The debt crisis that erupted in the second half of 1982 was the result of several interrelated developments in the 1970s and early 1980s: adverse developments in the world economy, inappropriate economic policies in many developing countries, and sharp swings in the availability of external financing, particularly bank lending.

I. Origin of Debt Crisis

The debt crisis that erupted in the second half of 1982 was the result of several interrelated developments in the 1970s and early 1980s: adverse developments in the world economy, inappropriate economic policies in many developing countries, and sharp swings in the availability of external financing, particularly bank lending.

The adverse external developments which confronted developing countries during the period from 1973 included large increases in world energy prices and decreases in the prices of other primary commodities, which led to a substantial deterioration in the terms of trade for many countries. At the same time, international interest rates rose to unprecedented levels, resulting in a sharp increase in the “real” cost of servicing foreign debt. For non-fuel-exporting developing countries in Latin America, for instance, the “real” interest rate on foreign debt1 increased from minus 10 percent during 1973-78 to plus 8 percent during 1979-82. In addition, the prolonged recession in industrial countries and protectionist tendencies adversely affected the worldwide demand for developing countries’ exports; industrial countries’ imports declined by 4 percent in real terms between 1979 and 1982, after average annual increases of 6½ percent in the preceding decade.

These external shocks affected countries to differing degrees. Not all developing countries experienced debt-servicing problems, even among those that were heavy borrowers. For many, a substantial increase in external debt was matched by rapid export growth. Developing countries in Asia, for example, pursued policies that promoted faster growth in exports than in external debt between 1973 and 1981, and the debt-service ratio of the region did not deteriorate. Key factors in this performance were the adoption of appropriate exchange rate policies and policies that mobilized domestic savings and channeled them to productive uses. In a number of cases, the implementation of these policies took place in the framework of Fund-supported adjustment programs.

Policy responses to external shocks were thus a central factor explaining countries’ subsequent payments difficulties. To offset terms of trade deterioration and a decline in export receipts, many countries adopted expansionary fiscal policies to maintain domestic income. In Latin America, for example, public sector deficits as a share of gross domestic product (GDP) more than doubled between the late 1970s and the early 1980s. Large fiscal deficits were financed by substantial external borrowing and a rapid rise in domestic credit to the central government. Often, domestic bank credit was also increased to support public enterprises. As a result, total domestic credit expansion was often excessive. Countries that subsequently restructured their debts experienced much faster credit expansion during the three to five years prior to the restructurings than countries that did not restructure.

Distortions in relative prices such as exchange rates, interest rates, and producer prices depressed domestic saving rates and led to misallocation of resources. The real effective exchange rate of a restructuring country typically appreciated significantly during the two years prior to a request for debt restructuring, compared with virtually no appreciation for non-restructuring countries as a group. This appreciation contributed to a deterioration in the trade account and, in conjunction with depressed real interest rates in domestic money markets, also induced capital outflows. For countries in the Western Hemisphere, negative errors and omissions—frequently an indicator of such outflows—rose from 5 percent of exports during 1977–79 to 16 percent during 1980–82, when they were equivalent to one third of these countries’ net external borrowing during these years.

In addition to the impact on external borrowing of the macroeconomic policies cited above, external debt and international reserve management policies also contributed to debt-servicing difficulties. The crucial factor lay not in the maturity structure of the debt but in the relationship between this structure and the liquidity available to countries to meet their amortization commitments. At the end of 1981, the ratio of short-term bank debt to assets with banks was four times higher for restructuring countries than for nonrestructuring countries. The ratio of undrawn credit lines to outstanding bank debt for restructuring countries was half the ratio prevailing for nonrestructuring countries. Thus, restructuring countries were generally more vulnerable to unexpected changes in the international environment.

A last factor that contributed to the emergence of the debt problem was the availability of external financing at seemingly favorable rates. The easy access to international capital markets during the 1970s and early 1980s allowed countries to finance external imbalances and to postpone adjustment; at negative real interest rates during much of the 1970s, the costs of such a policy appeared manageable. Within a decade, non-oil developing countries increased their total external debt sevenfold, to $700 billion at the end of 1982, while their exports rose only fivefold during the same period. Commercial banks were willing to increase their exposures in developing countries with unsustainable policies for several reasons: the availability of large inflows of deposits from surplus countries; competitive pressures to maintain market shares; and inadequate risk assessment of cross-border lending.

II. Management of the Debt Crisis

Initial Response

The spread of serious debt-servicing difficulties among developing countries from mid-1982 onward posed a threat to the economies of the countries affected and also to the international financial system. To resolve these difficulties, a coordinated effort by the debtor countries, official and bank creditors, and international financial institutions was necessary. This effort addressed three principal concerns: how to link financial support effectively to economic policies that would restore countries’ creditworthi-ness; how to provide payments relief in ways that would rebuild debtor-creditor relations; and how to coordinate support among large and diverse creditor groups. These concerns guided both creditor and debtor countries, commercial banks, and international institutions in arranging financing to support debtor-country policies that were designed to regain viable external positions and to help restore sustained economic growth.

Effective adjustment policies in debtor countries were clearly necessary to restore countries’ creditworthiness and lay the basis for renewed growth, encouraging a resumption of bank lending, export credit flows, and official development assistance. Adjustment policies were also necessary to pave the way for a return of flight capital and an increase in direct foreign investment and other non-debt-creating flows. Prompt implementation of policies affecting both the demand and supply sides of developing countries’ economies was seen as key to their return to more normal access to international capital markets. In this connection, project, sector, and structural adjustment loans from the World Bank were an important complement to Fund-supported economic adjustment programs.

Because of their impact on global economic and financial conditions, appropriate policies in industrial countries were also recognized as essential in facilitating the resolution of external payments difficulties confronting developing countries. A sustained improvement in the external finance of developing countries was seen to depend crucially on the pursuit by industrial countries of policies favorable to a recovery of international trade, on more open markets for developing countries’ exports, and on the establishment of lower and less volatile real interest rates in financial markets. Policies to foster efficiency and structural flexibility were also needed to help restrain protectionist pressures, thus avoiding the creation of barriers that would inhibit developing countries from earning the foreign exchange necessary to service their external obligations.

From the outset of the debt problems, creditors undertook a coordinated endeavor to support the adjustment efforts of developing countries and to secure an appropriate balance between financing and adjustment while meeting the need for equitable burden sharing among creditors. For countries engaged in restructuring their debts, financial packages involving support from bank and official creditors were assembled on a case-by-case basis within the context of Fund-supported economic adjustment programs, with the mix of adjustment and financing tailored to each country’s circumstances and prospects. As negotiations proceeded on adjustment programs, authorities in financial market countries and the Bank for International Settlements (BIS) were instrumental in providing immediate, temporary financial support through bridging loans.

Official debt reschedulings typically covered both principal and interest payments on medium-term and long-term loans. Financial packages arranged with bank creditors generally consisted of a debt restructuring covering amortization payments on medium-term and long-term debt, together with any arrangements necessary to ensure the maintenance of short-term credit lines. Additional funds from commercial banks, as well as from other creditor groups, were required in many cases to avoid overly rapid adjustment that could have had adverse consequences for economic growth. However, after widespread payments difficulties had emerged, banks were reluctant to extend financing on a spontaneous basis, even to countries that were undertaking internationally supported adjustment programs.

Thus, where appropriate, a “new money,” or concerted lending, package was also assembled; these packages involved equiproportional increases in bank exposure to a restructuring country and were coordinated by bank advisory committees in conjuction with the implementation of Fund-supported adjustment programs. During 1983–84, banks committed $31 billion in concerted lending, and agreements to maintain $33 billion of short- and medium-term facilities were reached.

The Fund played a key role in these efforts by helping to design and by monitoring adjustment programs for debtor countries, by mustering financing from official and commercial sources to support economic policy reforms in debtor countries, and by seeking to encourage mutually consistent economic policies in industrial countries through the Fund’s surveillance function. In this process, close cooperation between the Fund and other creditors, in particular commercial banks, developed. The Fund, together with member countries and creditor banks, assumed a more active role in helping to catalyze adequate financing to support adjustment programs as the concerted lending approach to the provision of new money was adopted.

Multiyear Restructurings and Enhanced Surveillance

The immediate threats of the debt crisis—potential defaults by indebted countries and international banks with adverse consequences for the international financial system and the world economy—were thus handled relatively successfully. But by mid-1984, creditors and debtors realized that the debt situation had to be seen in a longer-term perspective: solutions would take longer than had originally been anticipated, but annual reschedulings required too much time of all participants and did not provide the stable framework required for growth-oriented adjustment.

Creditors were therefore willing to enter into longer-term arrangements with countries that had already made progress in adjusting their economies in order to facilitate their return to more normal access to commercial credit. Such longer-term arrangements appeared particularly appropriate in cases where countries were confronted with bunchings of amortization payments that appeared to inhibit spontaneous financing flows. Banks have negotiated multiyear (debt) restructuring agreements (MYRAs) with 12 countries since 1984, under which $135 billion has been rescheduled. Official creditors, under the aegis of the Paris Club, have agreed MYRAs with three countries.

Restructurings by both official and bank creditors normally depended upon a Fund arrangement being in place so as to give creditors assurance that policies pursued by the debtor in question would help restore external viability. However, it was considered inappropriate for a member country to covenant with banks that it would continue to request Fund arrangements for the number of years covered by a MYRA, in particular for a country that was expected to normalize creditor-debtor relations during this time. Thus, creditors and member countries sought ways to keep the Fund involved in advising a country on the design of its economic programs and in monitoring developments without a formal Fund-supported arrangement but with a closer involvement than under normal surveillance.

The enhanced surveillance (ES) procedure was therefore developed. The cornerstone of ES is a country’s preparation of a quantitative financial program that sets out major macroeconomic targets and policy objectives for the coming year. The Fund reviews such programs and, through half-yearly consultation reports, monitors the progress achieved in the implementation of programs and evaluates a country’s economic performance. These reports are made available to commercial banks to facilitate their credit assessment.

The Fund’s Executive Board has approved ES procedures for five countries. But actual experience with the procedure has been limited so far, since two of the five countries continue to use Fund resources instead, in light of developments in their external payments positions. Nevertheless, interest in the ES procedure remains strong, and a number of the recently agreed MYRAs envisage the possibility of ES after the expiration of an arrangement to use Fund resources.

The Baker Initiative and the “Menu” Approach

Despite the considerable progress achieved by 1985, debtor countries remained highly vulnerable to unfavorable developments in the world economy: growth in industrial countries decelerated in 1985; non-oil commodity prices in dollar terms declined by 13 percent; and oil prices declined by 5 percent. Many indebted countries continued to experience internal and external imbalances, but “adjustment fatigue” began to emerge as per capita incomes in many countries remained below pre-1982 levels. Finally, a major concern was that financing to developing countries had slowed down substantially—in particular, the growth of bank lending had declined progressively to an increase of only 1 percent in 1985.

It was against this background that the U.S. Secretary of the Treasury, James A. Baker III, launched an initiative at the Annual Meetings of the Fund and the World Bank in October 1985 to reinforce the debt strategy. The initiative stressed the validity of the case-by-case approach, emphasized the responsibility of industrial countries for an expanding world economy and open markets for developing countries’ exports and contained three mutually reinforcing elements: strong growth promoting adjustment and structural reforms in debtor countries; a continued central role for the Fund, together with increased and more effective structural adjustment lending by the World Bank and other multilateral development banks; and additional net lending from commercial banks to support economic reforms in debtor countries.

Since 1985, multilateral development banks have continued to play an important financing role in developing countries, with a rapidly rising share of policy-based lending. Moreover, financing packages involving new money totaling $16 billion have been assembled so far during 1986-88. Nonetheless, the assembling of bank financing packages became increasingly difficult. A main reason for this was the weakening in bank cohesion resulting from a sharper divergence in their business interests and exposures. Many smaller, less exposed banks, with little strategic interest in foreign countries, tried to get out of international lending activities; as a minimum, such banks wanted to avoid contributing to concerted financing packages. But even banks that wanted to remain active in the international markets had a clear preference for shifting away from general balance of payments financing2 and rebuilding commercial ties with borrowers in developing countries, because such activities often supported the activities of banks’ clients in industrial countries.

Bank financing packages negotiated during 1984-86 already included certain financing options, such as currency redenomination, interest retiming, on lending and relending, trade facilities, cofinancing, and debt conversion. These financing options were used to accommodate the business interests of creditor banks, thus facilitating their agreement to financing packages while providing concerted financing to debtor countries or maintaining existing exposure.

In light of increasing delays in assembling financing packages, additional items were added to the “menu of financing options” in 1987: early participation fees that provided an incentive to agree to a package quickly, securitization of existing bank loans and/or new money contributions that facilitated the tradability and “prioritized” the servicing of such claims, and exit bonds that allowed banks to reduce or eliminate their exposures while still contributing to the financing of a country by accepting lower interest rates and longer maturities.

A significant development has been the proliferation and more extensive use of market-based options that allow debtors to benefit from the discounts prevailing in the secondary market for bank debt. Since 1984, $8 billion in bank debt has been converted under official debt-conversion schemes; for Chile, almost 30 percent of medium-term bank debt has thus been converted. Private sector borrowers in Mexico were allowed to buy back certain types of debt at a discount in 1987, and $3½ billion to $4 billion in external debt was thus extinguished. Also in 1987, Bolivia and its bank creditors agreed to a buy-back of Bolivia’s bank debt. (See below.) And the exchange of Mexican bank debt for bonds combined securitization with debt reduction.

Low-Income Countries

The evolution of the menu approach has mainly, although not exclusively, been relevant for the middle-income countries because it applies to bank debt and financing from commercial banks. Normally, only a relatively small share of low-income countries’ external debt is owed to banks, and most of these countries need financing from official creditors on concessional terms. A recent example of an innovative financing technique used by commercial banks for a low-income country, however, was the Bolivian buy-back scheme. Using funds donated by governments, Bolivia was allowed to buy back about half of its bank debt at a price of 11 cents per dollar of face value. The Fund facilitated the implementation of the scheme by establishing a special account through which the donations were channeled.

For low-income countries undertaking strong growth-oriented adjustment programs, there was considerable progress during 1987 toward ensuring adequate flows of financial resources from official creditors. The establishment of the enhanced structural adjustment facility (ESAF) has effectively tripled—to about $9 billion—the amount of concessional resources the Fund can make available to such countries. The World Bank’s special program of action to assist the low-income debt-distressed countries of Africa has received substantial support from donors and will amount to more than $6 billion; the eighth replenishment of the International Development Association (IDA) is ready for disbursement; and the proposed general capital increase has been submitted to the Bank’s Board of Governors. Some of the regional development banks have also substantially augmented the resources at their disposal through capital increases and replenishment of funds for concessional windows. The Paris Club creditors have also extended longer grace periods and maturities on debt reschedulings for several low-income countries and are examining other possible means of reducing the cost of rescheduling, including the possibility of rescheduling at concessional rates.

III. Outlook

Significant external adjustment in many debtor countries and the strengthening of the international banking system are clearly positive results of the debt strategy. Nonetheless, serious problems remain: very few middle-income countries which required exceptional financing assistance have regained market access; external debt burdens have not generally become easier; the growth performance in most debtor countries remains unsatisfactory; and both “creditor fatigue” and “adjustment fatigue” are intensifying.

Strong cooperative efforts remain essential in the debt strategy. Continuing the case-by-case approach to debt problems is the only way in which adjustment programs and financing flows can be tailored to individual country circumstances.

Growth-oriented adjustment efforts by debtor countries remain essential; this view was stressed by the Fund’s Interim Committee in April 1988. The Committee also welcomed recent developments in the “menu approach” that could work—on a voluntary and case-by-case basis—to reduce the existing stock of debt. For low-income countries, adequate and timely assistance on concessional terms will be essential backing for programs of structural reforms and macroeconomic adjustment.

Industrial countries have a special responsibility to maintain open and growing markets for debtor countries’ exports. In this context, the progress made to date in the Uruguay Round of multilateral trade negotiations is welcome. But industrial countries also need to improve their policy coordination in order to strengthen economic performance.

The Fund is adapting its facilities and instruments in the light of recent developments and stands ready to provide a medium-term framework in which member countries and their creditors can find case-by-case solutions to debt problems. The Executive Board has studied the possibility of increasing the effectiveness of the extended Fund facility in supporting adjustment programs in member countries and catalyzing other sources of financing. Where countries have undertaken strong adjustment programs, more Fund resources may be made available, and extended arrangements may be lengthened from three to four years. In addition, the Executive Board is in the process of completing its review of a new external contingency mechanism that could help maintain the momentum of adjustment in case of adverse external developments.



The debt strategy has evolved constantly since 1982, reflecting the changing circumstances of the debtors and the creditors, in particular the greater difficulty in raising financing from commercial banks. (Raising financial assistance from official creditors has been a smoother process and the amounts and terms more predictable.) In 1982, an international banking crisis galvanized banks into swift and conceited action, making it possible for the Fund to catalyze about $45 billion in new bank finance during 1983–87. The Fund tried to encourage the quick assembly of these financing packages by delaying its own decision to approve access to Fund resources until the commercial banks had committed their financing. This process of assembling a “critical mass” has been an important technique in assuring sufficient financing for the adjustment program of the debtor, safeguarding the Fund’s resources, and obtaining a more rapid resolution of the banks’ mustering process. Through time, as systemic risk has lessened, banks have become more confident about pursuing their different business interests; competitive pressures have intensified; and the mustering of financial support for developing countries has become more difficult. These centrifugal pressures stem from the diversity of the creditor bank community, which contains over 500 international banks of various sizes with different perceptions of country situations and prospects; various regulatory, tax, and accounting environments; and, perhaps most importantly, vastly different long-term business strategies for coping with deregulation and financial innovation.

I will not repeat the evolution of financial techniques employed in the debt strategy, which is contained in Messrs. Watson and Regling’s paper, but I would just like to remind you that these innovations have been developed in part to match the more divergent interests of creditor banks with the need for debt relief, including exceptional relief, by the country. Thus, the debt problem has moved progressively over time from an international banking crisis to a problem of growth and development.

As the underlying debt strategy has evolved, several basic elements of that strategy have developed. To some extent, these elements reflect issues that were being debated when the debt problem erupted in 1982 and are still being debated, not only in the U.S. Congress but also, to some extent, in the presentations today.

First, a decentralized approach—that is, one that involves no centralized schemes—to resolving debt-servicing difficulties can be pursued. The decentralized approach keeps the bank debt in the hands of the banks that were largely responsible for overlending, and thus banks are not let off the hook. In addition, it could lessen concerns about any transfer of private risk to the public sector. Banks’ commercial relationships with the developing countries are also preserved by a decentralized market-based approach. In this fashion, countries’ eventual return to international financial markets can be facilitated.

Two, a case-by-case approach, rather than comprehensive solutions for all debtors, can be pursued. The case-by-case approach entails analyzing each debtor’s circumstances individually and tailoring both the adjustment program and the financing package to those circumstances. Thus, financing packages are differentiated based on performance—a point I will return to later. The case-by-case approach is also flexible enough to be adapted to the great diversity of experience among debtor countries. This approach has also been able to adapt flexibly to changes in the external environment—in oil prices and in interest rates, for example—that had not been anticipated.

Three, the debt strategy is a cooperative approach. A key consideration, which has not been stressed sufficiently by previous speakers, is the policies of industrial countries—their expansion of domestic demand, protectionism, and the mix between their fiscal and monetary policies, which have an effect on the level of interest rates: these are crucially important in assuring an economic environment that is hospitable to resolution of the debt strategy. Equally important are the policies pursued by the debtor countries themselves. The World Bank and the Fund collaborate to establish a framework for macro policies and structural policies that will enable debtor countries to attain sustained growth with external viability.

The creditors’ role in this cooperative approach is to provide financing to support sound policies through debt relief and new money (or other forms of assistance that reduce the debt-service burden, such as the Bolivian buy-back). In that effort, even though financing and debt relief are concerted, they remain nonetheless voluntary. No bank is compelled to contribute to a package. The voluntary nature of these packages has meant that, over time, with the decline in systemic risks to banks, a free-rider problem has emerged as some banks have chosen not to participate in financing packages while expecting to continue receiving their full interest payments. The free-rider problem has already become particularly difficult in the cases of small debtors and could extend to larger debtors.

Finally, incentives for adjustment and new financing have been an important consideration at each step in the evolution of the debt strategy. To support internationally endorsed policy packages, banks have tied their disbursements under concerted new-money packages to the implementation of adjustment policies supported by the Fund. Banks have also been innovative and imaginative in their approaches to debtor countries which have been pursuing sound policies. Examples are the Bolivian buy-back and the Mexican debt exchange, and similar innovations are in prospect for Chile and other countries. In these cases, banks have permitted the debtor countries who had accumulated more international reserves than had been anticipated under Fund programs—or, in the case of Bolivia, which had donated funds available—to use those additional funds to effectively buy back a proportion of their debts at a discount, thus blending debt reduction with debt creation (i.e., the earlier concerted financing).

The question of incentives—and, indeed, of moral hazard—extends, however, beyond those countries which have experienced debt-servicing difficulties to developing countries that have not experienced debt-servicing problems, such as India, Indonesia, Korea, and Malaysia. These countries have experienced adverse external conditions similar to those experienced by countries with debt-servicing problems, but they have managed to avoid the pitfalls because their economic policies during the late 1970s and early 1980s were substantially more successful. The question then is: What are the costs that the international system might incur, both now and in the future, by granting terms to those countries that have experienced debt-servicing problems that are more “favorable” than the terms granted to those countries that have performed well and have avoided debt-servicing problems? This question, more broadly one of moral hazard, is faced not only by central banks but also by the Fund as they attempt to chart the future evolution of the debt strategy and the international financial system.