Abstract

The sharp increase in the frequency and severity of external debt servicing difficulties has taken place against the background of a rapid rise in foreign borrowing by developing countries in recent years. Over the seven years from the end of 1974 through the end of 1981, i.e., prior to the emergence of widespread major debt servicing difficulties, the total external debt of non-oil developing countries increased at a compound annual rate of 20 percent (Table 1). In real terms—deflated by the unit value index for the exports of these countries, for example3—this debt increased at an annual rate of 10 percent. As a result the ratio of external debt to exports of goods and services rose from 1.0 to 1.2, and the ratio of external debt to gross national product (GNP) from 0.22 to 0.30.

Overview of Growth in External Indebtedness and Debt Service

Rapid Expansion, 1974–81

The sharp increase in the frequency and severity of external debt servicing difficulties has taken place against the background of a rapid rise in foreign borrowing by developing countries in recent years. Over the seven years from the end of 1974 through the end of 1981, i.e., prior to the emergence of widespread major debt servicing difficulties, the total external debt of non-oil developing countries increased at a compound annual rate of 20 percent (Table 1). In real terms—deflated by the unit value index for the exports of these countries, for example3—this debt increased at an annual rate of 10 percent. As a result the ratio of external debt to exports of goods and services rose from 1.0 to 1.2, and the ratio of external debt to gross national product (GNP) from 0.22 to 0.30.

Table 1.

Non-Oil Developing Countries: External Debt, 1973–821

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Source: International Monetary Fund.

See footnote 2 on page 1 for a definition of “non-oil developing countries.”

Covers public and publicly guaranteed debt and, where available, private nonguaranteed debt.

Debt with an original maturity of one year or less; series excludes data for a number of nonreporting debtor countries.

Principal and interest on medium-term and long-term debt and interest on short-term debt.

A major development during this period was the increasing importance of international banks as a source of funds for the developing countries. Thus, the share of debt owed to financial institutions in the total outstanding medium- and long-term public and publicly guaranteed debt of non-oil developing countries increased from 25 percent to 41 percent between 1974 and 1981. Consequently, the relative shares of debt to official creditors (which is usually of longer maturities) and debt to other private creditors declined. At the same time, short-term debt with an original maturity of one year or less increased at an unusually rapid pace. Between 1979 and 1981, short-term debt of non-oil developing countries rose twice as fast as medium- and long-term obligations, and by the end of 1981 it accounted for nearly one fifth of total debt outstanding of the non-oil developing countries. Over the same period, the rate of growth of short-term debt also exceeded by a substantial margin the rate of expansion of trade.

Debt service payments—comprising interest payments on total outstanding debt and amortization on long- and medium-term debt—of the non-oil developing countries increased at an annual compound rate of 23 percent over the seven years through 1981, somewhat faster than either their outstanding debt or their exports of goods and services, and the ratio of their debt service to their exports of goods and services rose from 14 percent to 20 percent. This rapid growth of debt service reflected primarily the rise in external debt outstanding and, to a lesser extent, the increasing share in total debt of bank credits at variable interest rates, combined with the sharp rise in international interest rates in recent years.

The relationship between the growth of medium- and long-term debt and debt service, on the one hand, and the growth of exports, on the other, varied considerably among various subgroups of non-oil developing countries. These differences may help explain in part the much greater incidence of debt servicing difficulties among some groups than among others. Asia was the only region where exports of goods and services of non-oil developing countries actually grew faster than their medium- and long-term debt from 1974 to 1981. Although these countries faced the same difficult international environment as did other developing countries, their aggregate debt service ratio only rose from 8 percent to 9 percent over this period, although there were important differences among individual countries. For the African countries, medium- and long-term debt increased over 80 percent faster than exports and, as a result, their debt service ratio more than doubled from 7 percent to 15 percent. The Latin American countries, which had entered this period with by far the largest debt and the highest debt service ratio, recorded the most rapid increase in debt of any region during 1974–81. Their debt increased 27 percent faster than their exports and their debt service ratio rose from 28 percent in 1974 to 42 percent in 1981. By the end of 1981, Latin American countries, which accounted for 43 percent of the debt of non-oil developing countries, were paying 57 percent of the debt service of that group of countries.

By economic classification of countries, the major exporters of manufactures among the non-oil developing countries accounted for 37 percent of the debt and 46 percent of the debt service by the end of 1981, and the corresponding figures for the net oil exporters were 23 percent and 27 percent, respectively. The low-income countries in this group of non-oil developing countries accounted for 17 percent of the outstanding debt but for only 4 percent of the debt service, as official creditors provided the great bulk of lending to these countries. At the end of 1981, the 20 major developing country borrowers4 owed 72 percent of the total outstanding debt of all developing countries and 81 percent of the debt service obligations due in 1981. For this group, 63 percent of their debt was owed to banks. The rapid increase in short-term debt noted above was largely attributable to these countries; at the end of 1981, one fourth of their debt was short term, compared with less than 10 percent for other developing countries.

Onset of Difficulties, 1982

The total external debt of non-oil developing countries is estimated to have increased by only 12 percent in 1982, considerably less than the average rate of expansion over the preceding seven years. New disbursements on medium- and long-term loans declined by 20 percent compared with 1981, while principal repayments rose sharply. The growth of short-term debt outstanding continued to decline, largely as a result of the slowdown in commercial bank lending, the causes of which were discussed in detail in International Capital Markets.5 The reduction in gross flows to the developing countries extended across all types of debt, all regions, and all classes of creditors.

The rate of increase in the debt service payments of non-oil developing countries also slowed in 1982, although the effects of a decline in the average nominal interest rate on outstanding debt of almost 1 percentage point was offset by a 22 percent increase in the amortization due on medium- and long-term loans. However, despite the slowing of the growth of total debt service payments, the aggregate debt service ratio for non-oil developing countries rose from 20 percent in 1981 to 23 percent in 1982, as export earnings actually declined by 3 percent. The increase in the aggregate ratio was accounted for almost entirely by Africa and Latin America, as the debt service ratios for other regions were broadly unchanged. By economic subgroup, the debt service ratio rose most sharply for net oil exporters and for the low-income countries.

In this environment of a marked reduction in new lending, a continued—albeit slower—rise in debt service, and declining export earnings, the number of developing countries experiencing external payments difficulties increased significantly. Payments arrears, which had remained at about US$5–6 billion over the preceding five years, rose to US$18 billion at the end of 1982; and many countries, including some of the largest debtors, approached their creditors for a rescheduling of debt service payments.

In light of the role of commercial bank financing, and the growing importance of bank debt restructurings, the following section reviews some salient characteristics of bank lending during this period.

Evolution of Commercial Bank Financing6

While the individual country experiences forming the basis for this paper are quite diverse, some generalizations on the evolution of bank finance may be useful. Of the non-oil developing countries that either have restructured or were in the process of restructuring their bank debt between 1978 and the third quarter of 1983, all experienced a period of very rapid increase in international bank loans prior to the development of debt service difficulties. The bank debt of countries engaged in restructuring increased by 25 percent per annum in the five years to 1981, compared with about 19 percent for the remaining non-oil developing countries (Table 2). As regards the countries that commenced negotiations or reached agreement with banks on debt restructuring since the end of 1982, their bank debt rose even more rapidly—by 28 percent annually—during this period.

Table 2.

Growth Rates of Banks’ Claims on Selected Group of Countries, 1978–821

(Percentage)

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Source: Calculations based on data from the Bank for International Settlements, International Banking Developments.

Weighted average of rates of growth for each country group. Derived from data on the stock of claims, which were not adjusted for exchange rate variations.

Average annual compound rate of change.

For the group of non-oil developing countries there was a marked and sustained increase in bank debt of less than one year remaining to maturity during the 1978–82 period, with the share of such debt in total bank debt rising from 41 percent to 46 percent (Table 3). While short-term debt, no doubt, increased substantially for some countries subsequently involved in bank debt restructurings, Table 3 shows that the share of debt with less than one year remaining to maturity was not very different, at least in aggregate, for the groups of countries engaged in restructurings and for other countries. However, if short-term debt to banks is related to countries’ claims on banks—which is an important component of their foreign exchange reserves—very striking differences become apparent (Table 4). The increase in the ratio of short-term debt relative to claims on banks and the high values of this ratio for countries involved in bank debt restructurings suggest that these countries had generally become vulnerable to any disruption or even to a temporary slowdown in new finance. Scaling debt service payments by export earnings or import payments yields similar results.

Table 3.

Bank Debt of Less Than One Year Remaining to Maturity as Percentage of Total Bank Debt, 1978–821

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Source: Calculations based on data from the Bank for International Settlements. The Maturity Distribution of International Bank Lending.

For countries with more than US$100 million in total debt to banks.

Unweighted average.

The sample size of two makes the median a meaningless concept.

Table 4.

Bank Debt of Less Than One Year Remaining to Maturity as Ratio to Total Claims on Banks, 1978–821

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Source: Calculations based on data from the Bank for International Settlements. The Maturity Distribution of International Bank Lending.

For countries with more than US$100 million in total debt to banks.

Unweighted average.

The sample size of two makes the median a meaningless concept.

In a number of countries, bank funding accompanied a surge in export receipts associated with the rise in commodity prices that characterized the late 1970s. With the subsequent stagnation or decline of many commodity prices, the willingness of banks to accommodate further large increases in their exposure to a number of countries declined. More specifically, an important source of subsequent financing difficulties for some oil exporting countries may be found in the initial overestimation of future oil revenues by both the country and the lending banks involved. On average, debt of oil exporting developing countries to banks grew by 16 percent annually between 1977 and 1981. However, the debt of the two oil exporting countries included in this paper grew, on average, at an annual rate of 33 percent, well above the rate for any other group of countries.

With few exceptions, bank lending expanded rapidly prior to the onset of payments difficulties, and often financed a widening current account deficit associated, inter alia, with expansionary fiscal policies. Particularly in some of the more recent cases, capital flight and rising interest payments pre-empted a growing part of the commercial financing inflows. Often the emergence of payments difficulties was anticipated by a sharp slow-down in the rate of growth of bank lending, sometimes accompanied by a pronounced shortening of maturities, which eventually led to a request to negotiate a debt relief arrangement. In earlier periods, these developments often took place over several years, and there was generally a marked slowdown in the growth of bank lending well before the commencement of difficulties.

However, the emergence of serious bank debt problems since mid-1982 occurred much more abruptly and, as a result, it was not generally accompanied by a marked slowdown in the growth of bank lending over the calendar year prior to the commencement of difficulties. For more than half of the non-oil developing countries for which data are available, debt restructuring discussions started after a year in which bank credit growth either approached or exceeded the average rate of expansion for the non-oil developing country group as a whole. In some other countries, the rate of expansion in bank debt in the year prior to the restructuring discussions was relatively low but still positive. This is in sharp contrast to the findings in External Indebtedness of Developing Countries, as all countries then reviewed had experienced a year of negative growth in net bank credit prior to requesting a bank debt restructuring.

Regardless of the speed with which a debt restructuring was sought, experience shows that additional bank credit became difficult to obtain once negotiations were under way. As a result, undisbursed commitments to countries reviewed in this study declined very sharply in 1981 and 1982 relative to total debt outstanding (Table 5). As a large number of negotiations have taken place since the second half of 1982, and as many countries that had rescheduled debt in earlier years subsequently negotiated new restructuring arrangements, it is not possible to draw firm conclusions at this stage regarding future access to international capital markets once bank debt has been restructured.

Table 5.

Undisbursed Commitments as Percentage of Total Bank Debt, 1978–82

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Sources: Calculations based on data from the Bank for International Settlements. The Maturity Distribution of International Bank Lending.

Unweighted average.

The sample size of two makes the median a meaningless concept.

Sources of Debt Servicing Difficulties

While the causes of debt servicing problems are not the principal focus of this study, some specific factors contributing to the recent intensification of difficulties are discussed briefly below. However, it must be emphasized at the outset that the economic and financial circumstances, as well as the policies pursued, have differed widely among those countries that have sought a rescheduling or refinancing of their external debt obligations. These differences were apparent both in the period immediately preceding the onset of debt servicing problems and also in respect of underlying developments and policies pursued over a longer period. While it is possible to identify certain sources of debt servicing difficulties that were present in many countries, or that played a major role in specific country groupings, firm conclusions cannot be drawn regarding the relative importance of the various factors involved.

In most of the countries concerned, the emergence of debt servicing difficulties reflected a combination of adverse external developments and inadequate domestic economic management, including insufficient adjustment to external events. As regards adverse exogenous shocks, starting in 1979 many non-oil developing countries and centrally planned economies were affected by the second large increase in oil prices, the prolonged recession of the early 1980s, and the rise in real interest rates. The oil price increase led to a marked deterioration in the terms of trade of the non-oil developing countries as a group. It should be noted, however, that, reflecting different degrees of dependence on energy imports, the effects were far from uniform among individual countries: indeed several countries in the group that experienced difficulties were actually net oil exporters. The severe and prolonged recession in industrial countries induced an overall decline in nominal prices of primary commodities, which exacerbated the deterioration in the terms of trade of many non-oil developing countries and also directly affected the growth of export markets. The softening of world oil prices in 1982 and 1983, together with production cutbacks, intensified already existing balance of payments pressures in some of the oil exporting countries, although it has had a positive effect for countries that are net oil importers.

A common and important factor present in varying degrees in all countries facing debt difficulties was the drastic change to relatively high real interest rates. Through much of the 1970s low or negative real interest rates were an important influence in encouraging the uptake of debt. In contrast, the sharp increase in nominal rates from 1979 was subsequently sustained at a time when world inflation was declining, and this resulted in very high real rates of interest; this was particularly true when the nominal rate of interest paid by some countries on their external debt was viewed in relation to changes in their export prices. Although there has been a decline in nominal rates in the period since 1982, real interest rates have remained high, especially for this point in the trade cycle. While during the 1970s high nominal rates combined with high rates of inflation implied an “accelerated amortization” of debt,7 the high ex post real interest rates of the early 1980s implied a transfer of resources for which many borrowing countries were unprepared.

Debt servicing difficulties reflected, to an important extent, the unfavorable external circumstances described above, but these were often compounded by inadequate economic policies (including weak external debt management policies) in many of the countries concerned. While, in general, countries tried to adjust to adverse external events, the adjustment undertaken was often either unduly delayed or was not on the scale necessary to restore external viability. Excess demand and balance of payments pressures often originated in the area of public finances and were reflected in large fiscal imbalances. Most frequently this resulted from insufficient control over current expenditures. Furthermore, in several instances where capital expenditures were a major element underlying expanded domestic demand, projects were often not viable, involving low rates of return and financing terms inconsistent with the gestation period. The financing of budgetary imbalances, apart from leading to sharp and unsustainable increases in external borrowing, frequently resulted in an expansion of domestic credit and in inflationary pressures. As a result, exchange rates often became unrealistic and domestic cost-price distortions tended to become more prevalent. The consequent loss in competitiveness strained the external current account position, while the internal and external imbalances were also encouraging speculative capital outflows, thus further increasing pressures on the country’s external reserve position.

The importance of bank borrowing in financing current account deficits in those countries encountering debt servicing difficulties differed markedly. Broadly, the countries concerned were in two groups. One group comprising the African countries and some of the smaller Latin American countries had relatively limited access to bank credit to finance their current account deficits. Except for occasional large inflows associated with major projects, bank borrowing generally financed less than 25 percent of the current account deficits of this group. For the other group of countries, such borrowing accounted for 50 percent or more of the current deficits and, in some instances, approached or even exceeded the current account deficit.

One might have expected the increasing reliance by developing countries on commercial bank financing to have resulted in economic policy management consistent with maintaining market credit worthiness so as to ensure continued access to private financing. However, access to substantial and growing net lending flows from commercial banks often tended to facilitate the expansionary demand and incomes policies described above and, in some countries, the maintenance of an unrealistic exchange rate. In several instances recourse to external finance delayed the necessary adjustment of domestic policies.

As regards the sequence of events immediately preceding the debt restructuring operation, experiences again varied considerably. In some instances, countries experienced a gradual drying up of external medium-term financing flows over a number of years and had recourse to shorter-term credits and exceptional financing on relatively less favorable terms, while running down foreign exchange reserves and frequently building up payments arrears on debt service and imports. The underlying deterioration in their external debt situation often became acute with the disruption in normal trade-related financing and the inability to secure normal rollovers of short-term financial debt.

For other debtor countries, however, the onset of debt servicing difficulties was rather more sudden and was sometimes brought on—or at least triggered—by regional events. This was true, first, for some countries in Eastern Europe and, later on, for some Latin American countries where banks’ perceptions of lending risks were influenced by the difficulties experienced by neighboring countries. In particular, even though in some instances major banks may have concluded that such countries were following prudent policies, uncertainty regarding the willingness of smaller lenders to continue to expand or even maintain their exposure in the light of problems in neighboring countries led gradually to the view that there was an increase in the riskiness of continued net lending. The heavy reliance by some of the countries in the affected regions on bank financing for their current account financing needs, and the large rollover requirements associated with the high share of short-term debt relative to foreign reserves and export earnings, made many countries quite vulnerable to even a slowdown or temporary interruption of bank lending flows. In these circumstances, fears became, to some extent, self-fulfilling as bankers’ concerns resulted in a marked decline in net inflows or even in net withdrawals of funds. This latter situation was more typical of countries that had relied relatively heavily on bank financing—generally the higher-income developing countries.

The following section summarizes the efforts of debtor countries to seek a resolution of the debt servicing difficulties just described by approaching official creditor groups and international banks to reschedule or refinance their external debt obligations.