Bailing in the private sector

During the last decade, there has been a significant bias towards bond financing on emerging markets, with private investors relying on a bail-out of bonds by the international community. The bias has been a main cause for recent excessive fragility of international capital markets. The paper shows how collective action clauses in bonds contracts help to involve the private sector in risk sharing. It argues that such clauses, as a market based instrument, will raise spreads for emerging market debt and so help to correct a market failure towards excessive bond finance. Recent pressure by the IMF to involve the private sector is facing a conflict between the principle to honour existing contracts and the principle of equal treatment of bondholders