The Use of Commercial Credits By Developing Countries For Financing Imports of Capital Goods
Author: International Monetary Fund. Research Dept.
Publication Date:
01 Jan 1970
eISBN:
9781451956276
Language:
English
Keywords:
SP; CMEA country; export; price; market; revaluation; export price; export unit value; price change; export volume; revaluation effect; Exports; Commercial credit; Credit; Export credits; Imports; Western Europe; Africa; Eastern Europe; Global; Europe; Asia and Pacific; capital goods; debtor country; grace period; public funds; Export-Import Bank; Insurance
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This paper is a revised version of a Fund staff study prepared at the request of the United Nations Conference on Trade and Development (UNCTAD), pursuant to a Resolution adopted by UNCTAD at its Second Session held in February–April 1968.1

Abstract

This paper is a revised version of a Fund staff study prepared at the request of the United Nations Conference on Trade and Development (UNCTAD), pursuant to a Resolution adopted by UNCTAD at its Second Session held in February–April 1968.1

I. Introduction and Summary

This paper is a revised version of a Fund staff study prepared at the request of the United Nations Conference on Trade and Development (UNCTAD), pursuant to a Resolution adopted by UNCTAD at its Second Session held in February–April 1968.1

The Resolution invited attention to the following questions: (1) To what extent should commercial credits be adapted to promote development as well as trade? (2) How should their acceptance and use be controlled by both recipients and lenders? (3) Should the terms be softened, and what would be the implications for both aid and trade? (4) Should the question whether any new institutional arrangements are needed to alleviate harmful developments in the field of commercial credit be further studied?

Following a description of the factual background (Section II) and of the evolution of techniques in the commercial credit field (Section III), the paper proceeds to an analysis of the issues raised in the terms of reference. The first question, concerning the extent to which commercial credits can be adapted to serve the needs of development, and the third, referring to the effects of softer terms on trade and aid, are examined together in Section IV, which deals with the adaptation of financial terms. The following two sections take account of the second question relating to the control of the acceptance and use of commercial credits. The term “acceptance” is interpreted to cover the quantitative aspects of control (Section V), while the term “use” is related to its qualitative aspects (Section VI). The paper does not examine the last question raised in the terms of reference.

Trade credits, including suppliers’ credits and contractor finance, have been the subject of recent studies by the UN Secretariat2 and the staff of the International Bank for Reconstruction and Development (IBRD),3 and problems associated with them have been discussed in international forums for a number of years. The preparation of this paper has benefited from discussions with officials in national governments and international agencies concerned with commercial credits and from written memoranda on the subject sent by the authorities of a few countries.

Scope of the study

While commercial credits are associated with the movement of all types of goods in foreign trade and range in maturity from under 90 days to over ten years, this study is concerned with the use of extended term credits in connection with the trade in capital goods. Except for transactions of small value, the trade in capital goods is usually financed with longer-term credits, i.e., credits exceeding one year. This study does not cover the trade in other goods that is normally financed with credits of up to 180 days, with somewhat longer terms extended for such commodities as agricultural inputs, road vehicles, and certain consumer durable goods. There have been instances of longer-term credits associated with the sale of certain agricultural commodities; these can be regarded as exceptions to the concept that credit terms should not exceed economic life, usually interpreted to mean the time taken for the commodity to be absorbed into the production process. There have also been sales on extended credit terms of military equipment by the major exporting countries; these credits are also not covered by the study.

The concentration of the study on the financing of capital goods should not be construed to carry any judgment that only those credits contribute to the development process. Commercial credits that finance the trade in other goods are also important in promoting the use of external funds in financing the current trade transactions of developing countries. This function comes to light when, for some reason, there is an interruption in the normal flows of trade credits. The affected country is forced to divert domestic savings to the financing of its foreign trade and to restrict imports when the margins for such diversion are exhausted, with disruptive consequences for orderly development processes. Despite their importance, short-term trade and banking credits have been excluded from the purview of this study, partly because statistics on them are sparse. Commercial credit flows to the developing countries from the group of countries belonging to the Council for Mutual Economic Assistance (CMEA) are also not covered; these credit flows are often merged with movements on bilateral payments accounts or are included without specific identification in bilateral economic assistance data. The study, therefore, is restricted to commercial credit flows from the other industrialized countries to developing countries.

Definitions

For purposes of this study, a working definition of commercial credits has been adopted in terms of certain typical features, viz., (1) the obligation of the buyer to make a downpayment prior to shipment; (2) the absence of explicit grace periods, with repayment generally commencing on completion of shipment; (3) an amortization schedule providing for periodic equal installments with no accumulation of maturities at the end of the repayment period; (4) the charging of a “commercial” rate of interest; (5) the confining of the credit to foreign exchange costs, exception being made only for such local currency costs as are directly associated with the implementation of a contract; and (6) the eligibility of the credit for national export credit insurance, a facility presently available in most capital goods exporting countries. With the exception of the last-mentioned, these features are also generally found in “public” export credits extended by specialized credit institutions drawing their funds mainly or wholly from official sources, such as the Export-Import Bank of the United States (hereafter referred to as the U.S. Eximbank), the Kreditanstalt für Wiederaufbau (KfW) in Germany, and the Export Development Corporation in Canada. The declared purpose of these and similar institutions is to promote the exports of their respective countries, and in formulating the terms of credit they have generally adhered to the usual terms offered by the trade.

The operations of such institutions are presently reported in statistics compiled by the Organization for Economic Cooperation and Development (OECD) and the IBRD as part of official flows, although recently the Development Assistance Committee (DAC) of the OECD has divided official flows into “official development assistance” and “other official flows,” with all “public” export credits recorded as part of the latter category. The exclusion of “public” export credits from the definition of commercial credits would, however, affect both the coverage of the statistical aggregates and the quality of the analysis, because essentially identical transactions would receive different treatment. For instance, export credits extended by the Export-Import Bank of Japan are classified as private credits on the formal ground that they are extended to Japanese exporters. There is no important difference, however, in the operations of this institution and, say, the U.S. Eximbank of the KfW when they lend directly to the buyer of capital goods. Hence, export credits from these “public” agencies are included in commercial credits for purposes of this paper.

In their upper maturity ranges, commercial credits show similarities to “aid” credits. Several exporting countries designate as “aid” certain types of transaction involving commercial funds. Their decision is made on the basis of a blending of public with commercial funds so as to bring about modifications in the terms and conditions of commercial credits, especially to reduce the rate of interest. The reduction in the cost of the credit is believed by these countries to justify the classification of such transactions as “aid.”

The interaction between commercial credits and “aid” constitutes an important part of this study, and despite the inherent difficulty of adopting objective criteria for separating these transactions, it is unavoidable for purposes of this study that some basis for making a distinction be found. Aid transactions are defined as official flows having a high concessional or grant element.4 Because of the possible ambiguity of the term “aid,” reference will be made to “concessionary” flows, in contrast to “commercial” flows. Furthermore, concessionary flows are assumed to be motivated by the interests of the recipient country (as well as those of the exporting country) and this motivation may be said to have an objective reflection in the involvement of the recipient government in the approval of the use of concessionary funds in the framework of inter-governmental agreements.

Finally, deriving from the definition of a “concessional” element is the usage of the terms “softening” or “hardening” the terms of credit. Given a specific discount rate, the concessional element in a transaction is increased as the rate of interest is lowered, or the maturity period lengthened, or both; hence, “softening” of terms is defined as any step that tends to raise the concessional element in a transaction. The word “adaptation” is used when, apart from “softening,” it is intended to cover other changes in typical commercial terms, e.g., reducing downpayments, or increasing the percentage of associated local currency costs, or lowering insurance/guarantee costs.

Summary

Commercial credits to developing countries have shown a sharply rising trend in recent years. Gross commitments for credits exceeding five years reached an annual rate of $4 billion in 1968, compared with less than $1 billion in 1963. The rise in credit flows has been at a faster rate than the growth of trade in capital goods; it has also reflected the changing characteristics of capital goods exports, the requests from developing countries for larger credits on extended terms, and the intensified competition among industrial countries. The geographical distribution of credit recipients indicates that the more advanced developing countries account for most of the recent flows, and there is some evidence to suggest that the flow has corresponded in a general way to the economic size and the phase of development of the principal recipient countries.

The adaptation of credit and insurance facilities to the changing needs of the export trade in capital goods has taken two lines. On the one hand the principal exporting countries have sought through legal, institutional, and other innovations to put themselves in a position to meet competition on credit terms, in particular that emanating from tied aid. On the other hand, they have sought to standardize the terms and conditions applying to the trade in capital goods through understandings of the Berne Union, and through ad hoc agreements. Other techniques of adaptation have been designed to partly insulate the costs of export credits from domestic interest rates, to facilitate the financing of large projects, and to allow greater flexibility in the use of credits in combination with other types of capital flows.

These adaptations in the commercial credit field have contributed to the rising net flow of credits from developed countries. With the demand for imported capital goods outpacing their foreign exchange earnings, commercial credits have been providing a growing element in the net flow of financial resources to developing countries. Their importance is likely to grow as industrialization proceeds, and their contribution to the development process could be enhanced with certain adaptation to their terms. Provided that a developing country is otherwise able to carry additional credits on commercial terms, some lengthening of the maturities to correspond more closely to the payout period of projects and the introduction of appropriate grace periods would be desirable modifications in support of sound projects in developing countries. Also, the covering of a greater portion of local costs than is customary might be helpful in certain circumstances, especially where the capital structure of enterprises and the state of development of domestic financial markets in a developing country would otherwise preclude the undertaking of highly productive projects.

As for the general softening of commercial terms, the arguments are somewhat inconclusive, partly because of the inherent difficulty of predicting the likely effects of changes in the terms of commercial credits on the volume, terms, uses, and geographical distribution of concessionary flows and partly because of differences in the interests of the recipient countries at different phases of development. Deliberate action to reduce interest rates and insurance charges, while possibly alleviating the foreign debt servicing burden, would require direct or indirect subsidization and would run contrary to the efforts of the international community to avoid the use of subsidies in export trade; it might also constrain the flow of commercial funds to the developing countries, as well as leading to misallocation of resources.

Insofar as commercial credits are used to finance repetitive transactions or result from continuing relationships between financial groups in exporting and importing countries, the management of commercial flows under normal conditions requires the maintenance of sound internal policies that permit commercial debt to be “rolled over,” with the possibility of the “float” rising in line with the growth of the country’s economy. Where credits are associated with the financing of nonrepetitive transactions of substantial value, the holding of an appropriate relationship between the rate of accumulation of commercial debt and the various indicators of debt servicing ability is important. When balance of payments difficulties endanger the servicing of external debt, the application of limitations on the further contracting of commercial and other external debts is likely to become necessary. These limitations might range from prohibitions affecting certain categories of debt to flexible ceilings that permit the authorized level of outstanding commercial debt to increase by a specified amount. In both normal and exceptional conditions, the collection and analysis of data of foreign debt obligations is an essential element of debt management, and to this end a registration procedure is recommended in normal circumstances for the private sector and a prior authorization procedure for the public sector.

Greater attention to the use of commercial credits by both recipients and lenders is necessary. In the borrowing country, the need is to adopt the right combination of economic policies (especially in regard to the pricing of capital and of foreign exchange) so as to create a general environment that is conducive to sound decision making by both the private and public sectors. In addition, problems have arisen, especially in the public sector, at the project level, and improved use of commercial credits might call for more adequate selection, preparation, and efficient implementation of projects in this sector. The lending agencies can exercise some degree of selectivity by (1) subjecting large projects to a closer scrutiny not only in respect of the creditworthiness of the recipient but also with reference to the economic returns from the project; (2) supporting joint financing arrangements under the auspices of the IBRD; and (3) experimenting with the use of general lines of export credit extended to development finance companies or similar financial intermediaries in the recipient country.

II. The Factual Background

In this section an attempt is made to analyze the main factors that have affected the trends in commercial credits during the period 1956–68, including the sources, destinations, and uses.

The data

Statistics on the flow of commercial credits to developing countries are compiled by the OECD and the IBRD. OECD data relate to principal creditor countries, which are members of the Development Assistance Committee (DAC) or the Group on Export Credits and Credit Guarantees (ECG), while the IBRD data used in this study are based on regular reports from debtor countries.

The coverage of neither source of information is complete.5 The statistics from the creditor sources are restricted to transactions in respect of which the exporter has been insured and/or the institution financing the transaction has received a guarantee from an export credit insurance agency. However, many multinational firms selling to affiliates, branches, or subsidiaries in developing countries do not always use insurance/guarantee arrangements for covering commercial credits. The same is frequently true of a number of large commercial enterprises, which have long-established connections in particular developing countries. In addition to these uninsured credits, the statistics on insured credits do not always make adjustments for the noninsured portion of credits. It is difficult to estimate the uninsured component of insured credits; it usually ranges between 5 per cent and 25 per cent of the credits, depending upon the policies of various credit insurers.

The IBRD information covers external debts contracted from private sources (including suppliers and financial institutions) by governments and their agencies, or by the private sector if guaranteed by an official agency in the debtor country. However, a substantial volume of commercial indebtedness has no official links in the debtor country and thus is not reported. In addition, reporting countries have often failed to include certain transactions that are in fact conceptually covered by the system, such as credits guaranteed by publicly owned banks. IBRD reporting does not cover military credits.

The present study uses data from the two sources for different purposes: while creditor reporting is used primarily to depict flows of credit to developing countries over the recent past, the debtor statistics are used primarily to analyze the outstanding amounts of commercial indebtedness of recipient countries and the associated debt service.

Trends in private insured and public commercial credits

According to data published by the DAC, the net flows of guaranteed private export credits6 to developing countries were at a yearly average of about $400 million during the period 1956–59.7 Since 1960 the net flows have shown a steady increase, reaching an amount of more than $1,743 million in 1968 (see Table 1 and Appendix II, Tables 11 and 12, for the distribution by lending countries).

Data on gross flows8 are not available on a comparable basis for the period prior to 1967, and there are statistical gaps even in the recent period. For 1967–68 available data indicate that the flows averaged US$4.5 billion a year and in 1968 were roughly equally distributed between credits up to five years and credits over five years. The average gross flows for credits over five years were approximately twice the average net flows; credits over one year but not exceeding five years averaged about seven times the net flows, which is indicative of the substantial repayments relative to new commitments associated with credits having short-term and medium-term maturities.

Table 1.

Net Changes in Insured Credits 1 Extended to Developing Countries by Member Countries of the Development Assistance Committee, 1956-68 2

(In millions of U.S. dollars)

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Sources: Appendix II, Tables 11 and 12.

Net flows relate to commitments to insure export credits or disbursements, inclusive of interest less cancellations in respect of credits repaid in a given year.

The OECD (DAC) classification of developing countries has been used in this paper.

Preliminary estimates.

An important feature in the development of commercial credits during the 1960’s has been the increasing role of credits over five years. The share of net insured credits with maturities over five years increased from 23.3 per cent in 1956 to 26.5 per cent in 1960 and to 73 per cent in 1968. Although comparisons between credits of up to five years and over five years must be interpreted with caution,9 data for a few countries indicate that insured credits in excess of five years were rare prior to 1960 (for public credits, see below). In Belgium only 4 per cent of insured export credits including credits under one year were for more than five years in 1955; their share in total credits had risen to 13 per cent in 1960 and to 45 per cent in 1968. In Germany no insured credits exceeding five years were reported before 1961; their share in total credits was 26 per cent in 1965 and increased to 41 per cent in 1968 (see Table 2). In Japan credits insured over five years were 11 per cent of the total export proceeds insurance in 1956; their share had risen to 85 per cent in 1968.

Table 2.

Gross Flows of Insured Credits1 Extended to Developing Countries by Member Countries of the Development Assistance Committee, 1967-68 2

(In millions of U.S. dollars)

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Sources: Organization for Economic Cooperation and Development, Geographical Distribution of Financial Flows to Less Developed Countries, 1966–1967; Appendix II, Tables 11 and 12; staff estimates.

Gross flows relate to insurance contracts in respect of credit commitments and precede disbursements by varying periods.

Figures on insured credits over five years are not comparable with data in Table 3. The former cover the insured component of credit commitments or disbursements and are inclusive of interest maturities; the latter represent contract values and are inclusive of downpayments. Figures in Table 2 may also include amounts that were refinanced during the year.

Preliminary estimates.

Staff estimates.

Totals have been split between up to and over five years on the basis of the ratio applicable to other countries.

The trend of insured credits over five years can also be traced from 1957 onward in data collected by the ECG. As shown in Table 3, the annual commitments to developing countries rose from small beginnings in the late 1950’s to more than $1 billion by 1965. In each year thereafter there has been a steady increase to an annual rate exceeding $3.2 billion in 1968.

Table 3.

Commercial Credits Exceeding Five Years Extended by Members of the Group on Export Credits and Credit Guarantees to Developing Countries, 1957-681

(In millions of U.S. dollars)

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Source: Organization for Economic Cooperation and Development, Trade Committee, Group on Export Credits and Credit Guarantees.

Includes sales of ships to Liberia and Panama: 1968—$580 million; 1967—$465 million; 1966—$245 million; 1965—$204 million; 1964—$125 million; 1963—$96 million.

Preliminary estimates.

Public export credits exceeding five years increased slowly during the period 1957–59; thereafter they showed a continuous increase reaching $760 million in 1968. The figure of $1,080 million in 1967 reflects the exceptional level of commercial aircraft exports from the United States. The U.S. Eximbank was the only source of such credits until 1962. Thereafter, public export credits have also been extended by way of direct loans to foreign buyers from the KfW as well as refinancing credits to national exporters and by Canada through loans extended by the Export Credit Division of the Export Credit Insurance Corporation, which was reorganized in 1969 as the Export Development Corporation.

Sources of commercial credits

The cumulative net flows of private insured credits may be taken as a measure of the contribution of each creditor country and its share in the outstanding amounts. According to this measure, Japan appears as the most important source with one fifth of the cumulative net credits extended (see Table 4 and Appendix II, Tables 11 and 12). It is followed by Germany with 18.4 per cent, France 16.0 per cent, Italy 13.4 per cent, and the United Kingdom 12.5 per cent. These 5 countries account for more than four fifths of the cumulative credits; they are followed by Switzerland with 6.5 per cent, Belgium with 3.7 per cent, and the United States with 2.8 per cent.

Table 4.

Sources of Insured Credit Extended to Developing Countries by Members of the Development Assistance Committee

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Sources: Appendix II, Tables 11 and 12.
Table 5.

Outstanding Commercial Credits in Selected Countries

(In millions of U.S. dollars)

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Sources: Table 8 and Appendix II, Tables 13 and 14.

Net change in guaranteed private export credits extended by members of the OECD and by Australia.

IBRD preliminary estimates for privately placed debt excluding bonded debt.

On December 31, 1967.

On September 22, 1968.

On June 30, 1968.

Table 6.

Major Recipients of Commercial Credits Exceeding Five Years Extended to Developing Countries by Members of the Group on Export Credits and Credit Guarantees, 1963–68

(In millions of U.S. dollars)

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Source: Organization for Economic Cooperation and Development, Trade Department, Group on Export Credits and Credit Guarantees.

Preliminary.

Table 7.

Share of Selected Developing Countries in Commercial Credits, Gross National Product, and Current Foreign Exchange Receipts and in Relation to Share of Manufacturing in Gross Domestic Product1

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Sources: Organization for Economic Cooperation and Development; author’s estimates.

Commercial credits cover combined flows of insured and public export credits exceeding five years in maturity and extended by ECG members in 1963–68. Data for 1968 are preliminary, GNP figures are at factor cost for 1967. Foreign exchange receipts are for 1968. Data for share of manufacturing production in GDP are for 1966 except where specified otherwise.

1967 data.

Table 8.

Credits Contracted or Guaranteed by Public Sector in Recipient Countries

(In millions of U.S. dollars and per cent)

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Source: Appendix II, Table 14.

1967 data.

On June 30, 1968.

Merchandise exports.

Table 9.

Commercial Credits Exceeding Five Years Extended to Developing Countries by Members of the Group on Export Credits and Credit Guarantees, by Purpose, 1963–68

(In millions of U.S. dollars)

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Source: Organization for Economic Cooperation and Development, Trade Committee, Group on Export Credits and Credit Guarantees.

Preliminary data.

Power plant and transmission equipment included under heading “Power.”

Including components and spare parts.

Table 10.

Average Cost of Financing Export Credits in June 1966 and December 1968

(In per cent)

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Source: UN, Department of Economic and Social Affairs, Export Credits and Development Financing: Part I, Current Practices and Problems (1966), p. 11, and Part II, National Export Credit Systems (1969), p. 2.

The 5.5 per cent rate applies only to transactions with developing countries and includes the insurance premium. The interest rate is 7.25 per cent for transactions with other countries.

The Export-Import Bank of Japan participates in joint financing with the commercial banks and charges between 4 per cent and 7 per cent, while the commercial banks apply rates of between 8.5 per cent and 9.0 per cent of their portion of loans; this gives a weighted average of about 6.0 per cent.

Prior to 1962 the rate was 1 per cent above the bank rate, with a minimum of 5 per cent; in January 1962 the London clearing banks and the Scottish banks agreed to finance medium-term export credits backed by a bank guarantee at a rate of 5.5 per cent for a minimum period of two years for the export of capital goods. The rate for transactions carried out under an ordinary insurance policy is 7.5 per cent to 8.5 per cent. In December 1968 the interest rate for export credits of up to two years was the current Bank of England rate with a minimum of 4.5 per cent.

This rate applies to export credits of over two years.

The small U.S. share in cumulative net credits is a reflection of the relatively recent origin of its insurance/guarantee program. While such facilities were established by most European countries during the inter-war period, the U.S. program was organized by the U.S. Eximbank in collaboration with a number of private insurance companies in 1961. In effect, there has been a contrasting evolution of facilities: the United States has moved from specialized institutional financing for exports toward insurance, while a number of European countries have moved from exclusive reliance on the insurance mechanism to the activation of specialized arrangements for export credits.

If gross data for both private insured and public credits exceeding five years are considered, Japan appears to be the most important source of commercial credits to developing countries, accounting for almost 28 per cent of the total credits extended in the period 1963–68. However, given the much greater share of Japan in the financing of ship exports to “flag-of-convenience” countries, its credits to developing countries are probably less than indicated by the unadjusted figures. The United States accounts for about 23 per cent of the total. These 2 countries are followed at some distance by Germany with 11 per cent, France with 10 per cent, the United Kingdom with 10 per cent, and Italy with 8 per cent. These 6 countries account for more than 90 per cent of the total insured and public export credit flows in recent years.

Destination of commercial credits

The outstanding commercial indebtedness of developing countries at the end of 1967 is analyzed on the basis of IBRD data, which cover commercial debts10 that are officially contracted or guaranteed in 76 countries. A comparison of these data with the cumulative net flows of private insured credits reported by the DAC over the period 1960–68 for 20 countries, which account for about four fifths of the respective totals, is made in Table 5.

The IBRD figures are substantially higher than the cumulative net insured credits for 13 of the selected countries. The divergence is primarily attributable to the fact that the cumulative DAC figures exclude outstanding credits at the start of the period 1960–68. A part of the difference may be explained by reference to the age of the debt. In countries such as Argentina, Brazil, and Mexico where the differences are large, considerable flows occurred prior to 1960, and substantial repayments on older debts have tended to reduce the net increase in insured credits in the period 1960–68. Also, the proportion of insured credits in the lending country may be lower than the proportion that is officially guaranteed in the borrowing country: this results when exporters or financiers in the lending country do not ask for insurance cover. The relatively low level of outstanding commercial indebtedness of Colombia and Venezuela might be attributable partly to the fact that they have availed themselves of banking credits from the United States for import financing that generally are not insured.11

For 7 countries, however, the opposite situation applies, i.e., the outstanding amounts, as reported to the IBRD, are less than the cumulative net changes in insured credits. While for 2 of these countries the IBRD data are less recent, the primary explanation appears to be the predominant weight of the private sector borrowing compared with the public sector, with the presumption that the former has no official guarantee in the debtor country. This is true for the two flag-of-convenience countries (Liberia and Panama) and is probably also true for Greece, the Philippines, and Nigeria. These discrepancies, among others, underline the need for caution in interpreting the available data.

Data on the destination of credits exceeding five years are available for the period 1963–68. These figures tend to support the evidence of geographical concentration indicated by the data on outstanding commercial indebtedness. The share of the 15 selected countries shown in Table 6 is more than 71 per cent of total credits. A substantial part of the credit extended to Liberia and Panama has been for the purchase of ships registered in their territories but with ownership located in developed countries. The share of these 2 countries has risen from 11.4 per cent in 1963–65 to 14.6 per cent in 1968. Three countries in Europe account for 16 per cent in 1963–65, rising to 18 per cent in 1966 but declining in 1968 to 9 per cent. Five countries in Latin America account for a substantial share, rising from 18.8 per cent in 1963–65 to 19.7 per cent in 1968. In this group, Mexico alone accounts for about 8.2 per cent of total credit extended to developing countries in the period 1963–68. Finally, 5 countries in Asia account for almost one fourth of the total credits, and India alone accounts for 9 per cent. Gross credits exceeding five years in maturity have therefore been extended predominantly to about a dozen developing countries in recent years; these include most of the largest—in population and gross national product (GNP)—developing countries, some of which have also been the main recipients of concessionary lending. The rest of the developing world together accounts for an average inflow of about $600 million a year.

There is some evidence to suggest that the flow of credits in recent years has corresponded in a general way to the economic size and phase of development of the principal recipient countries. Table 7 assembles the available data on the same countries selected for Table 5, except that Liberia and Panama have been excluded. For India, Mexico, Spain, Yugoslavia, Iran, the Philippines, Greece, Pakistan, Kenya, and Nigeria there is a reasonable correspondence between their ranking in recent credit flows and their economic size as measured by GNP and current foreign exchange earnings. Similarly, countries attracting large commercial flows also have a relatively large manufacturing sector, as shown in the last column of the table.

Two countries—Argentina and Brazil—record much lower credit flows than their economic size would appear to warrant. This is primarily a reflection of their cautious policies after a period of rapid accumulation of commercial debt which had resulted in a multilateral rescheduling of commercial debt. India, which accounts for the largest use of commercial credits, has a lower share of manufacturing production in its gross domestic product (GDP) than most of the other important recipients: this may reflect, however, the underestimation of output of small-scale manufacturing enterprises in India’s GDP.

External debt service

On the basis of IBRD data on outstanding external indebtedness that is officially contracted or guaranteed, the commercial debt of 76 countries at the end of 1967 was roughly 20 per cent of the total debt (see Appendix II, Table 14). The following frequency distribution shows the ratio of outstanding commercial credits to total debt.

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Almost three fourths of the countries represented have a ratio of less than 25 per cent. The lowest category includes 8 countries that report no guaranteed commercial debt. The high-ratio countries, i.e., those with a ratio over 25 per cent, include Argentina, Ghana, Korea, Mexico, and Peru.

Table 8 shows the structure of the outstanding foreign debt and debt servicing for the 20 selected countries. For each, the ratio of service payments on commercial debt to total debt service payments substantially exceeds the ratio of commercial debt to total debt; this is a measure of the large difference in terms between commercial and official loans. The same conclusion is derived from data available to the IBRD for 76 countries; the ratio of service payments on commercial debt to their total debt service was 41 per cent, while the ratio of commercial debt to total debt was only 20 per cent.

The following frequency distribution gives the ratio of commercial debt service to current foreign exchange earnings; it shows that few countries had a ratio higher than 9 per cent. In certain cases, the ratio has been influenced by debt reschedulings.

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Factors affecting growth of commercial credits

The rising flow of commercial credit to developing countries described previously is an integral part of the general extension of credit facilities associated with a growing volume of world trade. It also reflects an increase in the proportion of engineering goods in the total on which credit terms are customarily extended for periods exceeding one year. According to a study by the General Agreement on Tariffs and Trade (GATT),12 the share of engineering products in world exports rose from 19.1 per cent in 1955 to 31.1 per cent in 1960 and to 57.8 per cent in 1966. Exports of these goods to developing countries increased from $6.1 billion to $13.3 billion over the period 1955–66, more than 95 per cent being exported by the Western industrial countries and Japan. However, there is evidence that the growth of credits was at an even faster rate than the growth of exports on capital goods. The proportion of credits in excess of five years to export sales of machinery and transport equipment doubled between 1963 and 1967; the proportion remained virtually unchanged in the sales among developed countries, while for developing countries it rose from 8 per cent in 1963 to 20 per cent in 1968. No credits in excess of five years were extended to CMEA countries in 1963; in 1967 the proportion of credits to export sales was about one third.

An explanation for the growing proportion of commercial credits to sales is found partly in the nature of goods exported and partly in the pressure from developing countries for larger credits on extended terms and the growing competition among the industrial countries, which has led them to respond to some degree.

Requests from developing countries for purchases on extended credit terms increased as the demand for capital goods exceeded what could be financed out of their own resources. The accumulated foreign exchange reserves of a number of them in the war years were spent in the 1950’s when their export earnings were increasing at a slower rate than desired. Direct private investment was attracted to countries with natural resources, such as those having petroleum and other mineral deposits, or to countries having strong historical ties with metropolitan capital markets or important associations with countries willing to provide capital. In a number of developing countries these advantages did not exist. In some, the policy of public ownership of industrial enterprises or the insistence on a high proportion of national ownership in such enterprises discouraged potential private investors.

Another traditional channel for acquiring capital, viz., bond flotations in the capital markets of developed countries, recovered only slowly from the disruption of the 1930’s and 1940’s. Access to capital markets was restricted prior to the achievement of currency convertibility in the late 1950’s and still has not been fully restored. Moreover, many of the developing countries were newly independent and their creditworthiness was not yet well established.

Assistance from national governments or their agencies and from international institutions became the principal new source for capital flows to developing countries. Lending in this form was to a large extent to governments and often was tied to infrastructural projects. However, the developing countries also needed financing for other types of investment, e.g., the replacement of obsolete equipment, the expansion of existing industrial units, or the creation of new ones, for which the supply of government funds or those from international institutions, including the International Finance Corporation, was limited. In these circumstances, buyers in developing countries sought to cover part of their capital outlays with financing arranged by their suppliers.

Suppliers found it possible to respond to these pressures as the gradual liberalization of exchange controls allowed them to extend credits for longer periods; suppliers also found it necessary to respond in view of intensifying competition in markets for capital goods. Sales on credit were not necessary in the sellers’ market prevailing in the immediate postwar period. However, production expanded rapidly following the recovery of the economies of Western Europe and Japan, and a growing proportion of output moved into international trading channels. From the mid-1950’s “international exchanges of engineering products began to grow consistently and increasingly more rapidly than production.” 13 Table 9 shows the main purposes for which credits in excess of five years were extended to the developing countries in the period 1963–68. Ships (including components and spare parts) appear as the largest single category. Credits associated with their sale increased from US$172 million in 1963 to over US$1 billion in 1968; sales to developing countries were in excess of US$400 million in the latter year even after adjustments are made for the two flag-of-convenience countries mentioned earlier. While prior to 1960 the terms for ships were typically under five years, they have gradually lengthened to seven to eight years. Power plants represent a second major category, where there was an increase from US$116 million in 1963 to about US$650 million in 1968. There has been a trend toward the adoption of larger generating units, as power loads have grown sharply. Many public utilities have found it practicable to purchase high unit-value equipment only if payments could be met from operating revenues that accrued over considerably longer periods than five years. Another element has been the trend toward the purchase of sophisticated industrial plants on a “turn-key” basis where the supplier of equipment has also provided construction and engineering facilities. Moreover, in contrast to the pattern found in most developed countries where investment often takes the form of additions to existing plant by established enterprises, the sale, against buyers’ credits, of complete plants to new enterprises has entailed the provision of extended credit facilities because of the longer time required for the construction and “running-in” of new plants.

III. Evolution of Techniques

The adaptation of credit and insurance facilities to the changing needs of the export trade in capital goods has taken different forms, depending on the structure of the financial system, the nature of the existing institutional arrangements for export financing, and the development of the insurance industry. In a few exporting countries with flexible and broad-based financial systems, the need for changes in credit arrangements has been minimal; the modifications of insurance facilities have been sufficient to ensure the availability of export credits in the form needed. On the other hand, countries with specialized institutions for financing export transactions beyond the short-term maturities of the normal trade flows have found that modifications in the statutes and operating procedures of their institutions combined with minor changes in their insurance schemes were usually sufficient to achieve the objective of maintaining a competitive position for their exporters. In the intermediate group of countries there has been a need for organizational changes in the credit institutions, involving the setting up of new credit agencies or new forms of cooperation between existing ones, combined with innovations in insurance techniques. Finally, in a number of countries public funds have been mixed with commercial financing in order to achieve needed adaptations.

Whatever the changes in the arrangements adopted in the last decade or so, the objectives have been similar: to enable credit institutions to grant credits for longer periods; to insulate, to the extent possible, the cost of export finance from changing domestic credit conditions; to allow greater flexibility in adapting commercial terms to compete against tied-aid transactions; and to enable national exporters to bid for projects sponsored by international or regional banks under “joint financing” arrangements. This section attempts to provide a brief summary of the main changes made in credit and insurance arrangements in recent years.14

Financing extended maturities

Commercial credits were increasingly extended for periods longer than five years toward the end of the 1950’s. Prior to that time, the U.S. Eximbank was almost the exclusive source of commercial financing for extended maturities. Other countries found it necessary to establish facilities for longer-term lending for reasons discussed earlier. In countries like the United Kingdom, exporters were enabled to obtain such credits following the application of the “matching principle,” under which the national insurer was empowered to match, for a specific order, terms of credit exceeding five years from shipment provided that foreign competition had official support. While some countries interpreted such support to mean credit insurance, others took the view that with aid-tying the distinction between aid and other transactions could not be drawn objectively and therefore were willing to invoke the matching principle in such cases. In some other countries, such as Canada, Japan, and Finland, either new specialized institutions for long-term export credits were established or the powers of existing ones were enlarged to the same end. In most other countries a number of “pooling” or refinancing arrangements were activated under the auspices of banking consortia or specialized agencies.

In Belgium an agency designated as Creditexport was organized to administer the funds placed in a pool by 3 public credit institutions and 13 commercial banks. A similar arrangement was organized in France under the title of Groupement Interbancaire pour les Opérations de Crédit à l’Exportation to take some of the pressure off the Crédit National in the refinancing of long-term suppliers’ credits. Export credits can be refinanced by specialized institutions in Austria (through the Kontrollbank), France (through the Banque Françhise du Commerce Extérieur and Crédit National), Italy (through Mediocredito Centrale), Japan (through the Export-Import Bank of Japan), and Sweden (through AB Svensk Exportkredit); these institutions obtain funds either in their capital markets or from their treasuries.

Buyers’ credits

The financing of long-term commercial credits for large projects and for periods in excess of five years proved burdensome for exporters who, even when benefiting from export credit insurance, remained responsible for carrying anywhere from 5 per cent to 20 per cent of the credit risk through the entire length of maturities, and also continued to bear the risk of nonpayment for those contingencies that were not covered by the insurance policy. The incidence of these contingent liabilities seriously affected the capacity of the suppliers to raise credits for their own requirements. To overcome this problem, an important innovation was introduced after 1958. In that year, the German export credit insurance company, Hermes Kreditversicherungs-Aktiengesellschaft, was authorized to guarantee credits made available by financial institutions directly to foreign buyers of capital equipment as an alternative to the usual practice of insuring national suppliers. Similar arrangements were subsequently introduced in France, Italy, and the Netherlands. The United Kingdom introduced a scheme of Financial Guarantees in April 1961 designed to enable British credit institutions to make loans direct to overseas purchasers on extended credit terms.

Since the exporter is paid in cash, under buyers’ credit arrangements, his capacity to borrow remains intact. This innovation has also enabled the buyer to arrange financing with greater flexibility from a single source or from a consortium of financial agencies at uniform financial terms and thereby has facilitated negotiations with several exporters contributing to a single project. The use of the technique has been restricted to major projects because of the need for careful dovetailing between the buyer, a number of exporters, one or more financing institutions, and the insuring agency.

In the United Kingdom, “buyers’ credit guarantees” are available for projects costing £1 million or more, excluding local expenditure. In Germany, the comparable figure is DM 5 million; the credits to the developing countries are extended by the KfW in the form of “back-up” credits, i.e., the KfW picks up the financing one year after the completion of the project (considered as a warranty period) in the developing country. The KfW reimburses any financing provided to cover the production and warranty period from other financial sources. In France, the sum would in principle be at least F 25 million and must involve transactions carried out within the framework of a single foreign buyer with French firms for the execution of a specific program; the credit duration must be of eight years or more.

Lines of credit

A variant of this technique has been used in an experimental way by some countries to facilitate smaller value transactions. An agreement that specifies a ceiling up to which insurance cover can be authorized in favor of buyers in a single country, and the commodities involved, is reached in advance of the settlement of the supply contracts or the selection of construction projects to which the loans would apply. This type of agreement facilitates the extension of lines of credit by financial institutions in the supplying country to a development or commercial bank or even a purchasing agency in the buying country. Examples of such agreements are found in several of the principal exporting countries. The United Kingdom has made such arrangements in recent years with Israel (for industrial projects), with Brazil (for a mercantile fleet and more recently for petroleum equipment and related services), with the Central American Bank for Economic Integration (for public utility projects), with Mexico (for ancillary equipment for the petroleum industry), and with Yugoslavia (for miscellaneous equipment). Japan has also used line-of-credit arrangements in the framework of agreements with Argentina, India, Indonesia, Iran, Korea, Laos, Pakistan, the Philippines, the United Arab Republic, and Yugoslavia; a global ceiling is established, with the terms for individual projects to be negotiated subsequently. An exception was made in a Japanese arrangement with Argentina where the “maximum” or “most favorable” terms were agreed in advance for transactions of small value, i.e., ¥ 5 million or less.

More recently, the use of the line-of-credit technique has been broadened in at least one major exporting country. In promising markets, the export credit insurance agency has taken the initiative to seek out business opportunities, define the scope, and settle the financial terms of credit lines with overseas buyers before the latter enter into direct commercial negotiations with exporters.

Financial credits

While in most countries the term “buyers’ credit” is synonymous with “financial credit,” the latter term has a specific connotation in a few others. In this study it refers to credits granted by banks or other financial institutions in the exporting countries to foreign buyers for financing local expenditures connected with the installation of the equipment purchased, the construction of civil engineering works by local contractors, or the purchase of supplementary material or equipment produced by local firms. While most countries’ insurers are prepared to cover out-of-pocket local expenditures only up to a small percentage of the total value of the export contract, at least one country has been prepared to cover the full amount of the credit needs for this purpose.

Financial credits are also extended in some countries for meeting downpayments. In a few countries these credits can be covered by insurance if private funds are involved. It has been recognized that the buyer often falls back on borrowing from other sources within the exporting country for meeting the downpayment and that it might be preferable to have this type of borrowing under the purview of the same insurance agency. This innovation also permits national exporters to meet the competition from tied development loans, which usually dispense with a downpayment by the buyer. One major lender does not object to the downpayment being financed by borrowing, provided, however, that the funds are raised outside the exporting country.

Mixed credits

In addition to private financial credits for meeting downpayments and associated local costs, at least one country has used the technique of the crédit mixte for the same purpose by using budgetary funds. These public financial credits have been extended in the framework of accord de coopération and to some countries without such an accord.

The mixing of public funds with commercial credits has also taken other forms. In Switzerland, for instance, the earlier maturities (not exceeding ten years) are provided by private banks; budgetary funds at a lower rate of interest are linked up to cover the later maturities with a grace period equal to the length of the commercial financing. This type of link financing has also been referred to as crédits relais or as crédits joints. Another variant of the mixed credit involves the combination of public and commercial funds on different terms for a single financial package. These are designated crédits jumelés and differ from the crédits relais in that both the public and private components are repaid in parallel. The effective interest rate of the mixed financing depends on the proportion of public and private funds. Japan provides an illustration of this type of financing in the export of ships. The Export-Import Bank of Japan administers treasury funds that are offered at interest rates varying between 4 per cent and 7 per cent, while private banks provide credits to shipyards at well over 8 per cent; the combined financing covers approximately 70 per cent of the ship’s price, and both loans are repaid pro tanto. The main purpose of such mixing is to reduce the effective rate of interest; these credits are also referred to as crédits bonifiés.

Another variant of mixed credit is “parallel financing,” involving the provision of public funds to cover the difference between the proportion of the transaction covered by an export credit insurance policy and the lower proportion of financing provided by private banks. Such financing needs arise when the banks are not prepared to go up to the limit of insurance cover. In Germany, for example, the KfW granted parallel financing through the early 1960’s in respect of the portion of the insured transactions that a private banking pool, the Ausfuhrkredit-Aktien-gesellschaft, did not finance.

Insulating credit costs

A major purpose of the various mixing arrangements described above has been to increase the available funds for export financing and to maintain interest rates relatively stable in the face of changing domestic conditions so as to meet competition from abroad on credit terms. In some countries, however, the insulation of export financing is not done in this manner but takes the form of special rediscounting privileges at the central bank or refinancing arrangements with specialized institutions. Rediscount facilities at the central bank are normally confined to short-term and, less frequently, to medium-term credits. The United Kingdom has another technique as well; portions of export financing that can be rediscounted at the Bank of England are treated as part of the liquid assets that the commercial banks are required to maintain. Since they are in lieu of treasury bills or cash that the banks would otherwise have needed to hold, the banks have been able to maintain a rate of interest of 5½ per cent for financing under ECGD bank and financial guarantees.

Fixed preferential interest rates are frequently applied to the refinancing of export credits. In France, the Crédit National applies preferential interest rates to refinancing and receives government subsidies to the extent that it has to borrow on the capital market at higher rates than the preferential rate. In addition, specialized export financing institutions in a number of countries maintain fixed low interest rates, e.g., the Export-Import Bank of Japan, the Kontrollbank in Austria, and Mediocredito Centrale in Italy.

Interest rate subsidies, especially through budget appropriations, relating to commercial credits have increasingly been used to the same end. Interest rate subsidies are granted by Mediocredito Centrale to an export credit financing institution if it lacks sufficient funds to rediscount export bills under its normal facility. These subsidies are derived either out of net profits or through resources provided by the Government of Italy. In Belgium, the Ministry of Foreign Trade through budget appropriation can grant subsidies upon the advice of the committee for the promotion of exports of Belgian capital goods, especially established for this purpose.

As a consequence of these special financial arrangements, the average cost of financing commercial credits has become relatively uniform among major exporting countries (see Table 10). The average rates charged are usually lower than market rates and have been subject to little change in recent years, through 1968.

Joint financing

Since 1965 the IBRD has cooperated with governments and export credit institutions in major capital goods exporting countries in financing selected projects in a few countries. In 1968 these arrangements applied to three projects in Colombia and one project in Mexico. Export credits with a minimum repayment period of ten years financed a proportion of the amount of certain contracts equal to one half for Colombia and one third for Mexico. The related export contracts were negotiated under the IBRD guidelines for procurement, i.e., after full competitive bidding and independent of the terms under which the export credits were provided.

Various changes in insurance field

In most countries, the terms of credit are related not only to the nature of goods but also to the contract values. In the United Kingdom, for instance, postshipment credits of two years are not usually insured unless the contract value is over £50,000; for three-year credits the amount must be over £150,000 and for four years, over £200,000.15 In a partial modification of this policy, consideration is given to the provision of cover for aggregation of orders for specific goods, such as machine tools, on repayment terms related to the total value of such orders placed.

Another area in which evolution has occurred is in the strengthening of arrangements between credit insurers for covering contracts that involve suppliers in more than one country. Among the member countries of the European Economic Community (EEC), reciprocal arrangements exist for covering up to 40 per cent of the main contract that is subcontracted in another EEC country, provided that the contract has a value of not less than $7.5 million; the limit is up to $3 million for contracts of between $7.5 million and $10 million and up to 30 per cent for contracts exceeding $10 million. Switzerland and the United Kingdom have worked out similar collaborative agreements with a number of countries. There is increasing cooperation among credit insurers to accommodate an exporter/contractor even where the subcontracted portion is beyond the maximum specified or where the main contractor is in a country with which no formal reciprocity agreement exists.

A recent development in foreign investment insurance schemes has been the linking of such insurance to exports. In France the Compagnie Francaise d’Assurance pour le Commerce Extérieur provides cover for political and transfer risks associated with investments made by exporters in enterprises to which they have sold capital goods. The newness of the technical processes introduced and complicated installations make it difficult sometimes for the buyer to assess profitability and to operate the equipment efficiently in the earlier stages without outside assistance. In such instances he often asks his suppliers to take a share in the capital of the enterprise; the provision of insurance cover enables exporters to meet the special risks inherent in this type of participation. While the exporter is the beneficiary of the guarantee as a general rule, other parties may be given the benefit of the guarantee on a case-by-case basis, provided that the connection between the guaranteed investment and the export transaction is maintained. Most export credit insurers are prepared to cover the cost of services provided by the supplier for the installation and “running-in” of equipment.

The link between foreign investment and export financing has also been recognized in the creation of facilities in Canada through the Export Development Corporation (EDC) to insure risks connected with the establishment by Canadian exporters of offshore assembly plants, distribution networks,-or other investment prerequisites to the development of new foreign markets. In addition, the EDC is authorized to insure transactions requiring barter or complicated payments situations involving third parties, such as factoring firms and other businesses that assume responsibility for carrying the “accounts receivable” of exporters. Coverage of service and other invisible exports is also made possible. Whereas previously only engineering or other technical services were eligible, the EDC can insure against risks of nonpayment in the sale or licensing of patents, trademarks, or copyrights.

Measures to “standardize” credit terms

The techniques of adaptation of export insurance and financing described above have been accompanied by efforts to develop and to maintain orderly conditions of competition in the capital goods trades generally and in specific sectors. The rationale for these attempts at coordination of the policies of export credit insurers and their governments is discussed in the following section.

Berne Union

The earlier efforts were largely channeled through the Berne Union.16 In 1953 members of the Union came to an “understanding” to limit the maximum repayment period of insured credits to five years. This limit was applicable to credits for the financing of heavy capital goods. The ceiling was three years for light capital goods (e.g., agricultural machinery, lathes, and large commercial vehicles), 18 months for consumer durables, and 6 months for raw materials and consumer goods. At the same time, rules were established to require the exporter to assume part of the risk himself (between 10 per cent and 20 per cent) and to require the buyer to make a downpayment of 15 per cent to 20 per cent prior to completion of delivery. It was agreed that credits for which insurance cover was provided beyond five years would be notified to the Berne Union. Common policies as to terms of payment also were adopted from time to time by interested members of the Union for trade in wool, breeding-cattle, steel products, paper and pulp, electronic sorting machines, and buses; these uniform terms were sometimes applied to trade with specific countries.

By the end of the 1950’s departures from five-year limitations for heavy capital goods were becoming frequent. Longer repayment periods were granted de facto by adopting late “starting points” from which to count repayment periods. Credits extended direct to foreign buyers were considered as exempt on the grounds that the understanding did not cover them. In addition to increased efforts by recipient countries to maximize maturity periods, an important factor in this trend appeared to be the change in foreign assistance policies. Starting in 1958 certain countries, mainly for balance of payments reasons, decided to tie their commodity assistance to developing countries to procurement within their national territory. Procurement restrictions gradually became the general practice in most of the industrial countries, even where no balance of payments constraint was involved. Also, a number of countries that participated in aid coordination groups (such as the consortia for India and Pakistan under the auspices of the IBRD, or for Turkey under the auspices of the OECD) did not have statutory powers for providing aid; they stated that the only technique available to them was to support commercial credits on longer terms or to make other adaptations to such credits, such as permitting smaller downpayments, subsidizing interest rates, or making a more liberal provision for the financing of associated local costs. In other instances, budgetary exigencies, and particularly the difficulties of securing legislative approval for official long-term loans, made reliance on a mixing of public funds with commercial credits a method of making their contribution to the financing of development in less developed countries.

The Berne Union has continued to coordinate insurance policies among members, and until the early 1960’s it also effectively helped to limit the term of export credits to certain maximum periods. Since that time, departures from commonly adopted standards have become more frequent despite the precise definitions of “starting points” in 1961 and the introduction of compulsory disclosure to the Berne Union of “tied” buyers’ credits in 1962. The principle of “matching” export credit conditions has tended to spread the acceptance of more liberal terms, including those exceeding the five-year understanding, once these terms were initiated by one member. For instance, departures from the Berne Union understanding were originally confined to export credits extended to developing countries. Exports of capital goods to industrialized countries including Eastern European countries were generally financed by credits not exceeding five years. In April 1961 the U.K. Export Credit Guarantee Department facilitated the extension of long-term export credits by introducing its Financial Guarantee facility and continued its principle of applying the same credit insurance policies in relation to exports to all countries. Soon afterward arrangements were also introduced in Germany, France, Italy, and the Netherlands to enable exporters in these countries to offer longer-term export credits to buyers in Eastern European countries. Recently, long-term export credits have also been applied to sales of heavy equipment among the industrialized countries.

A major problem in the application of the Berne Union understandings has been the increasing scale on which export credits were financed from official sources, as described earlier. With the granting of long-term export credits becoming substantially dependent on government policies, adherence to the Berne Union understandings has required more cooperation among governments in the major capital goods exporting countries.

Attempts to harmonize and to coordinate export credit and export credit insurance policies have been made among governments that are members of the GATT, the EEC, and the OECD.

GATT

In formulating a Declaration to implement paragraph 4 of Article XVI of the GATT,17 a detailed list18 was prepared of measures that were considered as forms of export subsidies by a number of contracting parties. In the sphere of export credits, the following practices were listed:

  • In respect of government export credit guarantees, the charging of premiums at rates which are manifestly inadequate to cover the long-term operating costs and losses of the credit insurance institutions;

  • The grant by governments (or special institutions controlled by governments) of export credits at rates below those which they have to pay in order to obtain the funds so employed;

  • The government bearing all or part of the costs incurred by exporters in obtaining credit.

The Declaration19 entered into force on November 14, 1962 after being accepted by the Governments of Austria, Belgium, Canada, Denmark, France, Germany, Italy, Luxembourg, the Netherlands, Norway, Sweden, Switzerland, the United Kingdom, and the United States. For a number of years the Declaration has helped to avoid resorting to subsidies in the export credit field, but implicit adherence to it has weakened in more recent times, as shown by the increased use of practices to insulate export financing costs from domestic credit conditions.

EEC

Member governments adhering to the Treaty of Rome are required to refrain from providing official aid to exporters selling within the Community (Article 92) and to coordinate their aid measures with regard to exports to third countries so as to avoid distorting competition among the exporters of the Community (Article 112).

Export credit insurance institutions in the EEC countries in 1959 formed a Technical Committee to study the consequences of the Rome Treaty. This committee advised, inter alia, that policies with regard to export credits in excess of five years should be coordinated among the members. In response to this recommendation, the Council of the EEC established the Coordinating Group for Policies of Credit Insurance, Guarantees and Financial Credits (hereafter referred to as Coordinating Group) in 1960. The purpose of the Coordinating Group is to exchange information on, and to harmonize, to the extent possible, the conditions of export credit insurance and of financial credits, taking into account the understandings of the Berne Union. The Coordinating Group is also meant to promote the multilateralization of financial resources placed at the disposal of the developing countries. In 1962 a procedure was established calling for prior consultations among the members of the EEC in case contemplated export credit transactions involved directly or indirectly, wholly or partly, a government guarantee whose terms would constitute a departure from the Berne Union understandings. Export credits financed by the public sector were made subject to these prior consultations in 1965. Member governments are required to inform each other of the conclusion of bilateral agreements providing for global lines of export credit insurance, if the terms of these arrangements exceed the Berne Union understandings.

The exchange of information prior to the extension of export credits is one of the most important aspects of the consultation procedures within the EEC and makes it possible, in principle, for export credit institutions to match the terms offered by other countries of the Community. The consultations go beyond the question-and-answer procedure that is practiced in the Berne Union in that they are conducted not only with regard to the insurance of private credits but also in relation to export credits that are partly or wholly financed with the aid of official funds. The possibility of being able to match terms is thus extended over a wider range of transactions.

However, the implementation of a common policy toward export credits in excess of five years, which was recommended by the Technical Committee, but which is not required under the Treaty of Rome, has been less successful. The difficulties are due mainly to requests for matching the terms of officially supported credits extended by third countries, and to the practice of some EEC countries of using export credits as a means of channeling financial resources to developing countries. In particular, where aid consortia, consultative groups, or bilateral frame agreements exist, export credits are frequently used to supplement aid disbursements. In this connection, export credits are sometimes granted on terms exceeding the normal trade financing and approaching those of concessionary lending. Member governments also reserve the right to provide or to facilitate export financing in excess of five years in case the related contract is of special importance to an industry or area in the exporting country.

OECD

A broader cooperation with regard to export credits and export credit insurance has been sought within the OECD. On recommendation of the Trade Committee of the OECD, a Group on Export Credits and Credit Guarantees was established in 1963 with the aim of discussing policies and of improving cooperation among member governments in this field. The Group has discussed several proposals designed to promote a greater harmonization of policies and to limit credit competition among exporters. Among the more important proposals considered by the Group are (1) the establishment of an information system for credit transactions exceeding 5 years and mandatory disclosures pertaining to officially supported contracts under negotiation and (2) the setting up of a standard concerning the treatment of the local cost element in officially supported credit transactions tied to exports and an information procedure to be followed for transactions deviating from the standard.

In 1964 the Government of the Netherlands made a proposal for containing credit competition arising from tied-aid funds. Briefly, it was proposed that there be a maximum repayment period of 5 years for all export credits with industrialized countries and for small export credit transactions with developing countries; the latter would enjoy a ceiling of 8 years for contracts exceeding $1.5 million and of 10 years for contracts exceeding $5 million. The normal rules for credit terms, i.e., those pertaining to percentage of downpayment, local costs, equal installments, and percentage of insurance cover, would be applied to such credits and credit guarantees. Tied-aid credits would have a minimum maturity period of 15 years. In sales to developing countries, there would be a “buffer” or “neutral” zone stretching from 5 to 15 years for small contracts, from 8 to 15 years for contracts of more than $1.5 million, and from 10 to 15 years for contracts of more than $5 million. The mixing of commercial credits with official aid funds in a single “package” would be prohibited, and the matching of commercial credits with aid credits would not be permitted. The proposal was discussed during the period 1964–66 in the OECD, but no agreement was reached.

One variant of the Netherlands’ proposal, which has been discussed in the EEC, would provide for demarcation according to the end-use of the credit, in order to take into account the needs and circumstances of the underlying transaction. Under this variant, export credits would be reserved exclusively for industrial projects characterized by immediate profitability and rapid amortization. Tied public credits would be used essentially to finance projects with long-term profitability, particularly infrastructural projects requiring relatively long amortization periods and low interest rates. Export credits would have a maturity not exceeding 10 years. Public credits would not be granted for such maturities nor for the same purposes, except in untied form.

Attention within the OECD has shifted from a search for general solutions to the problem of credit competition to reaching agreement for standardizing the credit terms on specific commodities. Arrangements among certain governments cover aircraft and ground satellite communication stations. An agreement was adopted in June 1969 by an OECD Council Resolution relating to credit terms for ship exports. The understanding, as approved by 13 of the world’s principal shipbuilding countries, provides that, for all ship export contracts to be negotiated from July 1, 1969, export credits backed by governments should conform to the following conditions: a maximum duration of 8 years; a minimum downpayment of 20 per cent; and a minimum net interest rate of 6 per cent. The working of the understanding is to be reviewed by the OECD Council at least once a year.

Commercial credits from CMEA countries

The preceding discussion has focused on commercial credits extended by Western countries and Japan. Credits from CMEA countries are invariably treated by the countries concerned as official loans unless they take the form of swing limits under bilateral payments arrangements. However, certain credit facilities resemble somewhat the terms of commercial credits as defined in this study.

The CMEA countries extend three types of export credits to developing countries, namely, state credits, commercial credits, and state commercial credits; of these, the state credits are the most significant.20

State credits

State credits are usually granted on a government-to-government basis within the framework of bilateral economic cooperation agreements; the creditor country agrees to provide machinery and equipment for certain projects together with engineering services, while the recipient agrees to provide labor and locally produced materials.

The state credits that are essentially for economic assistance are usually granted at an interest rate of 2.5 per cent to 3 per cent per annum and are repayable over a period of 8 to 13 years, starting one year after delivery or installation of the equipment. Repayment may be carried out in traditional export commodities or locally produced goods, including goods manufactured with the equipment purchased with the credit.

Commercial credits

Commercial credits are granted by foreign trade organizations of the CMEA countries in connection with a particular trade transaction or contract. In certain countries (Czechoslovakia, Hungary, Poland, Rumania, and the U.S.S.R.), the central bank or other credit institutions may, if necessary, refinance the credits that the foreign trade organizations or industrial enterprises have extended. In two countries (Hungary and Poland), some industrial enterprises may also grant export credits directly. The foreign trade organizations and the industrial enterprises are autonomous entities, which make decisions as to individual export credits, subject to the general guidance and supervision of the Ministry of Foreign Trade, the central bank, or other authorities.

Commercial credits proper are usually granted at an interest rate of 4 per cent to 6 per cent per annum and are repayable over a period of 1 to 8 years. A downpayment averaging 10 per cent of the contract value at the time of signature and a similar payment upon delivery of goods is normally required. Each of these payments may be reduced to 5 per cent or increased to as much as 30 per cent, depending on the type of equipment and on various economic circumstances. The guarantee of the government of the buyer’s country or of a reliable credit institution in that country is often a condition. Repayment may be carried out in exports or in convertible currencies. A gold clause is sometimes inserted in the credit contract.

State commercial credits

State commercial credits constitute a facility that has been developed since 1964. They are granted on a government-to-government basis and are not tied to specific projects; they are available for any transactions that are arranged between trading organizations in the supplying and buying countries. In developing countries where the private sector plays a significant role in the development process, the state commercial credits appear to offer greater flexibility than the state credits. The interest cost is close to that of commercial credits, but the terms of repayment are close to that of state credits.

IV. Adaptations of Financial Terms

The desire of lending countries to avoid or at least to moderate competition in credit terms, on the one hand, and the desire of borrowing countries to obtain better terms, on the other, have focused attention on the question of what changes or adaptations, if any, affecting the terms of commercial credits could be made. A number of ideas have been canvassed for inducing modifications designed primarily to soften the terms on which commercial credits are granted by lowering downpayment requirements, reducing interest rates and insurance premiums, lengthening maturities, introducing explicit grace periods, or meeting local currency costs associated with projects. In this section an attempt is made to outline the arguments at two levels of discourse, i.e., the merits of modifying terms generally and the merits of specific types of adaptation.

Maintaining net resource transfers

Proponents of the view that the terms of commercial credits should be softened emphasize the role of these credits as an adjunct to the flow of external resources for financing economic development. The net increase in insured credits over the period 1956–68 has permitted a rising net resource transfer to developing countries, notwithstanding the fact that the customary terms associated with commercial flows give rise to repayment flows of substantial proportions in a relatively short period of time. It is argued that if these net transfers are to be maintained or even increased, the terms of commercial credits have to be modified to prevent or to moderate the emergence of debt servicing problems and to assure an equitable distribution of benefits between developed and developing countries.

As indicated in Table 2, the net transfer attributable to insured credits is a fraction of the gross flows in the period 1967–68.21 If the net flow of commercial credits to developing countries is to be maintained at any particular level, the gross flows have to be continuously increasing and must reach high levels in a fairly short period of time. Chart 1 illustrates this point for different sets of terms. On “standard” terms of 6.5 per cent and a maturity of 5 years, the gross inflows required to maintain a net transfer of $100 per annum must be doubled in 4 years and quadrupled by the eighth year. If the maturity period is lengthened from 5 to 10 years, with the interest rate unchanged at 6.5 per cent, the required gross inflow is doubled by the sixth year and more than quadrupled by the twelfth. If the interest rate is reduced to 3 per cent and the maturity period placed at 10 years, the gross inflow still has to double in the seventh year and almost quadruple in the fourteenth. By comparison, it can be shown that to maintain the same net flow on the revised “DAC average” terms (e.g., at 2.5 per cent interest with 30 years to maturity, including 8 years of grace), the required gross inflow has to be doubled only by the twenty-first year.

Whether a sufficient softening of terms to make a meaningful difference to net resource flows to developing countries can be achieved in the commercial credit field depends on the practicability of finding the means to this end and ensuring that the benefits of “softening” can be restricted to developing countries. The description of techniques in Section III has indicated that “mixing” of public with commercial funds has been the principal instrument for achieving any marked modification of terms. Rediscounting arrangements at central banks have generally been confined to short-term, and infrequently to medium-term, export credits. Since public funds have usually to be appropriated through legislative processes, a budgetary constraint might become a primary element in determining the growth of credits, which have hitherto responded largely to capital market forces and to the underlying flows of trade.

Chart 1.
Chart 1.

Required Gross Inflows to Maintain a Net Inflow of 100 Units Annually

(Selected alternatives)

Citation: IMF Staff Papers 1970, 001; 10.5089/9781451956276.024.A002

Moreover, there is no assurance that net commercial flows to developing countries would necessarily grow if softening techniques were applied. Indeed, a diversion of available commercial funds increasingly toward the more developed countries could occur with a corresponding effect on the rate of growth of lending to the less developed countries. This is based on the contention of the authorities in exporting countries that it is difficult for them to discriminate among groups of importing countries with respect to credit terms. There is pressure from manufacturers and traders dealing in given products to be allowed to extend the same credit terms regardless of the particular destination of individual transactions. To the extent that such distinctions cannot be maintained, the softening of terms, especially through the use of public funds, may involve a transfer of such funds to the developed countries and away from the developing world. Competition on credit terms has already produced, as indicated in an earlier section, a fairly narrow range of interest rates of between 5½ per cent and 6½ per cent. With borrowing costs rising throughout the world, the relative stability of rates in the commercial credit field resulting from official action has made it increasingly attractive for even large enterprises with dependable financial connections in their own money and capital markets to opt for commercial financing abroad when purchasing capital goods. While in earlier years the developing countries were almost the sole recipients of credits exceeding five years, a growing volume of such credit has been extended since 1963 to other countries. From about 3 per cent of total insured credits exceeding five years in maturity, the share of developed countries had risen to about 17 per cent in 1967. In the same period similar credits to the CMEA countries had risen from 7 per cent to almost 18 per cent; prior to 1963 no credits exceeding five years were reported for the latter group.22 A major softening of commercial terms might thus tend to increase the flow of commercial funds to the developed countries, which will, in any case, be seeking credit facilities for purchasing highly expensive replacement units in such areas as commercial aviation (air buses, supersonic aircraft), power plants (e.g., nuclear reactor stations), and industrial chemicals (e.g., petrochemical plants).

Assuming that larger gross flows of commercial credits will be forthcoming for the developing countries, the introduction of public funds for softening commercial terms could have unwelcome distributional effects. As noted in Section II, the more advanced among the developing countries have accounted in recent years for a preponderant share of commercial credits exceeding five years. These countries have large industrial sectors capable of generating projects that are typically suited to commercial financing on present terms. Even if softer terms could bring into the ambit of financing projects not now eligible, the availability of complementary factors of production, especially of managerial and administrative talent, may pose difficulties in project formulation for the less developed among the developing countries. A softening of terms for commercial credits may not prove to be of much assistance to a large number of these countries who might need softer terms on general welfare grounds. There might be other adverse distributional effects through the interrelationship of public funds used for subsidizing commercial credits and those available for official concessionary lending, to which attention is drawn later in this section.

A separate aspect, which must be kept in mind, is the possibility that commercial credits might tend to be politicized in the course of being softened. At the present time, these flows are largely the product of market initiatives, with little interference from the national authorities who support the underlying transactions primarily for export promotion purposes. The introduction of public funds into commercial flows might result in the paying of greater attention to the political relationships with the borrowing country.

Effects of trade flows

The proponents of the view that commercial credits should not be softened emphasize their role as an adjunct to the promotion of exports of capital goods from industrialized countries to all destinations. They point to the fact that countries exporting capital and other engineering goods have disparate capacities to provide credit that reflect, among other things, the state of development of their capital markets, their international position as net borrowers or net lenders on long-term account, and the types of institution available for financing commercial transactions. If undue weight is placed on credit terms, countries that are otherwise competitive in terms of price and quality will lose business only because they are unable to provide equivalent credit facilities. This would mean that trade flows would be dictated by purely financial considerations, which would be damaging to the interests of developing countries as well as the developed ones.

The longer-range effects would, it is argued, be especially damaging to the developing countries. The more advanced among them are already beginning to export engineering products, and a number of others are building substantial production capacities in engineering industries and can increasingly be expected to develop a capability for exporting in the future. According to a GATT study,23 the value of engineering products exported by eight industrializing countries (viz., Argentina, Brazil, Hong Kong, India, Mexico, Spain, the Republic of China, and Yugoslavia) amounted to almost $0.9 billion in 1966. These countries are bound to find a particular disadvantage in competing on credit terms because of their limited financial resources and lack of appropriate institutional arrangements for providing financing on a medium-term or long-term basis. In the absence of any checks on credit competition, these and other industrializing countries would be increasingly impeded in participating in what has been characterized by the above-mentioned GATT study as “the most dynamic sector of world trade.”

In evaluating the issue of the trade effects of credit, the first point to be noted is that the credit terms tend to be fairly uniform for a substantial portion of world trade in manufactured goods, including industrial “software” and consumer durable goods. While sales of surplus agricultural products by certain developed countries have created problems for exporters in countries that do not have the advantage of similar financing arrangements, there is by and large no serious problem of credit competition in the trade in raw materials. The problem can arise primarily for the trade in medium and heavy capital goods. In this instance, there is a widely accepted practice of relating terms to the value of the export contract, and extended terms are considered only for transactions of substantial value. In these transactions, it is normal for the buyer to take account of the availability and terms of credit as well as such factors as the time of delivery of equipment and the availability of back-up service facilities and of spare parts. Recognizing the weight attached to the credit aspect in decisions concerning the best source of supply, most developed countries have, as described in Section III, put themselves in a position to provide credit terms necessary to secure any export contracts that they regard as being in their own commercial interest.

The effects of competition on credit terms on the export prospects of developing countries in the medium and heavy equipment field is a subject with ramifications in a number of areas, including the planning of industrial strategy, domestic institutional arrangements, and international marketing facilities. The problem has been referred to the UN Secretariat and the IBRD by the UNCTAD for further analysis. In the context of the present study, two points can be made. First, the ability of exporters in developing countries to compete on credit terms depends primarily on domestic credit facilities being made available for this purpose. Second, there is some question whether in this area the interest of developing countries may not be divergent, both within the group of countries and even within each developing country. As pointed out in later discussion, any softening of credit terms may carry advantages for some countries that are not easily balanced against the disadvantages that may accrue to other developing countries, e.g., those that are able to export capital goods. In addition, some of the countries that are either presently or potentially exporters of such goods are themselves large importers of capital equipment, and there is again a question of where the balance of national interest lies in any softening of terms.

In any case, the trade in capital goods is a highly competitive one. Efforts to hold down competition on credit terms are apt to break down from time to time as exporting countries have reason to deviate in respect of particular products or in particular markets or to initiate departures in areas not subject to standard terms. In any long-range industrial planning that developing countries undertake, it is necessary to recognize that the terms of commercial credit are likely to continue to evolve in response to intense competitive pressures emanating from the more advanced industrial nations as well as from the CMEA countries.

Effects on concessionary flows

Another set of arguments advanced against the softening of commercial terms relates to the likely effects on the volume, terms, uses, and distribution of concessionary flows. The volume of concessionary flows could be affected adversely to the extent that softening would require the use of public funds. For instance, the subsidization of interest costs would require official help; in some countries, budgetary subsidies are used to bring higher domestic lending interest rates in line with “international” rates for commercial credits; the same result is achieved in other countries through rediscounting facilities with specialized financial agencies,24 which in turn depend on public funds. If the assumption is made that these would be the same funds that otherwise would have been used for providing concessionary credits to developing countries, any concerted softening of commercial terms would result in reducing the volume of concessionary flows.

Other potential effects of softer terms relate to the geographical distribution as well as the uses of concessionary lending programs. There is likely to be a diversion of official funds through mixing arrangements in favor of countries with the highest credit ratings, with relatively stable sources of foreign exchange earnings (such as oil-producing or other basic mineral-exporting countries), or countries that offer the best prospects for further trade. Also, in situations where all other factors were about equal, official funds in “mixed” loans might be used for projects in the private rather than the public sector, and to that extent some developing countries might not be able to obtain financing abroad for infrastructural projects, such as roads and power facilities, which require large amounts of long-term financing.

In addition to adverse effects on volume and distribution of concessionary flows, proponents of the view that terms should not be softened in respect of commercial credits believe that there could be deleterious consequences for the terms of aid. It is argued that such credits would become a substitute for concessionary aid, because if no clear distinction is made between aid and commercial credit and if the needs of aid are regarded as being met by softening the terms of commercial credit, “harder” donors would have no incentive to soften terms further, whereas “softer” donors may feel compelled to harden their terms.

This result may ensue for several reasons. For one, countries that feel that softened commercial credits represent an intensifying element in credit competition might be forced to divert budgetary resources earmarked for aid to the protection of commercial interests, e.g., through interest subsidies. For another, countries that have applied relatively concessionary terms might find it necessary to harden them in order to improve their chances of being paid. They may feel that their own concessionary assistance increases the capacity of a debtor country to take up credit on harder terms. This is possible, for instance, for loans provided with long grace periods, which permit a debtor to undertake short-term credits during this period of relief on longer-term loans. Furthermore, if lenders are providing funds for identical purposes on different terms, it is argued that the concessionary lender, in effect, finances the repayment of harder lenders, especially if the recipient country is continuously a net borrower. The joint effect of these considerations might suggest that softening of commercial credit would reduce the over-all grant element in the aid effort.

The preceding arguments appear to carry most weight at a level of reasoning where the resources for lending abroad are assumed to be fully transferable among uses and without any legal or administrative restraints on individual decisions of the lending country. This reasoning either abstracts from motivations or assumes that motivations for concessionary and commercial credit are the same. In practice, motivations are believed to differ greatly. A number of developed countries have made a general policy decision to provide concessionary assistance, in certain instances to developing countries with which they have close relationships. An adaptation in commercial terms by a single lending country in favor of some countries (not now receiving concessionary assistance) need not necessarily detract from the provision of the concessionary funds to countries already receiving such funds. On the other hand, even if it is assumed that some countries provide concessionary funds for much the same reasons as their support for commercial credits (i.e., they view “tied aid” as credit with terms softened beyond those that currently prevail for commercial transactions), it is not clear whether softening will necessarily be at the expense of concessionary flows. It has been argued, for instance, that there is a greater likelihood of attracting concessionary funds to countries with which strong economic connections are being built up through the provision of commercial credits. This could result from procedures established by developing countries, e.g., firms tendering for projects may be required to state what financial assistance their governments would be prepared to give in the event of their securing the contract.

The possible adverse effect of softening commercial terms on the terms of concessionary flows can be regarded, at least partly, as a semantic issue. If softer commercial credits were included in “aid,” it would be easier for some developed countries that restrict themselves almost exclusively to granting such credits to developing countries to meet internationally proposed “targets” on the volume of aid (e.g., the 1968 UNCTAD Resolution) without having to grant genuinely concessionary assistance. By the same token, however, it would become more difficult for these developed countries to comply with “targets” on the terms of aid (e.g., the revised 1969 DAC Recommendation). Moreover, there is a trend of thinking in the direction of specifying a supplementary volume target for official development assistance flows (e.g., the aid target specified by the Pearson Commission), which would be clearly distinguishable from other financial flows by the concessionality of the terms and their development orientation. To the extent that such measures of “aid” performance gain operational significance among donor countries as objectives of their assistance policies, there is at least a presumption that the motivation to improve aid terms would not be reduced by measures to soften commercial credits.

The argument that genuinely concessionary lenders would be under pressure to harden terms if a net borrowing country accepts “softened” commercial credits can be valid only under certain conditions. The fact that the country is a net borrower does not mean that it necessarily has to borrow in order to repay and that it can only repay hard lenders because of the availability of softer terms from other countries. A country’s capacity to service debt is a function of a number of interrelated factors with respect to its economic growth, its rate of savings, the productivity increases associated with the use of capital borrowed in the past, the debt profile that has resulted from past actions, its internal financial policies, and the general management of its balance of payments. If capital inflows are reduced or their terms hardened, debt repayment problems could represent only one element of stress, although admittedly a very important one. At the margin, the country could curtail its consumption level or slow down its investment program while maintaining debt service, and a number of developing countries have, in fact, done so.

Finally, there are differences in views on this subject among both the lending and the borrowing countries. Those who feel strongly that the softening of commercial credits will be really at the expense of concessionary flows are in a sense assuming that other forces will not be inducing lending governments to enlarge their contributions to these flows. Other lending countries appear to act on the conviction that the use of official funds for softening the terms of commercial credits is only an intermediary step that facilitates the establishment or enlargement of programs of genuinely concessionary assistance.

There are also differences in the expectations of individual developing countries. Those that press for softer terms appear to assume that these will be in substitution for harder terms on commercial credits extended at the present time, rather than at the expense of any other kind of capital. This assumption appears realistic to some of them because they believe from past experience that they are unlikely to receive concessionary flows to any significant extent; hence, they seek only to moderate the accumulation of external indebtedness by means of softening commercial terms and may be indifferent to the prospective effect on concessionary flows to other countries. In that sense, the interests of certain of the developing countries are at variance with the interests of some others. If the volume of concessionary assistance were rising faster, there might be less emphasis by most of the developing countries on softening of commercial terms. In any case, the strength of the contending arguments turns upon differences of view regarding future aid availabihties.

Merits of alternative adaptations

The preceding discussion suggests that the general arguments for or against softening of commercial terms are not conclusive. It is therefore proposed to proceed with an examination of some of the specific types of adaptation of commercial terms that have been mooted, viz., lower downpayments and a greater contribution to meeting local currency costs associated with the implementation of contracts, longer maturities (including grace periods), and lower interest rates and insurance premiums. While these are discussed separately for expository convenience, it is important to emphasize that these aspects are closely interrelated both conceptually and in practice. A credit contract is the product often of a lengthy process of negotiation, and concessions obtained in one respect may be offset by harder conditions in other respects.

The arguments for such adaptations focus on problems of foreign debt burdens of the economy as a whole and the operations and cash flows of the enterprise. It is pointed out that enterprises established in developing countries are often new entities that do not have depreciation and other reserve funds to meet downpayments or even the associated local currency costs. Nor do well-developed capital markets exist where equity capital or longer-term debt can be raised by new enterprises. Therefore, dependence upon foreign financing is likely to be heavier than in the more developed countries. Moreover, since repayment capacity is acquired only in the course of operating the plant and equipment purchased from abroad, it may be desirable to obtain longer maturity terms. Also, new enterprises do not usually fit into an existing framework of established markets or have the advantages of a well-trained labor force and experienced management as they can be expected to do in developed countries. Finally, during the initial stages of operation the enterprise may incur losses, which would be compensated by future profits; such a situation would suggest the need for a grace period. Some of these considerations are examined below.

Downpayments and associated local costs

In the appraisal of credit risks, many export credit insurers tend to view downpayment and local costs of credit terms together. This is because they consider both to be a measure of the creditworthiness of the buyer, his interest in achieving a sound transaction, and his ability to carry through with it by mobilizing the local currency for buying the foreign exchange needed for the downpayment and that needed for domestic expenditures on installation and running of the enterprise. It is also argued that the risk of collusive behavior between the buyer and the seller is greater, the smaller the downpayment or the larger the local costs advanced by the supplier. If a small downpayment is required, the supplier might find it easier, in collusion with the buyer, to raise the contract price and hand over part of the profit margin to the buyer, thereby facilitating the buyer’s ability to make the downpayment.

Another point of view considers that the maintenance of standards on downpayments and local costs derives from strict application of principles of casualty insurance (of which credit insurance is a part). In this view, the experience from which insurance prescriptions have evolved relates to a long period in which the trade in capital goods was predominantly among developed countries. Thus, opposition to the easing of down-payment requirements may have its origins in preserving certain insurance principles rather than because it modifies in any essential way the risk of the transaction. The buyer might, and often does, borrow elsewhere to meet his downpayment obligation, so that the over-all credit risk of the transaction is not diminished perceptibly.

The practice of national insurers shows considerable variations in the treatment of downpayments. The normal rule at the present time is to ask for a downpayment of 20 per cent of the contract value (with 10 per cent being required at the time the order is placed). A number of insurers are prepared, however, to reduce the percentage, as a matter of course, to 15, usually by lowering the payment required when the order is signed, and a few will accept 10 per cent of the contract value. Some countries that wish to impart an aid aspect to commercial flows do so by lowering downpayment requirements. One country has provided cover for loans to public sector projects with downpayments as low as 1 per cent of contract value. Another has been prepared to cover contracts even when it was known that the buyer was borrowing for meeting the down-payment, provided only that the loan for this purpose was raised in some other country. Finally, there have been instances of the buyer being permitted to draw on concessionary funds, which may have been provided separately by the government of the supplying country.

There has been less flexibility with regard to the practice on local currency costs where ordinary insurance cover is provided only for meeting costs that are directly connected with the implementation of the contract and within a limit not exceeding a certain percentage of the contract value. Most insurers require that local costs covered by the supplier not exceed the amount of the downpayment and that, in case of excess, it be repaid within a few months after completion of the construction of the project.

A number of reasons have been advanced in support of a strict adherence to the rules governing local currency costs. The principal one is that the link between credits and trade flows would be broken if the local costs were to be financed by the exporting country. Governments with balance of payments problems have been concerned about the additional amounts involved in such financing, which cannot be “tied” and hence can give no assurance that the foreign exchange thus acquired will be spent in the lending country. It has also been stated that the limiting of credits to the foreign exchange cost of projects would provide an incentive to the borrowers to mobilize the local cost component from domestic sources. However, the extent to which internal funds can be mobilized is a function of a number of variables and may not be significantly influenced by an exogenous inducement. If the local currency cost of the project cannot reasonably be met out of available domestic resources to which the enterprise has access because of the state of development of domestic financial markets, there is a case for the credit covering the insured domestic currency costs, provided of course that the project has been rationally chosen and that the country’s over-all balance of payments prospect permits additional debt to be taken up on commercial terms.

Grace periods and maturities

These two adaptations can be examined together because the introduction of grace periods can in practice be considered only in the context of longer maturities; otherwise, the effect is to create a ballooning of maturities toward the end of the credit period. By and large, an explicit grace period is not associated with commercial credit, although it is implicit in the definition of the starting point from which the maturity of credit is counted.25 For most official credits the grace period is reckoned from the date of signature or authorization of the credit. For private commercial credits, it is counted from the time physical possession is taken by the buyer in his own country; since this can be a year or even longer from the date on which the commercial credit is contracted, an implicit grace period may be said to exist. There have also been recent instances where export credit insurers have provided cover for private financing to the buyer from another source (i.e., a source other than the supplier) to cover the payments to be made during the “running-in” period of the equipment.

The case for longer maturities depends essentially on the payout period of equipment. As pointed out in the IBRD staff study, sound financial practice requires that maturities “be related more closely to the useful life of the goods they finance.” 26 While this principle is recognized by commercial lenders and insurers in the sense that credits exceeding useful life are not extended, the need for tailoring maturities to the cash flows generated by the enterprise is not usually accepted. It is argued, for instance, that the borrower can generate repayment for commercial credit from domestic borrowing or from surpluses earned in operations outside the particular enterprise. For example, the enterprise may have been established by a conglomerate-type firm or by a multinational firm, which can deploy resources from elsewhere. However, many industrial enterprises in developing countries tend to be new firms, represent pioneering investments, and do not have access to such financing as is found in most developed countries where a particular enterprise will usually fit within a framework of existing facilities. An operational rule that would tailor maturity terms to payout period is not easy to devise, because the payout period cannot be determined with precision for any particular type of equipment. There is, however, a strong presumption that equipment installed in a developing country will encounter longer delays in reaching profitable production than in a developed country.27 Moreover, the longer the delays in starting up operations, the greater the need for some explicit grace period. In these circumstances a case can be made at the enterprise level for considering longer maturity periods, and including explicit grace periods, for capital goods sold to newly established firms in developing countries. For the economy as a whole the lengthening of maturities and the introduction of explicit grace periods may alleviate the debt servicing problem by shifting the burden of repayments to later periods when presumably the country will have an improved capacity to meet them.

The cost of credit may, however, be affected as a result of lengthening maturities. The longer the maturity, the greater is the departure from what the financial community in most industrial countries regards as the limits of term lending, and consequently the greater may be the desire to build a risk premium into financing costs. An example of this is the additional cost of insurance cover. The premium is usually calculated as a percentage of the over-all liability in respect of the insured transaction, including total interest accruing during the life of the credit. Hence, at any given rate of premium, the total premiums charged is higher because of the larger interest component in total payments in longer-term credits. In fact, the rate of premium itself is usually raised to reflect the risk of the longer maturity, and the resulting premium cost can be quite substantial.

Even where the interest rate appears to be fixed without reference to the length of credit in special refinancing arrangements, the effective cost of credit tends to rise with longer maturities, because insurance premium charges are usually levied on the maximum credit amount, including interest charges. For example, a basic rate of 5½ per cent is charged by banks in the United Kingdom for credits extended under financial guarantees. To this basic rate must be added a number of additional charges by way of commitment fees, negotiation and management fees, insurance premiums, etc., so that the effective cost of credit at the end of 1968 ranged between 6.3 per cent and 7.2 per cent on an eight-year credit. While some of these charges are related to the over-all amount of the credit so that their cost per annum is reduced when the maturity of the credit is longer, others, such as the management fee, are levied as an annual charge.

Interest rates and insurance premiums

The arguments for lowering interest rates relate to the debt servicing capacity of the economy and the profitability of enterprises in developing countries. It is not easy, however, to disentangle the interest component of debt service from amortization of principal, because in most instances the statistics on commercial credits do not make this distinction. The fact that insurance premiums and banking fees add significantly to over-all interest charges renders the analysis of interest costs especially difficult. With these qualifications, it can nevertheless be asserted that the rate of interest has a critical importance in the evolution of the debt service.

While the lowering of interest rates and other charges would help significantly to alleviate the debt service liabilities of countries using commercial credits extensively, substantial changes in interest cost may be difficult, if not impossible, to achieve if the predominantly private character of these credits is to be maintained. Generally speaking, if commercial rates of interest cannot be charged, private funds may not be forthcoming to facilitate some of the other adaptations of financial terms (such as meeting of local costs or the introduction of explicit grace periods) that might be found desirable under certain conditions.

At the enterprise level, a lowering of the interest rate tends to increase its profit margin and thus provides additional inducements for investment; it also facilitates the undertaking of marginal projects. However, it is also important that credit for capital goods be obtained by enterprises at appropriate terms to assure that only those investments are undertaken that promise returns sufficient to cover market interest rates.

The issue of lower interest rates also has a bearing on the allocation of resources in lending countries. As described in Section III, the insulation of interest rates on export credits has required special rediscounting or refinancing arrangements and has led increasingly to direct or indirect subsidization from budgetary funds. Any induced lowering of interest rates would probably make general reliance on subsidies almost unavoidable for most, if not all, countries and would be directly contrary to the efforts of the international community to encourage countries to forgo the use of subsidies in export trade.28

Since neither the supplier nor his financier can afford to reduce interest rates unless official support is forthcoming, an insistence on lower rates by the buyer or his authorities may be met by charging a higher price than the supplier would otherwise have asked for. At the level of contract negotiations, a slight increase in the price can be effected not only by increases in the quotations for the prime contract but alternatively through higher charges on ancillary services provided or for spare parts supplied after the award of the main contract. Only slight increases in contract values are sufficient to offset the “loss” by way of lower interest rates.29

V. The Control of Commercial Indebtedness

This section explores some of the policies and institutional arrangements at the country level that may be useful for controlling the acceptance of commercial indebtedness. The initiation of a creditor/debtor relationship requires, at the trader level, an understanding by both parties of the costs and benefits of the contemplated arrangement based on accurate information on prices and performance of the goods, the terms of credit, and the expected contribution of the goods to meeting the repayment obligations adhering to the credit. From the standpoint of the borrowing country, a prime purpose of government policy is the protection of the network of these creditor/debtor relationships in a manner that allows the flow of commercial credits to be sustained over time.

Management of commercial flows under normal conditions

For purposes of commercial debt management, a useful distinction can be drawn between credits engaged in the financing of essentially repetitive transactions and credits extended for large and singular business ventures or investment projects. In addition to term financing of spare parts for capital goods and replacement equipment, the former type of credits covers a substantial volume of inventory financing provided by suppliers. While in many instances the borrower and the lender tend to be the same from one transaction to the next, the relationship must be understood in a fairly broad sense, because the financial nexus might be a continuing one even when the underlying transactions are not necessarily repetitive. This is seen typically in transactions between principals in exporting countries and their agencies, affiliates, or subsidiaries. Similar relationships also exist between financial institutions in exporting countries and large conglomerate-type business organizations, especially in the more industrially advanced developing countries.

The “nonepetitive” type of credit transaction is usually associated with installation of complete industrial plants (as opposed to additions to existing capacity) or the construction of infrastructural facilities such as bridges and power stations. However, the distinction between these and the transactions listed earlier is a somewhat arbitrary one; in a rapidly industrializing country, manufacturing capacity may be regularly expanded, resulting in repetitive business for suppliers, or infrastructural facilities may be extended within a principal-to-affiliate relationship, as is often true in the oil industry. These transactions may be found in developing countries that rely primarily on new public enterprises for implementing their investment plans, although it is by no means restricted to them.

While overlapping in practice, there is a clear-cut conceptual distinction between the two classes of credit transaction. In the repetitive type, the principal amounts owing, much like lines of credit extended by commercial banks to their correspondents, tend to be “rolled over” in the sense that new credits are extended as old credits are paid off; the amortization of principal does not, under normal conditions, constitute a charge on the borrowing country’s resources. The primary element in the management of the “float” of revolving commercial debt is the pursuit of economic policies that engender international confidence in the borrowing country and that help to integrate its national economy with that of the world. Another ingredient is the avoidance of sharp changes in the “normal” structure of debt, the notion having a practical significance in relation to commercial debts at the shorter end of maturities; a rapid accumulation of these debts invariably draws the attention to the debtor country’s economic management and may endanger the “roll-over” process, leading to an accumulation of commercial arrears and to the onset of a debt crisis.

For commercial credits used to finance large “nonrepetitive” transactions, it is necessary to assimilate their amortization requirements into the total debt servicing obligations of the country and to apply conventional “norms” of debt carrying capacity to them.30 Since debt service competes with domestic consumption and capital formation for a share of current output, the capacity to carry external debt must be judged in the light of prospective trends in growth of output and savings and the effectiveness of policies for resolving competing claims on them. While the essential constraint on debt servicing is the ability of the economy to release resources for meeting the debt service, it may be necessary to look more closely at the stage in resource use where the constraint appears.

Since payments for external debt must usually be made in foreign exchange, the constraint may apply at the stage where domestic resources have to be transformed into foreign exchange. The most frequently used measure of debt servicing capacity, the debt service ratio relating amortization and interest payments in a given year to the exports of goods and services of the same year,31 explicitly draws attention to this aspect of the constraint. Since commercial debt tends to be of shorter maturity than official concessionary debt, it may be necessary to relate debt service within the following three to five years to the expected foreign exchange earnings of the same period. This type of indicator emphasizes the need for caution in contracting debts that tax unduly the capacity of the economy to transfer resources abroad in the near-term future.

Alternatively, the constraint may appear in public sector accounts in cases in which the debt has been contracted substantially by public enterprises. Its servicing depends primarily on the ability of the government to generate the necessary revenues while maintaining an appropriate level of expenditures without recourse to inflationary financing. In these instances, the indicator to be used would relate the debt servicing obligations over a period of time to expected government revenues. This implies that the servicing of foreign debt is solely a budgetary problem in the sense that if the budgetary financing of foreign debt obligations is met there will not be any balance of payments difficulties. In practice, debt servicing difficulties have appeared in both the budgetary and foreign exchange areas and have interacted with each other to produce debt servicing problems.

Management of commercial flows under conditions of balance of payments strain

When a recipient country finds itself in serious balance of payments difficulties, the problem of managing commercial debt acquires a new dimension. It becomes necessary to consider the application of limitations on the further contracting of commercial and other external debts. To be effective, however, the limitations must constitute an integral part of an over-all adjustment of economic and financial policies designed to correct the underlying imbalances that precipitated the problem in the first instance.

The need for limitations is obvious when the balance of payments problem is associated directly with an excessive and rapid accumulation of external debt. The distribution of existing debt may have led to a “bunching” of debt service maturities, or the rate of accumulation of various types of debt may have become so rapid as to require correction. Where rescheduling of maturities has been confined mainly to maturities on commercial credits, the excessive indebtedness may be said to have been, in part, the result of poor control over commercial credits by the recipient country as well as the inadequate lending criteria of its creditors.

The degree of limitation to be applied by the borrowing country depends upon the severity of the indebtedness problem. The most restrictive type is the prohibition by the debtor country of certain categories of credit for a given period. The purpose of this is to provide a breathing spell during which the situation is prevented from deteriorating further while the magnitude of the problem is being assessed, guidelines are being evolved for limiting the accumulation of new debts, and procedures are being applied for ensuring the orderly repayment of obligations already incurred. The effect of prohibitions is to reduce the outstanding level of commercial credits by the amount of repayments that take place during the period for which the ban is in effect.

Less restrictive is a ceiling on new authorizations up to amounts that are lower than repayments during a given period. Here again, the outstanding level of indebtedness associated with commercial credits will decline. A lower degree of restriction involves a ceiling on new authorizations equal to repayments in a given period. This ensures that the outstanding level of indebtedness will not increase. Limitations of this type can be viewed as a “standstill” device, i.e., designed to prevent the level of indebtedness in the restricted category from rising. The permitting of an equivalent amount of new credit to be contracted as old credit is repaid is helpful in re-establishing the “roll-over” process while enabling the authorities to keep the debt situation under review.

Finally, the limitation may be formulated in a way that permits the total outstanding debt subject to control to increase during a given period but by a specified amount. This type of limitation is not aimed at reducing external debt but is usually intended to change the “profile” of debt by stretching out maturities over a longer period. This occurs implicitly since debts not subject to limitation are usually longer-term debts. The effect is produced explicitly by linking the debt ceiling to maturities. With heavy debt obligations in the near-term future, the over-all ceiling may be split into subceilings covering maturities up to, say, 5 years, between 5 and 15 years, and with no limitation on credits beyond 15 years.

The lifting of debt limitations is possible after varying time lags, depending on the country’s debt position and the success achieved in implementing the stabilization program designed to correct the balance of payments problem. When a country is already in serious debt difficulties, heavy foreign debt payments relating to past debt have to be made; at the same time the stabilization measures will affect other items of the balance of payments only gradually. Therefore, the improvement in the balance of payments of the debtor country and the restoration of its creditworthiness may be a slow process, and only gradually can the foreign debt limitations be reduced and the normal flows of commercial credits be encouraged.

Administration of debt policies

The above discussion indicates some of the complexities of applying limitations on commercial credits in critical situations and the need for constant surveillance at all times. The institutional arrangements that recipient countries already maintain for these purposes differ from country to country, and national policies affecting accumulation of commercial credits have been neither universally nor consistently applied.

The foremost difficulty in evolving an appropriate debt policy is often incomplete statistical reporting. Frequently, lack of adequate data complicates the formulation of sound policies even when the authorities in the recipient country are aware of the need to initiate restrictive measures in situations of actual or potential excessive indebtedness. In many instances where there are several agencies responsible for collecting data or where the relevant agency or agencies are outside the span of attention of the central policy-making organs of administration, reporting of the over-all situation in a systematic way has not been attained. The first step in effective debt administration is complete reporting of all external obligations and its timely review by the authorities. Experience indicates that the centralizing of debt reporting in central banks has distinct advantages, even if responsibility for the formulation of debt policies lies elsewhere.

The provision of timely information does not in itself ensure that serious indebtedness problems will not arise. It becomes necessary to proceed with the establishment of clear procedures for the management of various categories of debt. In developing these procedures, a distinction is usually made between the private and the public sector. While limitations on private commercial credits may be difficult to implement for practical reasons, in principle there is no reason to exclude them from official scrutiny. Where public sector guarantees are given to the private sector credits, the latter become a contingent liability of the government, and control procedure can be similar to those applied to public sector credits. Credits carrying no official guarantee could, however, be subject to a registration procedure in order to secure full information on debt being contracted by the private sector.

Public sector credits and guarantees can be subjected to a prior authorization procedure at all times, which would tend to ensure stricter financial discipline and to improve the working of public entities. In addition, insofar as the implicit guarantee of the state enables most public enterprises to shift rapidly to foreign borrowing in order to escape the pressures exerted by domestic financial restraints under a stabilization program, a limitation of their capacity to borrow abroad may be especially necessary under certain conditions.

A survey of debt administration machinery in 25 member countries indicates that for the public sector the final approval of foreign debt transactions is usually vested in the Treasury/Ministry of Finance. In some countries where investments are generally regulated in accordance with multiyear plans, the planning office plays an important role but has no final jurisdiction except in one country. In another the Ministry of Economy and Labor has final authority. The greater incidence of treasury control on credit-financed transactions is complementary to the expenditure control exercised in respect of current budgetary or cash appropriations. In countries where the bureau of the budget or similar agency in the office of the President or the Prime Minister has authority over the allocation of budget appropriations, as well as control over implementation, experience suggests that the location of final responsibility for approval of foreign credit financed transactions in the same agency is likely to produce effective implementation of debt policies.

The practice varies greatly in private sector transactions. In countries that operate exchange controls, the proximate authority may rest in the central bank or another exchange control agency but under the over-all control of the Treasury/Ministry of Finance. This is true, for instance, in sterling area countries and also in franc area countries. In countries not applying exchange controls there is ordinarily no control over foreign credit authorizations unless a guarantee is required from an official agency (including an officially supported development bank). In some countries guarantees are extended for making foreign exchange available only at the time when repayment obligations mature. In others, the official guarantee extends to making repayment in case the original borrowing enterprise is unable to meet its obligations. Control over private sector transactions has been enforced in some instances by requiring that a guarantee be obtained from an official agency before a foreign credit can be negotiated.

While the role of the central bank in respect of contracting or guaranteeing public sector borrowing is usually restricted to that of collecting data and advising the financial authorities, a more direct role can be and often is played by it in respect of private sector borrowing. This is a reflection of the close association of the central bank with the commercial banks, through which most private sector credit transactions are channeled. Given the normal reporting procedures established by the central bank for these banks, the administration of debt policies related to the private sector by the central bank is facilitated since existing channels of contact can be employed. If the central bank has an important function in the surveillance of foreign credits, it is able to play a more effective role as a channel of communication between the financial community at home and abroad. For these reasons, the participation of central banks in the administration of external debt policies is found to strengthen effective debt management in recipient countries.

Role of lending countries

In view of the fact that insurance (and, often, refinancing) agencies in lending governments play a supporting role in the extending of export credits to developing countries, a question arises whether they can be expected to play a role in regulating the volume of commercial indebtedness. The consensus expressed by officials of principal exporting countries is that the responsibility for controlling commercial debt obligations lies exclusively with the importing countries and cannot be discharged by lenders. Authorities of one lending country have stated this point of view quite explicitly:

When it comes to granting commercial credits, creditor countries cannot be expected to enter into joint agreements on restricting their exports; experience down the years has shown that this is impossible as the positions of the exporting countries differ too greatly… . Consequently, the creditor countries themselves can hardly be expected to solve the problem of permissible volume of commercial credits, nor can it be demanded of them that they do so.

The authorities of another lending country propound a similar view. They stated that there could not be any direct role in this field for credit givers and support this by arguing that:

Any agreed restriction of offers by the individual (exporting) countries to a particular figure must imply rationing and market sharing and this is unlikely to prove politically feasible among competing exporters; it would also limit the proper scope for a developing country to shop around for the best and cheapest product.

In general, there is a feeling on the part of the national credit insurers and their authorities that they have the means of keeping the level of credit exposure in individual markets under close observation. Also, the regular exchange of information in the Berne Union, on actual commitments as well as potential commitments (in the way of “offers to insure” issued to exporters), provides a fairly reliable picture of the debt situation of selected recipient countries.

It is difficult to reconcile this position with the experience of the past decade or so, which has witnessed the multilateral rescheduling of debts in eight developing countries. In addition a number of countries have renegotiated their maturing obligations on a bilateral basis. While a few of these countries have been characterized by problems of heavy debt service payments for many years ahead, a larger number have encountered what are essentially temporary difficulties from a “bunching” of debt maturities in two to three years. This in turn has usually reflected a surge of external borrowing on relatively short terms. Even if such surges could be detected at the time when they were occurring, rather than recognized in hindsight, there is a strong predisposition on the part of the lenders to seek to maintain traditional markets. This, in itself, is a reflection of commercial rivalries in the trade for capital goods. For instance, if commercial interests in any major exporting country are successful in securing insurance cover and financial assistance to take advantage of substantial borrowing demands of a particular developing country, which they may, in fact, have helped to promote, it is not easy for the authorities of other major supplying countries to deny similar facilities to their own exporters. A mutually reinforcing lending process may be set in train during which the normal precautions of export insurance and financial agencies may be overruled by the trade-promoting objectives of the authorities. Given the rapidity with which this process can add to the accumulating indebtedness of the borrowing country and the adverse repercussions on capital flows of emerging debt problems, there is at least a presumption in favor of achieving a greater degree of coordination of policies among the agencies within each creditor government that are responsible for commercial credits. In addition, there could be a greater willingness to support the efforts of the international institutions such as the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) to forestall debt crises through greater regard for lending on appropriate terms and through improved debt management policies and procedures in the borrowing country. These efforts are described in the following paragraphs.

Role of international financial institutions

IMF

During Fund consultations with developing countries, debt management policies are discussed, especially in countries where indebtedness problems appear to be emerging. Where a heavy debt burden has arisen or where a rapid accumulation of debts is threatening to disrupt financial stability, the Fund encourages member countries to adopt corrective measures through comprehensive stabilization programs and to exercise due care in the contracting of additional external debt. Frequently, specific measures affecting the contracting of certain categories of foreign credits have been incorporated in stabilization programs that were supported by a Fund stand-by arrangement.

Direct Fund involvement has taken place in a number of instances where the burden of servicing had become critical and in the context of the multilateral renegotiation of debts. In others, limitations on foreign debt were necessary to reinforce the effectiveness of domestic credit and fiscal policies and thus help the authorities to counteract a particular area of weakness in the management of the economy.

Provisions concerning foreign debt obligations were first included in stand-by arrangements in 1959; they affected the authorization of credits for government imports. Since then, a number of Fund member countries have taken specific measures relating to foreign indebtedness, and specific commitments regarding foreign credits have been included in a number of stand-by arrangements. Over all, these measures have constituted an essential part of the programs designed to re-establish normal external payments; they have helped to speed up the restoration of confidence in the economic management of the member country and thereby have reduced the disruption of credit flows to it.

IBRD

The Bank keeps the external debt of countries under review and brings to the attention of the authorities any developments that may cause concern. Where necessary, it helps countries to improve their management of external debt.

The Bank keeps records of all public and publicly guaranteed debt outstanding with a maturity of more than one year, including the terms and service schedules of these loans. Where needed, it helps to establish systems of reporting external debt. The information based on quarterly and annual submissions to the IBRD by recipient countries is being extended by supplementing it with information from creditor countries in the DAC under the expanded reporting system established with the collaboration of the OECD.

In countries where the debt service is high relative to present and prospective repayment capacity, the Bank normally specifies the minimum levels of concessionary finance (e.g., grants and loans with maturities of over 30 years and interest rates of less than 3 per cent per annum) and the maximum amounts of medium-term loans (e.g., maturities of less than 5–10 years and interest rates of 6–7 per cent or higher) that are compatible with prudent debt management.

VI. Improving the Uses of Commercial Credits

The problems of excessive indebtedness that have affected certain developing countries in recent years have directed attention to the uses to which external credits are applied. In fact, misuses have occurred in respect of both investments financed partly from abroad and those financed solely by domestic resources. The analysis of this section is, however, focused on ways of improving the quality of investments financed by commercial credits.

Possible misuse of commercial credits

The danger of poor investment uses arises from a number of overlapping factors. First, the normal practice on the part of commercial lenders of restricting credit to the financing of the foreign exchange component of projects can lead to resource misallocation. A country relying substantially on commercial financing has an incentive to influence its investment priorities in the direction of projects with a high foreign exchange content in order to maximize the use of foreign saving for its investment programs. Also, the choice of technology may be biased in favor of more capital-intensive uses because capital is available in the form of commercial credits from abroad.

Second, the availability of foreign credits may induce the public sector of the recipient country to enter into investment commitments for which domestic financing through savings has not been adequately provided; the local cost is then financed through excessive reliance on bank credits. A similar problem could arise when the terms of credit call for faster repayments than warranted by the cash flow from the investment; thus, when debt service payments begin before operations generate gross revenues sufficient for the purpose, there may be pressure to rely on bank credit to meet servicing obligations. In both cases an inflationary process may be initiated, with a number of distortions in the choice of investments.

Third, misuse can occur because of inadequate scrutiny at both the lending and the borrowing ends of commercial transactions. On the lending side, the basic motivation for the transaction is the promotion of export business, and this may lead to a situation in which immediate profit considerations outweigh other factors, such as an assessment of the borrower’s ability to carry out the project with productive results. The supplier has, however, a certain interest in the repayment capacity of the buyer because, even with insurance cover, he is responsible for carrying part of the risk. The possibility of inflating his price when competitive bidding procedures are not adopted may greatly reduce his own exposure to risk; this risk is substantially reduced when the foreign buyer is a state-owned enterprise.

On the recipient side there are two possibilities of slippage; the borrower may be a businessman who makes an injudicious decision, or his decision may be based on short-term profitability in a sheltered domestic market, which may not be consistent with the longer-term competitive position of the project. In some countries inefficiencies in the organization of markets or mistaken official policies affecting key relative prices can give incorrect signals to the private decision maker.

In public sector borrowing, the problem is sometimes one of inexperience in handling business relationships. The authorities may be too easily persuaded by strong selling techniques used by the supplier overstating the profitability of a project or understating the technical and managerial difficulties of operating it. Sometimes the problem may be even more serious; if there is little need to maximize profits and/or there is a desire to show results in some tangible form (e.g., the number of projects started by public officials during their tenure in office), the examination of the feasibility of projects may be perfunctory. The review process on projects subjected to scrutiny by international or bilateral official lenders may itself become a factor in inducing public officials to finance projects with commercial funds, because these have the advantage of becoming available more quickly and of being disbursed faster.

The role of recipient countries

The primary responsibility for the appropriate use of commercial credits must lie on the borrowing side. The testing of the economic feasibility of investments can best be done by the party to whom the benefit of investments will accrue directly. The question of what recipient governments might do to ensure that commercial credits are used to the best advantage can be discussed at two levels. At the level of the over-all economy, the need is to adopt the right combination of policies so as to create a general environment that is conducive to sound decision making. At the project level, the essential requirement is for measures aimed at adequate selection, preparation, and efficient implementation of projects financed under commercial credit arrangements. While both sets of measures are needed, the role of the over-all policy environment is sometimes neglected. If the authorities have taken steps to create the proper framework of policies, the issue of both the correct uses and the appropriate limits to the incurring of commercial indebtedness can more easily be resolved.

Past experience has indicated that in many of the instances of excessive indebtedness leading to default, inadvisable monetary and fiscal policies have been pursued in conjunction with an improper use of investment resources. These policies have been associated with serious inflationary pressures, which in turn have tended to increase reliance on short-term and medium-term commercial finance because longer-term capital has been reluctant to enter. The most frequent manifestation of poor investment policy has been in the areas of the pricing of capital and the pricing of foreign exchange. The former deficiency has resulted in a choice of projects that did not reflect the basic resource endowments of the recipient economy. The latter has tended to favor the greater use of foreign rather than domestic inputs in the investment-mix. Overvaluation of the currency has been particularly detrimental to sectoral resource allocation when sustained by severe quantitative restrictions on imports. The result has been to attract commercial funds toward import-substituting industrial activity with little potential comparative advantage and without materially helping the balance of payments because imports of raw materials, fuels, and spare parts have substantially replaced those of consumer goods.

At the project level, problems have often arisen in connection with the public sector. While a number of successful projects have been financed with commercial credits under the aegis of the public sector, many of the “unsound” projects in some of the recent rescheduling cases were undertaken by public agencies. In analyzing the reasons for these, several common difficulties were found. Inadequate preliminary appraisal of viability has been a major factor. The decision to launch a project may have been strongly influenced by the easy availability of credit. Another major deficiency is the inadequacy of competition regarding the sources of credit supply. This may be the result of a deliberate choice on the part of officials responsible for procurement—whose private interest in the transaction may override concern for competitive bidding. Many times, the lack of competitive bidding may be compounded by the “tie-ins” between suppliers of equipment, consultant firms that prepare the project design and test it for feasibility, construction firms, financiers, and the technical experts running the equipment after its installation. The infusion of competitive forces into the whole credit-negotiating process becomes difficult in the face of such “tie-ins,” especially when these are covert rather than open arrangements.

In a number of recipient countries, inefficient execution of projects financed under commercial credit arrangements has also constituted a major obstacle to their productive utilization. Sometimes the defective implementation consists of poor handling of technically related aspects of the same project—such as when credit-financed imports of equipment are scheduled for arrival at the construction site long before the erection of the associated plants. In others, the deficiency can be traced to the expansion, typically by the public sector, of credit-financed projects much beyond the limitations imposed by specific real shortages, notably technical and managerial skills. A major unfavorable feature of the experience in these cases is that a number of recipient enterprises are burdened with the servicing of external debts in respect of projects yielding little economic benefit. Therefore, the advantageous use of commercial credits in these countries is closely tied up with measures for ensuring sound execution and efficient operation of projects financed under such arrangements.

The role of lending countries

A number of considerations have deterred lending/insurance agencies from intervening in the consummation of commercial credits. To start with, the primary function of these agencies is to promote their countries’ exports in an intensively competitive market for capital goods; if satisfied that the borrower (or his guarantor) can repay the credit, they may not find it necessary to question the use of the credit. Moreover, a close surveillance of the economic feasibility of transactions concluded by the private sector is ostensibly alien to the economic philosophy prevalent in many lending countries and would be regarded as constituting unwarranted governmental interference in the conduct of private transactions of their own or recipient country nationals. This reluctance also exists toward public sector projects because it would appear to intervene in the prerogative of the recipient government, whatever the merits of the project, when an official guarantee of repayment is proffered.

The interchangeability between credit and cash availabilities of the borrower makes it practically impossible for lenders to influence in a meaningful sense the use of resources in the recipient economy. Any control on the use of commercial credits by the lending countries can only be as a supplement to the surveillance applied by the authorities in the borrowing countries. Many among the latter do make a careful use of commercial credits, and any control by the authorities in the lending countries would be unnecessary. Under circumstances where more careful scrutiny of the use of commercial credits is called for, it must be recognized that a case-by-case investigation would not be warranted for the majority of credits that are used to finance normal trade transactions for small contract values. Although these transactions may in the aggregate constitute an important part of a recipient country’s foreign debt obligations, their screening would impose a rather heavy administrative burden on both the lenders and users of commercial credits.

Finally, an appraisal of large investment projects, which would constitute the only type where some degree of surveillance could possibly be exercised, must have elements of uncertainty. Assumptions about key parameters of performance can differ among experts because of the essentially forecasting element involved and standards of “feasibility” can vary among appraisers of the same project. Moreover, the provision of commercial financing is usually one of the conditions that govern the awarding of the contract, and, in view of the competitive conditions prevalent in international markets, there is considerable incentive to use the maximum freedom of interpretation of available data in order to justify the financing of marginal projects. It is here that various interests in the transactions may diverge. On the one hand there are pressures from national exporters to obtain financing for their exports on an internationally competitive basis, while on the other hand agencies in the lending countries responsible for protecting the budget from claims for rescheduling press for careful analysis as to the economic feasibility of projects before credits are approved.

For these reasons, any policy of selectivity in the choice of projects for commercial financing requires a delicate balancing of interests, attitudes, and special circumstances in each lending country. Some degree of selectivity has been exercised by lending countries to a varying extent. In some countries where official support is extended primarily through insurance facilities, the authorities have sought to discourage dubious projects by insisting on obtaining stronger financial collateral from the recipient enterprise than would normally be required, e.g., the guarantee of the central bank may be insisted upon whereas ordinarily that of a commercial bank would have been acceptable; for public sector projects, guarantees from the treasury may be required in preference to that of the sponsoring ministry.

In a number of countries insurance/lending agencies do attempt to judge large projects not only on the basis of the creditworthiness of recipients or of their guarantors but also by reference to their feasibility. In most cases, feasibility analysis is restricted, however, to a projection of the cash flows generated by the investment as a check on the viability of the repayment schedule. Finally, a few lending agencies undertake a more thorough study of the economic (as distinct from the financial) merits of large projects, the manner in which these fit the requirements of the recipient economy, and their contribution to the balance of payments. Such studies are also undertaken by or on behalf of a few credit insurers.

In recent years, the commercial financing of investment projects has also been undertaken under joint financing arrangements with the IBRD. In this way, commercial credits have benefited from the careful feasibility studies that precede the commitment of funds by the IBRD. A number of lending countries have welcomed this approach as providing greater assurance of proper use of commercial funds, and a few others have expressed interest in supporting the enlargement of such arrangements if procedures for negotiation and administration of contracts could be simplified somewhat.

The IBRD has also enlarged its assistance to developing countries for the achievement of greater soundness in the selection of projects including those that are financed by commercial credits. At the request of recipient countries, it has reviewed the feasibility of projects for which financing from non-Bank sources was being sought. By identifying areas for which preinvestment studies are needed and by sponsoring or helping to organize such studies, the Bank has helped with the essential groundwork needed to establish an inventory of projects that are suitable for external financing. More recently, an Industrial Projects Department has been established for conducting comprehensive industrial sector reviews, which, in addition to examining the general strategies pursued and the policies for carrying them out, would be concerned with industrial projects in the process of formulation.

A considerable related effort has been carried out by the World Bank Group in assistance to national development finance companies; this has consisted not only of loans to and equity investment in such companies but also of technical assistance in connection with their organization and management, including advice on project appraisal procedures, thus contributing to the sounder selection of projects including many that may be financed by commercial credits. The useful role of development finance companies has been recognized by several lending countries, which have extended general lines of export credit or export credit insurance cover through them. Under these arrangements, investments by the recipient must be approved by the development finance company or a similar financial intermediary before the export credit funds are released. This type of “two-step” lending procedure can provide for more effective review by the authorities of the recipient country of the feasibility of proposed commercial transactions.

Each of the methods described above provides for more careful appraisals of medium-sized and large projects, and a greater willingness on the part of lenders to use them would afford better assurance of proper use of that part of their resources which is made available as commercial financing.

Cooperative actions for improving use

The proper use of commercial credits is a subject of concern for borrowing and lending countries alike. The problems that have arisen from unwise use are seen most clearly in countries that have to undergo rescheduling of their debts. Creditworthiness inevitably tends to be impaired, and the flow of credits including short-term financing may be temporarily suspended. The hiatus in normal commercial flows that accompanies and follows such rescheduling exercises often results in substantial dislocation of the economy of the recipient country. There is the additional problem of finding external finance to start new projects that can provide the future resources required to service the past accumulation of debts. At the same time, an unproductive use of commercial credits that leads to debt rescheduling may necessitate the expenditure of public funds in the lending country for meeting claims on past credits rather than for financing new activities in the same or other countries. The serious consequences for capital flows that result from default on contractual obligations underline the necessity, among other things, for cooperative efforts to alleviate problems arising in the use of commercial credits.

APPENDICES

I. Extract from Decision 29(11) Taken by the United Nations Conference on Trade and Development, Second Session, New Delhi, February 1–March 29, 1968

29(11). Improving the terms and conditions of aid alleviating the problems of external indebtedness

Commercial credits including suppliers’ credits

8. The Conference endorses the judgement in the Agreed Statement that commercial credits add to the flow of resources and can play a useful role, within limits, in promoting development. They are, however, no real substitute for long-term development aid.

9. It is noted in the Agreed Statement that four main questions arise:

(a) To what extent should commercial credits be adapted to promote development as well as trade?

(b) How should its acceptance and use be controlled by both recipients and lenders?

(c) Should the terms be softened, and what would be the implications for both aid and trade?

(d) Should the question whether any new institutional arrangements are needed to alleviate harmful developments in the field of commercial credits be further studied?

10. The Conference invites the IMF to prepare a study on these questions, in consultation with member Governments, with the secretariat of UNCTAD, IBRD and other appropriate institutions. This study should be made available for discussion in the Committee on Invisibles and Financing related to Trade, which will then decide whether to refer it to an inter-governmental group with equitable representation of developing and developed countries, or to deal with it in some other appropriate way.

II. Statistics

Table 11.

Net Changes in Guaranteed Private Export Credits with Maturities Ranging from One to Five Years Inclusive, Extended by Member Countries of the Development Assistance Committee to Developing Countries, 1956–68

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Sources: OECD, The Flow of Financial Resources to Less-Developed Countries, 1956–63, 1961–65, and 1966–67; OECD, Development Assistance Committee, “Statistical Annex,” Development Assistance, 1968–69; staff estimates.

Preliminary estimates.

Figures derived by prorating 1967 totals according to 1968 proportionate shares.

Figures prorated according to the proportion applicable to 1967 gross credits.

Table 12.

Net Changes in Guaranteed Private Export Credits with Maturities Over Five Years, Extended by Member Countries of the Development Assistance Committee to Developing Countries, 1956–68

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Sources: OECD, The Flow of Financial Resources to Less-Developed Countries, 1956–63, 1961–65, and 1966–67; OECD, Development Assistance Committee, “Statistical Annex,” Development Assistance, 1968–69; staff estimates.

Preliminary estimates.

Figures derived by prorating 1967 totals according to 1968 proportionate shares.

Figures prorated according to the proportion applicable to 1967 gross credits.

Excluding the nonguaranteed portion of guaranteed private export credits, except for France in 1966, 1967, and 1968; Austria in 1967; the United Kingdom in 1967 and 1968; and the Netherlands in 1968.