V. Reform 1982-83
- Michael Ainley
- Published Date:
- September 1984
It took a crisis to establish the General Arrangements to Borrow. It took another crisis to persuade the participants to change them. On both occasions, Fund quotas were inadequate; and on both occasions, the major industrial countries were unwilling to consider large quota increases as a way of meeting the problems. Instead, in 1982, the Group of Ten agreed to major reforms of the GAB similar, in most respects, to those which they rejected in 1978. Why did this happen? What are the changes? And how will they affect the Fund and the international monetary system in the period ahead?
1. The Reason Why
Reform of the GAB was a direct response by the major industrial countries to the serious strains which emerged in the international financial system in mid-1982. In short, the debt crisis. The strains, which became apparent with the well-publicized problems of Mexico and Brazil, were deep-rooted. They can be traced back to the growing inflationary pressures of the late 1960s and 1970s, to the oil price increases of 1973-74 and 1979-80, and to the unexpected depth and severity of the world recession after 1980. They can also be traced to delayed adjustment in many countries, industrial as well as developing, to the new, harsher economic conditions. Many countries, and the oil importing developing countries in particular, experienced large current account deficits which had to be financed by foreign borrowing on an unprecedented scale.
From 1973 to 1981, the total outstanding external debt of the non-oil developing countries increased at an average annual rate of approximately 20 percent. In 1981, this debt amounted to some US$555 billion, compared with US$336 billion in 1978.81 The ratio of this debt to these countries’ export earnings reached 120 percent in 1981 (and an estimated 137 percent in 1982). The extremely uneven geographic distribution of the debt was also significant. Much of it was concentrated among a small group of major borrowers in Latin America and Eastern Europe. The debt-service ratio for these countries was much higher than the average figure.
The bulk of the debt was owed not to official creditors, like the Fund, but to private banks, which had assumed the central role, in the 1970s, in recycling the Organization of Petroleum Exporting Countries (OPEC) surplus, in particular, and in intermediating between surplus and deficit countries, in general. In a sense, this role was a natural one. It was widely applauded at the time. On the one hand, the oil producers with structural surpluses, whose absorptive capacity was limited, needed a well-established commercial outlet for their surpluses that would enable them to make short-to-medium-term investments. On the other hand, the financing requirements of the (mainly oil importing) deficit countries far exceeded the amounts available from official aid, trade credits, and project finance, as well as from the regional and international financial institutions.
From the banks’ standpoint, country lending was more profitable than domestic lending. It provided new avenues for growth and expansion when loan demand in the industrial countries was depressed by recession and corporate failures. It looked reasonably safe in the light of historical experience with international loan losses up to 1975. The few reschedulings that had occurred had been handled smoothly. As importantly, the overwhelming proportion of new lending, notably by U.S. banks, went to supposedly healthy countries, like Mexico and Brazil, with impressive growth records and favorable export prospects. The banks were in a highly competitive market and were relying, in several cases, on out-of-date or inadequate information about the countries concerned. In the late 1970s, they assumed, as did most official forecasters, that global recession would be short-lived; that inflation would remain high, reducing the real value of the debt to be repaid; and that commodity prices would resume their upward trend, allowing country borrowers sufficient margin to repay.
After 1980, these assumptions were shown to be false. The world recession intensified in 1981 and 1982. The major industrial countries, notably the United States, moved decisively to monetary restraint, which was designed to break the upward trend in inflation and inflationary expectations in their economies. The result was slow growth, weak import demand, and very high interest rates for foreign as well as domestic borrowers. Protectionist pressures increased, and the volume of world trade actually fell, by 2½ percent, in 1982.
For the borrowing countries, this meant growing strains on both their current and capital accounts. Commodity prices remained low and export markets weak. At the same time, high interest rates generated large and unexpected additions to debt-servicing costs, on outstanding as well as new borrowing, since much of the banks’ lending was at floating rates of interest. Major borrowers, like Mexico and Brazil, were forced to rely increasingly on more expensive short-term loans; but this simply worsened the vicious circle of rising debt-service payments and additional borrowing needs, concentrated within a very short period.
For the banks and bank supervisors, levels of debt previously regarded as manageable came to be seen as large in relation to export receipts, present and prospective, and large in real terms. The need to tighten lending standards, avoid overconcentration of country loans, and improve the information base for country lending became increasingly apparent. The concerns of bank supervisors about country exposure were reinforced by the general decline in bank capital ratios since the mid-1970s and by the rise in potential losses on domestic, as well as foreign, loans.
In the summer of 1982, the banks called a halt. First Mexico, and then Brazil, were unable to obtain new, or to roll over existing, loans. The sudden realization that the two largest borrowers were in trouble prompted an immediate reappraisal of country risk by most banks. The result was higher spreads for virtually all country borrowers, irrespective of their particular circumstances, and an abrupt reduction in the availability of credit for specific countries. Lending to countries in “high-risk” regions, like Latin America, virtually stopped. Some banks, particularly the smaller regional banks in the United States and Europe, wanted to get out of country lending altogether. The confidence which had underpinned the financing flows of the 1970s was seriously threatened. There were real fears that trade and capital flows would contract further, leading to default by one or more country borrowers.
2. The Response
The immediate crisis was averted by a series of ad hoc rescue packages involving the BIS, central banks, governments, the commercial banks, and—crucially—the Fund. The central element in these packages, then and subsequently, was an adjustment program approved by the Fund that was aimed at achieving a viable balance of payments and debt-service position over the medium term. The Fund was the only international institution which could combine financing and adjustment. It was the only institution whose “seal of approval” could serve as a catalyst in prompting other lenders, private and official, to provide the new money required for meeting immediate repayment obligations, in the short run, and for undertaking orderly adjustment, with growth, in the longer run.
But the debt crisis, and the consequent increase in requests for Fund support on a large scale, highlighted the inadequacy of Fund resources. Despite two general quota increases in 1977 (32.5 percent) and 1980 (50 percent) which raised total quotas to SDR 61 billion, the Fund’s ordinary resources from quota subscriptions had not kept pace with either the growth in world trade and capital flows or with the growing needs of deficit members for balance of payments assistance. The two quota increases were political compromises which provided only limited additions to the Fund’s stock of lendable resources, which were rapidly used, particularly from 1980 onward.
The Fund had therefore supplemented its resources by sizable borrowing from surplus members, first under the 1977 supplementary financing facility (SDR 7.8 billion) and then under the 1981 enlarged access agreements with Saudi Arabia and other lenders (SDR 9.3 billion). This had allowed the Fund to lend substantially more (in terms of a member’s quota), for longer periods, to an increasing number of countries at a time of prolonged recession. It also meant that the Fund had the means available to deal with the immediate crisis of confidence in mid-1982.
However, the applications for large loans by Mexico and Brazil and the queue of further applications by other heavily indebted countries put the Fund’s liquidity under serious pressure. In 1982 and early 1983, disbursements and commitments by the Fund rose to record levels, not only under stand-by and extended arrangements but also under the less conditional special facilities. By late 1982, the Fund was running down ordinary resources and overcommitting its borrowed resources.
The obvious solution—namely, a further large general increase in quotas—was already under discussion within the Fund when the debt crisis emerged. But the discussions had failed to narrow the widely divergent views of members on the Fund’s role in the 1980s and on its appropriate size. On the one hand, some countries, particularly the developing countries, supported a doubling, or even a tripling, of quotas in line with the rapid increase in members’ financing needs. On the other hand, major creditors, such as the United States and the Federal Republic of Germany, supported a much smaller increase of 25 percent or—at the very most—between 40 and 50 percent, which they regarded as sufficient to meet members’ needs in normal circumstances and consistent with the Fund’s role as a lender of last resort. The quota review was also complicated, on this occasion, by the always controversial question of adjusting members’ quota shares to reflect changes in their relative economic positions.
The debt crisis gave new urgency to the quota review. It persuaded the major creditors to think again and to examine other ways of increasing Fund resources. As in all important Fund decisions, the attitude of the United States was crucial. The United States had close political and economic ties with Mexico, Brazil, Argentina, Peru, and other heavily indebted Latin American countries.82 U.S. banks were deeply involved in financing these countries’ development projects, trade flows, and balance of payments deficits. The threat to the stability of the international financial system posed by the debt crisis was therefore a threat to the U.S. banking system, to U.S. export markets, and to employment in U.S. export industries.
It was against this background that U.S. Treasury Secretary Donald Regan proposed, at the Annual Meetings of the Fund and the World Bank in Toronto in September 1982, that an “adequate” Fund quota increase, sufficient to cover members’ needs for temporary financing in normal circumstances, should be supplemented by “an additional permanent borrowing arrangement, which would be available to the IMF on a contingency basis for use in extraordinary circumstances.”83 The reform and enlargement of the GAB stemmed directly from this proposal.
From the standpoint of the United States and other major industrial countries, the proposal for a “crisis fund,” either separate from, or incorporated into, the GAB, had several advantages over the alternative of a large general increase in Fund quotas. First, a crisis fund would provide the Fund with more effectively usable resources than a quota increase of comparable size.84 It would also give the Fund immediate recourse to credit lines from countries in relatively strong external positions. The bulk of these credit lines would be usable in an emergency.
Second, the establishment of a crisis fund would demonstrate to the international financial community that the Fund was in a position to deal with severe threats to the system. This, in turn, it was argued, would provide private banks and official creditors with sufficient confidence to ensure that they would continue lending to countries in difficulty. It could also reduce the risk that problems in one country would spill over into other countries.
Third, creditors of the crisis fund would have an important voice in decisions on its activation, more so than they have in decisions on lending the Fund’s ordinary (quota) resources, which require only a simple majority in the Executive Board. Creditors could ensure that the Fund would borrow from the crisis fund only when the stability of the system was in jeopardy and only to finance strong adjustment programs in the borrowing countries. This was a particularly important selling point for the United States in getting congressional approval for new money to finance the Fund.
Secretary Regan’s proposal did not refer specifically to the GAB, leaving open the possibility that lenders to the crisis fund could include countries that were not Group of Ten participants. However, the General Arrangements offered a ready-made and well-tried framework for the proposal. It was quicker and easier for the Group of Ten to adapt the GAB than to start afresh with a new fund. The General Arrangements already incorporated the principal features, and the underlying philosophy, of the proposal. It is worth noting, in this regard, that the reform of the GAB left intact the separate consultative provisions of the Baumgartner letter.
Reform and enlargement of the GAB were, however, controversial. Such plans were disliked by several Fund members, and certain developing countries in particular, precisely for the reasons they were favored by the major industrial countries. They were seen as a substitute for a substantial quota increase, a substitute which would deprive the developing countries of influence and voting power in the Fund, and reduce the amounts they could borrow under the Fund’s regular policies. The quota increase of 47.5 percent (to SDR 90 billion) agreed in February 1983, shortly after the Group of Ten formally decided to enlarge the GAB, was felt by these countries to be completely inadequate.
As in the past, the developing countries also resented the effective veto of one small group of Fund members over a major source of the Fund’s financing. It was, in their view, inconsistent with the cooperative character of the Fund for an exclusive club of wealthy members to decide whether the Fund was short of liquidity and whether there was a threat to the system. These countries were also concerned that access to the enlarged GAB would not be uniform for all Fund members, (This issue is discussed later on.) It would be fair to say, as in 1962, that the Executive Board was “not enthralled” by the new-look GAB.
3. The Changes
The changes to the GAB decision—agreed by the Group of Ten and by the Executive Board in January and February 1983, respectively—became effective on December 26, 1983. They are fundamental. The main changes are as follows:
a. Overall Size
The total of individual credit lines under the GAB has been increased to SDR 17 billion. This was within the range of SDR 15-20 billion envisaged in the original U.S. proposal for a crisis fund. Some members of the Group of Ten were prepared to support a figure at the top end of this range, particularly as past experience suggested that it would be very difficult to increase the GAB again soon. Other members were, however, more conservative. The United States, in particular, was constrained by what the Congress could accept. As in 1962, the final figure was a political compromise.
b. Individual Credit Lines
The shares of individual participants in the increased total have been rearranged to reflect the changes in their economic and financial positions since 1962 and their ability to provide resources to the Fund. The new shares are shown in Table 4.
|Swiss National Bank||1,020.0||6.00||—|
As in 1962, the size of the individual credit lines was decided rather informally. There was no single or precise formula. A number of broad indicators were taken into account, such as gross domestic product, non-gold reserves, the calculations used in the most recent Fund quota review, and the relative contributions of participants to the 1977 supplementary financing facility. But it was just as much a question of working backward from an agreed total to accommodate the preferences and constraints of individual participants. The United States, for example, was prepared to provide one quarter of the total; and it was clear that the credit lines of the Deutsche Bundesbank and Japan should be the second and third largest, respectively. Other changes in relative positions were fairly minor. As in the past, the individual amounts may be reviewed periodically “in the light of developing circumstances” and changed with the agreement of the Fund and all participants.85
In a related change, it was also decided to raise the minimum amount of a credit arrangement for new participants. Originally set at the equivalent of US$100 million (and subsequently SDR 100 million), the current minimum, expressed in SDRs, is “not...less than the amount of the credit arrangement of the participant with the smallest credit arrangement.86 At present, the Sveriges Riksbank has the smallest arrangement, for the equivalent of SDR 382.5 million (Table 4).
c. Participation of Switzerland
As shown in Table 4, Switzerland has become a participant—through the Swiss National Bank—in the GAB.87 The change from the previous associated status reflects, inter alia, Switzerland’s wish to become a more equal member of the Group of Ten “club.” The credit line of the Swiss National Bank has been increased significantly, to SDR 1,020 million, in line with Switzerland’s economic and financial strength relative to the other participants. As in the past, the fact that Switzerland is not a member of the Fund means that the Fund cannot call on the revised GAB to finance transactions with Switzerland, except to make early repayment of claims held by the Swiss National Bank in case of balance of payments and reserve need.
d. Associated Borrowing Arrangements
The revised GAB decision allows the Fund to enter, in association with the GAB,88 into borrowing arrangements with members which are not GAB participants. The form of association with the GAB may take one of several forms. It could be very close. The Fund could, for example, conclude a borrowing arrangement with a nonparticipant on terms very similar to those that apply to GAB participants. With the consent of the GAB participants, such an arrangement could authorize the Fund to call on the GAB to finance transactions with the nonparticipant member, and to refinance claims of the nonparticipant which were encashed prior to maturity on balance of payments and reserve grounds. In this case, a nonparticipant would have virtually the same rights and responsibilities as a GAB participant.
Alternatively, the form of association between the nonparticipant and the GAB could be looser. For example, the Fund could agree a borrowing arrangement with a nonparticipant, for purposes similar to those of the General Arrangements and on comparable terms, but the Fund would not be able to call on the GAB to finance transactions with the nonparticipant or to refinance the nonparticipant’s claims if they were encashed prior to maturity. The precise form of the relationship with the GAB would be agreed separately between the nonparticipant and the GAB participants.
Finally, there is nothing in the revised decision to prevent the Fund from making other borrowing arrangements for purposes and on terms unrelated to the GAB.
e. Associated Arrangement with Saudi Arabia
The Fund has already concluded one associated borrowing arrangement, with Saudi Arabia, which became effective in December 1983 when the revised General Arrangements entered into force.89 Under the arrangement, Saudi Arabia will stand ready to lend the Fund up to SDR 1.5 billion on a revolving basis over five years, to assist in financing drawings by members for the same purposes and in the same circumstances as are prescribed in the revised GAB decision. The procedure for making calls, the interest rate, and most other terms and conditions are essentially the same as those in the revised GAB.
But the arrangement with Saudi Arabia is set apart from the GAB in three important ways. First, the Fund is not authorized to call on the GAB to finance transactions with Saudi Arabia. Saudi Arabia is therefore assuming responsibilities similar to those of the GAB participants but without similar potential benefits. On the other hand, Saudi Arabia is free to accept or reject any proposal by the Managing Director. In this respect, Saudi Arabia has more flexibility than the individual GAB participants, each of which is bound, under the procedures in the Baumgartner letter, to implement a proposal once it is accepted by the participants as a group.90 Third, the General Arrangements and the arrangement with Saudi Arabia may be activated separately. The Managing Director of the Fund is not legally required to propose a call on Saudi Arabia each time one is proposed to the GAB participants, nor is he required to propose a call to GAB participants each time one is proposed to Saudi Arabia.
The arrangement with Saudi Arabia does not refer specifically to the relationship between Saudi Arabia and GAB participants, which is covered in separate, informal understandings. But there is provision in the arrangement for converting it, at some future date, into a form more closely associated with the GAB and for the possibility that Saudi Arabia could become a participant in the GAB. The initiative for such changes would come from Saudi Arabia and would have to be accepted by both the Fund and the GAB participants.
f. Use of the GAB for the Benefit of Nonparticipants
The revised GAB decision allows the Fund, for the first time, to call on the participants to finance drawings by nonparticipants. But the Fund can do so only in certain well-defined circumstances.91
First, such drawings must be made in support of adjustment programs. Drawings on the Fund by nonparticipants in the (unconditional) reserve tranche; under the special facilities, such as the compensatory financing facility; or in the first credit tranche and not linked with a stand-by or extended arrangement will not be eligible for financing under the GAB. These requirements are more restrictive than those for drawings by GAB participants, since the Fund will continue to be able to call on the GAB to finance unconditional exchange transactions with the Group of Ten.
Second, special criteria must be met before the Managing Director may propose calls on the GAB to finance transactions with nonparticipants. The Managing Director must be satisfied after “consultation,” which will clearly involve the GAB participants, that
the Fund faces an inadequacy of resources to meet actual and expected requests for financing that reflect the existence of an exceptional situation associated with balance of payments problems of members of a character or aggregate size that could threaten the stability of the international monetary system.92
Again, these criteria are stricter than those for participants. In particular, the criterion referring to problems which could “threaten” the system is more severe than the language of the original and revised preambles, which allow the General Arrangements to be activated for the benefit of participants to forestall or cope with an “impairment” of the system.93 This is not necessarily a matter of semantics. “Impairment,” implying damage but not destruction, was preferred to “threat,” which suggested the risk of collapse, in the 1961-62 discussions precisely because the latter was considered too severe.94
Third, in making such calls, the Managing Director is also required to pay due regard to potential calls on the GAB for the benefit of the participants. This does not imply that a specified amount of GAB resources should, or will be, set aside to finance possible requests by participants. But it serves notice of the continued importance which the participants attach to the GAB’s original purpose.
On the surface, these three conditions are, to say the least, restrictive. In part, this is because the potential benefits for nonparticipants are not matched by any reciprocal commitment to lend to the Fund.95 However, to counterbalance this apparent stringency and to take account of some of the criticisms made by nonparticipants, the GAB decision has also been amended to make it absolutely clear that the revision and enlargement of the GAB does not affect the Fund’s authority to deal with requests for drawings by individual members. The decision specifically states that access to Fund resources will continue to depend on established policies and practices and not simply on whether the Fund is able to borrow from the GAB.96 If, for example, the GAB participants are not prepared to lend at any particular time, the Fund can try to borrow from other sources.
g. Other Changes
As often happens when a long-overdue reform takes place, the opportunity was also taken to update various provisions and to bring the GAB more into line with the Fund’s more recent borrowing agreements.
GAB creditors should now have no cause to complain, as they did in 1978,97 that the interest rate is too low. The interest rate on GAB loans will no longer be linked to the charges levied by the Fund on the drawings financed by GAB borrowing. It will now be market related, as it is, for example, under the borrowing agreements to finance the enlarged access policy. GAB creditors will earn interest at a rate equal to the combined market interest rate calculated by the Fund to determine the rate at which it pays interest on holdings of SDRs. At present, the combined market interest rate is determined on the basis of a weighted average of yields on short-term market instruments denominated in the five currencies that make up the SDR basket. The revised decision also protects GAB creditors against the possibility of a change in the Fund’s method of calculating the combined interest rate.98 Interest will accrue daily and be payable quarterly in SDRs, in the participant’s currency, or in other actually convertible currencies. At the same time, the ½ of 1 percent transfer charge payable by the Fund on GAB loans has been abolished.
It has also been agreed to denominate the individual credit lines in SDRs. This will avoid unintended changes in their value, caused by exchange rate fluctuations. The participants’ change of heart on this question can perhaps be traced to the large, and sometimes erratic, swings in the exchange rates of the major currencies since 1978, when a shift to SDR denomination was rejected.99 The SDR is now fully established as the unit of account for the General Arrangements. With the exception of Switzerland, however, participants will continue to make loans to the Fund in their own currencies. The Swiss National Bank will lend “freely usable” currency agreed with the Fund, since the Fund cannot borrow a nonmember’s currency.100
The repayment provisions of the GAB were designed, inter alia, to ensure that the Fund would repay GAB creditors as and when the GAB beneficiary repaid the corresponding drawing to the Fund, with a maximum repayment period of five years.101 The provisions did not, however, fully cover reserve-tranche drawings by participants after the Second Amendment of the Articles of Agreement in April 1978. Such drawings no longer had to be repaid to the Fund; but the Fund could subsequently sell the currency of the drawer to finance transactions with other members. The effect, of restoring the drawer’s reserve-tranche position in the Fund, was equivalent to repayment (if repayment had been possible).
This happened in the case of the U.S. reserve-tranche drawing in November 1978, which was financed in part by calls on the GAB. The United States was not legally obliged to repay this drawing; the Fund therefore repaid the two GAB creditors, the Deutsche Bundesbank and Japan, after the maximum repayment period of five years had elapsed. In practice, however, the Fund sold large amounts of U.S. dollars from 1979 onward which restored the U.S. reserve-tranche position in the Fund. But the Fund incurred no corresponding obligation to repay the Deutsche Bundesbank and Japan any sooner. This was unfair to the Federal Republic of Germany and Japan, particularly since the United States was receiving remuneration from the Fund on its restored re serve-tranche position at a higher rate than the two GAB creditors were earning on their outstanding loans. This anomaly has therefore been corrected in the revised GAB decision.102
As explained earlier, the formal provisions on transferability in the original GAB decision were supplemented by an Executive Board decision in March 1979.103 This decision was updated and changed in February 1984, after the revised General Arrangements became effective. The new decision provides that GAB claims may be transferred to the Swiss National Bank (now a participant) on essentially the same conditions as transfers to other participants. More significantly, the decision further broadens the scope for transfers of GAB claims among the participants, in line with the corresponding provisions in the Fund’s more recent borrowing agreements. The decision ensures that GAB claims will continue to be highly liquid assets which participants can mobilize in a crisis.104
In a separate, but related, decision, also taken in February 1984, Saudi Arabia was given considerable freedom to transfer its claims under the associated borrowing arrangement.105 Unlike GAB claims, which may only be transferred among the participants, Saudi Arabia may transfer its claims to any Fund member. This is a further example of the distinction between the GAB “proper” and the looser form of associated arrangement agreed with Saudi Arabia.106
The revised GAB decision also incorporates a number of other changes, mainly of a technical or tidying-up nature. For example, the amended Preamble retains the same broad description of the circumstances in which the GAB may be activated—namely, when supplementary resources are needed to forestall or cope with an impairment of the international monetary system, but the (now redundant) references to the “new conditions” of widespread convertibility and greater freedom for short-term capital movements have been dropped.107 The debt problems of 1982-83 showed, very clearly, that the Fund might need to call on the General Arrangements if the system were being impaired for other reasons.
Similarly, all references to stand-by arrangements have been expanded to include extended arrangements, which did not exist in 1962. The Fund will now be able to make calls on the GAB to finance both types of arrangement with participants and nonparticipants alike.
h. Period of Renewal and Review
Finally, the revised General Arrangements will remain in force for five years from December 1983. The functioning of the revised GAB, and in particular the use of the GAB for the benefit of nonparticipants, will be reviewed by the Fund and the GAB participants when they are considering renewal of the GAB for any subsequent period.