THIS PAPER REVIEWS options for dealing with developing countries’ debt problems. The paper does not attempt to make the case for or against any of the options reviewed but rather tries to clarify the issues.
The paper as a whole focuses on debtor countries’ relationships with private credit markets. The first section provides an overview of four aspects of the current debt situation. The second section looks at the current strategy and qualifications to it. It outlines several “growing out of debt” scenarios. The role of policy improvements by problem debtor countries is stressed as is the need for the international system to accommodate export expansion by them. The third section reviews a number of supplementary approaches to the debt problem, beginning with various market-based approaches, notably buy-backs, debt-equity swaps, and securitization. It then deals with debt relief, emphasizing the long-term implications for creditors and debtors.
Most figures in this paper refer to a category of developing countries—now 65 in all—called here “problem debtors” or “problem debtor countries,” these being the group described as “countries with recent debt service problems” in the IMF’s World Economic Outlook, April 1988, p. 106. They are defined as “…those countries which incurred external payments arrears during 1985 or rescheduled their debt during the period from end-1983 to end-1986 as reported in the relevant issues of the Fund’s Annual Report on Exchange Arrangements and Exchange Restrictions.”
I. Aspects of the Debt Situation
Disruption of Financial Markets Avoided
One initial problem associated with the inability of some countries to tap private credit markets in 1982 was the threat of instability and disruption of financial markets. Avoiding this threat, and the threat that the crisis might spread to a wider range of debtor countries, was one important priority in dealing with the debt crisis. Indeed, the term “crisis” seems appropriate to a situation in which the solvency of important financial institutions was called into question. Since it is clearly in the interests of both debtor and creditor countries to maintain an open and viable international payments system, any strategy to deal with debt issues must be evaluated with this in mind.
It is in these respects that the current strategy has probably best served the interests of both debtors and creditors. The potential costs of a breakdown in international financial markets have been avoided. Private lenders are in a much stronger position to absorb potential losses on their credits than was the case in 1982 when some debtors for the first time seemed unable to service their obligations. The capital-asset ratios for banks in nine industrial countries increased, on average, by about 16 percent from 1982 to 1986, namely from 4.4 to 5.1 percent. Moreover, as a result of a decline in U.S. banks’ claims on developing countries, their ratio of capital to these claims had doubled since 1982 to about 95 percent in 1986. For banks outside the United States the depreciation of the U.S. dollar has probably also generated substantial improvements in this ratio.1 Over the longer horizon the debt strategy seeks to restore economic growth in problem debtors and restore these countries’ normal access to international credit markets.
Current and Future Consumption in Debtor Countries
The servicing of debt obligations built up over the years of high borrowing has reduced consumption levels in some problem debtor countries below where they might have been otherwise and has clearly reduced the level of investment, thus limiting future consumption. Gross capital formation as a percent of GDP averaged 25 percent during 1970–82 for this group and since 1983 has been only around 19 percent. Estimates reported in the April 1987 World Economic Outlook suggest that the steep decline in investment ratios for problem debtors has allowed per capita consumption expenditures to remain roughly unchanged since 1982. It is clear, however, that for a number of debtor countries consumption per head has declined over the period. By contrast, per capita consumption expenditures in developing countries without debt-servicing problems increased by about 15 percent over the 1982–86 period. The buildup of debt would not have had this effect if all the debt incurred had been utilized for investment that finally ended up yielding rates of return at least equal to the interest rates on the loans. But, in most cases output in debtor countries has not grown as rapidly as expected, the value of purchasing power over imports even less so, and interest rates have turned out much higher than expected.
Thus, borrowing was based on expectations of both debtors and private and official creditors about the terms of trade, world real interest rates, and the economic growth in developed countries that—with hindsight—were too optimistic, even though they may have appeared reasonable at the time. Furthermore, it must be remembered that during the period of high borrowing savings ratios in many of the problem debtor countries fell; in other words, borrowing allowed them to sustain or raise consumption levels so that the reduction in consumption that was compelled later by the debt crisis was to some extent a consequence of higher consumption levels earlier—levels that, at least in retrospect, were too high.
Even without increased debt service, the decline in the terms of trade would have called for reductions in present or future consumption. The debt service obligations have added to this. Clearly this situation has set up severe strains.
Distribution of Savings Internationally
Another important aspect of the current situation is the possibility that an inadequate share of world savings is going to developing countries.
First of all, one must distinguish the so-called resource transfer from the transfer of savings. The resource transfer out of a debtor country is usually defined as the current account surplus plus all interest payments to nonresidents. The transfer of savings from a debtor, however, is measured by the current account balance plus the inflation premium in interest payments. The inflation premium can be measured by considering the portion of interest payments required to keep the real value of debt unchanged. For problem debtors the transfer of real savings is estimated to have been about $4 billion in 1987, assuming the relevant inflation rate to be 3.3 percent a year.2
It is reasonable to expect that a country will make interest payments to nonresidents for a period when it has in a previous period been absorbing large capital inflows. If the funds have been efficiently utilized they would have raised the real value of the country’s output by more than the subsequent payments needed to service interest on the debt. This is, after all, the logic behind placing interest payments to nonresidents among other service payments to nonresidents. Interest payments are payments for the use of nonresidents’ savings. Thus, the resource transfer is simply the cost that goes with the benefit of higher output. The problem with funds that were borrowed in the 1970s and early 1980s is that they did not always lead to the necessary rise in output. They were used either to sustain consumption levels or invested on the basis of expectations about interest rates and terms of trade that were widely held but unfortunately turned out to be quite wrong.
Problem debtor countries had a cumulated current account deficit of $82 billion from 1983 to 1987, but this does not imply that they were net borrowers in real terms from the rest of the world. While their nominal debt did rise as a counterpart of the current account deficit, the real value of that debt was eroded by inflation. Thus, about $100 billion in the interest payments recorded over this period represented amortization of debt rather than service payments for the use of nonresident savings. In other words, if account is taken of the inflation premium implicit in interest payments, problem debtors transferred real savings to the rest of the world that cumulated to about $18 billion from 1983 to 1987.
In effect, there has therefore been some net repayment of borrowing by the group as a whole. Over 1983–87 the decline in real debt came entirely from private sources as the real value of official credits to problem debtors rose while the real value of private credits fell by about 7 percent.3
From the point of view of world efficiency, funds should move internationally in response to prospective relative returns on investment opportunities whether in the public, the parastatal, or the private sector. Put very broadly, countries should be able to borrow if the expected risk-adjusted rate of return in terms of extra national output resulting from the new investment measured at expected and undistorted prices exceeds the world rate of interest. But the existence of market discounts suggests that the incentive structure discourages the flow of new funds to problem debtors.
The problem is that, in evaluating new investment opportunities in an indebted country, a resident or nonresident investor would consider his standing relative to existing creditors. When existing debt sells at a discount in secondary markets, potential investors might assume that new claims would also trade at a discount. This could be offset by relatively high expected earnings, but there are probably a limited number of investment opportunities that would be expected to yield this relatively high rate of return. In these circumstances, expectations that bring about the market discount will affect the distribution of new savings around the world, reducing the flow of new funds on a voluntary basis to problem debtor countries. This helps to explain the decline or even cessation of new lending.
Many developing countries have been able to maintain a normal relationship with their creditors, and it is not assumed here that it is beyond the grasp of those that have experienced difficulties to regain that status, as already shown by some countries. Moreover, it cannot be automatically assumed that the inflow of net new funds has been inadequate in all cases (i.e., that expected risk-adjusted rates of return at the margin generally exceed the world rate of interest). If countries have borrowed so much in the past that there has been an undue rise in their debt ratios, it may well be prudent to cease borrowing or even to reduce their indebtedness. Projects that yield the necessary rate of return may not exist. There is no presumption that all developing countries must be consistently net borrowers, and, for some, any addition to their indebtedness at market interest rates may currently be quite unwise. This is not to say that they may not be in desperate need of extra current resources to maintain present levels of per capita consumption or even to prevent a decline. But this really represents a need for concessional finance, for a change in domestic policies, or for both. Thus the decline of new lending may have some justification, especially if new funds would be used for the maintenance of consumption or if domestic policies or economic prospects are poor.
When interpreting the causes and implications of market discounts, some attention needs to be given to the characteristics of the instruments being traded and the structure of the market. For example, observed discounts on existing syndicated credits might reflect not only the market valuation of alternative new claims on the debtor country but also the characteristics and status of these particular financial instruments. Existing syndicated credits are illiquid instruments and prices quoted in these markets are in some cases not transactions prices but only prices that the intermediaries believe are representative of market conditions. They are not structured as “trading” assets—indeed the legal structure may create impediments, thus raising the cost of trading and thus resulting in a higher discount than tradable securities. For these reasons the secondary market for existing commercial bank syndicated credits may understate the value of claims on debtor countries. But the secondary market is likely to provide at least an indication of how investors at the margin view the relative returns required for general balance of payments lending to different countries. They may not reflect, however, the return that investors require from other forms of lending to the debtor countries, such as negotiable securities. Indeed, an underlying premise of market-based approaches to the debt problem is that alternative methods of financing could be more attractive to creditors.
Finally, there is some evidence that the market values of commercial banks’ stocks reflect the banks’ exposures to those debtor countries whose debts are heavily discounted in secondary markets. Thus, the very well developed market for bank equity seems to reflect the same valuations of the external debt as observed in secondary markets for syndicated credits.
Fiscal Problems of Debtor Countries
Another feature of the current situation is that external debt obligations represent a present and future expected fiscal commitment in the debtor countries. Interest payments accounted for about 16½ percent of fiscal expenditures of problem debtors in 1987, and for several of these countries interest payments accounted for more than 40 percent of total expenditures. These ratios reflect the fact that in most cases the external debt of developing countries was originally—or subsequently became—an obligation of the government. This fiscal obligation is likely to reduce domestically financed investment both directly through restricting capital formation by the government, and indirectly, since private investment may be a relatively attractive tax base. Higher taxes may also distort resource allocation. There are a number of different effects here.
First, expenditures on public investment have declined and, indeed, with inadequate gross investment the public capital stock may well have depreciated in some countries. Against this, it has to be borne in mind that some public investment in the recent past has been highly uneconomic, and the reduction of such investment could even be a blessing.
Second, there is an internal transfer problem—that is, a need to raise taxes now and in the future to finance service on the public external debt. Raising taxes involves familiar collection costs and distortions in relative prices and incentives. Particularly important is the effect of future tax liabilities on the extent and form of domestic investment.
Productive investment in domestic real capital is a relatively visible activity and hence liable to be taxed heavily in direct and indirect ways, and this could lead to a sub-optimal share of domestic savings going into such investment. This prospect produces incentives both for capital flight—the investment of domestic savings abroad—and for excessive investment in nonproductive assets. Furthermore, savings may be discouraged. Prospects of high taxation also discourage the inflow of new foreign capital into the private sector. Finally, the fiscal problem generates uncertainty as to the extent to which the government will resort to inflation in order to generate internal transfers to the government.
A fiscal problem is nothing new for governments, whether developed or developing, and as the debt service obligation may be just one out of many causes of such a problem, one needs to put the role of debt service in perspective. But for many countries the increased debt service obligations have been combined with a severe deterioration in the terms of trade that has eroded the tax base. Tax liabilities are likely to reduce investment unless the burden of earlier mistakes or misfortunes is to be borne wholly by cuts in consumption. The burden must be borne somewhere, unless it is possible to increase output sufficiently by supply side measures.
II. Debt Strategy
The present strategy is that debtor countries should grow out of their debt situation with the help of (i) improved policies that are expected to raise their rates of growth, (ii) official support from governments and multilateral agencies, (iii) new money from private lenders, and (iv) growing and open markets in the industrial countries for debtor countries’ exports. We discuss the role of domestic policy changes below. With regard to official funds, problem debtors have received about $124 billion in net new credits from 1982 to 1987. Increased efforts by official creditors (e.g., the Fund’s enhanced structural adjustment facility) hold substantial promise for the low income countries whose debt is small in absolute terms though not relative to their capacity to pay, but official credits are not likely to provide a significant offset to the reduced availability of private credit to the middle income debtors.
Given the availability of official finance, the key issue is whether it is possible for debtor countries to meet their current debt service obligations and yet gradually grow out of debt.
Growing Out of Debt: Possibilities
To start with, one particular scenario might be considered. This is perhaps closest to the scenario implicit in the current strategy. Suppose that a debtor country gets sufficient net new funds annually so that its nominal external debt grows at the rate of inflation in the country in whose currency the debt is denominated (e.g., the United States) or—which is the same thing—its real external debt remains constant. If the country’s debt/GDP ratio is 50 percent (roughly the average, net of official reserves, for the problem debtors) and if the real rate of interest on its debt is 4 percent, then the debtor country would have to make payments equal to 2 percent of its GDP annually to its foreign creditors. For the “average” problem debtor this would equal about 16 percent of exports.
One view is that this is not a great burden and is feasible. With real growth of, say, 3 percent a year, the debt/GDP ratio would steadily fall and after ten years it would be only about 37 percent. Given the same 4 percent real interest rate, only about 1½ percent of GDP would be paid to nonresident creditors. The country would be well on the way toward having grown out of debt. Both consumption and investment as a proportion of GDP could increase over time, and the rise in investment might further increase the growth rate.
Another view, however, is that this scenario would entail serious difficulties for many debtor countries. A payment of even 2 percent of GDP for an extended period would be quite large by historical standards. Moreover, these figures are based on averages for problem debtors. In fact about one quarter of all problem debtors have debt/GDP ratios that exceed 100 percent so that the ratios look twice as serious. Furthermore, it cannot be assumed that the real interest rate would stay at 4 percent or that problem debtors could borrow at market rates of interest. If, for example, the average problem debtor could attract private funds only by paying a 2 percent risk premium, then 3 percent of GDP and 24 percent of exports would have to be paid to nonresident creditors in order to keep real external debt constant. Finally, an important factor in recent years has been that declines in the debtor’s terms of trade have reduced the foreign currency value of their GDPs. Thus, a given foreign currency payment to nonresidents represents a larger share of the debtor’s output.
A crucial and essentially arbitrary assumption of this scenario is that real debt stays constant. One might consider some alternative scenarios.
One of these conceivable scenarios is that the nominal debt stays constant—that is, that the current account stays in balance, with no net new money being provided, some inflow from official sources being offset by net nominal amortization of commercial debt. The real debt will then decline in line with world inflation. If the nominal interest rate was 9 percent, then 4.5 percent of GDP and 36 percent of exports would initially be paid to nonresident creditors annually.
Compared with a constant real debt, this means greater payments to nonresidents now at the cost of reduced consumption or investment. If we suppose that the extra burden would be borne by consumption and not by investment we can assume the same growth rate as before, and the debt/GDP ratio will then fall more rapidly. The debt service burden will be heavier earlier but lighter later—a redistribution of the pattern of consumption over time. If some of the burden of the amortization of real debt is borne by reduced investment, the growth rate will decline and, to an extent, the burden will be borne by future rather than present consumption.
One might also consider the possibility that the country, even though already heavily in debt, increases its real debt further. Here the possibility can be considered that it borrows net in real terms to finance part of its debt service—that is, to avoid a decline in consumption that might otherwise be necessary.
If the rate of interest paid on external debt is equal to the rate of growth of nominal GDP and stays so indefinitely, the country could allow its debt to grow at the rate of interest (by borrowing all interest payments) while the debt/GDP ratio would remain at its initial level. The baseline scenario in the World Economic Outlook, April 1988, suggests that GDP growth in problem debtor countries might average 4.3 percent over the 1990–92 period. Real interest rates on dollar-denominated short-term debt might average about 4 percent. Thus, assuming moderate spreads over LIBOR and no changes in the terms of trade, the debt/GDP ratio would remain about unchanged if problem debtors as a whole reborrowed their interest payments.
The problem is that in the real world conditions change: one cannot rely on the interest rate payable by a debtor country staying indefinitely at or below the rate of growth, as the experience of the early 1980s has shown. The initial size of the debt is highly relevant. When the debt/ GDP ratio is around 50 percent or more it may be desirable that it be reduced over time because of the possibility that the real interest rate might rise or the growth rate fall in the future, hence imposing a serious debt servicing burden.
Finally, there is the scenario where a country deliberately amortizes its debt not only in real but also in nominal terms. It may choose to do so not only when rescheduling cannot be negotiated and new funds are not available, but also when it takes a long view about its prospects and chooses for some time to reduce its indebtedness even though new funds would be available. The debt/GDP ratio may be too high and the aim may be to reduce it to a more reasonable level even at the cost of considerable sacrifice in the immediate future. It may be thought desirable to finance domestic investment wholly from domestic savings, and, in addition, to use some savings to reduce the debt. The aim would be to reduce the debt service burden in the future and to work rapidly toward the reestablishment of full creditworthiness.
Thus, many debt scenarios are possible and the one that is chosen will inevitably differ by country. The choices that authorities make will depend both on external circumstances—notably the availability of funds, the possibility of rescheduling, interest rates, and the terms of trade—and on domestic preferences—notably the weight given to future welfare relative to current welfare. The choices also have implications for policies, a matter to be discussed further below.
Availability of Funds from the Market: Role of Banks
The first growing out of debt scenario presented above assumes that some net new nominal money will be available, even though real debt stays unchanged. Over time, the debtor country would then grow out of debt and regain normal access to credit markets. But one could take a more pessimistic view and regard a scenario involving little or no net new money, and possibly even net outflows, as being more consistent with the current preferences of private external creditors.
One interpretation of the current situation is the following. The market discount and the buildup of substantial loan loss reserves indicate a lack of market confidence in the repayments prospects of problem debtor countries. When there is a discount it cannot be in the interests of any individual bank to provide new money—or indeed to reschedule—at interest rates that do not fully compensate for this discount. A reluctance to provide new money at reasonable interest rates, and attempts by individual banks to “get out” as quickly as possible, are then not at all surprising. Moreover resident investors in the debtor country might also prefer offshore investments. This interpretation is, of course, subject to doubts about the full significance of secondary market prices of commercial-bank syndicated claims given the characteristics of the claims and the structure of the market.
Here it has to be stressed that the market discount on debt and the expectations that cause it are not determined exogenously. As noted below, they are influenced by policies of the debtor countries themselves. Furthermore, even for given policies these are influenced by the atmosphere of confidence or lack of confidence created by policymakers and others in the debtor countries. With respect to the scenarios, there is perhaps an element of circularity. The theme of the first scenario presented earlier is that, provided sufficient new funds are available to keep the real debt approximately constant, it would be possible for countries to avoid undue sacrifices in consumption and investment in the near future and gradually to grow out of debt. If their authorities see this clearly they can plan rationally and with a long view, and with every intention of meeting their debt service obligations. This prospect should then inspire confidence in the minds of the creditors—hence reducing the discount and making available new money. Yet the promise of new money is needed in the first place if the scenario is to be realized.
Role of Concerted Lending
The logic of concerted lending is that the reluctance of individual private creditors can be overcome by coordination of lending. When any one bank provides extra funds, it generates favorable spillover effects for other banks. It provides funds for the debtor country to pay interest on the debts that the country owes others. (For the group of banks as a whole this is defensive lending.) In addition, it may finance new investment that raises future taxable capacity, hence raising the ability to repay all banks in the future. Given these favorable overspill effects that banks create for each other through new lending, there is a familiar argument for coordination of banks’ lending. But, of course, the precondition for banks’ willingness to participate is that they expect to gain as a group.
The question is whether concerted lending (or the availability of official funds) can reduce the market discount and so eventually make concerted lending itself unnecessary. One view is that the scope for further concerted lending has not been exhausted. The need is for continued initiatives designed to coordinate bank lending and “internalize” the overspill effects. In effect, a convincing pledge of private or public lending to a debtor country would convince creditors that the existing debt will eventually be serviced on a normal basis. An alternative view is that concerted private lending, at least in its current form, would not be sufficient to ensure an adequate growth path for some or even any of the problem debtors, so that alternative approaches need to be considered.
Policies of Debtor Countries
Each of the growing out of debt scenarios is based on the assumption that future growth in external debt will be quite limited as compared with its growth in the 1970s and early 1980s. The effect that this will have on domestic capital formation and economic performance in debtor countries depends on their economic policies. As discussed above, limiting the growth in debt would require significantly greater fiscal effort. If, for example, payments to nonresidents are to be financed by domestic borrowing, the government would capture a larger share of domestic savings. The resulting crowding out of private domestic investment might place the growth objective, the essence of the strategy, out of reach. Financing through monetary expansion would cause or increase inflation—as indeed it has in some of the largest problem debtors. Finally, reductions in government expenditures or measures that increase revenues should be designed to limit the detrimental effects on capital formation and growth.
In choosing a debt strategy for an individual country it is crucial, therefore, that the availability of external finance be consistent with a policy framework that can be credibly maintained by the debtor government. For example, if the amortization scenario is chosen, the typical problem debtor would have to make substantial adjustments in its fiscal stance in order to carry out its debt service commitments to nonresidents. At the same time, the real exchange rate would have to be sufficiently depreciated to ensure the appropriate relative price of tradables to nontradables needed for the payment. If the constant real debt scenario is chosen, smaller adjustments in the debtor’s fiscal and exchange rate policies would be required in the near term, but a larger amount of external financing or better terms on existing debt would be necessary under this scenario.
A related part of the present strategy has been an emphasis on improved market-based policies in debtor countries. The aim has been to improve the efficiency of resource allocation, including the allocation of new investment, as well as the efficiency of state and parastatal enterprises, in some cases through their privatization. The objective is to raise the level of output and rate of growth even for given availability of foreign savings and a given domestic propensity to save.
In all countries, debtor or otherwise, industrial or developing, there is always scope for policy improvements, but what is possible and desirable clearly varies among countries as does the extent of actions that have been taken. In a number of the debtor countries there have been major changes, for example in trade policy, though no simple generalizations as to what has been achieved are possible. It can be argued that the productive potential of most of the problem debtor countries is sufficient to make possible full servicing of debts provided this potential is realized. Useful examples are set by some other indebted countries which, owing to sound policies, are not problem debtors.
If the real debt stays constant, the more policy changes are successful in raising domestic savings, investment, and efficiency—and hence the rate of growth—the quicker will be the decline in the debt/GDP ratio. Furthermore, the better the growth prospects on account of the implementation and success of these policies, the more justification there is for allowing the real debt to increase somewhat. Some new borrowing can then finance current debt service, hence possibly allowing a maintenance of or increase in per capita consumption that would not otherwise have taken place. In other words, some of the burden of the existing debt would be shifted forward in time. This is rational if the harvest of improved policies is expected to be reaped some years hence. Whether this is possible depends, of course, on there being willing lenders.
A crucial question concerns the effects of improved policies on the availability of new money. It is highly likely that signs of improved policies would in due course affect the market’s perceptions favorably and so make funds more readily and cheaply available. This is at the heart of the first scenario sketched earlier and the view that the current strategy can be successful. But the policy improvements have to be credible, that is, it must be expected that they will be consistently applied and they must have sufficiently wide support in the debtor countries. The commitments by governments must be clear and sustained. There is thus a connection between two parts of the present strategy: the availability of new money from the private sector and improved policies.
The requirements that have been set out here are easier to state than for policymakers to bring about: it is not just a matter of the present implementation of new policies—itself not usually easy—but also the creation of the necessary credibility. In this respect, Fund conditionality can play an important role. In particular, if debtor countries commit themselves to sound policies, the terms on which they can borrow from private creditors are likely to be improved. As discussed above, these better terms would in themselves make it more likely that the debtor countries could eventually outgrow their problems.
Implications for World Trading Patterns
If indebted developing countries are to keep their real debt constant over a prolonged period, or if real debt is actually to fall, this would have to be accompanied by prolonged outward resource transfers by them, that is, by trade surpluses. (The term “trade surplus” is used here as shorthand for “non-interest current account surplus” since the surplus required to finance interest payments can be obtained not just from net trade flows but also from the net flow of services other than interest payments.) Other countries would have to be prepared to accept the implications; some countries must be content to run trade deficits. Such deficits will inevitably emerge, but the question is whether they will lead to tensions in the form of protectionist measures in industrial countries that would limit growth. In a world perspective the orders of magnitude are quite small. In 1987 exports of goods and services of the problem debtor countries were about 9 percent of world exports. One might envisage for some time a trade surplus of 2 percent of world exports. Even if the surplus were, say, doubled, the effect would not be large in world terms (though effects for particular product categories may be significant).
Increased trade surpluses by developing countries of these magnitudes need not create overall unemployment in industrial countries. In the short run a shift toward greater surpluses by debtor countries might increase unemployment in particular industries in industrial countries that compete in domestic or foreign markets with the products of the debtors. But that cannot be the whole story. Higher trade surpluses would be associated with increased real interest or debt repayments, which would increase spending power elsewhere, no doubt primarily in the industrial countries themselves. The marginal shift into trade deficit in the industrial countries as a whole that is required if developing countries (or some of them) are to shift into surplus would involve some contraction of tradables industries in the industrial countries, but also expansion of nontradables.
The argument applies in reverse if the indebted countries do obtain debt relief or more new funds so that they can allow themselves trade deficits. In an overall sense, reduced spending resulting from reduced interest payments received by banks and others in industrial countries would be compensated by higher spending by the developing countries themselves. The shift in the industrial countries would be marginally into tradables.
Industrial countries can make adjustment by debtor countries more difficult through protectionist measures designed to discourage the latters’ export expansion, in effect worsening their terms of trade. A similarly adverse effect would result from slow economic growth in industrial countries even without an increase in protectionism. Whatever is the precise nature of the debt strategy, developing countries’ exports will have to increase, and the less they get debt relief or new funds, the more this is necessary. Given official transfers and the availability of new funds from the private sector, the trade balance outcome will have to fit in with the requirements of debt service. If export expansion is made too difficult, either by protectionism or by slow growth in industrial countries, the debtor countries would have to concentrate their adjustment on reducing the growth of imports relative to GDP growth. This would be much more painful for them, especially when imports are crucial inputs into local production.
With regard to current account imbalances, in whatever direction they move as a result of developments in the debt situation, the relatively modest orders of magnitude involved from a global point of view should be noted. In 1987 the aggregate current account deficit of the problem debtors is estimated to be $19 billion, which can be compared with the U.S. deficit of $152 billion and the Japanese surplus of $85 billion.
Finally, one might consider the case of industrial countries that have trade surpluses. If they did not wish to see their tradable sectors decline or did not wish to reduce their national savings or increase domestic investment—that is, if they wished to stay in trade surplus—while other industrial countries were not willing to accept offsetting trade deficits then, one way or another, funds would have to be channeled to developing countries to allow them to run the deficits. The problem is that, given the market discount and the expectations that have given rise to it, such funds will not necessarily flow through the normal market processes. Overseas development assistance by the surplus countries, or government guarantees involving a potential commitment of government funds, would be needed. But this means that the governments would have to borrow some of the excess of domestic private savings over investment to finance the aid.
III. Supplementary Approaches
Various supplementary approaches to the current debt strategy will now be considered. It is not strictly accurate to call them new since some are already under way and might be regarded as part of the current strategy, or at least as being consistent with it.
First, there are versions of a market-based approach. These developments are, in fact, already under way to a small extent, and it is worth considering what the implications would be if this approach is pursued on a much larger scale than now.
Second, there is debt relief. This is also not new since rescheduling can be regarded as a form of partial relief, even without interest rates being reduced. The concessional nature of such agreements is even more apparent if the new terms are compared with market discounts on existing debt. Furthermore, there are well-known cases of non-negotiated, partial relief, that is, unilateral actions designed to lead to relief. A debt strategy proposal that would provide relief and which has been frequently suggested is the idea of an international debt facility. Often it is suggested that it should be run by, or associated with, the Fund or the World Bank, or both. Proponents imply that the debt situation might be resolved by methods that involve financial support or guarantees from the members of the Bank or the Fund as a whole or, possibly, industrial countries only.
Market-Based Approaches
The bulk of private lending to developing countries in recent years has been intermediated by commercial banks in the form of medium-term syndicated credits. One response to recent difficulties in expanding this type of lending has been a search for alternative forms of private lending. Such initiatives involve the exchange of syndicated credits for an alternative liability of the debtor country or, less frequently, for cash.
In cases in which existing syndicated credits sell at a discount in the secondary market, the yield to maturity to a buyer is higher than the contractual yield. In this section, a number of cases are examined in which the debtor itself is the buyer of existing debt. If the debtor is to finance a buy-back of syndicated credit with borrowed funds, the cost of which is less than the yield on repurchased debt, or with the sale of assets that yield less, the contractual value of the debtor country’s outstanding debt and the interest payments on that debt would be reduced. The magnitude of the savings would depend on the discount at which the debt were purchased, the amounts that were purchased, and the cost of the borrowed funds.
Alternatively, the debtor country could use resources obtained through a current account surplus or a reduction in reserves, or from sales or conversions of alternative financial instruments, to buy existing debt at a discount. New financing could take the form of debt-equity swaps, proceeds from concerted lending packages, concessional assistance, sales of bonds, or any other transaction that places additional funds in the hands of the debtor country.
The cost of using reserves (or earnings from a current account surplus) to retire existing debt would depend on the best alternative use of funds. This might be measured by the return on foreign financial investments, by the potential cost of holding an inadequate level of reserves, or by the rate of return on domestic investment. To the extent that other instruments of external finance are used to finance the retirement of existing debt, the cost of such financing would tend to approach the effective cost of existing syndicated debt unless the country is able to differentiate the characteristics of the new external claims in a way that such claims would be seen as having less risk, higher seniority, or other advantages over existing debt. For example, a country might declare that the alternative financing instruments would receive priority when they pay interest (or dividends). Alternatively, the new instruments might not be subject to rescheduling and would not be included in the base for any future new money packages. On the other hand, if the country borrowed new funds at the same effective interest rate as prevailed in the secondary market for syndicated credits (i.e., taking into account the market discount), it would simply exchange instruments with the same contractual value.
The credibility of declarations designed to differentiate new debt, and thus the potential relative financing cost advantages of the alternative financing instruments, will depend on a number of factors. The smaller the amount outstanding of such instruments relative to the amount outstanding of syndicated credits, the greater the credibility that the debtor can maintain preferred treatment of such claims. Of course, the larger the debt servicing problem facing the country, the lower would be the credibility of such declarations.
Although a country may be able to reduce total interest payments and the total book value of external claims using other lower-cost financing instruments, other considerations should be taken into account. If additional external resources should be required in the future to service external claims, and if some form of concerted lending is needed, it may be more difficult to obtain sufficient resources because of a smaller concerted lending base. In particular, if the money center banks become net sellers of debt, they will have less to gain from defensive lending since the favorable overspill effects will go to many other holders of the debt as well as to themselves. Moreover, since the holders of the debt become more dispersed, they will find it more difficult to organize themselves, and thus they lose some of the bargaining power in relation to the debtors. These problems would be reduced if the new securities were bought by fringe creditors rather than the major lenders. In this case, the narrowing of ownership of a country’s debt could facilitate concerted lending.
Buy-Backs Financed by Current Account Surpluses or Sales of Reserve Assets
A relatively straightforward transaction would be for the debtor government to repurchase its own debt for cash acquired through a current account surplus or sales of reserve assets. From the debtor country’s point of view amortization at a discount is certainly preferable to amortization of debt at its contractual value. But there remains the basic question as to whether amortization, even at a discount, is desirable. It would be desirable if the savings on interest and principal on retired debt exceeded the benefits that could be derived from alternative uses of the funds that financed the buy-back. Since the buy-backs are voluntary transactions between debtors and creditors, they could be important vehicles for avoiding conflict. But the scope for such transactions is limited by provisions in syndicated credits that specify that all participants in the credit share in such a buy-back.
Buy-backs would allow the banks to dispose of some of their debt in the market and is a natural response to a changing perception of the value of the debt held in banks’ portfolios. Loan loss provisioning has made it possible for commercial banks to realize the losses that accompany sales of developing country debt. While the size of bank reserves currently varies across creditor countries, there has been a widespread increase in reserves in 1987.
Alternatively, a cash buy-back might be financed by foreign donors. When there are several donors and they act through a multilateral agency and the buy-back takes this last form, this is, in fact, the proposal for an international debt facility, which will be discussed below.
Securitization
In its purest form, securitization consists essentially of a process that increases the tradability of existing claims. But as argued above, it could also involve larger changes that would make the new claims more desirable than existing claims for other reasons. An example would be the assignment of collateral to new securities. As with buy-backs for cash, exchanges of new securities for existing debt would benefit debtors as long as the cost of the new security is less than the implicit yield on existing debt.
Securitization could reduce the cost of debt because it would increase its marketability and would make developing countries’ debt available to investors who might value it more highly than do current holders. Insurance companies, mutual funds, pension funds, and so on, as well as individual investors, might bid for new instruments and thus increase their market value. It is sometimes argued that commercial banks are not the best vehicles for the flow of private funds to sovereign borrowers, other than for short-term trade credit. In particular, in the 1970s the banks played an unusually prominent role in the light of historical experience. Thus, a return to bond-financing, as well as an increase in direct investment, would be a movement back toward a historical norm.
Debt-Equity Swaps
A typical debt-equity swap involves a straightforward set of transactions. In most cases the debtor government offers to swap its debt for domestic currency on the condition that the currency be used to purchase local equity. First, the investing company acquires existing debt in the secondary market or, in the case of commercial banks, utilizes its own holdings. Then it exchanges this debt with the debtor government for local currency so that the debt is retired. Finally, it uses the domestic currency to purchase local equity or finance approved domestic projects. As far as the debtor country is concerned, some of its foreign-currency-denominated debt has been retired early. This expenditure can be financed in a number of ways, and this is explained further below. From the point of view of the debtor country’s balance of payments, a prospective flow of public sector interest payments is replaced by a flow of private sector dividend payments. This has a number of implications both for the time-profile of payments and for the degree of risk-spreading involved. When there are dividend rather than interest flows, more of the risks of terms of trade changes, for example, are likely to be shared by the creditors.
The incentives that lead investors to participate in swaps vary from case to case. In some instances, investors have been able to purchase existing debt in the secondary market at a lower price than the price at which the government is willing to redeem it. If an investor purchases a foreign-currency-denominated debt instrument at a 50 percent discount and sells it to the debtor country authorities for 100 percent of the equivalent domestic currency price, the government can be thought of as offering a favorable exchange rate for this transaction. Thus, as compared to a cash purchase of equity, the debtor government has provided more domestic currency to the investor than he could have obtained at prevailing market prices. It is not necessarily the case, however, that such an incentive is required since, in most debtor countries, a simple removal of controls on foreign investment could also provide an incentive for the purchase of equities or direct investment.
An important issue is whether the net result of a debt-equity swap is that the country obtains more or less funds in total. On the one hand it is retiring debt, and to that extent there are less funds; on the other hand the attractiveness of direct private investment has been improved and this—on its own—is likely to increase the net inflow of such investment. Thus, if one thinks only of direct investment, “additionally” can be expected. But if one takes into account the retirement of debt, there is no general presumption that a net increase or decrease of inflow of funds would result.
Residents of the debtor country might also be encouraged to exchange their assets held offshore for their government’s debt in order to swap for domestic equities if the government agreed to waive any penalties or tax liability that might be associated with repatriation. Changes in regulatory constraints or policy changes that encouraged residents to repatriate so-called flight capital could play an important role in solving the foreign exchange problems of some debtor countries. Because debtor governments are often unable to tax earnings on such assets, official interest payments to nonresidents cannot be financed by private interest receipts on foreign assets that have resulted from capital flight. Again, it is clear that the fiscal problem faced by debtor country governments is an important aspect of the debt problem.
Opening domestic equity markets to foreign direct investment could bring benefits in terms of technology transfers and related benefits that exceed the “additional” capital inflow that might accompany such measures. Moreover, the capital stocks of most debtor countries are large relative to their external debts so that the potential for equity sales in exchange for debt is considerable. For these reasons some observers consider debt-equity swaps a potentially important part of the solution to the debt problem, even though swaps have totaled only about $4.5 billion through June 1987, or about 2 percent of the outstanding bank debt of countries with active conversion schemes.
An important constraint on debt-equity swaps is the fact that in most instances the equity attractive to private investors is owned by the private sector of the debtor country while the debt is owed by the government. It follows that the debtor government must finance the swap as it would any other expenditure. It must increase taxes or reduce expenditures, borrow on domestic credit markets or print money. The internal fiscal problem discussed earlier, which is at the heart of the debt problem, remains and is brought forward in time. It is a frequent concern that the method of financing would be through monetary expansion and hence would be inflationary. An alternative means of financing is for the debtor government to sell domestic-currency-denominated securities to domestic residents. But the ability of the domestic credit market to absorb such sales may limit the scope for debt-equity swaps. Indeed, it can be argued that if a country has a fiscal problem in paying interest on its debt, it must have an even greater immediate problem in trying to finance what is, in effect, a buy-back of its debt.
The fiscal problem could be avoided if publicly owned enterprises were privatized and the equity of the privatized enterprises were then swapped for debt. If privatization of public enterprises led to increases in efficiency, the debtor government would gain from a reduction both in its external debt and in the need to subsidize the public enterprise. However, if the government swapped debt for equity in currently profitable public enterprises, the reduction in the government’s future tax receipts would have to be set against the reduction in payments on external debt.
Proponents of debt-equity swaps usually have more in mind than a simple exchange of financial claims. In most cases some additional incentives, or the removal of existing disincentives, for the private investor are an integral part of such proposals. In some cases this might involve a direct subsidy by the debtor government or perhaps more frequently the relaxation of administrative controls over nonresident investment in the debtor country or repatriation of capital by residents of the debtor country. The debtor country might gain substantially from relaxing barriers to equity investments by nonresidents or by privatization. It is important to stress that such policy improvements (generally supported by the Fund) and the resultant benefits need not be linked to swaps of debt for equity.
In order to understand more precisely what is involved in a debt-equity swap, it is useful to think of it as being equivalent to a debt-for-cash swap, or buy-back, coupled with policy reforms that induce nonresidents to purchase equity in the debtor country. Provided the equity purchases are not actually subsidized—or that the firms or industries concerned are not excessively protected relative to other industries—there are likely to be clear benefits to the debtor country from such policy reforms quite independent from their association with a buy-back scheme, which in itself may or may not be beneficial.
Contingent Claims
The transformation of existing debt into equities or tradable securities would provide an opportunity to make future payments by debtors contingent on developments that will affect their ability to service debt. Since problem debtors would share in improvements in their economic performance, this could provide better incentives for economic adjustment. For example, a contingent contract might link interest payments to growth in exports. Moreover, since existing floating rate contracts are contingent on market interest rates, it might be beneficial to insulate interest payments from this source of uncertainty.
While existing contracts may be poorly suited to the needs of developing countries, contingent claims are better suited to allocate the risk of changes in the economic environment in advance than to allocate a loss after conditions have changed. Thus, an important lesson from the difficulties that have confronted many developing countries is that their contractual obligations should henceforth better reflect the uncertainties surrounding their ability to service debt. Nevertheless, an exchange of debt for contingent claims would not necessarily help to resolve the existing debt problem: the addition of a contingency clause to an existing claim would not necessarily change its market value.
Debt Relief
Debt relief can be defined as any change in the contractual arrangements that is favorable to the debtor. While market-based solutions transform the debt, debt relief is defined as reducing the contractual value of the debt in terms of present value.
Relief can be brought about as a purely voluntary act of the creditor, or it can result from a bargaining process in which the threat of delay or default—possibly partial default—plays a role. An extreme threat would involve debt repudiation.
Relief can take the form of the contractual value of the principal being written down, or it can take the form of rescheduling at reduced spreads over market interest rates. It can also involve a shifting forward of the payments stream. For example, for a limited period, part or all of interest payments might be capitalized at rates that do not reflect market conditions, so that the debt increases, the implication being that it will be easier to pay later than now, but that eventually—possibly a long time ahead—all interest and principal will be paid.
At least two questions arise here. First, is it to the advantage of creditors to grant relief and, in particular, to grant it voluntarily rather than under threat? Second, is it in the interest of debtor countries to obtain relief, especially when it can only be obtained with threat of default or with actual, possibly temporary, default? It is unlikely that there is a general answer applying to all cases. Following are some relevant considerations.
Point of View of Creditors
For the creditors as a group there is always a strong argument against reducing the contractual value of the debt—that is, providing voluntary debt relief—even when the chances of ever getting full debt service payments over the lifetime of the loan are considered quite slim. The reason is simply that the contractual value sets the “ceiling” to what might be paid back, and since there is always at least a slight chance that capacity or willingness to pay will turn out to be favorable, there would be a potential loss in reducing the ceiling. Even when banks write down the value of a loan in their books on the basis of their expectations of a possible loss, it is not necessarily in their interests to give up the possibility of full repayment. For an individual bank the argument against writing down the contractual debt is even stronger. If it does so while others do not, its share of eventual repayments will be reduced.
In general, “voluntary” relief will have to be tied to some other change in the outlook. The situation would be transformed from the creditors’ point of view if the reduction of the contractual value is associated with an increased probability of full or substantial repayments of the debt that remains. The problem is to provide the credible assurance. Proposals for the provision of debt relief as part of an agreement with debtor governments backed by Fund surveillance or conditionality really involve this kind of bargain. The key issue is whether any arrangements can be made that would yield assurances backed with sufficient credibility. It should be noted here that the more commercial debt becomes dispersed in the market the more difficult it becomes to strike bargains of this kind. These bargains clearly hinge on creditors acting as a group.
With the prospects of better policies, debt relief that effectively reduces actual debt service payments in the near future is likely to increase investment in the debtor country. This has already been discussed. It may do so through reducing the market discount on debt, through increasing the resources available to the debtor government for public investment and for support of private investment, and through reducing the prospective tax rates (including inflation tax) and so raising the expected profitability of private investment. Increased investment and hence growth in the debtor countries would increase the repayment prospects and hence, in this respect, benefit creditors. Of course, the possibility cannot be ruled out that the gains to debtors from debt relief would simply be used to increase consumption rather than improving repayment prospects of the remaining debt or increasing investment.
Another motive for relief from the point of view of the creditors could be the threat of some degree of default or subordination of existing credits. If it is clearly seen that there is a good chance that a country will not be able or willing to meet its full contractual payments, is there any argument from the point of view of the creditors for reducing the contractual value (apart from the consideration just discussed)? One argument is that it avoids the unpleasantness of default and so gives the creditors some goodwill that may stand them in good stead in later years when economic conditions in the debtor country have changed; giving something up that is likely to be lost anyway also reduces the costs of bargaining. Furthermore, it is at least possible that once serious default is contemplated it may not be partial, so that creditors may be better off by offering partial relief. In addition, default may involve penalties (e.g., deprivation of trade credits) that also impose some costs on creditors or others in creditor countries. Here again, the more commercial debt becomes dispersed, the less likely is it that creditors will be able to take all these considerations into account.
The willingness of commercial banks to grant debt relief will also be affected by the regulatory environment, by tax arrangements, and possibly by accounting conventions. This is a complex subject, which can only be touched upon here.
The accounting issue is straightforward. Market perceptions of a bank’s solvency may be influenced by accounting conventions—for example, whether debt on the books has to be written down when some similar debt has been sold at a discount or when relief in some form has been given, and whether it can be written down gradually or must be written down immediately. But such conventions do not affect the realities of the worth of the assets a bank holds. Presumably, it is always desirable that the accounts give a true picture.
The more important issue is the extent to which the cost of debt relief (given that there is a cost to the creditors) is shared by governments of the creditor countries. It may be shared in three ways. First, there may be direct or indirect subsidization of buy-backs, conceivably through the intermediation of an international debt facility. This will be discussed further below. Second, if debt relief is so great as to “use up” the whole of a bank’s capital (which appears highly unlikely for most banks in present circumstances), the security of deposits would be threatened, and governments would come to the rescue through deposit insurance and possibly lender-of-last resort action.
Third, and most important, are the tax implications. In most countries, credit losses, whether on domestic or foreign loans, involve tax relief, the details varying. This means that the government shares the losses. In this regard it may be particularly important if governments allow provisions against possible or expected losses to be set against current earnings when calculating taxable income. Such allowances can create incentives for provisioning since the bank would gain tax relief before losses are actually realized. It would, of course, also reduce the incentive for declaring a loss. But, by strengthening banks’ after-tax earnings, this could strengthen their bargaining power in their dealings with debtor countries.
Point of View of Debtors
For a debtor country, the benefits of debt relief voluntarily granted may seem obvious. After all, investment is likely to increase, and in addition more resources for current consumption will become available. But the long view must also take into account the effect on future creditworthiness. If circumstances induced creditors to grant relief this time, it could happen again, and the expectation of a repetition is likely to affect the availability of funds and their spreads in the future. Thus it may not be in a debtor country’s interests to obtain relief, or to apply pressure for relief.
The debtor country needs to assess both the likelihood that it will be in the market again within a reasonable time and how exceptional the circumstances of the last years that have given rise to the need for or offer of relief have been. If the circumstances are recognized in later years as having been exceptional, future potential creditors will attach only a low probability to a repetition of debt relief having to be provided. It can, of course, be argued that the combination of recession in 1981–82, high real interest rates, and then severe declines in the non-oil primary product terms of trade, combined with the severe and widely unexpected decline in the oil price recently, has been exceptional.
It is possible that some countries face interest payments that are so high relative to their ability to pay that there seems little likelihood that the country will regain access to additional credit in the foreseeable future. In such cases unilateral actions by the debtor country, such as interest moratoria or more extreme actions, may be considered. However, unilateral actions by debtors—as distinct from relief voluntarily granted—run the risk of substantial additional costs. The most important of these would be loss of access to trade credits and the international payments mechanism. This would result from the possibility that any payment made through the payments mechanism would be subject to the legal claims of creditors. In this event, the debtor would be unable to finance its trade or to make payments through normal channels. In the extreme the debtor country would be forced to barter its goods internationally.
The associated loss of world trade and efficiency would reduce the welfare of debtors, of their trading partners, and of creditors. For this reason, all parties have strong incentives to avoid this mutually costly outcome. Thus, it is desirable that creditors cooperate in setting conditions that will induce debtors to participate in strategies that minimize confrontation. For their part, debtors, in their own interest, should avoid actions that will ultimately result in their exclusion not only from private credit markets but also the international payments system. The international community has an important stake in ensuring that this option is not exercised since it is clearly not in the interest of either party or their neighbors.
International Debt Facility
A common proposal designed to deal with the developing countries’ debt problem is to set up an international debt facility that would buy debt at a discount and then write down its contractual value, hence providing debt relief. Similar proposals would have the facility guarantee repayment of credits that remain in private hands. The facility could be envisaged on a large or a small scale, possibly applying to only a few countries. Many of the general considerations associated with voluntary debt relief apply here as well. A difference, however, is that an officially supported facility is likely to involve some contribution or some guarantees from its owners. There are three main parties involved in a typical proposal, namely the debtor governments, private creditors, and the owners of the facility. It is then necessary to analyze how the costs and benefits of a typical proposal might accrue to the various parties.
The groundwork for the discussion can be established by considering a very simple case in which the expected capacity to pay off the debtor and the probability distribution around its capacity to pay remain unchanged and in which debt that is not sold to the facility is not subordinated to debt that is sold to the facility. The facility would offer to buy the debt of a developing country and would announce in advance that some part of the purchased debt would be forgiven.4 In this case private creditors will gain at the expense of the facility because the market price of debt will rise as the result of the forgiveness. This happens because, following the forgiveness by the facility, there will be a smaller stock of contractual claims on an unchanged expected capacity to pay. This is an example of the general proposition that it is generally inappropriate to assume that market prices would remain unchanged given any important change in the economic environment. In addition, the debtor country will gain because of the “ceiling effect” mentioned earlier. That is, the contractual value of the debt sets a ceiling on what the debtor country would pay and this will be reduced by debt relief.
Thus the various proposals for an international debt facility really have two aspects. First, there is a gain to the banks reflected in the higher market price, and resulting essentially from a transfer of risks from the private creditors to the facility. Second, there is a gain to the debtors owing to the reduction in the contractual value of the debt. Both these gains are obtained at the expense of the owners of the facility who acquire the new reduced debts with the inevitable risks they involve.
The likely gain to private creditors at the expense of the facility could be avoided if debt retained by private creditors is subordinated to debt purchased by the facility. There may be legal obstacles to this, but if it is brought about, the market price of debt remaining in the hands of private creditors might not rise following forgiveness of the part of the debt bought by the facility. In effect the potential increase in the value of the remaining debt owing to forgiveness could be offset to some extent by a fall in price owing to subordination of this debt relative to that held by the facility.
A full analysis of the potential costs and benefits of a facility is considerably complicated if likely total repayments (interest and amortization) are altered by the existence of the facility. For example, the operation of a facility could be combined with conditionally or other arrangements which reduced the risk of low payouts. In this case all creditors, including the facility, and perhaps even the debtor country itself, could be made better off. Creditors might be made better off since the likely payoffs on remaining debt would in the aggregate be higher than they were initially. The debtor country may also be made better off if conditionally allows it to commit itself convincingly to policies that it plans to undertake in any case. To the extent that such commitments are more credible this would allow the country to face a market discount which was more appropriate or which better reflected the country’s likely policy choices.
On the other side of the coin, it could be pointed out that debt facility proposals present a moral hazard problem. Debtors have an interest in the facility’s purchase price being reduced as much as possible. Thus the valuation of debt prior to the facility’s purchase may be manipulated by the debtor government. A constraint on such behavior is that it could involve a loss of credibility and perhaps a long-run cost to the debtor governments involved. It may be possible to overcome the moral hazard problem by establishing a purchase price above the market price or perhaps using the market price that prevailed at a specified day before the possibility of the facility was considered.
If a facility was to purchase a significant part of the commercial debt of the developing countries that currently have problems (as is sometimes proposed), this would involve a very large transfer of risk internationally from private creditors to governments or multilateral institutions. The governments that underwrite the facility directly or that underwrite the multilateral institution that operates the facility have to be prepared for their taxpayers to assume the risk. There would also be the problem of deciding which countries would be provided with the option of making use of the facility. In particular, such proposals can be viewed as benefiting countries that have not made adjustment efforts relative to countries that have made such efforts.
REFERENCES
International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington, April 1987).
International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington, April 1988).
Watson, Maxwell, and others, International Capital Markets, Developments and Prospects, World Economic and Financial Surveys (Washington: International Monetary Fund, January 1988).
At the time he wrote this paper Mr. Corden was Senior Advisor in the Research Department of the IMF, on leave from the Australian National University. He taught at Oxford University from 1967 to 1976. From 1989 he will be Professor of International Economics at the School of Advanced International Studies of the Johns Hopkins University.
Mr. Dooley, Chief of the External Adjustment Division in the Research Department of the IMF, is a graduate of Duquesne University, the University of Delaware, and the Pennsylvania State University.
Watson and others (1988), p. 39.
The appropriate choice of a deflator will vary according to the question investigated. For expositional purposes, the U.S. GNP deflator is used here.
In fact, nominal debt is estimated to have risen by more than the cumulated current account deficits for problem debtors over this period. This discrepancy may reflect valuation changes that do not appear in balance of payments data or errors in one or both sources of data. Both sources of data suggest that the real value of private claims on these countries declined over the period although debt statistics suggest that the real value of total debt rose somewhat.
If, alternatively, a part of the debt were not actually bought by the facility, but were only guaranteed by it—so that the private holder would have the right to sell the debt to the facility at contractual value or some discount—the effects would be roughly the same. The market value of debt that is not guaranteed would rise while the facility would have incurred an expected cost.