- Paul Streeten
- Published Date:
- September 1988
The paper by Azizali Mohammed is provocative and significant, pointing out that the terms of borrowing and the export performance can both be crucial and decisive in determining the likelihood of a debt default. In particular, either one of them can be sufficient to prevent a debt collapse, such as was prevented in South Asia and East Asia, both of which were favorably situated as compared with the Western Hemisphere (Latin America), where none of these favorable factors operated. East Asia seems to have been able to borrow capital while avoiding the debt crisis because it has had a good export performance. Similarly, South Asia has been able to avoid the problem because of its practice of borrowing at concessional official terms. In the Western Hemisphere, however, the Latin American borrowing nations had access to neither concessional sources of finance nor booming export markets. Thus, commercial finance proved viable only for the regions in East Asia where export performance had been especially favorable.
Let me start my comments with a set of broad issues. I have difficulty in appreciating the use of short-term liquidity indicators (e.g., debt-service ratios or debt-exposure ratios) in judging the longer-run viability of a nation’s debt program. The paper makes ample use of these two indices to judge selective performance of the borrowing countries. My own reservations in judging the dynamics of the debt process through piecemeal, short-run liquidity indicators like the ratio of debt to gross domestic product (GDP), the ratio of interest cost plus amortization to export earnings or even the ratio of reserves to imports (the last one not introduced in the paper) emanate from the following observations:
First, the use of such ratios to judge situations tends to ignore the fact that the level of new loans (net of amortization) to a country and their composition (e.g., direct or portfolio capital, balance of payments or project loans, etc.) often has an important bearing on the import coefficients or savings coefficients in the borrowing country. It is not an overstatement to say that the level of imports (and, hence, often the size of the trade deficit) has a tendency to adjust itself to the level of net capital inflows (via the licensing mechanism and other controls over exchange disbursement and imports). Thus, availability of external finance inevitably pushes up the import bill for the recipient nations and, hence, tends to increase the import-intensity of production and consumption. At a structural level, the phenomena can be explained by the technological changes leading to a greater import dependence on the part of the industrial units which receive borrowed funds, directly or through collaboration arrangements with foreign capitalists or governments. Simultaneously, the propensity to consume may go up, largely because of international demonstration effects, which become powerful as a result of capital inflows. Both of the above processes influence the absolute and the relative size of the foreign exchange gap (vis-à-vis GDP), which eventually is financed (expost) by net inflows of capital. Attention also needs to be given to the final use of the new loans (net of amortization) in the borrowing country in order to determine whether it can meet both the payments deficit resulting from the services deficit and the ex ante merchandise deficit. If the sources of new loans to a country dry up, it is forced to generate a trade surplus to meet the services deficit. If this is difficult to achieve, a typical debt-default situation emerges.
The arguments can be schematized as follows. The balance of payments of a country has three components, viz., the balance of trade (BT), the balance of services (BS) and the balance of net lending, or new loans (BL). As long as BS (primarily interest charges) can be met by BL, the country does not have to depend on BT for finance. Beyond this point, the avoidance of a debt crisis depends on the possibility of maintaining a BT surplus. Increases in imports, which are related to availability of external finance, may create difficulties in having a net export surplus, in addition to any difficulties experienced because of an adverse international economic environment.
The above arguments make it more meaningful to look at the ratios between BS and the net finance available (BT + BL) to identify an impending debt problem. A gradual or sudden drop in BL may, owing to the structural links to imports via technology, even lead to drops in GDP growth and in export capacity. This may cause additional problems which are not indicated by the liquidity criteria. For a country struggling to find financing in order to avoid defaulting on its debt, a sudden drop in new loans may impede the growth process. Countries in the Western Hemisphere have already experienced this phenomenon.
Debt exposures, measured by debt-GDP or debt-export ratios tend to reflect judgments of the adequacy of flows (GDP or exports) on the basis of the behavior of stock variables. This is of limited value, since the stock of outstanding debt may have a qualitative dimension, depending on the history or background of the debt contracts. Thus the 139 percent ratio between debt and GDP in Latin America during 1973–74 did not prevent U.S. multinational corporations from adding to fresh capital inflows. This does not tally with the more recent skepticism, in the context of Latin America, concerning new lending or direct investment, which, in my judgment, could have been proved risky even earlier. The debt-exposure ratios cannot identify the critical turning point beyond which debt collapse would be imminent.
Ratios between interest charges and export value do not reveal the real cost of the interest burden. The use of the real interest rate (deflated by export unit value) may be extended to develop a new criterion, viz., real value of interest charges, deflated by the unit value of the debtor country’s exports. It should not go unnoticed that the Western Hemisphere went through the severest price declines for exports—a phenomenon which explains a part of the aggravated problem in the region. (This also occurred in sub-Saharan Africa, which includes nations that had borrowed largely from official sources.)
My comments continue by drawing attention to the global tendencies in the terms of capital flows. According to Bank for International Settlements estimates relating to aggregate capital flows across nations, about 40 percent is channeled through the Eurobond market, where the debtor nations in the developing world have little access. Again, official development assistance has been tapering off in recent years, with such financing (on a net basis) providing not more than about 22.3 percent of the total current account deficit of developing countries in 1983. Bank credit, which financed about 70 percent of the current account deficit of developing countries in 1981, financed only about 20 percent in 1983. The sources of direct finance have been rather steady, meeting around 12 percent of the current account deficit during 1980-83. Given the above trends, it is unlikely that developing countries and, in particular, those in the Western Hemisphere would have gotten access to concessional sources of credit in the 1980s, even if they had not been in debt crisis. This description of capital flows to the developing world tallies with the huge current account deficit of the United States, which was about 3.5 times the total deficit of all developing countries put together during 1985. Thus, the simple macroeconomic balance of international capital flows has led to a global restructuring of investment, in much the same way investment was redirected away from its old empire by the United Kingdom in the late nineteenth century. Discussions of issues relating to the dire necessity of recycling the Japanese current account surplus in the 1980s highlight additional dimensions of the contradiction.
Finally, I would like to draw attention to the situation in sub-Saharan Africa, where the debt-exposure and debt-service ratios have been high. Although these African countries had not borrowed much at market rates, they could not, unlike the countries of South Asia, avoid a debt crisis. Thus, the generalizations arrived at in the paper to the effect that borrowing at market rates was the main source of the debt problem and that export performance was the major alleviating factor are not supported by Africa’s experience.
Use of liquidity indicators to judge the creditworthiness of debtor nations does not permit one to identify actual or potential debt-default situations. As a rule of thumb, the ratio between interest-income payments (net), BS, and the sum of the lending balance, BL, and the trade balance, BT, may prove more useful in identifying turning points.
The debt-servicing capacity of a borrowing nation is influenced, in the long run, by the structural changes relating to savings and imports, both of which are subject to the influence of capital inflows from abroad. Net inflows of capital from abroad may bring about increases in imports, as well as in domestic consumption. These changes may, in turn, eventually lead to sharp increases in the liquidity indicators of the borrowing country if it cannot generate exports and GDP growth. Outcomes such as the above are related to the actual quantum, as well as the composition, of the foreign capital inflows, on the one hand, and to the functioning of the borrowing economy, on the other. Placing an uncritical reliance on short-term liquidity indicators as measures of debtor capacity may lead one to overlook additional dimensions of the issue which are equally important.