The ideal-type crisis: three phases of public private interactions

As was shown earlier, what the few existing attempts to define PSI have in common is that they conceptualize PSI as a variable that can be separated into several categories, degrees, or phases (Cline 2004; Ghosal and Miller 2004; Haldane et al. 2005; Roubini 2004; Roubini and Setser 2004). Although we share this view, our main point of critique of the respective approaches is that they remain implicit about what characterizes each phase. Building on the approach of Thiemann et al. (2005), we define PSI as any kind of intentional, informal, or formal forms of cooperation between debtor governments and the private sector starting at that point in time when a debt crisis becomes likely. However, whereas the ECB authors constrain the concept to financial costs on the creditor side, we go beyond this definition, including also the not directly measurable actions of preventing crises (such as informally agreeing to keep money in a distressed country).

In contrast to this literature we try to conceptualize crises as processes. We propose a new perspective on PSI as a form of private public interaction with the goal to resolve a crisis. Essentially, we portray how an “ideal type” of a crisis would look and categorize the related instruments used by public and private actors in the course of a crisis. Figure 7.1 presents our timeline approach including three phases of interactions: phase 1 entailing “preventive efforts,” phase 2 “moderate losses,” and phase 3 “significant losses”

The first phase of PSI in a debt crisis is mostly characterized by informal policy efforts. More specifically, we define phase 1 on the basis of (1) a presentiment of a debt crisis or default; (2) an intentional effort by the private sector to solve the distress situation; and (3) some kind of informal agreement between debtor and creditors to prevent a crisis. Phase 1 may include any promise of creditors to maintain credit lines or maintain the overall level

Timeline approach to private-sector involvement

figure 7.1. Timeline approach to private-sector involvement.

of capital inflows. It is important to note, however, that this includes only voluntary and intentional efforts. One type of “private sector preventive efforts” would be attentive calls by chief executives of foreign banks or financial intermediaries to finance ministries in EMEs. Another example would be the promise to increase or maintain export credits.

Phase 2 is characterized by a more formal negotiation setting between a sovereign and its creditors and involves classic policy measures to address a liquidity problem. More specifically, we define phase 2 on the basis of (1) a formal negotiations between a government and its creditors; and (2) the emergence of debt agreement entailing losses—beyond mere symbolic costs—for private creditors. In this phase, both sides realize that informal agreements are not sufficient and that further steps need to be taken to avoid a more severe crisis. While the interaction in phase 1 was largely informal, negotiations in phase 2 have an official character. One distinctive criterion to identify such formal negotiations is the existence of a written agreement signed by both sides. Crisis resolution instruments applied in this phase can be rollovers, debt standstills, or short- or medium-term debt rescheduling without a cut in face value. Overall, creditor losses in this second phase remain comparatively low.

We define phase 3 on the basis of (1) the presence of a context of “default” with all or part of the debt payments not being serviced any longer; (2) debt renegotiations aimed at substantially reducing the debt burden faced by the debtor government; and (3) a debt restructuring leading to significant present value losses for private creditors. The dividing line between phase 2 and phase 3 of crisis workouts is the degree of losses following default. Once the crisis has reached phase 3, private investors have to accept losses beyond rollovers or maturity extensions, which could be considered as opportunity costs.

The three phases—Preventive Efforts, Moderate Losses, Significant Losses—describe the theoretically distinct forms of “involvement” of the private sector in relation to debtor governments.

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