Adjustment can mean many different things, but in this paper it refers to the process of adapting a country’s balance of payments to whatever unfavorable shock has upset the equilibrium.
The fundamental role of commercial banks is to accept the world’s savings from those who can be induced to save and to channel those savings to creditworthy borrowers with good investment opportunities. When banks do this well, their intermediation can be a powerful force for economic growth in the world.
Banks have a special role when adjustment is taking place. While the main task continues to be to channel savings to creditworthy borrowers, the specific purpose of the lending in this case is to tide the borrower over a difficult period while he adjusts to a new situation. The test of creditworthiness in this situation is whether the borrower, in fact, uses the time well to carry out the required adjustment. In the ideal case, lenders can make an invaluable contribution to casing the adjustment process of their clients. The required adjustment can be less abrupt, the growth of world production can be sustained, and the pain in terms of lost output and unemployment can be held to a minimum.
What is it that we are now adjusting to? One year ago, most of us would have answered, the “second oil shock.” In fact, if you were young and lived in an industrial country you might have thought that the only thing the world ever had to adjust to was an oil price increase. But “old-timers” from Latin America are aware that unfavorable shocks, such as declining commodity prices, were a problem long before 1973 and often the adjustment called for in the exporting country was even larger than the adjustment that occurred after the oil price increase.
Until about one year ago, I also thought that the world’s main current adjustment problem was to adapt to higher energy prices. 1 think you will agree, however, that the situation has become more complex than this. In fact, early in 1983 newspapers suddenly decided that the most frightening prospect facing the world was a sharp decline in energy prices. Some of the stories suggested that the world financial system could withstand a drop in oil prices to $25 a barrel, but if prices fell below that, oil exporting countries such as Mexico, Venezuela, Indonesia, and Nigeria would be unable to service their debts and this could lead to the bankruptcy of some of the world’s largest banks. The imminent threat of a world financial collapse was presented in almost exactly the same language as two years earlier, when oil prices rose, causing problems for Brazil, Korea, and the Philippines. That many journalists—and some U.S. congressmen—do not believe that the world’s economies or the world’s financial system are capable of adjusting to fluctuations in commodity prices and other similar shocks is discouraging; we have always had such fluctuations, changes, and uncertainties in the world; we have them now, and we will continue to have them.
In my view, the world’s economics and the international financial system are not as fragile as is thought, and, given time, both have proved to be capable of adapting to large changes. Unfortunately, very few people in developed countries realize this and only a few have any in-depth knowledge of developing countries. This lack of understanding may, in fact, itself be the biggest threat now facing the world economy: ill-conceived regulations to limit the flow of capital in the world could lead to a decade of depressed economic activity.
Imperceptibly during the past year, the world’s basic problem has switched: it is no longer adjustment to higher energy prices but adjustments to high real interest rates and to a dramatic slowing down of inflation and economic activity. The world, for the moment at least, has stopped growing. Exports of developing countries which grew by 20 percent a year from 1973 to 1980 remained almost flat from 1980 to 1982. This slowdown in activity is what we are now adjusting to, and the required adjustment affects everyone irrespective of boundaries.
But this is getting ahead of my story. To put our present problems in perspective, it is useful to discuss the adjustment process since the first oil shock in 1973.
Section 1 looks at the growth in external debt of the non-oil developing countries since 1973. There is a popular notion that these countries did not adjust adequately to the oil price increases of the past decade, but rather simply borrowed large amounts of money to finance their deficits, and consequently will not be able to service the resulting debt. The section considers, therefore, not only the debt but also interest payments on the debt and the growth of export earnings, which provide the means of servicing the debt. The section ends with a judgment as to the further growth of debt that these countries can safely manage over the next few years.
This is followed in Section 2 with a discussion of balance of payments trends in non-oil developing countries over the past decade. External debt is an outgrowth of the balance of payments, since debt is incurred to cover a deficit on current operations. Any effort to control the growth must, therefore, start by strengthening or adjusting the balance of payments; a reduction in borrowing without an accompanying adjustment of the balance of payments will simply result in payments arrears. Section 2 ends with an estimate of the amount of adjustment that developing countries are currently making in their balance of payments, an estimate of the financing required for the remaining deficit, and, in particular, how much of that financing can be expected from commercial banks.
Section 3 focuses directly on the claims of commercial banks on developing countries and looks especially at the current idea that commercial banks are dangerously overexposed in lending to developing countries.
1. EXTERNAL DEBT OF NON-OIL DEVELOPING COUNTRIES 1973–82, AND A LOOK AT THE FUTURE
The external debt of the non-oil developing countries (including over $100 billion of short-term debt) has now exceeded $600 billion.
Almost everyone agrees that this debt is large, and until recently, was growing too fast. Here, the consensus ends. Opinions differ widely on how the debt became so large, how serious the debt problem now is, and what attitude should be adopted toward growth of debt during the next few years.
Although the size of the debt is worrisome, particularly under present world conditions, most of the recent press reporting on the debt problem is unnecessarily alarmist, and this distorted presentation of the problem has itself become a danger.
The growth of developing country debt in the post-1973 period can only be properly understood if it is placed in the perspective of world developments during the period. From end-1973 to end-1980, the long-term external debt of the non-oil developing countries increased from $97 billion to $375 billion, which represents a compound annual rate of growth of 21.3 percent (Chart 1). It must be remembered, however, that these seven years were a period of unusually high world inflation and also high economic growth. As can be seen in the chart, the exports of goods and services of the non-oil developing countries, which provide the foreign currency earnings to service the debt, also rose rapidly, from $109 billion in 1973 to $404 billion in 1980, or at a compound annual rate of 20.6 percent. In fact, after stagnating momentarily during the 1975 recession, the export earnings of these countries actually grew slightly faster than their debt up to 1980. Furthermore, most other relevant economic variables, such as the gross national product (GNP) and total international reserves of gold and foreign exchange, also rose rapidly, approximately tripling in the seven years.
In retrospect, it is my view that while the foreign debt of the developing countries grew too fast from 1973 to 1980, the idea that it was completely out of control or rising out of all proportion to the countries’ capacity to service the debt is not borne out by these figures. On the contrary, I will argue that the international capital flows during the 1970s played an indispensable and reasonable role in the health and growth of the world economy in the period. One must remember that a by-product of the 1973 oil price increase was the concentration of a sizable amount of savings in a few oil-rich countries which had quite limited investment opportunities. The international banking system channeled these savings to those parts of the world that were short in savings but had good investment opportunities. This meant mainly developing countries, such as Brazil, with its hydroelectric potential and raw material wealth, Korea, with its disciplined labor force in manufacturing, or Mexico, with its oil reserves to develop. There is no doubt that much of the economic growth achieved by these developing countries and by the world as a whole in the latter part of the 1970s was a direct result of these capital flows.
The success of the recycling effort after 1973 depended on getting the funds to those countries where genuine investment opportunities existed and where the economic policies being pursued assured that the funds would be well used. These countries should then have been able to increase output rapidly, expanding both their own economies and the markets for other producers and, at the same time, generating through their investments the exports needed to service the debts. And this is exactly what happened. Contrary to the pessimistic predictions in 1974, the economic growth of the oil importing developing countries in the latter part of the decade was faster than in any comparable period and also faster than in the industrial countries. The best performance was in precisely those countries that received heavy infusions of capital, for example, Brazil, Mexico, Korea.
The most rapid growth in the developing countries in the late 1970s was in the export sector. This was essential to the adjustment process. It provided foreign exchange to pay for higher-cost energy imports and to service the debts incurred to carry out the required investments. But I will leave the fuller discussion of the balance of payments adjustment to Section 2.
Following these relatively favorable trends in the late 1970s, developments in the world economy in 1981–82 brought an abrupt change. The problem was not that debt began to increase more rapidly—in fact, the rate of increase recorded in long-term external debt seems to have declined slightly in 1981–82 to an annual rate of about 14 percent for the two years—but that the growth in exports of goods and services suddenly slowed down (Chart 1).
There is no doubt that the major single factor in the debt crisis which has spread through much of the developing world is the poor performance of exports in 1981–82. After growing by 20 percent a year for eight years, export earnings in 1982 were not much above the level of 1980. Exports in 1982 were, therefore, almost 40 percent lower than they would have been if the previous growth rates had continued. This, not energy prices, is what the world is now adjusting to. As would be expected, the abrupt halt in export growth is affecting principally those rapidly growing developing countries whose economic success in the 1970s was mainly dependent on exports, who integrated themselves closely into the world economy, and whose development strategy was based on external borrowing being paid for with export earnings. (Mexico, for example, expanded merchandise exports from $2 billion in 1973 to $20 billion in 1981, faster than almost any other country in the group, and it was the sudden downturn of the volume and price of oil shipments in mid-1981 that forced an immediate reassessment of the growth in debt.)
In addition to the unexpected stagnation of exports, the second development in the early 1980s which forced countries to re-evaluate their recourse to foreign borrowing was the sharp increase in interest rates. Average interest rates on the long-term foreign debt of the developing countries had been below 5 percent in 1973, but by 1980, they had risen to about 8 percent, and on the basis of preliminary estimates, they had risen to almost 9 percent by 1982. Because of this shift to higher rates, the growth in interest payments was far faster than growth of debt itself after 1979 (Chart 2). Average interest rates throughout the decade would be even higher, of course, except for the considerable amount of concessionary credit available to the low-income developing countries, but the portion of this type of financing in total debt has declined in the past decade. Nevertheless, for countries receiving large amounts of concessional financing, mainly the low-income countries of Africa and Asia, interest rates do not appear to have increased much over the past decade and real interest rates probably even declined as inflation accelerated.
The rise in nominal and real interest rates has had a particularly adverse effect on countries in Latin America, which borrow most of their funds at commercial rates. Consequently the possibility that real interest rates in the 1980s will remain higher than in the early 1970s cannot be ignored in planning a future debt strategy for these countries. The burden of an $80 million debt takes on a completely different significance when interest rates rise from a nominal 6 percent (real 2 percent) as in the mid-1970s to 16 percent (real 7 percent) as in the early 1980s. A difference of 10 percentage points in the interest rate on a $80 billion debt adds $8 billion to the current account deficit. It is not surprising, therefore, that the most severe payments crisis of 1981–82 occurred in those highly indebted Latin American countries that borrow on commercial terms; that the domestic policies in some of these countries during 1982 were often inadequate, because approaching elections or other political factors did little to alleviate the crisis.
To complete this introduction of the growth of debt, one must say something about the problem of short-term debt, that is to say, debt with an original maturity of less than one year. Even though data on short-term debt are tenuous, most estimates suggest that the short-term debt of non-oil developing countries was around $100 billion at the beginning of 1983.1
Traditionally, about the only source of short-term debt used by developing countries was trade-related. Imports would be paid for with a delay, or exports with an advance, of a few days or months. This not only provided balance of payments support to countries, but frequently also was a source of working capital to exporters and importers. Most debt-registration systems established for developing countries, including that of the World Bank, did not attempt to track these constantly changing “debts,” many of which existed for only a few days. Almost everything imported or exported by a country gets financed for a few days, at least while the payment is being processed. Current records on the amount of this debt are not only difficult to maintain but are also out of date by the time they become available. Moreover, in normal times one expects a certain stability in the amount of trade credit outstanding, although it must be admitted that some of the rescheduling difficulties in Latin America in the 1950s and 1960s were brought on by an overextension of this type of short-term foreign indebtedness.
During the past few years, a new type of short-term foreign debt has begun to emerge that is totally unrelated to trade and that often involves foreign agencies of commercial banks of the developing countries which have established themselves in New York, London, Paris, and other foreign money centers. These agencies behave like other banks in those centers, funding themselves by taking deposits or placements, often at maturities of 30, 60, or 90 days, or even overnight funds. The banks might channel two thirds or three fourths of their funds back to the country or head office and place the remainder in the developed countries or in other developing countries. The New York agencies of Brazilian banks, for example, might be lending in France, Mexico, and Chile, as well as to borrowers in the United States and Brazil. When the “home” country of the head office of one of these banks has balance of payments problems, the agency may experience a loss of short-term deposits, which adds to the total crisis. Most attempts by countries to measure their debt now seem to record the remittances which the agencies make to the home country. Some important series on lending, however, such as the BIS (Bank for International Settlements) quarterly series on bank lending, fail to capture these claims as part of the total claims on the country. I have brought up this short-term non-trade-related debt for two reasons. First, this type of debt appears to have risen rapidly with the proliferation of developing country banks around the world, and particularly during the past two years when countries were experiencing difficulties in raising funds in other ways. Second, this debt is by nature very volatile because it is funded with short-term deposits, which can be withdrawn suddenly at any sign of problem in the borrowing country, thereby adding to the sense of financial crisis.
To summarize, I think the growth in debt of developing countries until 1980 was not so irrational as is sometimes suggested. The debt was growing fast, but not faster than the capacity to service the debt. Since 1980, on the other hand, several developments have occurred that make the debt look excessive of which I cite three:
exports of the developing countries have virtually stagnated, mainly because of the world recession;
at the same time, interest rates in world markets have risen beyond expectations; and
domestic economic policies in some of the important debtor countries were temporarily inadequate, contributing to the poor balance of payments performance.
Against this background of the growth in developing country debt in the past decade, let me now turn to the question of where we go from here. What is a manageable plan for growth in the debt during the remainder of the 1980s? While recognizing all the pitfalls in planning for the future in an uncertain world, I think that almost everyone now agrees that the growth in debt must be slowed down to a much more moderate level. We need to be planning for at least a five-year period in which the growth in debt is slower, perhaps 2–3 percent a year slower, than the growth in capacity to service the debt as measured by the exports of goods and services.
With the present prospects for world inflation and growth, it would not be unreasonable to expect export earnings of developing countries to rise by 10 percent a year during the next few years, or about one half the rate of the 1970s. It is essential in this case to limit the growth in debt to 7 percent a year. An increase of 7 percent on total debt of $600 billion would represent an increase of about $42 billion in 1983 (Chart 3).
Some countries, particularly in Latin America and Africa, need an even slower rise in debt than 7 percent unless they are able to contract an increased portion on concessional terms, which does not seem likely. For example, in Brazil, economists have been talking of making sure that the debt does not grow in real terms during the next few years; and in Mexico a program has been adopted for 1983 and beyond that would result in a rise in total debt of less than 7 percent, even after allowing for some extra borrowing to increase the depleted international reserves. On the other hand, in Asia, there clearly are several countries that still could tolerate a rise in debt by more than 7 percent a year.
If during the next few years, the growth of external debt could be held at 7 percent a year then we would enter the late 1980s with a sustained period in which the debt of the developing countries would have grown more slowly than export earnings. Even more important, it would be a period that would show that the growth of debt can be controlled.
2. BALANCE OF PAYMENTS OF THE NON-OIL DEVELOPING COUNTRIES
This section discusses the balance of payments deficits in the non-oil developing countries during the past decade, how these deficits were financed, and the relationship between this and the growth of debt that was summarized in the preceding chapter. In particular, the role of commercial banks in financing the deficits and in promoting adjustment is discussed.
The annual current account deficit for the 110 non-oil developing countries is shown in the first line of Table 1. After reaching a peak of $102 billion in 1981, the deficit is estimated to have declined to $85 billion in 1982 and is projected to decline further to about $65 billion this year. If the projection turns out to be correct, it would represent a $35–40 billion adjustment in the balance of payments in two years; but because exports and imports of these countries are now more than twice as large as in the mid-1970s, this adjustment would be no larger in relation to the trade flows of those countries than the $19 billion reduction shown in the table between 1975 and 1977, following the first oil shock.
Non-Oil Developing Countries: Current Account Deficit and Financing
(In billions of U.S. dollars)
Non-Oil Developing Countries: Current Account Deficit and Financing
(In billions of U.S. dollars)
| Prel. | Proj. | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1973 | 1974 | 1975 | 1976 | 1977 | 1978 | 1979 | 1980 | 1981 | 1982 | 1983 | ||
| A. Current account deficit | 12 | 37 | 47 | 32 | 28 | 39 | 59 | 86 | 102 | 85 | 65 | |
| B. Addition to reserves | 10 | 2 | –2 | 14 | 12 | 16 | 12 | 5 | 2 | –10 | 8 | |
| C. Financing required (A + B) | 22 | 39 | 45 | 46 | 40 | 55 | 71 | 91 | 104 | 75 | 73 | |
| Financing that does not create debt | 10 | 13 | 12 | 12 | 15 | 17 | 23 | 24 | 26 | 26 | 26 | |
| Net unrequited transfers, SDR allocations, etc. | (6) | (8) | (7) | (7) | (10) | (10) | (14) | (14) | (13) | … | … | |
| Direct investment | (4) | (5) | (5) | (5) | (5) | (7) | (9) | (10) | (13) | … | … | |
| Commercial banks in BIS reporting areas | 10 | 15 | 15 | 21 | 15 | 25 | 40 | 49 | 50 | 22 | 20 | |
| Long-term borrowing from official sources | 5 | 9 | 11 | 11 | 13 | 14 | 15 | 21 | 20 | 22 | 22 | |
| IMF and other reserve-related credit | — | 2 | 3 | 4 | — | 1 | –1 | 2 | 5 | 8 | 8 | |
| Other (net) | –3 | — | 4 | –2 | –3 | –2 | –6 | –5 | 3 | –3 | –3 | |
Non-Oil Developing Countries: Current Account Deficit and Financing
(In billions of U.S. dollars)
| Prel. | Proj. | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1973 | 1974 | 1975 | 1976 | 1977 | 1978 | 1979 | 1980 | 1981 | 1982 | 1983 | ||
| A. Current account deficit | 12 | 37 | 47 | 32 | 28 | 39 | 59 | 86 | 102 | 85 | 65 | |
| B. Addition to reserves | 10 | 2 | –2 | 14 | 12 | 16 | 12 | 5 | 2 | –10 | 8 | |
| C. Financing required (A + B) | 22 | 39 | 45 | 46 | 40 | 55 | 71 | 91 | 104 | 75 | 73 | |
| Financing that does not create debt | 10 | 13 | 12 | 12 | 15 | 17 | 23 | 24 | 26 | 26 | 26 | |
| Net unrequited transfers, SDR allocations, etc. | (6) | (8) | (7) | (7) | (10) | (10) | (14) | (14) | (13) | … | … | |
| Direct investment | (4) | (5) | (5) | (5) | (5) | (7) | (9) | (10) | (13) | … | … | |
| Commercial banks in BIS reporting areas | 10 | 15 | 15 | 21 | 15 | 25 | 40 | 49 | 50 | 22 | 20 | |
| Long-term borrowing from official sources | 5 | 9 | 11 | 11 | 13 | 14 | 15 | 21 | 20 | 22 | 22 | |
| IMF and other reserve-related credit | — | 2 | 3 | 4 | — | 1 | –1 | 2 | 5 | 8 | 8 | |
| Other (net) | –3 | — | 4 | –2 | –3 | –2 | –6 | –5 | 3 | –3 | –3 | |
What are the prospects of achieving a reduction of the combined deficits of these countries to $65 billion in 1983? Not only is the reduction possible, but an adjustment of approximately this size is almost inevitable. In fact, the process is well on its way toward completion. Two countries alone, Mexico and Brazil, have adopted financial programs for 1983 calling for reduced current account deficits—$3 billion for Mexico and $7 billion for Brazil. The combined deficit of these two countries in 1981 was $24 billion. These two countries, which account for almost one quarter of the total debt and over one third of the debt for this group of countries, will therefore be achieving over one third of the required downward adjustment in current account deficits between 1981 and 1983. Similar adjustments are occurring in other large members of the group, such as Argentina, Chile, Korea, Yugoslavia, and South Africa. Furthermore, in some of these countries a previous outflow of domestic capital has also been slowed down or reversed, and while this outflow was not a part of the current account deficit, it was similar in that it required financing by recourse to foreign borrowing.
A current account deficit of $65 billion in 1983 is approximately the size which is consistent with holding the growth in foreign debt to $42 billion, or 7 percent of the outstanding debt at the beginning of the year. To understand this relationship between the current account deficit and the growth of debt, it is useful to look for a moment at one of the years in Table I. Take the year 1977 as an example. In that year, the deficit on current account was $28 billion; in addition, the countries increased their international reserves by $12 billion, requiring total financing of $40 billion.
Of the $40 billion of financing in 1977, $15 billion came from sources that did not create debt. These sources are direct investment by multinational corporations or official grants of aid, the latter mainly from industrial and oil exporting countries. The remaining financing in 1977 came from $15 billion of net lending by commercial banks and $13 billion of net long-term lending from official sources, such as the World Bank, the regional development banks, and the industrial country export-import banks. Net lending, of course, means the amount by which new loans exceed repayments on old loans, so that the indebtedness of the non-oil countries increases by the amount of net lending. The IMF and central banks did not engage in net lending in 1977, which is not unusual in a year when reserves increased rapidly. (Such indebtedness is not, at any rate, regarded as a part of foreign debt, but rather is netted out of gross reserves.) The final line in the table is a catchall, that is, a net figure of all other inflows and outflows of capital, particularly short-term borrowing from nonbank sources, minus any loans that the countries themselves make abroad through their own export promotion schemes or any recorded capital outflows from private citizens, plus errors and omissions; there was a small net outflow of funds in these categories in 1977. From these numbers, one would estimate that the foreign debt of the non-oil developing countries rose by about $30 billion in 1977 ($15 billion to banks, $13 billion long-term to official agencies, and perhaps a small amount of other debt—the latter is concealed in the net figures in the table by a corresponding capital outflow.)
For our purposes, the most interesting line in Table I is the financing provided to the developing countries by the commercial banks, and particularly the volatility of that financing. Although lending from other sources was relatively stable, loans from commercial banks rose sharply beginning in 1979, peaked at $50 billion in 1981, and were reduced again abruptly in 1982. Much of the criticism currently directed at banks is due to these wide swings in financing. Specifically, the criticism is that commercial banks expanded loans excessively from 1979 through 1981, thereby permitting countries to run deficits that were larger than could be sustained. Then, discovering their error during the course of 1982, the banks abruptly stopped lending altogether. (In fact, almost all of the estimated $22 billion of bank financing to these countries in 1982 occurred in the first half of the year, whereas in the second half of the year net lending appears to have been near zero.)
Mexico has been cited as the clearest example of this wide fluctuation in bank lending (Table 2). There can be little doubt that Mexico’s $13 billion deficit in 1981 was too large and that banks were indirectly responsible—in that the deficit closely parallels bank lending and that Mexico could not have incurred the deficit unless commercial banks had been willing to finance it. In fact, it was the sharp cutback in commercial bank financing in 1982, and Mexico’s resulting inability to import, which initiated the delayed adjustment and brought the deficit back down again to $6 billion in 1982.
Current Account Deficit and Commercial Bank Financing, 1977–83
(In billions of U.S. dollars)
Current Account Deficit and Commercial Bank Financing, 1977–83
(In billions of U.S. dollars)
| Est. | Proj. | ||||||
|---|---|---|---|---|---|---|---|
| 1977 | 1978 | 1979 | 1980 | 1981 | 1982 | 1983 | |
| Exports of goods and services | 9.2 | 11.6 | 16.3 | 25.0 | 30.6 | 29.4 | 34.5 |
| Imports of goods and services | 10.8 | 14.3 | 21.2 | 31.8 | 43.6 | 35.3 | 37.2 |
| Current account deficit | –1.6 | –2.7 | –4.9 | –6.8 | –13.0 | –5.9 | –2.7 |
| Financing of deficit | 1.6 | 2.7 | 4.9 | 6.8 | 13.0 | 5.9 | 2.7 |
| Commercial banks | — | — | 7.5 | 9.3 | 14.3 | 4.7 | 5.0 |
| Other (net) | — | — | –2.6 | –2.5 | –1.3 | 1.2 | –2.3 |
Current Account Deficit and Commercial Bank Financing, 1977–83
(In billions of U.S. dollars)
| Est. | Proj. | ||||||
|---|---|---|---|---|---|---|---|
| 1977 | 1978 | 1979 | 1980 | 1981 | 1982 | 1983 | |
| Exports of goods and services | 9.2 | 11.6 | 16.3 | 25.0 | 30.6 | 29.4 | 34.5 |
| Imports of goods and services | 10.8 | 14.3 | 21.2 | 31.8 | 43.6 | 35.3 | 37.2 |
| Current account deficit | –1.6 | –2.7 | –4.9 | –6.8 | –13.0 | –5.9 | –2.7 |
| Financing of deficit | 1.6 | 2.7 | 4.9 | 6.8 | 13.0 | 5.9 | 2.7 |
| Commercial banks | — | — | 7.5 | 9.3 | 14.3 | 4.7 | 5.0 |
| Other (net) | — | — | –2.6 | –2.5 | –1.3 | 1.2 | –2.3 |
How could Mexico’s excessive deficit in 1981 have been prevented and the necessary adjustment achieved more promptly? No doubt the ideal way would have been for the Mexican authorities to have recognized the emerging crisis and to have restrained the deficit through timely adjustments in the exchange rate and strengthening of monetary, fiscal and wage policies. Alternatively, creditors could have restrained lending in 1981, forcing imports down, as happened belatedly in 1982. Adjustment by one route or another was inevitable; and while timely adjustment forced by the creditors is certainly better than no adjustment at all, I think that we would all agree that it is a poor substitute for adjustment through the adoption of a comprehensive economic program.
When should commercial banks have cut back lending to Mexico and thereby have taken the initiative in forcing adjustment? Those who argue that this should have occurred in 1979 or 1980 are asking for something that is not realistic to expect even in the future. While Mexico’s policies clearly were somewhat too expansionary in 1979–80. so were those of two thirds of the other countries in the world. Commercial banks are not likely to force an adjustment, by withholding lending when policies in a country are only moderately unsatisfactory. Only the monetary authorities of the country are able to do this type of fine tuning.
By mid-1981, it was evident that Mexico’s external accounts had become so far out of line that prompt adjustment was needed to avoid lasting damage to the economy. Still, commercial banks lent Mexico $14 billion net that year, an amount equal to almost 30 percent of their total net loans to all non-oil developing countries. Why? It has been suggested that banks lack the full information and expertise required to make timely decisions. That is, no doubt, part of the problem. Despite considerable improvement in recent years, many commercial banks still have a limited capacity to spot balance of payments ailments at the initial sign of bad policies and only recognize the ailment 6–12 months later when the symptoms appear—in the form of outdated statistics. The newly formed Institute of International Finance, which is being established in Washington, D.C., will help banks to see trends developing more quickly, by improving the information available to banks
It would be a mistake, however, to think that it was only blindness to the facts that caused banks to lend Mexico so much money in 1981. Most banks were aware that the financial situation was deteriorating, although no one, of course, inside banks or outside, expected the extreme turn of events which occurred and made the situation much worse during 1982. The main reason that banks continued lending was that they had a long-standing relationship with borrowers in Mexico. Mexican government agencies and banks look to their creditors to tide them over short-run difficulties, and they arrange in advance credit lines that can be drawn on as needed. This practice is particularly prevalent in countries which do not keep large foreign exchange reserves, but rather depend on lines with banks to provide a cushion against unexpected developments, such as the temporary collapse of the world oil market in June 1981. These existing bank lines were specifically designed to allow a period in which to adjust, just as the large international reserves of Venezuela provided such a period. This is a reasonable and prudent arrangement, provided the borrower does, in fact, use the period to adjust. The utilization of such lines “delays” adjustment only in the same way that high international reserves delay adjustment. The crucial question is. Do the countries adjust? Most bankers were impressed in mid-1981 with the number of Mexican officials and technicians, particularly in the central bank, who recognized that adjustment was needed and who seemed confident that some important steps toward adjustment would be undertaken even in the pre-election period. Of course, this assessment proved to be wrong, and serious adjustment measures were not initiated until 1982. The central bank by then had exhausted both reserves and bank credit.
While the behavior of banks in Mexico in 1981 is not as extreme as is sometimes suggested, the banks as a group should nevertheless have been more restrained in granting credit in that year. How can banks do a better job in the future to promote timely adjustment?
Unfortunately, there are no miracle cures or obvious potential remedies. The solution is for banks to do a better job at what they are already doing, namely, trying to distinguish between, on the one hand, creditworthy countries who are encountering short-term problems but who are taking the necessary steps to correct the situation in the medium term, and, on the other hand, countries who are not coping successfully with their problems and whose situation is, therefore, continuing to deteriorate. Credit to the latter group must be restrained, not only in the lenders’ interest, but also in the borrowers’; borrowing countries are not helped by a continued flow of capital to finance inadequate policies that in the end leave them further in debt, with little to show for it.
For banks to do a better job in allocating credit around the world, two main improvements are needed. First, we need a better flow of accurate and timely information on country developments to all banks involved in lending. This can be arranged with the cooperation of borrowing countries, the IMF, the new Institute of International Finance, and the bank regulators in the major lending countries. Second, individual banks need to continue to develop their internal capacity to understand and interpret the information available on countries. This seems to be more of a problem, and for many small banks the development of this capacity may be so difficult that they would be better-advised to stay out of international lending altogether. The remaining banks will want to work closely with the IMF and to continue taking into consideration whether a country is vigorously implementing a program that has been endorsed by the IMF.
There has been considerable talk recently about the need for direct government control over commercial bank lending to developing countries. No one can argue with the idea that the governments have the responsibility to inspect banks and to set minimum prudential standards; this should and does include inspection of an individual bank’s lending procedures and its capacity to analyze developments in borrowing countries. However, the proposals that bank regulators in lending countries might actually decide how credit should be allocated around the world seems to have little merit. There is no foundation for the idea that public officials would make fewer mistakes than the banks themselves, and this would be particularly true if political considerations were allowed to play a role in the credit allocation. Poland is a good example of a deteriorating country situation where U.S. commercial banks were more alert than U.S. Government agencies to the approaching problems. Between 1977 and 1980, a time of rapid increase in international lending, the unguaranteed loans of U.S. banks rose from $1.21 billion to $1.46 billion, or about 21 percent. In the same period, on the other hand, loans and guarantees by U.S. Government agencies, mainly to facilitate U.S. farm exports which would not otherwise have found financing in the private banking community, increased sharply from $0.5 billion to $1.7 billion (a 240 percent increase). Public sector and private sector funds frequently have quite different justifications, but statements which characterize the U.S. banking system as blindly pouring large sums of money into countries whose external accounts are deteriorating do not seem to be supported by the data on Poland.
During the past year or two, commercial banks have received a new type of criticism, not for lending too aggressively but rather for being too cautious in renewing their lending to countries that were emerging from difficulties. This is a relatively new turn of events. In fact, in almost all of the programs adopted by countries with IMF support in those years, commercial banks renewed their lending so quickly that countries after a few months were gaining reserves so rapidly that central banks often were concerned about the resulting monetary expansion. Until 1982 most of the stabilization programs that failed to receive bank support were, in my view, programs that themselves were not fully credible. Unfortunately, there were a few such programs in the late 1970s—programs which banks were not convinced would produce sufficient adjustment to re-establish a viable balance of payments position even in the medium term.
During 1982, some commercial banks became so cautious that there was no assurance that banks as a group would renew lending to a developing country in difficulty even after the country had adopted a feasible medium-term balance of payments program. Mexico is a good example. The new authorities in Mexico, before and after assuming office, adopted an economic program with IMF support that represented a sharp reversal of the previous inadequate policies. This program was designed to reduce the balance of payments deficit on current account from $13 billion in 1981 to about $3 billion in 1983. Approximately $5 billion of new bank money was needed in 1983 to finance this deficit, clean up arrears, and restore the country’s depleted reserves to a minimum working level. Provided one believes the program is going to work, this $5 billion would be one of the investments that commercial banks have made in Mexico both from their own narrow interests and from their broader interest of preserving the health of the world economy. The international pessimism in late 1982 was so great, however, that there was no assurance that the commercial banks, which had lent Mexico $14 billion in 1981 when the country’s balance of payments was deteriorating, would provide the $5 billion needed in 1983 to support a strong program designed to ensure a viable balance of payments in the medium term.
The initiative of the IMF in arranging the $5 billion of commercial bank financing for Mexico in 1983 was essential in the circumstances. Even after Mexico had worked out a strong adjustment program, there was a danger that commercial bank support for the program would have been so weak that Mexico would have run out of international reserves again in mid-1983. A financial program in which a country runs arrears on payments can hardly be regarded as satisfactory. The Managing Director of the IMF, therefore, informed the banks in December that Mexico had adopted for 1983 what he regarded as a workable program—provided that the banks were prepared to put in new funds of $5 billion. Otherwise, the program would not be workable, and he would be unable to recommend it to the Executive Board.
Some newspaper accounts have reported that commercial banks regarded this initiative by the Managing Director as a form of arm-twisting, of dictating to banks how much they had to lend to Mexico. I do not view it in that way. Banks retained their freedom of action, but at the same time, they had to recognize that one consequence of not arranging for the $5 billion of Financing would be to make the Mexican program for 1983 unworkable. Not only do I think that banks retained their freedom of action, but I also anticipate that there may be cases where the IMF endorses programs that the banks are not convinced provide adequate adjustment even in the medium term; in these instances banks have no choice but to restrain their financing and take the consequences of the program not being submitted to the IMF Executive Board. The crucial test will be for countries to have adequate programs that are recognized to be so.
As you may know, the way that the $5 billion for Mexico has been arranged is for each bank with outstanding loans in the country to agree to increase them by 7 percent, and this seemingly simple formula has in fact taken weeks of work to organize. Why, if it was in the banks’ interest to support the Mexican program, has it been necessary to arrange the funding in such a tortuous way? The answer is that it was in the interest of banks as a group to do this, but the numbers involved were too large for a few of the banks to undertake it on their own. For all banks to go up 7 percent is reasonable, but it would be imprudent for a third of the banks to go up by 21 percent or more, while the other two thirds did not increase lending at all or even withdrew funds. It was essential, therefore, that all Mexico’s bank creditors participate.
3. COMMERCIAL BANK CLAIMS ON NON-OIL DEVELOPING COUNTRIES
The view has been expressed that the world banking system is now dangerously overextended in lending to developing countries and that it would be imprudent for banks to increase loans further even if the countries appear to be creditworthy. Proponents of this idea sometimes seem to be saying that even if the developing countries can safely increase their debt by moderate amounts in the next few years, it will have to come from sources other than commercial banks. In this section, I want to discuss this idea that banks are overcommitted to developing countries, by looking at the data from the point of view of the commercial banks themselves, and particularly the large commercial banks that provide most of the lending.
First, let me say that everyone agrees that commercial banks cannot return to lending at the rate that existed prior to 1982. in 1981, commercial banks increased their outstanding claims on non-oil developing countries by $50 billion, sufficient to provide almost one half of the financing needs of the countries in that year (Table 1 and Chart 4). This unusually large financing was recognized to be temporary while the countries adjusted to the unfavorable shocks of the late 1970s and early 1980s. In earlier years, commercial banks had to provide around one third of the financing, another one third came from official sources, and the final one third from direct investment, grants, and other sources that do not create debt. By 1982, this earlier balance was re-established. In fact, reacting to the overextension of the previous years, banks appear to have provided only about $22 billion in 1982, which was slightly less than one third of the $75 billion of total financing received by the developing countries in that year. It is reasonable to project that banks will continue to finance only one third or somewhat less of the requirements during the next few years. Fortunately, if the aggregate current account deficit of the non-oil developing countries is in the process of being reduced to about $65 billion in 1983, as I believe it is, this deficit can be adequately financed with approximately $20–22 billion of new money from commercial banks, or an increase of less than 7 percent on the claims of $325 billion that the commercial banks currently have outstanding in these countries. This is the kind of growth rate which can be prudently undertaken and sustained in present circumstances. The total portfolio of commercial banks probably will grow by a few percentage points more than this, which means that this type of lending will decline slightly in relation to portfolio, after rising strongly in recent years.
Sometimes it is suggested that banks are so overextended to developing countries that even a 7 percent annual growth rate in the next few years is excessive and that a more dramatic cutback in international lending is required; but the facts do not support this idea. On June 30, 1982, the last date for which data are available, the nine largest banks in the United States had total foreign currency claims (loans, placements, bankers’ acceptances, and other claims) on the non-oil developing countries of about $78 billion2 (Table 3). These nine banks account for almost two thirds of the lending done by all U.S. banks to developing countries, and the concern that U.S. banks are over extended is generally directed at them. The total assets of the nine banks last June 30 was approximately $600 billion, which means that their foreign currency claims on non-oil developing countries were equivalent to 13 percent of their total assets. In addition to these nine banks, 158 other U.S. banks have foreign portfolios which are of sufficient importance that they are required to report their foreign currency exposure to U.S bank regulators semi-annually. These 158 other banks have total assets of about $850 billion, of which about $45 billion represents foreign currency claims on non-oil developing countries. Such claims, therefore, account for approximately 5 percent of the total assets of these banks. For the U.S. banking system as a whole, the portion of such claims in the total portfolio is perhaps 7 percent. Does this represent a worrisome concentration of portfolio for the U.S. banks to have 5–13 percent of total assets in the form of foreign currency loans to developing countries? (Sometimes this is referred to as having one-to-three times equity in such loans, since equity usually represents something over 4 percent of assets.)
Nine Largest U.S. Banks: Total Foreign Currency Claims on Non-Oil Developing Countries and Areas, June 30, 1982
Nine Largest U.S. Banks: Total Foreign Currency Claims on Non-Oil Developing Countries and Areas, June 30, 1982
| In Billions of U.S. Dollars | As a Percent of the Banks’ Total Assets | |
|---|---|---|
| All non-oil developing countries and areas | 78.0 | 13.1 |
| Mexico | 13.4 | 2.3 |
| Brazil | 11.8 | 2.0 |
| Argentina | 5.3 | 0.9 |
| Korea | 5.1 | 0.9 |
| Philippines | 3.9 | 0.7 |
| Chile | 3.4 | 0.6 |
| Hong Kong | 2.7 | 0.4 |
Nine Largest U.S. Banks: Total Foreign Currency Claims on Non-Oil Developing Countries and Areas, June 30, 1982
| In Billions of U.S. Dollars | As a Percent of the Banks’ Total Assets | |
|---|---|---|
| All non-oil developing countries and areas | 78.0 | 13.1 |
| Mexico | 13.4 | 2.3 |
| Brazil | 11.8 | 2.0 |
| Argentina | 5.3 | 0.9 |
| Korea | 5.1 | 0.9 |
| Philippines | 3.9 | 0.7 |
| Chile | 3.4 | 0.6 |
| Hong Kong | 2.7 | 0.4 |
Diversification of assets clearly is an essential part of any system of risk control for a financial institution. No system of analysis of creditworthiness can ever foresee all the difficulties that might arise, and not putting all one’s “eggs in the same basket” is therefore an important consideration. That is to say, diversification of assets has a place in risk control even if the borrowers are judged to be creditworthy.
Leaving aside for the moment the question of whether the 110 non-oil developing countries are judged to be creditworthy, it is hard to see how the U.S. banking system, with 7 percent of its total assets in the form of foreign currency claims on these countries, could be regarded as overly concentrated in this direction. These countries account for perhaps 12–15 percent of the world’s GNP, and from a pure diversification standpoint, banks’ portfolios do not seem to be abnormally tilted toward these countries. (The economies of the countries of the Council for Mutual Economic Assistance (CMEA) are about equal in size to those of the 110 non-oil developing countries, and U.S. banks’ nonguaranteed claims on these countries total less that 0.3 percent of their total assets; so the suggestion that U.S. banks have poured money into these countries indiscriminately and are now heavily overextended is even more farfetched.)
There is also a prevailing idea that even if U.S. banks are not overconcentrated in lending to the non-oil developing countries as a group, they are too heavily involved in a few of the large developing countries, such as Mexico and Brazil. Five large developing countries, Mexico, Brazil, Argentina, Korea, and the Philippines, account for 50 percent of U.S. bank lending to the non-oil developing countries. Of course, the main reason for this is simply that these countries are much larger than most of the other countries. Brazil, for example, accounts for slightly over 15 percent of the total credit extended by U.S. banks to non-oil developing countries, but it also accounts for almost 15 percent of the GNP of the group. For the nine large U.S. banks, foreign currency claims on Brazil account for about 2 percent of their total portfolio, which is slightly less than Brazil’s share of world GNP. When size is taken into account, a large part, but not all, of the apparent abnormal concentration of credits in a few countries is explained.
In the final analysis, it seems to me that most people who are saying that the world banking system is too heavily involved in lending to developing countries are not really talking about asset diversification at all. They are simply making a judgment that developing countries as a group are not creditworthy, and obviously, for a group of banks to have 13 percent of its claims, or even 5 percent, on borrowers who are not creditworthy is too much. The fundamental question, therefore, remains, are the developing countries creditworthy?
Some of those who believe that developing countries are uncreditworthy seem to base their belief on the simplistic notion that people or countries with low incomes do not or cannot pay their debts, while those with high incomes do. This, of course, is too superficial a basis for bank lending. Most of the developing countries have had a good record in the past decade. In the case of my own bank, during the 1970s, loan losses as a percentage of total loans were less than one half as high in international lending as in the United States. While the data on developing countries are not available separately, the bank’s claims on that group were large enough that substantial losses on these loans would not have been consistent with the relatively good performance on international loans as a whole.
The world economy is now recovering from two years of slow growth, declining inflation, and relatively high interest rates. The adjustment to this new situation has been painful not only for developing countries, but also for most industrial countries. In my view, however, most of the developing countries are now well along in the process of adjusting to this new situation. Based on the above considerations, 1 believe that commercial bank lending can and will continue to play an important role in the economic development of these countries, by providing a further moderate growth of credit, as long as lenders and borrowers work closely together to maintain the health of the world economy and the creditworthiness of individual countries.
APPENDIX
Non-Oil Developing Countries: External Debt, Exports, and Interest Payments
(In billions of U.S. dollars)
Non-Oil Developing Countries: External Debt, Exports, and Interest Payments
(In billions of U.S. dollars)
| Outstanding Long-Term Debt, End-of-Year | Exports of Goods and Services | Interest Payments on Long-Term External Debt | |
|---|---|---|---|
| 1973 | 97 | 109 | 4.6 |
| 1974 | 120 | 149 | 5.7 |
| 1975 | 147 | 150 | 7.5 |
| 1976 | 181 | 177 | 8.3 |
| 1977 | 222 | 211 | 10.1 |
| 1978 | 276 | 249 | 14.2 |
| 1979 | 324 | 318 | 20.7 |
| 1980 | 375 | 404 | 30.1 |
| 1981 | 437 | 423 | 37.5 |
| 1982 | 485 | 416 | 42.0 |
| 1983 | 525 | 454 | 37.0 |
| 1984 | 562 | 500 | 38.0 |
| 1985 | 601 | 550 | 39.0 |
Non-Oil Developing Countries: External Debt, Exports, and Interest Payments
(In billions of U.S. dollars)
| Outstanding Long-Term Debt, End-of-Year | Exports of Goods and Services | Interest Payments on Long-Term External Debt | |
|---|---|---|---|
| 1973 | 97 | 109 | 4.6 |
| 1974 | 120 | 149 | 5.7 |
| 1975 | 147 | 150 | 7.5 |
| 1976 | 181 | 177 | 8.3 |
| 1977 | 222 | 211 | 10.1 |
| 1978 | 276 | 249 | 14.2 |
| 1979 | 324 | 318 | 20.7 |
| 1980 | 375 | 404 | 30.1 |
| 1981 | 437 | 423 | 37.5 |
| 1982 | 485 | 416 | 42.0 |
| 1983 | 525 | 454 | 37.0 |
| 1984 | 562 | 500 | 38.0 |
| 1985 | 601 | 550 | 39.0 |
Commentary*
CARLOS MASSAD
The paper by Jack Guenther discusses three main aspects: the growth in external debt in the non-oil exporting developing countries since 1973; the necessary financing, after adjustment, and how much of it can be expected from commercial banks in the next few years; and the exposure of commercial banks active in international lending in non-oil exporting developing countries.
The discussion of the first of these aspects starts by showing that the rate of growth of long-term external debt of non-oil exporting developing countries grows pari passu with the dollar value of exports of goods and services between 1973 and 1980. Guenther argues that the growth of debt during this period played a very useful role in the world economy since it occurred as a by-product of the recycling of liquid funds accumulated by a few oil-rich countries. However, the rate of growth of exports slowed sharply in 1981–82, and this is the main cause of the external sector problems of non-oil exporting developing countries. Furthermore, interest rates rose substantially in recent years, which complicated the problem further. Also, domestic economic policies in some debtor countries were temporarily inadequate. He finds that it would be necessary to plan for at least a five-year period in which the growth in debt falls 2 or 3 percentage points below the rate of increase in exports which is expected to be about 10 percent a year. He concludes this section pointing to a 7 percent a year increase in debt as a limit for the next five years or so. Some Latin American and African countries should expect their debt to grow at rates somewhat lower than this while some countries in Asia “could tolerate” a rise in debt of more than 7 percent a year.
In discussing the second aspect, that is, how much of the imbalance should be adjusted and how much of it could be financed from different sources, Guenther reports that most developing countries have already adopted financial programs leading to a substantial reduction in their current account deficits. Such deficits are estimated to decline from a peak of $102 billion in 1981 to about two thirds of that figure in 1983—an adjustment which would be no larger than the one achieved between 1975 and 1977, after the first oil shock, in relation to trade flows.
Taking into consideration other forms of financing, Guenther finds that the estimated current account deficit for 1983 is consistent with the 7 percent growth of the outstanding stock of debt. He calls attention to the fact that commercial bank financing is substantially less stable than the financing from other sources and that this lack of stability explains the problems experienced by some countries. He assigns this lack of stability to the fact that banks lack the full information and expertise required to make opportune decisions. He warns that the problem will not be solved, but rather aggravated, if the decision on how credit should be allocated around the world were to be left to bank regulators in lending countries arguing that “there is no foundation for the idea that public officials would make fewer mistakes than the banks themselves” (pages 198–99). Commercial banks have been criticized as lending too aggressively in the 1970s, and of becoming too cautious in the 1980s to the point where the Fund had to intervene and actively prod the banks to provide additional financing to some debtor countries with credible programs.
The last section of the paper is devoted to a discussion of the idea that banks may be overcommitted to developing countries. Guenther agrees with the opinion that commercial banks cannot return to lending at the rate that existed prior to 1982, but they can provide about one third of the total financing required by the expected current account deficit of non-oil exporting developing countries in 1983, which again would be about a 7 percent increase of outstanding claims. As the total portfolio of commercial banks is expected to grow faster than that, lending to non-oil exporting developing countries will decrease in relation to portfolio. Guenther justifies continuous growth of lending on the grounds of asset portfolio diversification while pointing out that developing countries have a good record as borrowers in the past decade.
The paper ends with a call to lenders and borrowers to work together and keep the world economy healthy and individual countries creditworthy.
I tend to agree with the general line of argument and, with some caveats, with the moderately optimistic view of Guenther’s paper. I would like to emphasize, however, a few aspects of the problem which seem to me are important for the full understanding of its implications. Such aspects are particularly relevant for the actions that ought to be taken both to smooth out the adjustment process and give credibility to an optimistic view.
Guenther recognizes at an early stage that the “size of the debt is worrisome, particularly under present world conditions” (page 186). Under different world conditions the size of the debt ought not to be worrisome at all. As a matter of fact, if for 18 non-oil exporting developing countries in Latin America, terms of trade in 1982 had been those prevailing on the average between 1965 and 1969, the deficit in current account of this group of countries would have been $17 billion smaller than the actual figures. If, in addition, interest rates had been those prevailing in the years 1978–79, the deficit in current account would have been $1.0 billion as compared with the actual figure of $25.2 billion. The results shown raise important questions: Are these shocks permanent or transitory? Should they bring about adjustment of financing?
The calculations are, of course, hypothetical. A change in the terms of trade or interest rates would probably have triggered other changes in policy and results. But the calculation is useful to give an idea of the explanatory power of these two variables, terms of trade and interest rates, in explaining the deficit in current account of the balance of payments. This calculation is not intended to diminish the domestic responsibility in debt and balance of payments management since both the debt and the deficit in current account are now with us. In this context, an exploratory study of nine countries in Latin America gives indications that foreign savings substituted for domestic savings in the period 1975–81 in five cases out of the total.
By the way, the relationships and mutual influences between the capital account and the current account in the balance of payments have been explored only recently in the literature; probably this explains why in different sections of Guenther’s paper the order of causality between capital inflow and deficit in current account is changed. It looks as though there are two types of cases in Latin America: those where excessive domestic spending based on an expansion of domestic credit led to a deficit in current account, which induced further borrowing abroad; and those where banks’ aggressiveness and an increased degree of openness of the domestic capital markets to foreign competition resulted in an inflow of foreign capital in the form of debt, which, through an overvaluation of the domestic currency despite negative effects of terms of trade, was transformed into an increased deficit in current account that facilitated absorption of the additional resources obtained.
These two types of cases, which seem to coincide with the oil exporting or non-oil exporting character of countries, ought to be distinguished because the recipes to produce adjustment should also be different. In the first case, excessive domestic spending through domestic credit creation should be curtailed as part of the adjustment process. In the second type of case, however, one might find that fiscal balance is well under control and that domestic credit is not expanding at any dangerous rate. This “good behavior” translates into relatively high real domestic interest rates as compared with foreign interest rates and in a substantive opening-up of the capital account which facilitates excessive private spending financed with foreign borrowing. This latter case is a nontraditional case and is difficult to recognize as a source of future problems except through the overvaluation of the currency and the imbalance in current account that accompany the process.
I would argue, as I have done in the last couple of years or so, that private overspending is as dangerous as public overspending in its effects on the external and internal balance of the economy. And perhaps private overspending demands a more painful adjustment process than public excesses.
General conditions in the world economy and domestic policies are thus crucial to determine whether the 7 percent rate of growth of the stock of debt advocated by Guenther is feasible. Let me note that a 7 percent growth of outstanding claims would be equivalent to financing interest payments, or slightly less than that. That is, no net foreign savings would be flowing to non-oil exporting developing countries through bank financing in the next few years. For Latin America this means transfer of real resources to the rest of the world, since countries in the area are not among those whose debt is expected to grow faster than the average. As a matter of fact, countries in Latin America are being “graduated” from the World Bank and even from the Inter-American Development Bank (IDB) on the grounds that they have easy access to private bank financing!
Here I believe it may be useful to give a few figures to gauge the adjustment effort being made in the continent. For the first time since the Great Depression all countries in the area, without exception, have registered a drop in gross domestic product (GDP) per capita in 1982, and the region as a whole has shown a decrease in the level of total GDP in that year. Total unemployment reached 40 million, and the trade balance has swung from a deficit of $12 billion in 1981 to a surplus of $1.0 billion in 1982, while traditionally this is a foreign saving recipient region.
It is clear to me that, over and above what banks could do, international action is urgently required to avoid a prolonged, politically intolerable, period of stagnation.
The official international financial institutions should be strengthened to make the private financial institutions viable. The resources of the World Bank and the IDB and other regional banks should be increased substantially. Those of the Fund should ideally be expanded to SDR 120 billion, which roughly implies only SDR 60 billion in usable currencies, a figure comparable to a one-year deficit in the current account of non-oil exporting developing countries, after adjustment.
A new allocation of SDRs should be agreed upon soon, to bring up international foreign exchange reserves at least to the level they had at the end of 1981. The well-known asymmetries of the power of the Fund on debtors and creditors give a recessive character to global policies at present. A new allocation of SDRs would provide a better distribution of efforts throughout the world, helping to reactivate the world economy. Banks would not expand their lending as they did in the past.
Institutionality for debt refinancing or reprogramming should be created to replace the outmoded “club” organizations. A debt reprogramming facility or a joint undertaking of the Fund and the World Bank, with access decided on the basis of objective indicators, but with terms and amounts of assistance studied case by case, would in a way only formalize, and give some stability, to present informal and hence erratic, arrangements. Financing for the facility could come from the interested banks themselves.
A debt reprogramming facility would probably reduce the costs to borrowers of reprogramming, which are now quite substantial. In fact, before World War II creditors used to take part of the cost in the form of a reduced market value of their bonds: most debt was bonded. Debtor countries or institutions could buy back those bonds at a fraction of their face value. Now, bank portfolios are not easily transacted in the market, except in articulo mortis. So, debtors take up the whole burden of debt and at substantially increased spreads and flats. Is this a by-product of creditors’ cartelization?
Trade and financing are closely linked. If exports of non-oil exporting, developing countries grew at 15 percent a year instead of the 10 percent considered by Guenther, external debt of non-oil exporting developing countries could grow at a rate of 12 percent, faster than interest payments, and still decrease relative to exports. But figures like these require a more dynamic world economy and trade, and no protectionist measures against the exports of developing countries. Perhaps these latter countries should consider getting together to make sure that their full bargaining power is brought to bear in trade matters.
Given the stock of debt already accumulated, changes in interest rates become a crucial element in external equilibrium of many debtor countries, so that smoothing out the effect of their changes on debtors could make a substantial contribution towards external stability. Mexico has made an interesting suggestion on this matter, and perhaps now is the time to give it serious consideration.
The new active catalytic role of the Fund is a sign of hope. Without it, the situation of many debtors would have already become unbearable. But this role, I believe, can continue to be effective only if it is (i) institutionalized, and (ii) accompanied by substantial additional resources, both conditional and unconditional. Without this, we will probably see an increasingly erratic behavior of countries and institutions in the adjustment process, a long, protracted period of slow recovery, and a growth of banks’ claims on non-oil exporting developing countries, particularly those of Latin America, perhaps substantially below the modest 7 percent coming out of Guenther’s calculations.
I would like to conclude my comments with Guenther’s words: Lenders and borrowers, and, I would add, international institutions, should “work closely together to maintain the health of the world economy and the creditworthiness of individual countries” (page 204).
Commentary*
ALBERTO BENSIÓN
These remarks will deal with several of the topics raised in Jack Guenther’s excellent paper.
Indebtedness Level
In the paper, external debt is defined in terms of medium- and long-term government-guaranteed liabilities and an estimate of private indebtedness with no government guarantee. It also includes an estimate of the short-term debt, with more detailed references to the private sector debt and, at the other extreme, to countries’ external assets being omitted from the analysis.
The short-term debt of the non-oil developing countries is estimated to have amounted recently to about $100 billion, as against a medium- and long-term debt of $485 billion. Other related estimates show that the short-term portion of the debt has grown more rapidly than medium- and long-term debt. This not only reinforces the general conclusion of the paper with regard to the excessive rate of external debt expansion in the recent past, but also makes the need for international banks to support adjustment programs even more urgent.
Private borrowing without government guarantee is, as you know, difficult to assess. On the one hand, some systems of exchange arrangements do not require systematic recording of such liabilities to foreign countries; on the other, there are exchange systems with an opposite focus, which encourage accounting entries not reflecting true external liabilities. Quite apart from the case of foreign branches of developing countries’ banks, which is examined in the paper, some countries have a banking system within their own boundaries which gathers foreign currency deposits of nonresidents. This could be considered a form of external indebtedness, indeed a highly volatile one, which has not been uniformly treated in the various countries’ statistics. Finally, some countries may hold foreign currency assets of nonresidents as one means of partially offsetting the debt. In this case, to determine the country’s net position as compared with the rest of the world, these assets should be subtracted from the debt.
Various Forms of Bank Assistance
Because of the debt incurred in the past and current liquidity problems, the first contribution the international banking community can make involves loans now maturing and the need to refinance them. At the same time, in view of the simultaneous need to bolster countries’ liquid reserves and the resources to be used to support the activities of certain economic sectors, it is also essential to provide new loans, at least temporarily.
Neither form of financial support can be confined to relationships with government-guaranteed debtors, but instead should be extended to the private sector in general and the banking system in particular. It is known that the majority of adjustment programs impose some degree of temporary contraction in certain economic sectors, which of course has an impact on their ability to pay off their existing external liabilities. In these circumstances, and taking into account the fact that there has also been some recurrence in recent years of excessive expansion of domestic bank credit as well, some of those who owe money to the banks will require refinancing arrangements similar to those now being made available to governments and their central banks. For this to be fully possible, the private banking systems of the countries concerned require financial support from the international banks.
Finally, there is a third form of assistance; it is indirect in nature but is extremely important to the economic functioning of countries and the success of their adjustment programs.
The various financial reforms introduced in these countries in recent years have tended to produce a more direct relationship than in the past between the interest rate, the position of the external sector, and the consumption and investment plans of economic agents. These variables in turn are highly dependent on the expectations of the private sector and its confidence in the ultimate success of the adjustment programs under way.
In these conditions, the private sector looks upon the financial support of the international banking community as a vote of confidence in the policy pursued by the authorities, which improves the general climate for business and makes it possible to overcome more easily the difficulties inherent in the initial period of adjustment.
Debt Projections
In response to the diversity of recently expressed views, the paper reaffirms the traditional concept that exports are the best indicator of a country’s external debt in the long term. Surely, under particular economic circumstances such as the present ones, the degree of external liquidity can be more important; however, it is no less certain that, fundamentally, export results continue to be the most significant element for evaluating a given growth policy and the ability of a country routinely to fulfill its external commitments.
Second, the paper reaches yet another conclusion which merits support, at least in general terms. Given the combination of the accelerated growth of debt in the past and the foreseeable persistence of high real interest rates in the future, it is advisable for increases in external debt in the next few years to be held below the level of the growth of exports.
Third, the paper includes specific projections of exports, debt, current account imbalances, and the supply of funds from various sources of financing. It is difficult to comment on this projected scenario without the information and global perspective which can be acquired only by constant work with the topic. It is known, for example, that various sources have ventured extreme predictions on topics such as future exports from the developing countries, these countries’ capacity to fulfill existing adjustment programs, and the supply of funds from the international financial markets. The latter point, at least, merits some comment.
Obviously, for the debt to increase in the future, under normal circumstances it must be assumed that new loans will more than cover the amortization payments on earlier loans. This gives rise to two thoughts.
From a strictly financial point of view, it would be desirable to concentrate such new commercial banks’ lending more than in the past on dealing with the countries’ problems of liquidity, cutting back in relative terms on the financing of investment projects for the time being. The latter form of credit assistance is normally tied to the import requirements of the investment, and hence cannot be used to deal with the purely financial expenditure required for loan amortization.
From another standpoint, it bears noting that, in times more normal than the present, it was customary banking practice not to have debts repaid but instead to roll them over so long as interest continued to be paid as due. To some extent, the increase in external debt projected for the future could be considered an application of the same idea, with the added factor that a new increase in debt is anticipated.
It is this latter argument which is the most difficult to accept fully, given the magnitude of the problems recently experienced by the financial system and, in particular, their great exposure to the public eye. Therefore, while the need for simultaneously refinancing the debt and providing new loans in the immediate future must be stressed, it appears more realistic to assume that once this phase is over, the next few years will have to be characterized by a level of debt that remains stationary or even declines slightly in real terms. This, moreover, is the scenario set forth for Brazil and Mexico in the paper.
Following this more restrictive hypothesis with respect to financing, the most important consequence could be that current adjustment efforts in individual countries should be prolonged somewhat in response to this new reality on international financial markets.
The Banks and the IMF
The relationship between the international banking community and the Fund appears, as we know, to have changed substantially as a result of recent financial events. Thus, while in the 1970s banks channeled their loans to the developing countries without regard to the Fund, credit agreements between the Fund and individual countries have now become a necessary condition for obtaining financial support from the international banks. This new functional arrangement appears to provide greater assurance than before that countries will have a more stable financing framework for their development plans.
We must therefore express our concern about the possibility referred to in the paper that banks may not consider programs worked out between individual countries and the Fund to be adequate, perhaps even to the extent that the banks would be prompted to cut back their future financial assistance.
Clearly international banks, like any other public or private institutions, cannot be bound by decisions of third parties. Be that as it may, there are a number of arguments in favor of banks’ giving priority attention to countries’ agreements with the Fund, at least under current economic circumstances.
As the paper notes, banks still do not have the information and capabilities required to understand and interpret fully the economies of individual countries or the viability of their adjustment programs. Furthermore, if deprived of their standing in the eyes of the international banking community, agreements with the Fund would lose a considerable proportion of the advantages which can mobilize public opinion in favor of their acceptance. Finally, it could well be now that direct relationships between the banks and individual countries would create a greater bias in favor of the aspirations of the larger debtors, to the detriment of the position of countries with smaller economies.
The numbers shown in the charts refer only to long-term debt; this is because the statistics on long-term debt of developing countries are relatively good, owing to the cooperation between these countries and the World Bank and the International Monetary Fund (IMF) over the past three decades.
This is after eliminating interbank deposits in booking centers, the inclusion of which would involve double counting. For example, if Chase places short-term funds in the Bank of America branch in Hong Kong, and the latter makes a loan to the Philippines, the placement in Hong Kong is removed from the statistics to avoid double counting of exposure.
The original version of this paper was written in Spanish.
