In looking at the short-term outlook for flows through international capital markets, the issue which has aroused most concern is the extent to which the markets will be able to play a major role in financing the deficits of oil importing countries, particularly developing countries. The broad conclusion reached in this paper is positive, but there are a number of significant qualifications, the most important of which is that while global constraints on bank lending are not likely to be an impediment to such recycling, some individual countries may well face difficulties.
In assessing the outlook it is useful to recall the experience following the 1973-74 oil price increases. In spite of the concerns expressed at the time, financing through international capital markets increased markedly, making a substantial contribution toward permitting adjustment to the rise in oil prices to be carried out gradually. Lending by international banks was particularly important for the non-oil developing countries. The process was by no means a smooth one and was disrupted at the time of the 1974 bank failures; as a result, spreads between lending and deposit rates widened sharply in 1974 and 1975. By and large, however, the markets can be said to have carried out successfully a major share of recycling. In this they were assisted by a favorable macroeconomic environment. The 1974-75 recession reduced lending opportunities in the industrial countries, so that banks were willing to maintain their lending to the developing world, and at the same time real interest rates were low enough to keep debt service requirements from becoming too onerous. The fact that in 1975 and 1976 industrial countries were able to reduce their demands for international bank lending by increasing their use of the international bond markets also enhanced the capacity of banks to intermediate for the non-oil developing countries.
Chart 1Net lending through international capital markets, 1971 to June 1980
1/ Does not exclude double counting due to banks’ issuing and holding of bonds. Totals for first half of 1980 are at annual rate
Comparisons with the previous experience are in some ways encouraging. Relative to the scale of recent international banking flows, the aggregate current account deficit projected for the non-oil developing countries in 1980 is considerably smaller than in 1974. Given the need for balance of payments finance, the macroeconomic environment for bank lending is once again broadly favorable. The slowdown in economic activity in the industrial countries will encourage banks to seek lending opportunities among developing countries. Interest rates appear to be declining from their recent peaks. The international bond markets are larger than they were in 1974, and with the term structure of interest rates now more favorable to bond issues than it has been in recent years, bond markets may be able once again to play a significant role in the recycling process. [Interest rates on U. S. dollars rose in the final months of 1980, after this paper was published.]
Other comparisons are less encouraging. As in 1974, doubts about the ability of the banks to intermediate to a sufficient extent stem from fears that prudential concerns will constrain bank lending, particularly if such constraints are reinforced too strongly by the trend, mentioned earlier, toward stronger regulation of international banking. Prudential and regulatory constraints apply both to balance sheet aggregates (such as capital-asset ratios and the relative maturity structure of assets and liabilities) and to exposure to particular countries.
Chart 2Non-oil developing countries: financing through international capital markets, 1971-80
1/ Totals for first half of 1980 are at annual rate.
Chart 3Terms on lending through international capital markets, 1973-80
1/ Medium-term publicized international bank credit commitments.
At the broad level the constraints do not appear to be critical to the aggregate volume of bank lending. It is true that if banks find themselves unable to cover the cost of prudent behavior, such as raising additional capital or increasing the maturity of their liabilities, they will cut back their lending; but if there is strong demand for loans, spreads between loan and deposit rates will rise, and banks will once again find it worthwhile to expand their role as intermediaries. In any short period, of course, there are bound to be limits on the extent to which lending can be increased, but the demands foreseen for 1980 do not appear so large as to test those limits. With the continuing standoff between borrowers and lenders, the extent to which spreads may have to rise is not yet clear. But there is little reason to think the increase will be so large as to strongly dissuade potential borrowers (which, for sovereign borrowers, might imply inappropriately rapid adjustment); fluctuations in market interest rates are likely to be a more important factor in borrowers’ decisions.
At the individual country level, however, constraints imposed by concern about creditworthiness might be more critical. After 1974 there was relatively rapid adjustment by many surplus and deficit countries, but there is no assurance that the process will operate as smoothly this time. At some point, continuing large deficits may threaten the ability of countries to continue servicing their debt, and if banks foresee such problems in individual countries they will be reluctant to continue lending to them. Bank exposures to a number of developing countries, moreover, are relatively larger in bank balance sheets than they were in 1974, leaving the banks with less room for additional loans to such countries. For 1980, the fact that most countries will be able to draw on high levels of reserves, as well as to draw down existing commitments and expand their use of trade finance, means that they should be able to get by with relatively modest amounts of new medium-term credit, but beyond the end of this year the picture is cloudier.
Thus, while broad balance sheet considerations do not appear to imply a problem for recycling, and while concerns about country risk are not likely to lead to any critical restraint on financial flows to particular borrowers in the current year, beyond 1980 the uncertainties are great. The non-oil developing countries will need to maintain a policy stance consistent with adjustment to the deterioration they have experienced in their terms of trade if banks are going to be willing to continue lending to them. If the oil surpluses persist, however, new steps will have to be taken to assist the traditional mechanisms in carrying out the recycling function.
The possibility that some significant borrowers may have trouble obtaining adequate financing beyond 1980 has broader implications. There is no obvious danger, in the near future at least, of the kind of significant bank failures which triggered an abrupt increase in spreads and a temporary disruption of the market in 1974. On the other hand, there is increasing concern about the “political” risk that, in today’s unsettled international environment, political actions might be taken which directly or indirectly would result in defaults by significant international borrowers. The debt crises in a number of countries in the late 1970s were on a relatively small scale which did not threaten banking stability, but the results could be more serious if one or two major borrowers experienced such crises, whether because of “political” factors or because of more purely economic difficulties.
International Capital Markets: Recent developments and short-term prospects (September 1980) was prepared by an IMF staff team headed by Richard C. Williams. Members of the team included Ulrich Baumgartner, Henri Chesquiere, Nancy Happe, C. C. Johnson, and Saul Rothman. Copies of this Occasional Paper may be ordered from Office of External Relations, Attention: Publications, International Monetary Fund, Washington, D.C. 20431, U.S.A.
To our readers
Finance & Development is distributed without charge by
the International Monetary Fund and the World Bank
to qualified readers. Once your name is on our mailing list,
you will continue receiving our publication only if you return the poll card
that will be sent to you every three years.
When you receive your poll card, you must return it promptly.
Otherwise, your name will be dropped from our list.