheit, supra note 27, at 35-36;
Lagos, supra note 32, at 147; Shilling & Toft, supranote 37; WORLD BANK, supra note 37, at
Xxx4i3i.This depends upon the proportion of the secondary market discount recaptured for the
4454SBeuechDhaeniti,esluHp.raCnoolete, 2D7e,batt-E3q6.uity Conversions,Debt-for-Nature Swaps, and the
Continuing World Debt Crisis,30 COLUM. J. TRANSNAT'L L. 57, 64 n.l (1992); Williamson,
supranote 24, at 479.
46See Buchheit, supra note 27, at 36; Sachs' Testimony, supra note 37, at 369; WORLD
BAN4K7B,uscuhphreaint,otseu3p7r,aantoxtexx2i7i-,xaxtx3ii6i.. Buchheit has not allowed here for the redemption
discount which accrued to the debtor country. Buchheit's comparison should have been
between 85 or 90 cents of local currency and the interest relief, but his point is otherwise well
4. FacilitationofRound TrippingTransactions
The round tripping of the proceeds of debt-equity conversions from the
local currency generated by the conversion back into foreign currency and
then back into local currency by another conversion has been described as
"an irresistible arbitrage opportunity" for "those so inclined. ' 4'8 In essence,
round tripping is a way to convert external debt into local currency in such
a way that the foreign exchange value of the local currency exceeds the
value of the converted external debt. However, round tripping is not
alchemy - the corresponding cost is borne in higher local indebtedness for
the debtor government.
Latin American countries attempted to prevent round tripping by
ensuring that the proceeds of a conversion were invested in an approved
project and by prohibiting the repatriation of principal or payment of dividends
abroad from the investment for a number of years.4 9 However, no country
managed to stamp out round tripping entirely, and this abuse appears to be a
cost of debt conversion schemes. 50
Debt-equity schemes may misallocate resources by sending incorrect
signals to investors. A debt conversion program provides a subsidized
exchange rate which, like all departures from the market, may lead to
inefficiencies such as the investment going into sectors of the economy sheltered
by tariffs and quotas.5 1 Most conversion programs provided incentives for
investment in priority sectors or regions, but these incentives were not
always sufficient to prevent debt conversion investment from worsening
structural imbalances in the local economy.5 2
Unless investment in existing plants or companies was restricted, as it
was in a few countries,53 investments under debt conversion schemes tended
to be in existing plants or firms whereas unsubsidised foreign direct
invest481d. at 37; see also WORLD BANK, supranote 37, at xxxii.
49Buchheit, supra note 27, at 37.
5 There are two methods by which round-tripping can be constrained: first, prohibiting
the participation of local investors, or second, tightening exchange and capital controls.
Elali, supranote 27, at 66. However, each method has detrimental side effects.
5"2DMEoBsSt hEoTsAtLc.,ousnutprireasnaottteem20p,teadt 3t4o; cBhlaancnkewl edlelb&tcNonovceerrasi,osnupfurnadnsoitnet3o8p,raitor1i7ty. sectors of
the economy, typically those that generated exports and foreign exchange, or into depressed
geographical regions of the country. See Maktouf, supranote 27, at 942. To the extent such
investments could be effectively channeled into export industries, the long-term balance of
the debtor country's trade might be improved. See Cole, supranote 45, at 66. Typically,
investment in a priority sector or a region resulted in a lower redemption discount, i.e., less of
the secondary market discount would go to the debtor country and more of the discount
wou53ldAgrgoetnotitnhae, inCvoessttaorR. icSae,eEMcuaakdtooru,f,asnudptrhaenPohteil2ip7p,iante9s1r2e-s1t3ri.cted investments in existing
plants or companies. See Lagos, supranote 32, at 153, 157 n.34.
ment is more frequent in projects that increase the productive capacity of
the economy. 4 As a result, most of the investments encouraged by debt
conversion programs merely resulted in a transfer of ownership of existing
assets rather than the creation of new productive assets.
Debt-equity schemes may also misallocate resources by using "the
proceeds of foreign equity investment or returning flight capital for the
retirement of external debt, thereby excluding other possible important
uses."'55 It is highly questionable whether the prepayment of external debt
was the most efficient use of the sale proceeds of the conversion
programs.5 6 The proceeds could have been used to pay for imports, repair
infrastructure, or other uses designed to improve the productive capacity of
the country. As Ricardo Lagos wrote, "paying the principal of the debt in
advance may not be good business since it has become a virtual fact that the
external debt will not be paid in its actual terms .... [T]he resources used
to pay the debt in advance are being diverted from other urgent possible
6. Incentivesfor Privatisations
While the facilitation of privatizations is, in some eyes, a benefit of
debt-equity schemes, the corresponding incentive to sell off national assets
is, in other eyes, a detriment, particularly because the assets sold are often
the most profitable and efficient.5 9 In many countries, the extent of
privatizations has been massive. For example, by the end of 1995, Brazil had
privatized most of its petro-chemical enterprises and virtually all of its state
enterprises in the steel and fertilizer sectors.60
541d. at 154.
55 DEBS ET AL., supra note 20, at 33; Cole, supranote 45, at 64-65. Cf Blackwell &
Nocera5,6sTuhperasanmoteea3r8g,uamt e1n7t. could be made with respect to the use of scarce foreign exchange
reserves to effect debt buy-backs, but the difference is one of degree. Buy-backs benefit
debtor countries when secondary market prices are so low that the cost of the buy-back is in
the order of two to four years of interest repayments. When a buy-back recaptures a
discount of 70% and upwards for the debtor country, its effect is quite different from a
debtequity swap that recaptures perhaps 10% or 15% of the discount for the debtor. See infra
text57aTcchoemsptaanteyiongf Cnohtiele1's38rofaodrscodnescildineeradtiopnreocifptihtoeuesflfyecitns othfebumyi-db-atcok-lsa.te 1980s when the
economic focus was on reducing external debt. The long-term costs to Chile of having to
effectively rebuild roads, which would have only required routine maintenance to avert their
disintegration, has been massive. Interview with A. Byl, International Bank for
Reconstruction and Redevelopment, Bond University (Feb. 20, 1996).
58Lagos, supranote 32, at 148.
56901Pdre.laitm1in53a.ry Offering Memorandum for the MYDFA Trust, at C-22 (Sept. 30, 1996)
(on file with the Northwestern Journalof InternationalLaw and Bus
iness). By year-end
, Brazil had privatized 41 enterprises for a nominal, face value consideration of $9.6
billion, the vast majority ofwhich was paid in Brazilian debt. Id. at C-22, C-23.
7. Equity Considerationsfor Local Investors
Debt-equity schemes give investors a preferential exchange rate, but in
most countries, local investors do not have access to the foreign exchange
which is required to purchase the debt on the secondary market. In
addition, local investors are not permitted to purchase foreign exchange for this
purpose.61 Such schemes are also seen as rewarding local investors who, in
defiance of local exchange control regulations, had moved their foreign
currency abroad prior to the debt-equity conversion.62 In Chile, protests
against these rewards were muted because local investors were permitted to
participate in the debt buy-back programs, but still were not permitted to
participate in the debt-equity programs.63 In virtually all other countries,
local investors were expressly or effectively excluded from all programs,
and this exclusion resulted in substantial local resentment.
C. Chile's Debt-Equity Program
Debt-equity schemes were, and are, consistently promoted by reference
to the success of Chile's programs. 64 Indeed, in the first three years of
operation, based upon the most favorable figures, Chile's debt buy-back and
debt-equity programs reduced Chile's total foreign debt by $3.8 billion,
which represented about nineteen percent of the debt existing upon the
programs' commencement.6 5 This is indeed a meritorious performance, and
Chile's programs were operated consistently over many years so that
additional investment was likely encouraged. Furthermore, Chile had strict
limitations on the repatriation of principal and remission of dividends
abroad, which restricted the drain on its foreign exchange reserves. Thus, it
is no coincidence that debt-equity's proponents always refer to the Chilean
experience; it has been entirely exceptional.
The Chilean economy had a remarkable capacity to absorb extra credit
without the credit expansion leading to inflationary pressures. This
capacity permitted the program to be opened, in part, to local investors, which did
61 See Buchheit, supranote 27, at 37-38.
621d. at 38. In Mexico local investors were not permitted to participate in such schemes
because this was seen as rewarding capital flight. Id.
63 Williamson, supra note 24, at 468, 470, 475. The unusual capacity of the Chilean
economy to absorb fresh funds and to hold a particularly tight rein on inflation meant Chile
could operate a liberal program and open the program to local participation. Chile's
approach is unlikely to succeed in other debtor countries.
64Cole, supranote 45, at 69; Lagos, supra note 32, at 139; see also Williamson, supra
note 24, at 479. In Cole's words, "Chile's debt-equity conversion program is the success
story to which all debt-equity proponents point." Cole, supra note 45, at 69. For a
contemporaneous example of Chile being held up as the successful model of a debt-equity program,
see Ross, Putting Debt/Equity in Context: Recapitalizing the Developing Nations, Remarks
at the Euromoney Conference on Debt-Equity Swaps, Santiago, Chile, at 9-12 (Apr. 26-28,
198685)L(aognofsi,lesuwpirthanaoutteho3r2),. at 143, 151.
much to quell local opposition.6 6 Furthermore, Chile was one of the most
developed and successful of the Latin American economies and thus had a
relatively large proportion of companies and projects that were attractive to
foreign investors. The absence of inflationary pressure and domestic
dissent enabled the programs to be operated consistently over the years so as to
generate real benefits for Chile. Nonetheless, Chile's programs have been
criticized heavily, particularly for their contribution to the sharp fall in
foreign direct investment.67 However, irrespective of whether Chile's
programs benefited Chile, and persuasive arguments have been made that they
did not,68 no other country except Brazil was able to operate its program for
sustained periods, and in Brazil's case, hyperinflation and economic
malaise were the apparent result.69 Accordingly, Chile's experiences do not
answer the question whether debt-equity programs were generally beneficial
for debtor countries. For that answer, we must return to the above analysis
of factors for and against such programs.
D. Conclusion for Debt-Equity Schemes
As the preceding discussion indicates, there are five factors in favor of
debt-equity schemes and seven factors against such schemes. However,
simple arithmetic will not determine whether debt-equity programs are
desirable. The quality and extent of the benefits and detriments must be
The principal potential benefit of such programs is the encouragement
of additional investment. This factor is generally recognized as the key
de"The programs of Argentina, Brazil (after June 1984, if the investor was an original
creditor), Mexico, and the Philippines were also open to local investors. Asiedu-Akrofi,
supra note 24, at 571. Yet, local participation in these countries did not quiet public criticism
of the programs, as it did in Chile, perhaps because the programs were seen as contributing
to ruinous inflations in a way they were not in Chile. Furthermore, Chile's debt purchase
program under Chapter XVIII was more extensively used by locals in Chile than conversion
programs were in these other countries. See infranote 107 and accompanying text.
67Direct foreign investment (the type that results in the inflow of foreign exchange) fell
from the already low figure of about $200 million in 1983-84 to about $110 million in
19851986. Chile's debt conversion programs were introduced in May 1985. Lagos, supra note
32, at 151. For a thorough consideration of the effects of the programs on Chile, see id. at
69 In a 1988 study, Amo Meyer and Maria Silvia Bastos Marques, two Brazilian
economists, adjudged that Brazil's program harmed the country. See Alan Riding, Debt-Equity
Swaps DrawLatin Criticisms,N.Y.TMES, Jan. 2, 1989, at A30 (critiquing the study).
Professor Sachs said in 1988 that "the debt-equity swaps in Brazil have been a major spur to
inflation, and have contributed disastrously to Brazil's economy this year." Sachs' Testimony,
supra note 37, at 370. Professor Sachs also stated that "the debt-equity program last year
was a major contributor to a hyperinflation which is now destabilizing the economy and
society." Id. at 369.
terminant of whether a debt-equity scheme offers major benefits. 70
However, the conception, planning and implementation of international
investment require substantial time. Because of the time involved in learning the
program, investigating potential investment opportunities, settling upon an
investment, acquiring the debt or options on the debt in the secondary
market, and bidding in the conversion process, a debt-equity program is
unlikely to result in much additional investment in its first year of operation,
beyond the portfolio investment in local shares, if permitted. However,
only Brazil and Chile allowed their programs to run uninterrupted over
many years. The programs in virtually all other debtor countries typically
ran for a year or so, and then were shut down because of inflationary
concerns and local investor resentment. After a year or two, the programs were
reopened, only to be shut down again after about six to eighteen months of
operation. Buchheit has rightly described additional investment as "[t]he
only sensible justification for inaugurating a formal debt equity conversion
programme.... 71 Yet, the stop-start nature of most programs guaranteed
that little additional investment could result from them.7 a These Latin
American experiences show that if Eastern European and other countries
choose to extend their debt-equity schemes to include external debt, they
must do so for an extended period of time such as three years but preferably
longer. Otherwise, they will risk obtaining all of the detriments of
including external debt, rather than the principal benefit of such a move.
The repatriation of flight capital afforded by debt-equity schemes was
a significant benefit for Latin American debtors. However, this benefit was
achieved at the cost of rewarding people who had earlier broken the foreign
exchange regulations. As debt-equity in this sense is merely a preferential
exchange rate, the same end could have been achieved in Latin America by
simpler means. Capital flight on the Latin American scale never occurred
in Eastern Europe because the local currencies were not freely convertible.
Accordingly, the repatriation of flight capital is unlikely to be a significant
benefit in Eastern Europe's debt-equity schemes for external debt.
The other three benefits of debt-equity programs are: (1) debt service
relief; (2) recapture of secondary market discount; and (3) facilitation of
privatizations, were extremely modest in the Latin American context. The
first two of these benefits must be set against the need to repay about ninety
percent of the face value of the loan immediately in local currency, a debt
usually funded by the issuance of domestic bonds. The typical result found
in Latin America of inflationary pressures and an increased fiscal drain on
the government due to domestic interest rates being invariably higher than
foreign ones, will also be the case in Eastern Europe. The secondary
mar7 0DEBS ET AL., supranote 20, at 28; Buchheit, supranote 27, at 35.
7 1Buchheit, supranote 27, at 35.
72Mexican officials maintained that up to 80% of debt conversion investment would have
come into Mexico in any event. Riding, supranote 69, at A34.
ket discount recaptured by Latin American debtors was usually modest and
grossly insufficient to offset the increased domestic funding costs. There is
no reason to suggest that Eastern European debtors will be able to reclaim
larger portions of the secondary market discount. Finally, it is debatable
whether the facilitation of privatizations is a benefit to countries using
debtequity programs, but privatization is less of a benefit in the transformation
of former command economies in Eastern Europe than it was in the
"structural adjustment" of the economies of Latin America.
Against these modest benefits, the disadvantages of debt-equity
schemes for external debt are very real. In particular, the major
disadvantages include the loss of the foreign currency that would otherwise have
accompanied foreign direct investment if not channelled through a debt-equity
scheme, the massive budgetary burden of redeeming the debt in local funds,
the inflationary pressures on the local economy, and the misallocation of
resources. These disadvantages apply equally wherever such schemes for
external debt are implemented. These factors combine to make debt-equity
schemes, in the words of Professor Jeffrey Sachs, "the worst possible
arrangement from the point of view of the debtor country." 73 Throughout the
1990s, Eastern European countries have struggled to contain severe
inflationary pressures. 74 In this context, the added inflationary effects of
debtequity exchanges are likely to be ruinous.
A number of Latin American countries announced or implemented
privatization schemes in the late 1980s. 75 Privatizations can be divided into
two groups: first, those in which state-owned assets are sold for external
debt, and second, those in which the assets are sold for domestic debt or
cash. The previous analysis regarding debt-equity swaps applies for the
most part to privatizations for external debt, which are, after all, simply
massive one-shot debt-equity swaps. The principal difference between
privatizations and other forms of debt-equity conversions is that in a
privatization, the local currency issued to redeem the external debt is immediately
paid to the government to acquire state-owned assets and therefore the
inflationary effects are minimized.76
privatized are usually among the mOorne tphreodouthcetirvehainnd,puthbelicasosewtsnetrhsahtipa.r7e7
Whether assets such as national airlines, oil companies and steel makers
were an appropriate price to pay to reduce their debt of the 1970s is highly
questionable given the banks' negligence and over-aggressive salesmanship
in making the loans.78 For economic rationalists, privatizations are
beneficial because they reduce the total indebtedness of the debtor and result in
the transfer of valuable assets from "inefficient" state control into
"efficient" private sector control, but others have likened the sale of national
assets to "some surrealistic capitalist fantasy . . . whose . . . hero sells off
arms, legs, and much else to stay alive., 79 According to this view, the costs
of privatizations will be borne by the citizens of Latin America well into the
next century.80 Overall, the desirability of privatizations is a vexed issue.
Wherever implemented, privatizations need to be handled with great
care as they are irreversible and potent. Privatizations appear to be required
to introduce private ownership of productive assets into former command
economies. The case for privatizations in Eastern Europe is certainly more
compelling than in Latin America. With the exception of Bulgaria, most
privatization schemes in Eastern Europe to date have been focussed on
domestic investors. This is a wise policy choice by Eastern European
governments because the sale of productive national assets to foreign interests
76Stephen Fidler, Debt Reduction: The Coming Game, FIN. TIMES, Jan. 12, 1989, at 39;
Letter from Lee C. Buchheit to author (Feb. 24, 1997) [hereinafter Buchheit Letter] (on file
with the NorthwesternJournalof InternationalLaw & Business).
77The Australian cartoonist and poet, Michael Leunig, deals with economic rationalism
and privatizations in the following poem:
They're privatising things we own together
They're flogging off the people's common ground
And though we're still connected by the weather
They say that sharing things is now unsound....
MIC7H8AJaEmL eLsEUWN.IGC, hTilhde, PTehoepLleim'siTtsreoafsuCrree,dinitAorBs'URNiCgHhtsO:FTPhoesECYa4s0e (o1f99T2h)i.rd World Debt, 9
SoC. PHIL.& POL'Y 114, 138-39 n.1 (1992).
79 LAWRENCE MALKIN, THE NATIONAL DEBT 125-26 (1987); see also Cohen, supra note
37, at 121. Privatizations provoked heated opposition in the debtor countries. See Defusing
the Debt Bomb the Less Painful Way, WALL ST. J., Apr. 1, 1985, at Al; Eric N. Berg, U.S.
Banks Swap Latin Debt: Concerns Get Equity Stake, N.Y.TIMEs, Sept. 11, 1986, at Dl.
80The arguments for and against privatization raged in Britain, where large scale
privatization began under Margaret Thatcher, and continue today in Australia as the conservative
federal government proposes the sale of the national airline, telecommunications company
and other national assets. The arguments are the same whether in Britain or Brazil, Australia
or Argentina. However, the consequences ofthese arguments are far greater in Latin
America, a region so poor that economic errors cost lives.
81Yet, many authors have tried to make compelling cases for privatization in Latin
America. See Sebastian Galiani & Diego Petrecolla, The ChangingRole of the Public
Sector: An Ex-Post View of the PrivatizationProcess in Argentina, 36 Q. REv. ECON. & FIN.
131, 131, 149 n.2 (1996).
in times of economic distress will result in fire-sale prices, hardly a fair
recompense. Sale to local interests retains the control and proceeds of the
productive assets within the country.
In Britain and Australia, privatizations have been the choice of
conservative governments focused on fiscal rectitude, balanced budgets and
economic rationalism. In Latin America, notwithstanding the presentation of
privatizations as "as a deliberate, freely adopted policy choice applauded by
ideologues in Washington and local beneficiaries,, 82 privatizations were an
economic necessity, not a choice. 8 Privatizations were "[tlhe almost
unavoidable result of dozens of governments' virtual bankruptcy. '84 This has
not been the case in Eastern Europe where privatizations have been driven
by the need to reform command economies into market economies.
IV. DEBT-FOR-NATURE AND DEBT-FOR-DEVELOPMENT SWAPS
Debt-for-nature and debt-for-development swaps were significant in
Latin America, and could be significant in Eastern Europe and elsewhere,
for their capacity to fund nature conservancy and relief work. These types
of debt exchanges were never conducted, and are unlikely ever to be
conducted, on a scale sufficient to significantly effect a debtor's overall
indebtedness. For example, the reduction in indebtedness of $80 million by the
debt-for-nature swap in Costa Rica in the late 1980s8 5 was less then one
percent of the total debt, yet the local currency proceeds of the swaps were
described by Costa Rica's Minister of Natural Resources, Energy and
Mines, as being "absolutely essential .... There would [otherwise] have
been no money to purchase land bridges between parks, to start tree
nurseries for farmers, or even to fight forest fires. ' 6
82 JORGE G. CASTANEDA, UTOPIA UNARMED THE LATIN AMERICAN LEFT AFTER THE COLD
Northwestern Journal of
International Law & Business
B. Debt-for-Nature Swaps
The first-born offspring of debt-equity swaps were debt-for-nature
swaps, of which there are two broad forms.87 In the first form, a country's
debts are purchased and canceled in exchange principally for the country's
on-going protection of a designated part of its land.88 In the second form of
debt-for-nature swap, the debt is exchanged for local currency which is then
used by local conservation groups, often in association with international
conservation groups, for various environmental projects in the debtor
country.89 This second form of exchange has a number of advantages over the
first. The perceived loss of sovereignty is far less when there are a range of
projects selected with local input rather than when the entire transaction is
for the preservation of one area of the country designated by a foreign
conservation group. Sovereignty is a highly sensitive issue in many Less
Developed Countries ("LDCs") where it was seriously eroded by the debt
crisis and its consequences.9"
Another advantage of using the second form of debt-for-nature swap is
that the funds can be used for local needs because the local conservation
groups determine the use of the funds. The designation of an area as
pro87For an explanation of debt-for-nature swaps, see generally Priya Alagiri, Give Us
Sovereignty or Give Us Debt: Debtor Countries' Perspective on Debt-For-NatureSwaps, 41
AM. U. L. REv. 485, 487 n.2 (1992); David Barrans, PromotingInternationalEnvironmental
Protections Through ForeignDebt Exchange Transactions,24 CORNELL INT'L L.J. 65, 65
n.1 (1991); Cole, supranote 45, at 57; Tamara J. Hrynik, Debt-for-NatureSwaps: Effective
But Not Enforceable, 22 CASE W. REs. J. INT'LL. 141 n.l (1990); Julian C. Juergensmeyer
&James C.Nicholas, Debt ForNature Swaps: A Modest But Meaningful Response to Two
InternationalCrises, 5 FLORIDA INT'L L.J. 193, 194 n.2 (1990); Wee, supra note 86, at 57
8 An example of the first form of debt-for-nature swaps is the first debt-for-nature swap
in July 1987 in which Conservation International, a U.S. conservation group, purchased
about $650,000 face value of Bolivian debt for $100,000. Under an agreement with the
Bolivian government, the external debt was cancelled in exchange for commitments to protect
some 1.2 million acres of biosphere reserve and adjoining land and 2.8 million acres of
forest reserve, and commitments to establish a fund in local currency for the on-going
management and protection of the biosphere reserve. See Chamberlin et al., supranote 26, at
44143; Hrynik, supra note 87, at 142-45; Wee, supra note 86, at 61; Debt-for-Nature Option,
SwAPs: TBE NEWSLETTER OF NEw FIN. INSTRUMENTS, Nov. 1988, at 1, 4 [hereinafter
89An example of this form of transaction is, coincidentally, the second debt-for-nature
swap, which was between the World Wildlife Fund (WWF) and Ecuador in December 1987.
The WWF acquired Ecuadorian debt with a face value of$1 million and assigned this debt to
Fundacion Natura (Ecuador's leading private conservation organization). Under a prior
agreement, this was then exchanged with the Ecuadorian government for local currency
bonds to the value ofS1 million at the official exchange rate. Fundacion Natura then applied
the interest on these bonds to a range of its activities concerned with protecting and
managing natural areas. Upon maturity, the principal of the bonds will establish an endowment
fund for Fundacion Natura. Chamberlin et al., supranote 26, at 443-45.
90For a discussion of sovereignty and local input issues, see generally Alagiri, supra note
87, at 496-503; Barrans, supranote 87, at 79-80; Wee, supra note 86, at 63-65.
tected is a developed world notion, which may not be entirely appropriate
when applied in the context of a LDC in which people still have to forage
for food and fuel in the designated areas. 91 Other examples include Poland,
a country with catastrophic pollution problems, in which a pollution
cleanup to protect people was seen locally to be a far higher priority than
the preservation of bird life habitats by the foreign sponsored
Debt-for-nature exchanges have also been implemented in Costa Rica,
the Dominican Republic, the Philippines,93 Madagascar, Bolivia, Ecuador,
Mexico, Poland, and Zambia.94 Between 1987 and 1994, debt-for-nature
swaps resulted in about $178 million face value of debt being exchanged
for environmental protection.95 Their success should be seen in offsetting
to a limited extent the environmental damage, particularly deforestation, 96
occasioned by the need to earn foreign exchange to service foreign debts,
rather than in terms of the ever-so-slight reduction in the debt burden of
some countries.9 7
C. Debt-for-Development and Debt-for-Education Swaps
Furthermore, debt-for-nature swaps themselves spawned two further
useful variants: debt-for-development swaps and debt-for-education swaps.
Debt-for-development swaps typically involve the donation of debt to, or
acquisition of debt by, an aid agency which, by prior agreement with the
host country's central bank, exchanges the debt for local currency to be
91The first debt-for-nature swap, in Bolivia, attracted criticism on these grounds. See
Alagiri, supranote 87, at 499-501; Wee, supra note 86, at 64 & n.71; Barrans, supra note
87, at 81-82.
92D.H. Cole, CleaningUp Krakow: Poland'sEcological Crisisandthe
PoliticalEconomy of InternationalEnvironmentalAssistance, 2 COLO. J. INT'L ENVTL. L. & POL'Y 205,
241-43 n.2 (1991); Cole, supranote 45, at 76. Scientists predict that up to "25 percent of all
Poles will contract some form of pollution-related cancer." Id.
93The Philippines exchange involved the WWF and was in the second form. The
relevant Philippine government department, a local environmental foundation, and the WWF
governed the application of the funds. See Chamberlin et al., supra note 26, at 444-45 &
n.119 44F.acundo Gomez Minujin, Debt-for-NatureSwaps - A FinancialMechanism to Reduce
Debt and Preserve the Environment, 21 ENVTL. POL'Y & L. 146, 147 n.3&4 (1991).
Furthermore, debt-for-nature swaps have been expanded dramatically in scope by the donation
of debt by some governments; the U.S. government donated up to $100 million of debt and
the German government donated $60 million of debt to Poland to finance environmental
programs. Cole, supranote 45, at 80-81.
9965 WJ. OERuLgDenDeEBGTibTsAoBnLE&S, RsaunpdraallnoKte. 8C5u, ratits8,9A-9D0.ebt-for-Nature Blueprint, 28 COLUM. J.
TRANSNAT'L L. 331, 332 (1990).
97Wee, supranote 86, at 57-59; Debt-for-NatureOption, supranote 88, at 1.
used to fight hunger and disease and promote development in that country.98
Debt-for-development swaps are a highly effective means for aid agencies
to increase the buying power of their foreign currency in local currency. If
handled properly they pose none of the infringement of sovereignty
problems associated with some styles of debt-for-nature swaps and they
"enhance the ability of aid organizations to operate programs that make people
their first concern." 99 The scale of debt-for-development swaps, which
grew out of debt-for-nature swaps, has far eclipsed debt-for-nature swaps.
It has been estimated that from 1987 to 1994 between U.S. $750 million
and U.S. $1 billion face value of foreign debt was cancelled in
debt-fordevelopment swaps °0 with UNICEF alone converting nearly U.S. $193
million of debt-for-development.101 In the same period, a total of about
U.S. 1$01277 million of foreign debt was converted in debt-for-nature
Debt-for-education swaps are another application of the basic principle
that the acquisition of debt and its tender to the debtor country for discharge
can, by virtue of the debt's secondary market discount, magnify the
purchasing power of one's hard currency for local currency; the only difference
in this case is that the local currency supports educational rather than
developmental goals. 0 3 In the first debt-for-education swap, Harvard University
multiplied its purchasing power almost three times. 04
Debt-for-Nature, Debt-for-Development, and
Debt-for-nature, debt-for-development, and debt-for-education swaps
made no significant difference to the total indebtedness of Latin American
countries. However, measuring the effect of the swaps on debt levels
misses the important roles that the swaps did play. Bolivia, a desperately
poor country, was able to reduce its debt burden dramatically and preserve
some of its ravaged environment, through debt-for-nature swaps using
donated funds. 0 5 Costa Rica received funding for conservation efforts where
none would otherwise have been available. Villages in Peru, the Sudan and
elsewhere have drinking water today because of debt-for-development
swaps. The effect of these debt exchanges on the debt crisis was negligible.
However, the effect of these debt exchanges on nature conservancy and
development programs was far from negligible, and these types of debt
exchanges were one of the very few positives to flow from the debt crisis. 10 6
V. DEBT BUY-BACKS
A. Debt Buy-Backs in Latin America
As their name implies, debt buy-backs involve the acquisition of debt
by the debtor either directly from creditors or through the secondary market.
Chile implemented Latin America's first buy-back scheme in 1985. Chile's
debt conversion program had two main limbs, which are commonly referred
to as Chapter XVIII and Chapter XIX after the implementing laws. Chapter
XVIII was a debt purchase program for Chilean companies or persons
wishing to purchase foreign debt and convert it into local currency.F07 The
local market. The proceeds amounted to some $2 million, or almost three times Harvard's
initial contribution. These funds, now owned by the local foundation, were invested in the
United States. The investments are designed to realize about $150,000 per annum ofwhich
about 85% will be used to fund scholarships for Ecuadorian students to attend Harvard and
the balance will fund local costs for research and study in Ecuador by Harvard faculty and
students. Jennifer F. Zaiser, Note, Swapping Debt for Education: Harvardand Ecuador
Providea Modelfor Relief,12 B. C. TIRD WORLD L.J. 157, 180-83 (1992).
105Jeffrey D. Sachs, Comprehensive Debt Retirement: The Bolivian Example, 2
BROOKINGS PAPERS ON ECON. AcriviTY 705 (1988).
1"6Although, on balance, the harm done to the environment because of the debt crisis
out w10e7Tighheedcomnasnidyertiamtioesn tohef rCehpialier'sefdfeobrttscfounnvdeerdsiobny pdreobgt-rfaomr-snaintutrheisswaratpicsl.e has been
simplified. For example, certain debt-equity swaps could be conducted under Chapter XVIII and
conversions were also possible under Decree Law 600, which represented a third limb of the
conversion program. In addition, some 32% of conversions between 1985 and 1990
occurred outside the formal program, typically by way of direct agreements between debtor
companies and their creditors. For a full consideration of Chile's debt conversion program,
see generally Williamson, supranote 24, and for more information on informal conversions,
see Williamson, supra note 24, at 465-66.
international banking community was not pleased with Chile's proposed
debt repurchase scheme, but the banking community did not attempt to
block the scheme and, by 1988, even permitted Chile itself to buy back its
own debt.10 8 The cause of this surprising degree of acceptance is not
known. One reason may have been Chile's economic growth and
stability'0 9. Also, Chile's orderly and efficient administration of these debt
conversion programs made Chile the international banks' favorite LDC debtor.
Another possible explanation may have been that the transactions were
commonly called Chapter XVIII conversions rather than debt buy backs.
Regardless of the explanation, Chile's debt conversion programs have been
consistently hailed as the most successful of any debtor nation and the
appropriate precedent for other debtors to follow."0 One of the central
components of Chile's debt conversion programs was a debt purchase scheme.
Under Chapter XVIII, the Chilean government held regular, fortnightly
auctions at which local companies would tender the amount of discount
they were prepared to accept in exchange for the right to purchase and
convert external debt.' A typical discount was about fifteen percent of the
face amount of the debt."? If the Chilean government accepted a local
company's tender, the Chilean entity would then buy the external debt of
Chile in the secondary market with dollars. The Chilean entity would
acquire these dollars either at a slight premium within Chile," 3 or perhaps
more commonly, from dollars already held abroad. 4 The external debt
would then be converted at the official exchange rate, less the tendered
discount, into peso-denominated bonds which could be sold in the local
market.115 Hence, a company that purchased the debt at sixty-five percent on
the secondary market, and tendered a discount of fifteen percent, would
have received eighty-five cents worth of pesos for sixty-five cents of U.S.
currency and would have increased the value of its foreign currency some
thirty percent, less associated transaction costs. These transactions were
debt purchases rather than debt buy-backs because the debt purchaser was
not necessarily the debtor because these transactions were open to Chileans.
Because the transactions were open to Chileans, the common criticism that
debt-equity programs subsidised foreign investors at the expense of locals
was rarely heard in Chile.
Chapter XIX was a conventional debt-equity scheme distinguished by
the consistent and timely efficiency of its operation.1 16 Interestingly, while
Chile was repeatedly applauded for its Chapter XIX debt-equity scheme by
Chapter XIX,17 and yet Chapter XVIII attracted ruenldateirveClyhalipttteler aXttVenItIiIonth.!an8
international banks, more debt was converted
One of the more significant uses of buy-backs in the 1980s was in the
repurchase of private sector debt by Latin American corporations. For
instance, between 1983 and 1988, Mexican corporations almost halved their
level of indebtedness, from $22.3 billion to $14.5 billion,1 9 principally
through buy-backs. In a mixed debt buy-back and equity swap, the Alfa
Group, one of Mexico's largest corporations, agreed with its foreign
creditors in 1988 to exchange $25 million in cash, $200 million in Mexican
government paper, and forty-five percent of the group's stock in exchange for
$920 million of the Alfa Group's debt.120 During this period, Argentine and
Brazilian companies also repurchased their debt by negotiating private
buybacks with their creditors.1"1 In Brazil, local banks and industrial
compatailed information was required on the source of the funds and nature of the investment. See
Asiedu-Akrofi, supranote 24, at 543 n. 14; Williamson, supranote 24, at 450.
5sAsiedu-Akrofi, supranote 24, at 542-43.
1 6 Foulke, supranote 112, at 38.
17 Id. Up to December 1987, about $1.5 billion of debt had been converted through
Chapter XVIII and about $660 million through Chapter XIX. See Truell, supranote 110.
118This may well be an example of the international banks controlling the debate. As
Professor Sachs has written, "It is no accident that Citicorp, rather than the debtor countries,
is the world's leading advocate of debt-equity swaps." Sachs, supranote 105, at 705.
"1 Peter Truell, Latin American Debt PromptsAction, WALL ST. J., Sept. 22, 1988, at 12.
12Asiedu-Akrofi, supranote 24, at 557.
121Martin W. Schubert, Overview of Financial Business Trends for 1989: How to Profit
from the Use of Debt as a Means of Exchange in a Changing Latin America, Address at
Latin American Investors Issues: 1988-89 - Salient Trends and How to Profit from Them
(Sept. 16, 1988) (on file with author).
nies were particularly active, buying back about $150 million of their debt
each month through much of 1988 in informal transactions.122
In addition to the formal debt-exchange auctions and informal
buybacks by local companies, foreign investors in need of local currency in this
period began to initiate private buy-backs, most often in Brazil. The
foreign investor would seek an agreement with a private sector debtor for the
debtor to repay the debt in local currency. The investor would then acquire,
at a substantial discount, the external debt of that debtor and swap it with
the debtor for the local currency. 123 The investor would thus obtain local
currency without the limitations on the use of the proceeds imposed in the
formal debt-exchange auctions, and usually at a more advantageous price.
It has been estimated that $3 billion of Brazilian debt was discharged in this
manner in 1988.124
Neither buy-backs nor debt-equity swaps were a new idea. 125
However, while debt-equity swaps were received enthusiastically by the banking
community, debt buy-backs met with tremendous resistance and were only
tolerated initially for "basket case" countries like Bolivia 26 and,
anomalously, for Chile. There were three reasons for this resistance. First,
buybacks were seen to result in the transfer of the debtor's foreign exchange
reserves to the selling banks. However, this transfer would only have
occurred if the buyback prices overvalued the debt, i.e. if the "real" value of
the debt was less than the price that the debtor paid to repurchase it. Yet the
money-centre banks that objected to buy-backs on these grounds had long
argued that the secondary market undervalued the debt and that buy-backs
"2 Better Brazilian Exit Bond Terms Sought, 720 INT'L FIN. R. 1204 (Apr. 16, 1988).
Banks did these conversions under Resolution 63 and industrial companies under Resolution
123 Chamberlin et al., supra note 26, at 459; see also BrazilianDebt ArbitrageMay be
Too Good to Last, EuROMONEY, Apr. 1988, at 40.
124Jeremy Bulow & Kenneth Rogoff, The Buyback Boondoggle, 2 BROOKINGS PAPERS
ON ECON. ACTIVITY 675, 699 (1988) (comments of Rudiger Dombusch); see also
Chamberlin et al., supranote 26, at 459 n.166.
125In the 1880s, Peru crafted a resolution of its indebtedness in one, novel, massive
debtequity swap: British bonds were exchanged for stock in Peruvian Corp., the owner of the
state railways, lands, and mining concessions. MARICHAL, supranote 2, at 120. Between
1935 and 1939, Chile repurchased about one-third of its bonds at an average price of 15% of
face value. Anayiotos & De Pinies, supranote 22, at 1655.
126Bolivia established a buy-back scheme in July 1987 in which the foreign exchange
was donated by anonymous sources thought to be The Netherlands, Spain and some
wealthier Latin American countries. Bolivia offered to repurchase its debt directly from all of its
131 creditors in a coordinated scheme at a price of 11 cents on the dollar. At the time,
Bolivian debt traded at six to eleven cents in the secondary market, interest payments having
ceased in mid-1985. For an outlay of $34 million, the country repurchased some $308
million of debt, which represented about 46% of its $670 million foreign commercial bank debt.
See generallySachs, supranote 105; Peter Truell, BoliviaBuys BackNearly HalfofIts Debt
at a Fractionof the Fdce Value, WALL ST. J., Mar. 18, 1988, at 23.
were usually at a price that was close to the secondary market price. Such
flawed 27reasoning served as a major impediment to the growth of
The second reason for bank opposition to buy-backs was because the
debt forgiveness was so obvious. The realpolitik of rescheduling in the
1980s could accommodate covert debt forgiveness but blanched at the
prospect of overt forgiveness. The third reason was the 'moral hazard'
ocacansyiosniteudatbioynbtuhya-tbraecwkasr.dsInthseosvoevreeirgenigndedbetbtteorrmfso,r 'fminoarnacliahlamzairsdb'ehdaevsciorirb. e12s1
Informal debt buy-backs are a classic example of moral hazard because the
secondary market price of the debt is acutely sensitive to the actions of the
debtor country.129 If a country institutes a moratorium on interest payments,
the price of a country's debt falls through the floor as Brazil's did between
July 1989 and early 1991 when Brazilian debt could be acquired for as little
as twenty-two cents on the dollar. 130 In such a situation, two years of
unpaid interest not only deflates the price of a country's debt, it liberates the
funds to purchase it.1
Formal debt buy-backs usually require the consent of the creditors as
such conduct is generally considered to be in breach of the mandatory
prepayment and sharing clauses typically found in sovereign loan
agreements. 32 However, consents are only required if the debtor repurchases its
own debt. In the typical informal buy-back, the debtor uses either a
stateowned company to acquire the debts or appoints a third party to buy the
debts and acquires beneficial ownership of the debts through a participation
127Comments of Michael Pettis, Managing Director, Bear Steams & Co, New York City
(Feb2.82L0e,e1C99.6B)u(cohnhfeiilte, wMitohrtahleHNaozrathrdwseastnedrnOJtohuerrnDaelolifgIhnttse,rInNaTt'iLonFIaNlL.aLwAw& RBnuvs.in1e0ss()A.pr.
1991). In mid-1990, bankers were reportedly "growing increasingly frustrated at the fact
that there is not much they can do to Brazil, which has well over U.S. $8 billion in foreign
reserves, and has made no attempt to start talks or to even make a token payment on more
than U.S. $5 billion of overdue interest." Brazil Debt Downgradeon Hold, 831 INT'L FIN. R.
26 (June 16, 1990).
129Buchheit, supranote 128, at 10, 11; Anayiotos & De Pinies, supranote 22, at 1657.
130For instance, Brazilian debt traded at 22 cents on the dollar in March 1990, LDC
Secondary Market Prices,819 INT'L FN. R., Mar. 24, 1990, 35; 24 cents on the dollar in July
1990, LDC SecondaryMarket Prices,835 INT'L FIN. R., July 14, 1990, 29; 22 cents on the
dollar again in October, LDC SecondaryMarket Prices, 847 INT'L FIN. R., Oct. 6, 1990, 29;
and 24 cents on the dollar in January 1991, LDC Secondary Market Prices,861 INT'L FIN.
R., J3a1nA. 1f9u,rt1h9e9r1,ex2a3m.ple of moral hazard arose in mid-1989 when Yugoslavia was accused
of attempting to sell $50 million of its debt on the secondary market to drive down the price.
Yugoslavia Tries to Drive Debt PriceDown, 781 INT'L FN. R., June 24, 1989, 26. Yugosla
via's debt buy-back scheme was particularly active at the time and a lower price would have
tive on the ProcessofRescheduling,10 ANN. REv. OF BANKING 329, 332-33 (1991).
Neither of these cases infringes the typical mandatory
prepayment clause or the sharing clause. Indeed in these cases the banks may
not even know the debtor has effectively extinguished its own debts. The
numbers, if not the morals, of interest moratoria and debt buy-backs are
highly attractive to debtors 134 and are, in Lee Buchheit's words, "the
nightmare of every banker.' 35 The fact that debtors could only repurchase debt
that some banks were willing to sell at the depressed price did not in the
eyes of the banking community make the conduct less reprehensible.
In hindsight, debt buy-backs proved to be the principal source of debt
relief for Latin American debtors. They certainly afforded many times the
amount of debt relief of debt-equity programs while attracting a fraction of
the attention. Indeed, the very degree of relief contributed to the parties
keeping quiet about these transactions.
From the debtor's perspective, buy-backs suffered from few of the
disadvantages of debt-equity conversion programs (although even buy-backs
have had their trenchant critics). 136 Buy-backs were independent from, and
did not replace, direct foreign investment. Particularly when secondary
market prices for the country's debt were low (Brazil effected the majority
of its buy-backs at prices around twenty cents on the dollar), the short-term
costs of the buy-back were entirely reasonable as those short-term costs
could be recouped entirely by the interest savings of the next few years. 137
Buy-backs were made in foreign currency and funded from foreign
exchange reserves and were not funded by printing money or by issuing local
13 Buchheit, supra note 128, at 10.
134 For example, consider the case in which a debtor declares a two-year moratorium on
repayments of principal or interest. After twelve months or so, in the case of both Argentina
and Brazil, such a moratorium drove the secondary market price of their debt to around 20
cents on the dollar. If the price of a country's debts falls to 20% and the country saves all
the funds it would have paid out in interest at, say, 9%per annum, after a year it can begin
repurchasing its debt progressively on the secondary market. Over the two years the nation
will have saved enough money by not making repayments to retire effectively all of its
outstanding debt. This is a neat and highly tempting alternative to the indefinite repayment of
interest on the full face value of the debt. Of course, not all of a country's debts will be
available for repurchase on the secondary market as many lenders will not part with their
portfolios at that price. This point only applies with respect to the debt available on the
135Buchheit, supra note 128, at 11.
136Bulow & Rogoff, supra note 124. Bulow and Rogoff criticize buy-backs on the
following two grounds: first, buybacks overvalue the debt as the debtor pays a price equal to
the average value of the debt while the debt reduction achieved is only at the margin, and the
marginal value of the debt is less than the average; and second, because a sovereign debt
buy-back, unlike a domestic buy-back, does not reduce the size of the pool of assets
available to creditors upon default, it serves the creditors' interests more than the debtors. Id.
However, even Bulow and Rogoff write that "it is better for a debtor country to agree to buy
back debt at 30 cents on the dollar than to use the same resources to pay interest, which
amounts to buying back debt at face value." Id. at 698.
137See supra note 134.
currency bonds. Thus, the buy-backs were not inflationary. Buy-backs did
not provide a preferential exchange rate for investors, thereby leaving far
less scope for misallocation of resources.13 8 Buy-backs did not attract
criticism in the debtor countries because: (i) the buy-backs did not favor foreign
investors over local investors; (ii) the debtor country recaptured the entire
secondary market discount; and (iii) the debtor nation retained its
productive national assets. Indeed, of all the disadvantages of debt-equity
schemes, only round-tripping abuses remained a problem with buy-backs.
As the largest buy-backs during this period were by governments (in
various forms) and parastatals, round-tripping, for the most part, could be
If further evidence of the debtor's desirability for buy-backs is
required, one need only look to the behavior of the debtor countries. While
no countries other than Brazil and Chile were able to sustain debt-equity
programs for more than one or two years, and while Brazil only managed to
do so at the price of severe economic dislocation, most debtor countries
pursued buy-back schemes aggressively and consistently over a number of
years. With buy-backs, the stop-start indecision, which characterized the
implementation of debt-equity schemes, was absent. From the perspective
omfeathLoadtionf Adembetrriecdauncdtieobntoarvianiltahbele.1193980s, buy-backs were the most effective
B. The Effectiveness of Debt Buy-Backs In Eastern Europe
Given the effectiveness of debt buy-backs for debtors in Latin
America, why have Eastern European and other debtor countries in the
mid1990s embraced debt-equity and privatization schemes and largely ignored
The answer to this question has four elements. The first is that Eastern
European countries, in the main, have wisely limited their debt-equity and
privatization schemes to local participants using domestic debt. This avoids
most of the problems associated with debt-equity and privatization schemes
while retaining most of their benefits.
The second element of the answer is the power of the economic views
promoted by the World Bank, the International Monetary Fund and the
international commercial banks. Ideas are far more powerful than is
com1391t is arguable that a country's foreign exchange reserves could be put to a better use
than a debt buy-back, but unless the country was prepared to default completely on its
external debt when secondary market prices were low, better uses for the reserves were not
available to Latin American debtors in the 1980s.
1391n 1988, Professor Sachs recommended that the IMF and World Bank support the
institution of buy-back schemes. Sachs' Testimony, supranote 37, at 373. The result
Professor Sachs sought was eventually achieved, at least in part, through informal schemes, but not
the formal ones he had advocated.
monly realized. Keynes, in his seminal work, expressed this well when he
[T]he ideas of economists and political philosophers, both when they are right
and when they are wrong, are more powerful than is commonly understood.
Indeed the world is ruled by little else. Practical men, who believe themselves
to be quite exempt from any intellectual influences, are usually the slaves of
some defunct economist. Madmen in authority, who hear voices in the air, are
distilling their frenzy from some academic scribbler of a few years back. I am
sure that the power of vested interests is vastly exaggerated compared with the
gradual encroachments of ideas .... [S]oon or late, it is ideas, not vested
interests, which are dangerous for good or evil. 140
The idea of debt-equity swaps has a great many proponents, far fewer
detractors and a superficial attractiveness. Debt buy-backs, on the other
hand, have few proponents, many detractors, and put temptations before
debtors which, in the eyes of banks, are illicit. However, it was buy-backs,
not debt-equity swaps, which promoted the interests of those who suffered
the most from the debt crisis and did most to remedy the power imbalance
between the banks and the debtors.
The third element of the answer is the interests of the international
financial community. Debt-equity swaps permnit the actual losses which are
occasioned on the exchange too largely be concealed and not recorded in
the bank's books. Debt buy-backs permit no such fuzziness - a sale for
cash requires a write-down, which, if reserves are inadequate, adversely
affects profits in the current quarter. The actual value of the equity in a swap
may be no more than the cash received in a buy-back but the equity's value
is difficult to quantify and may increase over time. Debt-equity swaps
allow banks to postpone the day of accounting reckoning and throughout the
1980s the international banks chose transactions which preserved their
balance sheets over transactions which actually lost less, or made more,
money. Furthermore, history proved kind to bank investors in debt-equity
swaps in Latin America. A sustained bull run in Latin equities markets
meant many such investments were highly lucrative. For these reasons, the
international financial community will seek to participate in debt-equity and
privatization schemes in Eastern Europe and elsewhere. This will present a
choice to the Eastern European debtor countries, which they will have to
exercise most carefully.141
140 JOHN M. KEYNES, THE GENERAL THEORY OF EMPLOYMENT INTEREST AND MONEY
14'The history of the attitudes of Bank Advisory Committees ("BACs") to debt-equity
schemes in Latin America is interesting. Initially, BACs were opposed to the concept of
debt-equity schemes and expressed their extreme displeasure when Chile proposed, in 1985,
to amend existing restructuring agreements to permit debt-equity conversions. However,
within a short five years, BACs underwent a complete about-face and routinely insisted,
sometimes over the opposition of the debtor countries (as in the case of Mexico), that
restructuring agreements (including Brady bonds) expressly authorize debt-equity conversions.
The fourth and final element in why debt-equity has been so popular in
Eastern Europe and elsewhere is the personal interests of the
decisionmakers in the debtor countries. As Professor Luiz Carlos Bresser Pereira,
Brazil's Minister of Finance, wrote in 1987,
debt-equity conversions [are] ... a form of coopting the elites of the debtor
countries, making their interests common to the interests of the major creditor
banks.... [T]he ones who make large profits from these conversions are a
small, but influential, minority in the debtor countries. Thus the debt-equity
conversions are a powerful - and subtle - instrument to turn a significant part
of the elites in the debtor co1u4n2tries contrary to or at least uninterested in a
global debt reduction scheme.
In Latin America in the 1980s, debt-equity swaps served to spread the
benefits of the secondary market discount among the elites of the debtor
countries so that the elites would support the status quo. Certainly,
debtequity schemes in Eastern Europe today offer the economic elite many
opportunities to profit whereas debt buy-backs do not, thus explaining the
elites' support of debt-equity schemes. As Cole has written, "For most
investors, debt-equity exchanges are truly a no-lose situation, offering
increased profit potential on investments they would have made anyway. 143
The popularity of debt-equity schemes in Eastern Europe and elsewhere is a
potent example of the power of ideas, for evil as well as good.
This article has considered the principal types of debt exchanges.
From a debtor's perspective, the promotion of debt-equity schemes using
external debt and privatizations for external debt may enrich the debtor's
rich today at the cost of impoverishing their poor both today and for
generations to come. To use Professor Rudiger Dornbusch's word, the
advocacy of such debt-equity schemes by the International Monetary Fund,
World Bank and U.S. Treasury has been "obscene." 144
See Buchheit Letter, supra note 76, at 1. At the bank level, much of the reason for this
about-face had to do with the upward pressure on secondary market debt prices exerted by
the demand for debt for use in debt-equity conversions. At the political level, until Nicholas
Brady endorsed explicit debt relief in his speech in March 1989 (see description of Brady
Plan supra note 18), debt-equity schemes were one ofthe few market-based voluntary
initiatives that held out any hope of reducing the debt burden for LDCs, and thus were promoted
by the policy makers in Washington, DC.
142Solving the Debt Crisis:Debt Relief and Adjustment, InternationalEconomic Issues,
and Their Impact on the US. FinancialSystem: Hearing Before the House Comm. on
Banking, Fin. and Urban Affairs, 101st Cong. 330, 340 (1989) (statement of Luiz Carlos
143 Cole, supranote 45, at 68.
144The full quotation is as follows: "Washington has been obscene in advocating
debtequity swaps and in insisting that they be part of the debt strategy. The U.S. Treasury has
made this dogma, and the IMF and the World Bank, against their staffs' professional advice
and judgment, have simply caved in." PanelDiscussion on Latin American Adjustment:
Governments in Eastern Europe and elsewhere need to think carefully
before allowing external debt to be used in debt-equity and privatization
programs. To date, most debt-equity and privatization schemes in Eastern
Europe have only permitted the use of local debt. Such schemes suffer
from few of the significant problems considered earlier. The use of local
debt leaves the money supply unchanged, and thus should not fuel
inflation. 145 The use of local debt imposes no extraordinary budgetary burdens
on the domestic government, does not facilitate round-tripping, should not
result in the misallocation of resources provided that investment is open
across all sectors of the economy and poses no equity considerations for
local investors. Indeed, the only potential disadvantage of debt-equity
schemes that use local debt is that the schemes may be subsidizing, by the
public purse, investment that would have been made anyway.
The expansion of debt-equity or privatization programs in Eastern
Europe to include external debt is thus a very large step as it will bring with
it the litany of troubles considered earlier. 1 6 In particular, most Eastern
European economies appear poorly adapted to withstand the inflationar7
pressures that will accompany debt-equity schemes that use external debt.' 47
While Eastern European decision-makers may have considerable
experience with debt-equity and privatization schemes using local debt, if they
permit the use of external debt, they are embarking on an entirely new
enterprise for which the appropriate precedent is the history of debt exchanges
for external debt in Latin America - a precedent that, from a debtor's
perspective, is far from encouraging. It would be a tragedy if Eastern Europe
provides yet another example of the "sophisticated stupidity," identified by
Galbraith, which is so often at work in financial matters.
10See Ryszard Rapacki , Privatizationin Poland:Performance,Problems and Prospects, 37 COMp. ECON. STUDIES 57 , 59 ( 1995 ). The original, overly ambitious goal of the program was to reach this milestone by the end of 1992 . Id. at 57. 1995 , availablein LEXIS , News Library , Txtnws File.
17Richard Lapper, Conversion Deals Are Back in Fashion - Debt -Equity Programmes , 35See Asiedu-Akrofi, supranote 24 , at 572; DEns ET AL., supranote 20, at 27.
36See Asiedu-Akrofi , supranote 24 , at 572.
37InternationalEconomic Issues and TheirImpact on the U.S. FinancialSystem: Testimony Before the House Comm . on Banking, Finance and Urban Affairs, 101st Cong . 355 , 369 ( 1989 ) (statement of Jeffrey D . Sachs, Harvard University) [hereinafter Sachs' Testimony] ; see also Steven M. Cohen, Give Me Equity or Give Me Debt: Avoiding a Latin AmericanDebt Revolution , 10 U. PA. J. INT'L. Bus . L. 89 , 121 ( 1988 ); Shilling & Toft, Debt Equity ConversionAnalysis- A Case Study ofthe PhilippineProgram ,World Bank Discussion Paper No. 76 , 4 .04 ( 1990 ); Williamson, supra note 24, at 478-79; WORLD BANK, 73Sachs' Testimony, supranote 37 , at 368. These comments of Professor Sachs were directed at Latin America, but apply equally to Eastern Europe .
74R.A. Selg & M.J. Ades , Closed-Market to Open-Market ChallengesFacingEastern Europe (visited Dec. 5 , 1996 ) <http://www.srs.gov/shrine/html/generallsci-tech/stpubs/abstractsf 161.html>.
75Brazil announced its privatization program in April 1988, listing 64 state-owned companies as potential candidates . Better BrazilianExit Bond Terms Sought , 720 INT'L FIN. R . 1204 ( Apr . 16, 1988 ).
84 Id. The first privatization scheme in Chile was by choice rather than necessity and was remarkably extensive, resulting in the privatization of551 of the 596 state-owned enterprises in existence in the late 1970s . Milman, supra note 5 , at 172. However, necessity forced other Latin American countries such as Argentina, Brazil, and Mexico to privatize .
85 WORLD BANK, WORLD DEBT TABLES 1996 - EXTERNAL FINANCE FOR DEVELOPING CouNTRIES 90 ( 1996 ) [hereinafter WORLD DEBT TABLES] .
86Lincoln C. Wee , Debt-for- NatureSwaps , A Reassessment of Their Significance in International EnvironmentalLaw, 6 J. ENVTL . L. 57 , 63 ( 1994 ) ; see also Alvaro Umana, Costa Rica Swaps Debtfor Trees , WALL ST. J., Mar. 6 , 1987 , at 31.
98For instance , in December 1988 , Midland Bank donated some $800,000 face value of Sudanese debt to the United Nations Children's Fund (UNICEF) . UNICEF arranged for the Sudanese government to continue servicing the debt in local currency (as opposed to the foreign currency in which it was denominated) and these interest payments were invested in water, sanitation, reforestation, and health education programs administered by UNICEF in the Sudan . Stephany Griffith-Jones & David Wainman, DonationsofLDCDebt by Banks to Charities ,in THiRD WORLD DEBT, supranote 32 , at 99-100.
'Eve Burton , Debt for Development: A New Opportunityfor Nonprofits , Commercial Banks, andDevelopingStates, 31 HARv. INT'L. L .J. 233 , 243 ( 1990 ).
I°°KAISER & LAMBERT, DEBT SwAPs FOR SUSTAINABLE DEVELOPMENT - A PRACTICAL GUIDE FOR NGO's 14 ( 1996 ). Much of the debt converted in debt-for-development swaps was official bilateral debt (i.e. loans made by developed countries to the LDCs) and was donated by the developed countries for development purposes . For instance, in 1994 Canada forgave 75% of the C$ 22.7 million of Peru's official bilateral debt and converted the balance for development purposes. Similar arrangements were entered into between Finland and Peru ( 1995 ), Germany and Peru ( 1994 ), Switzerland and Bulgaria (1995), and the United States and the Philippines ( 1995 ). Id. at 8.
"I d. at 16.
' 021d. at 12-13.
103The discount in the secondary market is the main significance of all of these debt exchanges . Minujin, supranote 94 , at 147-48.
1041n 1990 , Harvard University and Ecuador entered into a debt-for-education agreement . Harvard acquired $5 million of Ecuadorian debt at 15 . 5% of face value for $775,000 and exchanged it with the Central Bank of Ecuador for 50% of face value in local currency bonds. The bonds were transferred to a newly formed local Ecuadorian educational foundation which sold the bonds in Ecuador and used the proceeds to purchase US dollars in the 108In the words of Chile's chief debt negotiator, Heman Somerville, "We have signed at least two amendments (one that allowed the buyback) and we have been able to get endorsement of 100% of banks in record time." FreeFallin SecondaryMarket,750 INT'L FIN. R . 3864 , 3865 (Nov. 12, 1988 ). For instance, Chile repurchased some $229 million face value of its debt in October 1988 at an average price of 56.3% of the face amount of the debt . Id.
'Economic growth averaged about 5% per annum throughout this period, and in 1988 Chile's trade surplus approached $1.85 billion. See Peter Truell, Chile Buy-Back ofForeign Debt at DiscountSet, WALL ST . J., Sept . 22 , 1988 , at 4.
"°Peter Truell , Chile PushesDebt-Conversion Program , WALL ST. J., Dec. 9 , 1987 , at 34; Williamson, supranote 24 , at 441- 42 . It is intriguing that while that many other countries implemented debt-equity schemes along the lines of Chapter XIX, few implemented debt buy-back schemes similar to Chapter XVIII. This may be because few other economies shared Chile's distinctive capacity to absorb new long-term debt . See Williamson, supra note 24 , at 443.
112William G. Foulke , Remarks at the Heritage Foundation Center for International Economic Growth Conference on Debt/Equity Conversion: A Strategy for Easing Third World Debt 35, 37 (Jan. 21 , 1987 ) (transcript available at the NorthwesternJournalofInternational Law and Business).
"3The typical premium was about five percent .
" 4 Chapter XVIII can be viewed as a scheme to facilitate and make attractive the repatriation of flight capital because participants under a Chapter XVIII conversion do not need to reveal the origins of the foreign debt being converted whereas under Chapter XIX , de-