Why borrow? Every student of economics in his first semester is taught that the three basic factors of production are land, labor, and capital, and that the relative abundance or dearth of these factors will shape what and how much a country may produce. This rather crude and elementary postulate cannot, of course, tell us very much about the actual structure of production, which depends on a host of other factors, especially once one admits the role of international trade. But it will serve as a point of departure.
Characteristic features of virtually all less developed countries (the major oil exporters being the significant exception) are a dearth of capital and a relative abundance of land and labor. The scarcity of capital reflects, especially in poorer developing countries, an inability to generate adequate domestic savings. A developing country attempting to mobilize the capital resources needed to foster economic development may try one of two basic approaches or a combination of the two: it may opt to try to “go it alone”—depending on its own efforts to generate the necessary resources; or it may decide to supplement whatever domestic savings can be mobilized by imported capital, that is, by borrowing abroad.
To a large extent, the emphasis on the first, autarkic, and the second, “internationalist,” approach depends on the prevailing social and political ethos of the country in question and its willingness to enter into economic intercourse with other nations. This stance will color not only how the developing country views the role of foreign capital but also how countries, whose own surplus savings (or whose financial market in the case of recycled savings) provide the supply of capital, regard the prospects for lending to that country. Economic aid apart, the willingness of capital exporters to provide financial resources depends not only on narrowly quantifiable ratios such as the expected rate of return, but also on a broader assessment of risk which encompasses the political and economic policies and prospects of the borrowing country.
External capital inflows supplement domestic savings and, at the same time, provide the borrower with scarce foreign exchange. Their effect on development depends, of course, on the use to which these flows are put. If borrowing is used simply to satisfy some current consumption need, then it will clearly not contribute to economic growth and may in fact retard it. On the other hand, if borrowing is used for investment in productive ventures, then it could play a considerable role in the mobilization and better utilization of the country’s available resources. The foreign exchange could, for instance, be used to import the machinery and technical expertise needed to produce and process domestic reserves of minerals. External borrowing may also be used to meet purely transitory problems, such as a balance of payments (BOP) crisis brought about by a shortfall in the country’s main export commodity. In such cases, foreign borrowing could make an indirect contribution by helping to avoid the necessity for drastic measures, which might interrupt its development program, in order to cope with temporary difficulties. In such a situation, however, a correct diagnosis of the problem would be crucial: unless the difficulties were truly transitory and self-reversing, borrowing abroad could well delay necessary adjustments.
Surge in borrowing
Recourse to external capital is not a necessary precondition for rapid economic development, and it is certainly not a sufficient one. However, borrowing abroad to supplement domestic savings has been a feature of most countries at some point in their historical development, at least since the industrial revolution. For example, the United States was a net capital importer until around the turn of the present century, and pre-revolutionary Russia borrowed extensively from Western European countries. In our own time, flows of capital across international boundaries have reached unprecedented levels, spurred on by high levels of economic growth in the advanced countries (hence, a supply of capital) and the conscious and deep commitment of most governments in the developing world to accelerate the pace of economic development (hence, a demand for capital). These tendencies were promoted and facilitated by the generally liberal climate of the international economy since World War II, in particular the removal of restrictions on payments and financial transfers. In the decade of the 1970s, there was a dramatic increase in borrowing and external debt, as shown in the accompanying chart and table, brought about by these factors together with the sudden phenomenon of large surpluses of oil exporting countries. The level of outstanding public debt (including the undisbursed element) rose from $74.7 billion in 1970 to an estimated $351.9 billion in 1978, which represents an average annual growth rate of over 21 per cent. To get a full measure of the dimensions of this international financing one would have to add the short-term debt (that is, less than one year’s maturity) as well as the nonguaranteed private borrowing by developing countries. This total can only provide a rough idea of magnitude, since some countries may not report such debt; but total nonguaranteed private borrowing by developing countries in 1978 was thought to represent about 17 per cent of total public and publicly guaranteed debt.
Foreign loans must be repaid, even if this is done through new borrowing. If a borrowing country’s repayment commitments surpass its ability to service its debt and to raise new capital, debt servicing problems will arise. The enormous surge in borrowing during the past decade outstripped the economic performance—in particular, the export growth—of some developing countries, taxing the debt servicing ability of these countries, even though in global terms, because of inflation, the growth of exports by all developing countries has been in line with the growth of indebtedness during the last decade. However, there has been a large increase in the number of countries encountering external debt problems during this period. Between 1974 and 1979, the number of countries that experienced arrears on their external debt obligations or were obliged to seek a rescheduling of their foreign debt rose from 4 to 20. The need for borrowing by developing countries is not likely to abate in the 1980s. On the contrary, given the needs of development, the necessity of servicing the outstanding foreign debt, and the financial requirements of meeting anticipated current account BOP deficits—particularly serious in view of the sharp increase in energy prices and the slowdown in the world economy—the need to borrow abroad is likely to increase. If there is a further increase in such borrowing, the prospect is for more countries to face difficult debt servicing situations. This enhances the need for appropriate policies on the part of the borrowers to avoid incipient difficulties.
The effects of certain economic decisions are instantaneous or short term. Decisions regarding borrowing abroad, on the other hand, have repercussions over a long period of time. A decision to borrow $100 million today will set in motion a stream of financial obligations that have to be met over, say, a period of 15 years. Put differently, a decision to contract foreign debt involves earmarking a portion of the borrowing country’s future production. Thus, mistakes can be costly, but, because of the long-term nature of much debt, they may be fully revealed only many years later when the obligations have become burdensome—a burden probably being faced by a different set of policymakers. Hence, the central purpose of external debt management is to determine how much foreign debt a country should be contracting over time and on what terms.
|Average rate of growth|
|1970||1971||1972||1973||1974||1975||1976||1977||1978||(In per cent)|
|Africa (south of the Sahara)||7.9||9.3||10.5||14.6||18.5||21.6||25.6||31.1||37.7||21.6|
|East Asia and Pacific||8.8||11.6||14.4||17.5||24.5||30.1||38.4||46.0||58.4||26.7|
|Latin America and Caribbean||21.3||24.0||29.1||36.2||46.8||55.6||72.0||87.3||109.7||22.7|
|North Africa and Middle East||10.9||13.4||15.7||20.1||23.4||31.6||40.0||55.3||64.9||25.0|
|More advanced Mediterranean countries||10.4||12.6||14.6||16.6||20.6||23.3||28.8||34.3||41.3||18.8|
Components may not add to totals due to rounding.
Components may not add to totals due to rounding.
There is no simple or magical formula for determining a figure for the “optimal” indebtedness of a country, even though, as in other fields of economics, elaborate mathematical approaches have been attempted. Besides, the concerned policymaker does not have the luxury of dealing in abstract terms based on models of how the economy supposedly functions. He has to balance the many competing needs and pressures of the economy, and external debt is only one part of a much broader macroeconomic picture.
In regard to debt management, the policymaker must take account of the long-term consequences of his decisions; his policies will also be influenced by the repercussions of past decisions. In other words, he must begin with the level of already contracted and outstanding external debt, its maturity structure, and the stream of debt service payments to which the country is already committed. He then has to take into account a number of other crucial factors. The most important are forecasts of the economic performance of the country, reflected not only by the anticipated growth in the gross national product (especially the growth in exports), but also by factors such as inflation, the country’s ability to generate savings, and the level of reserves. These will help him to partially determine how much debt the country can afford. Another aspect of this same question is the cost of new debt, namely, the maturity and interest rate of new loans. Bearing in mind the cost, the policymaker must decide what is the country’s capacity to incur new debt or, in other words, what is the sustainable rate of growth of new foreign borrowing over time for the country in question?
If an idea of the sustainable level of debt is one thing, the decision of how much of the capacity to utilize and what types of loans to contract is a difficult matter. The latter is a function of numerous factors reflecting the country’s economic structure and needs. The debt manager’s task, however, is also to ensure a tolerable structure of debt, that is, an adequate spread of maturities; diversification of borrowing sources; maintenance of a margin of borrowing capacity for unforeseen developments, such as emergency borrowing for BOP; and so on.
One of the key difficulties of debt management is that neither the policymaker nor his country has control over many of the main determinants of the factors in the evaluation. For example, the growth of exports for most developing countries is subject not only to the vagaries of climatic conditions (for agricultural products) but also to the changes in the level of economic activity in industrial countries (for mineral products): both of these factors are entirely beyond the control of the developing country in question. Similarly, the terms on which new debt can be contracted are exogenous; they cannot in general be influenced by any particular developing country: they are determined by forces in international capital markets which reflect overall supply and demand conditions. Too much must not be made of these points, however. One of the basic arguments for borrowing abroad is that it will allow additional investment and thus promote the growth of exports. This implies that export growth is not entirely exogenous, beyond the reach of a country. On the contrary, external borrowing can provide the ingredient essential for export growth; but it must be accompanied by proper national policies essential to ensure that it is fruitful.
If a principal goal of external debt management is to keep the growth of debt within the country’s capacity to service it, a second objective would be to take actions to anticipate and avoid potential debt crises. If one occurs, officials should undertake timely rescheduling of the debt on appropriate terms. To some extent these crises are engendered by outside forces beyond the country’s control. For example, a country’s ability to service debt may be suddenly and sharply affected by an export shortfall, and this danger will be greater the larger the country’s exposure to foreign borrowing. Here the task would be to overcome a short-term “cash squeeze” problem. More fundamentally, domestic and external policies—such as rapid monetary expansion or an overvalued exchange rate—may cause BOP problems, which, of course, will create difficulties for external debt management. The task of forecasting potential debt servicing difficulties would be easier if there existed readily identifiable warning signals. This, unfortunately, is not the case. Not only can debt problems arise very suddenly, but also they can be due to a variety of factors, many of which cannot be predicted with any useful degree of accuracy. (Nor is a knowledge of past debt problems of much use in forecasting the future.)
A third, more mundane, but nonetheless important, aspect of debt management involves a satisfactory system of monitoring, registering, and approving of foreign debt. Indeed, without a satisfactory system—that shows the country’s debts, who is borrowing, and how much—the other objectives of external debt management cannot be adequately met.
When debt crises do occur, the debtor country has to enter into negotiations with its creditors on the rescheduling of its debt, to stretch the forthcoming repayments over a longer period than originally agreed. Here again, prompt debt management action is important. A rescheduling is relatively easier when the debt crisis involves “bunching,” where the principal cause of the problem is one of maturity structure, with an excessive number of repayments falling due in a relatively short period of time. Far more difficult are the cases where, in addition to excessive borrowing and bunching, there is a more basic cause of the debt problem—a deeper BOP crisis whose origin must be sought in monetary and fiscal policies, inflation, an overvalued exchange rate, stagnation of exports, or an excessive growth of imports. In such cases, a rescheduling of the debt repayments will bring short-term relief, but, unless the underlying causes of the problem are addressed, the debt problem is merely postponed and renewed negotiations become necessary a year or two later.
The Fund and external debt
The International Monetary Fund is involved with the external debt problems of its members in two important respects: first, in cases where Fund resources are made available in support of a stabilization program, the stand-by arrangement often includes provisions regarding new borrowing during the period covered in the arrangement. Second, the Fund plays an important role in cases where its members face debt rescheduling situations.
The Fund’s Executive Board adopted new guidelines in August 1979 for performance criteria relating to external debt limitations in IMF-supported stabilization programs as part of a general review of the conditionality attached to the use of Fund resources undertaken earlier. The core of the guidelines is that, when the size and growth of external debt in a member country is a relevant factor in the design of an adjustment program, limitations may be placed on new foreign loans with maturities of over one year, up to a limit determined by conditions in international capital markets; at present, the upper limit includes loans with maturities of from 10 to 12 years.
External public debt outstanding (including undisbursed) of 96 developing countries, by type of creditor, 1970-78
Source: World Debt Tables [World Hank. EC-167/79] Volume 1.
The rationale for the inclusion of debt ceilings as an integral part of stabilization programs is twofold. First, it may be assumed that there is considerable substitutability between domestic and foreign sources of credit. As one of their fundamental features, stabilization programs invariably contain limitations on the expansion of domestic credit. These limitations could be evaded and hence exceeded if potential borrowers were able simply to substitute foreign for domestic credit. Second, apart from, or in addition to, the need to attain the objectives of the credit program, it may be desirable to set debt limitations in cases where a country is facing an actual or imminent debt servicing problem. In the case of maturity bunching, for example, the purpose of the limitation would be to improve the maturity profile of the country’s debt by restricting the number of new debts with relatively short maturities.
The second aspect of the Fund’s role relates to the renegotiation of existing foreign debt between a member country and its official creditors. Typically, these negotiations take place in Paris and are referred to as “Paris Club” renegotiations. The Fund plays the role of a neutral middleman, its task being to assist both sides to achieve a satisfactory solution. For the developing debtor country, the Fund provides technical assistance and support in preparing the necessary documentation and the analytical review to be presented at the creditors’ meeting. For the creditors, the Fund pro vides an assessment of the economic situation and prospects of the debtor country. A Fund representative, who takes part in these negotiations, may provide additional details to creditors regarding the economic performance of the country in question, including an assessment of the BOP implications of alternative proposals for debt relief made by creditors. Frequently, the creditors make the granting of debt rescheduling subject to the conclusion of a stand-by arrangement between the member country and the Fund.
This brief survey suggests that, while external borrowing can make an important contribution to economic development by increasing the resources available for development, it cannot simply be left to itself under the assumption that somehow the debt will refinance itself for an indefinite period. The management of external debt, which in essence involves matching a country’s borrowing capacity to its economic performance, is an important component of economic policy. It is not an easy task, since some of the major determinants of economic performance, and hence borrowing capacity, are beyond the control of the national authorities. Nevertheless, the control of foreign indebtedness and the avoidance of debt crises, does lend itself to prudent management. In the longer run such management would assist rather than hamper the course of economic development.