Do the London Accord of 1953 and the Indonesian settlement of 1970 offer any guidance in resolving today’s debt problems?
Recently a number of people have suggested that the sovereign external debt of severely indebted countries should be treated and renegotiated in the same way as the Federal Republic of Germany’s obligations after World War II. Yet most who make that suggestion have a rather inexact idea of the nature of the German debt and how it was treated. This article attempts to describe the German debt that was subject to renegotiation in 1951-53 and to explain how it was treated in the London Accord of 1953. The article then goes on to consider the other similar major debt settlement—Indonesia in 1970—designed by Hermann Abs, the head of the German delegation that participated in the London Accord. For many of today’s sovereign debtors—particularly those for whom a large proportion of their debt is either owed to official creditors that participate in the Paris Club or to other bilateral official creditors—the Indonesian exercise probably constitutes a more appropriate model.
The conference that led to the London Accord was convened by the Tripartite Commission on German Debts, consisting of representatives of the governments of the United Kingdom, France, and the United States, and was attended by delegates from creditors in 22 countries, observers from three countries, as well as the Bank for International Settlements.
Germany’s position at that time could be convincingly presented as being unique—a major industrial nation, defeated in war and partitioned, with many of its industries destroyed, but nonetheless a nation whose political and economic health the creditors’ governments were anxious to restore. The London Accord dealt both with Germany’s prewar debt, which was in large part owed to foreign bondholders, and Germany’s postwar debt owed to the Governments of the United Kingdom, France, and the United States, arising from economic assistance.
The occupying powers offered concessions on these postwar claims (which amounted to some $3.7 billion), provided the German Government was able to reach an equitable settlement on its prewar debt. Agreement on all the main terms for dealing with this prewar debt was reached by August 8, 1952. The Tripartite Commission thereafter proceeded to draft the intergovernmental agreement containing the terms of this settlement, as well as the bilateral agreements providing for the postwar claims. These agreements together constitute the London Accord, which was signed in February 1953. However, it is with the treatment of the prewar debt—in particular the sums outstanding on the Dawes and Young loans—that this article is mainly concerned.
This article makes substantial use of Hermann Abs’ own writing and of Dr. Thomas Kampffmeyer’s “Towards a Solution of the Debt Crisis: Applying the Concept of Corporate Compositions with Creditors,” German Development Institute, Occasional Paper No. 89.
Categories of prewar debt
The authorities of the Federal Republic of Germany had accepted responsibility for all official German debt of the prewar period (despite Germany’s postwar partition) and for the debt that Austria incurred while it was under German occupation.
A steering committee and four negotiating committees, each with representatives of both creditors and debtors, dealt with the main classes of debt. These were, first, the Reich and Lander debts (i.e., the debt of the various government authorities), which were mainly in the form of bonds and accounted for about half the total principal owed. Second, there was debt to banks in various countries covered by a “standstill agreement” concluded between German banks and their foreign creditors after Germany had run into foreign exchange difficulties in 1930. Third, there were commercial and industrial obligations, most of which were attributable to debts arising from foreign ownership of industrial and other assets in Germany. Fourth, there was a wide variety of other medium- and long-term public obligations, but these amounted to only a very small part of the principal outstanding.
How much was owed?
Mr. Abs has been quoted as saying that before the London Accord, the German debt was DM 29.5 billion (comprising prewar debt of DM 13.5 billion and postwar debt of DM 16 billion), and that after the London Accord the debt was DM 14.3 billion (comprising prewar debt of DM 7.3 billion and postwar debt of DM 7 billion). Expressed in this way, the nominal debt reduction achieved in the London Accord would appear to be a little over 50 percent.
In fact, although conventionally quoted, this estimate understates the concessions gained by Germany in respect of the pre-World War II obligations. That is because the figure quoted by Mr. Abs did not fully take into account either the application of the gold clause, which was part of many of the original loan agreements, or the compounding of interest upon interest that was in arrears. Taking these two elements into account would have substantially increased the amount of the prewar debt owing to foreign bondholders.
Who were the creditors?
In 1951, the foreign creditors whose prewar loans had not been serviced for almost 20 years were, in the main, bondholders. They were not the major commercial banks, export credit agencies, or multilateral financial institutions. Save to the extent that governments themselves held the bonds, the creditors did not truly have the power to negotiate on their own behalf, let alone to impose a settlement upon the debtor. The negotiating was, in fact, done by officials of the governments of countries where most of the bondholders were known to be domiciled. These countries were the United States, the United Kingdom, Switzerland, France, the Netherlands, and Sweden. It was estimated that US claims represented about 40 percent of the total, while British claims were about 17 percent.
The terms of the settlement
As presented in August 1952, and reproduced in the financial press at the time, the individual measures proposed for reducing Germany’s obligations arising from its prewar debts appeared quite modest. They would not, in most cases entail any reduction in the original principal amounts. Arrears of interest up to 1944 were to be recalculated at about two thirds the contracted rate of interest, on the basis of simple rather than compound interest, and were generally to be funded with 20-year bonds carrying interest at 3 percent. Some bonds representing arrears of interest due after 1944 would not be issued or paid until after the unification of Germany. Future interest obligations were to be reduced below those of the original contracts. For example, the rate on the Dawes Loan (non-US issue) would be reduced from 7 to 5 percent, and on the Young loan, from 5½ to 4½ percent. Amortization would begin after five years, with extended maturity dates, but repayment would be accelerated if creditors were prepared to accept blocked deutsche marks for investment in Germany.
Finally the gold clause, where it had previously been applicable (i.e., for virtually all major loans other than those with a dollar clause), was dropped and replaced by a dollar clause. The gold clauses were initially inserted in loan agreements to protect lenders against depreciation of their own currencies, and required that payments of both interest and capital should be at a rate that would yield the equivalent in gold to the values prevailing at the time that the original loans were contracted. From the period of contracting the loans up to 1952, the dollar had depreciated about 40 percent against gold, while the European currencies (with the exception of the Swiss franc) had depreciated by much larger percentages. The substitution of the dollar clause for the gold clause meant, therefore, that all claims subject to a gold clause as of 1952 were reduced by approximately 40 percent, with the prospect of further reductions in future obligations should the price of gold expressed in dollars rise further.
Measuring debt relief
There is more than one way of measuring debt relief. One way is to compare the present value of the payments to be received by creditors under the negotiated settlement with the present value of the payments the creditors would have been entitled to under the terms originally contracted. On that basis, taking account of (1) the removal of the gold clause, (2) the agreement not to compound interest on interest payments that had been in default, and (3) the lowering of the interest due on future payments, I have calculated that the London Accord offered Germany debt relief of about 70 percent on its main categories of prewar defaulted loans.
To those reading a summary of the provisions for the first time, that degree of debt reduction may seem surprising. But there are a number of reasons why the extent of debt reduction embodied in the London Accord is substantially greater than an initial reading might suggest. First, the present value of the stream of interest receipts from a long-dated bond is likely to exceed substantially the present value of the eventual repayment of the principal. It is, therefore, advantageous for the debtor to offer to leave the principal owed intact in exchange for concessions on the interest rate. Second, when arrears have been allowed to accumulate for some 20 years, the small retroactive change from a compound to a simple interest rate amounts to a very considerable concession. (The BIS appears to have been the only creditor in the settlement to have been granted interest on the arrears of interest.) Third, the various concessions were structured in the deal effectively to enhance each other. Fourth, the abandonment of the gold clause amounted, in itself, to a major concession.
Indonesia and its creditors, 1968
It was a political event—the ending of the Sukarno Government in 1966 and its replacement by the government of President Suharto—which paved the way to a situation where the Indonesian Government was prepared to settle with its creditors and the main creditors were keen to settle with Indonesia. At issue was $3,133 billion of debt, at end-1968, distributed between four main groups of creditors, The Inter-Governmental Group of western creditors was owed $1,558 billion (of which the United States $565 million, Japan $373 million, Germany $227 million, Italy $150 million, and France $142 million); Eastern bloc creditors, including China, were owed $1,173 billion (of which USSR $864 million, Poland $127 million, Czechoslovakia $74 million, and German Democratic Republic $62 million); other governments were owed $157 million (of which Yugoslavia $120 million), and residual commitments amounted to $246 million. Thus the Soviet Union was, by quite a large margin, the largest single creditor and the United States the next largest.
At a Paris Club meeting in October of 1968, it was agreed that an independent expert be asked to analyze Indonesia’s debt problems and to propose various options for solving them. In early 1969, Hermann Abs accepted this commission, with the World Bank and the Kreditanstalt fur Wiederaufbau agreeing to share its cost.
The aim was to restore Indonesia to international creditworthiness with access to normal credit facilities, to make it eligible for loans from the international financial institutions and from private sources, to restore the country as an important partner in world trade with a view to reducing dependence on foreign aid, and “to give the Indonesian government freedom and independence in its decisions on fundamental economic questions.”
As in the London Accord, Mr. Abs stuck to the principle that the principal of loans should (eventually) be repaid in full, but that creditors should be realistic in accepting prolonged amortization periods and reductions in contracted rates of interest. He posited that it would be hard for Indonesians to understand if the debts inherited from the Sukarno period could not be cleared within a generation, effectively defined as 30 years. When anticipated aid flows were taken into account, the impact of the revised debt-servicing burden should not be such that it would impede an acceptable rate of economic growth. In calculating the relief that would be required, Mr. Abs referred to the tenet that a debt-service ratio should not normally exceed 15-25 percent of export earnings. But he recognized that the government’s capacity to generate resources internally was likely to be even more restricting than the country’s ability to make external transfers.
In line with its terms of reference, the Abs report offered the creditors three options. First, to continue with annual negotiations, in which case these obligations would accumulate quite quickly to a sum that would clearly be beyond the debtor’s capacity to repay. Second, to defer the problem to some time in the future by agreeing on small annual payments to the creditors for a number of years, leaving it open as to how the balance should be treated. Third, to seek to implement a comprehensive solution based upon a realistic view of the situation. Mr. Abs made it clear that he himself favored the third option and offered proposals accordingly.
Despite opposition for a considerable period from the Governments of Germany, the United Kingdom, France, and Italy, the Abs proposals were eventually agreed to on April 24, 1970, by Indonesia and all categories of creditors, with only one significant modification, which related to the rescheduling of interest arrears rather than their outright forgiveness. Parallel, but bilateral, negotiations with the USSR, Yugoslavia, and other Eastern bloc creditors had procured agreement on terms that were similar (and in some respects more favorable to the debtor) than the terms agreed to by participants in the Paris Club.
The 1970 settlement
In the settlement, principal and interest owed were again treated differently. Repayments of all principal owed on credits with maturities of more than 180 days were rescheduled, at a zero rate of interest, to be made in 30 annual installments from 1970 to 1999. However, during the first eight years (1970-78), Indonesia was allowed the option of deferring 50 percent of the annual amortization installments on three occasions until the last eight years (1992-99), the interest on any such deferments being at 4 percent. Advantage was later to be taken of this favorable clause.
All interest owed on the earlier loans and additional interest arising from earlier rescheduling operations were consolidated into a sum that, without attracting future interest, would be repaid in 15 equal annual installments commencing in 15 years’ time (i.e., in 1985). The net effect of these provisions, taken together, amounted to debt relief of 57 percent.
As part of the settlement, Indonesia and the creditor countries were to be given the opportunity to review the arrangements after ten years in the light of Indonesia’s economic development, with the option either of bringing forward the amortization payments of principal, or of completely—or partly—canceling the repayments of the contractually agreed upon interest.
Principles as precedent?
How much of what was accomplished in the London Accord in 1953 and in the Indonesian settlement of 1970 can usefully serve in the 1990s as a precedent for other severely indebted countries?
The differences and the difficulties facing debtors and creditors alike are formidable. One problem resides in the different mixture of creditor institutions confronting sovereign debtors today, which may well render agreement between all of them more difficult. Another major difference for many sovereign debtors is the predominance of commercial bank debt at variable interest rates, along with the impact of different national regulatory and tax treatments. Still another problem may be described as a form of contagion. Whereas it was possible to present Germany in the early 1950s and Indonesia in the late 1960s, each as something of a unique case that need not set a precedent, so many debtor countries are in a similar predicament today that concessions in the form of debt relief accorded to any one are bound to be cited as a precedent by many others.
Nonetheless, it does seem that there may be some principles and lessons to be derived from the study of these two major settlements that might be applied with mutual benefit in future settlements with creditors. For the creditors, it appeared easier to accept reductions in interest due and in arrears than on the principal of the loans; and in the German settlement, very substantial relief was accorded through the cumulative impact of a series of concessions rather than through a single major write-down of claims. Not all classes of debt were considered to have an equal weight of claim, but within each class of debt all creditors were treated equally.
On the debtor’s side, probably the most important consideration was that the terms of the settlements were compatible both with the internal transfers to government that would be required to meet repayment schedules and with an external balance of payments position compatible with an acceptable rate of economic growth. Other important factors were the existence of substantial arrears in the case of Germany that clearly were not going to be serviced at all without a settlement, and the genuine desire of creditor governments to see the debtor nation, following political reform, regain normal access to capital markets. For even the reduced debts to be serviced—as they were after both the German and the Indonesian settlements—the governments and peoples concerned need to be offered a convincing prospect of recovery.