Xi’s Costly Obsession With Security
How a Quest for Control Threatens China’s Economic Growth
Over the past year, the problem of the debt of less-developed countries has been of intense concern not only to the private banks which hold most of that debt, but to the governments of the LDCs and of the creditor countries and to the multilateral institutions that have had to play a major part in a well-coordinated initial set of measures to stem the problem and bring it gradually under control. These efforts remain of the utmost importance for the continuation of a worldwide economic recovery and for the stability and progress of the LDCs themselves.
This article focuses on the longer-term aspects of the problem. Its thesis is simple. It is that the real problem regarding LDC debt, in the long or even medium term, is the source of future credit for their imports of capital goods. In the absence of increased public money, new mechanisms are needed to assure access to private funds. There is an urgent need for a system which would have practical political appeal, and we believe that such a system should seek to mobilize support from the export sectors of the industrial countries through joint financing by the national export credit organizations, private commercial banks, and the World Bank.
In exploring the need for such a system, and its possibilities and potential difficulties, we shall briefly look first at the present situation and the measures now underway, then at the needs of the LDCs and the potential sources of future credit, and finally at what a joint financing mechanism might look like. Its aim would be to tap private funds on a new basis that would effectively meet the needs of the LDCs, especially for imports of capital goods, and thus contribute greatly to their resumed growth and to the welfare of both industrialized and developing countries.
The use of private bank funds by the more advanced LDCs has been going on since World War II and began to be an important component of their external financing in the late 1960s. Such credit has been intrinsic to their rapid economic growth and their demand for exports from the industrialized world. Over these years various countries have encountered and have overcome numerous liquidity problems-some of them very alarming. However, the sudden rush of Mexican capital out of that neighboring country immensely dramatized the speed with which prolonged recession, combined with unrealistic economic policies, could produce difficulties even for a country with an excellent payment record. Those events in Mexico, followed by the experiences of several other major borrowers, understandably have attracted widespread attention. All eyes have been focused on the commercial banks' portfolios of debt and the accumulation of current maturities.
One aspect of concentrated attention on maturing debt in 1982 and 1983 has been rapid effective cooperation among commercial banks, governments, the International Monetary Fund (IMF) and the borrowing countries themselves to confront the problem. Their cash advances and rescheduling arrangements have prevented a collapse of confidence in the world financial system. The arrangements have required greater discipline and more rapid adjustment by borrowers. They also have allowed the borrowing countries to continue importation from the industrialized world, although at a lower rate.
All of the parties to those arrangements have recognized that we have been passing through the longest period of recession since World War II, with its drastic impact on commodity prices, volume of trade, and interest rates. Both borrowers and lenders had expected continuing inflation. All of them realize, also, that credit to developing countries is indispensable for world economic recovery and growth.
Outside that circle of direct participants there has been considerable creative thought aimed at the rescue of LDC borrowers and their lenders from the problems of the present portfolio. The tendency of these analyses has been to take a "snapshot" of today's problem and devise a sweeping "now" solution. In fact, the present situation needs to be viewed as one frame in a moving scenario that began decades ago and will extend even farther into the future.
The principal LDC borrowers from private banks are the semi-developed countries which, by their nature, must be continuous and growing importers of capital and credit. No nation has yet moved from "underdeveloped" to "industrialized" without steadily increasing flows of credit, even when following enlightened policies to stimulate local capital formation and attract foreign direct investment. To be "developing" is to be in debt. Semi-developed countries are structural capital importers whose productivity in the use of capital is high. The more natural and human resources such a country has, the more it needs to borrow to make use of them.
Each year since World War II, these countries have produced and exported more and more raw materials as the industrial world's supplies have fallen short of demand. In the process, the developing countries have diversified their exports and trade flows. Each year they have purchased more and more capital goods and materials manufactured in the developed world, coming to account for between 25 percent and 40 percent of the export-oriented employment of the United States, Canada, Europe and Japan. U.S. trade with LDCs has grown the most of all.
Each year, also, the major LDCs have borrowed more and more abroad. Until the past three years of recession, borrowing paralleled the growth of their GDP (gross domestic product) and trade. If they are to continue as suppliers of needed goods for the industrialized world and remain vital expanding markets for the latter's industries, they will require credit each year in the future.
Meanwhile, over the past decade, an increasing number of countries have adopted more outward-looking policies: reducing tariffs and payment restrictions, liberalizing financial systems, and allowing realistic interest rates. The growth of the local private sector and use of foreign private credit have been part of that liberalization.
In this moving panorama, the present portfolio is not where we most need to focus regarding new mechanisms. Proposals such as asset recycling or discount of private bank loans to LDCs are not pointed at the real problem. The fundamental question is where the new money will come from in the future.
Loan portfolios of major commercial banks have been built up over years of complex client relationships and involve a great variety of public and private borrowers in each country. Apart from the transfer risk-the lack of availability of dollars-these loans represent a wide array of commercial credit risk. They are being rescheduled case by case in the only way that is practical or feasible. One by one, the countries are concluding arrangements in which the IMF and commercial banks are advancing new funds, and banks are extending all or part of loan maturities falling due in the 1982-84 period of greatest stress. In each case, the rescheduled loans and new advances are arranged in response to programs of the borrowing governments worked out with the IMF to adapt exchange rate policies to present realities, hold down current expenditures, increase revenues, and expand domestic savings, so as to meet future payments of principal and interest.
The probability of success in managing the present portfolios through the recession in this way is high. The basic reason is that the fundamental productivity of the principal borrowers continues intact. Many developing countries-like industrial nations-have structural problems in their economies. Some have invested in uneconomic import substitution, and some have allowed agricultural development to lag behind industry. However, we are not dealing with economic machines that have broken down. Ninety percent of LDC debt to U.S. banks is owed by 15 countries. The basic economic sectors, although under strain, are functioning productively in all of them.
These countries all have distinct strengths and weaknesses. The refinancing of their debts therefore has to be tailored very specifically.
The rescheduling as such, of course, does not solve all of the problems of LDC debt. The time borrowed by stretching out maturities must be followed by continuous application of sound policies with due attention to structural weaknesses. There must also be a background of reasonable economic growth in the industrialized countries.
The money borrowed has been used mainly to buy or create something. Local and foreign funds gathered since World War II by the semi-developed countries have been employed primarily to increase production. Much of that new production is only now coming on stream and will add steadily to future repayment capacity. Internally generated savings for LDCs accounted for roughly 18 percent of their GDP in early 1960 and increased to over 25 percent of GDP by 1980.1 As a group, developing countries have devoted a greater proportion of their cash flows to the investment sector than have industrialized countries. Real domestic investment among LDCs increased by 8.1 percent annually over the past 20 years compared to about 4.4 percent for industrialized economies.2 Until the recession, debt grew at essentially the same pace as production and exports.3 When debt of the 15 major borrowing nations is compared to their growing economies and international trade, it may be questioned whether many countries in fact overborrowed up to the period of the recession. Furthermore, the main increase in debt took place in a decade of high world inflation and frequently negative interest rates. The same capital goods imported today would require even more debt.
The current problem is not the ability to produce. The problem is that assets were acquired with debt having maturity schedules based on expected income which has not come on stream as planned, primarily due to a sudden change of the industrialized world from inflationary boom to deflationary recession. In some countries the problem has been made worse by incorrect fiscal, monetary, and foreign exchange policies, with resulting disintegration of public confidence and discouragement of exports. The countries are not helpless before present events. They can change unrealistic policies, and most of them are doing so rapidly. It is increasingly recognized by the economic authorities of the countries that realistic policies work for their own eventual political benefit, as well as improving credit-worthiness.
The process of rearranging the debt maturities of a basically productive borrower, to allow time for policy changes to improve cash flow, is not "postponing the problem." This is a standard solution used every day by banks in both domestic and international lending, for large and small borrowers. The very creation of the IMF was an expression of worldwide judgment that such liquidity problems do indeed exist from time to time-and have solutions to which the government concerned can contribute significantly by better economic management.4
This patient case-by-case approach, negotiated by the people with the most intimate knowledge of the practical possibilities and political complexities, is indeed working. Banks have no illusions about these reschedulings. Further adjustments may well have to be made later in some of the programs. The rescheduling arrangements after all are based on government commitments to policies, the results of which cannot be projected precisely in numbers. Also, expectations of exports may evolve differently. IMF-guided reschedulings are usually designed to be at the very outer edge of the country's economic and political capacity. If they later need adjustment to changed conditions-and the productive machine is still operating adequately with the sound policies-such "re-reschedulings" are not significantly different from the original exercises. Neither are they intrinsically less sound than "new" credits made to the countries five years from now-or the ones made and repaid five years before the present recession. In respect to transfer risk, it is the amount of service on principal and interest of total outstanding debt in relation to total foreign exchange earnings that matters-not the specific loan to which repayments pertain. Overall, the countries by their nature will build debt until they themselves become capital exporters. With all its resources, it took the United States well over a century to become a source of surplus savings for the capital-short parts of the world.
Sweeping solutions which would remove the present portfolio from the hands of the original lenders certainly cannot be relied upon to produce new lending from the banks so "assisted." How many boards of directors would be responsive to programs of new loans for borrowers whose existing loans-and potentially, future loans-were subject to arbitrary judgments requiring write-off? Neither lenders nor borrowers are seeking such a one-way ride to nowhere in order to handle the present portfolio.
Governments of the industrialized countries will need to continue their important role. The U.S. Federal Reserve and the Bank for International Settlements (BIS) have been acting very decisively in the present difficulties and should continue to do so as needed. Central banks of the industrialized countries need to organize better all aspects of the international safety net, to meet unpredictable emergencies. They should continue to give quick, effective assistance to any specific banks suffering from faltering public confidence, as they do in situations of purely domestic origin.
However, the political realities in the United States and other countries constrain the direct role of governments in meeting the long-term credit needs of LDCs. There is not a very clear public memory of the late 1920s and early 1930s, when shrinking trade combined with financial crisis led to a major depression. Accordingly, there has been little public discussion of the really central problem. What, in fact, will be the source of new financing for LDCs to import capital goods in the future?
A quick survey of the practical possibilities for increased flows of funds from the existing channels is not encouraging.
The present austerity programs of these borrowers certainly will reduce demand for new credit drastically for the next few years. Beyond that, it can be hoped that lower fiscal deficits and more realistic domestic interest rates and tax policies will improve internal savings and capital formation. One wonders how much more the countries can be expected to accomplish in this respect, bearing in mind how high their savings and investment rates have been compared with the rest of the world. Middle income LDC domestic savings reached the equivalent of 24.5 percent of GDP in 1980.5 Let's assume very optimistically an improvement to 25.5 percent in that rate by the 15 principal LDC borrowers, which would produce $11 billion per year.6 These domestic currency funds would partially substitute for foreign currency borrowings.
We need to note that the semi-developed or "newly industrialized" countries, which are the large borrowers from private banks, by definition are building more capital-intensive economies. They have growing needs for machinery and equipment, technology, infrastructure and public utilities for a rapidly urbanizing society. This element can be expected to utilize a large part of the improved domestic savings.
More realistic policies regarding foreign direct investment can assist to an important degree (and bring improved technology and management). However, in the wake of prolonged inflation and lagging domestic investment in the United States and much of Western Europe, foreign investment will come to the LDCs only very selectively and with expectations of relatively high returns. The most optimistic estimate of private direct investment would be $10 billion more per year7 over the next five years-a straight projection of the past five years' experience.
The World Bank and the regional development banks would be the most logical sources of increased credit. Their long-term money is the kind best suited to a world of slower economic growth and numerous long-term structural adjustments. It is in the very best interest of the industrialized nations to increase substantially the funding of the World Bank and most of its regional counterparts. Unfortunately, the public of the United States is very far from an adequate recognition of the implications of continued LDC growth for its well-being. Few voters understand what it means to them, in terms of employment opportunities, that 40 percent of U.S. exports go to LDCs.8 Still fewer understand that exports to LDCs will continue only if there are future flows of credit to the importing nations.
In terms of net new flows to all LDCs, in 1981 the World Bank added $3.8 billion, other multilateral agencies $5.1 billion and bilateral flows $10.7 billion. An optimistic view of member government support for the World Bank (in the light of the current controversy concerning the IMF quota) would put increased World Bank net lending at $5 billion more per year. One can add $6 billion for the regional institutions and $14 billion for bilateral credits and aid, based on straight-line projections of the past ten years. This adds up to $25 billion per year in new flows of credit or grants. However, in recent years a large share of all such loans and grants have gone to countries other than the 15 nations which are the largest borrowers from the private commercial banks. Those large semi-developed borrowers, which have been the cause of recent concern, are not likely to receive more than $7 billion per year from all official institutions without significant changes in lending policies by these organizations.
Latest estimates of the net borrowing of the 15 largest borrowers, reflected in national development plans and current adjustment programs (and taking into account their maximum efforts to increase domestic savings), show their requirements to be in the neighborhood of $50 billion per annum.9 How will the need compare with resources? After deducting $ 10 billion of direct investment and $7 billion from public funds (World Bank, bilateral aid, etc.) this probably leaves a minimum gap of $33 billion annually.
Such a gap between economic need and the funds from aid programs and multilateral development banks grew throughout all of the 1970s. It was filled by the commercial banks' lending of Eurodollars. Such private lending to LDCs increased at an annual rate of 32.5 percent from 1972 through 1981 in current dollar terms, averaging $29 billion per year. In 1972, according to World Bank estimates, financial-market outstanding credit to LDCs amounted to only $36.7 billion. The total rose to $273.4 billion by late 1981. This latter amount accounted for an estimated 60 percent of total LDC outstanding foreign debt in that year.
It appears probable that the principal private banks in international lending-some 60 multinational private institutions and a few hundred regional and secondary banks-will indeed continue lending to LDCs. This is not because they are permanent captives of the borrowers, any more than they have been captives of Chrysler Corporation or New York City. It is because the semi-developed countries represent the most dynamic part of the world economy; they have become indispensable sources of raw materials, and vital markets, for the industrialized countries. There will continue to be demands for credit generated by the banks' corporate clients, who rely increasingly on the developing world for their prosperity. In an atmosphere of even modest world growth, loans to the governments of rationally managed industrializing nations should compare reasonably with other credit opportunities.
However, the rate of increase of such lending is likely to be less than in the 1970s. Banks may be discouraged by their governments from continuing their participation. Continual dramatization of the problems of LDCs might affect confidence of investors and thus indirectly reduce the capacity of the banks. Barring these potential impediments, the major banks will remain in the business because they will find it to be sound. However, it would be unrealistic to expect that they will continue to fill a steadily increasing portion of the requirements, as in the past.
Let us assume that the major private banks do increase their lending at a rate equal to the rate of increase of their capital funds. Ninety-four percent of all bank lending to LDCs is conducted by the largest 60 banks. If capital funds of these banks grow in the next five years at a rate equal to expected inflation, this would supply $28 billion of new credit each year to the 15 major borrowers. Assume, for the sake of simplicity, that the small regional U.S. banks and the secondary banks of Europe, Japan and the Middle East on average maintain their present absolute levels of outstanding credit. Add the $28 billion of commercial bank contributions to the previously mentioned sources to give total new available funds of $45 billion annually. Subtract that total from the estimated requirements of $50 billion and there is still a shortfall of $5 billion per year.
Net IMF financing has increased rapidly from $1.2 billion in 1980 to $5.6 billion in 1981 and $6.3 billion in 1982; it is further expected to increase to $13.5 billion in 1983. However, it is not included in the flows estimated above, because such financing is strictly to provide temporary relief to tight liquidity positions, eliminate payments arrears or build up minimum reserves and not for development financing.
These are all estimates, of course, and in general they reflect an optimistic view of the amounts that will be in fact available from various sources of finance. All are based on expectations of moderate economic growth in the industrialized countries. They assume no new major obstacles to restrict international trade expansion or restraints imposed by regulatory authorities that reduce commercial bank lending. However one adds it up, there is still an unfilled need of significant magnitude.
It would appear that one of three things must happen. If nothing new is done, the developing countries will meet their debt servicing obligations. However, they will lag further in their growth and become a brake holding back the prosperity of the rest of the world.
Alternatively, existing multilateral and government financial institutions can be strengthened with public funds to expand their activities and return their contribution to its previous relative importance.
The final possibility is that new mechanisms or channels of finance may be created to utilize private savings. This paper examines briefly some potential mechanisms to meet future LDC financing needs, primarily with private monies, using taxpayers' funds on a small enough scale to be politically feasible in the next few years.
Each of the two principal sources of LDC credit today-multilateral institutions and the private banks-have some strengths and some limitations regarding LDC lending. The private banks have flexible, quick, efficient access to the largest pool of internationally mobile funds in the world today-the Eurodollar market. As the product of years of inflation, most of the money is available only with the interest rate fixed every few months. The total amount and ownership of such floating-rate funds shift continuously, but there is a core amount which is quite stable as to its availability-at a price-and the private banks know how to obtain it, wherever it may be, on the best possible terms.
Lending to the 15 major LDC borrowers represents only about 10-15 percent of the assets of major banks. Their other activities as depositories of short-term funds and as domestic lenders place definite limits on the proportion of banks' portfolios that can be committed to LDC loans at long term. Also, while commercial banks have a superior capacity to evaluate medium-term lending for productive enterprises, they have less capacity to analyze the final shape of a country's development program, long-term public policies or overall natural resources.
The World Bank group has these latter capabilities. (So do various regional and government institutions in varying degrees.) The World Bank also has the strength of substantial stable fixed-rate funds, from its capital and from its long-term bonds. These funds are indispensable for loans of 15 years or more. Because of legal and policy restrictions, the World Bank currently does not mobilize floating-rate funds in a major way out of the Eurodollar markets-the only international private source of money available on the scale needed.
New solutions should attempt to make use of the strengths of each of the principal lenders. Ideally, World Bank long-term money should be conserved for the long-term maturities. Lending capacity of the private banks should be used primarily for the shorter-term financing to match their liquidity considerations and their best expertise.
One idea which has been under discussion for the past two years has been to increase the leverage of the World Bank. World Bank lending presently is restricted to funds from its own capital, paid in by the member governments, plus proceeds of its medium- and long-term bonds placed in capital markets. These are issued to the extent of unpaid but callable capital. Under this system the World Bank borrows and lends an amount roughly equal to its paid-in and callable capital-a gearing of one to one.
There have been proposals to increase this gearing in the World Bank itself. This is a very useful approach and should be studied actively. It may have the disadvantage of impact on one of the Bank's principal strengths-its ability to place its long-term bonds in the market on nearly the same terms as the U.S. government.
A variation of this idea would be to form a subsidiary of the World Bank which would be more highly leveraged and would borrow directly from the Eurodollar market to raise floating-rate funds, with which to carry the early maturities of long-term programs. This would also seem to be worthy of study and presumably has been receiving it. In the end, most bond specialists would expect some impact on terms of the World Bank's long-term borrowing under any such solution. It would be a trade-off, but probably a good one. In any event, there appears to be resistance to the concept and it has not moved forward so far.
Another theoretical avenue for using private Eurodollar funds on a larger scale without drawing commercial banks beyond prudent levels would be a scheme of guarantees or insurance against country risk. Several versions of this idea have been under discussion for some time. Expanded public "country risk" insurance is worthy of analysis-as is the possibility of government cooperation and support for private insurance and reinsurance schemes.
In general, such proposals so far have lacked political appeal, because of the level of understanding in the United States and elsewhere about the general public good to be derived from them.
The question arises, therefore, as to what sectors of the major industrial countries would be most likely to understand and support a program for increased lending to LDCs. It seems probable that these would be the exporters of capital goods. Stagnation in the semi-developed countries spells sharply reduced imports of machinery, equipment and technology from manufacturers in the United States, Canada, Europe and Japan. Recent drastic reductions in Mexican imports have brought this point home in the United States.
In each of the industrialized countries there is an entity (such as the U.S. Export-Import Bank) specifically created to maintain and increase exports by various credit techniques. Is it possible to imagine a new organization closely allied with the World Bank, but legally separate from it, which would be backed by the export credit entities of the principal industrialized countries? Such a new organization could be leveraged more highly than the World Bank. It could also be housed with the World Bank and, for a fee, have access to its analyses and loan judgments, as well as its accounting and other support services. The world doesn't need another public or private bureaucracy to increase loan activity-just a different balance sheet. Even the board of directors of the new entity could be made up of the same individuals who represent those countries on the World Bank Board of Governors-or they could be the Executive Directors from those countries.
What would such an "Export Development Fund" do? It would make loans beyond the optimum maturities for private banks (seven to eight years) and less than the 15-year or longer maturities that make best use of World Bank monies. The new organization would obtain its loanable funds by placing its own floating-rate 8-to-14 year notes with investors in the Eurodollar market. Initially, such notes might be taken up by the private commercial banks participating in the early maturity loans.
Such direct obligations of a multinational entity owned by public authorities of major industrialized countries, holding a diversified portfolio of World Bank-approved loans, clearly would represent a different level of risk than individual loans to specific countries. Over time, a secondary market might be created for such obligations so as to provide them with some degree of liquidity. Initially, it may be necessary for the export credit organizations or some multilateral institution to stand ready to repurchase the notes under specific circumstances, until the new loan portfolio is built up and a "track record" established.
New lending to LDCs for imports of capital goods would combine the forces of the various institutions. In a given large project or program, up to 20-year financing would be arranged, with commercial banks taking the early (one-to-seven year) maturities, the World Bank taking the later (15-20 year) maturities, and the new entity carrying those in the middle. All of the loans would have been evaluated by the World Bank and the private banks. Loans to a given borrower would be linked together by cross-default clauses, or would simply constitute separate "tranches" of one loan.
Apart from adding more private money to the total supply, such a scheme would also provide, on average, longer-term credit. This will be important in a future of basic economic adjustments and slower average growth. The concentration of private bank financing on the earlier maturities of long-term loans will make it possible for commercial banks to keep short-term trade credit growing with trade.
Obviously, a formidable series of obstacles would stand in the way of such a program, but there might be a shorter list of roadblocks for this device compared with others. The central political appeal is that the new financing would be related to the exports of the industrial countries in a visible manner.
Many aspects obviously need study. Would each national export credit organization be able to take a broad cooperative view of the interests of its exporters and modify charters or policies to invest in a joint effort? Could these organizations promote financing which would not be directly and immediately linked dollar-for-dollar to exports from their own countries? Would the World Bank be able to carry out the role described without diluting its present effectiveness?
Could a market be created for the new floating-rate notes and how? There is a market of uncertain size now for medium-term floating-rate notes of major corporations in the Eurodollar market.
Could notes of the new entity be placed at rates which, when reloaned, would not exceed the cost of the only available alternative-private bank floating-rate loans? Do the various export credit organizations have the legal capacity to invest (by equity shares or by subordinated debt or by "callable" obligations) in such an organization? Could they acquire that authority where it doesn't exist?
There can be a question as to whether the borrowing countries could soundly take on longer floating-rate obligations, in view of the difficulty of predicting cash flows far into the future. They are currently doing so, in general, for loans often years. One approach to this problem would be to have the World Bank absorb some interest costs when rates rise above certain ranges, being repaid when they fall below, with any final difference added to or subtracted from its own long-term fixed-rate loan, at the end of the financing. This concept is embodied in a recently announced program for expanding co-financing between the World Bank and commercial banks.
Answers to these questions should be pursued. The present comments are intended primarily as catalysts to begin discussion and to focus thinking beyond the present "crisis management." Clearly, something new is needed soon to provide the continued growth of credit to LDCs which will be vital over the years ahead to promote world trade and sustain world recovery.
1 World Bank Annual Report, 1982.
3 Robert Solomon of the Brookings Institution, in an address to the fourth annual convention of the Panamanian Bankers Association, March 16-18, 1983, noted that despite domestic policy weaknesses, the major borrowers had a remarkable record of real economic growth. In the decade of the 1970s, South Korea's GDP and exports grew at average annual rates of ten percent and 25 percent respectively. The annual growth of Brazil was 8.7 percent, with a nine percent increase of exports. Mexico's GDP increased at an average annual rate of 6.5 percent. Chile grew at 7.8 percent annually during 1976-80, with the share of exports to GDP doubling. Argentina's exports increased at an annual rate of 11.9 percent during the second half of the 1970s.
4 Since its establishment in 1946, the IMF has carried out over 562 such programs. At the end of April 1983 it had in place 39 Standby or Extended Fund Facility (EFF) arrangements for the gross total of SDR 25.2 billion; 15 with Western Hemisphere countries and 24 with others. From January 1978 through January 1983, 23 orderly private refinancing or debt restructuring agreements have been completed with IMF consultation.
5 Derived from World Development Report 1982 of the World Bank.
7 OECD Economic Outlook, Paris: Organization for Economic Cooperation and Development, December 1982.
8 Overseas Development Council, U.S. Foreign Policy and the Third World Agenda 1983.
9 Bank of America estimates, May 1983.