Chapter

Appendix I. Financing of Payments Imbalances Through International Capital Markets, 1974–78

Author(s):
R. Williams
Published Date:
September 1980
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The sharp increase in the world market price of oil in 1979, which resembles, in terms of magnitude, the steep oil price adjustments of 1973–74, has revived interest in how the world financial system coped with the large shift in payments imbalances which occurred at that time. As is happening again in 1979–80, the traditional pattern of current account balances, under which the industrial countries sustained substantial surpluses which had their counterpart in capital imports by the non-oil developing countries, with the oil exporting countries generally in approximate balance, was changed radically. Given the short-run limits on the absorptive capacity of the major oil exporters, maintenance of the volume of oil exports implied massive current account surpluses for the oil exporters, matched by deficits on the part of industrial and non-oil developing countries. As it turned out, after 1973, while much of the surpluses went into official aid, direct investment, and government obligations in industrial countries, about one third of the surpluses found their way into international capital markets for reasons of flexibility, security, and rate of return. Developing countries, at the same time, turned to those markets for a substantial proportion of their balance of payments financing requirements. At the time there were widespread fears that the international capital markets would be unable to cope with financial flows of such magnitude, but in the event they were able to do so.

The principal problem in international finance in 1974 was the need to ensure the recycling of oil surpluses, particularly to the non-oil developing countries, although also to the minor industrial countries. This appendix examines the role of the international capital markets in this regard, with emphasis on the recycling of the oil surpluses in 1974 and 1975. The main focus is on the way in which international banks were able to expand their ability to serve as international financial intermediaries, particularly in financing developing country deficits, but there is also some discussion of the role of the bond markets, and the section concludes with a brief account of developments from 1976 through 1978, by which time the oil surpluses had virtually disappeared.

Payments Imbalances Following the Oil Price Increases of 1973–74

The change in the pattern of current account balances which accompanied the 1973–74 rise in oil prices is summarized in Table 6. The global sum of current account deficits increased fourfold in 1974, compared with the average for 1971–73; the oil exporting developing countries moved from a position of near balance in 1971–73 to large surpluses in 1974, which gradually declined until 1977, then dropped sharply in 1978. Most of the increase in 1974 had its counterpart in a sharp swing from surplus to deficit for the industrial countries, but in 1975, with widespread recession, these countries returned to surplus, while the deficits of non-oil developing countries continued to grow. Economic recovery in 1976 put industrial countries back into deficit, and the deficits of the non-oil developing countries began to decline. By 1978 the old pattern of current account balances re-emerged, with industrial country surpluses providing the basis for capital flows to the non-oil developing countries. One significant change from the pre-1974 pattern was that some of the oil exporting countries still had substantial surpluses, while others were in almost equally substantial deficit (see Table 24). The global sum of current account deficits remained high, but in real terms declined considerably from its 1974 peak.

Table 6.Current Account Balances, 1971–781(In billions of U.S. dollars)
Average
1971–7319741975197619771978
Industrial countries18–1316–2–531
Seven largest14–5228834
Other4–8–6–10–13–3
Developing countries–831–1184–31
Oil exporting4683540325
Non-oil–12–37–46–32–28–36
Centrally planned economies2–2–9–7–2–4
Memorandum item
Sum of all current account deficits–18–76–78–73–76–85
Source: Table 24.

Excludes official transfers. The asymmetry between total deficits and surpluses is due to statistical errors and omissions and timing asymmetries in the recording of exports and imports.

Excludes Fund member countries.

Source: Table 24.

Excludes official transfers. The asymmetry between total deficits and surpluses is due to statistical errors and omissions and timing asymmetries in the recording of exports and imports.

Excludes Fund member countries.

Table 7.Net Borrowing Through International Capital Markets, 1971–78(In billions of U.S. dollars)
Average
1971–7319741975197619771978
Borrowing from banks2750407075110
Industrial countries162210314349
Developing countries91823302547
Oil exporting3891017
Non-oil1515211530
Centrally planned economies249849
Unallocated6–2136
Bonds81020303130
Industrial countries5514202118
Other356101012
Total new bank and bond financing356060100105140
Less double counting–1–2–2–4–5–8
Total net new bank and bond financing34585896100132
Sources: BIS; Board of Governors of the Federal Reserve System; World Bank; and Fund staff estimates.
Sources: BIS; Board of Governors of the Federal Reserve System; World Bank; and Fund staff estimates.

Role of International Capital Markets in 1974–75

Dimension and Direction of International Lending

The strong preference of oil producers for keeping their assets in liquid bank deposits, together with the strong demand by deficit countries for balance of payments finance, provided banks with the opportunity to greatly expand their role as international financial intermediaries after 1973. International lending by banks, net of redepositing, rose from an average of US$27 billion in 1971–73 to US$50 billion in 1974 and total net borrowing through international bank and bond markets rose from an annual average of US$34 billion in 1971–73 to US$58 billion in 1974 (Table 7). Bank lending began to slow in the second half of 1974, as the growing prudential concerns on the part of banks, which were given emphasis by some well-publicized bank failures in mid-1974, began to have an effect, and in 1975 it declined to US$40 billion. International bond market activity almost doubled in 1975, however, keeping total lending through international capital markets at the same level as in 1974.

Syndicated lending by banks, the main vehicle for bank balance of payments financing, rose by 36 per cent in 1974 (Table 8) with a rapid rate of expansion in the first half of the year followed by a sharp downturn after mid-1974. New commitments continued to decline in 1975.

Bank lending to non-oil developing countries amounted to an annual average of US$9 billion in the period 1971–73 (Table 9). Non-oil developing countries received more than one third of total new syndicated bank lending during this period and financed one half of their current account deficits and reserve accumulation through borrowing from banks. Net bank lending rose to US$15 billion in 1974, most of which was secured in the first half of the year, as the bank crisis of mid-1974 also affected lending to developing countries. The current account deficits of non-oil developing countries grew further in 1975; with bank borrowing unchanged, most of the increase was met by drawing down reserves. The ratio of bank borrowing to the sum of the reserve accumulation and current account deficits of non-oil developing countries declined from an average of 50 per cent in 1971–73 to 35 per cent in 1974–75, with new sources of finance such as borrowing through international bond markets playing only a minor role for the non-oil developing countries, providing about 2 per cent of their total financing needs in 1974–75 (Table 34).

Table 8.Publicized Medium-Term Credit Commitments, 1972–781(In billions of U.S. dollars)
1972197319741975197619771978
Industrial countries4.511.817.65.59.512.933.5
Seven largest3.69.413.22.24.66.522.1
Other0.92.44.43.34.96.411.4
Developing countries4.08.29.412.016.118.436.8
Oil exporting1.12.70.73.13.55.510.2
Non-oil2.95.58.68.912.612.926.6
Centrally planned economies20.30.71.12.72.42.63.0
International organizations and unallocated0.20.40.40.70.30.4
Total8.820.928.520.628.734.273.7
Source: Table 30.

Medium-term publicized international bank credit commitments.

Excludes Fund member countries.

Source: Table 30.

Medium-term publicized international bank credit commitments.

Excludes Fund member countries.

International bank lending to non-oil developing countries was concentrated on a relatively small number of countries. Most prominent among these were Brazil and Mexico, which accounted for 42 per cent of syndicated lending commitments in 1974–75 (Table 30). Ten other large borrowers accounted for a further 39 per cent of such commitments. While some of the large borrowers had had substantial recourse to international bank borrowing well before 1974, other countries such as Korea, Malaysia, Morocco, and the Philippines became significant borrowers only after the oil price increase of 1973–74.

Main Factors Affecting Banks’ Role as International Intermediaries

The expansion of the role of banks as international financial intermediaries in 1974 and 1975, particularly vis-à-vis the non-oil developing countries, was affected by developments in a number of areas. Macroeconomic developments in the world economy were, broadly speaking, favorable to that expansion. Microeconomic developments—matters related to bank objectives and the constraints on their activity imposed by prudential concerns—were less favorable, and accounted for the relative decline in the role of banks in 1975.

The principal macroeconomic factors affecting international bank lending in 1974–75 were the recession in industrial countries and the decline in interest rates which followed with some delay. The decline in economic activity in the industrial countries was partly responsible for the increase in the financing requirements of non-oil developing countries, but at the same time led to a reduction in the demand for bank finance in industrial countries. Banks were thus given an incentive to look for additional business abroad, and maintained their lending to non-oil developing countries in 1975 despite the rise in prudential concerns regarding such lending. (The substantial switch from bank loans to bond market borrowing by the industrial countries, discussed below, also released bank lending capacity to the benefit of developing countries.) At the same time, the decline in interest rates in 1975, through lowering the interest rate burden on borrowers, facilitated recycling. The impact of the fall in interest rates on debt service of the non-oil developing countries in 1975 was about US$2 billion (2 per cent of exports); for some countries the proportion was considerably higher. The fact that much of the increase in net bank lending could take the form of short-term trade financing also made the task of recycling easier.

Table 9.Borrowing Through International Capital Markets by Non-Oil Developing Countries, 1971–78(In billions of U.S. dollars)
Average
1971–7319741975197619771978
Total net new bank lending to non-oil developing countries911515211530
Share of total net new bank lending (per cent)31.230.037.530.020.027.3
In proportion to current account deficits and reserve accumulation (per cent)50.036.633.346.737.554.6
Total net new bond borrowing by non-oil developing countries111234
Memorandum item
Share of claims on non-oil developing countries in net international claims of banks2 (in per cent, end of period)26.527.328.929.128.127.9
Sources: Tables 34 and 35.

Includes oil exporting developing countries.

Net of redepositing among banks.

Sources: Tables 34 and 35.

Includes oil exporting developing countries.

Net of redepositing among banks.

Table 10.Terms on Publicized Medium-Term Credit Commitments, 1973–781
197319741975197619771978
Average maturities (years)
Industrial countries8.137.885.735.996.738.28
Developing countries9.648.195.205.356.178.10
All categories of borrowers8.898.015.215.496.448.24
Average spreads (per cent)
Industrial countries0.640.691.371.310.960.66
Developing countries0.991.021.561.571.401.09
All categories of borrowers0.780.831.471.471.220.90
Memorandum item
Average six-month Eurodollar deposit rate (per cent)29.3211.207.616.136.429.36
Sources: Calculated from data shown in Tables 31 and 32; and Morgan Guaranty Trust Company, World Financial Markets.

The country categories are those used by the World Bank.

Average of month-end prime banks’ bid rates; the offer rates (LIBOR) commonly used as a basis for Eurodollar lending are generally 0.125 per cent above bid rates.

Sources: Calculated from data shown in Tables 31 and 32; and Morgan Guaranty Trust Company, World Financial Markets.

The country categories are those used by the World Bank.

Average of month-end prime banks’ bid rates; the offer rates (LIBOR) commonly used as a basis for Eurodollar lending are generally 0.125 per cent above bid rates.

The sharp rise in balance of payments financing requirements in 1974 gave rise to concerns about the creditworthiness of borrowers, particularly the non-oil developing countries. As at the present time, these concerns related not so much to the immediate situations of such countries but to the fear that larger deficits would continue to the point where debt service requirements would become unmanageable. These prudential concerns regarding international bank lending were brought into sharper focus by the failure of some banks in 1974, which also led to expressions of concern about such matters as the adequacy of bank capital to cope with the inevitable credit and maturity mismatch risks.

Although the bank collapses were not related to international bank lending per se but were caused by losses in the foreign exchange market, the bank failures had major consequences for interbank relationships and international lending. Tiering of interbank deposit rates became considerably more pronounced and many small and medium-sized banks withdrew from the market, leaving more of the recycling up to those big banks which tended to receive deposits themselves. Large Japanese banks also retreated from the market because of prudential concerns, particularly on the funding side. Connected with these events was an abrupt hardening of lending terms and a decline in new credit commitments (Tables 10 and 11). Average spreads jumped from 0.71 per cent in the second quarter of 1974 to 1.25 per cent in the fourth quarter and increased further during most of 1975 and maturities declined by more than two years. The eventual arrival of much harder terms was to be expected, in view of the surge in demand for bank intermediation, but the crisis of mid-1974 probably resulted in a much more rapid stiffening of terms and decline of lending volume than would have otherwise been the case. The impact on borrowers of higher spreads was more than offset by the decline in market interest rates. In 1975 LIBOR18 averaged more than 4 percentage points below its level in 1974.

Table 11.Publicized Medium-Term Credit Commitments: Evolution of Volume and Terms, 1974 and 1975
CreditAverageAverage
CommitmentsSpreadMaturity
(Million U.S. dollars)(Per cent)(Years)
1974
First quarter6,4500.828.73
Second quarter12,3920.717.92
Third quarter4,5750.877.60
Fourth quarter3,5931.257.13
1975
First quarter3,1141.445.63
Second quarter4,8301.515.25
Third quarter4,8301.535.23
Fourth quarter7,2021.495.10
Source: Calculated from World Bank data.
Source: Calculated from World Bank data.

Bond Markets19

Relatively unattractive yields permitted only a moderate increase in the volume of international bond issues in 1974, but after interest rates began to decline and the widespread inverse yield curves disappeared, the international bond market performed an important—albeit indirect—function in the recycling effort, and new issues almost doubled to US$23 billion in 1975 (Table 12). Another factor contributing to the rapid expansion of the bond markets was the widening of borrowing facilities for dealers, which added to the liquidity of the international bond market. By providing a large part of the financing needs of the industrial countries—almost 60 per cent of their bond and credit financing—the international bond market reduced the potential burden on the international banking system and allowed the latter to help meet the increasing needs of developing countries.

International Capital Markets in 1976–78

While the recovery of the industrial countries from recession increased the surpluses of the oil exporting countries in 1976, in the next two years the surpluses declined rapidly. Although many countries, particularly the non-oil developing countries, continued to have large current account deficits, a return to a more viable international payments situation seemed to be under way. With confidence thus restored and more profitable terms available on bank lending, banks rapidly expanded their activity and, by 1978, borrowing from international banks amounted to US$110 billion, almost four times the annual average in 1971–73; including bonds, total borrowing through international capital markets reached US$132 billion, compared with an annual average of US$36 billion recorded in 1971–73. New syndicated credit commitments grew by an annual average of close to 30 per cent in 1976–77, then doubled in 1978. The return of many medium-sized banks in various capital market countries—for which international lending was a major source of expansion in view of slackening domestic credit demand—was an important factor in the strong recovery of international bank lending after 1975. Other factors contributing to the growth of international lending in the second half of the 1970s were the expansion of world trade (which rose by about 50 per cent in terms of U.S. dollars between 1975 and 1978), low real interest rates, and borrowing by many developing countries for building up foreign reserves.

Table 12.International Bond Issues and Placements, 1973–78(In millions of U.S. dollars)
197319741975197619771978
Total international bonds19,91412,30122,82134,31136,09437,316
of which:
Foreign bonds5,3147,78612,30118,94316,61021,377
Eurobonds4,6004,51510,52015,36819,48415,940
Total international bonds by borrowing country2
Industrial countries5,3935,80415,80223,37423,32422,724
Developing countries1,4049561,2622,0924,2255,767
Oil exporting12462531777861,653
Non-oil exporting1,2818941,2101,9153,4394,114
Centrally planned economies401017225630
International organizations2,9355,4035,3308,2567,1608,425
Other181993265171,130371
Source: World Bank, Borrowing in International Capital Markets.

Components may not add to totals due to rounding.

The country classifications are those used by the Fund.

Source: World Bank, Borrowing in International Capital Markets.

Components may not add to totals due to rounding.

The country classifications are those used by the Fund.

Lending spreads on loans to industrial countries eased in 1977, this was followed by a further softening of terms—for developing countries as well—in 1978. In 1978, average spreads on syndicated credits to industrial as well as to developing countries exceeded only slightly the levels recorded before mid-1974. Average maturities also increased from 4.5 years in 1976 to 7.5 years in 1978 with little differentiation between industrial and developing countries. In 1978, interest rates rose substantially but, because of the increase in inflation, real rates remained low.

With prudential concerns having eased, bank lending to non-oil developing countries rose to an annual average of US$22 billion in 1976–78, compared with US$15 billion in 1974–75. The ready availability of bank finance delayed adjustment in some countries and by 1977–78 some medium-sized borrowers among developing countries (e.g., Turkey and Zaire) experienced serious external payments problems which gave rise to questions about the banks’ criteria for international lending.

A significant development in international bank lending was the decline in the role of U.S. banks in international lending from 1977 onward. While U.S. banks held about 36 per cent of all international bank claims at the end of 1976, this share fell to 29 per cent at the end of 1978. The growth in international claims of U.S. banks slowed from 32 per cent in 1976 to 13 per cent in 1978 (Table 36). The main reason for the decline in the role of U.S. banks seems to have been the reduced profitability of international lending. This made domestic lending more attractive—domestic credit demand was relatively strong in 1977 and 1978—and also tightened the overall capital constraint.

By 1976, further large gains were recorded for issue volume in the international bond markets, with new issues rising by one half to US$34 billion. The principal contributory factors leading to the expanded growth in 1975 were again in evidence in 1976, and industrial country borrowers again accounted for the bulk of international issues, maintaining a share of close to 70 per cent. Although during 1977 and 1978 interest rates in the major markets other than the United States continued to decline, the foreign exchange markets became somewhat unsettled, as the U.S. dollar depreciated sharply against other major currencies. The resulting exchange rate uncertainties depressed investor demand. Also, there was lessened demand for financing from entities of industrial countries, to whose paper investor interest was mainly directed. Although the issue volumes in 1977 and 1978—at US$36 billion and US$37 billion, respectively—approximated the level in 1976, the pattern of borrowing showed a marked change. Over the period 1977–78, developing country bond issues and placements rose almost threefold (to US$5.8 billion), thus increasing the developing country share of international bonds from just 6 per cent in 1976 to 15.5 per cent in 1978.

18Interest rates on medium-term syndicated credits are usually defined in terms of the spread ewer LIBOR—i.e., the margin over the London Interbank Offer Kate, the average rate at which major banks are prepared to deposit funds with each other. Each loan agreement specifies, among other things, the major banks which are to be considered in the calculation of LIBOR, the maturity of the deposits (usually six months), and the dates at which the interest rate on the loan is to be adjusted on the basis of LIBOR (usually at six-month intervals). There are many variations on this pattern—one of which is to relate the interest rate to the U.S. prime rate rather than to LIBOR.
19The international bond market comprises both the several foreign bond markets, in which issues of foreign entities are originally offered by syndicates composed principally of firms from one country, sold mainly in that country, and denominated in the currency of that country, and the Eurobond market in which issues are originally offered by an international syndicate and placed principally in countries other than the country of the currency in which the bond is denominated.

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