Finance and Adjustment: The International Debt Crisis, 1982-84

This report provides an overview of the international debt problem which has significantly disturbed the international economic environment of the 1980s. It describes the characteristics of the less developed country (LDC) debt and discusses the role of major participants in the debt crisis. The study shows how the role of the participants has evolved during the crisis. Lastly, some of the issues arising from the debt crisis are discussed.

Report No. 84-162 E FINANCE AND ADJUSTMENT : THE INTERNATIONAL DEBT CRISIS, 1982-84 bY Patricia Wertman Analyst in International Trade and Finance Economics Division September 17, 1984 HJ 8045 For. Gen. T h e (:ongressionaI Reseal-ch S e n ice \\.arks c.ac.ll~si\el\f o ~ the (kngress. conducting rcsearc-h.;rrl;il\.ring Irgislatiorl. and providing inthrmation at the recluest of' c.ommittees. \It'inbers, and their staffs. T h e S e n i c e makes such r-esear.ch a\-ailatde. \\.irIlol~tpartisan bias. in wan\. fornls in(-luciingstudies. reports, conlpilag s . recluest. (:K.s tions. digests. a n d backg1-ountl t ~ r i e f i ~ ~I.po11 assists cornnlittees in anal>./irlg legisl;iti\e pr-oposals and issues, and in assessing t h e possible et'tkc.ts ot these pr~oposals and their alternati\.e~.I'he Service's senior spec ialists ;inti subject anal>.stsa r e also available for per-son;il c.onsi~lt;ition\ in their r-especti\-efields ot'espertise. CRS- i i i ABSTRACT This paper provides an overview of the international debt problem which has significantly disturbed the international economic environment of the 1980s. It describes the characteristics of the less developed country (LDC) debt and discusses the role of major participants in the debt crisis. The study shows how the role of the participants has evolved during the crisis. Lastly, some of the issues arising from the debt crisis are discussed. CONTENTS ................................................................ iii INTRODUCTION ...................................................... I1 . CHARACTERISTICS OF INTERNATIONAL DEBT ............................. 3 A . Size .......................................................... 3 B . Concentration ................................................. 3 C . Composition ................................................... 5 D . Pricing ....................................................... 5 E . Structure ..................................................... 7 F . Summary ....................................................... 7 I11. ACTORS ............................................................ 9 A . The U.S. Government ........................................... 9 B . The International Monetary Fund (IMF) ......................... 11 C . The Bank for International Settlements ........................ 13 D . The Borrowers ................................................. 14 E . Lenders and Supervisors ....................................... 19 1 . "A Rolling Loan Gathers No Loss" or the Recognition of Losses ................................................... 24 2 . The Allocation of Costs .................................... 27 ABSTRACT ............................. 29 V. LESSONS ............................................................ 35 V. CONCLUSION ........................................................ 39 IV. TRADE. COUNTERTRADE. AND PROTECTIONISM FINANCE AND ADJUSTIIENT: I. THE INTERNATIONAL DEBT CRISIS, 1982-84 INTRUDUCTION Following t h e o i l p r i c e r i s e s of 1973-1974, t h e subsequent world-wide r e c e s s i o n , and t h e d r o p i n commodity p r i c e s , t h e d e b t l e v e l s o f many d e v e l o p i n g countries rose rapidly. F u r t h e r OPEC ( O r g a n i z a t i o n of Petroleum E x p o r t i n g C o u n t r i e s ) o i l p r i c e r i s e s i n 1979-1980, a major t i g h t e n i n g i n U.S. monetary p o l i c y s t a r t i n g i n October 1979, a n o t h e r worldwide r e c e s s i o n accompanied by h i s t o r i c a l h i g h s i n r e a l i n t e r e s t r a t e s , and a n o t h e r d e c l i n e i n commodity p r i c e s f u r t h e r i n c r e a s e d LDC d e b t l e v e l s . By l a t e 1982, when B r a z i l and Mexico, t h e two l a r g e s t borrowers, n e a r l y d e f a u l t e d on t h e i r e x t e r n a l d e b t , t h e problem had become a major i n t e r n a t i o n a l c r i s i s . o f t h e d e b t problem -- T h i s paper c o n s i d e r s s e v e r a l c h a r a c t e r i s t i c s i t s s i z e , c o n c e n t r a t i o n , c o m p o s i t i o n , s t r u c t u r e , and p r i c i n g , t h e r o l e of t h e v a r i o u s p a r t i c i p a n t s , and t h e impact on world t r a d e and f i n a n c i a l markets. F i n a l l y , t h e r e i s a b r i e f d i s c u s s i o n of p o l i c y i s s u e s involved. 11. A. CHARACTERISTICS OF INTEKNATIONAL DEBT Size The O r g a n i z a t i o n f o r Economic Cooperation and Development (OECD) has e s t i m a t e d t h a t t o t a l d i s b u r s e d medium- and long-term d e b t o f t h e less developi n g c o u n t r i e s was $606 b i l l i o n a t t h e end of 1983, having r i s e n d r a m a t i c a l l y from $86.0 a t t h e end of 1971. 1/ A r e c e n t World Bank e s t i m a t e which i n c l u d e s s h o r t - t e r m d e b t p l a c e s t o t a l Third World d e b t a t $810 b i l l i o n a t t h e end of - - 1983. 2 1 31 Gross hard c u r r e n c y d e b t o f E a s t e r n Europe and t h e S o v i e t Union was e s t i m a t e d by t h e C e n t r a l I n t e l l i g e n c e Agency (CIA) t o be $28.7 b i l l i o n a t t h e end of 1982. 4/ B. Concentration The i n t e r n a t i o n a l d e b t i s n o t o n l y huge, but a l s o h i g h l y c o n c e n t r a t e d . T a b l e I , produced from OECD d a t a , emphasizes t h e s h a r p c o n c e n t r a t i o n of t h e LDC d e b t ; i t i s o r g a n i z e d by s i z e of d e b t s e r v i c e . The OECD b e l i e v e s t h a t s i z e o f d e b t s e r v i c e i s a more meaningful way t o a s s e s s d e b t c o n c e n t r a t i o n because a l a r g e d e b t on s o f t terms g e n e r a t e s o n l y a s m a l l d e b t s e r v i c e . 1/ p. 5 4 7 -2/ OECD. The OECD E x t e r n a l Debt of Developing C o u n t r i e s , 1983 Survey. World Bank. World Debt T a b l e s , 1983. 1984 ed., T a b l e 9, p. x i i . 3/ The number of c o u n t r i e s i n c l u d e d i n t h e OECD Survey and t h e World Bank Debt T a b l e s a l s o d i f f e r s . The OECD e s t i m a t e c o v e r s 157 c o u n t r i e s ; i n t h e World Bank e s t i m a t e 133. -4/ CIA. Handbook of Economic S t a t i s t i c s , 1983, p. 46 and p - 71. 338.1 T o t a l 20 C o u n t r i e s 301.2 ( % of Grand T o t a l LDCs) (67.7) T o t a l LDCs 445.0 (70.5) 35.2 24.8 0.6 0.6 0.6 0.5 0.3 0.2 0.5 0.2 0.6 (73.5) 50.3 31.8 (74.6) 48.1 37.5 1.2 0.9 0.6 0.7 0.7 C.4 1.0 1.O 1.O 0.2 0.9 0.2 0.9 0.7 0.6 0.2 0.7 0.2 I n t e r e s t Paid Next-ranking c o u n t r i e s a/ Borrowers a r e r a n k e d by a v e r a g e d e b t - s e r v i c e p a y a e n t s i n 1981-82. i n c l u d e b r a e l ( n o t i n c l u d i n g o f f i c i a l m i l i t a r y d e b t ) , Morocco, T h a i l a n d , Taiwan, I v o r y C o a s t . b/ OPEC Member. c/ - Net o i l e x p o r t e r . d / O u t s t a n d i n g i n t e r n a t i o n a l bank l o a n s f r o m DAC c o u n t r i e s and i n t e r n a t i o n a l c a p i t a l markets (oFher t h a n o f f i c i a l l y guaranteed e x p o r t c r e d i t 8). Source: OECD. E x t e r n a l Debt o f D e v e l o p i n g C o u n t r i e s , 1 9 8 3 Survey. p. 54, 5 5 , 7 6 , 7 7 , and 83. (74.3)(75.7) (7P.5) 82.3 99.7 107.5 81.4 1.8 1.7 2.1 1.8 1.7 2.1 2.0 1.9 1.6 (82 6 ) 200 .O 75.4 1.7 1.7 1.3 1.6 1.4 2.2 1.8 1.8 2.0 61.2 1.2 1.3 1.1 1.2 1.4 2.0 1.2 1.1 1.6 Debt S e r v i c e P a i d 165.6 3.9 5.4 3.6 5.2 0.5 11.9 8.8 15.0 9.1 20.7 372.0 0.8 3.5 0.1 2.9 o f w h i c h owed t o b a n k s , d / 1982 2.7 7.9 2.2 8.4 (67.5) (67.4) 506.7 551.7 10.2 8.2 14.5 7.1 18.9 8.7 7.0 13.9 6.0 18.2 Philippines Greece Turkey Portugal India 16. 17. 18. 19. 20. 2.4 6.0 3.0 7.4 2.9 5.2 2.5 7.1 Egypt Saudi Arabia b/ Nigeria b/ 'Iraq b/ P e r u /; Year-end D i s b u r s e d Debt: 11. 12. 13. 14. 15. Korea, Rep. I r a n b/ ~ u g o s ha i Chile Indonesia b/ Brazil Mexico c/ ~ r ~ eina n t V e n e z u e l a b/ Algeria b/- Borrower TABLE 1. D i s b u r s e d Long-Term D e b t , Debt S e r v i c e , and I n t e r e s t P a i d , A l l LDCs and 2 0 L a r q e s t Borrowers a/ Y e a r End 1980-1982: ($ b i l l i o n ) found t h a t t h e 20 l a r g e s t d e b t o r s a c c o u n t e d f o r 76 p e r c e n t o f t h e d e b t s e r v i c e - p a i d by LDCs. 51 I n d e e d , B r a z i l and Mexico t o g e t h e r a c c o u n t e d f o r 25 p e r c e n t of t h e debt s e r v i c e . 6/ Thus, i n t e r n a t i o n a l d e b t i s h i g h l y c o n c e n t r a t e d , i n - c r e a s i n g t h e r i s k t o h o l d e r s o f t h e d e b t and v i o l a t i n g g e n e r a l l y a c c e p t e d p r i n c i p l e s of p o r t f o l i o d i v e r s i f i c a t i o n . C. Composition: P u b l i c o r P r i v a t e fund s o u r c e s As shown i n t a b l e 11, o f t h e t o t a l d e b t d i s b u r s e d a t year-end 1983, 21 p e r c e n t was o f f i c i a l development a s s i s t a n c e ; 8 p e r c e n t , n o n - c o n c e s s i o n a r y m u l t i l a t e r a l a s s i s t a n c e ; 23 p e r c e n t , e x p o r t c r e d i t s ; and 4 8 p e r c e n t , p r i v a t e market c r e d i t s . During t h e 1970s t h e r e had been a s h i f t from i n t e r - g o v e r n m e n t a l t r a n s f e r s t o i n c r e a s e d p r o v i s i o n o f f u n d s by t h e p r i v a t e markets.. This can be a t t r i b u t e d t o t h e s u c c e s s w i t h which p r i v a t e m a r k e t s r e c y c l e d t h e OPEC balance-of-payments s u r p l u s and t o t h e u n w i l l i n g n e s s o f t h e OECD governments t o provide financing. S i n c e p r i v a t e f i n a n c i n g i s more c o s t 1y t h a n government loans, t h i s s h i f t increased t h e l e v e l of debt service. D. Pricing Much of t h e borrowing from p r i v a t e s o u r c e s h a s been done by t h e more advanced d e v e l o p i n g c o u n t r i e s a t f l o a t i n g r a t e s , t h a t i s , a t a s p r e a d o v e r t h e -5/ -6 / OECD. Ibid. E x t e r n a l Debt o f Developing C o u n t r i e s : 1983 S u r v e y , p. 42. TABLE 2. Sources of Long-Tern Lending to LDC (percent of total) 1971 1975 1980 - 1983 41% 342 244: 2 1% Private Markets 24 34 40 48 Source: External Debt of Developinq Countries: Official Development Assistance Non-Concessionary Multilateral Assistance Export Credits OECD. 1983 Survey. p . 69. London Interbank Offered Rate (LIBOR) or the U.S. prime rate. 71 The use of floating rate debt increases the vulnerability of large borrowers to the impact of rising interest rates which increase debt service costs. Argentina, Brazil, South Korea, and Mexico, as leading borrowers, had the highest floating rate debt, accounting together for 81 percent of the floating rate debt. 8/ In addition to pricing international loans with variable interest rates, loans are also most frequently denominated in U.S. dollars. In periods of an appreciating dollar, this also increases LDC debt service. 71 The London Interbank Offerred Rate is the rate at which high quality hanks-in London are prepared to lend to each other in the interbank market. The interest rate on Eurocurrency loans is usually expressed as a "spread" over LIBOR. 8/ - OECD. External Debt, p. 67. CRS- 7 E. Term Structure There has also been a major shift in the term structure of LDC debt: the debt has become increasingly short-term. This is, in itself, an indication that LDC debt is viewed as increasingly risky. As a country's economic situation deteriorates, %anks become increasingly unwilling to lend at longer maturities. Large amounts of short-term debt open the borrowing countries up to increasing difficulties in rolling over existing debt. Countries having large short-term debt include Argentina, Brazil, South Korea, and Mexico. F. Summary The size, concentration, composition, pricing, and structure all combine to make the international debt issue one of paramount concern. Nothing, however, dramatized the problem more clearly than the late 1982 international financial crisis caused by the near default of the system's two largest borrowers--Mexico and Brazil. Emergency intervention by the International Monetary Fund (IMF), the Bank for International Settlements (BIS), the U.S. Treasury, the Federal Reserve and other central banks, accompanied by the forced lending of the private international banks served to contain the effects of the 1982 crisis. The next section of this paper looks at the institutions, the role they have played in the international debt crisis, and how they may themselves have been changed by the crisis. ACTORS 111. A. The U.S. Government 9/ The U.S. countries. Government h a s been a major s o u r c e of f i n a n c e f o r t h e d e v e l o p i n g As o f September 3 0 , 1983, t h e U.S. Government had made $52.4 b i l l i o n - i n long-term l o a n s t o d e v e l o p i n g c o u n t r i e s , i n c l u d i n g OPEC n a t i o n s . 1 0 / These l o a n s were a a d e under a v a r i e t y o f l e g i s l a t i o n , i n c l u d i n g t h e F o r e i g n A s s i s t a n c e Act of 1961, t h e A g r i c u l t u r a l Trade Development and A s s i s t a n c e Act o f 1954 (P.L. 83-480), and t h e Export-Import Bank Act of 1945. Most o f t h e s e d e b t s a r e owed by government o b l i g o r s . I n a d d i t i o n t o t h e d e b t owed t o t h e U.S. Government by d e v e l o p i n g c o u n t r i e s , - $2.2 b i l l i o n was owed by E a s t e r n Europe and t h e S o v i e t Union. 11/ The b u l k o f t h e s e l o a n s a r e a c c o u n t e d f o r by Commodity C r e d i t C o r p o r a t i o n (CCC) l o a n s t o Poland, World War I1 l e n d - l e a s e t o t h e S o v i e t Union, and U.S. Bank (Eximbank) l o a n s . Export-Import C u r r e n t l y , however, i n E a s t e r n Europe o n l y Hungary, Romania, and Y u g o s l a v i a a r e e l i g i b l e f o r l o a n s from t h e U.S. 9 / For a f u l l e r t r e a t m e n t o f d e b t owed t o t h e U.S. F o r e i g n I n d e b t n e s s t o t h e U. S. Government : An Overview. C o n g r e s s i o n a l R e s e a r c h S e r v i c e , March 29, 1984, 34 p . s e e Wertman, P a t r i c i a A. L i b r a r y of Congress, 10/ U.S. T r e a s u r y . O f f i c e o f t h e A s s i s t a n t S e c r e t a r y f o r I n t e r n a t i o n a l ~ffai;. S t a t u s of A c t i v e F o r e i g n C r e d i t s o f t h e United S t a t e s Government, September 3U, 1983. CRS- 10 The 1T.S. Government has extended energency assistance during the debt crisis, notably to Mexico and Brazil. It has done this bilaterally through the Exchanqe Stabilization Fund and other government agencies and multilaterally through such agencies as the Bank for International Settlements. The U.S. also participates in debt rescheduling. on deht rescheduling is clear and specific. U.S. Government policy All deht rescheduling Is to be done on a case-by-case basis within the context of a creditor club, that is, the fornal group of creditors who negotiate with the debtor countries. This club is known as the Paris Club and is part of the Organization for Economic Rescheduling is on the basis of nondis- Cooperation and Development (OECD). crimination among creditor countries. Private unguaranteed credits are to be on terms comparable to qovernment and government-guaranteed credits. The debtor country is to inplement an economic prograa to correct its economic difficulties, usually in cooperation with the Tnternational Monetary Fun3 (IMF). The 11.S. will reschedule payments in arrears and falling due not more than one year following the rescheduling negotiations. Finally, deht relief is not to be given as a form of development assistance. 121 As the debt crisis has accelerated, the number of reschedulings has increased rapidly. Between 1956 and the end of 1982 the Paris Club had held at least 6 0 debt reschedulings for 2 0 countries. L3/ were rescheduled. T.n 1983 debts of 15 countries The impact of rescheduling varfed. According to an IMF 12/ 1J.S. NatConal Advisory Council on Znternational Monetarv and Financial ~olicies. Annual Report for Fiscal Year 1982. July 14, 1983, p. 65-66. 13/ IMF. Debt Rescheduling: September 1983, p . 28. What 9oes T t Mean? Finance and Development, Survey, 141 o f f i c i a l d e b t r e l i e f amounted t o l e s s t h a n 30 p e r c e n t o f t o t a l d e b t s e r v i c e payments due when o n l y c u r r e n t m a t u r i t i e s were r e s c h e d u l e d , t h a t i s , payments f a l l i n g due d u r i n g t h e c o n s o l i d a t i o n p e r i o d . When a r r e a r s were i n c l u d e d d e b t r e l i e f was r a i s e d t o 100-200 p e r c e n t o f a c t u a l d e b t s e r v i c e i n about one f i f t h of t h e c a s e s surveyed and more t h a n 200 p e r c e n t i n a f u r t h e r one f o u r t h . Where o f f i c i a l i n d e b t e d n e s s t o o f f i c i a l c r e d i t o r s r e p r e s e n t e d a small p o r t i o n o f some c o u n t r i e s t o t a l d e b t , r e l i e f was c o r r e s p o n d i n g l y s m a l l . B. The I n t e r n a t i o n a l Monetary Fund (IMF) The IMF has played one o f t h e most i m p o r t a n t r o l e s i n t h e d e b t c r i s i s . The 146-member i n t e r n a t i o n a l monetary o r g a n i z a t i o n was founded i n 1945 t o foster international financial stability. medium-term The Fund p r o v i d e s s h o r t - and l o a n s a t below market r a t e s ( c u r r e n t l y 6.6 p e r c e n t ) t o member c o u n t r i e s e x p e r i e n c i n g balance-of-payments w i t h them economic p o l i c y conditions--1MF about fundamental economic a d j u s t m e n t . difficulties. These l o a n s c a r r y conditionality--intended t o bring The amount o f r e q u i r e d adjustment and t h e amount o f f i n a n c i n g a r e f i n e l y t u n e d . LMF c o n d i t i o n a l i t y i s r e s t r i c t i v e and may i n c l u d e s u c h t a r g e t s a s t h e l e v e l o f government s p e n d i n g , growth o f money s u p p l y , exchange r a t e s , and t h e t r a d e b a l a n c e . F a i l u r e t o meet t h e s e t a r g e t s c a n r e s u l t i n d e l a y e d disbursement of IMF l o a n s o r t h e i r r e n e g o t i a t i o n . A v a i l a b i l i t y of p r i v a t e funds i s a l s o a f f e c t e d by compliance w i t h IMF programs. C o n d i t i o n a l i t y i s a unique a t t r i b u t e o f IMF l o a n s . For t h i s r e a s o n P a r i s Club c r e d i t o r s and commercial banks i n s i s t t h a t t r o u b l e d borrowers have an IMF accord. IMF c o n d i t i o n a l i t y i s , however, t h e c e n t e r o f much d e b a t e . 1 4 / T h i s paragraph f o l l o w s Brau, E. and R.C. W i l l i a m s . Recent M u l t i l a t e r a l Debt E s t r u c t u r i n g s w i t h O f f i c i a l and Bank C r e d i t o r s . Washington, D. C., I n t e r n a t i o n a l Monetary Fund, December 1983, p . 21. CRS- 12 While the principle of conditionalitv is, by and large, not contested, there are strong rnisgivinss about the design and application of conditionality. In particular country cases these misgivings related to the specifics of the performance criteria. Frequently, Fund credits are negotiated in the midst of an economic crisis, with reserves plummeting, foreign debts accumulating, accelerating inflation and serious dislocations to domestic production. While t h i ~ increases the value of access to the Fund, as a 1-ender of last resort, it also gives Stand-by negotiations an unwanted flavour, with the meaber government feeling it is rushing into actions it would rather avoid and believing that it is in a weak negotiating position vis-avis the Fund. The Fund, for its part, sees itself as forced into imposing harsher conditions than would have been necessary had the member requested assistance at an earlier stage. The policy conditions laid down may be resented, both because of the loss of sovereignty implied and because of a belief that the Fund's objectives do not necessarily coincide with those of the national government. The Fund, on the other hand, often sees itself made a scapegoat 151 for unpopular measures made inescapable by poor economic management. - The basic issue is whether the policy conditions are too "tight" or too "loose," that is, whether they involve too much or too little economic discipline. IMF conditionality consists of various austerity measures which usually result in a recession in the recipient country, although economic growth may reappear in the later stages of a program. Particular concern has been expressed that the pro- longed austerity which may be required by the current crisis is politically and economically unsustainable. Indeed, the imposition of TMF conditionality has sometimes been the occasion for riots, most recently in the Dominican Republic. At another level the efficacy of IMF programs has been questioned. Recently the IMF listed some of the countries in which its program had been beneficial: Mexico, India, Pakistan, Kenya, Somalia, Mauritius, Turkey, Hungary, Romania, 15/ Sutton, Mary. In Killick, Tony, ed. The IMF and Stabilization: ~ e v e l g i nCountry ~ Experiences. New York, St. Martin's Press (1984). p. 4 . CRS- 13 and Yugoslavia. 16/ There is also a debate whether IMF prescriptions, when applied multilaterally, are not cumulatively destructive of the goals which the IMF is trying to achieve. Nevertheless, under current circumstances private funds would Se unlikely to be forthcoming without conditional IMF loans, and these private loans comprise the major share of lending to Third World countries. Lastly, it should be noted that the deep involvement of the TMF in the debt crisis represents an important shift in the 1MF1s role as a provider primarily of shortterm funds to industrial nations to being a provider of medium-term funds to developing countries (lending to industrial countries in the future should not be discounted). This shift is a result of major disequilibria in the world economy, as well as economic mismanagement by individual countries. Thus, further instability in the international econo-ny may imply a continued high demand for IMF financing and further quota increases. Although the IMF does not reschedule debt, it acts as a catalyst in negotiations between borrowers and lenders, fostering cooperation between governments, central hanks, the Bank for International Settlements, and the commercial banks. In this role the IMF stepped out aggressively during the Mexican and Brazilian debt problems of late 1982. The TMF not only told the banks to lend but, in order to insure that the countries got the funds necessary to assure success of the adjustment program, told them how nuch to lend. The TMF which once was con- cerned that commercial banks not threaten IMF conditionality by lending too much is now concerned that too little will be lent. IMF assessment of how much funds the banks will provide, that is, of a country's capital account prospects and its implications for the current account, are key to the level of IMF funding. 16/ IMF. Fund Managing Director Describes Case Studies, IMF Survey, ~ e b r u G y6, 1984, p. 33, 42-47. CRS- 14 Finally, the IMFfs ability to provide resources to the LDCs was greatly enhanced by the expansion, in late 1983, o f its quotas by 47.4 percent to SDR 90 million (about $98.5 million). source. The quotas are the IMFfs basic lending The IMF General Arrangements to Borrow (GAB), which were initially intended to finance balance of payments difficulties encountered by members of the Group of Ten, were also expanded to permit access by all IMF members in the event of a major international financial crisis. C. The Bank For International Settlements (BIS) Located in Basel, the Bank for International Settlements (BIS), the central bank for central bankers, played an important role in the 1982-83 debt crisis. The BIS provided short-term bridging loans to five countries: Mexico, Argentina, Brazil, Hungary, and Yugoslavia. The loans were intended as financing until loans from the IMF could be obtained. Provision of credit for developing countries represents a departure from the normal role of the RIS, and the BIS has curtailed its loans to troubled LDCs. Thus, future involvement by the BIS in international debt problems appears unlikely, although it may depend on the extent of the crisis. D. The Borrowers Throughout most of the 1970s the major borrowers had deteriorating balance- of-payments accounts. Payments deficits accompanied by foreign borrowing and a large external debt are normal for a developing country, as it was for the U . S . in its infancy. However, the unprecedented rise in oil prices followed by inter- national recession and declining commodity prices led to dramatic payments 17/ - Argentina never drew on its standby credit. CRS- 15 deterioration and a run-up of LDC debt. about the debt level. As early as 1975 concern was expressed Further oil price rises exacerbated the problem. The run-up of real interest rates following a shift in U.S. monetary policy in October 1979, rising dollar exchanse rates, and a shift to short-term and floating rate debt also increased the LDC debt burden. A major recession in the industrial world and rising protectionism made it difficult for developing countries to earn the foreign exchange needed to pay their debts. For many countries, their ability to adjust to these external shocks was frustrated by poor demand management and unrealistic exchange rate policies. Poor debt management meant that many countries simply failed to realize the scope of their debt problem until their debt crisis was upon them. Domestic economic policies are also a major determinant of the existence and extent of a debt problem. The Latin American countries chose to follow the path of import substitution. That path led to quotas, overvalued exchange rates, and increased foreign borrowing. At the same time exports were handi- capped. By comparison, most of Asia successfully chose export-led growth. Exchange rates and other prices were not fixed and the market mechanism usually allocated resources. The results of these policies are summarized by the Economist: 18/ GDP Crowth 1973-80 Latin America Asia 5.8% 5.3% 18/ The Policy Difference. ~ e ~ t e m b e24, r 1983, p. 39. 1981 - -0.1% 5.8% 1982 -1.5% 3.7% Average 1.4% 4.97 In World Economic Survey, The Economist, CRS- 16 Clearly, while import substitution policies initially Led to faster growth, an export-led growth stategy had higher average qrowth and was more resistant to economic recession. Conventionally a debt crisis must be met by some combination of financing and economic adjustment. adjustment is required. The greater the availability of finance, the less The degree of adjustaent is also determined by the severity of the economic and financial crisis. 191 linked to weak economic policies. - reform. Severe debt problems are closely Thus, economic adjustment means policy In practice, the focus is on denand management and pricing policies, including exchange rate and interest rate policies. Oversized fiscal deficits must be cut back by cutting government spending and subsidies and by raising taxes. Cuts in public sector borrowing, credit expansion, and money supply are intended to control inflation. Overvalued exchange rates, typically a major cause of debt problems, are corrected by devaluation, with the hope that resources will be directed to the export sector. This mix of deflation, disinflation, and devaluation aakes the upper tranche adjustment programs economically painful and politically difficult. For these reasons, for example, Argentina has so far failed to negotiate an IMF program. However, economic adjustment is inevitable and the alternative of adjusting without a program could well be more difficult. Moreover, in the later stage of an IMF program economic growth may emerge. ' IMF programs are tailor-made for each country. Programs are the product of negotiations between debtor countries and the IMF and are embodied in a confidential "letter of intent" to the Managing Director of the IMF. 191 IMF, Survey, - February 6, 1984, p . 42. At CRS- 17 the same time, IMF rules require equal treatment of members, hence, the similarities of the programs. Economic policy change are expressed In These targets are largely fiscal and monetary, "performance targets." occasionally qualitative (such as balance of payments restrictions), but never supply side. Although inflation is frequently a major problem, the inflation rate itself is rarely a target. access to IMF funds. Performance targets are the Countries often find the targets difficult to meet, principal measures of adherence to adjustment programs, thus governing fall out of compliance, then renegotiate or cancel the proqram. The success of IMF programs in individual countries appears to be mixed, whether compared to key economic variables of the immediate past 20/ or to the performance criteria. - A look at the Third World's two largest debtors illustrates some of the difficulties of measuring success. In return for a $3.9 billion credit Mexico reportedly agreed to one condition in its letter of intent cent of GNP. -- the reduction of its budget deficit to 8.5 per- (Additional details were apparently contained in an unreleased technical agreement.) Mexico has successfully compiled with its IMP per- formance targets, yet Mexico remains in the severest economic crisis of its history. The achievement of large trade and current account surplus during the last two years was offset by recession, high unemployment, and high inflation. In the wake of Mexico's difficulties, Brazil, the Third World's largest debtor, was forced to negotiate a $4.9 billion extended arrangement with 20/ See discussion and footnotes in Killick and Sutton in Killick, Tony, ed. Adjustment and Financing in the Developing World: The Role of the International Monetary Fund. International Monetary Fund, Washington, D.C., 1982. p. 3 4 - 3 5 . CRS- 1R the Fund. Conditions included cutbacks in government subsidies, state com- panies, and debt. In a test of its will to deal with its economic problems, Brazil failed to cutback wage indexation, a major cause of inflation. As a result Brazil fell out of compliance with its IMF programs. The IMF did not resume lending until after passage of a new wage measure, Decree Law 2065, in Noveaber 1983. Despite mofication of the wage indexation law, in the first quarter of 1984 inflation was at an annual rate of 230 percent. Brazil's IMF accord does not contain an inflation target, but other targets imply an inflation rate of about 100 percent. The present rapid inflation has jeopardized Brazil's adherence to targets which are in its program and caused Brazil to be out of compliance with its fifth and latest IMF accord. Mean- while, Brazil's trade surplus has soared; unemployment in industrial areas is stabilizing; and the government, disagreeing with private economists, is forecasting economic growth for the first time in four years. Thus, economic results following imposition of an IMF program in Brazil also appear to be contradictory. Tn addition to the conventional approaches of finance and economic adjustment, a political approach to the debt problem has been suggested recently, namely the formation of a "debtors' cartel" to extract more favorable terms from lenders. This idea has been discussed by the nonaligned nations, but it is in Latin American where the idea has gained the aost acceptance. In Latin America, with more than half of the outstanding LDC external debt, the idea of a debtors' cartel was first discussed in Ecuador at a March 1983 qeeting of the Inter-American Development Bank. In September 1983 a report produced by the U.N. Commission for Latin America and the Latin American Economic System was discussed at the OAS meeting in Caracas. According to the Wall Street Journal this report recommended institutionalizing CRS- 19 the restructuring of debt, greater refinancing, longer postponement of principal payments, additional new financing, lower fees and interest rates on refinancings, and increased loans from government and multilateral organizations. 21/ the proposal wanted more money on easier terms. In sum, At meetings held in Quito from in January 9-14, 1984, and Cartagena on June 19-20, 1984, these proposals were amplified. The failure of a debtors cartel to develop has been in part because of the disparate interests of the major borrowers, such as Brazil and Mexico, and the smaller borrowers. As one banker put it "the cocktail theory of a debtors' cartel is not the real world. There are too many different trade patterns among debtors, different political systems and different staqes of negotiations - with the IMF." 22/ For the moment, at least, the debtors will go the more traditional route of rescheduling, financing, and adjustment. rescue of Argentina by four Latin debtors reinforces this view. The recent The signi- ficance of the cartel idea may well be the extent to which it merges with earlier LDC demands for increased long-term aid and a new economic order. Beyond pressing for more funds and softer terms, the option of outright default is only likely to be taken when a country perceives it has less to lose and more to gain from such an action, such as Cuba in 1962. no countries have so far chosen to default. In this debt crisis Cessation of trade, cutoff of loans, attachment of assets, and general economic isolation of default -- are an extremely high -- the consequences price to pay for getting out from under foreign debt, especially when rescheduling is an alternative. 21/ Rout, Lawrence. Bankers Worry Monday's OAS Meeting May Boost Support for Debt Moratorium. Wall Street Journal, September 2, 1983, p . 16. 22/ Brazil to Join Caracas Debt Strategy Talks, Financial Times, A U ~ 10, U ~1983, p. 1, 4. Recent loan packages negotiated by Mexico, Brazil, and Peru have softened terms. It is problematic, however, whether this is the market's recognition of economic improvement in these countries or a recognition that, over the long pull, debtor countries probably cannot sustain a continuation of previously high borrowing costs. E, Lenders and Supervisors At the end of December 1983 the banks reporting to the BIS had assets in 23/ Domestic U.S. banks accounted for apthe non-OPEC LDCs of $256.2 billion. proximately $127.6 billion of this lending, nearly SO percent in Latin America. 241 With such large holdings it is not surprising that the international debt crisis of 1982-1983 has had as dramatic an impact on international lenders and international financial markets as it has had on other actors in the international financial system. Important changes have occurred in the international money and capital markets. quality. Fundamentally, there has been a greater emphasis on This has resulted in some market tiering. The $1-trillion interbank market consists of short-tera deposits banks keep with each other. Banks unable to obtain funds in the interbank market may face a liqudity crisis threatenins the entire system. This is not just a hypothetical possibility. When Ranco do Brazil, the settlements bank for Brazil, was having difficulty meeting its obligation in mid-December 1982, five Mew Pork banks lent it $175 million rather than allow the market to come to a halt. This is important not only because the interbank market 231 BIS. International Banking Developments. ~ ~ r i l T 9 8 4 .Table 5 . 241 Federal Reserve Board of Governors. p. A57. v. 7 0 T ~ ~ r i1984. l Fourth Quarter, 1983. Federal Reserve Bulletin, CRS- 2 2 was nearly brought to an abrupt stop, hut also because an acutely clear message was delivered; loans between banks carried a risk. Banks began to reexanine their interbank lines and the market began to shrink dramatically. Maintainence of interbank lines became a crucial factor in major debt rescheduling~,such as Mexico and Brazil. Regional banks, in particular, were reluctant to maintain interbank lines, creating a major problem. Market shrinkage, however, may have left the market smaller and healthier. 25/ Perhaps the financial turmoil of 1982-1983 had its deepest impact on the Eurodollar syndicated loan market. In 1983, the volume of lending in the Eurodollar loan market dropped by one-third to $ 6 4 . 3 billion, the sharpest decline ever recorded by the OECD. This shrinkage largely reflected concern over credit risk, but it also reflected the increasing use of International Ranking Facilities (IBFs) in the U . S . and increased use of floating rate notes. Toward the end of 1983 market concern for quality meant that most loans went to OECD countries, and, since more banks were chasing fewer borrowers margins were also shrinking. New loans to developing countries were almost exclusively "forced lending," that is, banks are being forced to maintain or increase lending in support of IMF adjustment programs. International credit is to a large extent being allocated. Syndicated loans have, in practice, become nearly an open-ended commitment to the borrower. Rescheduling makes it difficult for a bank to withdraw from a loan 25/ See for example, Atkinson, Caroline and James L. Rowe Jr., Smaller ~ a n k r s l a s hLoans, Complicating Brazil Resue, Washington Post , February 23, 1983, F1, F2; Bennett, Robert A., I.M.F. Plans Plans Pressure on Banks to Help Brazil, New York Times, December 15, 1982, p. Dl, D3; and Hall, William, Banks Urged to Keep Open Credit Lines, Financial Times, February 19, 1983, p. 1, 14. consortium. Moreover, bankers are likely to find their actions constrained in this fashion for years to come. This has made Eurodollar loans to LDCS relatively unattractive. A secondary market in Eurodollar credit that includes both sub-participation, in which larger banks sell parts of loans to smaller banks, and a discount market in reschedule4 sovereign debt also developed in 1983. The market is small (about $2 billion), in comparison to the major international financial markets, but 26/ growing. - It introduces on element of flexibility, allowing banks to partially restructure their balance sheets, increasing their liquidity, and enabling them to lend to more highly rated borrowers. It also helps to solve the problem of mismatched maturities and enhances the primary syndicated loan market. It can, however, adversely affect the rescheduling process, as, for example, when Bankers Trust sold some of its Brazilian exposure while simultaneously participating in 27/ Brazil's advisory committee. The regulatory climate has also changed substantially as a result of the debt crisis. On April 7, 1983, the Federal regulatory authorities issued a Joint Memorandum which improved supervision and tightened regulation of the international lending of U.S. banks. The Joint Memorandum included clear guidelines for bank examiners commenting on large international exposure, public disclosure of large concentrations of country debt, amortization of spreads and fees earned in debt rescheduling, and the requirement to maintain reserves for "troubled" international credits. Shortly thereafter Federal 26/ Montagnon, Peter. Debt Crisis Brings New Creativity to Banking. ~ i n a n x a lTimes, December 15, 1983. p. 21. 27/ Hector, Gary. The Banks' Latest Game: ~ e c e m K r12, 1983. p. 112. Loan Swapping. Fortune, regulators imposed a requirement on the 17 largest banks to maintain capital equal to 5 percent of their assets by 1954. The requirenent merely locked in existing capital levels in nost cases. The Joint Memorandum was issued in a climate of congressional charges of hank irresponsibility in LDC lending and was perhaps intended to preempt more stringent congressional action. Congressional desire for tighter con- trol of international lending by U.S. banks was eventually embodied in title IX of PL 98-181, the "International Lending Supervision Act," which was enacted on November 30, 1983. This law requires Federal authorities to evaluate foreign country exposure and transfer risk and to establish procedures taking these into account in evaluating capital adequacy. of capital adequacy are to be established. Minimum levels Special reserves may also be required when a bank's assets have been impaired by "a protracted inability of public or private borrowers in a foreign country to make payments on their external indebtedness." Fees are to be amortized and disclosure requirements are tightened up. Increased international cooperation on the issue of bank supervision may also be aiding international financial stability. Following the 1974 collapse of a large German hank, 1 . D . Herstatt, a committee of major central banks (the Committee on Banking Regulation and Supervisory Practices or the Cooke Committee after Peter Cooke of the Rank of England, its Chairman) was established to examine problems of international banking regulation. This committee, the main organ of international banking cooperation, prepared the first Rase1 Concordat. The Concordat was endorsed by the governors of the major central banks in December 1975, but was never published. It established lines of authority for the supervision of branches, subsidiaries, and joint ventures CRS- of international banks. 24 Branches were to be primarily the responsibility of parent supervisory authorities; subsidiaries and joint ventures, of host authorities. It stopped short, however, of addressing the central problem of how lender-of-last resort responsibilites are to be shared. In part this is because lender-of-last resort responsibilities must necessarily be left vague so as not to encourage bank imprudence. hazard" problem. in August 1982. This is known as the "moral The limitations of the 1975 Rasel Concordat were revealed The bankrupcy of Italy's Banco Ambrosiano threatened a Luxembourg subsidiary, but neither the Italian nor the Luxembourg authorities would take responsibility for the Luxembourg subsidiary, which was allowed to fail. The failure of either authority to take responsibility called into question the validity of the 1975 Base1 Concordat. Concordat was issued in May 1983. A revised Rasel It clarifies lines of supervisory authority by emphasizing supervision of a bank's business on a consolidated basis by parent country authorities. Although the failure of Banco Amhrosiano was unrelated to the debt crisis, it served to strengthen international cooperation in a critical area at a critical time. Participation in the debt crisis has not been limited to the commercial banks. Investment banks also play a role. Approximately 10 investment banks are involved in giving advice to developing countries on financial matters, including debt rescheduling. The most important of the investment banks which are giving countries advice is the combined financial service of the Troika, consisting of the firms of Lazard Freres et Cie in Paris, S. G. Warburg h Co. in London, and Lehman Brothers Kuhn Loeb in New York. The Troika signed its first contract in February 1975 with Indonesia, at the onset of Pertiminia's difficulties, thereby initiating a new phase in bankers' role as CRS- 25 advisors to sovereigns. By March 1983, Institutional Investor was estimating the fee income from advising governments was $50-$60 million, fully half of 28/ which was accounted for by the Troika. - The investment banks' role as advisors to financially troubled countries has sometimes generated opposition from commercial banks involved in debt negotiations who tend to view the investment bank as polarizing the negotiations. This was particularly the case in the two-year rescheduling of Costa Rican debt, thee longest negotiations on record. Nevertheless, clients appear to be willing to continue the relation- ship, although some have pressed for lower fees. Counseling on debt and reserve management, borrowing and trade strategies appear so far to be a positive contribution to improving the financial expertise of the developing countries. 1. "A Rolling Loan Gathers No Loss" 29/ or the Recognition of Losses For some time there has been a debate whether the debt crisis is a liqudity crisis or a solvency crisis, i.e. whether the LDCs cannot pay now or cannot pay ever. This debate tends to fog the issue, polarizing it into one of alternatives, thereby possibly obscuring policy options. 30/ One banker bridged this chasm by terming the LDC debt crisis a "long-term liquidity crisis." 31/ is likely to be a matter of time and degree. Payment Nevertheless, the perceived ability to pay determines the relative amounts of finance and adjustment. 25/ Koenig, Peter. Country Advice: ~nvestor,v. 17, March 1983, p. 369. Tales of the Troika. If Institutional 29/ Pardee, Scott. Prospects for LDC Debt and the Dollar. Federal ~ e s e r Bank z of Kansas City. Economic Review, January 1984, p. 6. 30/ See Bell, Geofrey and Graham Ruttidge. How To Account for Problem ~oans, The article details a range of models of countries experiencing varying degrees of debt difficulties. 31/ de Vries, Rimmer at the Cato Institute Conference, "World Debt and the ~ G e t a r yOrder." January 20-21, 1984. Proceedings soon to be published. t h e c r i s i s i s c o n s i d e r e d t o be a m a t t e r of l i q u i d i t y , t h e n more f i n a n c i n g i s r e q u i r e d ; i f a m a t t e r of s o l v e n c y , more a d j u s t m e n t w i l l h e n e c e s s a r y . If t h e s e a r e u n s u c c e s s f u l , t h e n t h e hanks f a c e t h e n e c e s s i t y of w r i t i n g o f f some of t h e i r assets. To w r i t e - o f f a l o a n i s t o r e f l e c t t h e Loss on t h e b a n k ' s b a l a n c e sheet, resulting, a t b e s t , i n a decrease i n p r o f i t s . Banks' LDC a s s e t s have d e t e r i o r a t e d w i t h a widening gap between t h e nominal v a l u e and t h e market v a l u e ( a s , i n d e e d , t h e e x i s t e n c e of a d i s c o u n t market i n d i c a t e s ) . Under some c i r c u m s t a n c e s LDC l o a n s may be w r i t t e n o f f a g a i n s t t h e banks' l o a n l o s s r e s e r v e s , a p a i n f u l e x p e r i e n c e . i n 1983 U.S. Consequently r e g u l a t o r s moved t o s t r e n g t h e n t h e f i n a n c i s l system by r e q u i r i n g t h e 17 l a r g e s t U.S. banks t o i n c r e a s e t h e i r c a p i t a l t o 5 p e r c e n t of assets. By t h e end of 1983 a l l had complied. ( P r i m a r y c a p i t a l i n c l u d e s e q u i t y , d e b t s e c u r i t i e s c o n v e r t i b l e i n t o common s t o c k , and r e s e r v e s f o r l o s s e s . ) t h e m s e l v e s have a l s o t a k e n measures. The b a n k s S i n c e bank s h a r e s were weak, U.S. s o l d $2.5 b i l l i o n i n p r e f e r r e d s t o c k . 32/ banks Provisions t o loan l o s s reserves by t h e t o p 10 banks were up by $2.9 b i l l i o n o r by 1 3 . 5 p e r c e n t i n 1983. 331 I n c r e a s e d l o a n l o s s r e s e r v e s p u t banks " i n a s t r o n g e r p o s i t i o n t o a b s o r b f u t u r e problems, p a r t i c u l a r l y i n l i g h t o f c o n t i n u e d u n c e r t a i n t y i n v a r i o u s c r e d i t - m a r k e t s " a s Rank o f America P r e s i d e n t Sam Armacost p u t i t . 34/ On t h e o t h e r hand, nonperforming l o a n s i n c r e a s e d by $ 1 4 . 1 b i l l i o n d u r i n g 1983. 35/ 32/ L a s c e l l e s , David. Why t h e Banks Have B u i l t Up T h e i r R e s e r v e s . ~ i n a n c i a lTimes, A p r i l 2, 1984, p. 1 6 . 33/ - Ibid. 34/ I b i d . Bank of America i n c r e a s e d i t s l o a n p r o v i s i o n s from 0 . 8 7 p e r c e n t t o 1.25 p e r c e n t i n t h e f a c e of c o n s t a n t e a r n i n g s . 35/ B a l l , William. F l a t P a t c h e s i n a Champagne Year. ~ a n u 2z4 ,~ 1984, p. 1 3 . F i n a n i c a l Times, CRS- 2 7 In addition to general reserves, under the terms of the International Lending Supervision Act of 1983 (Title T V of the IYF legislation, P.L. 98-181) special reserves against specific losses may be requfred. The requirement to establish special reserves amounts to declaring a default and is likely to be used sparingly in order to avoid undermining any efforts that a country might be making to straighten out its arrears. Putting aside any additions to loan loss reserves--general or special-adversely affects a bank's profits picture. Since a loan loss reserve is often replenished at the time of a write off, the effect is to take the loss out of earnings. As one banker stated: "the courage with which people establish loan 36/ Because loss reserves is inversely proportional to the size of the loan." of their more limited exposure, regional hanks are in a better position to recognize losses. This also helps to explain their reluctance to continue in various loan consortia; they simply have less to lose. The issue just discussed is the recognition of losses, but losses can be avoided or hidden. Financing may be extended to keep a borrower afloat or to assist adjustment. Financing can also be used to avoid losses. avoid losses is to "front-end load." A major way to This procedure permits the rapid drawdown of new loans, usually for the purpose of paying arrears on earlier loans. The major advantage of front-end loading is that it prevents earlier loans from becoming non-performing and it increases bank profits. are offset by equally substantial disadvantages. to an incentive to run up arrears. These advantages The front-end load amounts Quick disbursement makes it easier for the borrower to break commitments or, conversely, it diminishes the leverage 1984,~. 36/ Hector, Gary. 84. The True Face of Bank Earnings. Fortune, April 16, of lenders over the borrower. By papering-over losses it impedes the develop- ment of long-term solutions to the debt problem. loading makes the debt crisis worse. In addition, front-end Total debt and total debt service are increased and added to existing debt aggregates. Moreover, the so-called "new" financing results in no new productive capacity able to produce export earnings to defray the debt in the future. structural; it feeds upon itself. Thus, the debt problem has become To preserve the present apparent viability of the international system an illusion has been created which may actually increase system vulnerability. Lastly, front-end loading is unlikely to reduce the risk of voluntary default. 2. The Allocation of Costs Between 1973 and 1982 the non-oil producing LDCs had a cumulative cur37/ rent account deficit of $541.9 billion. - (This number would expand if oil producers with current account deficits were included.) The deficits were largely financed by net external borrowing amounting to $425.6 billion. $179.5 billion or 42.4 percent of net borrowing came from private financial institutions, not including short-term credit. Long-term borrowing from official sources amounted to $132.5 billion or 31.3% of the total net longterm borrowing. Reserves were drawn down by $66.5 billion. Thus, private financial institutions played the dominant role in financing the LDC deficits occurring in the post-1973 era. The relative shares of the sources of LDC finance affects at least the initial distribution of the real costs associated with the deterioration of loans to LDC's. TJltimately, however, these costs 37/ For a yearly breakdown and additional details on the financing of thrcurrent account deficits, see IMF. Annual Report 1983, p. 33. will be allocated either by political decisions of the borrowing and lending countries, arbitrarily or consensually, or by the private international financial markets based on the existing distribution of outstanding financing. Numerous proposals have been put forrard which would have both recognized the losses and allocated them, often to U.S. taxpayers. Most of these pro- 38/ posals called for discounting LDC debt an3 for a protracted payback. None of these proposals attracted much political support in the 17.S. More modest proposals call for the banks to cap interest, lower "spreads", extend longer or variable maturities, lengthen grace periods, lower fees, and provide greater equity financing. In this case costs of the LDC loans would remain with the banks. If the debt problem is chronic, the Congress and other major legislative bodies may face decisions regarding the costs of the LDC debt crisis, their allocation, and, perhaps, their socialization. 38/ The two most well-known of the proposals are put foward by Kenen, peter-. Outline For a Proposal for an Interntional Debt Corporation. Princeton University, May 3, 1983 and Rohatyn, Felix G . A Plan for Stretching Out Global Deht. Business Week, February 28, 1983. p. 15-18. IV . TRADE, COUNTERTRADE, AND PROTECTIONISM E x p o r t s p r o v i d e t h e hard c u r r e n c y e a r n i n g s which a l l o w d e v e l o p i n g c o u n t r i e s t o pay t h e i r d e b t s e r v i c e . They a l s o r e p r e s e n t a s i g n i f i c a n t p o r t i o n of GDP. A f t e r a d r o p i n e x p o r t e a r n i n g s i n 1982, t h e r e was a s l i g h t i n c r e a s e i n e x p o r t e a r n i n g s d u r i n g 1983 ( s e e t a b l e 4 ) , a t t r i b u t a b l e t o economic r e c o v e r y . A t the same t i m e , a marked d e c l i n e i n i m p o r t s r e s u l t e d i n a n improvement i n t h e t r a d e deficit. F u r t h e r c u t s of LDC i m p o r t s , however, may b e d i f f i c u l t t o a c h i e v e . t h e f i r s t p l a c e , some LDCs r e q u i r e s u b s t a n t i a l food i m p o r t s . Secondly, imports o f components f o r manufactured goods i n t e n d e d f o r e x p o r t a r e a l s o a n i m p o r t a n t p a r t of t h e t r a d e p i c t u r e ; they can n o t be c u t without jeopardizing f u t u r e TABLE 4 . I n t e r n a t i o n a l T r a d e o f t h e Non-Oil ( b i l l i o n s of U .S. $ ) E x p o r t i n g LDCs Exports D o l l a r Value Annual P e r c e n t a g e Change -- +3.3 -4.8 + l .8 Imports D o l l a r Value Annual P e r c e n t a g e Change -- +6.9 -10.5 -5.3 -73.49 +28.9 -47.15 -35.8 Trade Balance D o l l a r Value Annual P e r c e n t a g e Change Source: -86.07 -- -103.4 +20.1 In IMF, I n t e r n a t i o n a l F i n a n c i a l S t a t i s t i c s , August 1984. export earnings. A r e l a t e d p o i n t i s t h a t t h e non-oil producing developing c o u n t r i e s have f a c e d a d v e r s e and worsening t e r m of t r a d e e v e r y y e a r s i n c e 1980. I n p o r t p r i c e s have r i s e n f a s t e r t h a n e x p o r t p r i c e s . It simply t a k e s more e x p o r t s a l e s t o p u r c h a s e t h e same amount of i m p o r t s . The U.S. h a s p l a y e d an i m p o r t a n t r o l e i n t h e LDC t r a d e . I m p o r t s from t h e U . S . amounted t o $ 6 3 . 3 b i l l i o n o r 15.9 p e r c e n t of t o t a l non-OPEC LDC imports. The non-OPEC LDC t r a d e d e f i c i t w i t h t h e U . S . was $3.0 b i l l i o n . I f OPEC n a t i o n s a r e i n c l u d e d , LDC e x p o r t s t o t h e U . S . would r i s e by $26.4 b i l l i o n and i m p o r t s by $23.2 b i l l i o n . C a l c u l a t i o n s from IMF f i g u r e s a l s o i n d i c a t e t h a t t h e U . S . h a s a p r o p o r t i o n a t e l - y l a r g e r s h a r e of LDC t r a d e t h a n o t h e r i n d u s t r i a l - c o u n t r i e s . 39/ LDC t r a d e i s a l s o h e a v i l y d e p e n d e n t on t h e U.S. market. I n 1982, $60.3 b i l l i o n o r 19.5 p e r c e n t of a l l non-OPEC LDC e x p o r t s went t o t h e U.S. As shown i n t a b l e 5, t h e t r a d e o f s e v e r a l major b o r r o w e r s as i s even more depend e n t t h a n t h e a v e r a g e LDC on t h e U . S . market. TABLE 5. E x p o r t s t o t h e U.S. a s a P e r c e n t a g e o f T o t a l E x p o r t s , S e l e c t e d C o u n t r i e s , 1982 Mexico Venezuela Peru Chile Argentina Philippines S o u t h Korea Source: 39/ - IMF D i r e c t i o n s o f T r a d e Yearbook, 1983. C a l c u l a t e d from IMF, D i r e c t i o n s of T r a d e , Yearbook, 1983. LDC trade is frequently concentrated by product, causing market disruption in some industries, such as steel. The need to increase exports because of debt service problems has exacerbated the problem. The recent recovery has apparently not given much respite to some import-beleaguered sectors. Moreover, the GATT estimates that 30 to 40 percent of the non-oil producing LDCs' exports are under some kind of restraint in the markets of the creditor countries. 40/ Protectionism may save jobs in the short-run but it does so at the cost of preventing the LDCs from servicing their debt and increasing their imports from each other and the industrial nations. While imports from the LDCs may displace U.S. jobs in some industries, exports to the LDCs also expand U.S. job opportunities. U.S. Between 1981 and 1983 exports to the 11 major debtor countries shown in table 5 dropped by $15.2 billion, representing a significant loss of jobs. 41/ Only South Korea consistently increased its imports from the U.S. This may, in part, reflect Korean attempts to deflect U.S. protectionism and deal with 1J.S. demands for a more open Korean market. a drop in both U.S. 1983. In any case, the debt crisis has resulted in exports and jobs in the export sector. 40/ General Agreement Geneva, 1983, p. 14. on Tariffs and Trade. International Trade 1982/ 41/ Reportedly, the Commerce Department estimates that 25,000 jobs are generated by each $1 billion of exports. Farnsworth, Clyde H. Third World Debt Means Fewer Jobs for People. New York Times, December 11, 1983, p. E3. This would imply an estimated job loss of 383,000. CRS- 3 4 TABLE 6. U.S. Exports to Selected Major LDC Borrowers (billions of dollars) Count rv Mexico Venezuela Peru Chile 3.4 Brazil Argentina Philippines South Korea 4.3 2.6 3.8 3.4 2.5 1.3 1.8 1.0 5.5 1.9 5.9 4.2 4.7 2.2 1.8 5 -1 28.6 38.4 4 1 .Q 33.1 26.7 -- +34.2% +Q.1% -21.0X -19.39: 1.9 1.6 2.0 Nigeria Poland Yugoslavia TOTAL CHANGE (percent) Source: U.S. Department of Commerce, FT 990, various years. As discussed above, the LDC debt crisis has intensified protectionist pressures in the import-competing industries and unemployment in the export sector. It has, thus, made the management of trade policy nore difficult. Lastly, it has the potential to adversely distort resource allocation in the IT.S., with an unfavorable impact on the U . S . international competitive position. This would be particularly likely if the debt crisis is prolonged. Finally, one of the by-products of the LDC debt crisis is the growth in countertrade, or barter, trading in which export sales are paid for in kind. Traditionally, countertrading has most often occurred hetween Eastern Europe and the industrialized West. With the onset of the debt crisis, however, it has increasingly involved Third World countries. As a result, countertrade has been growing, with estimates that it now accounts for 20-40 percent of world trade. 42/ Its chief advantage is in enabling an overborrowed country to trade when they might otherwise not be able to trade. This may be particularly important as increasing amounts of new credit go to the repayment of interest. However, countertrade has serious drawbacks. It is costly. Since countertrade often involves goods which are inferior or obsolete, companies involved in such deals usually raise their "prices" to reflect the possibility that goods received in such transactions may not be resaleable. It is also inconvenient for a corporation asked to resell countertraded goods outside their own sector. Lastly, and most seriously of all, it represents a breakdown in the multilateral international trading system into bilateral arrangements which is extremely destructive to the allocative efficiency of the trading system. It is not a substitute for a more open market. 421 International Trade Reporter. sept=ber 13, 1983. p. 868. U.S. Export Weekly, v. 19, no. 23, V. LESSONS There are varied lessons to be learned from examining the debt crisis. Some of these lessons are briefly summarized below: 1. Exogenous (external) factors are a major determinant of external debt problems. The price of oil was an important external variable helping to precipitate the international debt problems in the early stages. Later, U . S . domestic economic policies became very important since they resulted in high real interest rates and world-wide recession. 2. Domestic economic factors are also very inportant. Countries pursuing export-led growth strategies, tend to have less serious problems with external debt than those pursuing import substitution policies. 3. Poor debt management is a major cause of the crisis. Beyond good macroeconomic policies, effective external debt management involves knowing the debt, deciding how much to borrow, and selecting the appropriate available financing. 43/ In most countries experiencing debt-servicing difficulties these conditions for effective debt management are not met. In particular, country after country did not keep sufficient records to determine the extent of their borrowing. The IMF and the investment banks are trying to improve debt management. 4. The debt problem has been met with more than an ad hoc or "muddling- through" response. Elements of the international system have changed. Inter- 4 3 / Hope, Nicholas and Thomas Klein. Lssues in External Debt Management ~inanz and Development. September 1983, p. 2 4 . national banks are locked into "forced lending," but are in better financial condition than a few years ago. The syndicated loan market has all hut dried up, but the floating rate note market has expanded. In perhaps one of the most significant changes, the IMF has taken a role of leadership in the rescheduling process. The rescheduling process itself appears to have been institutionalized, with a protocol concerning the order of negotiations having emerged. The U.S. and, reluctantly, the BIS have played a very important role in providing ernergency loans. 5. Trade offs must be made between the amount of financing and the amount of economic adjustment. To a large extent this is determined by a country's political capacity to carry forth an austerity program. The stability and success of an IMF progran is, thus, the hostage of political constraints. A miscalculation could be dangerous. 6. The timing of an IMF adjustment program may perhaps be important to the success of the program. The Mexicans who used "shock treatment" have had better success than the Brazilians whose approach to the Fund was somewhat slower. The two cases are not entirely comparable, however, and there may be no single "right" timing. 7. There is a chasm between the positions of the money center banks and the regional banks. So far, the banks have largely remained united but this unity may fragment if conditions worsen. 8. Fragmentation would complicate negotiations. Protectionism by the Paris Club creditors deprives LDCs of the ability to pay their debts and to purchase goods inported from the developed world. l'he developed countries, therefore, pay a substantial price for protectionism as well as the LDCs. V . CONCLUSION During 1983 and e a r l y 1984 p r o s p e c t s f o r h a n d l i n g t h e LDC d e b t problem improved. The key f a c t o r , economic r e c o v e r y i n t h e d e v e l o p e d c o u n t r i e s , was s u f f i c i e n t l y s t r o n g t o a i d t h e LDCs. T h i s meant t h a t LDC e x p o r t s t o t h e i n d u s t r i a l n a t i o n s expanded, h e l p i n g t o b r i n g a b o u t improvement i n t h e i r c u r r e n t account. Commodity p r i c e s a l s o improved d u r i n g 1983. prices, i n p a r t i c u l a r , did not r i s e dramatically. Meanwhile, o i l Diminished r e v e n u e s h u r t t h e o i l - e x p o r t i n g LDCs, b u t t h e low o i l p r i c e s h e l p e d t h e o i l - i m p o r t i n g LDCs. I n f l a t i o n was a t t h e l o w e s t l e v e l i n f i f t e e n y e a r s . O t h e r f a c t o r s c o n t r i b u t e d g r e a t l y t o t h e improved s t a t e o f t h e LDC d e b t problem i n 1983. The i n t e r n a t i o n a l f i n a n c i a l s y s t e m a d a p t e d c r e a t i v e l y a s t h e c r i s i s u n f o l d e d a f t e r l a t e 1982. The IMF h a s p l a y e d a l e a d e r s h i p r o l e , and i n t h e view o f many, f o r b e t t e r o r w o r s e , an IMF program i s t h e s i n e q u a non of a d e b t rescue. The r e s c h e d u l i n g p r o c e s s i t s e l f h a s become i n s t i t u t i o n a l i z e d S h o r t - t e r m d e b t and d e b t s e r v i c e r a t i o s f o r t h e b o r r o w e r s d e c l i n e d . Conditions i n t h e f i n a n c i a l m a r k e t s a l s o seemed t o improve making banks b e t t e r a b l e t o w i t h s t a n d t h e p r e s s u r e s o f t h e LDC d e b t c r i s i s . were g e n e r a l l y up. Some w r i t e - o f f s were made. C a p i t a l r e s e r v e s and p r o f i t s Balance s h e e t s appear t o have b e e n h e a l t h i e r , a l l o w i n g some growth i n " s p o n t a n e o u s " new c r e d i t d u r i n g t h e l a s t q u a r t e r t o a r e a s o u t s i d e L a t i n America. The f l o a t i n g r a t e n o t e m a r k e t expanded p r o v i d i n g a s o u r c e o f f u n d s f o r b o t h b o r r o w e r s and f o r t h e m a j o r i n t e r n a t i o n a l banks. A s m a l l d i s c o u n t market f o r LDC d e b t emerged d u r i n g 1983. . Improvements in bank regulation should provide the climate for greater international financial stability. Nevertheless, some of the achievements of 1983 appear to hide future difficulties. Despite an expansion of exports, improvements in the current account balance were also bought at the expense of severe import compression rather than just export expansion. Future export growth and recovery are, therefore, likely to be hampered. In 1983 debt service exceeded net inflows by $11 billion; the 441 developing countries, incongruously, have become net exporters of capital. Latin America, which has the severest debt problems, has received little new lending. Perhaps most seriously of all, the world debt problem is just being rolled over into the future. As Harold B. Malgram, former U.S. Trade Repre- sentative, stated it, "[mlost of the debt problems have simply been postponed in the hopes that world economic growth, improved trade performance and lower interest rates will make the future a better time to address fundamentals." 451 The World Bank estimates that 65 percent of all LDC debt will fall due in 1987. 461 Finally, the debt rescue packages result in both increased total debt and increased debt service. Successful management of the debt crisis depends to a large extent on the macroeconomic policies of the industrialized countries, especially the United States. 441 - Sustained noninflationary qrowth wtth lower real interest rates, World Bank. World Debt Tables, 1983-1984, p. x. 45/ Farnsworth, Clyde H . ~ a n u a v2, 1984, p. 39, 41. IMF Girds to Meet Bids for Aid. 461 Bureau of National Affairs. ~ e b r u z y7, 1984. p. L10. Daily Executive Report. New York Times, moderately rising commodity prices, stable oil prices, and a realistically priced dollar would provide a congenial environmnent for easing the crisis. increases in the FJ.S. Recent prime rate belie such a scenario and have generated increased concern about the ability of the LDCs to handle their debt. Finally, concern has been expressed by some writers that the debt crisis has moved into a new phase. As Scott Pardee formulated the problem, rtlhe flash point has shifted from purely financial considerations, which influence the ability to pay, to political considerations, which might affect the willingness to pay. The fear in the markets now is that one or more countries will be forced by events to flatly repudiate their debts. Such an action is likely to be in a political context in which hard work and skillful negotiation 47/ by experts in international finance just won't matter. Since the 1982 onset of the crisis no country has repudiated its debt and pressures against doing so are strong. Nevertheless, we may he moving into a new and more difficult phase of the T A W debt crisis. 47/ - mls/jt Pardee, Prospects for LDC Debt and the Dollar, p. 3.