III Export Credits and the Debt Strategy
- International Monetary Fund
- Published Date:
- March 1990
Until 1983, most agencies had little experience of payments difficulties on sovereign loans. A few had substantial exposure to countries that had rescheduled in the 1970s, but for the most part major borrowers had not had to resort to debt reorganizations. Over the seven years from 1976 to 1982, 15 countries, only 3 of which were major debtors,15 had rescheduled debt service obligations to official creditors. The amounts involved (including official development assistance (ODA) and other bilateral loans, as well as export credits) averaged less than $2 billion a year (see Chart 2). In 1983–85, however, many other recipients of large amounts of export credits encountered payments difficulties: Argentina, Brazil, Mexico, Morocco, the Philippines, and Yugoslavia, among others, concluded agreements with Paris Club creditors. During this period, claims rescheduled by the Paris Club amounted to over $10 billion a year, and an increasing share of agencies’ portfolio of cover was to countries that had rescheduled; by the end of 1985, 35 percent of the disbursed stock of officially supported export credits to developing countries was accounted for by the 34 countries that had rescheduled, compared to 10 percent at the end of 1982.16 In addition, substantial arrears had been accumulated by a number of other countries, although no agreement had yet been reached to restructure their debts.
Chart 2.Official Multilateral Debt Renegotiations, 1976–88
Sources: Paris Club Agreed Minutes and Fund staff calculations.
These developments changed fundamentally the operating environment of export credit agencies, and creditors needed to evolve a new strategy to address the problem. Until the mid-1980s the normal practice of agencies had been to go off cover for countries that had rescheduled, and to wait for a return to full creditworthiness before accepting new business. As it became clear that debt-servicing difficulties were likely to be protracted, creditors needed to find ways not only to fill short-term financing gaps but also to provide new credits to countries implementing adjustment programs.
The debt strategy applied by export credit agencies has realized these twin objectives. Through debt reorganizations under the auspices of the Paris Club, agencies have given comprehensive debt relief, including, in many cases, rescheduling of interest and previously rescheduled debt. At the same time, they have been prepared to make substantial commitments of new export credits to countries that have rescheduled, providing the countries appeared to be implementing appropriate policies and had reasonable prospects for being able to service new credits. Comprehensive data are not available, but data for the 17 rescheduling countries included in the Berne Union quarterly survey17 show that in the 27 months from July 1987 to September 1989 new commitments (including short term) amounted to some $27 billion, or 9 percent (at an annual rate) of agencies’ exposure to these countries at the end of 1986.
Although this section focuses on the debt strategy, it is important to bear in mind that many of the largest developing country recipients of export credits have avoided debt service problems. Of agencies’ total exposure to developing countries in the early stages of the debt crisis, in fact, well over half was accounted for by countries that have not rescheduled.18 For these countries, official support of export credits has continued to play its traditional role of providing medium-and long-term capital to promote exports for use in development projects. The basis for these flows has been the focus of the recipient countries on projects that by and large have been well conceived and on maintaining a generally appropriate economic policy environment. Many of these countries, like the rescheduling countries, have experienced economic shocks in the 1980s, but have managed to adjust and to avoid rescheduling. A key aim of the debt strategy is to bring rescheduling countries back to the same degree of normal access to export credits.
The Debt Strategy for Official Creditors: Debt Subordination
The heart of the strategy has been the policy of debt subordination. The first multilateral agreement to restructure a country’s debts establishes a cutoff date; debt service payments falling due on loans committed before that date are eligible to be consolidated under the first or subsequent agreements, but those falling due on loans committed after the cutoff date are not, and are to be serviced in full on a timely basis.19 On the strength of the subordination of old (pre-cutoff date) claims to new (post-cutoff date) claims, official creditors have been prepared to extend new credits to countries that continue to experience balance of payments difficulties but are implementing adjustment programs.
The last modification of a cutoff date was in 1984 for Sudan. Since then, when countries seeking further debt reschedulings have asked Paris Club creditors to change the cutoff date, such requests have been refused. Without exception, the agencies covered by this study indicated that the fixity of the cutoff date was the sine qua non of extending new credits. They noted that the premiums and fees charged for export credit cover are small in relation to the market discounts on private loans to heavily indebted countries. And so cover could only be provided without unacceptably large implicit subsidies from the taxpayers of creditor countries if there were a firm commitment to service all new loans in full. Agencies said that a change in the cutoff date would have a large and immediate impact on cover policy; several indicated that they would go off cover for any business with that country.20 Moreover, agencies said that a change in the cutoff date for one country would signal a significant change in the overall debt strategy, and would have an adverse impact on the availability of export credits for a wide range of countries, not just for the country concerned.
Another strand to the strategy of debt subordination has been the exclusion of short-term debts from rescheduling.21 This means that cover continues to be provided for short-term trade credits and sight payments when payments difficulties emerge on longer-term loans, as long as such credits continue to be serviced promptly. Access to such cover is important for the smooth operation of an economy, as it ensures the continuing availability of imported raw materials and spare parts, and also essential capital goods. A brief interruption in the availability of cover for medium- and long-term business, on the other hand, may have limited adverse implications for the operation of the economy.
Another aspect that has evolved since the early 1980s is the treatment of claims on the private sector. Until 1985, loans to private sector borrowers that had not been guaranteed by the government of the debtor country were usually included in debt consolidations. They were only excluded for countries that had convertible currencies through membership in currency unions. As the private sector had free access to foreign exchange in such countries, agencies generally continued to offer cover for credits to private sector buyers even when they were closed for business with the public sector, providing that deficiencies in the country’s policy framework did not impair the general creditworthiness of private buyers. In recent years, however, private sector credits have been excluded from consolidations for a number of other countries. Although this has narrowed the potential base for debt relief, the subordination of public sector borrowings to those by private buyers has encouraged agencies to support private sector development through new export credit cover, while at the same time providing relief from the public sector’s debt service burden. Although it may not be appropriate in all cases, most agencies indicated that it was desirable to keep private sector borrowings outside the scope of debt reorganization.
Cover Policy for Countries with Paris Club Reschedulings
In recent years agencies have shown increasing flexibility of cover policy in situations where countries sought rescheduling from official creditors. Most agencies indicated that it was still their policy to go off cover for countries requesting a first rescheduling from official creditors, for two main reasons. First, until the multilateral agreement had been concluded, the coverage of the rescheduling would not be clear, and agencies would have no assurance that new credits would not be captured in the consolidation. Second, until understandings had been reached with the Fund on a set of economic policies that could be supported by the use of Fund resources, agencies would not have adequate assurance that the country would be in a position to service new debt. As short-term debts have seldom been included in consolidations, agencies would tend to remain open for short-term business if the country continued to service such debts and indicated clearly that it would not request their consolidation. Similarly, agencies might remain open for the private sector when it was clear that only public sector debts would be covered. Agencies almost always went off cover for medium-term credits to the public sector, however, because even if the country indicated that it would not seek consolidation of debts incurred after a certain prior date (the cutoff date), there had been instances of countries amending their request.
Cover could be resumed after a multilateral agreement had been reached. Depending upon the payment record and economic prospects, however, some agencies would wait until the bilateral agreement had been finalized, or possibly until the first payment due under the agreement had been made. Thus there could be a relatively long interruption of medium- and long-term export credit cover for a country requesting a first debt reorganization, even when the country dealt with its debt service in an orderly fashion. In contrast to agency practice in the early days of the debt crisis, however, the interruption would normally be measured in months, not years; of course cover, when resumed, was likely to be more restricted than it was before the payments difficulties emerged.
The relative promptness of cover resumption reflects the fact that new credits are unlikely to be captured in any subsequent reschedulings, since no cutoff date has been changed in the last five years. Thus for countries that requested second and subsequent debt reorganizations, most agencies indicated that there would be little, if any, interruption of cover provided that the payment record on post-cutoff date debts and rescheduled claims was satisfactory and the country was continuing to implement sound economic policies.
Agencies noted that now that the strategy of debt subordination has provided them with a basis for going back on cover quickly after a first rescheduling and very quickly after subsequent reschedulings, they face a dilemma when countries encounter payment difficulties but attempt to work their way out of them without rescheduling. Agencies would like to support their adjustment efforts by remaining open, but fear that rescheduling may eventually be needed, in which case the absence of a previously determined cutoff date means that new credits would be caught up in the rescheduling. Going off cover, however, might itself provoke rescheduling. In general, therefore, agencies tend to remain on cover, but on a more restricted basis, as long as payments do not fall into arrears.
Debt Reduction and Export Credits
The modification of the global debt strategy over the last year to include debt and debt service reduction has had two aspects. Since October 1988, the Paris Club has been granting concessional rescheduling terms to certain heavily indebted low-income countries,22 while in 1989, commercial banks have been negotiating debt and debt service reduction packages with a number of middle-income countries.
Most agencies believed that, in general, low-income countries with large debt service problems were not creditworthy for commercial credit, and that their financing requirements should be met by concessional aid. Thus few agencies were prepared to offer cover for medium-term credit, other than the commercial part of mixed credits, to most of these countries. Concessional debt reschedulings would help low-income countries to return to viability, which would justify an eventual reopening of medium-term cover, but the process was still expected to be a long one. Indeed, some agencies considered concessional rescheduling a sign that the country would not reach viability quickly; asking for concessions was tantamount to admission that the country did not expect to regain access to export credits for many years to come.
Agencies viewed the situation of middle-income countries rather differently. For some of the first countries that had negotiated with banks, agencies were already open to a considerable degree. Debt reduction in the context of strong adjustment programs should hasten their return to viability, and hence provide a basis for a further opening of medium-term cover. Agencies could then support part of the external finance needed for these countries to return to a high rate of growth.
Several agencies noted that demand for export credit cover might increase, if protracted negotiations led to cutbacks in lending by commercial lenders; in practice, however, they did not expect immediate large increases. They emphasized that a liberalization of cover policy would depend on whether debtor countries seized the opportunity to implement strong adjustment measures that would, in turn, enhance prospects for rapid growth.
A number of agencies and supporting government departments (guardian authorities) expressed concern that the advent of commercial bank debt reduction could lead to pressures on official creditors to offer comparable concessions to middle-income countries, for which banks were generally the largest creditors. They believed that the arguments for debt reduction by commercial banks did not apply to official creditors. They pointed out that in contrast to the banks, bilateral official creditors had been prepared to reschedule interest payments, and had been willing to extend new financing through officially supported export credits as well as bilateral loans and grants.
A Debt Strategy for the Future: Improving the Quality of Export Credits
The ultimate goal of the debt strategy is to restore heavily indebted countries to balance of payments viability, thereby permitting a return to the normal capital flows that other developing countries have continued to receive. The restoration of viability largely depends on the adjustment efforts of the countries concerned, supported by financial assistance on appropriate terms from creditors.
Adaptations in the practices of export credit agencies have permitted export credits to play an increasingly effective role in this strategy. Given the experience of the last ten years, however, agencies have been searching for ways to improve the quality of export credits to avoid a recurrence of the problems of the 1980s. At the macroeconomic level, the focus has been on improving country-risk assessments. At the micro-economic level, the focus has been on how to ensure that credits are used in support of appropriate projects; lending to the private sector, where presumably profit incentives promote efficient projects, has particular attractions.
Country Risk Assessments
In recent years agencies have devoted greater resources to assessing the creditworthiness of borrowing countries. This task has become more important as cover policy has shifted from simple on/off decisions when there are payments difficulties to providing cover at a price when the country’s prospects warrant this. Recent payments experience continues to be the most critical indicator of creditworthiness, but the country’s ability to service new medium- and long-term loans is also important.
Some agencies have developed quantitative techniques that systematically collect available information to help determine the appropriate level of both premiums and country exposure ceilings. Others have concentrated on improving access to and use of information provided by guardian authorities and, in some cases, other government departments.
Export credit agencies draw information on developments in borrowing countries from a wide range of sources, including unpublished Fund and World Bank staff reports, embassies in the borrowing countries, and private organizations. Agencies said that they attached particular importance to Fund reports because of their assessments of the stance of macroeconomic policies and analysis of the medium-term prospects for the balance of payments. Several agencies said that they modified medium-term projections to take account of differing assessments of commodity prices, interest rates, and the strength of policy implementation.
Exchange of Information
Agencies have developed a number of channels for exchanging information and opinions on both individual countries and more general issues. The Berne Union holds regular meetings at which the stance of cover policy and a range of technical issues are discussed. In addition, the Berne Union provides information to members on the level of activity and stance of cover policy of member agencies for the 40 countries covered by its quarterly survey. As membership in the Union is limited to agencies and does not include representatives of guardian authorities, however, the ability to discuss some policy issues is limited. In 1985, the process of consultation was strengthened when the participants in the OECD Consensus (which includes representatives from the guardian authorities) agreed to meet regularly in the framework of the Export Credit Group to discuss a broad range of issues affecting export credit agencies as well as developments and the outlook for a number of countries.
Agencies reported that in recent years they have paid increasing attention to the quality of projects they support. In contrast to the late 1970s and the early 1980s, when they relied mainly on project assessments prepared by potential borrowers, on the assumption that in any case their true security was the guarantee of the host government, agencies now emphasize independent evaluations of a project’s economic viability.
Some agencies have developed in-house capabilities for project appraisal. Others depend on assessments made by the World Bank, other multilateral development banks, and, where necessary, private consultants. In general, agencies give greatest weight to assessments by the World Bank, although for large projects they noted that it could be helpful to have additional assessments from independent consultants. In the case of projects endorsed by regional development banks, a number of agencies indicated that they would prefer that the bank concerned provide some of the financing.
Cofinancing arrangements, in which agencies provide support for part of the finance for projects selected and developed by the World Bank, have also improved project selection. Under such arrangements, the World Bank is able to mobilize additional resources for development, while agencies increasingly welcome involvement in projects not only endorsed by the Bank but also partly financed by World Bank resources.
Data prepared by Bank staff indicate that planned cofinancing with agency loans or cover (for new Bank operations approved) reached a peak of $1.9 billion in 1982/83,23 subsequently declining to $0.4 billion in 1985/86 (Chart 3). As with other activities of export credit agencies, this type of cofinancing has recovered; by 1988/89 agencies’ new planned commitments had reached $1.5 billion. In recent years, cofinancing by export credit agencies has been particularly important for World Bank projects in middle-income countries, accounting for 18 percent of the planned external financing of World Bank projects over the years 1985/86–1988/89. It has also been significant for projects in creditworthy low-income countries.
Chart 3.Cofinancing of World Bank Projects, 1979/80–1988/89
Source: World Bank staff estimates.
1 Excludes untied lending by EXIM Japan.
2 Includes untied lending by EXIM Japan.
3 Includes IBRD and IDA loans.
4 Per capita GNP in 1986 dollars as published in the 1988 World Bank Atlas.
Lending to the Private Sector
Consistent with the increased role that many countries are giving the private sector, agencies have been placing increasing emphasis on providing cover for exports to the private sector in developing countries. Agencies mentioned that the trend toward excluding private sector loans from Paris Club rescheduling agreements provided a further incentive for this type of business, as did liberal private sector access to foreign exchange. Several agencies also mentioned the increasing reluctance of governments of indebted countries to provide guarantees.
Agencies face a number of practical problems with nonguaranteed lending to the private sector. In many cases they do not have adequate information on potential private sector borrowers in developing countries. Up-to-date balance sheets are often not available, and varying accounting standards and practices make it difficult to assess the financial strength of enterprises. Agencies also noted that the legal systems of some developing countries made it difficult to enforce their claims.
To deal with these difficulties, agencies have sometimes channeled cover for exports to the private sector through commercial or development banks in developing countries. The banks serve as intermediaries between foreign lenders and final borrowers. They are fully responsible for assessing the viability of the investment and the creditworthiness of the buyer, as well as for obtaining what they consider the necessary security from the importer. Agencies thus cover only the risk associated with the possible failure of the borrowing bank and the transfer and other political risks. Besides having ready access to the detailed information required to assess both the quality of the investment and the creditworthiness of the borrower, domestic banks are in a good position to monitor the implementation of investment expenditures and to secure legal redress in the case of nonperformance by the final borrower. Moreover, some agencies felt that as the demand for cover would originate with buyers, the average quality of the investments might be higher than when the demand stemmed from exporters who were keen to expand their business. Many countries, however, lacked suitable institutions to take on the role of intermediation.
The recently announced EXCEL program is a similar type of operation. The program envisages loans to local development banks or other financial institutions, mostly from lenders supported by agency cover, but also from the World Bank, which would be on-lent to private sector borrowers. In addition to providing a part of the necessary finance, the Bank would help to identify suitable institutions in developing countries and would be involved in vetting individual loans. The loan from the Bank would be structured so that amortization of the loans supported by agency cover would be completed ahead of amortization of the Bank’s loan. Agencies would not benefit directly from the World Bank’s preferred creditor status, but the Bank would pledge “best efforts” to seek full repayments. Agencies found attractive the role of the World Bank in identifying intermediary banks and allowing for relatively early repayment of loans supported by the agencies, as well as the best efforts clause concerning repayment.
A number of agencies noted that loose domestic financial policies in some debtor countries discouraged the private sector from taking the exchange risk involved in borrowing abroad, one consequence of which was importing on a cash basis rather than by drawing upon external credits. The absence of an appropriate interest rate and exchange rate policy and an efficient forward market was seen as a particular problem in this regard, as private sector importers were not able to use market instruments to reduce exchange rate risk.
Other Developments in Project Finance
The growing emphasis on the quality of the underlying project can help to avoid situations where a poorly conceived project adds to a country’s balance of payments problems but does not provide safeguards against payments problems emanating from other sources. Agencies thus have been exploring financial arrangements that can help to ensure that a project will not only be viable but will also generate repayments, even if the country concerned runs into debt-servicing problems.
Limited Recourse Financing—BOOT Projects
Limited recourse financing makes the link between project viability and repayment explicit, as repayments are based on the financial success of the project rather than the financial strength of the buyer or guarantor. In recent years agencies have given careful consideration to one form of limited recourse financing—build, own, operate, and transfer projects (BOOT). The use of these techniques has been considered in Turkey, for example, for the construction of a metro system and electric power generation stations.
The details of BOOT arrangements vary from case to case. In general, a company in an industrial country would build a large capital-intensive project in a developing country. When the construction was completed, the company would operate the project and be allowed to repatriate some combination of fixed debt service payments (if earnings were adequate) and some part of any profits earned. Ownership would be transferred to the host country after the original claims had been repaid.
Limited recourse projects are attractive for the host country, since they provide a mechanism for financing capital-intensive projects with repayment taking place only if the foreign investor builds and runs the project successfully. Export credit agencies also find it attractive to support projects in which experienced contractors take full responsibility for construction and initial operation. Agencies have noted, however, that decisions by the host government could have a pervasive influence on the profitability of such enterprises, through the impact of pricing policies, labor laws, and the regulatory environment. A major stumbling block to reaching final agreement on BOOT operations has been the difficulty in negotiating assurances on these aspects that were satisfactory to all concerned. In some cases, in fact, the role envisaged for the export credit agency has been expressly to provide insurance against the nonperformance of specific undertakings given by the host government, such as the convertibility of external payments and administrative measures that may affect the project.
Given these complexities, few such projects have materialized thus far, and the initial experience has been mixed, with at least one agency sustaining substantial losses. Agencies continue to explore possibilities in this area, but most express skepticism that they will provide a channel for significant volumes of international finance.
Cover for Equipment Leases
Most agencies are now prepared to offer cover for leasing contracts for movable physical assets. For the most part, these are limited to leases on aircraft engaged in international flights; coverage is also available for leases on ships. Agencies offer policies that provide cover for both the commercial and transfer risks associated with the payments on these leases, as well as coverage for a comprehensive range of political risks, including the detention or appropriation of the asset without adequate compensation by the government in the debtor country. Cover for leases is likely to be a buoyant area of business over the next few years as airlines replace their aging fleets to meet safety and noise regulations.
Agencies are also exploring the use of escrow accounts. Under an escrow account mechanism, all or part of the foreign exchange earned by a project is deposited in an account held abroad; debt service payments to creditors then have priority over other uses of the foreign exchange by the country concerned.
A number of agencies saw escrow accounts as a second-best solution for lending to countries that were not generally creditworthy. They thought that such arrangements enabled countries to obtain finance for projects that could not otherwise have been contemplated. To the extent that the projects generated net earnings of foreign exchange, they would help to alleviate the general scarcity of foreign currency, and would thereby ease relations with other creditors. At the same time, creditors would have better assurance of repayment of the new loans both as a result of the improved administrative discipline associated with these arrangements and because they would have first call on earnings from the project in the event of a general deterioration of the external accounts.
Although the use of escrow accounts could allow a country access to external resources, agencies recognized that complications could arise from a macro-economic perspective. By weakening the link between the implementation of appropriate policies and the availability of new credits, such arrangements would reduce the incentives for countries to adopt and maintain policies that would allow the normalization of relations with creditors. To the extent that a large part of export receipts was committed to servicing specific loans, the operation of escrow accounts would reduce the authorities’ flexibility in the face of payments difficulties and increase the likelihood of arrears to creditors not operating escrow accounts. This would impair the ability and willingness of such creditors (including multilateral organizations) to provide financing to the countries concerned. In the end, escrow accounts might have little value to either debtors or creditors.
The use of escrow accounts for public sector projects runs counter to the policy of debt subordination, which has served as the basis of the debt strategy for official creditors. That strategy has emphasized that servicing old (in that case, pre-cutoff date) loans is subordinated to servicing new loans. But escrow accounts attempt to subordinate all other loans, including those newer than the ones protected by the escrow accounts. Other creditors thus often insist that their new loans not be subordinated in this fashion.24 For example, World Bank loan agreements (as well as those of commercial banks) typically contain negative pledge covenants25 that in principle bar such subordination for public sector borrowings, though the implementation of such clauses has sometimes proven problematic.
By contrast, escrow accounts for private sector projects may represent a legitimate means of containing commercial risks; but their ability to do so depends on the existence of a relatively liberal exchange system and an absence of any public sector involvement or support.