THREE ASPECTS OF THE DEBT PROBLEM of developing countries are touched upon in these notes: the magnitude and geographical coverage of the problem; the requirements for the successful resolution of difficulties from the side of the debtors; and the evolution of the issue from the side of the creditors.
The total debt of developing countries (excluding eight oil exporters in the Middle East) was estimated to be $828 billion at the end of 1984, of which $126 billion was short term, that is, with a maturity of one year or under. The World Economic Outlook (WEO) estimates of April 1985 made by Fund staff classify 66 countries as having avoided debt-servicing problems; these account for 41 percent of total debt. A group of 57 countries, accounting for the rest of the debt, are classified as having experienced debt-servicing difficulties in the recent past, as reflected in the incurrence of external payments arrears or in a restructuring of debt between 1981 and 1984. About $243 billion—or roughly one half of the debt owed by this group—is carried by five countries—Brazil, Ecuador, Mexico, Venezuela, and Yugoslavia, which are moving toward multiyear restructuring agreements (MYRAs) with the banks, reflecting significant progress in correcting their external imbalances through strong adjustment policies.
The rest of the debt owed by countries with recent problems is carried by 20 countries in Latin America and the Caribbean accounting for $111 billion of debt, 26 countries in Africa accounting for $73 billion, 4 countries in Asia ($41 billion), and 2 in Europe ($26 billion), for a total of about $250 billion. This is a substantial figure, but far below the global sum of $800 billion plus used by a number of analysts when discoursing on the debt problem of developing countries.
Issues for Debtors
Troubled debtors can be classified as either “market” or “official” borrowers. The issues confronting these two groups of countries differ. While both include countries with inadequate domestic policies and debt and reserve management problems during the debt build-up phase, the difficulties of the market borrowers were intensified by their obtaining more than two thirds of their (predominantly dollar-denominated) loans from commercial creditors at variable interest rates. The rise in dollar interest rates after 1979 was accompanied by a bunching of maturities in 1980–82 as banks sought to lower their risks by shortening their exposures, and debtors acquiesced rather than face reduced inflows. The recession-induced decline in export receipts was reflected in reserve losses and in rapid increases in ratios of debt and debt service to exports of goods and services and was followed by a sharp curtailment of bank credit facilities, in part as a result of the “contagion” effects of the Polish and Mexican crises. The troubled market borrowers are to be found in Latin America and the Caribbean region but also include several countries in West Africa and one each in Asia and Europe.
The second group facing debt difficulties—the “official” borrowers—is mostly to be found in Africa, especially the sub-Saharan region, but includes several countries elsewhere. From 1978 to 1982, these official borrowers obtained two thirds or more of their external borrowings from official sources at fixed, often concessional, interest rates, and their loans were denominated in the currency of the official lenders. Their problems are more often than not attributable to severe structural and public enterprise management problems and to the continued stagnation of markets for their primary commodity exports, especially in Europe where the recovery has been modest compared to North America and Japan.
It is important to keep the distinction between these two groups in mind in formulating the conditions for the resolution of their debt problems, even if one principal element remains common—the need for strong and credible adjustment measures to correct weaknesses of domestic policy and impart the flexibility needed to respond to a changing external environment.
Regarding the troubled market borrowers, a rapid decline in their reliance on commercial sources of credit has already occurred, partly in response to the limited availability of bank financing outside the concerted lending in the context of debt restructuring agreements. In 1983, disbursements under these “new money packages” amounted to $12.7 billion and were estimated at $10.2 billion in 1984. The total amounts of debt restructured in agreements signed or agreed in principle are estimated at $35 billion in 1983 and $110 billion in 1984 (including $69 billion under the Mexican and Venezuelan MYRAs). An additional $28 billion of short-term debt was rolled over in 1983 and $33 billion in 1984 through agreements to maintain interbank exposures and trade-related credits or working capital facilities. As a result, the debt-servicing obligations of this group in the next several years consist substantially of interest payments. Even so, their debt-servicing ratios remain at very high levels and higher interest rates would delay return to normalcy, whereas a decline would accelerate progress toward it.
A promising approach for the market borrowers would be an extension of the MYRA approach. However, commercial banks have been willing to consider longer-term arrangements, at finer margins, only when the debtor country has made sufficient progress in its external adjustment to forego the need for new money packages and provided it is seen to be firmly committed to policies that would hold its net external financing requirements to what could reasonably be expected to be forthcoming from spontaneous lending.
A major question in the sustainability of the debt situation is the revival of private sector investment in a number of the market borrowers. As a first step, such a revival requires a settlement of arrears and current payments to foreign suppliers that are not covered by the restructuring arrangements, the latter mainly relating to public sector obligations. Rapid depreciation of exchange rates previously held at unrealistic levels, the raising of domestic interest rates to yield positive returns to savers and to discourage capital flight, and the curtailment of government expenditures, especially for business subsidies, has resulted in massive financial trauma for many private firms in heavily indebted countries. The resulting insolvency has been a primary factor in the shrinkage of private investment, whether on the part of domestic or foreign investors. A number of schemes has been introduced to enable private debtors to begin settling their obligations or restructuring them through the provision of foreign exchange cover (such as through the FICORCA scheme in Mexico), or through retention schemes for applying a portion of export proceeds directly to the payment of debt and preferential exchange rate arrangements. However, the longer-range revival of private sector confidence depends on the effective pursuit of sound and stable macroeconomic policies by their governments.
As for the official borrowers, their immediate difficulties have been ameliorated through debt relief in the Paris Club framework and in a number of cases, through bank restructurings as well (these borrowers include Jamaica, Liberia, Madagascar, Malawi, Senegal, Sierra Leone, Sudan, Togo, Zaïre, and Zambia). Unlike the banks, which have been prepared to reschedule 100 percent of principal but not interest payments, official creditors have applied debt relief to 85-90 percent of both principal and interest obligations falling due in a given period, plus the consolidation of arrears. However, no MYRA-like arrangements have yet been agreed for official borrowers, although there is some movement in that direction in response to requests from several debtor countries. The debt service ratios of official borrowers remain high because of a rapid build-up of debt without a commensurate inrease in exports. Beyond adequate debt relief, there is an urgent need for sufficient official funds on substantially concessional terms to be provided to the poorer countries for meeting payments for essential imports and services. These flows would need to be assured over a number of years, given that structural problems can be resolved only gradually.
A closer alignment of aid policies with export credit cover policies is also important. In the past, a number of countries have discovered that the onset of payments troubles has resulted in an immediate cut-off from normal trade credits because of the inability of official export credit insuring or guarantee agencies to maintain cover, thereby compounding these difficulties. As in the case of market lenders, the agencies attach importance to the successful pursuit of adjustment strategies before being prepared to resume normal cover.
Issues for Creditors
From the lending side, a relevant distinction is between credits from official sources or officially guaranteed credits, and those that are strictly private and unguaranteed in the creditor country. Official export credit agencies have paid out substantial claims and while their ultimate solvency is not called into question since their operating deficits and trading losses would, it is assumed, eventually be covered by government budgets, these have produced negative reactions in the application of cover policies. These reactions have of course been even more severe in the case of the commercial lenders, especially the banks.
Published data on banking sector claims are based on a narrower coverage than those compiled from debtor sources. Claims data are based on estimates by the Bank for International Settlements (BIS) and on the Fund’s International Banking Statistics (IBS) series, while liabilities are based on direct country reports used in the IBS. Claims on non-oil developing countries (defined as cross-border interbank and nonbank credits, by residence of borrower) were in the neighborhood of $462 billion (excluding offshore centers) at the end of September 1984. Amounts owed to the banks by countries that have experienced debt-servicing difficulties in the recent past would be approximately $325 billion. Of this, however, the four Latin American countries and Yugoslavia that are negotiating MYRAs with the banks account for $221 billion. Moreover, the banks would have covered their risks on a portion of the amounts lent through obtaining guarantees from official export credit agencies. In any event, the total debt held by the banks is distributed among a number of national banking systems, with the U.S. banks responsible historically for about 40 percent of the total.
An improvement in the U.S. banks’ ratios of capital to total assets has occurred in the 1982–84 period, largely as a result of an increase in U.S. bank capital of approximately 12 percent per annum. Their claims on non-oil developing countries have risen by about 15 percent over the same three-year period or slightly below the cumulative growth of total assets of approximately 18 percent. As a result, the exposure of U.S. banks to developing countries has declined substantially relative to their capital. Put another way, U.S. banks’ capital which was equivalent to 60 percent of their exposure to non-oil developing countries at the end of 1981 had risen to 72 percent by September 1984 and has now returned to the level that obtained in 1979.
The situation in the case of the non-U.S. banks is harder to evaluate. Their claims on the non-oil developing countries do not appear to have fallen relative to their total claims, in part because of the appreciation of the U.S. dollar relative to the banks’ home currency, given the fact that a high proportion of such claims would have been denominated in U.S. dollars. However, their capital has increased since the end of 1981 and they have strengthened their balance sheets by building up reserves against specific exposures. Thus, despite the difficulty in quantifying the pace of improvement for non-U.S. banks, it is clear that the risk exposure to developing countries of banks in industrial countries has declined materially in relation to capital plus reserves and any decline in the exchange rate of the dollar would accelerate this process.
There are other indicators of an improving situation for the banks. First, in the MYRAs that have been negotiated, banks have been permitted, at their option, to redenominate a portion of existing loans into their domestic currencies. While this is to take place gradually, such redenomination reduces funding risks for non-dollar-based banks, both in terms of market financing and the possibility of support from their respective central banks, and reduces as well the effect of future exchange rate movements on banks’ exposure relative to domestic currency capital. For the debtors, diversification into non-dollar currencies would reduce current interest costs, but this gain could be offset to the extent of a depreciation of the U.S. dollar.
A second development has been the tendency on the part of banks to extend new funds in the form of trade- or project-related loans rather than purely financial credits to governments. Such loans enable banks to monitor more closely the use of these funds and to act in direct support of the export activities of their customers.
Finally, banks have taken an increasing interest in cofinancing with the World Bank and have sought greater involvement of the World Bank in assessing sectoral policies and in evaluating projects. All these measures should help to unlock future bank lending and lay the basis for a resumption of spontaneous lending, even if on a scale below that of the 1978–82 period.
A Banking Perspective
David Lomax *
One of the main responsibilities of the banks, and one for which they have not had full credit in my view, has been to administer the debt process. The negotiations for rescheduling debt and for the provision of new money have been in many cases extremely complicated. Thirty-five countries have rescheduled bank debt since 1982. In many cases the number of banks involved has been in the hundreds, with over six hundred in the case of Mexico, over five hundred for Brazil, and over three hundred for Argentina. The types of debt involved have varied enormously, from private sector debt, government guaranteed debt, interbank debt, short-term export credit, short-, medium-, and long-term debt, forfeit debt, and a host of others. The banks, in conjunction with the governments concerned, have had to establish a full data base and then negotiate over the debt, with the country, with the International Monetary Fund, and among themselves. In several cases new money has been required, so the banks have needed to agree on an appropriate figure among themselves and collectively, with pressure being exerted as appropriate to produce the required amount.
This process has required from the banks considerable administrative skill, a great deal of integrity, and a substantial amount of diplomatic talent. Had they not possessed these attributes, the debt management process could have broken down simply from ineffective handling. The banks had a strong and direct interest in effective handling, but their deftness in dealing with the situation nevertheless deserves recognition.
There are only two ways in which money may flow from a lender to a borrower or from an investor to a recipient; flows are either essentially concessional, and I will refer to these henceforth as aid, or they are commercial. As far as governments are concerned, aid comes out of national budgets and is easily identifiable. As far as the commercial world is concerned, banks and other organizations can offer money on commercial terms, but in no circumstances can they offer concessional finance to any significant extent. That would be a violation of the laws and customs under which they operate. This firm distinction between aid and commercial money is very important, since many analyses of the debt situation tend deliberately or inadvertently to fudge this issue and merely confuse the analysis.
Banks have provided new credits to developing countries in recent years in two main forms: in negotiated circumstances, normally in conjunction with Fund-supported adjustment programs, to countries that have been rescheduling debt; and through the normal commercial market-place to creditworthy countries.
The statistics on money lent in conjunction with Fund programs between 1983 and early 1985—or what has been termed “involuntary” new money—are provided in Table 1. The amount was substantial, $15.4 billion in 1983, $12.7 billion in 1984, and a prospective $7 billion in 1985. So far, any country that has negotiated and adhered to an agreement with the Fund, and has calculated a cash flow requirement and agreed to it with the Fund and the banks, has received that cash. Not every bank may have taken part in the negotiations, and not every bank may have provided the amount suggested under the new money requirement, but for all practical purposes the cash required from the banks was forthcoming. In March 1985, for example, the only constraint on the provision of $4.2 billion of new money to Argentina was its inability to adhere to an agreement with the Fund.
New Bank Money Provided in Rescheduling Situations
(In billions of U.S. dollars)
Bridging loans to finance interest arrears.
New Bank Money Provided in Rescheduling Situations
(In billions of U.S. dollars)
Bridging loans to finance interest arrears.
New Bank Money Provided in Rescheduling Situations
(In billions of U.S. dollars)
Bridging loans to finance interest arrears.
While the banks would like all other banks to take part in an agreement to provide new money, it has been accepted that in practice an agreement may be effective even if a few small banks do not participate. The key feature for success is the participation of the major banks. The only occasion when the major banks have failed to pull together was when a major Middle Eastern bank creditor refused to cooperate in an agreement on the Philippines and seriously disrupted the planned signature and disbursement of new monies, so that negotiations could not be completed. Funds have, however, been made available to creditworthy countries and the nature of the international financial market in early 1985 means that terms have become much easier. A wide range of new capital market instruments have emerged in the sovereign risk area. Thus, for example, a creditworthy country like Thailand has been able to obtain funds not just from the syndicated lending market as in the past, but from capital market issues on very fine terms.
The result of these two factors has been that, in spite of any fears to the contrary, the provision of money from commercial banks to developing countries has been largely demand led. When countries have been able to satisfy Fund-supported programs, which included negotiations about new cash flows, then the new money has been forthcoming. By definition, of course, creditworthy countries have been able to raise funds from the market-place. This situation might be difficult to maintain fully in the future, but much would depend on the actual amount of involuntary money required from the world’s banking system. As one looks ahead, the amount of new involuntary money required by major debtors like Brazil and Mexico is very much lower than it used to be, and if that trend continues there is no potential major problem in this field. But if a major debtor seemed likely to require, say, $5 billion or so, year after year, of involuntary new funds, it could well be unsustainable.
U.S. Law and Practice
A key element to understanding the banks’ approach to the debt situation is the dominance of U.S. banking law and practice over the structure and conduct of the negotiations. (The U.S. legal and supervisory structure is extremely complicated, and for this purpose need not be considered in detail; the general term “legal practice” will be used without separately identifying the practices of the supervisory authorities, the Securities and Exchange Commission (SEC), accountancy conventions, or others.) Under U.S. legal practice, a loan is regarded as nonperforming if interest is overdue by more than 90 days, and as value impaired if interest is overdue by more than 180 days. Under those circumstances, in general, interest may not be taken into profits on an accrual basis, and provisions may be required against the loan, both as against profits and as against capital. Moreover, once a loan becomes impaired, interest may be taken into profits in the future only if it is brought fully up to date on a cash basis. This extremely general statement of the position is meant to indicate simply that the fulcrum of pressures in negotiations between indebted countries and the banks has been the need, if loans are to remain current, for interest arrears to be kept as short as possible, and preferably not to breach the 90-day and 180-day limits. This constraint has been felt when countries have been in arrears with interest payments, and at times banks have made special bridging loans to help tide countries over an interest date.
More generally, in the earlier phases of the debt crisis after August 1982, many indebted countries needed cash flow relief from the commercial banks in order to be able to meet import and interest payments. The dominance of U.S. legal practice meant that this cash flow relief took the form of new money, on more or less commercial terms.
There are many other forms that cash flow relief could have taken, notably concessions on interest. There was some discussion, and perhaps resentment, among banks elsewhere in the world that they were being constrained to operate so tightly in conformity with U.S. law and practice on the grounds that other forms might be more convenient for them. I doubt whether such a view is correct; to negotiate under the U.S. system was probably the best in the circumstances and certainly created no particular problem for banks elsewhere. The initial resentment was as much annoyance at having to negotiate under specified or constrained circumstances as with the actual form of the negotiating structure.
Concessions and Costs
The dominance of U.S. legal practice in the debt negotiating format has severely constrained the forms of concessions that may be made by the banks. Under this practice, if a bank changes a loan structure, or offers a form of credit that clearly violates the “normal” structures of commercial lending, that loan may be classified as nonperforming or value impaired, with consequent costs for the banks of provisions against profit and capital. This means that when banks made concessions, the loans were left looking like normal commercial transactions, but perhaps with changes at the margin. Thus, for example, margins may be lower than levels that might be negotiated in a free market or maturities may be extended, as in the multiyear rescheduling agreements (MYRAs) agreed with Mexico during early 1985 and under negotiation with other countries. The structure of fees may also be changed to differ from normal commercial practice.
The banks have faced pressure from the U.S. Federal Reserve System and other government agencies to offer such concessions to borrowing countries. One of the arguments put forward was that there might be a perverse relationship between risk and lending charges. Charging full commercial terms might increase the risk by making it less likely that the borrower would be able to sustain the debt. Pressure also came from government agencies that wished to give some political support and incentive to the borrowing countries, and thought that such concessions would be appropriate. Among the banks, several arguments were heard on concessional terms. Some were concerned about profitability as such and therefore wished to have substantial margins and fees, which others thought were also justified by the risk. Other banks were not especially concerned about the profitability of this particular aspect of their global business structure, and were therefore prepared to go along with any reasonable figure. The argument was also put forward that the main objective of the banks was to achieve an orderly resolution of the global debt situation, and that in this context the margin on individual loans was a small consideration. There was therefore a very strong case for reducing margins and fees to give the borrowing countries an incentive to negotiate reasonably with the banks and to see some benefit from their efforts at adjustment. My own bank, and I personally, would attach much greater weight to the latter arguments, and the course ultimately followed was to settle for concessions at the margin.
As commercial organizations, the banks have been judged, indeed scrutinized, by a variety of outside agencies, which in turn can exert pressure on them. They are watched by depositors who may move their funds elsewhere; by rating agencies that may downgrade a bank’s paper and thus increase the cost and reduce the availability of funds; by the stock market, which may mark down a bank’s shares and thus increase the cost and reduce the availability of capital; and by customers and the public at large, who may take their business elsewhere. These constraints sharply limit the extent to which commercial banks may engage in concessionary or noncommercial behavior, and mean in particular that the timing and amount of any concessions must be controlled.
This point was illustrated vividly in May 1984 when the then President of the U.S. Federal Reserve Bank of New York, Mr. Anthony Solomon, organized a meeting that discussed the possibility of placing a cap on the interest rates paid by developing countries. There are various forms of rate-capping, some of which (such as balloon repayments or extended maturities) may under certain circumstances fit with a fully commercial situation, but some of which (such as the banks simply forgiving interest above a certain interest rate) are completely noncommercial. In the event, the market-place did not wait for the fine print but demonstrated a hostile reaction to the idea, with rumored near-runs on two U.S. banks. These were taken very seriously, since at the same time Continental Illinois was in its last throes as an independent commercial bank. The idea of rate-capping thus had to be abandoned forthwith. I should like to think that those who put forward the idea knew this would be the outcome, to kill once and for all the idea that unlimited concessions could be obtained from the commercial banks.
There is a view, encouraged particularly by the very severe adjustments made by certain developing countries, that the banks in some sense have a duty to “pay” or make concessions. But, as indicated above, it is not possible for the banks to offer, negotiate, or commit themselves to, significant noncommercial concessions. The banks have, however, been “paying” privately; many, often at the request of supervisory authorities whose views have become public, have made large provisions against loans extended to certain countries. These provisions will have come out of profits and in some cases out of capital. Although some argue that the banks have (unjustly, perhaps) been doing well both out of new lending and rescheduling, and the situation of individual banks varies a great deal, it is doubtful whether all banks have in fact done well. Given the costs of provisions, many banks would probably have had greater profits if they did not have these particular loans on their books.
In the event of major banking problems, as Continental Illinois created, the doctrine of “moral hazard” has probably been exercised fully by the supervisory authorities. This doctrine suggests that in order not to encourage bad banking, the supervisory authorities should make sure that those who engage in it do not receive any reward for their efforts. In the case of Continental Illinois, the shareholders received, in the end, one thousandth of a cent for their shares, which means they were, in effect, wiped out. Many senior officers had their careers terminated, and were at an age and in a situation when starting new careers could well be difficult, while the officers most directly involved with the banking practices that led to the problem have been sued both by the bank and by outside agencies, and in some cases have been charged under criminal law. There is thus no evidence at all from recent practice that the banks are being particularly mollycoddled by the supervisory authorities.
Partly at their own volition and partly under pressure from supervisory authorities, banks around the world have been strengthening their balance sheets in case some indebted countries may be unable or unwilling to handle their debt effectively over the medium term and move back toward the commercial market-place. This has been done by increasing provisions or reserves, depending on the jurisdiction under which individual banks operate, and by raising fresh capital. Indeed, a certain tiering of banks may be discerned, with the banks that can take strong measures doing so, and other less well placed banks not taking such measures. The most recent loan agreements, notably the MYRAs, have allowed banks to convert some debt to their own currency, and away from dollars, in order to ease their funding situation. This change caused some negotiating difficulty, and in any case applied to a very small proportion of the total debt outstanding. The very sharp increase in the value of the dollar during 1984, in which banks’ assets had been denominated, meant that for banks with nondollar capital, the capital burden from their developing country debt increased significantly. For some European banks, despite substantial provisioning, their unprovided exposure in their own currency to certain developing countries will be as high in 1985 as it was at the beginning of the crisis in 1982. This situation is one where the systemic attributes of the international financial system, notably the extreme volatility of exchange rates that has emerged from the floating exchange system, have a substantial impact upon the operational aspects of the banks, and on their capacity to handle their existing exposure and take on new debt.
The response of supervisors around the world to the international debt crisis, and to the problems in particular countries, has been that formal supervision has intensified. In many countries the requirements on liquidity, on capital, and on exposure have been tightened heavily. The result has been to put many major banks under very severe balance sheet pressure, and to lead to attempts to earn fee income and to do off-balance-sheet business, in some cases by creating contingent liabilities. However, recent developments show that supervisors are concerned that such liabilities should be brought within the ambit of capital adequacy controls.
Supervision is a form of implicit tax, in that by requesting or requiring banks to do things they might not do under normal commercial circumstances, it imposes an implicit tax on that commercial activity. If the balance sheet constraint is too great, achieving any desired level of new net or gross lending to developing countries becomes correspondingly more difficult, given the other considerations that need to be borne in mind in deciding balance sheet policy. If supervision is “too tight,” whatever that means, then the banks are unable to obtain the profits they might wish, since the implicit tax prevents them from transacting certain business; and indeed, the banks may be forced into riskier forms of expansion. The fact that the U.S. banks in Illinois were not allowed to generate substantial retail deposit bases, and were thus not allowed to expand organically in their own backyard, was in my view an important reason why banks that did want to expand were forced to do so through other means. Thus they became involved in a large way in the Eurodollar market, and in corporate lending elsewhere in the country. Both of these areas were relatively unfamiliar to senior management, and both were intrinsically riskier than either a local retail deposit base or the local corporate market-place. However well meaning, over-tight or inappropriate supervision can do positive harm.
This should not suggest that positive harm has yet been done, but the possibility merits consideration. What is the optimal level of supervision or degree of tightness of supervision that would allow the worldwide banking system to satisfy the social demands that the Fund and governments would like to place on it?
A key interaction between the commercial banking system and governments in the industrial countries relates to export credit policy. These governments have, through organizations like the Export-Import Bank, a colossal exposure in developing countries. All these export credit and export credit insurance organizations are bound more or less by their statutes to cover their costs, which means that they should clearly withdraw cover or charge adequate fees for countries where the risk is too great to continue current practices. But if these organizations do restrict cover to the riskier countries, which are inevitably the main indebted countries, either those countries will not be able to acquire the imports they need, or a substantial risk will be transferred onto the commercial banks, which those banks may be unwilling to accept over and above their planned exposure under existing new money agreements. This transfer of risk may be attempted at the detailed level, with export credit insurance organizations being willing to cover a smaller proportion of a loan for a particular country, or at the macro level, where the global cover provided throughout the industrial countries by their export credit insurance organizations may be insufficient to cover the total import requirements of the rescheduling countries.
This policy issue is now being addressed at the level of the Organization for Economic Cooperation and Development (OECD). This is one area in which the OECD governments are inevitably drawn in, and cannot avoid having a policy, whether damaging or beneficial. It is of paramount importance to the developing country situation that the OECD countries put together a collective policy that ensures adequate cover for the indebted countries.
Many developing countries had, by the early 1980s, a future amortization schedule that produced very substantial bunching in the mid-1980s. The solution was to negotiate MYRAs, which essentially extended the maturities of existing debt. (The pre- and post-MYRA schedules for Mexico are given in Table 2.) There was clearly no way in which these countries could repay the debt on the amortization schedule, and at the same time it was unlikely that many countries would, by the mid- and late-1980s, be sufficiently strong financially to go back into the marketplace on a voluntary basis. The situation was that either the commercial banks and the countries would be engaged in perpetual annual negotiation, often rescheduling the same debt, or that some longer-term solution had to be found. The disadvantage of annual rescheduling was that it was inadequate to deal with an evident problem. It entailed a degree of stress on all parties that was unnecessarily high. Insofar as rescheduling negotiations were continuous, there was a greater risk that at some point they could break down, for an economic or political reason, and this could bring the debt structure of any particular country crashing to the ground. The appropriate solution was, therefore, to negotiate a marked extension in the maturity of these debts.
Mexico’s Public Sector Debt Repayment Schedules
Mexico’s Public Sector Debt Repayment Schedules
|Before MYRA||After MYRA||Amortization of|
on Multiyear Basis
|(In billions of U.S. dollars)||(In percent)|
Mexico’s Public Sector Debt Repayment Schedules
|Before MYRA||After MYRA||Amortization of|
on Multiyear Basis
|(In billions of U.S. dollars)||(In percent)|
The first MYRA was for Mexico. This rescheduled $20 billion of maturities falling due between 1 January 1983 and 31 December 1990 over 14 years, with one year’s grace; $5.9 billion due in 1987 stretched over 12 years, starting in 1987; and $17.7 billion due from 1988 to 1990 over 11 years, beginning in 1988. The interest on the debt would in most cases be at a variable rate linked to the London Interbank Offered Rate (LIBOR), or to a rate to be decided if a currency other than the dollar were used. Amortization would start at 1.244 percent in 1986, and would average 3.367 percent per annum during 1986–91, 7.814 percent per annum during 1992–94, and 14.0885 percent per annum during 1995–98 (see Table 2). This extension of the negotiation to cover maturities was absolutely necessary since there was no point in maintaining unnecessary pressure on all parties. Deliberately to leave a country with a commitment for heavy amortization in the late-1980s that could obviously not be satisfied would have served no useful purpose.
The banks have been involved with the Fund in the detailed cash flow negotiations regarding rescheduling and new money requirements. They have not been willing to provide new money unless a country had a Fund-supported program. This seems to be the correct decision. When banks had, by definition, “too much” debt outstanding to a country that could not handle it, the country clearly could not satisfy other lenders of any new money unless it were to be seen to be returning to creditworthiness and market access. There could hardly be a better indication of a country moving back toward creditworthiness than its negotiation and satisfaction of a Fund-supported program.
In cases such as Venezuela, the banks initially asked for a Fund-supported stabilization program, although Venezuela was only rescheduling and was not requiring new money. In the event, Venezuela was able to obtain its rescheduling without having to go to the Fund although it was pursuing adjustment policies that received unofficial Fund corroboration.
Venezuela’s dilemma also arises in the case of MYRAs—namely how can banks ensure that a country will be pursuing a fairly orthodox economic policy if it does not require new money so that the banks have no opportunity to negotiate specific conditions. The answer has been that the Fund would conduct “extended” Article IV consultations twice a year with the borrowing country, and a report on that would be made available to the banks, which would then be in a position to decide to terminate the agreement if they regarded the country’s performance as unsatisfactory. Mexico has agreed that such conditionality may be applied in the case of its MYRAs.
This area of joint action between the Fund and the commercial banks obviously suffers from being somewhat ambiguous; the responsibilities of the various parties are not entirely clear, and the criteria for judgment are equally open to many interpretations. It is not clear what the advantage to the banks would be if they terminated an agreement that involved no new money, in view of their interpretation of a Fund report. This solution of using extended Article IV consultations as a form of mini-conditionality is clearly a compromise between the requirements of the various parties, with the banks wishing to have some form of guidance in their assessment of a country’s performance. It remains to be seen how effective it is. As has well been noted, the dominant issue facing a developing country in its debt management is the weight it gives to future access to the commercial market-place. That imposes a true discipline on a borrowing country.
In 1983, the banks founded the Institute of International Finance (IIF) in Washington, to collect data on international debt, to formulate joint policy positions and discuss issues among banks, and to be a spokesman for the banking industry on certain points. The IIF got off to a relatively slow start but appears to be consolidating its position, and it will form an excellent channel of information given its proximity to the Fund, the World Bank, and other Washington institutions, combined with the personal contacts that have existed and will exist between its staff and key Washington figures. This represents an attempt on the part of the banking system both to improve the data which is available, and to formulate common analyses and joint positions on current debt matters.
No Global Solution
The banks are constrained very severely by external pressures, and their structure as commercial organizations also severely restricts what they are able to do. The case-by-case approach has, in my view, been inevitable. If one were to think in terms of global solutions, then one has to ask three questions:
□ How much money is required and where would it come from?
□ How would one apportion costs among the OECD countries?
□ How would one apportion benefits among developing countries?
Whatever the answers to these questions, it has become clear that the OECD governments have no intention of putting together a global solution. In point of fact virtually no “aid” money has come from the OECD countries at all. Money has been provided under crisis circumstances, such as from the U.S. agencies in August 1982 when Mexico ran out of cash, and governments have borne costs, involuntarily, from the problems faced by their export credit insurance organizations. But apart from crisis money, the OECD countries have contributed nothing. For example, their attitude toward the most recent replenishment of IDA was scandalous, given the acknowledged seriousness of the international economic situation, which has been constraining substantially the growth of developing countries, including the poorest.
The banks and the developing countries have thus been put into a situation of tough negotiation. One of the initial merits of the case-by-case approach was that by generating negotiating tension, all the participants were forced to identify clearly their true interests. Within their own commercial constraints the banks have played a full and cooperative part. The future of the debt situation will depend on the view the developing countries take of their own best interests, and on their willingness and ability to handle their debt well. The evidence so far is in many ways extremely hopeful, although there are negative elements. This is, however, not a point on which the commercial banks have a policy view. They will continue to play their part cooperatively, within their own commercial constraints and whatever framework is created by the OECD governments, the dominant influence.
A Borrower’s Perspective
Ernesto Zedillo Ponce de Leon*
There is no doubt that the relative size of the external debt of developing countries took on impressive proportions during the ten-year period that ended in 1982. Many concerns, both analytical and practical, had been raised periodically about the phenomenon since the mid-1970s, but few—if any—foresaw the violent chain reaction that would be triggered by the Mexican announcement of August 1982. That is not to say that such an announcement came out of nowhere. At the time, the Mexican economy—much like that of other major developing countries—was in the middle of a serious crisis, which world financial markets had already reacted to by neglecting both to provide additional credit and to arrange for rolling over maturities falling due. Within a few weeks of the Mexican announcement, the smooth and substantial lending to developing countries that was such a conspicuous feature of the 1970s had become a fact of the past.
Extensive analysis has been made elsewhere of how the debt problem developed since the first oil shock. Needless to say, the most diverse views have emerged on the subject. Yet it is now clear that no single explanation is generally valid. The mix of external and internal shocks leading to severe balance of payments problems have varied substantially from country to country. Beyond this undisputable but unrevealing fact, it is unnecessary to reiterate the primary causes of the problem. Rather, it would be more fruitful to look at the way in which it has been faced during the last two and a half years, and to inquire—albeit superficially—into what lies ahead.
The Current Strategy
Not only did the Mexican affair trigger the crisis, but it also brought immediately to the fore the main ingredients of the approach that was to prevail in the way the problem was dealt with. The dramatic announcement of August 20, 1982 had been preceded by talks on a stand-by agreement between the Mexican authorities and a Fund mission, as well as difficult but successful negotiations to obtain a credit package from the U.S. Treasury Department and the U.S. Commodity Credit Corporation. Almost simultaneously with the eruption of the crisis, the Federal Reserve, together with several European central banks, became openly involved by contributing to a $1.9 billion facility managed by the Bank of International Settlements (BIS) that was made available as temporary support for Mexico’s balance of payments. The episode also anticipated other important facts about the more general debt drama. On the debtor side, the largest Latin American countries were to be dominant, whereas private commercial banks—predominantly U.S. banks—would be the main creditors.
Much criticism has been directed at the handling of the debt problem since late 1982. But the critics have failed to recognize that the (admittedly) tortuous, piecemeal solution that emerged in the last months of 1982 was the only possible approach toward a cooperative solution in the short run. Events occurred so fast that no room was left to entertain alternative schemes, except for outright default and fierce retaliation. The existing institutional framework barely allowed for a minimally cooperative strategy, in which creditor banks could try to avoid—or at least minimize—losses, debtors could seek balance of payments relief without relying on actions that would ban them permanently from international capital markets, the monetary authorities could help prevent a seepage of debt problems into their own financial systems, and the International Monetary Fund—seizing a “once in a lifetime” opportunity to recover the ground lost in past years—could step into the act by negotiating and supervising the stabilization programs of the indebted economies. From this diversity of interests, the current approach to the international debt problem was put together.
Within this framework, a first task was to restructure, on a case-by-case basis, some portion of the external debt owed to commercial banks by several of the largest debtors. Although the final outcome in each case was somewhat different, the principle of arriving at a market-oriented arrangement prevailed in practically all instances. This explains why the consolidation periods in the first round of restructuring were quite short, and spreads were raised substantially above those originally contracted. (Consolidation periods are those in which amortization payments due for rescheduling have fallen and will fall due.) In general, no interest payments in arrears were rescheduled. Repayment periods were generally kept in line with those under long-term, normal lending agreements. By the same token, the restructuring exercises left untouched sensitive areas of the outstanding nonofficial debt. Thus, a sort of gentleman’s agreement held for interbank deposits so that these obligations could be rolled over—at a high cost for debtors, of course. Furthermore, debtor governments agreed to pay liabilities falling due in the floating rate note and bond markets.
As important as preserving market practices was the issue of fairness among commercial bank creditors in the rescheduling exercises. Every bank’s exposure was carefully defined at a certain date and used to determine both the amounts to be rescheduled and each creditor’s contribution to the fresh money packages. Needless to say, putting together these packages was also essential to the whole strategy. New lending was the carrot that led debtor countries to swallow the market rescheduling, as well as the orthodox stabilization programs that accompanied them. Not surprisingly, getting all bank creditors to accept the new lending facilities has proven to be increasingly difficult. That is why it is known as “forced” lending.
Except for a few cases, debt arrangements have been explicitly linked to the design of and compliance with Fund-supported stabilization programs. It is not an exaggeration to say that, thanks to this fact, the Fund has regained its foremost position in the handling of problems affecting global financial stability. In the eyes of the monetary authorities of industrialized countries and of money-center banks, the Fund is now a much more valuable institution than it was only a few years ago.
In other quarters, however, the Fund is blamed for many of the undesirable side effects that have accompanied the stabilization programs of the highly indebted economies. This sort of criticism has been raised not only by political groups within the countries under Fund programs, but by a number of respectable academics. But even while admitting that the Fund’s involvement in the debt problem and its consequent balance of payments adjustment process has not been totally faultless, technically and politically speaking, it is equally objectionable to blame the Fund’s role during the recent crisis so much. In most cases, adjustment had to take place, irrespective of the Fund’s intervention. Quite often, the so-called social costs of adjustment are not adjustment costs, but ills caused in the first place by the external and internal phenomena that led to the crisis itself.
Quite paradoxically, the contribution of other important official lenders—either multilateral or bilateral—to the solution of the debt problem has been quite ambiguous, if not detrimental in certain cases. Not that reschedulings of liabilities owed to official entities were totally nonexistent. The trouble was (and still is) that, in general, official creditors—when not openly rejecting restructuring—have pursued and achieved better terms than those obtained by private creditors. A supposedly firm intention to continue lending, and even increase exposure, has been the main argument provided by official creditors for not matching the schemes negotiated with the private banks. But committing resources is not the same as actually providing them. Many inflexibilities of a legal and economic nature may be built into committed credits, and preclude their use, even if the need for foreign savings is enormous.
The newest development on the debt front consists of the multiyear restructuring agreements (MYRAs) that Mexico and Venezuela negotiated in principle with their bank creditors in September 1984. Other important debtors are now pursuing similar arrangements. From the debtor’s perspective, a MYRA leads to a full consolidation of external public debt and its restructuring, at maturities considerably longer than those granted up to now by private banks. In the case of Mexico, the repayment period of the debt in the package is to be extended to 14 years. MYRAs also provide for lower spreads, still within market margins, the substitution of some reference interest rates, and some currency diversification options not considered before. The acceptance of MYRAs among creditor banks has rested upon two conditions: first, only countries that are well on their way to a full recovery with balance of payments stability are to be granted this kind of deal; second, the idea that if “forced” lending to such countries is to be ended, a comprehensive restructuring effort is needed at any rate. Thus, MYRAs are seen as a necessary condition for normalizing the return of these countries to international capital markets.
Summing up, it can be said that the piecemeal approach has proven to be successful until now. After all, its chief goals—to avoid country defaults, bank failures, and a serious disruption of international trade—were attained. Nor have the actions undertaken since 1982 harmed the future chances of debtors to regain a normal access to international capital markets. Banks have not forgiven principal nor interest on the external public debt of large debtors. Some losses have occurred on private debt, but from commercial—not sovereign—risk. With different degrees of success, debtors have adjusted their economies—although it is yet to be seen whether this adjustment can yield permanent positive results. The crisis has also been a useful learning process. Both debtors and creditors have shown much more care and responsibility in dealing with rescheduling than they exhibited in the era of excessive lending. Banks should now be more capable of undertaking sovereign risk analysis. As a result, future voluntary lending—if it ever comes back—would be made on a sounder basis.
The Road Ahead
The question arises whether a continuation of the case-by-case approach will be successful in the medium and long run. Unfortunately, the answer to this question seems to be no. This view is based on two highly interrelated considerations. First, troubled debtor countries, notwithstanding their dramatic adjustment since 1982, are generally nowhere near to achieving stable economic growth. Second, the solvency of such debtor countries is far from settled. Furthermore, even if such solvency exists “on paper,” based on sensible projections of the relevant macroeconomic variables, it does not follow that the developing countries—other than the well-known Asian “miracles”—would regain normal access to international capital markets.
The pessimism arises from the recognition that a scenario of full recovery and solvency in the heavily indebted economies requires the simultaneous occurrence of several conditions, some of which may be unattainable, judged by current trends. Very high real interest rates, an over-strong dollar, depressed commodity prices, uncertainty about the future growth of industrialized economies, and mounting protectionist practices by the latter are only a few of the negative factors affecting the growth and debt outlook of developing countries.
The conventional solvency analysis shows that a healthy coexistence of capacity to pay and economic growth crucially depends on the evolution of the size and cost of the debt relative to the expansion of exports. The main difficulty with such solvency is that real interest rates have tended to increase again in the last 18 months and are not likely to fall—in fact, they may even rise further—in the near future. Considering the recent behavior of export prices (both for commodities and relevant manufactures), expected export prices, and changes in nominal interest rates, estimated real interest rates of about 10 percent are not likely to be too high. With such large real credit costs, the export growth that is required to adjust systematically the debt-export ratios of debtors is unlikely to be consistent with expected growth in gross domestic product (GDP) for the industrial countries or with the renewed protectionist stance that they are likely to adopt.
The outlook is even worse if expectations for high real interest rates are coupled with those for an appreciating U.S. dollar vis-à-vis the European currencies and the Japanese yen. This appreciation not only tends to depress commodity prices, but it also makes it much harder for debtors to keep their real exchange rates at levels consistent with their export aspirations. The anti-inflationary policies actively pursued by some of the large debtor countries impose a restriction on how fast they can adjust nominal exchange rates to compensate for the real appreciation of the dollar; in the process, export price competitiveness is eroded. By the same token, the combination of high interest rates and a constantly appreciating dollar makes it very difficult for developing countries to prevent the substantial outflows of private capital that clearly complicate their debt problem significantly.
The above considerations strongly suggest that the continued economic discipline on the part of debtor countries that is necessary for overcoming the present crisis fully could well be betrayed by an adverse international environment. The developing countries are fully aware that the abundant and inexpensive foreign financing of the 1970s is probably gone forever. These countries’ policymakers know that to resume growth, much more than a successful short-run stabilization program is required; to return to the investment rates consistent with at least moderate GDP growth, debtor countries will have to depend on domestic savings. In some instances, this might imply raising their savings rate as much as five or more percentage points above historical levels. It would be frustrating—and, certainly unacceptable—if the increased savings, rather than being channeled to finance investment, were used to continue amortizing external debt in real terms, as has been the case during the last three years. Nor would it be very gratifying if the benefits of reduced consumption were to be swallowed by the very high foreign interest rates initially caused by fiscal policies that are far removed from those preached to debtor countries nowadays. It would be equally frustrating if the export surpluses, generated thanks to (socially costly) expenditure reducing and switching policies, could not be placed in the markets of developed countries—not because of quality or price, but because of protectionist measures.
The debt problem, therefore, may still pose a serious threat to global financial stability in the future, despite the achievements of recent years. If the U.S. fiscal deficit cannot be controlled, for instance, or greater monetary policy coordination achieved among developed countries, or the new protectionist trends reversed in the foreseeable future, the time might be ripe to pursue less orthodox, albeit rational, debt management schemes.
At this stage, it is still in the interests of the larger debtors among the developing countries not to endorse any plan that would punish their private creditors in any way. The emphasis should be on actions to restore creditworthiness, not to damage it. In this respect, a faster implementation of MYRAs for a wider spectrum of countries would seem advisable, even if the debtor fails to meet some of the criteria that the bank advisory committees applied in the Mexican and Venezuelan cases. That is not to say that MYRAs should be granted with no conditionality at all, but that, for example, simpler—but perhaps sounder—rules for assessing creditworthiness should be applied. Thus, export performance and real exchange rate behavior should be given more attention than other aspects of the debtor’s macroeconomic performance.
But the main responsibility—assuming that both debtors and banks continue to play their respective roles prudently—now lies with the governments of western countries. In addition to practicing sounder macroeconomic policies, they should undertake more decisive debt relief. To the extent that this would significantly lighten the debt burden of debtors, the latter’s chances for full recovery—both of GDP growth and solvency—would be enhanced. Debt relief does not necessarily imply “giving away taxpayers’ money.’ A number of heterodox, but sensible, proposals have been put forward in recent years that are worth considering more seriously. Simonsen’s worldwide income-tax-free bonds issued by developing country debtors are a good example. The placement of these bonds would significantly reduce the cost of credit for the issuer and could provide for some reduction of the banks’ present exposure, leaving more room for future lending by these creditors. Obviously enough, if the governments of some developed countries provided a partial or total guarantee, the instrument would become much more marketable and even less costly for the debtor. In exchange for the guarantee, some form of “servicing priority” could be attached to the instrument and perhaps a collateral (such as an export) could be offered to the guarantor government.
As Simonsen also suggests, the same kind of instrument may be used to inject new resources into the World Bank and the Fund, although more direct and significant contributions to these institutions by the developed countries are, in any case, long overdue. Lending criteria by institutions such as the World Bank should be revised at once, so that its lending to developing countries can be disbursed more expeditiously. Packages cofinanced with private banks either by the World Bank or its affiliate, the International Finance Corporation, would prove especially valuable to restore confidence in private creditors. Emphasis should be placed on export-oriented projects.
Finally, the dogma of “no interest-capitalization” has to be overcome. Capitalizing interest should not be considered a poor banking practice, especially if the interest accrues at a market rate. Sooner or later, regulators will have to accept some form of explicit interest capitalization. It should prove especially useful in dealing with the debt problem of poorer countries that now seem condemned to exclusion from the private lending market for a long time—even decades. When the problem is rather one of full liquidation of the debt, concepts such as “cap disbursements” and “cap interest rates” are indeed relevant. Appendix I develops a full repayment formula with the following characteristics: interest accrues at a market rate (equation 10); actual disbursements of the debtor depend, not on the market rate, but on a real cap rate and on how well the world economy does in each year; finally, the repayment period is, therefore, endogenous. There would exist a repayment term negotiated in principle, but deviations from target both in the actual real rate of interest from the real cap rate and in GDP growth in industrial countries would cause the term agreed upon to be extended or reduced, depending on the sign and size of such deviations (see equations 4 and 5).
Let: lt = Interest payments on the external debt; it = nominal market interest rate; rt = real rate of interest; ϵt = relevant international inflation rate; Ît = cap nominal rate;
Given the country’s total exports at t = 0, N could be determined, according to a formula such as:
where α is a fraction to be negotiated with creditors.
Total yearly disbursements to creditors, Pt, would be determined according to:
where, Tt = T (
Notice that if it = ît and gt =
In this case, disbursements (Pt) would be constant if properly measured at present value (at t = 0) and equal to S0/N = X0
Mr. Mohammed is Director of the Department of External Relations, International Monetary Fund.
Dr. Lomax is Group Economic Adviser, National Westminister Bank, United Kingdom.
Mr. Zedillo is employed by Banco de Mexico. The opinions expressed in this paper are personal and should not be attributed to the author’s employer.