Mohsin Khan, Morris Goldstein, and Vittorio Corbo
Published Date:
September 1987
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Fawzi Hamad Al-Sultan

Mr. Carey makes two extremely important points that have also come up in various comments by other speakers. First, the nature of the problems in developing countries demands both a change in approach and response capacity from institutions involved in development assistance. This no doubt applies as well to nonconcessional flows from the commercial banking institutions and the international capital markets. Second, the adjustment process, because of the severity of the problems and the increasing volatility of commodity prices, interest rates, and other variables has tested the administrative abilities of both the smaller and larger developing countries, but particularly in smaller and poorer ones.

I feel, as do many other speakers, that the Bank has adjusted its approach more adequately than has the Fund, but both institutions still need to emphasize much more institution building, particularly among the poorer countries, if these countries are to achieve the basic fundamentals for growth. In terms of response capacity I think the Bank needs to develop more speed. In fact, the Bank has shown itself capable of reacting very fast in certain situations, but the overall process is still much too slow. Also, in terms of response, both the Bank and the Fund need to be able to respond with more funds. Mr. Reed makes the point well in his paper, showing a relative diminishing role for both the Bank and the Fund in developing countries. An increase in developmental assistance would enable countries to lengthen the adjustment process and make it more politically feasible.

Before going into some financing aspects, I want to emphasize one point, made earlier by some speakers, which is the need to separate the debt problem from the adjustment problem. If one can draw the parallel between countries and companies, then the adjustment process involves changes in the companies’ strategy, management, productive machinery, and so forth, while its debt problem would involve financial restructuring. If we concentrate on the debt problem, Mr. Carey, among others, argues for a workable default mechanism, and Mr. Reed feels that a larger equity component, through developing countries’ opening up their capital markets, should be part of the long-term solution. I don’t think that there is any question that there should be relief; the question is how much and how should this relief be structured so as to safeguard the soundness of the financial institutions and maintain the developing countries’ access to these capital markets.

A fundamental requirement when we are talking about relief is the change in attitude required from both ODA institutions and commercial banks in addition to the “culture” change to meet new needs proposed by Mr. Carey. As to ODA, other speakers have spoken of the real transfer of resources from the developing countries to the OECD as being close to $100-120 billion annually as a result of the decline of oil and commodity prices. To offset this, there has been tangible real increase in the level of ODA from the OECD countries. Some form of concessional mechanism for recycling such flows could be part of the relief package, and achieving the 0.7 percent aid targets should be pursued seriously. Also, their attitude toward increasing the World Bank’s resources, in particular, should allow a more liberal use of the guarantee mechanism. The combination of both can be used to negotiate lower margins and rescheduling fees for the middle-income indebted countries. Concessions can also be made within the present framework particularly since much of this aid was tied to procurement. As to the commercial bank role, I found Mr. Reed short on self-criticism on the efficiency of capital markets and the banks in particular. From the 1970s, capital markets have become increasingly international, and over the past year there has been even more deregulation and more globalization. Not only has this led to a much larger number of offshore and consortium banks, but it has also fostered a larger syndication of loans. However, there are two crucial aspects to this expansion. First, this led to such intense competition that quality was sacrificed. Funds were being made available to borrowers at levels and rates that even the borrowers were surprised at. Second, the extranationalization went beyond national regulatory authorities’ control, which led to higher multiplier effects and greater liquidity, which have contributed to greater volatility.

The point I want to make is not one of blame, but that more prudent banking could have eroded the size of the debt problem, and that the banks too need to make an adjustment to the changed circumstances. I don’t think that the approach should be “either the countries adjust or the banks would walk away.” The banks have a fundamental interest in the development of the “problem” economies, particularly since that is where the growth and an increasing part of their business is expected to come.

I agree with Mr. Reed that banks should be part of the recovery process. The traditional rescheduling exercises work if, as Mr. Carey mentions, the problem is seen as one of liquidity. However, if the problem, as we know it, is more fundamental—then the need is to restructure the debt and so inject new funds so that the debt-ridden countries are given sufficient medium-term relief to make further funds available for growth and a resumption of creditworthiness. It would be up to the capital markets and the commercial banks to be more creative in finding new ways of carrying long-term debt and increasing its transfer into equity instruments. In the case of the poorer developing countries, some debt forgiveness would have to be contemplated. I understand that this might have to involve changes in regulations in the major financial markets, particularly those regulating commercial banks, and changes in the attitudes of developing countries toward the role of the private sector and equity investment, so that the transfers into equity are not expected to be substantial over the next three to five years. This makes us look the debt burden straight in the face. If the Banks are willing to change their attitude and approach, however, I am confident that the market will too.

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