International Monetary Fund Membership and Sovereign Bonds

Zachary Oseland
 International Debt Finance Spring 2010
4/28/2010
I. Introduction

While recent press coverage of Greece, Iceland, and other countries’ sovereign debt

problems may suggest otherwise, sovereign debt default is not a new phenomenon. Greece has

been struggling with its foreign debt for well over a century. In 1893, only 63 years after it was

first recognized as a state independent from the Turkish Empire, Greece was bankrupt. The

Prime Minister sought bondholder approval to reduce payments by 70%. They did not approve.

So Greece simply stopped servicing all of its foreign debt.1

In 1898, Greece issued its first bond since the bankruptcy: a 2.5% bond that would

mature in 1918. If 2.5% seems like a low yield for a country that went into full default only five

years earlier, that is because the international community decided that Greece was not to be

trusted with servicing its own loans. In order to issue this bond, Greece was forced to submit to

the oversight of the Great Powers: France, Great Britain, and Russia. These countries guaranteed,

with joint and several liability, the repayment of the bonds. In exchange for this guarantee,

Greece was subjugated to the authority of the International Financial Control Commission, a

group of financial delegates representing Germany, Austria, Hungary, France, Great Britain,

Italy and Russia. Greece was stripped of most of its powers of taxation, including control over its

ports and state monopolies like spirits, all of which were given to the Commission. Because

Greece had shown that it could not be trusted to administer its own finances, other countries had

to step in to both collect funds for the sovereign and to service make debt payments on behalf of

the sovereign.

1
Lito Apostolakou, The Bankruptcy of Greece in 1893, available at
http://greekhistory.suite101.com/article.cfm/the_bankruptcy_of_greece_in_1893 (last visited Apr. 21, 2010).

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 In recent years a number of countries have proven themselves to be similarly

untrustworthy. While the International Financial Control Commission no longer exists, there are

formal organizations of countries like the International Monetary Fund that provide economic

assistance and oversight to these struggling sovereigns.2 IMF membership could be seen as a

modern, albeit less stringent, equivalent of Greece’s submission to the Commission in 1898.

Most countries, even developed countries with valuable natural resources and no history of

external default, agree to follow certain IMF rules and procedures to maintain their membership.

Ever the contrarian, Venezuela’s Hugo Chavez announced in 2007 that he planned to

revoke his country’s membership in the IMF.3 The biggest problem with this plan was that

Venezuela’s bonds stated that “the Republic (of Venezuela) ceas[ing] to be a member of the IMF

or ceas[ing] to be eligible to use the general resources of the IMF,” would constitute and event of

default, which would trigger acceleration of repayment. Fears over the consequences of a default

caused Venezuelan bonds’ market yields to drop significantly.4

Unfortunately for those interested in sovereign debt default, Chavez did not follow

through with his promise. In fact, in late 2009, Venezuela received a new $3.5 billion Special

Drawing Right from the IMF,5 an amount significantly higher than its $2.6 billion quota.6

From 19th century Greece to 21st century Venezuela, international external oversight has

had an important effect on sovereign debt. This paper will examine the occurrence and

significance of IMF membership provisions in sovereign bonds: which countries promise to

2
International Monetary Fund: Our Work, http://www.imf.org/external/about/ourwork.htm (Last visited Apr. 14,
2010): “The IMF oversees the international monetary system and monitors the financial and economic policies of its
members.”
3
W. Brandimarte & M. Badawy, Banks recommend cut Venezuela debt exposure on IMF news, May 2, 2007,
available at: http://www.reuters.com/article/idUSN0260434220070502
4
Id.
5
Darcy Crowe, Venezuela’s central bank reserves boosted by IMF infusion, Sep. 17, 2009, available at:
http://www.hacer.org/latam/?p=549 (Last visited Apr. 13, 2010)
6
IMF Members’ Quotas and Voting Power, Apr. 9, 2010, available at:
http://www.imf.org/external/np/sec/memdir/members.htm (Last visited Apr. 15, 2010)

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retain their membership in the IMF? Why make this promise? And what effect does this promise

have on the bond? The attached Excel document contains the research underlying the following

discussion.

II. Discussion

A limited number of sovereigns were analyzed for this paper. Sovereigns will be divided

based on their consistency: those that do or do not contain the membership provision in every

bond, and those that include the provision in some bonds but not others. This distinction is made

only for organizational purposes. The consistency of the sovereign appears random, but a more

thorough analysis than is made in this paper may be able to explain why all sovereigns are not

consistent.

a. Consistent Sovereigns

i. Brazil

Brazilian bonds do not contain an IMF membership provision. From 1995 to 2010, Brazil

issued bonds denominated in yen, dollars, and reales, none of which included the provision. The

bonds’ maturation dates ranged from nine to fifteen years, and their yields ranged from 5.875%

to 12.5% for the real denominated bond. The only one of these bonds that even mentions the

International Monetary Fund is the 1995 yen issue, which appears to have been sold to Japanese

institutions. This bond has an “External Affairs and Membership in International Organizations”

section which states that "Brazil is an original member of the International Monetary Fund."

However, this is statement does not appear to create any obligation for Brazil, and no other

mention of the IMF is made in this or any other bond.

ii. Chile

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 Chilean bonds do not contain an IMF membership provision. In 1999, Chile issued a

$500 million floating rate four-year bond that contains a brief mention of the fact that Chile is a

member of the IMF and has been using IMF financing for years, but this mention is less than a

paragraph in length, and does not contain any promise to retain membership in the future.

In 2004, Chile issued a $600 million 6.875% ten-year bond that contained a lengthy

discussion of IMF’s substantial financing of Chile, including Chile’s repayment obligations to

the IMF, but again, no explicit promise to retain IMF membership. The rationale for the

expansion of this section is unclear, particularly since it creates no higher obligation for Chile.

Perhaps Chile wanted to reassure investors regarding its IMF membership without creating a

potential for default by actually promising to retain membership.

iii. Colombia

Colombian bonds contain an IMF membership provision. Between 1993 and 2009,

Colombia issued dollar and peso denominated bonds with maturities ranging from nine to thirty

two years and yields ranging from 6.125% to 12% for the peso denominated bond. An interesting

variation in Colombian bonds is that some contain the provision in the “Events of Default”

section, and others in the “Default and Acceleration of Maturity” section, with slight changes in

the language used, as shown in the chart. The significance of this variation is unclear, as the

variation is random over time and does not seem to affect yield or maturity. Perhaps the variation

can be explained by the use of different lawyers and underwriters, or another of the possibilities

discussed in the final section of this paper.

iv. Costa Rica

Costa Rican bonds contain an IMF membership provision. Between 2000 and 2004,

Costa Rica made three separate $250 million issues. Maturities ranged from ten to twenty years,

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and yields ranged from 6.548% to 9.995%. All three contained the exact same language in the

same section of the governing document regarding Costa Rica’s commitment to retaining its IMF

membership. Unlike some other countries whose IMF provisions are in “Events of Default” or

“Acceleration of Maturity” sections, Costa Rica’s is in a section titled “Certain Covenants of the

Republic.”

v. Guatemala

Guatemalan bonds contain an IMF membership provision. In 2001 and 2004, Guatemala

issued bonds with ten and thirty year maturities respectively, and yields of 10.25% and 8.125%

respectively. Like Costa Rica, Guatemala’s provision is in the “Covenants” section, not the

“Defaults” section.

vi. Italy

Italian bonds do not contain an IMF membership provision. Bonds issued between 1993

and 2010, with values between $1 billion and $2.5 billion, yields ranging from 3.125% to 6.75%,

and maturities ranging from two to ten years, contain absolutely no reference to the IMF. Italy

made no promise to retain its IMF membership in any of these issues. In fact, the existence of the

IMF is not even mentioned. Considering Italy’s well known financial issues, the absence of a

membership provision suggests that investors believe Italy is trustworthy absent external

oversight.

vii. Belgium

Belgian bonds do not contain an IMF membership provision. Belgium has some of the

oldest bonds available on ThomsonOne, dating back to 1985, and none of the bonds, from 1985

to 2010, contain a mention the IMF. Bonds were issued in deutschemarks, euros, and dollars,

with maturities ranging from five to thirty one years, and yields ranging from 2.75% to 5.375%.

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Belgium does not promise to retain its IMF membership or even mention the fact that it is a

member in any of these bonds.

b. Inconsistent Sovereigns

i. Greece

Greece’s use of the IMF membership provision is complicated, and can probably be

understood best by reference to the chart. To summarize, the provision seems to have

disappeared around 1998. The disappearance could be explained by a variety of factors, but it

appears that basic changes in how the bonds were written are to blame.

In 1994, the membership provision was in the “Default; Acceleration of Maturity”

section. Later bonds dropped the acceleration language in favor of an “Events of Default”

section, where the provision appeared later in 1994. By 1998, the provision had moved to the

“Redemption and Purchase” section while other default provisions remained in “Events of

Default.” By 2002, the “Redemption and Purchase” section had been significantly simplified.

What had been a multi-page list became a couple of short paragraphs, and the membership

provision disappeared. The disappearance does not seem to have affected Greek bond yields.

ii. Venezuela

Venezuelan bonds contained an IMF membership provision until Chavez made his

announcement. Issues in 2001 and 2004, a $200 million 11% seven year and a $1 billion 7%

eleven year bond respectively, both contained the standard “ceas(ing) to be a member of the

IMF…” language in the Events of Default section.

Bonds issued in 2007 and 2009 (long term 7%) do not contain this event of default.

Instead, both state, very prominently on the first page of the prospectus, that "the provisions

relating to events of default in the Bonds differ from those contained in the substantial majority

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of its other outstanding public issues of Venezuela's capital market indebtedness in that the

Bonds do not contain an event of default provision that would be triggered if Venezuela were to

cease at a future date to maintain its membership in the International Monetary Fund or cease to

be eligible to use the general resources of the IMF." And later in the prospectus, "the Bonds will:

not contain an Event of Default provision that would be triggered if Venezuela were to cease at a

future date to maintain its membership in the IMF or cease to be eligible to use the general

resources of the IMF."

These statements indicate that the IMF membership provision has some value to

investors. If it had no value, it would be unnecessary to affirmatively state that the provision

would not be included. Other inconsistent sovereigns have not included similar warnings in the

bonds that did not contain the provision, so perhaps Venezuela was forced to give investors some

explanation just because Chavez’s statements got so much attention.

iii. Argentina

Argentina’s approach to the IMF membership provision varies with no clear pattern. In

1992, Argentina issued a $250 million 8.25% five year bond. The “Negative Pledge and

Covenants” section of this bond indicates that “(i)n the Trust Deed, the Republic has given

certain covenants to the Trustee, including a covenant that the Republic will maintain its

membership in, and its eligibility to use the general resources of, the International Monetary

Fund.” Whether a bond is governed by trust is not a factor that was analyzed in this paper, but as

a factor that may have an effect on the membership provision, it is included below as a

suggestion for further research.

In 2001, Argentina issued a substantially similar bond, a $227 million floating rate with a

three year maturity that included the same language as the 1992 issue. But to complicate this

8
analysis, it issued a bond in 1999 that did not contain the membership provision. The 1999 bond

was euro denominated, but similar in other respects to the 1992 and 2001 bonds: €250 million

9.25% three year. This bond states that "It should be noted that Argentina still has recourse to

IMF assistance,” and contains a lengthy discussion of past and present IMF finances in

Argentina, but does not include a promise to retain IMF membership. The significance of this

promise’s absence is unclear, given that the promise was included in issues immediately

preceding and subsequent. Perhaps European investors care less about IMF membership, or

maybe Argentina’s European issues are just managed by different lawyers and underwriters.

In 2005, Argentina made an exchange offer on $81 billion of its outstanding debt. The

document governing this exchange notes that "(t)he IMF is Argentina's single largest creditor,"

and includes a lengthy discussion of IMF-Argentina agreements. This discussion makes it

obvious that if Argentina were no longer a member of IMF, its finances would be in absolute

chaos. However, the terms in the offer that would govern the new bonds do not contain any

promise to retain IMF membership like that found in Argentina’s 1992 and 2001 bonds. When

compared with Panama’s exchange offer, the lack of a membership provision here is mysterious,

particularly considering Argentina’s total reliance on IMF funding. Because Argentina would

default on all of its bonds if it were to pull out of the IMF (because it would have no money),

adding an explicit default provision for not retaining membership would impose no additional

obligation on Argentina. The absence of the membership provision in this exchange offer

suggests that it has little value, or that its value is reduced when a sovereign’s absolute reliance

on the IMF is well known.

iv. Panama

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 Panama issued bonds in 1978, 1999, 2004, 2006, and 2009, among other years. None of

these bonds contained an IMF membership provision, though the IMF was mentioned in some of

the prospectuses.

The 1978 issue, a $70 million twelve year floating rate bond, states that Panama is a

member of the IMF, and contains a relatively detailed analysis of Panama’s Special Drawing

Rights. However, it contains no promise to retain IMF membership.

In 1999, Panama issued a $500 million thirty year 9.375% bond that did not contain a

membership provision, did not contain the analysis of Panama’s IMF financials, and did not even

mention the existence of the IMF. It is unclear why the IMF did not come up in this bond,

especially considering Panama’s later issues.

Panama’s 2004 issue was for less money and less time than the 1999 issue ($326 million

19 year maturity), but carried the same 9.375% yield. This bond contained an “IMF

Membership” section that, in a short paragraph, explained Panama’s recent dealings with the

IMF, but contained no promise to retain membership.

The 2006 bond, a $1.4 billion thirty year 6.7% issue, contained a similar “IMF

Membership” section. Why this section was not included in 1999, since it was included in 1978

and 2004, and the 2004 issue appears less risky but carries the same yield, is unclear. It seems

unlikely that Panama hired different counsel to draft only one bond.

In 2009, the “IMF Membership” section disappears. This $323 million six year 7.25%

bond references money forthcoming from and owed to the IMF in its financials section, but there

is no separate “IMF Membership” section, and like the previous bonds, no explicit promise to

retain IMF membership.

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 The only time Panama has obligated itself to retain its IMF membership was in 1996,

when the country attempted an exchange offer for $70 million of past due bonds. The document

governing this offer provided for varying yields and maturities based on the note to be

exchanged. A characteristic that would be common among all new notes was that “The Republic

ceas(ing) to be a member of the International Monetary Fund” would constitute an event of

default.

The inclusion of the IMF membership provision in this offer suggests that its inclusion

makes a bond more valuable, and that investors trust the IMF to provide some oversight over a

sovereign with a history of default. When Panama was particularly desperate for money because

it was in default to past bondholders and presumably was in need of spending cash, the only way

it could access the international markets was by promising to remain a member of the IMF, a

promise it has not made in any other situation.

While the 1996 Panamanian offer provides some support for the proposition that

investors view IMF membership as some sort of extra guarantee, that support is somewhat

negated by the absence of the membership provision from later issues. The 1999 issue, only three

years after the exchange offer, does not even mention the IMF. If the membership provision was

essential to accessing capital markets in 1996, it would stand to reason that it would be essential

in 1999 as well. The transition from being in default to being stable enough to guarantee a thirty

year bond seems like it would take more than three years. So, the significance of the membership

provision remains unclear.

III. Conclusion

The factors considered in this paper do not adequately explain the occurrence or

importance of the IMF membership provision. If the provision had substantial value as a

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reassurance to investors that some outside body was overseeing the sovereign, bond yields or

maturities should change depending on whether the provision appears. This is not the case. The

size of the offering, the yield, and the maturity appear completely unaffected by the presence or

lack of the membership provision. Less obvious factors like the currency in which the bond is

denominated also provide no clear explanation.

It would stand to reason that, if external oversight was the purpose of the provision, then

less economically stable countries would use the provision more often than stable countries. This

does appear to be true, but to such a limited extent that economic stability is at best an

incomplete explanation for the presence and value of the provision. Of the countries examined,

less stable Central and South American countries included the provision more than their more

stable European counterparts, but countries like Chile and Panama have never used the

provision. This apparent randomness leads to no clear conclusion.

IV. Suggestions for Further Research

This paper is probably most valuable as a starting point for future research. There are

many more factors that could explain the occurrence and significance of the IMF membership

provision than were analyzed here.

For example, my research was based only on prospectuses filed with ThomsonONE. I did

not consider whether the bonds were issued under a trust, or another type of agreement. Bonds

that were issued under trust agreements may have governing documents other than the

prospectus, documents which could contain the IMF membership provision or some other

external oversight provision.

Regardless of the bond’s structure, the membership provision I looked for may be

unnecessary because of some other provision. If some other language has the same substantive

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effect as the membership provision, the provision’s inclusion in some bonds can be explained by

counsel’s laziness or predilection towards repetition. For example, most bonds contain language

to the effect that a default on any other “external indebtedness” would constitute a default on the

bond. Whether dropping out of the IMF, and failing to repay any funds lent by the IMF, would

constitute an external indebtedness default is beyond the scope of this paper, as are any other

provisions that could have a similar effect.

The attached spreadsheet contains the section in which the provision appeared, and the

language used in each provision, as well as any non-binding references to the IMF. Whether

variations in the language of the provision or the heading under which it is located has any

meaning is unclear.

IMF membership may change in relative importance based on a country’s IMF quota

compared to its SDR or other funds owing to the IMF. I did not analyze, with the slight

exception of Venezuela, any country’s financial standing with the IMF. It could be that the

membership provision is more important as the country borrows more, relative to its quota, from

the IMF.

Also not considered were such factors as: who drafted the bond, who underwrote the

issue, who acted as counsel for the sovereign and the underwriters, or on which exchange the

bond was listed. Analysis of any of these factors could provide greater insight into the IMF

membership provision.

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