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Challenging the Legitimacy of Suharto Era Government Debt
by: Julie Ota
Recently, Jeffrey Winters, an associate-professor at Northwestern University in Illinois, said Indonesia should seek a partial debt moratorium on debts accumulated during the 30-year rule of former president Suharto at a seminar on foreign debts organized by Aid Watch.
Winters has been arguing that international lenders, particularly the World Bank, should be held responsible for lending some $30 billion to Indonesia, when they knew it was being abused by a corrupt regime for over a decade. This year alone, Indonesia is expected to make payments of around Rp 120 trillion (about $10.75 billion) in principal and interest, half of which are to service foreign debt.
Recently, Bank Indonesia warned the government of the possibility of a financial crisis induced by growing foreign debts. The debts are now classified as in the alert stage and included $128.6 billion of government debts and $85.6 billion of private debts in April 2011. Despite the high fiscal burden of foreign debts, Indonesia has not made an attempt to claim that its debts are illegitimate or that the lenders have breached their duties, as Winters suggests. The legal theories for making these claims may be too undefined, and Indonesia may be too concerned about the political and financial repercussions of seeking debt relief based on these theories.
Options for Reducing Debt Obligations
Indonesia’s decision to ask for debt relief must balance a variety of considerations, including the difficulty of repaying the debts, maintaining good relations with creditors, and the ability to obtain credit on good terms in the future.
If Indonesia were to seek debt relief, it could ask for relief or charity, based on poor economic conditions or an inability to repay the debts. However, Indonesia’s fiscal conditions do not allow it to qualify for multilateral initiatives of the G8 and its level of indebtedness is considered sustainable by many international lenders. Another option is to claim that a portion of the foreign debts are “odious debt” or “illegitimate”.
Alternatively, Indonesia could try a new legal approach, arguing that lenders neglected their responsibilities and demand reduction based on the illegal behavior of the creditors. This is the approach that Winters has advocated for in the past, but at this time it remains untested.
Illegitimate/ Odious Debt
Under national banking laws, banks often have a responsibility to act in good faith and it is well established that reckless or corrupt loans should not be repaid. For example, British law requires banks to respect the “ordinary principles of fair dealing” and bear a responsibility for assessing the viability of a project. Increased awareness of lenders’ responsibilities has led to the concept of illegitimate debts.Illegitimate debts can be characterized as loans that are deficient to such an extent that the bank is considered to have failed its fiduciary responsibilities by making them, and as a result has no right to demand repayment.
Similarly, the theory of odious debt holds that the national debt incurred by a regime for purposes that do not serve the best interests of the nation should not be enforceable. Under this theory, the debts are personal debts of the regime that incurred them and are not debts of the state. The concept is similar to the idea that contracts signed under coercion or duress are invalid. There are three main components to an odious debt claim:
1) the general population does not consent to the borrowing;
2) the proceeds do not benefit the general population or the state; and
3) the creditor knows both of these facts at the time of lending.
This is not a well-established legal principle and has not been cited by any national or international tribunals as a reason to repudiate a debt claim.
Indonesia’s situation seems to fit the requirements for an odious debt claim against the World Bank. Arguably, the Indonesian population was unable to consent to the borrowings during Suharto’s regime. In addition, the proceeds of the loans were often misappropriated or used for failed projects like the East Timor transmigration program that did not benefit the general population. Furthermore, there is evidence that the World Bank knew about the corruption and diversions of funds to pay government officials. In 2004, Transparency International (TI) named Suharto as the most corrupt politician of the previous two decades. TI estimated that Suharto stole $15-35 billion. Between 1966 and 1998, World Bank loans to the Suharto government totaled around $30 billion, and it is estimated that approximately one-third of this ($10 billion), was misappropriated with the Bank’s knowledge.
Although Indonesia might meet the theoretical requirements for an odious debt argument, the mechanics of applying the doctrine are unclear.
Illegal Creditor Argument
Winters argues that the World Bank Articles of Agreement impose a fiduciary duty on the Bank. Article III, Section 5 (b) of the World Bank International Bank for Reconstruction and Development Articles of Agreement states:
“The Bank shall make arrangements to ensure that the proceeds of any loan are used only for the purposes for which the loan was granted, with due attention to considerations of economy and efficiency and without regard to political or other non-economic influences or considerations.”
This clause was intended to protect loans from being stolen or misused, and arguably places a duty on the Bank to make sure that funds are not misappropriated.
Although the Articles of Agreement are a legally binding Charter, they do not specify the consequences if the Bank’s fails to adhere to it. However, the World Bank is recognized as a legal entity under international law and faces legal procedures ranging from internal hearings to proceedings in the International Court of Justice. Theoretically, a client government that has replaced a corrupt dictatorship, or a class action suit by aggrieved citizens or NGOs could be brought against the Bank to demand debt relief, due to the Bank’s failure to fulfill its responsibilities under Section 5 (b).
Iraq
Iraq’s debt re-negotiations provide an illustration of how a country that does not qualify for poverty based debt reductions may reduce its debt obligations, and of a new regime’s approach that avoids making an odious debt claim.
After the ouster of Saddam Hussein’s regime in the spring of 2003, Iraq had approximately $130 billion of external debts. The debt included Paris Club bilateral debt ($42.5 billion), non-Paris Club bilateral creditor debt ($67.4 billion), commercial creditors ($20 billion), multilateral creditors ($0.5 billion). However, Iraq is considered a middle-income country, due to its large petroleum reserves, so it would not ordinarily qualify for poverty based debt reduction.
Led by the Bush administration, a consensus was reached that Iraq would receive debt relief on terms that were unique given its economic resources. Negotiations led to an 80% reduction of Paris Club and commercial debts. Iraq’s debts to the World Bank and IMF were cleared in 2004, largely by contributions from Paris Club donor countries. The U.S. forgave its Saddam-era debts, worth $4.1 billion, in November 2004. Negotiations with non-Paris Club bilateral creditors are ongoing.
Iraq’s example illustrates that the international community is willing to shield a debtor from its creditors on an ad-hoc, case-by-case basis. But, its impact may be limited.Strong Bush administration support for Iraq’s debt reduction likely contributed to the Paris Club’s willingness to negotiate. And, the willingness of lenders to reduce debts may be strongly correlated to a perceived potential threat to U.S. and international security.
The Iraqi case also shows the hesitation to make an odious debt claim. The idea of repudiating Iraq’s debts under the concept of odious debt was raised by some U.S. members of Congress in 2003, in H.R. 2482 The Iraq Freedom from Debt Act, but the bill was not enacted. Meanwhile, Iraqi officials have continued to claim that they will not seek repudiation under the odious debt theory, preferring to seek debt relief under a more established approach.
Similarly, the Indonesian government may be reluctant to pursue illegitimate/odious debt claims or argue that lenders breached their responsibilities. Although it may be enticing to think about renegotiating debts, the legal standards and mechanisms for making an illegitimate debt or breach of duties argument are unclear. The uncertainties, combined with a desire to maintain good relations with creditors, may make it unlikely that Indonesia will pursue debt reduction using these arguments.
Julie Ota is a Legal Consultant at Hukumonline.
by: Julie Ota
Recently, Jeffrey Winters, an associate-professor at Northwestern University in Illinois, said Indonesia should seek a partial debt moratorium on debts accumulated during the 30-year rule of former president Suharto at a seminar on foreign debts organized by Aid Watch.
Winters has been arguing that international lenders, particularly the World Bank, should be held responsible for lending some $30 billion to Indonesia, when they knew it was being abused by a corrupt regime for over a decade. This year alone, Indonesia is expected to make payments of around Rp 120 trillion (about $10.75 billion) in principal and interest, half of which are to service foreign debt.
Recently, Bank Indonesia warned the government of the possibility of a financial crisis induced by growing foreign debts. The debts are now classified as in the alert stage and included $128.6 billion of government debts and $85.6 billion of private debts in April 2011. Despite the high fiscal burden of foreign debts, Indonesia has not made an attempt to claim that its debts are illegitimate or that the lenders have breached their duties, as Winters suggests. The legal theories for making these claims may be too undefined, and Indonesia may be too concerned about the political and financial repercussions of seeking debt relief based on these theories.
Options for Reducing Debt Obligations
Indonesia’s decision to ask for debt relief must balance a variety of considerations, including the difficulty of repaying the debts, maintaining good relations with creditors, and the ability to obtain credit on good terms in the future.
If Indonesia were to seek debt relief, it could ask for relief or charity, based on poor economic conditions or an inability to repay the debts. However, Indonesia’s fiscal conditions do not allow it to qualify for multilateral initiatives of the G8 and its level of indebtedness is considered sustainable by many international lenders. Another option is to claim that a portion of the foreign debts are “odious debt” or “illegitimate”.
Alternatively, Indonesia could try a new legal approach, arguing that lenders neglected their responsibilities and demand reduction based on the illegal behavior of the creditors. This is the approach that Winters has advocated for in the past, but at this time it remains untested.
Illegitimate/ Odious Debt
Under national banking laws, banks often have a responsibility to act in good faith and it is well established that reckless or corrupt loans should not be repaid. For example, British law requires banks to respect the “ordinary principles of fair dealing” and bear a responsibility for assessing the viability of a project. Increased awareness of lenders’ responsibilities has led to the concept of illegitimate debts.Illegitimate debts can be characterized as loans that are deficient to such an extent that the bank is considered to have failed its fiduciary responsibilities by making them, and as a result has no right to demand repayment.
Similarly, the theory of odious debt holds that the national debt incurred by a regime for purposes that do not serve the best interests of the nation should not be enforceable. Under this theory, the debts are personal debts of the regime that incurred them and are not debts of the state. The concept is similar to the idea that contracts signed under coercion or duress are invalid. There are three main components to an odious debt claim:
1) the general population does not consent to the borrowing;
2) the proceeds do not benefit the general population or the state; and
3) the creditor knows both of these facts at the time of lending.
This is not a well-established legal principle and has not been cited by any national or international tribunals as a reason to repudiate a debt claim.
Indonesia’s situation seems to fit the requirements for an odious debt claim against the World Bank. Arguably, the Indonesian population was unable to consent to the borrowings during Suharto’s regime. In addition, the proceeds of the loans were often misappropriated or used for failed projects like the East Timor transmigration program that did not benefit the general population. Furthermore, there is evidence that the World Bank knew about the corruption and diversions of funds to pay government officials. In 2004, Transparency International (TI) named Suharto as the most corrupt politician of the previous two decades. TI estimated that Suharto stole $15-35 billion. Between 1966 and 1998, World Bank loans to the Suharto government totaled around $30 billion, and it is estimated that approximately one-third of this ($10 billion), was misappropriated with the Bank’s knowledge.
Although Indonesia might meet the theoretical requirements for an odious debt argument, the mechanics of applying the doctrine are unclear.
Illegal Creditor Argument
Winters argues that the World Bank Articles of Agreement impose a fiduciary duty on the Bank. Article III, Section 5 (b) of the World Bank International Bank for Reconstruction and Development Articles of Agreement states:
“The Bank shall make arrangements to ensure that the proceeds of any loan are used only for the purposes for which the loan was granted, with due attention to considerations of economy and efficiency and without regard to political or other non-economic influences or considerations.”
This clause was intended to protect loans from being stolen or misused, and arguably places a duty on the Bank to make sure that funds are not misappropriated.
Although the Articles of Agreement are a legally binding Charter, they do not specify the consequences if the Bank’s fails to adhere to it. However, the World Bank is recognized as a legal entity under international law and faces legal procedures ranging from internal hearings to proceedings in the International Court of Justice. Theoretically, a client government that has replaced a corrupt dictatorship, or a class action suit by aggrieved citizens or NGOs could be brought against the Bank to demand debt relief, due to the Bank’s failure to fulfill its responsibilities under Section 5 (b).
Iraq
Iraq’s debt re-negotiations provide an illustration of how a country that does not qualify for poverty based debt reductions may reduce its debt obligations, and of a new regime’s approach that avoids making an odious debt claim.
After the ouster of Saddam Hussein’s regime in the spring of 2003, Iraq had approximately $130 billion of external debts. The debt included Paris Club bilateral debt ($42.5 billion), non-Paris Club bilateral creditor debt ($67.4 billion), commercial creditors ($20 billion), multilateral creditors ($0.5 billion). However, Iraq is considered a middle-income country, due to its large petroleum reserves, so it would not ordinarily qualify for poverty based debt reduction.
Led by the Bush administration, a consensus was reached that Iraq would receive debt relief on terms that were unique given its economic resources. Negotiations led to an 80% reduction of Paris Club and commercial debts. Iraq’s debts to the World Bank and IMF were cleared in 2004, largely by contributions from Paris Club donor countries. The U.S. forgave its Saddam-era debts, worth $4.1 billion, in November 2004. Negotiations with non-Paris Club bilateral creditors are ongoing.
Iraq’s example illustrates that the international community is willing to shield a debtor from its creditors on an ad-hoc, case-by-case basis. But, its impact may be limited.Strong Bush administration support for Iraq’s debt reduction likely contributed to the Paris Club’s willingness to negotiate. And, the willingness of lenders to reduce debts may be strongly correlated to a perceived potential threat to U.S. and international security.
The Iraqi case also shows the hesitation to make an odious debt claim. The idea of repudiating Iraq’s debts under the concept of odious debt was raised by some U.S. members of Congress in 2003, in H.R. 2482 The Iraq Freedom from Debt Act, but the bill was not enacted. Meanwhile, Iraqi officials have continued to claim that they will not seek repudiation under the odious debt theory, preferring to seek debt relief under a more established approach.
Similarly, the Indonesian government may be reluctant to pursue illegitimate/odious debt claims or argue that lenders breached their responsibilities. Although it may be enticing to think about renegotiating debts, the legal standards and mechanisms for making an illegitimate debt or breach of duties argument are unclear. The uncertainties, combined with a desire to maintain good relations with creditors, may make it unlikely that Indonesia will pursue debt reduction using these arguments.
Julie Ota is a Legal Consultant at Hukumonline.
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