Repudiating odious national debt

April 23, 2003

Free Market Foundation

By law, in most countries, individuals do not have to repay money that others fraudulently borrow in their name. Similarly, a corporation is not liable for contracts that the chief executive officer enters without the authority to bind the firm. But international law does not exempt citizens of a dictatorship from repaying a debt incurred by a dictator for personal and nefarious purposes.

One potential solution to this problem is for the international community to empower an independent institution to assess a regime’s legitimacy and to declare any sovereign debt subsequently incurred by an illegitimate regime “odious” and thus not the obligation of successor governments.

In this new setting, debtor countries would no longer need to fear that their ability to borrow from abroad or to attract foreign investment would suffer if they refused to repay debts fraudulently incurred in their name.

Creditors, both private and public, would curtail loans to regimes identified as odious, knowing that successor governments would have little incentive to repay them.

Such a reform would not only limit the debt burden of poor countries but also reduce risk for creditors and hence lower interest rates for legitimate governments that borrow.

Two enforcement mechanisms could help eliminate lending to odious regimes.

First, new laws in creditor countries could make it illegal to seize a country’s assets for non-repayment of odious debt odious debt contracts, in other words, could be made legally unenforceable.

Second, foreign aid to successor regimes could be made contingent on non-repayment of odious debt.

Donors could refuse to give aid to a country that, in effect, was handing the aid over to banks that have illegitimate claims. If the foreign aid were valuable enough, successor governments would have incentives to repudiate odious loans, so banks would refrain from originating them.

Source: Michael Kremer and Seema Jayachandran, Odious Debt: When Dictators Borrow, Who Repays the Loan? Spring 2003, Vol.21, No.2, Brookings Review, Brookings Institution.

For text http://www.brook.edu/press/review/spring2003/kremer.htm

For more on Third World Problems http://www.ncpa.org/iss/int/

FMF Policy Bulletin\15 April 2003