Chapter V The Debt Situation: Prospects and Policy Issues
Author: International Monetary Fund. Research Dept.
Language:
English
Keywords:
WEO; fuel exporter; debt ratio; real GNP; long-term debt; debtor country; demand management; debt-servicing problem; debt-export ratio; financing package; debt-problem country; Debt service ratios; Imports; Exports; Export performance; Sub-Saharan Africa; Global; Asia and Pacific; Western Hemisphere; U.S. dollar price; Debt service
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Abstract

The heavy burden of external debt remains the dominant factor in assessing medium-term prospects for a large number of developing countries. For these countries, the medium-term outlook remains considerably less favorable than for countries that avoided large increases in debt and debt-service ratios during the period 1973–82. The following section focuses on the evolution of the debt situation over that period. The next section sets out a medium-term scenario for developing countries, together with an analysis of the scenario’s sensitivity to certain alternative developments; this analysis gives some indication of the likely future vulnerability of the system to the kinds of global economic disturbances that occurred in 1979–82, and is intended to place in perspective the proposals reviewed in the following section. The final section then sets out some tentative conclusions on the nature of the systemic weaknesses that may impede resolution of existing debt-servicing problems and could lead to a recurrence of similar problems in the future. The section is concluded by a review of relevant policy issues, distinguishing the contributions to be made by governments of debtor and creditor countries, by private creditors, and by the Fund, the World Bank, and other international institutions.

The heavy burden of external debt remains the dominant factor in assessing medium-term prospects for a large number of developing countries. For these countries, the medium-term outlook remains considerably less favorable than for countries that avoided large increases in debt and debt-service ratios during the period 1973–82. The following section focuses on the evolution of the debt situation over that period. The next section sets out a medium-term scenario for developing countries, together with an analysis of the scenario’s sensitivity to certain alternative developments; this analysis gives some indication of the likely future vulnerability of the system to the kinds of global economic disturbances that occurred in 1979–82, and is intended to place in perspective the proposals reviewed in the following section. The final section then sets out some tentative conclusions on the nature of the systemic weaknesses that may impede resolution of existing debt-servicing problems and could lead to a recurrence of similar problems in the future. The section is concluded by a review of relevant policy issues, distinguishing the contributions to be made by governments of debtor and creditor countries, by private creditors, and by the Fund, the World Bank, and other international institutions.

The Debt Situation Since 1973

Sources and Symptoms of the Crisis

In varying degrees, all developing countries were affected by the various shocks to the global economy that occurred in the late 1970s and early 1980s. These shocks complicated domestic economic management and contributed to the loss of creditors’ confidence in many developing countries. The resulting curtailment in the growth of private bank exposure to these countries after 1982 left many debtor countries unable to roll over maturing debts and finance current account deficits. While many countries rapidly adjusted their domestic policies, and some were able to avoid serious liquidity problems, for a large number of others adjustment efforts were not sufficiently timely to prevent the emergence of debt-servicing problems. The entire episode was characterized by the apparently rapid emergence of problems of unexpected severity. Optimistic expectations proved unfounded in several respects, namely with regard to the duration of the recession and of high real interest rates, the financial strength of the commercial banks, and the strength of economic policies and prospects in the debtor countries. In retrospect, it is easier now than it was at the onset of the payments difficulties in 1982 to identify the sources of weakness in the system.

There is, of course, long historical precedent for countries in the early stages of their development engaging in net international borrowing in order to raise their rates of investment and economic growth. However, failure to control adequately the growth, structure, and terms of external borrowing can lead to balance of payments difficulties and ultimately a protracted setback to economic development. For example, while external indebtedness may at times grow more rapidly than output, the ratio of debt to GDP cannot increase indefinitely without threatening the solvency of the debtor, namely, its ability to service debt out of current national income. Analogously, a continued tendency for the ratio of debt to exports to grow is a sign that the economy will eventually experience liquidity problems—that it will not be able to generate sufficient foreign exchange to meet both debt service requirements and at the same time pay for essential imports. Furthermore, a persistently negative difference between the rate of growth of exports and the average interest rate on debt suggests a tendency for additional net borrowing to add to long-run debt-servicing difficulties.

In addition to these considerations, there are those relating to the structure and terms of debt. Important indications of these include: the proportion of total debt at commercial terms; the share of total debt at variable interest rates; the average maturity of debt; and the share of short-term debt in the total. The terms and maturity of debt are reflected to some extent in the frequently cited ratio of debt service payments (total interest payments plus amortization on medium-and long-term debt) to exports of goods and services. While rising debt service ratios can be quite compatible with successful economic policies (for instance, if foreign borrowing is used to finance efficient export-promoting or import-substituting investment), a country with a rising debt service ratio is, other things being equal, becoming more vulnerable to adverse external developments (such as higher interest rates, a decline in the terms of trade, or a reduction in new capital inflows). In gauging the extent of such vulnerability, it is sometimes useful to take into account also the ratio of short-term debt to exports of goods and services. While short-term debt (much of which consists of trade financing) is normally rolled over, during a crisis of creditor confidence there may be reluctance to continue lines of credit and other short-term financing facilities.

The total external debt of capital importing developing countries grew rapidly throughout the period 1973–82 and, except during 1979–80, outpaced the growth of exports or GDP; during the ten-year period 1973–82, external debt grew at a compound annual rate of 20½ percent, while the value of exports grew by 16 percent and nominal GDP by 12½ percent.1 During 1973–78, however, average nominal interest rates on external debt averaged only 5¾ percent—much lower than the rate of growth of exports or GDP in nominal terms—so that debt service ratios, although rising, were still relatively moderate (Table 19). The average interest rate on debt rose substantially during 1979–80. Although the impact of this increase on debt-servicing positions was temporarily masked by a sharp rise in export prices, there were signs of a growing vulnerability to developments in external financial markets. The proportion of total debt subject to variable interest rates continued to rise as a result of the increased reliance on bank lending, and the share of short-term debt in total debt also increased significantly during the second half of the 1970s (Table 19).

Table 19.

Capital Importing Developing Countries: Selected Indicators of External Debt Developments, 1973–85

(Period averages; in percent)

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Excluding Nigeria and South Africa.

The consequences of these shifts in the structure of external debt became apparent in the early 1980s. The total external debt of the capital importing countries continued to grow rapidly during 1981–82, at an annual average rate of around 15 percent (Chart 29). High interest rates on world financial markets, together with the increased share of debt subject to variable rates, contributed to a further increase in the average interest rate on external debt, which reached almost 10 percent. At the same time, the value of exports and GDP of the capital importing countries stagnated under the impact of the world recession. As a result, debt and debt service ratios rose substantially, while the large volume of short-term debt relative to export earnings contributed to an increasing incidence of liquidity problems, as creditors became reluctant to roll over their short-term commitments to a number of countries. The movements in these indicators differed substantially, however, between the groups of those countries that did, and those that did not, encounter debt-servicing difficulties.2 The debt-to-exports ratio of the first-mentioned group almost doubled between 1975 and 1982, rising from 121 percent to 235 percent, while over the same period the ratio for the second group rose only moderately, from 81 percent to 89 percent.

Chart 29.
Chart 29.

Capital Importing Developing Countries: Exports, Total Debt, and Interest Rates, 1971–851

(In percent)

1 U.S. dollar values of exports of goods and services and of total short- and long-term external debt, and London interbank offered rate on 6-month U.S. dollar deposits.

The group of countries with debt-servicing problems also paid higher average interest rates on their external debt than other countries, largely because of the former group’s greater reliance on borrowing from private sources, including banks; at the end of 1982, over 70 percent of their total long-term debt was owed to private creditors, compared with less than 50 percent for the non-problem countries. The combination of higher debt-to-export ratios, higher average interest rates, and somewhat shorter maturities contributed to much higher debt service ratios for the countries with debt-servicing difficulties—averaging 35 percent during 1981–82, compared with under 13 percent for the non-problem countries. In addition, the share of short-term debt in total debt was almost 50 percent higher in the debt-problem countries.

The most frequently cited cause of the deteriorating external debt situation of the capital importing countries was the series of external shocks of 1979–83 that to some extent affected all developing countries. But domestic developments prior to that time, as well as earlier external debt management policies, greatly influenced the vulnerability of capital importing countries to these external shocks. Certain key domestic developments are briefly reviewed here, followed by a discussion of the policy background.

The principal rationale of external borrowing is to raise investment, and thereby growth of output, above levels that would otherwise have been attained. There is no direct way of measuring the extent to which the increased external borrowing in the 1970s and early 1980s was used for investment purposes and to what extent it was used to offset a reduction in domestic saving. Indirect evidence is provided, however, by the behavior of saving and investment ratios in the period leading up to, and immediately after, the onset of the debt crisis. For the countries with debt-servicing problems, the domestic saving rate tended to decline after the mid-1970s to the period 1978–82 (Chart 30). Growing inflows of foreign savings were thus used largely to maintain the existing investment ratio, rather than to increase it. In effect foreign saving was, at the margin, financing a reduction in domestic saving. When inflows of foreign savings dried up after 1982, the domestic investment ratio plummeted. Countries that did not encounter debt-servicing difficulties had a rather different history. Although saving in these countries generally represented a smaller share of national income, saving ratios tended to rise after 1977.3 Hence foreign borrowing seems to have been used largely to support additional investment.

Chart 30.
Chart 30.

Capital Importing Developing Countries: Gross Savings and Capital Formation, 1977–851

(Percent of GDP)

1 Median values of gross saving and gross capital formation, as a percentage of GDP, in each group of countries.

There is also the question of the efficiency of investment, which may be roughly measured by the frequently used incremental output-capital ratio. The wide fluctuations in this ratio across countries and between years are influenced, however, not only by the efficiency of investment but also by annual fluctuations in output, such as the recent declines in GDP growth in developing countries. Nonetheless, it is worth noting that the countries without debt-servicing problems tended to show significantly higher incremental output-capital ratios than those with debt-servicing problems (see Statistical Appendix Tables A5 and A7).

The external financing requirements of capital importing countries were greatly increased by outflows of resident capital. Such outflows were particularly large in relation to GDP during 1977–80. For capital-importing countries as a whole, capital outflows increased the external financing requirement by about two thirds compared to the needs of current account financing alone; for countries in the Western Hemisphere, the external financing requirement was almost doubled in this manner. While for some countries, especially in Asia and the Middle East, capital outflows represented in large part the prudential accumulation of official reserves and, to a lesser extent, trade credits used to promote exports, in other regions the capital outflows from developing countries were mainly accounted for by outflows of private savings.

Another element in the deteriorating external position of a number of capital importing developing countries in the 1970s and early 1980s was the inadequate extent to which borrowed funds were used to increase the economy’s capacity to generate foreign exchange earnings. This tendency is suggested by the stronger export performance of countries that avoided debt-servicing problems. These countries’ export volumes grew between 1973 and 1982 at a compound average rate of 4¾ percent, as against less than ¾ of 1 percent for debt-problem countries, reflecting in part different export compositions but also a more favorable policy stance.

The domestic developments that have just been briefly outlined had their roots to a considerable extent in the policies pursued in these countries. For a large number of countries, the mid-1970s initiated a long period of expansionary fiscal and monetary policies, accompanied by a set of pricing, interest rate and exchange rate policies, as well as trade and exchange restrictions, that tended to reduce domestic savings, harm the efficiency of investment, encourage capital flight, and discourage the growth of exports (particularly the growth of manufactured exports). In varying degrees, policies of this sort contributed to the rapid accumulation of external indebtedness in countries that eventually developed debt-servicing problems. By contrast, countries that were able to avoid such problems often had domestic policies that to some degree were more successful at encouraging the domestic mobilization of savings, the efficient use of investable resources, and export growth and diversification. This is not, of course, to say that domestic policies were the only cause of the deteriorating external position of the countries with debt-servicing problems, nor that policies in countries without such problems were beyond criticism, but merely to indicate that there is evidence of a tendency to greater policy weakness in the former group compared with the latter. Current and prospective ways in which policies in these countries might be strengthened are reviewed later in this chapter.

Weaknesses in demand management and supply-side policies in the debt-problem countries were often closely associated with the manner in which the external debt was managed. Several aspects of debt management may be noted briefly here. First, there was the rate at which the external indebtedness of the public sector was expanded, which in turn was closely related to the evolution of the fiscal deficit. Another factor was the effectiveness with which the authorities recorded and monitored both public and privately contracted debt; this influenced the speed of shifting domestic policies in reaction to external difficulties. Vulnerability to such difficulties was influenced by the extent of the shift to borrowing from commercial sources at market-related terms, rather than from official sources at concessional terms, and to short-term rather than medium-term and long-term borrowing. These factors were interrelated: the more rapidly countries increased the relative amount of their external borrowing, the less adequate was available official financing and the heavier was the reliance on commercial sources, while lack of control over external borrowing by the private sector enhanced the danger that short-term debt and overall debt service would grow to unsustainable magnitudes.

Superimposed upon the domestic developments and policy stances just discussed were a series of external shocks beginning in 1979. These shocks not only led initially to higher current account deficits and a larger accumulation of external debt, but eventually also weakened the confidence of creditors and thereby reduced the inflow of new financing.

The first of these external shocks was the series of oil price increases that occurred in 1979 and 1980. Perhaps surprisingly, the countries with the greatest payments difficulties in the early 1980s had benefited as a group from the oil price increases, but oil exporters such as Mexico, Nigeria, and Venezuela soon experienced serious debt-servicing problems from expansionary government expenditure programs, large increases in foreign borrowing, and domestic investments whose prospective yields were mismatched with amortization payments on this borrowing. By 1982, when oil prices began to weaken, some of these governments were heavily overcommitted to debt-servicing payments that were posited on continued high oil prices. At the same time, of course, the price increases of 1979–80 posed serious adjustment difficulties to oil-importing countries, especially countries exporting chiefly non-oil primary commodities, whose terms of trade fell sharply over the period 1979–82.

The recession in the industrial countries in 1980–82 not only contributed to the weakening of non-oil primary commodity prices, as well as to the decline in oil prices from 1982 onwards, but it also led to a cut in the growth, and in some cases even an absolute decline, of export volumes. The resulting fall in the purchasing power of developing countries’ exports was concentrated especially heavily in the traditional oil exporters in the Middle East, which are not net capital importers, while Africa was also quite severely affected. For other groups, the purchasing power of exports continued to grow, albeit at a much slower rate than during the 1970s.

The sharp increase in nominal interest rates in industrial countries in 1979–80 quickly fed through to the interest rates that had to be paid on external debt, because a large proportion of the debt was at variable interest rates—especially in the Western Hemisphere and the countries with recent debt-servicing problems. Moreover, since the increase in nominal interest rates occurred shortly before the dollar price of internationally traded goods began to fall (owing to the recession and the appreciation of the dollar), real interest rates rose sharply in 1980. For similar reasons, there was also a sharp increase in the ratio of interest payments to exports: for example, this ratio more than doubled between 1978 and 1984 for debt-problem countries.

The payments problems resulting from the increase in real interest rates did not initially lead creditors to doubt the continued debt-servicing capacity of most indebted countries. Indeed, it is clear in retrospect that there were shortcomings in the risk assessments made by private creditors and bank supervisors. At the same time, while Fund surveillance resulted in the transmission of warning signals to certain debtor countries in the context of Article IV consultations, it did not produce the perception of a global debt problem until a relatively late stage. By 1981, however, doubts as to the solvency of some debtors began to arise as the financial community focused on the debt-servicing problems of Poland. This was followed by concerns about Western Hemisphere and African borrowers in 1982–83. Net lending by private creditors to the debt-problem countries fell from $57 billion in 1981 to virtually zero in 1983 (excluding arrears accumulation to private creditors—see Statistical Appendix Table A42). This development was paralleled by, and to some extent related to, the large shift in current account positions of major creditor countries, in particular, the rapid increase in the current account deficit of the United States.4

A final external development of significance to developing countries was the strong appreciation of the U.S. dollar over the period 1981–84, This development was, of course, closely related to the sharp rise in interest rates, but had an analytically distinct impact on the capital importing developing countries by depressing the U.S. dollar prices of internationally traded goods without a corresponding effect on the U.S. dollar magnitude of external debt, about 80 percent of which is estimated to have been denominated in U.S. dollars. For these countries, about two fifths of the rise in debt ratios between 1979 and 1983 is estimated to have been brought about by the real appreciation of the U.S. dollar.

In considering the impact of the external shocks mentioned above, it may be asked why they resulted in serious debt-servicing problems for some countries and not for others. The answer lies in part with the levels and structures of debt that different countries had at the onset of the adverse global developments, but also with the policies pursued in reaction to those changes and in the underlying orientation of trade and development policies. It is perhaps significant that countries with debt-servicing problems allowed their average current account deficit to widen considerably between 1979 and 1982, from 17¾ percent of exports of goods and services to 30 percent, while that of the non-problem countries rose only slightly, from 8 percent to 9¼ percent (see Statistical Appendix Table A35). These current account developments to a substantial extent reflected fiscal developments, as the average central government fiscal deficit of the debt-problem countries grew, as a percentage of GDP, from 2¼ percent to 4¾ percent between 1979 and 1982, while that of the non-problem countries grew by only 1 percentage point during the same period (see Statistical Appendix Table A19).5 Finally, as noted earlier, the group of countries without debt-servicing problems had considerably larger and more buoyant export sectors: their exports amounted to an average of over 25 percent of GDP during 1979–82, compared with only 20 percent for the debt-problem countries, and grew (in value terms) at an average rate of over 11 percent, more than twice as fast as the exports of the debt-problem countries.

Management of the Debt Crisis, 1982–85

The emergence of widespread payments difficulties after mid-1982 faced the international financial community with the need to take coordinated action in order to avert a breakdown of the international trade and payments mechanism. The strategy that evolved consisted of an appropriate blending of adjustment and finance. Effective adjustment was seen as essential to help restore the confidence of creditors and to lay the basis for a return to sustainable growth in the future. Coordinated financing packages were required to maintain the flow of essential imports, to preserve debtor-creditor relations, and to retain the participation of a wide range of creditor institutions.6 These measures have had beneficial results, in terms of both strengthening the balance of payments and the debt structure of capital importing countries, and limiting the extent of the setback to domestic growth. In all these aspects of the international strategy, the Fund has played a leading role: by promoting appropriate adjustment policies, by providing large amounts of financial assistance (purchases of SDR 31 billion during 1982–85), and by coordinating and catalyzing financing from other sources.

The external adjustment achieved by the debtor countries is best measured by changes in the ratio of the current account deficit to exports. For the 15 heavily indebted countries,7 this ratio fell from 35 percent in 1982 to under 1 percent in 1984. One significant indicator of these adjustments is that many indebted countries now have large surpluses in their merchandise trade accounts, arising from the need to meet large debt-servicing obligations without recourse to heavy additional borrowing. The adjustments producing these results, however, were not easy to carry out. Once payments difficulties arose, the financial imbalances and price distortions already in place increased the difficulty of carrying out speedy and effective adjustment policies. The longer price-distor-tionary measures had been in force, the more difficult it was, politically and administratively, to carry out corrective policies. Similarly, the longer the period over which an unsustainable level of government expenditure had been in effect, the more difficult it was to bring fiscal deficits down when external sources of credit dried up. Strong initial emphasis on demand management measures, without accompanying supply-side measures of equal effectiveness, led to a disappointing growth performance in a number of countries, despite the recovery of growth in world trade and output in 1984.

A major feature of the debt strategy since 1982 has been an unprecedented number and scale of debt restructurings and financing packages, both by banks and by the official creditors operating through the Paris Club. Beginning in mid-1982, a large number of countries approached banks for new financial arrangements; over the period 1983–85, 31 countries reached agreements with the banks affecting some $140 billion of debt, not counting the amounts involved in further restructuring agreements currently in the process of negotiation. During the same period, the Paris Club came to agreements with 31 countries to restructure official and officially guaranteed debt.8 As a result of the restructurings, it was possible to stretch out maturities of large debt repayments already coming due during this period. The financial packages made it possible in a number of cases for debtor countries to reduce substantially their overhang of short-term debt, in effect exchanging it for debt of longer maturities. As a result of these developments, the most heavily indebted countries have been able to reduce both their debt service ratios and the absolute amounts of short-term debt, even though the overall debt ratios have remained relatively stable. For example, the ratio of short-term debt to exports of the 15 heavily indebted countries was reduced from 68 percent in 1982 to 38 percent in 1985, even though their ratio of total debt to exports rose gradually from 263 percent to 286 percent. As a result of the new financing arrangements, together with the accompanying adjustment efforts, the cumulative fall in output for the 15 heavily indebted countries was limited to 4 percent of GDP in 1982 and 1983, before recoveries of 2¼ percent and 3 percent of GDP in 1984 and 1985, respectively. This can, of course, certainly not be considered a satisfactory growth performance over the long term—particularly not for many countries in sub-Saharan Africa where per capita incomes have been falling since the 1970s. As discussed later, bolstering the growth performance of debt-problem countries has become a major objective in the future management of the debt situation.

Medium-Term Scenarios

The efforts made thus far to improve the external position of those capital importing developing countries with recent debt-servicing problems have resulted in a dramatic strengthening of their current accounts. There has, however, been little decline in their total external debt relative to exports, although a substantial improvement in the structure of that debt has occurred. The growth of output and exports of the capital importing countries revived with the economic recovery of 1984–85, although performance in these regards was still unsatisfactory in many countries. This section addresses two key questions for the remainder of the 1980s: (1) the nature of the efforts that will be required on the part of both debtors and creditors to consolidate the progress made in dealing with debt difficulties; and (2) the implication of these efforts for the medium-term evolution of variables such as GDP growth and the ratio of debt to exports.

As in the World Economic Outlook reports of 1984 and 1985, the starting point of the Fund staff’s medium-term scenarios is a “baseline” case representing the implications of certain broadly plausible assumptions for certain major variables in the world economy. After exploring the outcomes of this scenario, this section reviews alternative outcomes based on sensitivity analyses of the effects of changes in the following variables: the availability of additional external financing, the growth rate of output in industrial countries, the level of interest rates, the price of petroleum, the effective exchange rate for the U.S. dollar, and the prices of non-oil primary commodities.

Baseline Scenario

The baseline case is built on a set of assumptions that relate in large part to certain key developments in the industrial countries (see Chapter IV for the policy background to these assumptions). Perhaps the most important of these developments is the gradual reduction of the U.S. Federal Government deficit from about 5½ percent of GNP in 1985 to about 2½ percent of GNP in 1991, as a result of expenditure-reducing measures. Because of these measures, real interest rates are assumed to remain fairly close to the lower levels reached at the end of 1985, with the 6–month Eurodollar LIBOR at 7½ percent during 1986/87 and 8 percent for the period 1988–91 (Table 20). (In the absence of measures to reduce the fiscal deficit, the staff would have expected upward pressure on real interest rates to re-emerge in the medium term.)

For reasons explained in Chapter IV, the real value of the U.S. dollar and the Canadian dollar is assumed to decline by 2½ percent a year against all other currencies during 1988–91. No changes in real exchange rates among major floating currencies are assumed to occur in 1986–87, and real exchange rates among non-dollar currencies are assumed to remain unchanged during 1988–91.

Table 20.

Summary Results of Baseline Medium-Term Scenario, 1977–91

(In percent)

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Compound annual rates of change.

London interbank offered rate on six-month U.S. dollar deposits, deflated by the U.S. GNP deflator.

In U.S. dollars.

Includes trade financing.

The reduction of the U.S. fiscal deficit and the continuation of nominal interest rates near current levels are assumed to result in sustained but moderate growth rates of output among the industrial countries (Table 20). GNP deflators would be close to 4 percent in the United States throughout the period, while for industrial countries as a whole they would remain at 3½–3¾ percent. Prices in world trade would reflect mainly the price and exchange rate assumptions already described, in addition to special developments in specific commodity markets. The world price of manufactures in U.S. dollar terms is projected to rise by 14 percent in 1986, following a series of annual declines in 1981–84 and a small upturn in 1985. This largely reflects exchange rate developments that had already occurred by early 1986. After 1986 prices of manufactures are assumed to move broadly in line with U.S. price level developments, rising by about 4½ percent in 1987 and (reflecting the influence of the effective depreciation of the U.S. dollar) at the same annual rate in 1988–91. The U.S. dollar price of non-oil primary commodities, having fallen sharply in 1985, is projected to rise by about 12 percent in 1986 (reflecting chiefly a rise in coffee prices), by 1 percent in 1987, and by about 4¼ percent for each year during 1988–91. Oil prices are assumed to average $16 per barrel in 1986 and $15 per barrel in 1987, and then to remain constant in real terms during 1988–91. Because of current uncertainties in the oil market, this should be regarded solely as a working hypothesis, and in light of recent developments in that market a sensitivity analysis described later in this section considers the implications of a rise in oil prices after 1986.

A further important set of assumptions concerns the availability of external financing for developing countries. For the group of capital importing developing countries as a whole, it is assumed that flows of official development assistance will remain approximately constant in real terms and foreign direct investment will rise roughly in step with real GDP in host countries, while trade credits increase in line with imports. The attitude of commercial banks with regard to non-trade-related financing would remain cautious, although showing some continued response to the recent U.S. initiative. Reflecting these assumptions, private lending to the capital importing developing countries is projected to rise at an annual average rate of about 3 percent over the period 1988–91.

A final important set of assumptions underlying the baseline scenario concerns the policies being pursued by the capital importing developing countries themselves. In constructing the scenario, Fund desk economists for the countries surveyed were asked to describe the policies most likely to be pursued by each country’s authorities over the forecast period. The resulting policy projections reflect the fact that external circumstances are continuing to compel the authorities in many countries to follow policies directed toward reducing internal and external financial imbalances. This is particularly true of countries with recent debt-servicing difficulties and sub-Saharan African countries, which are projected to reduce fiscal deficits, raise investment-GDP ratios, and moderate inflation, all to a significant degree. Such developments result in the continuation of low ratios of current account deficits to exports—still only 6 percent in 1991 for the capital importing developing countries as a group (Table 20). A steady decline in the ratio after 1986 is foreseen for countries with recent debt-servicing problems—especially fuel exporters, where these ratios are projected to rise sharply in 1986—but a slight rise for countries that have managed to avoid debt-servicing problems (Statistical Appendix Table A54).

The continuation of policies such as those described above, together with relatively weak export prospects and still fairly high real interest rates, produces an outcome of steady but rather modest rates of growth of output for the capital importing developing countries. GNP is projected to rise at an average annual rate of about 4¾ percent during 1988-91, virtually in line with the projected rates of export growth. Imports, after relatively slow growth in 1986-87, are projected to grow at a slightly higher rate than output in 1988-91, representing a partial recovery from the severe cutbacks in imports in 1982-83. These growth projections are similar to those of the baseline scenario in the World Economic Outlook, April 1985 as the effects of slightly lower economic growth in the industrial countries are offset by those of slightly lower interest rates.

There are large differences in projected growth performance among groups of countries: for example, the average annual growth rate of output during 1988—91 in sub-Saharan Africa is some 2½ percentage points lower than that of Asia (Statistical Appendix Table A56). Another quite striking contrast is between countries with and without recent debt-servicing problems. For countries that are still recovering from debt service problems, the average annual growth of GDP in 1988-91 is projected at just over 4 percent, while countries that have avoided such problems are projected to grow at an annual rate of nearly 5½ percent. These differences in growth prospects are closely related to parallel differences in export performance, which influences the growth of GNP directly, through the contribution of the export sector to output, and indirectly, through the effects of foreign exchange earnings on import capacity. These results suggest that countries in the slower-growing groups still face serious structural problems, including the limited degree of outward-orientation of their growth process, while the countries without such problems have a stronger underlying basis for sustained growth. Nevertheless, these projections imply for certain groups—in particular, the small low-income countries—improvements in export performance that would require major policy shifts. The results also show the impact of the lower oil prices that are already included in the baseline scenario. Lower oil prices have a net negative effect on the group of countries with recent debt-servicing problems. Capital importing fuel exporters are projected to have lower rates of growth of output and imports than nonfuel exporters (Statistical Appendix Table A56).

Compared with the outcome of the baseline scenario in the World Economic Outlook, April 1985, the 1986 scenario shows somewhat smaller current account deficits relative to exports during the projection period.9 Nevertheless, the debt-to-export ratios in 1990 are considerably higher than for the same year in last year’s scenario. This reflects disappointing export levels for the developing countries in 1985 and lower expected export growth rates in 1986 and 1987 rather than any major change in growth rates expected over the medium term. Another important factor is the net negative effect of the fall in oil prices on capital importing developing countries as a whole. The ratio of debt service to exports, however, is only a little higher than in last year’s projection, as the effect of higher debt-export ratios is offset by lower nominal interest rates, an assumption justified by the recent fall in interest rates and the improved outlook for fiscal action in the United States.

For the capital importing developing countries as a group, the debt-export ratio is projected to decline from 163 percent in 1985 to 140 percent in 1991, while the ratio of debt service to exports falls from some 24 percent to 21¾ percent (Table 20). The fall in the debt service ratio is entirely on account of a reduction in the ratio of interest payments to exports, occurring because of both lower interest rates and the fact that exports are growing more rapidly than debt over this period. Despite the latter fact, the amortization ratio rises slightly, because of the rescheduling of payments originally due before the scenario period. There are considerable differences, however, between the groups of countries with and without recent debt-servicing problems. For the debt-problem countries, the debt-export ratio declines from 261 percent in 1985 to 206 percent in 1991. The debt-service ratio of these countries falls from 37 percent to some 32 percent, despite a slight rise in the amortization ratio. For the non-debt-problem countries, by contrast, the debt-export ratio increases slightly (remaining a little above 100 percent), reflecting the fact that the initial ratio was more nearly viable. The debt service ratio of this group of countries remains at close to 16 percent throughout the scenario period (Statistical Appendix Table A55).

The results of the baseline scenario may be briefly summarized as follows. If the capital importing developing countries continue strong adjustment efforts, in the face of moderate rates of economic growth in the industrial countries, they may expect a gradual strengthening of their external position together with moderate rates of output growth. Among particular groups of countries, however, outcomes will differ significantly. For both the highly indebted countries and the sub-Saharan African countries, the prospective growth performance will remain barely adequate and, in the case of the African countries, will not be accompanied by a marked lightening of the external debt burden. For the capital importing fuel exporters, maintaining a moderate rate of growth over the medium term would be consistent with only a slow improvement in their external debt position, which is likely to receive a severe setback in 1986. By contrast, however, groups of countries without debt-servicing problems, especially the Asian countries, enjoy far more buoyant growth prospects, and are able to countenance the continuation of debt and debt-service ratios at close to their current levels. In comparing the groups with better and worse growth prospects, there is a close association between the growth of exports and of GDP.

Alternative Projections

Six alternative projections were carried out to test the sensitivity of the baseline results to changes in six key variables in the global environment: the amount of external financing, growth of output in the industrial countries, interest rates in international financial markets, the price of petroleum, the real effective exchange rate of the U.S. dollar, and the prices of non-oil primary commodities. Policies in the capital importing developing countries are assumed to be unchanged, with targeted reserve-import ratios assumed to be the same as in the baseline scenario. Unless otherwise indicated, it is assumed such policies are constrained by the availability of external financing. The alternative projections are described briefly below and shown in detail in Statistical Appendix Tables A57-A62; key results are shown in Table 21.

Table 21.

Capital Importing Developing Countries: Alternative Medium-Term Projections

(In percent)

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Compound annual rates of change.

Each of the sensitivity analyses focuses on the effect of altering a single variable. Of course, it is also of interest to consider alternative scenarios, in which several variables change together. For example, a strategy in which additional lending was accompanied by improved policies (and perhaps also by higher market growth in the industrial countries) would have different consequences from simply a change in lending flows. Some of these considerations are explored at the end of this section.

The first of the sensitivity analyses examines the consequences of additional lending, from both commercial and official sources, to countries with debt-servicing problems; there is assumed to be no change in lending to the non-debt-problem countries. The total amount of increased lending was assumed to lead to an additional annual growth of private exposure to the debt-problem countries of l¾–2 percentage points for the period 1987-91 (with an increase of perhaps half this amount in 1986) and an additional annual increase in official exposure of about 3 percent. The only change in GDP in this alternative projection results from changes in import volumes, as no change occurs in the growth of export markets. This approach was taken in order to isolate the effects of the lending per se. The possible orders of magnitude of additional increases in GDP growth resulting from improved domestic policies in developing countries, and of additional export growth resulting both from such policies and higher industrial country imports, are examined at the end of this section.

The outcome of the projection for additional lending is a combination of somewhat higher growth of both imports and output in 1986-88, and a much more moderate decline in the ratio of debt to exports. By the last three years of the scenario period, however, the additional financing would be insufficient to finance the continued acceleration of import growth, in part owing to the accumulated addition to debt service payments. For the debt-problem countries as a whole, the average growth of real GDP during 1986-88 is 1½ percentage points higher than under the baseline assumptions, but by 1988 the debt-export ratio is 14 percentage points higher; the debt service ratio, 1 percentage point higher; and current account deficits as a ratio of exports have steadily increased (from 2¼ percent in 1985 to 9¾ percent in 1988) instead of declining slightly as in the baseline case. Although growth of GDP in 1989-91 is ½ of 1 percentage point below that in the baseline outcome, the level of real GDP exceeds that in the baseline throughout the period. On the other hand, the final debt-export ratio is some 28 percentage points higher than in the baseline scenario, with little improvement in the debt service ratio between 1986 and 1991 (Table 21 and Statistical Appendix Table A57).

A second sensitivity analysis focuses on the impact of slower growth in the industrial countries, other things held equal. Specifically, growth of GNP in the industrial countries was assumed to be 1 percentage point lower throughout the period 1987-91. (It may be noted that the resulting magnitudes, with signs reversed, give indications both of the possible gains from an increase in industrial country growth and of the impact of a series of trade liberalizing measures by these countries taken over the scenario period.) The results of this sensitivity analysis are relatively straightforward (and dramatic) for the capital importing developing countries: a sharp fall in the rate of growth of exports, and, on the assumption of no additional external borrowing to meet the shortfall in foreign exchange earnings, a concomitant fall in the rate of growth of imports and consequently in that of output (Table 21). While overall levels of external debt are thus the same as in the baseline scenario for all country groups, debt-export and debt service ratios are somewhat higher, owing to the lower level of exports. For the capital importing developing countries as a whole, the average rate of growth of exports during 1987-91 (the years for which the lower growth in industrial countries is assumed) is just over 3 percent, or about 1½ percentage points lower than in the baseline scenario. This leads to a fall of about 1¼ percentage points in the average annual growth rate of GDP. The outcomes of this alternative projection for all of the various sub-groups follow this pattern closely, with somewhat greater sensitivity to the changed assumption shown by countries with relatively greater dependence on exports of manufactures. Although for this reason the growth rates of output for sub-Saharan African countries fall less sharply than do those of most of the other groups, the resulting economic growth implies zero or negative growth of per capita income for many of the countries in this region.

Another element of the global economic environment to which great interest attaches is the level of interest rates in financial markets in the industrial countries. Strictly speaking, the interest rate on loans to the developing countries also contains a variable element of spreads and charges, which reflect the creditworthiness of the borrower. Although variations in the size of these spreads and other charges are of significant importance to the cost of the loan to the borrower, movements in the base interest rate have nevertheless tended to be more volatile. To examine the effects of these movements, an alternative projection was prepared on the assumption that the level of interest rates (LIBOR) was 1 percentage point lower than in the baseline scenario throughout the period 1987-1991. The impact of this change is felt chiefly in 1987, the year in which lower rates are assumed to take effect, with all variables after that year growing at the same rates assumed in the baseline projection. The chief impact is on the rate of growth in output, as the lessened burden of interest payments, in the face of little change in exports and unchanged amounts of external financing, result in a rise of over 1 percentage point in the growth of imports in 1987 and a consequent increase of over 1 percentage point in the growth rate of GDP. While there is a subsequent reversal in the rate of growth of output, the level of output is permanently slightly higher (four tenths of 1 percent) than in the baseline case, and there is also a permanent reduction of about a percentage point in the debt service ratio. For countries with debt-servicing problems, however, these outcomes tend to be more marked (Table 21).

Because of the possibility that oil prices might differ from those assumed in the baseline scenario, an alternative projection was calculated in order to isolate the impact of this variable on the medium-term outcome. It was assumed that the price of oil would increase10 by $5 a barrel compared with the baseline assumption (that the price of oil will average $15 a barrel in 1985 and remain unchanged in real terms thereafter).11 The chief impact of this scenario is a sharp rise in output in capital importing fuel exporters, and a fall in output (though of smaller magnitude) of non-fuel exporters, which are assumed to offset the cost of additional import payments by reducing their overall import volumes (Statistical Appendix Table A60). While the change in oil prices has a continuing effect on the level of output in the two groups, growth rates return virtually to normal by 1988. Debt and debt service ratios become lower for the fuel exporters, because of higher export receipts. For capital importing countries as a whole, the net effect is positive: perhaps this is best explained by the fact that the value of net exports by developing to industrial countries increases. To assess the full implications of higher oil prices, it would of course be necessary to take account of induced changes in other variables, such as the level of international interest rates and the growth of demand in industrial countries.

Because of the importance of the U.S. dollar exchange rate, an alternative projection was prepared based on the assumption of an additional 5 percent real depreciation of the U.S. and Canadian dollars occurring at the end of 1986 (and taking effect in 1987). It was assumed that the prices of manufactures and non-oil primary commodities in world trade were held the same in SDR terms as under the baseline scenario. These prices would thus rise by an additional approximately 3 percent in U.S. dollar terms. The nominal price of oil in U.S. dollars was, however, assumed to be unaffected by the additional depreciation. As in the case of the sensitivity analysis for a lower interest rate and higher oil prices, the impact of the additional dollar depreciation influences several variables in 1987, but has little or no subsequent effect on their rates of change. For countries with a net surplus on non-oil merchandise trade, the more rapid growth of prices of manufactures and non-oil primary commodities yields an increase in export revenues greater than additional import payments, hence an increased capacity for real imports, supporting a higher rate of growth. The opposite is the case for those with a deficit on non-oil trade, typical both of most oil exporting countries but also for some oil importers with very large overall trade deficits. For the capital importing countries as a whole, the net growth effect over the medium term is negligible (Statistical Appendix Table A61), For countries with debt-servicing problems, the overall once-for-all rise in foreign trade prices as a whole, combined with the dominance of U.S. dollar-denominated external debt in the total, results in a decline of about 3 percentage points in the debt-export ratio.

For a large number of countries, especially low-income countries, a crucial factor in the global economic environment has been the movement of prices of non-oil primary commodities, relative to those of petroleum and manufactures. An alternative projection was carried out based on the assumption that the U.S. dollar prices of these commodities increase by 3 percent per annum over 1988-91, instead of the 4.2 percent assumed in the baseline scenario, and compared to the 4.5 percent per annum increase in the dollar prices of manufactured traded goods. Not surprisingly, the impact of the relative decline in non-oil primary product prices depends mainly on the structure of foreign trade of the countries involved. For the capital importing developing countries as a whole, annual growth rates of output are lowered by ½ of 1 percentage point over 1987-91, but for sub-Saharan Africa, the difference is closer to 1 percentage point. For all groups, however, there is a significant change in the ratios of debt and debt service to exports, since the U.S. dollar value of exports changes by more than that of the debt variables. For the entire group of capital importing countries, the debt-export ratio is almost 3 percentage points higher by 1991, and the debt service ratio ½ of 1 percentage point higher, than the baseline outcome; this impact is more pronounced for the groups with especially heavy debt burdens.

Future Prospects

The prospects of the capital importing countries, especially of the most highly indebted groups, are vulnerable to external factors, especially to a slowdown of growth in the industrial countries. For the highly indebted groups and for sub-Saharan African countries, there is little or no margin for downside developments: any substantial external setback will result either in a decline in the already very moderate growth projected under baseline assumptions, or in a reversal of improvements in the external debt situation, or in some combination of the two. Whatever the precise outcome, it would have serious implications both for the state of creditor confidence and for the internal political support for needed policy reforms.

Two recent developments provide examples of possible changes in the external environment that would affect the prospects of developing countries in more complex ways than those described in the foregoing sensitivity analysts. In the U.S. debt initiative, for example, additional external financing is intended to be combined with growth-oriented adjustment policies to boost borrowing countries’ growth rates. It will be recalled that the impact of additional financing on commercial terms, taken by itself, is to raise the rate of growth for the next few years, but at the cost of retarding the decline in debt and debt service ratios. One way such an outcome could be avoided would be through improved domestic policies that, inter alia, helped raise not only the growth of output but also the growth rates of exports. For example, improved domestic policies that raised a country’s saving and investment ratios by 10 percent (say, from 20 percent to 22 percent of GDP) and that lowered the incremental capital-output ratio by 10 percent (say, from 4 percent to 3.6 percent) would raise the output growth rate by about 1 percentage point. If, in addition, pricing and exchange rate changes were such as to encourage exports to expand in line with output, there need be no significant deterioration of the current account: of course, exports might expand even more rapidly, and the same policies are also likely to encourage some degree of efficient import substitution. It should also be noted that a sound domestic policy framework—particularly as regards demand management, interest rate, and exchange rate policies—is the best instrument available to reduce, or even reverse capital outflows, which is a necessary component of policies to raise saving and investment ratios without undue reliance on additional lending.

If such policies were to be pursued by a large group of heavily indebted developing countries, exploiting the full potential for a debt strategy based on these policies would need to be accompanied by a stronger expansion in industrial country markets for the exports of indebted countries. This in turn would require some combination of faster growth of GNP and more liberal import policies in the industrial countries. If, for example, the additional lending foreseen in the sensitivity analysis was accompanied by policies, both of industrial and developing countries, that enabled the latter to increase their export earnings growth by 1 percentage point, growth rates of GDP in borrowing countries could be raised by nearly an additional percentage point, and debt and debt ratios would be somewhat reduced compared with the outcome of the sensitivity analysis. This increase is thus largely complementary to the one cited in the previous paragraph, but additional to the increases in output resulting alone from additional lending. The overall result would be growth rates in excess of 1 percentage point higher than those in the baseline scenario.

Another alternative external environment, in which changes in several variables occur, is the possibility of a more rapid pace of reduction of the U.S. fiscal deficit (see Chapter IV). In such circumstances, industrial countries’ output and world interest rates might be lower in the short run than in the baseline scenario, and the U.S. dollar might depreciate more rapidly in real terms. If there were no additional external financing available to the capital importing countries, the short-term impact on these countries would be to lower the growth of output (because of the initially adverse impact on the global economy of the sharp reductions in the U.S. fiscal deficit) but also to reduce debt and debt service ratios, because of greater real depreciation of the U.S. dollar and lower interest rates, respectively. If more external financing became available—for instance, because of the easing of pressures on capital markets in the industrial countries—-many developing countries might be able to increase their borrowing and thereby support a faster growth of output in the medium term. In the longer run, with a recovery in industrial country growth, the recovery of exports in capital importing developing countries would permit a reduction of such a dependence on external borrowing.

Policy Issues

Recent experience with the external debt situation has brought general recognition of a number of weaknesses in the policies of creditors and debtors, in the practices of private creditors, and in international financial arrangements generally, all of which contributed to the widespread payments difficulties arising in the early 1980s. Recognition of these weaknesses implies various steps that might be taken to avoid a recurrence of such difficulties in the future. At the same time, the precarious medium-term prospects for the more highly indebted capital importing countries underline the need to further develop the efforts that have been underway since 1982 to strengthen the position of these countries. In this section, after a review of the systemic weaknesses revealed by emergence of the debt problem and the short-term requirements for dealing with it, the relevant policy issues are discussed. For convenience these issues can be grouped under four main headings: the challenges facing governments of creditor countries, governments of debtor countries, private creditor institutions, and the Fund and other multilateral institutions.

Policy and Systemic Weaknesses Revealed by the Debt Crisis

Earlier in this chapter, the payments difficulties encountered by a large number of borrowing countries in the early 1980s were reviewed. For many of these countries, the foundations of debt-servicing problems were laid with the heavy borrowing of the 1970s; these problems then came to a head through the conjunction of an unusually unfavorable set of global economic conditions (reflecting to a considerable extent developments in major industrial countries), inadequate demand management and supply-side policies in many debtor countries, and inappropriate levels and modalities of external financing (for which both creditors and debtors share the responsibility). Any one of these factors would have sufficed to create serious payments difficulties for a number of borrowing countries; the combination of all three explains the depth and breadth of the problems that in fact emerged.

The medium-term scenario described in the previous section illustrates the continued vulnerability of developing countries to changes in the global environment. The fact that the domestic policies of the larger industrial countries have powerful effects beyond their own borders suggests the desirability of expanding the use of procedures, such as Fund surveillance, for ensuring that the interests of the international community are fully taken into account by the authorities in those countries in framing their policies.

With regard to the organization and modalities of international finance, the systemic weakness displayed various aspects. These have to some extent been discussed in the first section of this chapter, as well as other places,12 and will be only briefly summarized below.

(1) The vulnerability of market-borrowing countries to external disturbances has been greatly increased by the growth in the relative importance of private sources of financing, and by the sharp increase in the percentage of external debt on which interest is paid at market or market-related interest rates, and at floating (rather than fixed) interest rates. In addition, the increasing relative dependence on debt rather than equity financing meant that borrowers’ debt service obligations were independent of fluctuations in export receipts—caused, for example, by variations in world prices of primary commodities—and ran the risk of increasing if interest rates moved perversely with levels of economic activity (as occurred in 1980-83). For private creditors, in this instance, the advantage of a floating-rate debt—namely, reducing the interest rate risk—was offset by the disadvantage of increasing the risk of arrears and default on both interest and amortization.

(2) The shift of commercial bank lending from trade-related or project-related loans extended to specific enterprises or individuals, to general balance of payments support extended to sovereign borrowers, meant that banks’ judgments of creditworthiness were based solely on the borrowing country’s overall prospects and policies, which were more uncertain and difficult to evaluate than specific purposes for borrowing. It was not until a “debt crisis” had clearly emerged that regulatory agencies pressed banks to improve their capital ratios and to dilute the concentrations of exposure in their balance sheets in response to the overall economic situation in debtor countries.

(3) On the debtor country side, however, there was also in many instances insufficient attention given to both the monitoring and management of external debt. Even in certain major borrowing countries, where public and publicly guaranteed external debt was reasonably well accounted for, there was lack of information on the magnitude, terms, and amortization profile of external debt contracted by the private sector. In some smaller countries, accounting for the external debt of even the public sector was in disarray, so that debt-servicing problems came with little warning and therefore without enough time to adopt the measures needed to avoid accumulation of arrears.

(4) The increased dependence on borrowing from commercial banks at shorter average maturities increased the vulnerability of borrowers because the amortization of loans was scheduled before the average gestation period of investments (especially public sector, infrastructural investment) was over. This problem was exacerbated when borrowing was undertaken, as occurred in some instances during the 1980-82 period, not to finance additional investment, but to avoid painful adjustment measures in response to the balance of payments strains created by weakened trade balances and higher interest rates.

(5) A decade or so of rapidly increased dependence on commercial sources of financing also served to diminish pressure for more rapid expansion of official bilateral and multilateral sources of finance, that is, officially guaranteed loans of export credit agencies, assistance from multilateral development institutions, and bilateral governmental grants and loans. Hence, when commercial bank financing suddenly dried up after 1982, there was little existing impetus for a stronger growth of financing from other sources.

Immediate Adjustment and Financing Needs

The debt-servicing difficulties that came to a head in 1982 were handled with a considerable degree of success by strong measures and cooperative efforts of debtor country governments, creditor institutions (and their respective monetary authorities), and the Fund. Nevertheless, as indicated earlier, the countries that encountered debt-servicing problems remain, on the whole, highly vulnerable to unfavorable global economic developments. Despite strong adjustment efforts in these countries and despite a recovery of growth in world trade and output, for many of these countries debt and debt service ratios have been brought down only slightly, if at all. Preventing further increases in the debt service ratio, in the face of high interest rates, a large overhang of short-term debt, and heavy amortization payments initially scheduled for each of the years since 1982, was in itself a major accomplishment. For many heavily indebted countries, however, especially in Africa and Latin America, the adjustment that has occurred has yet to yield a favorable growth performance.

It is this weak growth performance that has led to a set of proposals put forward by the United States Secretary of the Treasury at the Annual Meeting of the World Bank and the Fund at Seoul, Korea, in October 1985. These proposals (referred to as the U.S. initiative) included the pursuit of effective growth-oriented adjustment programs by the debtor countries; net increases in exposure by private creditor institutions; increased lending by the World Bank and other multilateral development banks; and a continued central role for the Fund, in collaboration with the Bank, with regard to financial assistance, policy advice and surveillance, and the catalyzing of financing from private creditors. As illustrative figures for a key group of 15 heavily indebted countries (referred to earlier in this chapter), additional new commercial bank lending of $20 billion and $9 billion in additional new official financing over 1986-88 were mentioned, but the same framework could apply to other countries with debt problems and should be accompanied by continued lending to countries that have avoided debt problems.

The disappointing growth performance of a number of countries has been due both to the relative weakness of the recovery in the industrial world, and to the fact that many indebted countries have given insufficient emphasis to the adjustments needed to stimulate the growth of domestic productive capacity. This has been reflected in a tendency to cut investment rather than current outlays when reducing government expenditure, to delay price adjustments for key commodities or factors of production, and to favor administrative control over imports rather than more efficient means of rationing scarce foreign exchange. While the measures that have been taken to improve macroeconomic balance should have positive long-term effects on output growth, there is still a clear need for a greater emphasis on supply-side measures (discussed below). Furthermore, despite the general objective of reducing the ratio of debt to exports, additional external financing may be necessary in some instances to stimulate investment in new export-oriented capacity, and the magnitude of the financing gaps in some cases requires that some financing take the form of general balance of payments lending by commercial banks.

From the side of creditor institutions, however, it has often proved difficult to mobilize funds for new financing, as smaller commercial banks have at times expressed reluctance to continue their participation in financing packages, and both large and small banks in some countries have also had to adjust to stricter bank regulations and supervision. In this latter regard, the governments of creditor countries are faced with the need to balance their efforts to strengthen bank regulations and supervision with a recognition that continued lending to countries undertaking economic adjustments would also serve to improve the quality of commercial bank balance sheets.

Another crucial element in the role played by the banks is the effective continuation of the Fund’s advice, support, and surveillance of members’ adjustment programs. In some cases, this may take the form of further use of Fund resources; in others, the technique of enhanced surveillance may facilitate the negotiation of a MYRA with commercial and official creditors. At the same time, the greater emphasis on growth-oriented adjustment programs, urged in the U.S. initiative, strengthens the efforts of the Fund in promoting policies conducive to economic growth and implies the enhanced importance of close collaboration between the Fund and the World Bank.

The terms and modalities of debt restructurings or financial packages remains an urgent issue in some cases. For certain countries, a combination of especially unfavorable external circumstances and inadequate economic management has resulted in situations in which debt service payments are far in arrears and normal restructuring arrangements would not suffice to keep future payments schedules within the country’s capacity to pay. Some arguments have been put forward for financial arrangements that would ease both current and future burdens for debtor countries. Whatever the benefits and drawbacks of such an approach, a strong case can be made for the appropriateness of private creditors responding to the financing needs of adjustment programs that, if successful, would result in more adequate debt-servicing capacity in the future.

Finally, the success of adjustment programs and the effectiveness of new financing continue to depend crucially upon a favorable global economic environment. What combination of domestic policies in the major industrial countries will produce such an environment, and whether it is desirable or possible to coordinate policies among these countries, remain questions of pressing urgency. Real interest rates are still high by long-run historical standards; much excess capacity and unemployment remain in a large part of the industrial world, discouraging new investment and productivity growth; protectionism, far from being rolled back as would be desirable, threatens to make new advances. For indebted countries, these developments retard progress in reducing debt-servicing burdens and increasing export earnings, and thereby tend to depress their own growth of output.

The Policy Challenge: Governments of Debtor Countries

At the outset, it should be noted that a large number of developing countries have continued to service their debt without interruption and without especially critical payments difficulties even throughout the late 1970s and early 1980s. Some of these countries were oil exporters or countries benefiting from workers’ remittances or other service receipts from petroleum-producing neighbors. Others had pursued over a period of years prudent debt management policies, strictly limiting either the amount of nonconcessional borrowing or the overall use of external financing. In addition, some of these countries had undertaken either long-run policy reforms or timely adjustment measures that made it possible for them to adapt themselves rapidly to the changed external environment after 1979.

For the countries that faced less favorable conditions or whose policies had proved less timely and effective, the emergency measures adopted to deal with severe payments difficulties tended, as mentioned above, to be focused primarily on demand restraint, import controls, and exchange rate adjustments. To varying degrees, these were accompanied also by supply-side measures, but in a number of cases much remains to be done to accompany the necessary initial reductions in expenditure with private sector incentives and public sector initiatives that will stimulate savings, investment, and growth. Among such measures are: (1) improved mobilization of domestic savings, through more attractive interest rates on deposits and fostering the development of financial institutions and instruments; (2) policies to discourage capital flight and encourage repatriation of private foreign assets, through maintaining appropriate exchange rates, interest rates, and investment incentives, as well as a generally sound demand-management framework; (3) careful choice and monitoring of public sector investment projects, and, in general, more efficient allocation of public sector expenditures; (4) reform of public sector enterprises, putting their activities on a cost-efficient basis with realistic pricing of their goods and services, thereby reducing the fiscal burden of subsidization, and, where appropriate, privatizing the enterprises; (5) reduction and eventual elimination of price subsidies to consumers and producers; (6) establishing agricultural producer prices in line with prices in world markets and realistic exchange rates; (7) elimination of trade and exchange controls, and reduction of excessively high tariffs, which serve to distort the domestic structure of production; and (8) realistic exchange rate policies, to maintain the desired degree of international competitiveness of domestic producers.

In addition to these measures, an important aspect of a debtor country’s overall economic strategy is the management of its external debt. Where public and publicly guaranteed debt is not already being registered and monitored by a centralized agency—often, for example, the debt of public enterprises is incompletely recorded—such a procedure should be initiated. Next, procedures need to be established to report and monitor foreign borrowing and lending by private institutions and individuals; in a number of countries, significant progress has recently been made in this area with the support of technical assistance from the Fund. Once a proper reporting and monitoring mechanism is in place, the authorities should carefully examine the choices available to them: the amount and terms of borrowing (between fixed and floating interest rates, for example); the currencies in which debt is denominated; the possibilities for attracting equity investment instead of debt-creating borrowing; and the level and composition of international reserves. Finally, and most broadly, the borrowing strategy pursued is inseparable from the overall objectives and implementation of domestic policies: the amounts by which debt and debt service are planned to grow are closely related to the size and financing possibilities of fiscal deficits, but in strategic terms need to be geared to projected rates of domestic growth of output and to prospects for the absorption of exports by world markets. These prospects, in turn, depend partly on projections of global economic variables, and partly on a realistic appraisal of the results of economic policies. In both respects, recent experience has proved the wisdom of choosing projections that are based on realistic assumptions and that make prudent allowances for downside risks.

The Policy Challenge: Private Creditors

The policy issues faced by private creditors fall in several categories. First, there is the organization of continued concerted lending for countries where new debt restructurings and financial packages still need to be carried out and spontaneous lending has not resumed. Second, there are a number of complex questions regarding the terms and modalities of such restructurings or packages, as well as longer-term questions with respect to the modes of future financial instruments that would be best designed to meet the needs of both creditors and debtors. Third, there are issues concerning the policy conditions that should accompany both restructurings and new financing, and the future role of the Fund and Bank with regard to such conditionality. Finally, there are various continuing issues regarding the supervision and regulation of banking practices by governments in creditor countries.

The expressions of support for the U.S. initiative by the commercial banks of major creditor countries in December 1985 encourage hope that these issues will ultimately be resolved. A major problem is how to ensure the continued participation of smaller banks in financing packages. Another is how to gain support of the banking community for financial packages in cases where the record of debt service payments and adjustment programs has thus far not been such as to encourage confidence. The mechanisms for cooperation among banks in the areas of joint negotiation and monitoring of financial packages also have scope for further evolution; these mechanisms are themselves related to further issues, such as the roles of the Fund and the World Bank in the formulation and monitoring of adjustment programs in borrowing countries, and the possible development of new financial mechanisms (such as marketable bank claims) that could, over time, supersede the familiar approach of syndicated loans; these issues are taken up below.

In making decisions on appropriate financial packages, the views of private creditors, individually or collectively, necessarily differ widely depending on the individual borrowing country concerned. For a number of countries that were able to avoid serious payments difficulties during the past five years, spontaneous capital flows have never been suspended. For others, temporary payments difficulties have been successfully dealt with through a combination of effective adjustment policies and financing packages, and as a result the resumption of spontaneous flows is at least foreseeable. For a third group, adjustment policies, while producing some positive results, have not yet met major objectives of the initial program, and the resumption of spontaneous flows seems more remote. Nevertheless, in these cases, it may still be possible to organize needed financial packages on the basis of concerted lending. A last group of countries is at a yet earlier stage of dealing with payments difficulties. The wide variety of these cases underlines the necessity of maintaining a case-by-case approach both to determining financing arrangements and to evaluating the effectiveness of policies in the borrowing country.

Viewing the longer-run future evolution of the debt situation, it is apparent that developing countries should attempt to return eventually to a structure of new financing more like that of the 1960s and early 1970s, namely one that is less dependent on bank lending at commercial terms and variable interest rates. There may also be ways in which commercial bank lending could be packaged and organized that would make it less vulnerable to downswings in the economic situations of borrowing countries and less likely, under such circumstances, to engender threatened pull-outs by participating banks.

An eventual change in the structure of new financing would depend on increases in two forms of capital assistance. One would be an increase in official development assistance, from both multilateral institutions and bilateral sources, the latter including official export credits; these are discussed briefly below. Another would be an increase in various forms of bond and equity financing. For one important type of equity financing, foreign direct investment, the issues are clear enough. Much depends on the policy environment—as well as the political and social climate—within the host country, its willingness to accept higher levels of such investment, the opportunities made available for acquiring assets in the host country, and the regulatory and tax environment offered the foreign investor. Tax and foreign trade policies in the home countries of investors also play an important role: for instance, an easing of protectionist import restrictions tends to encourage investment in export industries in developing countries.

The volume of bonds issued by developing countries on international capital markets declined in the late 1970s, as use of bank credit increased, but a recovery is now possible with the widespread use of floating rate notes and other innovations in this market.13 Most developing countries, however, are not yet sufficiently creditworthy to enter the bond market. One proposal aimed at encouraging the provision of new commercial bank finance is for the official guaranteeing of commercial bank loans. Certain types of guarantees already exist—for example, the partial guarantees offered by the World Bank on certain of its cofinancing arrangements, and guarantees by official export credit agencies of export credits from banks. There are strong reasons to oppose the generalization of official guarantees, which would tend to weaken the responsibility of private creditors for their lending decisions. Nevertheless, in view of the likely preference of banks for trade rather than general purpose financing, an expansion of export credit guarantee facilities by the official agencies in favor of countries with effective adjustment programs could be an important move toward resuming normal financing flows to these countries, without altering established practices.

The Policy Challenge: Governments of Creditor Countries

As suggested earlier, the governments of creditor countries face a wide range of direct and indirect responsibilities in connection with successful management of external debt problems. An immediate issue is the compatibility of regulations and guidelines imposed by bank supervisors with the kinds of financing arrangements that seem called for from the viewpoint of stabilizing the external position of debtors (and in the long run, protecting the assets of creditors). The supervisors are understandably concerned with the deterioration in the financial soundness of some banks, which in a number of cases has arisen from poor performance of domestic as well as foreign loans. In some cases, however, the need to restore ratios of capital to certain types of assets (including outstanding loans to certain countries or groups of countries) has affected the willingness or ability of banks to participate in restructurings or packages that involve refinancing or new financing. In such circumstances, regulatory authorities have to take fully into account the contribution that maintaining flows of credit to heavily indebted countries can make toward improving the medium-term prospects of these countries and thus strengthening the soundness of existing loans.

Another crucial set of issues revolves around the creditor countries’ direct and indirect contributions to official development assistance. Through contributions to and participation in major policy decisions of the multilateral institutions, especially the Fund and the Bank, the industrial countries, particularly the largest ones, can set the pace and direction in which a joint debt strategy can develop. The magnitude and direction of bilateral assistance, and policies guiding the nature and scope of guarantees offered by official export credit agencies, also raise a number of issues.

Perhaps the most important potential contribution of the creditor countries to the amelioration of the debt situation lies in their predominant influence over developments in the world economy. The sources of this influence are well-known and documented extensively, for instance in past and current World Economic Outlook reports. They require, therefore, only brief summary here. Sustainable, stable growth rates in the major industrial countries form the basis of adequate growth rates of trade volumes and output throughout the world, as well as the stability and buoyancy of prices of primary commodities. From the standpoint of the developing countries, access to industrial country markets is crucially linked to the growth of those markets, for on those two variables depends in large part the growth of exports, imports, and output in the developing countries. It is in this respect that easing trade restrictions is such an important element in improving the latter countries’ economic prospects. For heavily indebted countries, another crucial economic variable in industrial countries is the level of interest rates, which in turn depends on the fiscal-monetary mix in the largest of these countries.

The Role of the Fund and Other Multilateral Institutions

To a considerable degree, the role of the Fund in dealing with problems of heavily indebted members may be expected to remain very similar to its role in the past, especially the functions it has performed since 1982. Many countries will continue to carry out Fund-supported programs, receiving both policy advice and financial support from the Fund and also the benefit of the Fund’s catalytic role with regard to mobilizing support from both the commercial banks and official bilateral lenders. In some instances, as is already true for Venezuela, member countries may carry out adjustment programs without use of Fund of resources but under the regime of “enhanced surveillance,” under which the Fund periodically reports on the progress of adjustment policies and such reports are made available to the pertinent bank advisory groups.

Another issue that arises is the relationship between Fund conditionality and the conditionality of the World Bank’s structural adjustment programs. The two institutions share the aim of fostering a set of policies leading to financial stability, higher rates of investment and growth, and improved rates of growth of exports. Means will need to be found to build on existing Bank-Fund collaboration with regard to the advice given to members on the formulation of policy objectives and instruments. Such collaboration will involve in a number of cases the joint examination of a country’s economic situation and prospects and the arrival at concerted views on policy measures to be taken, while taking care to avoid cross-conditionality.

Since the onset of widespread payments difficulties in 1982, there have been a number of suggestions revolving around the notion that the Fund or the Bank would provide guarantees of private debt or even more direct intermediary functions between private creditors and debtor governments. The objections to the widespread use of official guarantees have been stated earlier. Cofinancing arrangements between the Bank and private banks have occasionally included a partial guarantee by the Bank. With regard to the Fund, no direct participation in commercial financing operations is possible under the Articles of Agreement, except for the possibility of market borrowing to replenish the Fund’s ordinary resources.

The Fund and Bank, as well as other multilateral financial institutions, have been mentioned as sources of expanded multilateral development assistance. There has been discussion of increasing Bank disbursements, or of increasing the permissible ratio of commitments to capital, as well as of future increases in capital subscriptions and in International Development Association (IDA) funds. The use of Fund resources does not, of course, fall under the heading of development assistance, but the new terms of the Structural Adjustment Facility, based on repayments of the original Trust Fund loans, do fall under the category of medium-term assistance to low-income countries on concessional terms. As for expansion of the activities of multilateral development institutions other than the Bank, these depend principally on expanded resources drawn either from donor country contributions or market offerings.

The discussion earlier in this section emphasized the importance of global economic developments for the efforts of indebted countries to improve their external positions. In this connection, a principal task of the Fund is to exercise multilateral surveillance over these developments, especially with respect to those policies in major industrial countries that have a significant influence. While most other multilateral institutions do not have analogous functions, mention might be made of the potential importance of the activities of the General Agreement on Tariffs and Trade in both opening further export markets for developing countries and in inducing them, through the process of trade negotiations, to gear their own economies more closely to world prices and export opportunities.

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Cover World Economic Outlook, May 1986
World Economic Outlook, May 1986
Author: International Monetary Fund. Research Dept.
ISBN:
9781451944785
ISSN:
0256-6877
Publication Date:
01 Jan 1986
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781451944785.081
Pages:
278
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    Capital Importing Developing Countries: Exports, Total Debt, and Interest Rates, 1971–851

    (In percent)

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    Capital Importing Developing Countries: Gross Savings and Capital Formation, 1977–851

    (Percent of GDP)

Capital Importing Developing Countries: Exports, Total Debt, and Interest Rates, 1971–851

(In percent)

Capital Importing Developing Countries: Gross Savings and Capital Formation, 1977–851

(Percent of GDP)