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There is a distinct rumble. Is it the noise of an impending second crisis of Latin American and other developing country debtors, or is it the start-up of world economic recovery, which will gradually pull lenders and borrowers alike away from the edge of a financial abyss?
In this article I will start by reviewing briefly the elements that make Latin American debt a far graver problem than the debt of developing (or socialist) countries in other areas. I will then review developments since last fall, leading to the conclusion that a serious gap now looms between the current account deficits of Latin American countries and the external financing sources needed to offset these deficits.
This statement of the problem is followed by an assessment of the general and specific requirements for action, including a review of existing proposals and my own specific suggestions. These include measures that might be taken in the near term to improve the prospects for lasting recovery. My central thesis is that the problem remains acute and that additional measures and contingency plans are urgently needed.
The debt problem of developing countries is largely a Latin American one. The relative size of the debt of the region is much larger than in the case of other developing areas; its composition-two-thirds from commercial banks-gives it short maturities and commercial interest rates; and export earnings with which to service the debt are modest in relation to the burden of debt service. These features mean that the grave economic problems which have been facing most Latin American countries in the last year or so are unlikely to spread, at least with the same force, to other developing areas.
On the other hand, the regional concentration of the problem means that virtually all countries in Latin America and the Caribbean are viewed as one by commercial bank lenders, an attitude which has drastically cut capital inflows to the region, regardless of country differences, and thus makes the task of recovery much more difficult. The fact that the external debt has been built up over the last decade, but especially in the last four years, shows that the problem is not only a cyclical one but a longer-term one. As in a natural catastrophe, the first step is emergency action, followed later by reconstruction and recovery.
The high interest rates of 1981-82, together with the unexpected depth and duration of the international recession, which led to a sharp deterioration of the terms of trade of developing countries, were the critical factors which sparked the debt crisis of 1982-83. In the wake of debt crises in Argentina and Mexico, international commercial bank lending ground to a halt, forcing, as foreseen, the renegotiation of part of the external commercial bank debt of Brazil, Chile and Venezuela, as well as Ecuador, Peru and Uruguay.
The 1983 interest payments on the external debt of the Latin American and Caribbean countries are expected to be close to US$40 billion, even if international short-term interest rates do not increase above their level at mid-year. This figure has to be set against projected merchandise exports of about US$96 billion, compared to US$110 billion in 1981. Even with a significant immediate recovery of export earnings as a result of renewed economic growth in the industrialized countries, the interest burden would still be very heavy and likely to continue so into 1984 and 1985, unless there is a major offsetting inflow of capital. The immediate problem for the major Latin American debtor countries is therefore simple and stark: major outflows without comparable inflows.
Even though developing countries, regardless of their levels of income, suffered heavily from the international consequences of the 1981-82 recession, the debt aspect of the problem is basically concentrated in Latin America. Other developing areas have major balance-of-payments problems, of course. Much of sub-Saharan Africa has been engulfed in a chronic balance-of-payments problem since the oil price increases of the early 1970s. Some important oil-exporting countries, such as Indonesia and Nigeria, are caught in a financial and economic squeeze as a result of the drop in oil prices and the cuts in exportable volumes. Others, such as Korea, the Philippines and Yugoslavia, have been hard hit by the international recession. However, the major problem brought on by the international recession and the high interest rates of 1981-82 is concentrated in Latin America. Only the Philippines, among the countries shown below, has levels of debt which are comparable to those of the major Latin American borrowers.
ESTIMATED DEBT BURDEN OF SOME MAJOR DEVELOPING COUNTRIES
(amounts in US$ billion)
(a) (b) (c) (d)
Total External Debt, Estimated 1983 Ratio of (a) Estimated Interest
Including Undisbursed, F.O.B. Merchandise To (b) Due 1983 As % of
At End 1982 Exports Debt to Exports Exports (b)
Argentina 39 9 4.3 50
Brazil 86 22 3.9 46
Chile 17 4 4.2 50
Mexico 86 22 3.9 46
Venezuela 33 14 2.3 29
AMERICA1 330 96 3.4 42
Algeria 15 12 1.3 14
Indonesia 22 19 1.2 21
Korea 37 24 1.5 18
Philippines 21 5 4.2 48
Nigeria 11 12 0.9 11
LDCS2 350 330 1.1 12
1 Including Caribbean and other countries not listed.
2 All other developing countries except centrally planned economies and Middle East OPEC countries.
SOURCE: Derived by the author from Bank for International Settlements, Maturity Distribution of International Bank Lending (July 1983); Morgan Guaranty Trust Co., World Financial Markets (June 1983); International Monetary Fund, International Financial Statistics, various issues; and World Bank, various Annual Reports.
NOTE: These are estimates, subject to error, and should be used with care.
The question is not only a statistical one. The fact that most international banks have cut back very sharply on new loans to Latin America almost regardless of country differences-other than operations which are tied to reschedulings and to stabilization programs supported by the International Monetary Fund (IMF)-has tended to precipitate payments problems. Even countries with low debt burdens, such as Colombia and Trinidad and Tobago, are not finding it easy to obtain new loans. Fortunately, these attitudes of lenders, who have gone from optimism to pessimism, have not extended to the economies of Asia, so that at present there is little risk of a generalized debt crisis.
The fact that the debt problem is largely, although not exclusively, a Latin American one is illustrated by two highlights from the table:
-The ratio of the stock of outstanding debt to the flow of merchandise export earnings, which provide the foreign exchange to service the debt-admittedly an oversimplified measure of the weight of debt1-is more than three-to-one in the case of Latin America compared to about one-to-one for the rest of the developing world.
-As a result, in 1983 Latin American and Caribbean countries as a group will need to devote, at present interest rates, about 42 percent of their merchandise export earnings to pay interest on their external debt, compared to 12 percent on average for other developing countries. The ratio approaches 50 percent for the large debtors such as Argentina, Brazil and Mexico. It is as if a homeowner had to devote half his monthly income to interest payments on his home mortgage. (These numbers assume that world interest rates do not rise for the second half of 1983, and that export earnings are on target.) Obviously, repayments of principal are not counted in these numbers. On the medium- and long-term debt, principal repayments represent approximately another 20 percent of export earnings for Latin America as a whole, after the refinancings committed or under discussion so far in 1983.
Since Mexico announced in August 1982 that it was unable to meet the repayment of principal on the external debt of its public and private sectors, a number of major events and trends have unfolded. At the risk of oversimplification, these trends can be grouped as negative and positive, although the interrelationships are quite complex.
Perhaps the most striking on the negative side has been the sharp drop in new commercial bank lending to almost all Latin American countries. According to the Bank for International Settlements (BIS), the net flow (after repayments) from commercial banks to Latin America in the second half of 1982 was only about US$5 billion, mostly because of the disbursement of earlier commitments to Brazil, compared to an annual rate of about US$25 billion starting in 1979 and through the first half of 1982.2 Net flows from banks in 1983 are unlikely to be much above US$8 billion, mostly as a result of net lending associated with debt rescheduling. The music has indeed stopped for Latin America; net flows to the other developing countries, mostly in Asia, have also declined but at a slower pace.
Since commercial banks have provided more than two-thirds of the capital inflow into Latin America, not just for the last three years but for the last decade, the interruption creates major adjustment problems. The interruption of net new lending led directly to the inability of Brazil to meet its principal repayments after December 1982 and to the subsequent similar problems of Venezuela, Chile, Ecuador, Peru and Uruguay, in addition to the existing problems in Argentina and Mexico.
A second and related development has been the cutback in trade financing. Lenders, particularly the smaller banks, have naturally enough reduced their lines of credit for export and import financing and in some cases eliminated them altogether. Official export agencies, which play a key role in medium-term equipment financing, have also cut back. Although clear statistics are not available, the dearth of new financing, combined with the drastic economic recession in virtually all Latin American and Caribbean countries, has led to a sharp drop in exports from the industrialized countries to Latin America, and also in exports between Latin American countries and between them and other developing countries. In the case of Brazil, for example, one-third of exports in 1981 went to the rest of Latin America and to other developing countries, primarily in Africa and the Middle East, all of them depressed markets at present.
Exports from the industrialized countries to Latin America, which accounted for one-third of their exports to non-OPEC developing countries, fell by 21 percent in 1982 and are still falling in 1983. U.S. exports to Latin America, which were in 1981 equivalent to two-thirds the value of U.S. exports to Western Europe and double those to Japan, also fell by the same proportion in 1982. This fall in export sales from US$42 billion in 1981 to US$34 billion in 1982 had a direct cost of between 100,000 and 130,000 jobs lost in the United States, and is continuing in 1983.3 Even though Latin America absorbs only about seven percent of the exports of the industrialized countries, the sharpness of the drop in exports, which affects in particular already depressed industries such as equipment and machinery, is undoubtedly a drag on world economic recovery. For some European countries, the fall in sales to developing countries could, in 1983, make the difference between a mild economic recovery and no growth at all.
A third related point is the extent of the economic depression in Latin America. For a time in 1981, some economies, particularly Mexico's, shielded themselves from the world recession by massive external borrowing to finance public investment and consumption. As the lending stopped and long-delayed adjustment measures, such as devaluation and public spending cuts, had to be taken, the recession hit with double force. Devaluations had to be much larger than if they had been taken in time, giving a tremendous impetus to inflation. Mexico has had a devaluation of about 400 percent (in terms of pesos per dollar) in the last 18 months. Comparable devaluations have taken place over the same period in Argentina, Chile, Brazil and Venezuela.
The effect on the industrial private sector, which in all these cases had been encouraged by the policies of the authorities to borrow abroad, has been devastating: domestic sales in some cases have fallen by 30-40 percent in real terms, as incomes have lagged behind inflation. This has sharply cut the ability of enterprises to generate cash flow, while the amount needed in local currency to service external debt has increased three or four times in the last year. It is not an exaggeration to say that a major portion of private large-scale industry in Latin America-not to mention chronically sick state enterprises-is today in effect bankrupt. The worldwide intensification of trade barriers, a direct result of the international recession, aggravates the problem.
The policy of stimulating economies through public spending reached its peak in 1982; in Argentina, Brazil and Mexico, the public sector deficits as a proportion of the Gross National Product reached levels of 14 percent, 12 percent and almost 17 percent respectively. Deficits of this magnitude were key causes of large exchange-rate devaluations, and the combination has pulled up annual rates of inflation so far in 1983 to perhaps 300 percent in Argentina, about 130 percent in Brazil, and over 100 percent (although now declining) in Mexico. Such stratospheric numbers eventually lead to major social and political strains. Inevitably, the process of strengthening public finances creates for a while even more inflation and discontent, as public enterprise prices and taxes are raised.
No one can deny the urgent need for major financial surgery, particularly on exchange rates and public finances. However, the suddenness and size of the measures required, plus the lack of a significant external capital inflow to help the adjustment, is creating a potentially explosive mixture of falling incomes, rising unemployment and galloping inflation. For Latin America as a whole, 1983 will be the third successive year of declining real income per person. I estimate that over the period 1981-83 real income per head will have fallen by about ten percent, and by larger percentages in the lower middle-income groups, such as government workers and non-unionized service workers. Unemployment rates, which are admittedly very difficult to measure in Latin America, are probably hovering close to 20 percent in major industrial centers such as Buenos Aires, Mexico City, São Paulo and Santiago, without counting the indirect unemployment of people working part-time or selling lottery tickets and knickknacks on street corners.4 With the gradual weakening of the system of extended families helping their kin, and without any unemployment insurance, such numbers are not sustainable for very long.
Why has there been no social explosion so far? There is no easy general answer. In the case of Mexico, for example, the rapid income growth until 1981 has provided some cushion, as has temporary or permanent migration to the United States. A well-disciplined political organization and tradition, with close control over the major trade unions, has enabled the government to keep wage adjustments behind price increases, a key element in the fight against inflation. In other cases, the lack of apparent reaction may come from the suddenness of the change, which has left populations stunned, so to speak. Another element has been the increasing discussion of economic issues in the press which, as a result of growing literacy in urban areas, has created an awareness of the magnitude of the economic problems being faced. The new Peruvian Finance Minister, for example, got an unexpectedly sympathetic public response earlier in 1983 to his program to cut public spending to the bone.
In general, however, if there is no bread on the table, these positive developments can over time be offset by great social strains. The combination of inflation, unemployment and declining real incomes provides a breeding ground for such tensions. Explosions are usually not announced.
On the positive side of the ledger, the most important development in the last year has been the unquestioned desire of most governments to put their financial house in order. Brazil took that decision as early as December 1980, but it takes time and a hospitable international environment to succeed. All the governments of the major economies of the region have taken significant and in some cases drastic economic steps in the last six to nine months. Undoubtedly, the interruption of significant new lending by commercial banks has been the major stimulus for such measures. But that interruption is also the biggest question mark on whether the stabilization programs can succeed in a reasonable period of time. We will look at that crucial question later.
The other positive but also qualified development is the decline in world interest rates since mid-1982. The London interbank rate for six-month deposits, which has been the base rate for most international bank loans, fell from a peak of 16 percent in June 1982 to about 10 percent in the last quarter of 1982. After falling somewhat in the first quarter of 1983, the rate had risen back to 10 percent by mid-year and rose further to about 11 percent in mid-August 1983. Two points qualify this progress, however-the significant increase in bank charges above this base rate, and the uncertainty surrounding future interest rates.
The increase in bank charges is particularly important in the case of Mexico, which was paying very low margins over the interbank rate. With the new charges, Mexico is paying about 13 percent as of mid-1983 on its refinanced debt (which amounts to about US$40 billion of the US$60 billion in variable-rate debt). This level results from three changes: the base rate is now (at the option of the lenders) the prime U.S. lending rate, which is generally higher than the interbank rate (which is a deposit rate); the spread above that base rate has been substantially raised; and various additional fees have been attached to the refinancings and the new loans associated with them. Similar charges are included in the refinancings negotiated for Argentina, Brazil, Chile, Ecuador, Peru and Uruguay.
Most of these countries were already paying higher costs than Mexico, so that the effect of the changes on them is smaller. Furthermore, there are reasons for the changes: management fees for new loans are normal (although the new charges are on the high side), and the shift to a U.S. prime rate base option was important in order to convince smaller regional banks in the United States to remain in the loans. On the other hand, the argument that higher charges are justified because debtors had become riskier is more debatable. For one thing, the risk becomes difficult to measure when a debtor cannot service his debt; no premium can compensate that risk. In fact, in the case of major U.S. and Canadian corporations which have undergone debt restructurings in recent years, the interest rate charged by banks during the reorganization period has often been below market rates. These corporations have been represented by financial advisers independent of the banks: so far most major Latin American debtors have not wanted to antagonize lenders by hiring independent financial advisers, although the history of the refinancings so far shows that there might have been merit in an outside opinion on realistic debt-servicing possibilities.
The other problem concerns the trend of U.S. short-term interest rates, which are the preponderant influence on rates in the Euro-currency market. Already in the second quarter of 1983, the interbank Eurodollar rate was up by about one percent, adding on an annual basis US$2.2 billion to Latin American interest payments abroad. If short-term U.S. rates were to go up another point or so in the second half, as some economists predict, because of the effects of present and prospective U.S. budget deficits, the total increase in debt servicing cost for Latin America since the spring of 1983 would be close to US$5 billion on an annual basis, a very significant sum at a time of sharply reduced capital inflows.
In short, the drop in interest rates-while positive on the whole-has present problems and future uncertainties.
A third positive development, which flows from the decline in imports and in interest payments, is the sharp reduction in the current account deficit of the region, in effect the requirement for external finance which remains after current inflows, principally exports of goods and services, have been used to pay for current outflows, mainly imports and interest. The very nature of developing economies, which need to import capital in order to supplement their inadequate domestic savings, means that they have a current account deficit and thus a need to borrow abroad and attract investment capital. However, Latin America and the Caribbean, largely as a result of the drop in incomes and the sharp decline in imports of the last year, have greatly reduced their need for external finance. The current account deficit of the region has fallen from US$38 billion in 1981 to US$33 billion in 1982, and is expected to fall to about US$18 billion to US$20 billion in 1983-if one assumes that international interest rates remain at mid-year levels. If interest rates were to go up further, the financing gap would begin to rise again. A return to the interest rates prevailing in mid-1982, for example-even though it is highly improbable-would entirely wipe out the improvement in the current account deficit of the last year.
The crux of the matter is that, even though the financing gap has been sharply cut, the availability of external resources has declined even more. The uncertainties about how Latin American and Caribbean countries will finance themselves over the next couple of years are undoubtedly a crucial concern of both lenders and debtors. The future trend of commercial bank lending is uncertain and a part of the new loans which have accompanied recent reschedulings of commercial bank debt is being used to finance the higher charges above the base interest rate. Foreign direct investment, which until recently covered about one-fifth to one-quarter of the current account deficit, has slumped in the wake of the recession both in the industrialized countries and now in Latin America. The return of flight capital which left a number of major Latin American economies in recent years could be important, but will take time. Finally, as we will discuss later, the multilateral development institutions-such as the World Bank and the Inter-American Development Bank-face resource constraints.
The present arithmetic is forbidding. Sources of net capital inflows-about US$8 billion of commercial bank lending, approximately US$2 billion of net disbursements from the multilateral development banks, and an equivalent amount of supplier credits previously negotiated-leave a significant financing gap, larger than what can be covered from private investment. Thus, even though the current account deficit has declined, the problem of covering it has become far more acute.
In sum, despite the drastic adjustments of the debtor countries and the major moves undertaken by the IMF and the banking community, there is a serious possibility that the Latin American current account deficit for 1983-and the similar amounts in prospect for 1984 and 1985-will not be met. The result could only be progressive deterioration in the economic situation of the key Latin American countries-with attendant dangers to political stability-and a spiral of events that could include inability even to meet interest payments on loans.
Is it reasonable to expect these countries to work their way out of their present economic and financial predicament? In recent months various projections have been constructed to show how this might be done.5 Most of these projections show that if the industrialized economies grow at a reasonable rate (say three percent per year), if interest rates do not increase beyond mid-1983 levels (ten percent for the six-month Eurodollar interbank rate), and, most especially, if a modicum of capital inflows can continue, then most of the major debtors could resume economic growth and service their external debt more or less comfortably by about 1986. But there are many uncertainties. Most projections highlight the very limited room to maneuver in the next two or three years.
The relationship between lenders and debtors has created an unusual degree of interdependence. This is particularly the case with commercial banks, which have provided the bulk of external capital to Latin America in the last decade. The relationship is a little like that of two people on a see-saw: if one jumps off suddenly, both are likely to get hurt. Very large losses could affect major international commercial banks if countries are unable to work their way out of trouble. The problem concerns not only U.S. banks but also banks in Europe, Canada and Japan, as well as part of the debt to suppliers.
However, given the large share of the Latin American debts held by U.S. banks (about 45 percent of the debt to commercial banks), it is likely that leadership on the issue will have to come from the United States. Sizeable reductions in net income could affect some large banks if significant loan loss reserves had to be set aside for major Latin American debts, in the event that interest payments lagged substantially behind schedule. Banks have already set up such reserves for some of the debts owed by the Latin American private sector.
For problems to be worked out, there is a clear need to change the perception of hopelessness which permeates the international climate at present, particularly in the debtor countries. This pessimism could encourage some debtors to leave the hard road of financial discipline and adjustment and be tempted by apparently easier solutions such as a "cartel" of debtors. Export more? Import quotas on yarn, orange juice, specialty steels, which are just three recent examples, are conveying the wrong message. More official funds? Even the 50-percent quota increase for the IMF has had an uphill battle in the U.S. Congress. Economic recovery in the industrialized world? High and rising real interest rates could slow down the recovery. As lenders and borrowers look for solutions, they find closed doors and blocked paths.
Another important need is to maintain an atmosphere of calm. Each new confrontation creates an air of crisis which makes it difficult to maintain a flow of lending from banks less involved internationally. Smaller and so-called "regional" banks, which account for about 15 percent of the outstanding international commercial bank debt of Latin America, undoubtedly want to get out of these loans, a trend which would put great pressure on the larger banks to increase their exposure even more than planned. So far a confrontation has been avoided, but any rumors of an impending crisis in a particular country affect confidence adversely.
The sensitivity of individual countries' problems is illustrated by the case of Brazil, which faces a fairly drastic adjustment program with the IMF. As of this writing, it appears that the IMF has restored the ability of Brazil to draw funds under the facility agreed earlier in the year, after Brazil implemented a new tough set of anti-inflationary measures mainly to keep wage adjustments below inflation. This has avoided, for the time being, a major problem for Brazil's lenders, whose disbursements on a US$4.4-billion loan are tied to disbursements on the IMF facility. However, the dearth of additional capital inflows continues to make it difficult for Brazil to service interest on time. As problems are aired publicly, including the initial well-publicized requirement by the Bank for International Settlements that Brazil had to repay an earlier emergency loan on time, the task of avoiding confrontations and possible crises becomes more difficult.
Until now, market mechanisms have handled the problems of debtor countries as they arose. But it is not clear whether such mechanisms can continue to be effective by themselves, without leadership by the governments of the major industrialized countries. For the lending banks, a serious dilemma arises: on the one hand, it is quite clear that they cannot continue lending at anything like the breakneck pace of 1979-81; on the other hand, if lending does not expand moderately, it will be very difficult for lenders to collect interest on past loans. For debtor governments, most of which clearly recognize the need for tough belt-tightening measures, the problem is that austerity may be too costly in social and political terms and that a gradual approach may not be feasible because of the lack of external finance and the delay in the recovery of export earnings.
Rather than discussing whether we are or are not in a crisis, or whether it is an issue of insolvency (that the borrowers can "never" pay) or illiquidity (that they cannot pay now), which are questions of degree and definition, it is more useful to outline the preconditions for both the debtors and the lenders to work their way out of the problem:
-First, it is useful to distinguish between the immediate future and the longer term. The coming year is probably the critical one, since export income of the debtors will still lag for a time until an international recovery is in full swing, while large interest payments will come due at a time of very limited capital inflows. This is not to say that there is not a longer-term problem, as the refinancings being arranged now start becoming due in three or four years. Moreover, there are historic reasons, summarized later, which suggest that the pattern of development of Latin America cannot easily be changed. Nevertheless, from the practical point of view of dealing with the most urgent problems first, it is important to analyze possible action in terms of what is politically feasible now, not a year or two from now. Anyone familiar with the mood of parliaments in major industrialized countries, especially the U.S. Congress, has to recognize that there is no room for quick big-scheme solutions where taxpayers would directly or indirectly have to put up substantial new funds.
-Second, no single party can carry the whole load of adjustment. Any arrangements must involve some effort on the part of both the lenders and the borrowers. This has been the case so far, although the degree of effort on each side-namely continuing some positive net flow of lending by the banks, and financial discipline and austerity on the part of the debtors-is viewed suspiciously by the other. It is doubtful if serious problems can be avoided in the future without some intervention by the governments of the main lenders to help stimulate a larger capital inflow.
-Third, any way out thus has to emphasize the restoration of capital inflows. To be sure, these flows cannot over time rely only on commercial bank funds. A better balance than in the last decade has to be found between investment capital and loans. Obviously, however, direct and portfolio investment will take some time to revive.
-Finally, it is essential to remove the obstacles to the revival of export growth. The extent to which the growth of protectionism in recent years has affected Latin American economies is not clear. Countries in South and East Asia have been affected as much, if not more. But it is clear that special interests in North America, Europe and Japan, for what are locally very understandable reasons, but which affect only a relatively small percentage of labor forces and of commerce, are gaining strength as the effect of the recession gets translated, after a lag, into political processes. Governments are applying remedies that may no longer be needed by the time they are implemented but which could have proportionately significant effects on the ability of debtors to sell abroad and earn foreign exchange.
In looking at the immediate future, the most urgent measures are to keep up an inflow of capital, to reduce the burden of interest payments, and to stop the rise of protectionism. The role of the governments in the major industrialized countries is crucial in all three actions.
The ability of the international financial fire brigade, the International Monetary Fund, to function is crucial. It is essential to put in place as soon as possible the increase in the resources (paid-in quotas of countries) of the IMF. Several points should be made. First, available IMF resources are nearly depleted. If any large industrialized country were to need special assistance from the Fund now, a distinct possibility, the resources of the Fund would be exhausted. Second, even the quota increase, now in train, of about 50 percent simply catches up with past world inflation and would not contribute significant new real resources.
Third, the Fund is not, as some politicians appear to think, a giveaway to developing countries. It is a currency pool, which makes foreign exchange available to all member countries-the United States has been a borrower in the past-under rather strict conditions, in order to replenish the foreign exchange reserves of countries facing balance-of-payments problems. It is not a provider of long-term capital. Finally, since the quota increase will probably take at least until mid-1984 to be put into place, there is still a need for a temporary special facility, financed by the existing "General Arrangements to Borrow" or some other form of cooperation among capital surplus countries.6
If the quota increase of the IMF cannot be approved as proposed, and even if the approval takes many more months, such a negative would be a clear signal, both to debtors and lenders, that the major countries of the world do not consider the present problems important enough. Some debtors would be tempted to default, and lenders would then wind up knocking at the doors of their central banks for what could then amount to a costly bailout. It is unfortunate that the increase in the resources of the IMF, which was needed anyway, has coincided in time with a political debate, especially in the United States, on whether the debt problem should be laid at the door of the lenders or the debtors, both of whom are seen as villains.
A second avenue that should be explored quickly is how to stimulate more lending by the World Bank and the Inter-American Development Bank. Unfortunately, the net resource transfer-disbursements less payments of principal and interest-of the World Bank to Latin America in the last fiscal year was only about US$500 million, a relatively modest sum, and has stayed at approximately that level since 1980. Even though disbursements rose in fiscal 1983 to US$2.3 billion, because of a larger proportion of sector support loans, amortization and interest absorbed the whole of the increase. The IADB, which has a lower cost mix of funds because of the concessional Fund for Special Operations supported mainly by the United States, has been able to raise the net transfer moderately from about US$600 million to US$800 million over the same period.
In order to increase World Bank lending, which is tied to projects, many of which have either been suspended or sharply slowed down in the last two years, there is a need for greater resources and for more flexible lending policies. The United States has basically opposed such policies, which would emphasize sector-support or "structural adjustment" loans, although it has recently toned down its opposition somewhat.
The entry of China into the Bank, and the uncertainty of future contributions by industrialized countries, particularly the United States, to its concessional window-the International Development Association-has drawn Bank funds away from possible loans to Latin American borrowers. Latin American countries are thus giving special support to the IADB. With its recently approved increase in capital, the regional bank can now significantly expand its activities, although some redirection of lending policies may be needed for the difficult two or three years ahead.
For both the World Bank and the IADB, a quick-fix solution to future funding has been promoted by those who recommend a doubling of the so-called "gearing ratio," which is the ratio of capital contributions by the major creditworthy members of the institution (basically the Organization for Economic Cooperation and Development countries) to the outstanding borrowings. That ratio is currently about one-to-one. The solution envisaged is thus simply to borrow more without providing more guarantee capital.
This is not a worthwhile course. The fact that deposit-taking commercial banks have a ratio of paid-in capital to assets in the United States of about 5-6 percent is not relevant to a long-term development institution which has to borrow the bulk of its resources in the capital markets. Bondholders, who rightly view the obligations of both institutions (and the Asian Development Bank as well) as guaranteed by the United States, Japan, Germany, etc., would now begin to look instead at their loans to developing countries. The resulting downgrading of the bonded debt of the World Bank and the regional multilateral development banks would be costly to borrowers and would end up being an irreversible step.
It is easier to increase as soon as possible the capital of the World Bank-and restore funds to the Fund for Special Operations of the IADB-particularly since the capital increases require little cash. The recent IADB capital increase involved only 4.5 percent in cash. In essence, the development banks are thus already like insurance or guarantee schemes organized to pass through relatively low cost funds to their borrowers. It is probably easier to increase their callable capital, which is in effect a "guarantee" capability, than to establish a whole new guarantee scheme-although that idea should not be discarded if it becomes absolutely necessary to stimulate an adequate net flow of commercial lending.
New lending by the multilateral agencies, as long as it can be targeted at the real problems faced by countries, is preferable to more emphasis on co-financing with commercial banks. In the present market, co-financing with commercial banks will not work simply on the basis of cross-default clauses, such as the World Bank and IADB have provided between their loans and the related commercial bank loans. The whole of international bank lending is cross-defaulted-that is, a default on one loan can trigger a legal default on all the debt and guarantees of a particular borrower-yet that has not prevented payment delays and de facto defaults. In the present market, only a guarantee will work, but in that case both the international institutions and the countries are better off with straight lending at the less-than-commercial rates which the multilateral development banks can provide.
Third, it is urgent to reduce the interest burden. The problem is complex. Much depends of course on the path of international interest rates themselves, which are closely linked with U.S. rates and difficult to predict. But even if basic rates remain at their mid-1983 level, it is clear that the interest burden is very heavy indeed. This has stimulated a number of proposals to refund the debt of some (or all) developing country debtors into long-term obligations at less than market interest rates.7 Unfortunately, most of the schemes are unlikely to be feasible politically and would probably also have negative side effects, principally in drastically reducing new commercial bank lending for a long time.
It is quite unlikely that any of the schemes so far advanced to reduce the load of debt could be implemented in the next year, since they all require, in varying degrees, the multilateral approval of governments. Opinion in creditor countries is generally not sympathetic to such schemes. Progressives look upon these ideas as a bailout of imprudent lenders, and conservatives, as a bailout of irresponsible debtor governments.
Such schemes, in the improbable event that they were economically and politically feasible, also run into the problem that they would probably stop further bank lending for a very long time. The charge against bank earnings would be too large because the loans could not be recycled except at very large discounts. Moreover, the idea that official institutions such as the IMF, which are having a hard time raising additional resources for their established operations, should bear this additional burden seems impractical.8 Yet the recycling schemes do make the important point that the debt service burden is too high.
What might be possible, in a contingency plan that would be activated in an emergency, would be a temporary reduction of the interest burden-so designed as to avoid damaging the prospects for continued lending on a moderate scale. For the banks, many of which would obviously resist such a move strongly, it would at least have the advantage of reducing the increase in their lending, since at present, before Latin American export growth revives and new sources of capital inflows can be developed, an additional dollar of interest service by the borrowers is financed (in simplified terms) by an additional dollar of bank lending and exposure. It may be better, at least during the immediate recovery period, for lenders to sacrifice the 50-60 cents of net after-tax earnings which a dollar of added interest income provides, in exchange for not having to put up an extra dollar of lending.
Thus, it is worth considering whether the banks might not be better off working out a temporary arrangement on interest charges than having to come up with last-minute financing packages in the midst of a crisis. I stress that such an arrangement would have to be temporary, and that the reduced interest could not be below the market costs of funds if the central objective of keeping some flow of lending is to be maintained.
Under several of the broad refunding schemes proposed so far, the interest reduction would be well below the cost of funds to the commercial bank lenders-as low as six percent in one specific proposal. But even if the new interest rate under these schemes were set at nine percent-while the London interbank rate stood at ten percent-the savings to the Latin American debtors of about US$7 billion would be achieved only at the cost of great if not irreparable damage to the chances of financing the remainder of the current account deficit of Latin America. A more modest proposal to reduce interest charges, for example, to no more than one percent over the interbank rate, including all other charges, for a period of about two years-until world recovery begins to pull up Latin American foreign exchange earnings-would still save debtors at present rates about US$4.5 billion annually, without damaging to anything like the same extent the chances for new lending.
It is unlikely that bank lenders would by themselves accept such a reduction, even a modest one proposed on a contingent basis. There would no doubt have to be some government persuasion. Given the time constraints, direct persuasion, as has occurred in the recent refinancings, may be better than a large international conference, which requires much preparation. If interest rates look at all as if they are again on the rise, consideration of some sort of scheme to reduce the interest burden at least temporarily will become urgent. Otherwise, as export earnings failed to recover in the wake of the negative effects of higher interest rates on recovery in the industrialized countries, lenders would find themselves facing the dilemma of having to lend more simply to get paid the higher interest due.
A related point is whether a quid pro quo for the reduction in interest charges might be necessary, such as some form of medium-term international or government guarantee for net new lending. Even if this were politically feasible, however, we have just noted that it would take time to put such an arrangement in place. Perhaps the understanding that a guarantee would, as a last resort, be given serious consideration by governments would be enough stimulus to arrange a contingent scheme to reduce interest costs in the immediate future. That and the continuation of net capital inflows are the only avenues of action open for the short term, together with the continuation of difficult austerity measures in the borrowing countries.
It is clear that the policies which could yield results soon are difficult to enact. Moreover, something is needed on each front, especially on replenishing the resources of the IMF and on lowering the interest burden without jeopardizing new flows, a most difficult task. In order to put all the pieces of the package together, some form of concerted action by the governments of the major money and capital markets of the world is needed. Of course, each month that passes without a major crisis reinforces the feeling in some quarters that the worst is over and that eventually the problems will evaporate in the wake of world recovery. Such a view gives an uneasy comfort but is not consistent with the magnitude of the financing problem, especially as seen from the debtor countries.
So far, the temptation to stray from the path of IMF-supported austerity has been avoided by the governments of Latin America. But the present equilibrium is a tenuous one. It is quite conceivable that the government economic teams which have followed such policies could be jettisoned in the face of strong political opposition. The refinancings linked to the IMF credit facilities would then be called into question and a period of confusion could well follow. At that point some governments might be tempted to talk and think of a debtors' cartel, in the sense of a coordinated suspension of debt service. The idea is at present viewed by financial policy makers in most countries as a product of the lunatic fringe. But if these officials and their policies do not receive enough external support now, there is the risk that the lenders might face a very different cast of characters. That is why it is important to focus in a more concerted fashion on possible solutions while the problem appears to be in remission.
For the medium term, the proper emphasis should be to continue to find ways to stimulate new capital flows, especially in the immediate years ahead. To do that within the short time available is extremely difficult. No one scheme or source of flows will do. Complicated new arrangements are unlikely to be feasible. Nor can new flows simply be blank checks to underwrite a revival of state-enterprise deficit spending in borrowing countries.
Besides the areas already mentioned, there are others which could be of great importance to economic recovery, although not immediately. The longer horizon does not mean that the necessary policies should not be put in place now. Two important areas are:
Private investment. This is not a promising source for the next year or two, but could be of great importance once economies revive. In the early 1960s, private direct investment provided about 40 percent of the net capital inflows into Latin America, particularly into Brazil and Mexico. In recent years, the proportion has fallen to 20-25 percent. In 1981-82, net flows were about US$6 billion to $7 billion annually, a sum which has fallen in 1983. It is essential to establish the preconditions now for an investment recovery later. Mexico has already begun to take measures, for example by reducing in practice the requirements for domestic ownership. Peru is breaking away from the Andean Group's ill-conceived restrictions on foreign direct industrial investment. Multilateral investment guarantee schemes, which have been under study for many years at the World Bank and elsewhere, deserve another look.
Of equal or even greater importance is private domestic investment, since its revival would pull back into Latin American countries part of the large sums which fled in 1981-83. For example, perhaps US$20 billion to $25 billion is estimated to have left Mexico and Venezuela, the two most notable cases, in that period. While some of what has gone out will stay out, more realistic exchange rates, political stability and a revival of domestic markets would, in time, begin to attract some of the flight capital. Unrecorded flows of this type could make a big difference once the beginnings of improvement are visible.
Credit insurance. Since it is important to keep some bank lending going, albeit on a more controlled scale, several schemes have been advanced under which a multilateral credit insurance facility could be established, to be run on an agency basis by the World Bank or the IMF, or a combination of the two. The facility would cover additional lending. Setting up a multilateral arrangement is probably desirable but politically difficult and time-consuming.
In the meantime, individual export credit agencies, working with the World Bank and the IADB, could more quickly get themselves organized.9 The resources are there: for example, as of May 1983, the U.S. Export-Import Bank had barely committed one-tenth of its authorized lending for fiscal 1983, largely because of the cut-backs in development projects around the world. Commitments for the full fiscal year are likely to be well below authorizations. Of course, changes in legislation would in some cases be required, but they would probably be easier to obtain than for a multilateral scheme and could be set in motion while a multilateral arrangement is designed and evaluated.
On the multilateral front, the idea of an Export Development Fund10 also has much appeal, especially if it could be expanded from lending to developing countries for capital goods imports to helping to finance the exports of these countries, which represent, in general, transactions which are liquid, usually secure, and suitable for commercial finance.
There is only limited time to put into effect policies which would produce results by 1986-87, when the first big repayments on the recent refinancings are due. The struggle into recovery will not be easy: as I emphasized in my earlier article, the economic problem in the major Latin American countries is not simply a cyclical one but arises in part from their historical stage of development.11 For countries such as Argentina, Brazil, Mexico and Venezuela, with relatively large internal markets in comparison with the export-oriented East Asian economies, the thrust of development has been industrialization for domestic consumption and the building of infrastructure for a rapidly growing population. In that sense, the pattern of development has some similarities with that of the United States a century ago. The difference is that real interest rates were then at the historic norm of about three percent in real terms, whereas today, for Latin American borrowers, the real rate on their commercial debt is closer to nine percent in real terms.
Another important feature has been that the major Latin American economies have not in the last three decades been able to provide enough jobs, particularly for the growing lower middle class, which wields increasing political power.12 Political pressures have thus built up to provide jobs through the government and state enterprises. Similar pressures act to maintain overvalued exchange rates and interest rate subsidies-which help middle class consumption-all of which tends to build up budget deficits, stimulate borrowing and hold back the growth of export earnings. This set of policies also tends to hold back employment, particularly in manufacturing, where advanced social legislation for a minority of the labor force tends to push up wage costs to levels which are uncompetitive internationally.
Such policies underlie, with periodic changes in emphasis, much of Latin America's rapid economic growth in the postwar period and will not change quickly. There is therefore a long-term aspect to the debt problem beyond the admittedly more pressing cyclical problem.
A clean and simple, conceptually satisfying scheme to "solve" the debt problem obviously has intellectual appeal, while the present muddling through is fraught with danger. For the time being, however, political realities, especially in the United States, make it very difficult to envisage an all-encompassing scheme. There is far more political concern within the United States about Central America than about the debt question, although the long-term effects of the latter could turn out to be very serious.
As long as nothing explodes, there will be little interest in setting up contingency mechanisms. Only a real crisis, which hopefully will not occur but is unfortunately a distinct possibility, will powerfully concentrate the minds of policymakers other than the central bankers and Treasury officials who have already been involved. In the meantime, everyone would be better off if lenders, authorities in the lenders' countries, and major borrowers work together in setting up a concerted program to help existing official institutions to do more and to establish contingency plans to lower the interest burden of commercial debt, in the event that the debt burden cannot be managed.
Both lenders and debtors face a critical period. While there are indeed some chances that the problem will gradually be overcome by world economic recovery, the risk of major crises ahead is high. It is therefore vital to anticipate these problems in a concerted fashion, well ahead of time, rather than run the risk effacing them at the very last minute.
1 Comparing stocks to flows can be misleading. However, since interest is a proportion of the debt outstanding, the comparison is of some use. Also, it could be argued that all exports, including services (such as tourism), should be taken into account. Since Latin America as a whole has a negative balance on services, the concept of export of goods and services seems an inappropriate measure.
2 The BIS' Fifty-Third Annual Report, June 1983, p. 116, shows only US$100 million. However, a later estimate, of July 1983, shows US$5 billion of net flows for the second half of 1982, largely for the reason noted. The first quarter of 1983 showed no net loan flows to Latin America other than US$2.5 billion associated with the Mexico and Brazil refinancings.
3 Jeffrey E. Garten, "The Big Debtors Try to Dig Themselves Out," The Wall Street Journal, August 1, 1983, p. 14, reports that in the first four months of 1983 U.S. exports to Latin America fell 40 percent from their 1982 level in the same months. The job loss for 1981-82 is the author's estimate, based on a ratio of about 12,000 to 15,000 jobs per US$1 billion in sales.
4 Official statistics in Argentina, Brazil and Mexico show lower numbers. However, these statistics depend largely on figures for jobs lost, rather than being computed in terms of all those seeking work.
5 For example, see, among others, Morgan Guaranty Trust, World Financial Markets, June 1983; William R. Cline, Developing Country Debt under Alternative Global Conditions, 1983-86, Washington, D.C.: Institute for International Economics (forthcoming in book form, summer 1983). The largest international banks have their own projections, as has the Federal Reserve Bank of New York.
7 For example, Felix Rohatyn of Lazard Freres (in Business Week, February 28, 1983) suggests that a major portion of credits be turned into long-term low-interest bonds, under the aegis of the IMF. Peter Kenen of Princeton University (New York Times, March 6, 1983) proposes that a special agency buy the loans from the commercial banks at a discount, with the proceeds of long-term bonds. A proposal along similar lines, but using the World Bank, has been made by Richard Weinert in Foreign Policy, Spring 1983. Minos Zombanakis has proposed a Loan Guarantee Fund in the IMF (The Economist, April 30, 1983). There are a number of other interesting proposals.
8 For a discussion, see Yves Laulan, "A New Approach to International Indebtedness," The Banker, July 1983.
9 See, for example, Harold Lever, "The Lever Plan," The Economist, 9-15 July, 1983.
12 See, for example, G.P. Pfeffermann, "Latin America and the Caribbean: Economic Performance and Policies," The Southern Review of Management and Economy, Winter 1982.