There are several reasons for the current concern with the external debt situation of developing countries. By the end of 1976 their total debt had almost doubled in nominal terms since the end of 1973. The indebtedness of some prominent developing countries (including Brazil and Mexico) had risen even more, and the proportion of borrowing from private sources had also increased rapidly. There has been substantial lending by a relatively small number of commercial banks whose exposure has given rise to some anxiety. Debt service ratios have risen. It is widely feared that maturities have shortened dangerously as the result of the shift toward private sources of lending, and it is also widely feared that developing countries are likely to face serious debt service difficulties in the next few years and may have reached the limit of their capacity to borrow. It is feared, too, that private lenders may not have the desire or the capacity to continue to increase their lending to developing countries.
But anxieties about the developing countries’ debt situation are not very meaningful in aggregate terms, for the debt situation varies greatly from country to country. Some countries have borrowed very little. Others have a long history of heavy borrowing, and the ratio of their total debt outstanding is up to 50 per cent of their annual gross national product (GNP) and more than double their annual export levels. Nor is there any simple pattern of indebtedness among countries which corresponds to income levels and rates of economic growth. Some of the poorest and slowest growing countries have been among the heaviest borrowers, but so have some of the richest and most rapidly growing countries. Most countries were borrowing in recent years to allow time for a more gradual adjustment to higher oil prices and to ride out the recession, but some were doing so to postpone essential adjustments unduly. Some mineral-rich countries have borrowed heavily in boom times and have found themselves in serious difficulty in price troughs when lenders have been more cautious. Private lenders, too, vary widely in their lending exposure by sector and by country.
The growth of indebtedness has to be considered in the long run in relation to the growth of GNP. In shorter-run terms, as debt service represents a contractual obligation for payments abroad, the levels of reserves and export earnings are vital. The effectiveness of debt management is also critical. A rapidly growing country with expanding exports and well-managed debt is likely to handle relatively high debts better than a country with slow growth, stagnating exports, and little, but poorly managed, debt.
These caveats are important in analyzing the overall debt situation. The estimated external medium-term and long- term debt of developing countries at the end of 1976 stood at some $170 billion (see Table 1). Another $50 billion or so was outstanding in short-term obligations (of less than one year’s maturity). These largely consisted of trade credits which are by nature self-liquidating. However, some countries, finding themselves in balance of payments difficulties, were turning over short-term loans for long-term purposes. These obligations in due course became transformed into medium-term to long-term debt and were then recorded as such. (Fund drawings are, of course, included in these debt estimates.)
|From official creditors||26||41||13||80|
|From private creditors4||3||70||16||89|
The low-income countries account for less than one fifth of medium-term and long-term external debt, and the bulk of their borrowing is from official sources. Most of this debt contains a relatively high grant element. Its present value when discounted at market terms is about two thirds of the nominal value. The middle-income countries’ debt is about two thirds of the total, and more than 60 per cent is owed to private creditors. (About 75 per cent of total debt from private sources is publicly guaranteed by governments of developing countries, while some of the other 25 per cent is guaranteed by the lending governments or transnational corporations. Guarantees overlap and definitions of “guarantee” vary from institution to institution.) The oil exporting countries that are heavily populated have also been relatively heavy borrowers in the past, and most have come back into the market in the last two years.
Within each income group, borrowing is highly concentrated in a few countries. India, Pakistan, and Zaire have been the principal low-income borrowers, with all but Zaire borrowing mainly from official sources. Argentina, Brazil, Chile, Korea, Mexico, Peru, and the Philippines were the principal middle-income country borrowers, with most of their debt owed to private creditors. Middle-income countries also borrowed substantial amounts from official sources—some 60 per cent of total official lending between 1973 and 1976—but the principal recipients were the poorer middle-income countries. Turkey is a rather special case where relatively small and short-term borrowing from private sources has led to problems because of underlying balance of payments difficulties. Egypt, whose per capita income in 1975 was $310 (which just brought it into the middle-income category), borrowed heavily, mainly from official sources. Algeria, Indonesia, Iran, and Venezuela were the principal oil exporting borrowers. Together, these 16 countries accounted for nearly 80 per cent of all debt of developing countries.
Debt growth in the 1970s
In 1955, when debt data were fragmentary, the total medium-term and long-term external debt of developing countries was about $8 billion. By 1960, however, it had almost doubled as new countries became independent and lending began to replace colonial transfers. After World War II South Asia moved from reserve surplus to deficit, and this was an important factor in the growth of aggregate debt. The average annual growth rate of borrowing accelerated in the early 1960s, and by 1967 the external debt of the developing countries had reached a level of $36 billion.
The late 1960s and early 1970s were periods of rapid growth for a number of middle-income developing countries, and this was accompanied by increased borrowing. This success in efforts to transfer capital to developing countries was as welcome as it was unanticipated. When petroleum prices increased in 1973, the oil exporting countries began to generate large surpluses. The recession in the industrial countries in 1974-75 led to high current account balance of payments deficits, with a concomitant jump in borrowing demand. Both borrowers and lenders had sufficient experience to be able to take advantage of this liquidity in international capital markets. Indeed, banks proved to be responsive and versatile, more so than official lenders, in meeting the developing countries’ needs in the changing conditions of the mid-1970s. Lending from private sources had already been growing more rapidly than lending from official sources in the late 1960s, when banks began first to complement suppliers’ credits and then to substitute other loans for them. (It is estimated that by 1976 suppliers’ credits only accounted for some 25 per cent, and banks for more than 70 per cent, of lending from private sources.) It was this experience in the late 1960s and early 1970s with the use of Eurocurrency funds that made the rapid acceleration of lending from financial institutions possible between 1973 and 1974.
The mid-1970s were years of high inflation. Despite the rise in nominal terms, the increase in the developing countries’ external debt was not as great in real terms as it had been in the 1960s (see Table 2). The growth of external debt in developing countries has, moreover, been an aspect of their growing participation in the world economy. There was some overall increase in the ratio of external debt to national income in the 1970s, but only the low-income countries experienced a significant rise in debt in relation to exports.
|Public debt 1955-65|
|Total debt 1967-72|
|From official sources|
|From private sources|
|Total debt 1973-76|
|From official sources|
|From private sources|
Aggregated data are of course again only of limited relevance. There are many exceptions to the general trends that these figures suggest. In some countries the ratios of debt to national income and to exports increased much more rapidly than they did for all countries in the income group as a whole; but for other countries which were in poor economic situations in the 1960s, and for the oil exporting countries, the ratios declined (see Table 3).
The increase in the developing countries’ reserves was also more rapid than the increase in debt. The official international reserves of non-oil developing countries grew from some $9 billion in 1967 to $47 billion in 1976, and for oil exporting developing countries the increase was from $2 billion to $32 billion.
Debt service capacity
Much of the current concern about the developing countries’ indebtedness arises from fears about their ability to service their debts and the possible “domino” effects if one after another should run into insoluble servicing difficulties. Clearly this is again a problem of individual countries, and particularly those that have been borrowing heavily from private sources in recent years. Some of these countries have had a history of debt servicing difficulties that have led to debt reschedulings since the 1950s; by contrast, several of the others have become relatively high debtors only in the 1970s. Part of the concern also stems from the difficulty of identifying those countries that are likely to find themselves unable to service their debts. But the causes of debt service difficulties vary widely.
In the 1960s the slowing down of flows from official sources to high debtor countries such as India led to requests for debt relief. When the rate of inflow declined, debt service obligations fell only after a lag; the combination of a decline in net transfers, stagnating exports, and high food import demand led to a critical balance of payments situation. A similar situation could recur for some of the heavy low-income borrowers from official sources if the rate of real official flows were to continue to decline sharply.
Currently, however, there is more likelihood of problems arising from the servicing of debt from private sources. Such difficulties would probably be associated with short-term balance of payments disruptions. If short-term and medium-term borrowing has been allowed to increase very suddenly in a country (especially if the authorities do not keep track of the debt service charges that are due on foreign borrowing), an unanticipated rise in service obligations may lead to a foreign exchange shortage. However, there is a greater probability that strains could be associated with sudden changes in other components of the balance of payments, such as an unanticipated drop in export earnings or an increase in imports. Such disturbances give rise to adjustment problems whether or not a country has large debt service obligations. Nonetheless, the presence of debt service charges exacerbates such a situation in two significant respects. First, the burden of adjustment falling on other flows is significantly increased. To mitigate the costs of such adjustments, it is advisable to hold larger foreign exchange reserves, and the high borrowers from private sources seem to be doing this. Second, if reserves are about to be exhausted, the financing of adjustment becomes very difficult. If other forms of balance of payments support are not available either, then a request for a refinancing accommodation from creditors could be expected as a last resort. Risk is thus determined by a great variety of factors, including the pattern of outside shocks, the speed of adjustment, the volume of reserves, and the effectiveness of balance of payments management.
|Average annual |
(In per cent)
|Debt as a |
|Oil exporting countries|
|Total, developing countries|
an Australian, joined the Bank staff in 1968, and is Director of the Economic Analysis Department. Mrs. Hughes has published widely on industrial development.
The most widely used indicator of debt servicing capacity—the debt service ratio—is thus very deficient as a measure of either the borrowers’ or the creditors’ risk. Countries with similar debt service ratios may vary widely in their ability to service their debts, whether that ratio is 10 per cent or 40 per cent; conversely, countries with widely divergent debt service ratios may have similar debt service capacities. The debt service ratio is particularly inadequate (as are all indicators) if calculated for a single year. The direction and magnitude of changes over time are crucial to any interpretation of debt service indicators.
As debt service and exports are only two of the variables which enter into the external financial position of any country, they must be used in conjunction with information about the other relevant variables such as: imports and the current account balance; the overall balance of payments; the amount of external liabilities; new external liabilities, gross and net of repayments (and disinvestment in the case of private investment); the amount of external assets (particularly reserve assets); and changes in external assets. Many of these must be “scaled” —-that is, related to other magnitudes, such as GNP, trade, or reserves. Variables when combined must be expressed in comparable units of account (such as rates of growth at constant and current prices) to avoid meaningless comparisons. In financial analysis, current prices and exchange rates are usually appropriate, although some series must be deflated to illustrate the effect of price changes.
None of the substantial efforts that have gone into the search for specific indicators or ratios which, alone or in combination, could be used to predict debt service capacity have been successful. There is no substitute for a thorough analysis of national economic management, with particular attention to the management of debt, in the assessment of creditworthiness. Such assessments must continue to rely heavily on judgment. The debt service ratio, because of the contractual charge of debt service on exports remains the relevant starting point in the analysis of creditworthiness, but it cannot substitute for an in-depth knowledge of a country’s situation and prospects based on regular contact and analysis. Casual judgment based on partial indicators may lead either to excessive optimism and a lack of prudence in borrowing or to excessive pessimism and the destruction of a balanced investment climate. An interruption in lending could, indeed, create severe liquidity problems.
Although average interest rates have risen as borrowing from private sources has increased, interest rates have lagged behind inflation so that real interest rates, even on borrowing from private sources, have been low. It is doubtful whether real long-term interest has been much above 2 per cent per annum in the last ten years or so.
The multilateral financial institutions by providing evaluations of borrowing countries’ economies have become an essential component of the maintenance and sound expansion of private capital flows to developing countries.
Overall the shortening of maturities has not been as great as was expected. Moreover, borrowing from private sources can generally be refinanced from time to time if a country continues to grow vigorously. In such cases it is the interest component of debt service that becomes relevant to a country’s ability to meet its obligations. Thus, while interest plus amortization could amount to well above 30 per cent of likely export earnings for some of the large borrowers in the next few years (reflecting the heavy borrowing of the mid-1970s), refinancing arrangements that are mutually satisfactory to borrowers and lenders could reduce such ratios quite significantly.
The uncertainty surrounding the economic prospects for the industrial countries suggests a conservative estimate for the likely volume of official capital flows in the future. A continuation of the 3-4 per cent average annual real increase experienced in the past decade seems likely. Given the severe development problems of the low-income countries and the stated objectives of aid donors to shift official flows to the poorest countries, the bulk of these concessional funds (and of grant aid) is likely to go to the low-income countries.
A redistribution of official flows in favor of low-income countries implies that the middle-income and oil exporting developing countries will wish to continue to borrow from private sources. The heavy borrowers of recent years are likely to slow down their rate of borrowing, but new borrowers, notably the densely populated oil exporting countries, are likely to increase their borrowing.
From the point of view of the lenders, two components may be distinguished. First, there is the requirement for refinancing facilities by existing borrowers who do not need to reduce their level of debt. Banks usually wish to continue a relationship with good clients. Refinancing facilities have been available for even relatively weak economies in the recent past, and they are likely to continue to be so for recent major borrowers. In addition, the requirements of several of them for new capital may be abating, as a result of their success in the adjustment process. The large oil-rich countries, however, are beginning to borrow again. Furthermore, with continuing growth, new countries are reaching levels of income and exports which make them creditworthy to private lenders, particularly if they also possess a rich natural resource.
There are also signs of potential expansion by lenders. Within the United States, which has accounted for more than 50 per cent of private lending to developing countries, the number of banks involved is growing, and European, Japanese, and other banks are also becoming more interested and participating more. Banks are attracted by the returns on lending to developing countries, which has been more profitable than lending to most industrialized countries. Differentials in interest, fees, and commissions have been sizable, while losses experienced to date have been minimal. The various forms of borrowing and lending guarantees by country and by corporation have offset what were initially perceived as risky lending operations, although guaranteed lending has risks of its own. It can diminish responsibility on the part both of creditors and of borrowers. The multilateral financial institutions by providing evaluations of borrowing countries’ economies have become an essential component of the maintenance and sound expansion of private capital flows to developing countries.
A reasonably sanguine outlook for long-term private capital flows does not mean that no problem situations will develop. The stability of international flows is always of great concern. Even with the competence of debt management in countries such as Brazil and Korea, there remains the risk of payment difficulties arising from political disturbances, external balance of payments shocks, and natural disasters. For less ably managed economies, there is the added risk of domestic mismanagement. Should there be a disruption and arrears on debt service in some major debtor country, the confidence of the banking community may well be threatened. Another risk is that some creditors may suddenly withdraw their support from one or more countries because they feel overexposed, because political events lead to an impairment of confidence, or because bank examiners conclude that claims have become too risky.
Such risks may be judged small or great by different observers, but they are indisputably real. The relatively short maturities of private lending and the need for frequent refinancing or new borrowing makes the situation particularly vulnerable to such risks. However, the situation also contains important elements of strength. The range of financial facilities to which middle-income countries now have access is more flexible than in the past. This makes it possible for them to manage maturities and to mitigate bunching problems more easily. The Fund’s facilities are being expanded. The reserve positions of many countries have been greatly strengthened. The major banks active in lending to developing countries assess country risk and are not likely to lump dissimilar situations together; in their view, the most dynamic developing countries have already become more attractive investment prospects than some of the problem-ridden industrial economies. The links between the banks and their clients in developing countries also seem a more stable relationship than was the case when these countries depended on suppliers’ credits. Furthermore, borrowers from private financial sources are likely to be reluctant to request rescheduling when they realize that this step could cut off their access to private sources of borrowing. In sum, there are debt problems, but with appropriate policies they should be manageable.