(SANITIZED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00447R000100120001-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 18
• Document Creation Date: December 22, 2016
• Document Release Date: March 14, 2011
• Sequence Number: 1
• Publication Date: June 1, 1985
• Content Type: REPORT

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Directorate of -t-
Intelligence
the IMF-Supported
Adjustment Programs
Latin America: Challenging
Seeret
ALA 85-10060
June 1985
Copy 3 8 0
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 Directorate of Secret
the IMF-Supported
Adjustment Programs
Latin America: Challenging
This paper was prepared by
contributions by
African and Latin American Analysis. It was
coordinated with the Directorate of Operations.
Comments and queries are welcome and may be
directed to the Chief, South America Division, ALA,
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ALA 85-10060
June 1985
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Latin America: Challenging
the IMF-Supported
Adjustment Programs
Key Judgments Since the LDC debt crisis broke in 1982, most Latin American govern-
Information available ments have adopted International Monetary Fund (IMF)-supported ad-
as of 8 May 1985 justment programs to reduce their external financing requirements. Their
was used in this report.
relationships with the Fund have been uneasy, however, and US embassies
throughout the region report that these countries are becoming more
troubled as the financing crisis persists. For example:
? Mexico's decision to speed economic recovery to make a strong showing
in the July 1985 local and gubernatorial elections will probably mean the
country will not be meeting most of its IMF targets later this year.
? Brazil's Sarney as well as Uruguay's Sanguinetti are publicly indicating
that tough IMF austerity is unacceptable and that the Fund will need to
become more realistic and flexible in designing programs.
? Argentina's President Alfonsin has been reluctant to comply with IMF-
supported adjustments to avoid providing a rallying point for his political
opponents.
Peru's Belaunde has let IMF assistance lapse rather than implement
tougher measures, which he views as socially destabilizing, while Alan
Garcia, who will take power in Lima this July, has publicly called for by-
passing the IMF to deal directly with international bankers.
? Bolivia's Siles and Colombia's Betancur refuse to implement IMF-
supported stabilization programs, fearing the political consequences.
As internal concerns about the domestic political costs of adjustment
programs mount, Latin leaders also face a growing demand from interna-
tional bankers to comply vigorously with their Fund-supported programs.
The IMF "seal of approval" is still required before government creditors
and commercial banks will act on a debtor's request for financial assis-
tance, s 1985 wears on, we believe
popular demands for more jobs, higher wages, better schools, improved
health care, and the like will increasingly collide with stabilization
requirements. The IMF-supported adjustment programs probably will be
the battleground, with the risk that a confrontation will disrupt Latin
America's ability to continue servicing its $84 billion debt owed to US
banks.
Beyond the immediate repayment risks, we believe that current Latin
American negotiations with the IMF could also have a lasting impact on
other important issues. In the economic area, these include creditors'
iii Secret
ALA 85-10060
June 1985
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willingness to provide financial support and US export and investment
performance in the region. In political terms, building financial crises have
the potential to undermine the debtors' ability to consolidate civilian rule,
control narcotics trafficking, and subdue insurgencies. The economic
difficulties of the states in the region may also open opportunities for the
Soviets to expand commercial relationships.
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Financial Rescue Programs Sputtering
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Compliance With IMF Programs
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Impact on Current Financial Packages
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Scope Note This is one of several papers published or under way in the Directorate of
Intelligence that examine the experiences of developing countries with
IMF-supported adjustment programs. This paper deals with 10 Latin
countries that have received the bulk of the attention of the international
financial community since the LDC debt crisis emerged from Mexico and
Brazil in 1982. The paper outlines the difficulty that most of these debtors
have had complying with their negotiated IMF programs and the problems
ahead for bankers and financial negotiators as the adjustment programs
increasingly take on a political dimension
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Latin America: Challenging
the IMF-Supported
Adjustment Programs F
Financial Rescue Programs Sputtering
After a decade of heavy foreign borrowing, Latin
American countries encountered severe difficulty in
servicing their combined $240 billion foreign debt in
1982. Reduced export earnings, high world interest
rates, and an abrupt cutback in bank lending after
Mexico announced its payments moratorium caused
serious financial strains for the region's largest bor-
rowers. Major debt defaults were avoided, however,
with a set of financial rescue packages coordinated by
the International Monetary Fund (IMF). The Fund
became the focal point for securing cooperation be-
tween private banks and Latin American governments
in extending new medium-term loans and reschedul-
ing maturing debts. By March 1983, Mexico, Brazil,
Argentina, and Chile joined Peru in making IMF-
supported adjustments. In June, Ecuador resolved its
differences with the Fund and qualified for assistance.
In our view, Latin American debtors' compliance with
IMF programs is still the key to obtaining some $5-10
billion in new foreign financing and rescheduling $40
billion in payments in 1985.' According to US Embas-
sy reporting most of
the financial rescue programs are now being delayed
in the face of the region's continued difficulty in
meeting IMF performance criteria. Moreover, all
signs point to difficulties between the major Latin
American debtors and the IMF for some time to
come.
Compliance With IMF Programs
The IMF suspended disbursements on Brazil's 1985
program in February after a finding of noncompli-
ance. According to press reports
Brasilia exceeded the public-sector bor-
rowing requirement and missed monetary control
targets for December 1984, resulting in an inability to
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Table I
Latin America's Major Economies:
Debt Currently Owed to US Banks a
23.6
26.6
a Includes short- and medium-term loans owed by public- and
private-sector borrowers to US banks.
control inflation that official statistics report is about
230 percent at an annual rate. The new government's
financial team quickly committed itself to getting the
IMF program back on track, and soon after assuming
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government spending, limits on federal lending, and a
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Brazilian officials privately expect difficulties in nego-
tiating fiscal, monetary, and inflation targets with the
IMF in the months ahead. Sarney almost certainly 25X1
will reassure the IMF that he supports stabilization in
principle, but we believe he lacks the political will to
implement a tough adjustment program to control
inflation. Moreover, given his delicate political posi-
tion and the widespread antagonism among Brazilians
toward the IMF-an attitude reflected in recent
public opinion polls-Sarney probably will not want
to be perceived as acquiescing to harsh austerity
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A country making use of IMF resources is generally
required to carry out an economic policy program
aimed at achieving a balance-of-payments perfor-
mance that its economy can sustain on its own. This
requirement is known as conditionality. The point of
conditionality is that balance-of-payments financing
and adjustment of the underlying distortions that
created the original payments problem go hand in
hand. The Fund aims for the country to have a
current account deficit that can be sustained by
capital inflows on terms compatible with the develop-
ment prospects of the country and without resort to
restrictions on trade and payments.
Fund programs and performance criteria are designed
jointly with the member country. The corrective
strategy provides for reduction of balance-of-pay-
ments deficits and a reorientation of the economy
toward sustained growth; it avoids purely deflation-
ary policies that may have a deleterious effect on
investment and that fail to encourage the required
shift of resources to the external sector. Fund-
supported programs emphasize a number of major
economic variables, such as domestic credit (nearly
all programs entail limits on credit expansion),
public-sector financing, external debt, exchange rates,
interest rates, and some commodity prices.
The financing available to members of the IMF
through standby and extended fund arrangements is
available in portions at specified intervals, and is
drawn subject to meeting the agreed performance
criteria. Any failure to observe the criteria prevents
drawings until the Fund and the member examine
whether further measures are necessary and they
contract a new understanding on any needed changes
in the program.
measures. Although Brasilia has yet to specify its
negotiating position, we believe that a reconciliation
will come, but only after several months of rancorous
negotiations aimed at securing more lenient perfor-
mance targets. Should the IMF insist to the end on
rigorous austerity, we believe Brasilia may reconsider
the advisability of a Fund-supported program.
The Fallout From Brazil's Abrogation
of its 1962 IMF Agreement
Stagnant exports and a falloff in foreign investment
led Brazil into a balance-of-payments crisis in 1961.
The civilian Quadros government agreed to a $2
billion refinancing package in cooperation with the
IMF, international bankers, and the US Government,
but the succeeding Goulart administration did not
follow through on promised economic stabilization
measures. The IMF halted disbursement of standby
credits in mid-1962 and Brasilia abrogated the ac-
cord, causing a cutoff of foreign funding.
According to academic studies, Goulart was unable
to implement austerity and comprehensive economic
reforms in the face of civilian demands for sustained
growth. Brazil's economic difficulties intensified
throughout 1963-manifest in accelerating inflation,
growing joblessness, and recurrent payment crises.
Some academic sources contend that Brazil's worsen-
ing economy helped bring about the 1964 military
takeover. Three months after assuming control, the
military government of Castello Branco concluded an
agreement with its creditors by implementing tough
financial reforms.
Mexico recently received approval from the IMF for
the last phase of its three-year Extended Fund Facili-
ty, after almost six months of negotiations
Fund officials approved
the 1985 program only after Mexico City announced
substantial cuts in budgeted government spending.
Some recent economic developments are already jeop-
ardizing Mexico's ability to comply with its tougher
commitments later this year. According to the US
Embass the govern-
ment decided sometime in late 1984 that it must
speed economic recovery even at the cost of rising
prices and overvaluation of the exchange rate to make
a strong showing in the July 1985 local and guberna-
torial election. The US Embassy reports that the
results of this decision are already being felt-public-
sector spending pushed well above the target level
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$2.4 billion
during the first quarter, while the value of the peso
was propped up by the administration. During Janu-
ary-March, the trade surplus eroded 40 percent to
economic growth.
The full economic impact of this year's election
strategy will not be felt until late summer or early fall.
By then we expect Mexico will not be meeting most of
its IMF targets. The administration's spending spree
will push the budget deficit far above target levels and
will keep inflationary pressures high for the rest of the
year. We project the increase in the cost of living will
reach about 60 percent this year, far above the 45-
percent goal. Mexico City's trade surplus will deterio-
rate even more with the growing overvaluation of the
peso discouraging nonpetroleum exports and the soft
world oil market cutting oil export earnings. Until the
peso is adjusted, imports will rise with more rapid
limitations
Weak trade performance combined with large interest
payments on its foreign debt could cause Mexico to
experience its first current account deficit since the
financial crisis of 1982. Moreover, until the de la
Madrid administration accelerates exchange rate de-
valuation, capital flight will remain a problem. Under
these circumstances, Mexico will be forced to draw
more from its foreign exchange reserves, rather than
adding to reserves as called for in the IMF program.
Mexico may also be forced to seek loans in interna-
tional capital markets that exceed the IMF program
Argentina's IMF-supported program was suspended
in mid-March after inflation-caused by growing
budget deficits according to the local financial
press-spiraled to an annual rate of 800 percent. New
program targets are being renegotiated with the IMF,
but Bue-
get tightening-will be implemented.
nos Aires says it intends them to be "workable"
targets. Recently, the US Embassy reported that
Buenos Aires plans to raise taxes, signaling its willing-
ness to implement austerity. The government has
publicly indicated that more stringent measures to
control inflation-monetary restraint and some bud-
Regardless of Buenos Aires's intent, extended compli-
ance with any Fund agreement will be difficult at
best. Strikes-already occurring among private-sector
workers and municipal employees-will probably be-
come more frequent as wage increases are held below
inflation. Military coup plotting also could become
more serious, in part because of severe cutbacks in the
armed forces budget. The parliamentary elections in
November should spark even greater popular de-
mands for improvements, especially as the economic
slump causes unemployment to rise. With nearly all
domestic political pressures pointing to less austerity,
we expect another renegotiation for new IMF targets
within a few months after concluding the revised
agreement.
Unlike Brazil, Mexico, and Argentina, most of the
Andean debtors continue to shun IMF-supported ad-
justment programs because of the potential political
fallout. For example:
? Colombia is avoiding an IMF standby agreement
for domestic political reasons, according to US
Embassy reports, despite its growing need for for-
eign financing.
= Bogota prefers enacting some austerity mea-
sures on its own to avoid the perception of subservi-
ence to the Fund, but also hopes an IMF blessing of
this approach will reopen access to foreign credits
needed to develop export-oriented energy projects.
? Bolivia holds infrequent discussions with the IMF
for a standby program. The politically weak, lame-
duck Siles government is unwilling to impose the
tough austerity necessary for a Fund accord for fear
of massive social unrest,
? The IMF suspended Peru's program last year, citing
budgetary violations, and Belaunde refuses to take
the tough steps to get the program back on track
prior to the end of his presidential term in July.
Moving against the trend of avoiding IMF-supported
programs, the Fund approved Ecuador's request for a
new one-year, $103 million standby arrangement on
29 January. Quito had complied with its 1984 IMF
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Table 2
Status of IMF Programs and Compliance:
Brazil, Mexico, Argentina, and Chile
Most Performance
Recent
Target
Trillion Cruzeiros
Public-sector borrowing 67.8 Press reports indicate Brazil
requirement violated target by 10
percent.
Public-sector operational 2.1 Press reports indicate
surplus public-sector deficit.
Net domestic assets of -50.0 Brazil violated target as
monetary authority monetary restraints loos-
ened in December.
Monetary base 8.5 US Embassy reports Brazil
expanded money base by
nearly 28 percent in the
fourth quarter.
Money supply 16.0 Brazil nearly doubled the
targeted increase in money
supply.
Billion Mexican Pesos
Net credits to the public 3,958 Mexico is likely to violate
sector by the Bank of target to finance the budget
Mexico c deficit.
Cumulative overall public- 430 Mexico is likely to just meet
sector deficit d the target, but probably will
miss more stringent targets
later this year.
Cumulative changes in net 127 Mexico is likely to miss the
domestic assets of the Bank first-quarter target.
of Mexico
Cumulative net foreign 500 Mexico will meet target.
borrowing by the public
sector c
Cumulative change in net 1,000 Weakening current account
international reserves of and capital flight are likely
the Bank of Mexico a to cause Mexico to barely
meet target.
a Targets set for fourth quarter 1984.
b Targets set for first quarter 1985.
c Adjusted.
d Limit tested at end of each period.
e Amount subject to ceiling is defined as the difference between
note issue and net foreign assets.
f September 1985/September 1984.
s Targets set for calendar year 1985.
Most Performance
Recent
Target
Cash deficit of the 8.7
nonfinancial public sector
(percent of GDP)
Net domestic assets of 884.5
Central Bank (billion
pesos)
Net international 8.85
reserves (billion US $)
Limit on outstanding 2.6
external payments arrears
(billion US $)
Consumer inflation f 300
(percent change)
Current account deficit 2.2
(billion US $)
Chile s
Violated as monetary
restraints loosened.
Missed target by $600
million.
Argentina is failing to stay
current on payments.
Target cannot be attained;
inflation now 850 percent.
Probably violated target by
$500 million in 1984.
Billion US $ (except where noted)
Current account deficit 1.38 Chile likely to miss target as
trade surplus remains
depressed.
Chile has already drawn
down $380 million through
February, according to US
Embassy.
Inflation (percent change, 25.0
Dec/Dec)
as government increases as-
sistance for earthquake
reconstruction.
Inflation is running at a 35-
percent annual rate through
February.
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The Financial Pitfalls of Bypassing the IMF:
The Case of Peru
A fall in copper prices and anchovy exports plus
increased oil and military imports led the Peruvians
toward greater foreign borrowing in the mid-] 970s. In
1976, commercial banks agreed to roll over Peru's
debt contingent upon enactment of a stabilization
program designed by the lenders. Lima initially
fulfilled its commitments and the banks released
$400 million in loans, but in early 1977 government
spending far exceeded the program limits set. Banks
refused additional loans without IMF participation.
causing banks to suspend rollovers.
Through July,.Peru and the IMF negotiated for a
formal program, but violent strikes and riots caused
by cuts in food and fuel subsidies led the government
to break off its IMF discussions. Peru then tried to
bypass the Fund and deal directly with its creditors,
but without the ability to monitor and enforce policy
adjustments. Bankers insisted that Lima conclude an
IMF agreement, and such an accord was signed in
November 1977. The government met its quantitative
targets only for a three-week period and the Fund
again declared Peru out of compliance in early 1978,
Fund reports.
program requirements, and the new government is
seeking to strengthen Ecuador's external position and
reduce inflation by working with the IMF. It has
agreed to tougher limits on external borrowing, credit
creation, and public-sector spending, according to
this year.
Chile reached preliminary agreement with the IMF
on 15 February for a three-year, $750 million Extend-
ed Fund Facility. According to US Embassy reports,
the 1985 program targets include limits on public-
sector borrowing and the deficit, a slight increase in
international reserves, and a 30-percent reduction in
the current account deficit to $1.4 billion. According
to press reports, Chile's new Finance Minister, Her-
nan Buchi, has asked for greater flexibility in meeting
performance targets; for its part, the IMF has agreed
to raise the budget deficit target to 3.5 percent of
GDP to permit public spending for reconstruction of
extensive earthquake damage that occurred earlier
Although Chile is publicly committed to its IMF
agreement, we believe that reconstruction of damage
from the March earthquake will impede compliance
with the program's domestic targets. The earthquake,
which Santiago claims caused an estimated $1.8
billion in damage to homes, schools, roads, and ports,
will probably result in a growing budget deficit and
will increase the current account deficit by well over
$300 million in excess of the IMF target. US Embas-
sy reporting indicates that exports of two major
foreign exchange earners-copper and fruit-will re-
main at the same depressed levels as last year, while
Santiago will be hard pressed to reduce imports by the
targeted 13.2 percent if it is to help in postearthquake
reconstruction. Further, US Embassy reports indicate 25X1
spot shortages from the earthquake will push the cost
of living beyond the 25-percent inflation target.
Compounding strains on the IMF-supported program
this year will be banker unwillingness to meet Chile's
request for new foreign funding. According to US
Embassy reporting, Chile's debt negotiations are at an
impasse over Santiago's request for $1 billion in new
loans in 1985, while bankers remain adamant they
will provide only $500-700 million. Because of these
difficulties, we believe the economic team will be
forced to draw down Chile's foreign exchange reserves
to meet debt servicing obligations, despite its pledges 25X1
to the IMF to keep reserves at the December 1984
level of $2.0 billion. In our opinion, Santiago will seek
waivers on every IMF target and threaten suspension
of its debt payment if creditors are not accommodat-
ing.
Impact on Current Financial Packages
Foreign bankers have reacted to the spate of noncom- 25X1
pliance with Fund-supported programs by delaying
rescheduling agreements and new loans for those
Latin American debtors having difficulties meeting
IMF-backed adjustment programs. Bankers had post-
poned for six months the formal conclusion of Mexi-
co's $49 billion debt restructuring program until the
IMF approved a revised stabilization program in
March, according to the financial press. Upon an-
nouncement that the IMF suspended talks with Brazil
earlier this year, its bank advisory committee-which
had reached tentative agreement on the terms of a
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multiyear rescheduling agreement covering some $45
billion in debt-and the Paris Club halted their
respective debt negotiations, pending a new agree-
ment between Brazil and the IMF. Argentina's bank
creditors are withholding the first $2 billion disburse-
ment of the $4.2 billion loan package signed last
December when the IMF suspended a $230 million
payment, according to a Fund statement. Buenos
Aires was unable to obtain an emergency bridge loan
to repay overdue interest. Instead, it made a $50
million payment toward public-sector interest arrear-
ages to prevent US regulators from downgrading
Argentine loans, according to the press.
The large Latin debtors are not the only ones facing
difficulties with international bankers. According to
US Embassy reporting, bankers are still reluctant to
grant Colombia's request for $800 million in new
funds until Bogota obtains an IMF agreement to
monitor its self-imposed adjustment program. Finan-
cial assistance packages for Peru and Bolivia remain
stalled over their unwillingness to negotiate with the
IMF and clear interest arrears.
While bankers are reluctant to put themselves further
at risk in such countries, they are apparently still
willing to consider financial assistance for Latin
American countries that are accepting Fund-support-
ed programs. Ecuador's financial rescue package-
which includes $200 million in new money and the
rescheduling of $4.3 billion-is nearing completion,
according to the financial press. Chile's preliminary
IMF agreement in February helped lead to the re-
sumption of rescheduling talks in mid-March. Al-
though bankers are resisting Santiago's $1 billion new
money request, US Embassy reporting indicates that
the Chileans will probably receive between $500
million and $700 million in new bank loans)
In looking ahead, we see some fundamental changes
in Latin America that will affect the financial situa-
tion. One of the critical challenges facing Latin
debtors is balancing longer run international financial
requirements against the immediate internal needs of
being responsive to the electorate in emerging demo-
cratic systems. With the inaugurations of civilian
presidents in Brazil and Uruguay last March, there
are now nine civilian governments at the helm of
financial rescue programs. Although we judge that
these leaders recognize the necessity of economic
stabilization to maintain creditor cooperation and to
foster recovery, they are now taking a tougher stand
on the politically risky aspects of the IMF's recom-
mendations. Since the Cartagena, Colombia, meeting
last June, the newly installed governments have begun
to take a more political approach to economic prob-
lems, a factor that will probably complicate the
management of their financial rescue programs in the
future.
Longer Run Financing Needs
The objective of the IMF programs has been to assist
countries to attain a viable balance-of-payments posi-
tion through policies that reduce or eliminate the
economic distortions that in part caused the payments
difficulties in the first place. The adjustment pro-
grams usually involve currency devaluations, tax re-
form, stricter budget controls, reductions in the scope
of government enterprises, and development of a more
market-oriented environment to bring demand for
foreign funds into line with international bankers'
willingness to lend.
The likelihood of difficulties in complying with IMF
programs portends that progress in resolving debt
problems and toward stronger long-term economic
growth will be slow in Latin America. We believe
those debtors who repeatedly fall short of their targets
will suffer disruptions of loan disbursements and
delays in obtaining debt rescheduling necessary to
lessen debt constraints. As it is, we estimate that
Latin America's current account deficit could poten-
tially triple to about $6 billion in 1985. On the basis of
bankers' reactions to date, we judge it highly unlikely
that bank financing will be available to cover such a
deficit, and almost certainly would not be voluntary in
the absence of an IMF-supported program. Looking
ahead, most US econometric forecasting services pro-
ject that major Latin American debtors' current
account deficits will persist in the $6-10 billion range
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difficult.
through the end of the decade. New external shocks-
such as slower OECD growth, increased interest
rates, and lower commodity prices-would only make
the payments strains of the region that much more
difficult.
As far as economic growth is concerned, Latin Ameri-
ca faces weak economic prospects through the decade.
Many commercial and academic forecasters expect
the region to grow at an annual average rate of 3
percent through 1989 with only a slight reduction in
inflation. They base this dismal outlook on the lack of
new development financing and continued import
restraints. We believe that patchwork reforms will
also leave serious budget deficits to fuel the region's
average 140-percent inflation rate for the foreseeable
future. If inflation stays in this range, we believe it
will continue to undermine capital formation and
discourage the repatriation of capital needed to bol-
ster domestic investment. We also believe growing
economic uncertainty will make Latin American ef-
forts to attract new foreign direct investment more
capacity.
Against this economic setting there is always the
chance that one or two key debtors may seriously
consider breaking with IMF-supported programs in
an attempt to revive their economies through populist
policies, such as deficit spending, large wage in-
creases, and rapid monetary expansion. We believe
that if a break occurred the cessation of new lending
and possible debtor default that would follow would
markedly hurt Latin growth prospects. A recent
academic study concludes, for example, that the
forced import cutback that would follow a default
would reduce Latin American output by over 6
percent in the first year-an economic plunge twice as
severe as Latin America's 1983 recession, the worst
on record. According to this study, Latin America
probably would follow a lower growth path for a
decade because foreign exchange scarcities would
reduce imports while the cessation of voluntary lend-
ing would undercut new investment in productive
Democratic Politics
Regardless of the economic realities, US Embassy
and press reports indicate that there are growing
popular demands throughout the region for improved
living standards. According to the Economic Commis-
sion for Latin America, real per capita income in
Latin America has fallen back to levels of the late
1970s in the wake of global recession and the ongoing
austerity programs implemented to resolve debt diffi-
culties. The new civilian authorities in Argentina,
Brazil, and Uruguay, elected on promises of change
and improvement, must demonstrate economic pro-
gress or face challenges to their rule. New leaders
scheduled to take over this summer in Peru and
Bolivia will have similar prospects. We believe most of
these governments probably will be tempted to stimu-
late short-term growth to expand employment and
business activity, despite the adverse impact such
forced growth would have on inflation and their
external finances.
The implementation of stabilization programs, in our
opinion, will be more difficult as these new leaders try
to balance the conflicting demands of key interest
groups. At the least, we believe the civilians will
increasingly press the IMF to ease its conditionality
requirements:
? Labor unions in Argentina, Bolivia, Brazil, Peru,
Uruguay, and Venezuela are becoming strident in
demanding higher wages, according to a review of
press and US Embassy reporting.
? Business is seeking wage restraints, price hikes,
import protection, and growth policies aimed at
absorbing idle capacity, according to US embassies
in the region.
? Legislatures will probably become more involved in
financial matters-Brazil's Congress has already
served notice that it intends to scrutinize new debt
agreements, according to the US Embassy.
? Leftists, such as the radical factions in the govern-
ing parties in Argentina, Brazil, and Peru, are
advocating repudiation of the foreign debt to restore
social spending and accelerate growth,
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Prospects for the Cartagena Debtors' Group
Eleven Latin American debtor countries-known now
as the Cartagena Group-met in late June 1984 in
Cartagena, Colombia, to discuss debt and trade
problems facing the region. Although bankers wor-
ried about the formation of a Latin debtors' cartel,
the region's key decisionmakers refrained from radi-
cal action.
most Latin leaders recognized that collective action
to force easier repayment terms would only jeopar-
dize their access to foreign funds as well as their
individual efforts to negotiate debt restructuring
agreements with creditors. With the largest debtors-
Brazil, Mexico, Argentina, and Venezuela-willing
to deal individually with creditors, the Cartagena
Group has subsequently become a less potent politi-
cal force
Despite several followup meetings, US Embassy and
press reporting indicate that support for unified re-
gional action against creditors is still marginal. At its
February 1985 meeting in Santo Domingo, the Carta-
gena Group again resisted radical proposals, such as
tying debt service to exports or capitalizing interest
payments. Instead, Latin Americans called for in-
creased financing on easier terms through existing
multilateral channels and for a political dialogue
with creditor countries. In April, the Cartagena
Group renewed its call for the participants at the
Bonn summit meeting to enter into a political dia-
logue on the debt issue. According to the communi-
que issued at the meeting, the Cartagena countries
made a plea for understanding, stating cooperative
action by the industrial countries would help allevi-
ate Latin external debt burdens and preserve democ-
racy in the region. Although the goals of the political
dialogue were not well articulated, the debtors were
in agreement that international trade and monetary
reforms were needed to assure growth
we judge that the
Cartagena Group, given the present degree of disunity
among its members, is unlikely to form a debtors'
cartel over the near term. The group will probably
continue to support positions that do not interfere
with bilateral debt renegotiation. We also believe,
however, that, if Latin debtors see little financial
relief in sight, the group would be increasingly in-
clined over the longer term-individually as well as
collectively-to step up pressure. Creditor banks and
developed country governments could face demands
to share the adjustment burden by granting easier
repayment terms and trade concessions.
Under these conditions, we believe a severe deteriora-
tion of relations between Latin debtors and bankers
could follow. In the absence of organized collective
action, we speculate that a small country-or group
of countries like Peru and Bolivia-could publicly
refuse to pay any of its debt because of domestic
strife caused by austerity. Such a situation could
conceivably spread, in a domino effect, to a larger
debtor, such as Argentina. In a variation on this
theme, the smaller debtors would quietly suspend
payments and receive the tacit support of the larger
debtors in hopes of benefiting from any concessions
granted by creditors to the smaller debtors. Finally,
we can also envision a spontaneous debtors' rebellion
breaking out whereby most of the Cartagena coun-
tries withhold debt repayments as their debt negotia-
tions individually reach an impasse with creditors.
? Military leaders, watching these political moves
closely in the event they need to intervene to quell
unrest, are seeking to restore appropriations affect-
ed by budget cuts.'
The adverse reaction to economic adjustment is not
split cleanly along partisan lines. The politically im-
portant Latin American middle class-which spans
the political spectrum-is also demonstrating concern
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Bankers' Response to Latin Debt Difficulties
International bankers as a group appear to be having
difficulty responding to Latin America's continuing
debt difficulties.
creditors are concerned about the ability of Latin
increased international reserves.
governments to hew to austerity needed to stabilize
their economies and strengthen their payments posi-
tion. Bankers are continuing to insist that the IMF
exercise a role in overseeing economic adjustment
programs even for countries that do not require
temporary balance-of-payments support. For exam-
ple, Brazil's multiyear rescheduling is contingent on a
new IMF agreement, even though the country is
running a near-balanced current account and has
Argentina, Chile, and Peru.
Banker cohesiveness, however, wanes when debtors
request additional lending. Growing uncertainty
among some bankers about the efficacy of Latin
stabilization programs is translating into increasing
difficulty in assembling new loans, especially for
the largest lenders are still
willing to increase their exposure, numerous smaller
lenders are refusing to participate in these credits.
Smaller US and European banks, according to finan-
cial press are also
willing to consider alternatives to providing new
money, such as interest capitalization schemes and
limits on interest payments as a share of export
earnings. More worrisome, the smaller lenders are
still also inclined to reduce their exposure to the
region, preferring to
write off their debts, sell them at a discount, or
to Peru earlier this year following President-elect
Alan Garcia's public threat to bypass the IMF. Under
such conditions, we judge that financial assistance in
support of Latin America's economic adjustment will
increasingly fall to the major international banks.
the larger
creditors recognize that resolving Latin debt prob-
lems will require both time and patience. They
continue to approach debt problems pragmatically on
a case-by-case basis, and still demand a credible
stabilization program for strengthening the balance of
payments in return for financial assistance. Recently,
however, the larger creditors have shown a willing-
ness-manifest in the recommendations of bank advi-
sory committees that they control-to accept other
than a formal IMF-supported adjustment program.
In September 1984, for example, the bank advisory
committee agreed in principle to grant Venezuela a
multiyear debt rescheduling on easier terms as long
as Caracas continued its self-imposed stabilization
program and cleared up past due debts. This year,
Colombia's bank advisory committee agreed to a new
money and debt rescheduling package in support of
an internal stabilization program that would simply
be "monitored" by the IMF.
larger creditors are cognizant of rising demands
throughout Latin America for more rapid growth. As
a result, the creditors are now agreeing to multiyear
rescheduling agreements on easier terms for debtors
making a "good-faith" adjustment effort. For exam-
ple, Mexico and Ecuador have recently been formally
granted multiyear rescheduling in support of their
adjustment programs. Similarly, the larger creditors
are also calling on the World Bank group to comple-
ment these efforts by providing new credits and
guarantees in support of long-run structural adjust-
The larger creditors operate under varying regulatory
constraints that limit their collective ability to adapt
to debtors' problems and demands. Even so,
some of these creditors are
experimenting with innovative forms of debt relief.
According to press reports, financially troubled Peru
has already convinced Soviet and some European
creditors to accept barter goods instead of money as
payments for debts.
Osome US large banks may be willing to provide
such export marketing assistance to Peru and Boliv-
ia. Recently, Chile's bank advisory committee has
agreed to change the timing of interest payments-
thus far interest payment schedules have been sacro-
sanct-in an effort to provide additional foreign
exchange savings. At this juncture, however, the
larger lenders continue to shy away from implement-
ing bold financial reforms, such as sharply reduced
interest rates or interest capitalization schemes, pro-
posed by major debtors for resolving Latin America's
financial problems.
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about the advisability of IMF-recommended adjust-
ments. According to recent United States Information
Agency public opinion surveys in Brazil, Colombia,
Costa Rica, and Venezuela, most of the adjustment
policies traditionally negotiated with the IMF-such
as wage restraints, price increases, and devaluation-
are seen as harmful measures by majorities in each of
these countries. Moreover, these surveys reveal that in
Brazil over half of those polled considered agreements
with the IMF as a harmful policy option; in the other
countries respondents viewed IMF programs as gener-
ally more harmful than helpful. Instead, according to
these polls, import restrictions and the formation of a
Latin debtors' group are chosen-by large minorities
to small majorities-as the most helpful measures in
dealing with the debt crisis.
Outlook and Implications for the United States
Against this backdrop of economic and political chal-
lenges, we judge that most Latin American debtors
will agree to live with some kind of IMF-supported
adjustment programs to obtain debt rescheduling,
new money commitments, and other bilateral and
multilateral assistance. We believe, however, that
most Latin American nations will probably fall out of
compliance with their programs, and that the IMF
and debtor governments will find it necessary to revise
the terms of these programs more frequently. Thus,
we expect these countries' relations with the IMF to
become more contentious as political considerations
are increasingly injected into technical negotiations.
With the IMF-supported adjustment programs enter-
ing this phase, we believe Latin debtors will expect
Washington to play an increasingly active role in
keeping financial rescue on track. As 1985 wears
on, we believe that Latin debtors will press US
officials to:
? Intervene in disputes with the Fund to soften condi-
tionality, thus seeking to balance the requirements
of economic stabilization against the political imper-
atives of democracy.
? Nudge lenders to provide credit and debt reschedul-
ing and help design financial strategies that support
economic recovery.
We judge that some Latin American debtors may
look favorably on recent US efforts to assist countries
complying with IMF-supported programs. They may
see such initiatives as selective multiyear reschedul-
ings of official debt in Ecuador, willingness to provide
expanded export financing facilities to Brazil, and
new investment insurance guarantees to Ecuador as
tangible moves to exert subtle pressure on creditors
toward more flexible and innovative financial ar-
rangements.
For the longer run, we judge that continuing uncer-
tainty surrounding Latin America's external financial
situation will affect US strategic interests in a number
of areas:
? Economic discontent will contribute to social res-
tiveness and could heighten the popular appeal of
more radical leaders, such as Leonel Brizola in
Brazil, enabling leftist-leaning candidates to be
brought to office through the ballot box.
? Declines in living standards will provide incentives
for increased narcotics production and trafficking,
which will further challenge US-sponsored eradica-
tion efforts.
? Budgeting stringencies will impede the ability of
governments to control insurgencies and limit funds
available for pacification programs.
? Continued financial turmoil will provide new, albeit
limited, opportunities for the Soviets to expand
commercial ties.
? Persistent debt repayment problems will cause the
Latin countries to eye periodically the formation of
a debtors' cartel.
Regardless of how events unfold, we believe that
US-Latin American economic relations will remain
troubled for the foreseeable future and as such will be
a factor that must be weighed in the full range of
bilateral dealings for at least a number of years to
come.
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Secret
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