- Mohsin Khan, Morris Goldstein, and Vittorio Corbo
- Published Date:
- September 1987
International Monetary Fund
Mr. Reed’s presentation has been clear and concise, and his main argument is quite straightforward. He has dealt only in an indirect manner with the subject at hand, which is the role of external private capital flows in the context of growth-oriented adjustment programs. That is, Mr. Reed has not really addressed the question of how private capital flows may contribute to the reestablishment of growth prospects in indebted countries or in what amounts, except to the extent that it cites some elements of the Baker proposal. He has focused instead on the question of how the direction taken by the debt strategy may affect the future flows of bank finance to developing countries and the prospects for normalization of debtor/creditor relations.
Mr. Reed notes that, despite the success of the “first phase” of the debt strategy in avoiding a systemic collapse and in facilitating a dramatic adjustment of external imbalances, the approach followed thus far is coming under stress—as he puts it—”due to the discrepancy between the climate for investment created by certain countries and the conditions for investment required by the world capital markets.” We are at a turning point, and Mr. Reed foresees two distinct paths which may be followed.
First, countries may opt for implementing the necessary policies for the reestablishment of an appropriate investment climate, accepting the “discipline of the market,” and thus regaining a status of creditworthiness. Countries that follow this route will find it in their own interest in the long run to accept the terms and conditions set by the market. Second, they may opt for another option, following the “concessionalist school” and attempt to force creditors to grant off market concessions.
Countries that follow the “market way” will eventually be rewarded with a resumption of private capital flows on a voluntary basis. In contrast, the “cocessionalists” will be cut off from international capital markets and will have to settle for the morsels of official finance. In substance, Mr. Reed has made a political statement; but, since this is not a political forum, I will resist the temptation to make a similar type of statement and limit my intervention to two brief remarks.
The argument that countries should accept the market discipline is fundamentally asymmetric if it is not extended to private creditors, and to commercial banks in particular. For some time now, the market has been discounting the debtor countries’ debt, which trades in the secondary market at values considerably below those originally contracted. Yet commercial banks insist that the servicing of this debt be done with reference to the contractual value rather than to the market value. If banks, as Mr. Reed puts it, “. . . play an important role in transmitting this discipline (the market’s) to all borrowers, including banks themselves, not just the problem countries,” why is it that they refuse to accept the market’s realities, which should tell them something about the soundness of their lending decisions? In other words, if the disciplinarian does not discipline himself, why expect others to accept it quietly? I will not extend my remarks about discipline to cover the lending boom of the 1970s. It appears that banks did not talk much about discipline in those years.
The significance of the above considerations certainly goes beyond the search for symmetry in the outlook for the future path of the debt strategy. It is becoming increasingly evident that the observed wedge between the contractual and the market valuation of existing debt is an important inhibiting factor for the generation of new investment, both in physical and financial assets. The reason is that potential takers of new debt fear that it would fall into the same category as the old debt, so that the market would value it at a discount. Let me illustrate this point with the same example used by Mr. Reed to show the recent difficulties encountered by “steering committees” to sell concerted financial packages to commercial banks: the Mexican debt restructuring.
Throughout the process of “selling” the package, the reluctance to participate shown by several smaller regional banks has, in my view, more to do with the fact that Mexican debt is selling at a discount in the secondary market than with the so-called concessions included in the package. The worst offender among these seems to be, in the view of Mr. Reed, the inclusion of contingent finance facilities. It is doubtful, however, that these can, first of all, be called concessions, and that they have been an overriding concern to the banks. Let us recall that the so-called oil facility is built around a symmetrical band and that, at least until a few days ago, the prospects were that less money would be required from banks on account of this facility.
Some smaller banks have actually sold debt at a discount in the secondary market. Naturally, the prospect of adding to their portfolios—in the form of new credits—an asset that is being traded at a discount is not very attractive.
An ostensibly positive aspect of decreased cohesiveness of the banking community is that it would allow for a wider range of financial arrangements, such as, for example, the automatic capitalization of interest (which, incidentally, was one of the original proposals of Mexico to the banks). In trying to broaden the range of financing modalities, however, the banks not only find difficulty in reaching agreements with their country customers on the terms and conditions of new financing, but increasingly have problems reaching agreement among themselves as well. This phenomenom, which is typical of the decisionmaking process in cartel-type organizations, has to some extent been fostered by the approach adopted by the governments of creditor countries and multilateral organizations.
It is alleged that, in order to preserve the stability of the international financial system and be able to respond “systematically,” a system of “rewards and penalties” has been set up whereby the indebted countries must individually negotiate with groups of creditors, thereby institutionalizing a banks’ cartel.
The system of rewards and penalties, however, has become increasingly lopsided. Clearly the “reward” to be received by the indebted countries that have pursued intensive adjustment programs would be the restoration of economic growth and normal relationships with creditors factors, which in turn should lead to recovery of their debt-servicing capacity.
I will return to this point in a minute, since this is my second comment. As is well known, however, the anticipated growth did not materialize, and the chance of restoring “normal” relationships with creditors)—a return to spontaneous or voluntary lending—is still very remote for most of the indebted countries. Indeed, some of the contradictions inherent in the strategy pursued so far have become more obvious, particularly following negotiation of the Mexican financing package.
On the one hand, as noted, banks that have already withdrawn from voluntary financing are more and more reluctant to participate in concerted financing schemes. When they do so, they use various means to minimize their participation as much as possible. Economic subcommittees seek to reduce the financing requirements derived from balance of payments projections agreed with the multilateral organizations. Similarly, the banks try to obtain guarantees from the latter for at least part of the financing to be committed.
Perhaps the most obvious paradox is that, although creditor governments, banks, and multilateral institutions have defended the implementation of a case-by-case strategy from the start, the fear of setting a precedent seems to be a decisive factor in the course of negotiations. This is clearly a contradiction in terms with the so-called case-by-case approach.
The banks’ reluctance to provide an increased flow of financing to the indebted countries and their inflexibility in granting concessions raise serious doubts as to the viability of the current strategy. First of all, it is clear that no genuine system has actually been adopted for considering each case individually, adjusting the amount and terms of the financing to individual requirements. In fact, the strategy has been one of uniform treatment, in which a series of ritual steps or states must be adhered to by the indebted countries (with one or two exceptions) beginning with a Fund adjustment program and followed by agreements with the World Bank, and so forth, if they wish to obtain from the banks any arrangement on a rescheduling of debt principal or—perhaps—a reduction in surcharges.
Let me now turn very briefly to my second comment, which refers to Mr. Reed’s proposition that countries that accept the market’s discipline and do not ask for concessions—and, incidentally, one must be careful in specifying what this word really means—can aspire to a prompt return to a creditworthy status and the resumption of spontaneous lending. Countries of the “concessionalist persuasion,” on the other hand, will be permanently cut off from capital markets.
While this may be the case, neither history nor present experience provide evidence to support this view.
Debtor countries have so far—or until very recently—maintained normal interest payments to commercial banks, and what we observe is a steady and pronounced decline in the granting of new credits. According to the most recent information compiled by the Fund, bank lending to Latin America has declined from $15 billion in 1983 to $5.6 billion in 1984 and to $1 billion in 1985, increasing to $4 billion in the period January-September 1986.
It would appear that the eventual resumption of spontaneous lending to indebted countries will depend more on improved prospects for the region than on the fact that these countries may be asking for concessions today. Banks will lend again on a voluntary basis when they consider that it is good business to do so, and this in turn will depend to a large extent on how effectively the debt overhang can be reduced to levels that will help the restoration of confidence.
D. Joseph Wood
Vice President, Financial Policy, Planning and Budgeting
I find myself responding to a presentation by Mr. Reed that I found in many respects more attractive than the paper. I understood Mr. Reed’s presentation as suggesting that there is nothing inherently flawed in the current arrangements, that they need to be applied perhaps with better manners, and that the developing countries must resist the temptation and blandishments of those who would have them go down the concessions path. But given that, one can look forward to satisfactory outcomes in the arranging of external financing packages.
I have to say my own sense is a little less sanguine than that. My sense is that the arrangements for putting together external financing packages for the middle-income countries are under strain (the tension that Mr. Reed referred to) and that it is important to try to understand the sources of that strain so that we can address them effectively.
I understood Mr. Reed’s background paper as pointing to the tendency on the part of developing countries to seek more attractive terms as a particularly important source of strain. He was at pains in his oral presentation to indicate that that wasn’t simply a matter of interest rates, it was more generally a question, he said, of the texture of the agreements.
Nevertheless, I think one can use the interest rates as a proxy or symbol of the kind of distress that arises in putting together these packages, but I find that that way of looking at the problem distracts attention from what is an important weakness.
In saying this, I don’t mean to question the assertion that the lack of overall attractiveness of these packages, including the possibility of narrower-than-desired spreads, makes it harder for the advisory committee to sell these packages—that is obviously the case—but that is really a normal feature of the negotiating process. Each side stresses the difficulties it faces in delivering on any deal that involves terms less favorable than those they entered the negotiations with. Just as the advisory committee members will stress the difficulties of selling the deal to the banks that aren’t at the table, so governments can be expected to stress the difficulties they will have in selling the deals to their populations if they can’t show some visible signs of progress.
It is tempting, therefore, to take these references to the lack of attractiveness of the packages as simply an extension of the good hard negotiating tactics that one would expect in these negotiations. I don’t think anyone really would judge the acceptability of these restructurings or the new money packages in terms of the normal risk/return calculations. What I would assume the banks have in mind is not the alternative of placing their funds at some more attractive risk/return combination, but rather the alternative of losing the servicing of the outstanding debt, that is, a default of interest. Banks are prepared to pay something either through increased financing or in other ways to avert such a situation, and it is natural that they want to pay as little as possible.
Many observers, among whom I include myself, thought that the Baker Initiative, which suggested that the increase in commercial bank exposure only needed to be a small fraction of the interest due, was in fact a pretty good deal from the perspective of the commercial banks. What has happened in practice is that the scale of the new money packages has proven—with Mexico a notable exception—to be, if anything, a little smaller than what Secretary Baker suggested.
But the borrowing countries have conditioned their agreement to these smaller packages on some narrowing of spreads and on provisions for contingency financing. It seems to me a little disingenuous to argue, as the background paper does, that the problem is with the demands for narrower spreads and contingency financing without at the same time acknowledging that the exposure growth has in fact been negligible or even negative in many of these countries.
But if I am right about the collective interest of the banks in securing the contingent servicing of the interest, then why is it that the system for arranging these packages is under strain? Is it simply a matter, as a newspaper has recently suggested, of excessive brinksmanship on both sides? Or are there structural problems?
My own view is it is some of each. There is a degree of brinksmanship in these negotiations that would be regarded as just good tough bargaining in ordinary bank/client negotiations, but as applied in the current arrangements, it is worrisome. It is a little bit like playing with fire in a forest that is becoming increasingly parched. Our prevailing conventional wisdom insists that those with matches have to decide where and when to build their fires since, if the forest ranger instructs them and something subsequently goes wrong, the fire builders could seek redress from the ranger. Surely, however, there is a point, and we may be approaching it now, at which the costs of maintaining this conventional wisdom may become too high.
Apart from this, there are structural weaknesses, and this is really the point I wanted to make, and I think I am here agreeing with Mr. Ortiz. Mr. Carey refers to the absence of any default mechanism that has acceptable long-term costs. I would phrase the problem somewhat differently. While I think the banks have a clear collective interest in closing deals and averting default on interest, I don’t think they have in place any very effective decisionmaking machinery. The advisory committees have no power to bind the banks they represent and hence the agreements that they reach have to be kept very simple; some would even say simplistic.
One example is the lack of a threshold for excluding banks that have miniscule exposure, which tends to lead to a prolonged approval process. Another is the continued use of historical base, even when some banks, as Mr. Ortiz mentioned, have managed to dispose completely of the claims that they held on the date of that historical base.
The continued viability of the arrangements for putting together external financing packages depends, in my view, not on ever more labored attempts to maintain the cohesion among a group of lenders with increasingly disparate interests, but rather on devising modifications in the arrangements which will permit some recognition of very real differences in interest. This is already happening to some extent via the use of debt conversions. And I would agree with Mr. Reed that this area deserves the increased attention it is now getting.
In addition, I sense that we may not be too far away from the time when banks will be able to accept actions in a country such as Bolivia that they could not accept in a country such as Brazil; in other words, they will find a way to make distinctions among countries that will be consistent with the rhetoric in favor of case-by-case approach.
Thus, to conclude, Mr. Chairman, my diagnosis is that the problem in arranging external financing packages is not simply a matter of unattractive texture of the deals or a lack of good manners on the part of the Bretton Woods Institutions and the chief U.S. regulator. I think also a part of the problem is a flawed mechanism for reaching and enforcing decisions that reflect the collective but not the monolithic interest of the commercial banks.
Hence, one place to look for improvements is not in trying to shore up an eroding cohesion via avoidance of lower spreads or other things which are unattractive to the banks, but rather in trying to devise ways to ease some of the pressures through new arrangements that permit distinctions to be made among banks and among borrowing countries.
Alassane D. Ouattara
Director, African Department
International Monetary Fund
Mr. Carey’s paper raises a number of difficult questions to which there are no easy answers. I find myself in agreement with Mr. Carey that there is a need to strengthen the process of coordinating foreign aid to support the attainment of a sustainable rate of growth under conditions of financial stability in developing countries. In my remarks, I shall confine myself to some key issues that arise from Mr. Carey’s paper, drawing on our experience in the African countries.
First, Fund-supported adjustment programs have indeed been designed to reduce financial imbalances and restore the conditions for sustained economic growth. These programs have, inter alia, helped countries to reduce their financing needs and to mobilize the needed resources on appropriate terms. Thus, these programs have enabled countries to progress faster toward the achievement of a viable external position and sustainable growth rates. In view of experience in Africa, Mr. Carey’s assertion that “in restrospect, the terms of Fund finance were inappropriate to many of these cases and now constitute a burden . . .” is not totally correct. While financing on more favorable terms might have been desirable, one has to consider what the alternatives would have been. In the absence of other resources, had the Fund not reacted quickly in the early 1980s to the requests for assistance by these countries, would not the total cost of disorderly adjustment have been higher?
Second, a point not fully brought out in the paper is that, once external financial assistance has been committed to support a country’s adjustment program, the timely flow of such assistance is critical to the success of the adjustment program. In our experience, shortfalls or delays in the disbursement of committed financial assistance have often hindered the adjustment efforts of a number of countries. In some cases the momentum for adjustment was lost, and its resumption took considerable time.
Third, the impression that the Fund is withdrawing finance from developing countries needs to be qualified. As mentioned before, the Fund reacted quickly to assist the African countries facing major imbalances in the early 1980s. During 1981-84, purchases from the Fund averaged annually SDR 1.7 billion, while repurchases averaged annually only SDR 420 million. During 1985, purchases amounted to almost SDR 1.0 billion, while repurchases were close to SDR 800 million. In 1986, purchases dropped to SDR 800 million, while repurchases rose to SDR 1.1 billion. However, during 1986, efforts to mobilize resources at concessional terms were intensified, as the Fund stepped up its efforts to play a catalytic role. At the end of 1986, the Fund had 20 stand-by arrangements and 6 arrangements under the Structural Adjustment Facility in Africa. Thus, while the involvement of the Fund remains substantial, the emphasis has been increasingly on ensuring that the mix of resources utilized by member countries is conducive to achieving an improvement in their external position and does not overstretch their debt-servicing capacity.
Fourth, I cannot share Mr. Carey’s view that Professor Kindleberger’s “default mechanism” would have somehow been a positive factor, forcing adjustment. Such a “default mechanism” would have disrupted the working of financial markets and brought about disorderly adjustment, with the attendant costs. The recent debt crisis illustrates well the point. In this regard, the Fund has worked to promote financial stability and orderly adjustment, taking into account economic externalities—both costs and benefits—that are not fully reflected in the workings of financial markets.
Fifth, like Mr. Carey, I am concerned about the impact on the developing countries of a recession in the industrial countries. While clearly the adjustment process would become even more difficult for the developing countries in such an environment, the international community, including the Fund and the World Bank, will need to react promptly to assist the affected countries. I therefore welcome the thrust of Mr. Carey’s paper on the urgent need to strengthen the joint effort between the developing countries and the international donor community to ensure that growth-oriented adjustment programs receive adequate financial support in a timely and coordinated manner on appropriate terms. This seems essential given the spread and depth of the adjustment effort in Africa.
In this regard, the Fund has already taken an important further step in facilitating the coordination of financial flows to countries adopting appropriate adjustment programs by setting up the Structural Adjustment Facility (SAF). The Fund has so far approved ten SAF-supported programs, six of which are for African countries (Burundi, The Gambia, Mauritania, Niger, Senegal, and Sierra Leone). Many more are in the pipeline. A key element of this facility has involved the provision of joint assistance by the Fund and World Bank staffs to IDA countries to prepare a policy framework paper that defines the medium-term policy strategy of the country and the financing requirements. While it was envisaged that the document would provide a focal point to coordinate the flow of financial resources to support growth-oriented adjustment programs the document has not yet become as important in this regard as envisaged. As the international community becomes more familiar with this new facility, the policy framework paper could well start to play the role originally envisaged for it.
I share Mr. Carey’s analysis of the trend of slow growth in official development assistance (ODA) over the next few years. Commercial banks will not resume their normal lending to the two country groups during this period. As a result, there will be an enormous gap between the supply of and the demand for development finance in these countries. The point has been raised in Mr. Carey’s report, but the solution to this serious mismatch has not been found. I will try to bring your attention to two aspects that I believe might be helpful in addressing this issue.
As Mr. Carey pointed out, there have been significant and notable shifts in the pattern of financial flows to developing countries. One shift is that multilateral flows now constitute 24 percent of total, up from 10 percent in 1980. This shift reflects not only recent economic realities but also a fundamental change in the philosophy of aid policy among donor countries.
As we all know, the current dominance of ODA in the provision of financing to developing countries will continue. This means that ODA is going to play a crucial role in assisting the two country groups to implement their growth-oriented adjustment programs. Therefore, the effectiveness of ODA is more critical than ever at this juncture.
Mr. Carey’s report has rightly pointed out that two new and fundamental changes have emerged in today’s development financing. First, ODA providers need to respond to a diverse range of country situations rapidly, flexibly, and coherently. Second, the nature of current development problems demands a program rather than project approach to the delivery of development assistance and finance. Both developments indicate that the efficiency and effectiveness of ODA have an important bearing in the success of the bold adjustment program undertaken by developing countries.
I fully share the OECD’s conclusion or self-criticism with regard to the deficiencies in ODA and, more specifically, in bilateral aid. The slow-moving political decision-making process and complicated aid procedure have made bilateral aid inflexible, irresponsive, and ineffective. Furthermore, we know all too well that political and commercial considerations are being weighed heavily in determining bilateral aid allocation.
Despite the recognition of these deficiencies in the donor community, we all appreciate how difficult it is to make improvements. While anticipating some minor changes, such as better coordination and less complexity in the aid process, we have to admit no fundamental solution is in sight. Therefore, if we expect ODA to play an effective role in development finance, we should rely more on multilateral institutions.
Multilateral flows are now on a rising trend. We consider this a healthy trend and welcome it. We feel, however, that the role of multilateral development institutions can and should be further strengthened. They are not only more flexible and more effective but can play more roles than bilateral agencies.
Let me take the World Bank as an example to illustrate what a multilateral institution can do. We all agree policy environment holds the key to a sustainable growth. ODA can be effective only if it is tailored to the specific development needs of individual countries. The Bank has a wide range of experience in different countries with diverse political, economic, cultural, and social structures. In addition, the Bank is served by a large international staff representing a number of ways of thinking and considerable collective wisdom. Therefore, the Bank is in a good position to help countries design their development planning and program. Moreover, since political and commercial factors play less a role in allocating Bank’s resources, the Bank can be neutral and objective in formulating each country’s lending program with the result that resources can be efficiently put to productive and effective use. The Bank enjoys a comfortable edge over bilateral agencies in this respect.
Exactly for this reason, the Bank has stood as a reputable and major player in the cause of development over the past 40 years. Of course, some shortfalls do exist in the Bank’s operations. We always caution the Bank management not to be overconfident. The Bank should avoid imposition of its policy prescriptions on member countries. A one-way track in policy dialogue is bound to fail.
Another strength of the Bank lies in its technical assistance. For each country, the Bank makes long-term planning including institutional building and human resource development. The Bank can help countries to strengthen weak links so as to enhance the efficiency of use of resources. We think this assistance is as valuable to recipient countries as is financial assistance. For example, recently the Bank has launched programs providing debt- and financial-management assistance to member countries. If we had had this assistance in the 1970s, debt problems for some countries might have been less serious than they are today.
At this time, I believe multilateral development institutions should play a larger role in helping countries to return to a sustainable growth path. I hope to see more resources shifted from bilateral to multilateral channels. In this connection, I disagree with Mr. Carey on one point. I believe that net transfers are a key factor in measuring the World Bank’s contribution to development. As long as the resources are being put to effective use, the Bank should aim at maximizing its net transfer to developing countries.
In my view, the credit standing of the Bank can be strengthened by stronger support from all governments, such as by injecting large amounts of capital in the Bank’s capital base and maintaining adequate reserves.
I would also like to comment on the recycling of Japanese or other countries’ capital surplus. I agree with Mr. Carey’s analysis in the paper. I think, however, we need some innovative ideas in this respect. The recycling mechanism in the 1970s is no longer working in the 1980s. If we do nothing and just wait for things to happen, we are going nowhere. Even if the market eventually goes back to normal, the help this brings will come too late and too little. In my view, we have to act to accelerate the process. For one thing, the commercial banks are not going to be the key players in recycling in the 1980s. Perhaps the surplus could be intermediated through multilateral institutions. Greater access to Japan’s market by the World Bank and direct loans to the Fund are ways to achieve this intermediation. These, however, are sporadic measures, lacking a long-term framework. Probably, the time has come for us to take a serious look at an old idea—the Bank’s Bank.