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Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Directorate of Secret Intelligence MASTER FILE CM1,11: GO NOT 1 E CUT O MARK OJ Financially Troubled Borrowers: Prospects for Debt Rescheduling Secret GI 82-10220 October 1982 437 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Directorate of Secret Financially Troubled Borrowers: Prospects for Debt Rescheduling This paper was prepared by Economics Division, Office of Global Issues. It was coordinated with the National Intelligence Council. Comments and queries are welcome and may be directed to the Chief, Third World Issues Branch I Secret GI 82-10220 October 1982 25 25 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Financially Troubled Borrowers: Prospects for 0 Debt Rescheduling Key Judgments The international financial system is under greater stress than at any time Information available since World War II. Western banks face 18 separate debt reschedulings as of 4 October 1982 this year, led by Mexico, Argentina, Poland, and Romania. The near-term was used in this report. potential for rescheduling also exists for a number of other countries, including Chile, East Germany, Hungary, Peru, the Philippines, and Yugoslavia. Many international financial experts are concerned about Brazil's sudden difficulty in obtaining foreign loans. Although we believe the international financial community can absorb an orderly sequence of reschedulings, the rise in reschedulings has important implications for lenders and borrowers: ? A growing share of bank loans to countries experiencing payments problems is being rescheduled and partially written off to the detriment of bank liquidity and profits. As a result, the credit ratings of several ma- jor banks have recently slipped and could further deteriorate, which could reduce the overall volume of lending to LDCs. ? The Mexican, Argentine, and Polish payments crises have increased bankers' perceptions of risk in international lending. Banks may sharply curtail lending to other countries-even to those with good credit ratings-which could precipitate additional financial crises and possible reschedulings. The loss of banker confidence and risk of precipitous lending cutbacks are our most serious concerns. A cutback in the growth of Western bank lending would force debtor nations to undertake or strengthen austerity measures to compensate for the reduced availability of foreign exchange. Such moves would seriously impede economic growth and could cause political and social unrest in some countries. Another option is accelerated debt rescheduling; at the extreme, debtor countries could simply stop payment on their external debt. We are especially concerned about Brazil's sudden difficulty in obtaining foreign loans, which could spiral into an international financial crisis. iii Secret GI 82-10220 October 1982 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 0 Should one or more major, countries repudiate their external debt or call for a sustained moratorium on debt servicing, the implications for the international system would be serious. The likelihood of debt repudiation is remote-among other things it would jeopardize a country's access to international credit. The decision to do so, however, would be made on political grounds. We currently have no indication that any major debtor country is willing to take such a drastic action. Secret iv Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret 0 Financially Troubled Borrowers: Prospects for Debt Rescheduling Seeds of the Current Problem The combined external medium- and long-term debt of LDCs and Eastern Europe grew from $111 billion at yearend 1973 to $515 billion at yearend 1981. Nearly 85 percent of the debt is held by the LDCs. Most of this rise was funded by Western commercial banks. Before 1974 developing countries received over half of their financing from official sources, generally at below-market rates. By yearend 1981, Western bank loans to both LDCs and Eastern Europe stood at $375 billion and accounted for the bulk of their total external debt (see chart). The enormous growth of external debt can be partial- ly explained by the desire of several Third World countries-such as Brazil, Mexico, and South Ko- rea-and East European nations to industrialize their economies rapidly. Specifically, they borrowed heavily to finance the development of export industries, with the belief that subsequent foreign exchange earnings would more than repay the loans. Market conditions during the past decade encouraged this approach: ? On the supply side, the recessions reduced industrial country loan demand, causing bankers to compete aggressively for East European and LDC business. Moreover, Western governments frequently encour- aged greater bank lending to promote exports. ? Low real interest rates throughout most of the 1970s encouraged greater borrowing because debt- ors expected to service their loans with cheaper dollars. In addition, many countries-such as Mexico and Chile-opted to borrow heavily to maintain domestic consumption levels rather than undergo the painful adjustments associated with higher world energy prices following the 1973 oil embargo. Furthermore, for most borrowers, the recession in the West that followed each of the oil price crises cut demand for LDC exports which, along with the rapid rise in LDC oil import bills, put more pressure on borrowing to cover trade deficits. Western Bank Loans to LDCs and Eastern Europe MWe The 1979-80 oil price crisis greatly altered borrowing conditions. It put borrowers in the position of having to take new loans both to meet the second round of high oil prices and to pay off loans coming due from the first round: ? As borrowers in general became riskier customers and loan terms deteriorated, several major LDCs drew down reserves and borrowed short term, ac- tions that worsened their liquidity position and increased their susceptibility to foreign exchange shortages. ? The dramatic rise in interest rates in 1980-brought about by the restrictive monetary policies of the major OECD countries-compounded the debt Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 In addition to the rise in external debt, creditors are very concerned about the short-term debt positions of LDCs and Eastern Europe. We estimate total short- term debt-defined as external liabilities of less than one year in original maturity for these countries at $150-160 billion at yearend 1982; total medium- and long-term debt at yearend 1982 is estimated to be $625 billion. For the most part, short-term debt consists of syndi- cated loans of short maturity, overdrafts or revolving lines of credit, bills of exchange, and letters of credit. In general, these are related to trade transactions and, in a sense, are self-liquidating; their absolute level tends to maintain a stable relation to the value of a country's trade, and the amounts involved are normally rolled over from year to year. However, at any given moment, the outstanding amount may place a net immediate claim on a country's foreign ex- change reserves, thus affecting the overall payments position, including the country's debt servicing abili- ty. As short-term credits are rolled over, they become the equivalent of a medium-term source offinance and may account for a substantial portion of a country's debt profile. In spite of the importance of short-term debt, no comprehensive data have been compiled on a basis consistent with the medium- and long-term debt statistics produced by the World Bank and the OECD. Some estimates are available, but for most individual countries, a substantial part of their short- term financial transactions are often not properly recorded in the balance of payments but are lumped into the "errors and omissions" item. In those countries for which we have made short-term debt estimates, the figures vary considerably: Country Total Debt Billion US $ Short-Term Poland 25 1 Philippines 16 5 Chile 14 3 Romania a Yearend 1981. b Some analysts believe Brazil's short-term debt may actually be closer to $18 billion. At times, countries have resorted to sharp increases in short-term borrowing because of either a desire to avoid longer term borrowing at higher rates or an inability-because of declining credit standing-to obtain longer term credits. Greater short-term bor- rowing has caused serious problems for certain countries including Argentina, Mexico, and Venezue- la. The constant need to roll over the short-term debt, combined with deteriorating lender risk perceptions, have added to these LDCs' already large debt burdens. Creditors are concerned that other debtors could fall into the same trap, with the end result being more debt restructuring and rescheduling. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Table 1 Selected Countries: Debt Service Ratios a Philippines 20 23 28 29 Poland 15 67 80 80 Romania 22 20 27 32 a Ratio of medium- and long-term principal repayments and total interest payments to exports of goods and services. b Estimated. servicing problems of the LDCs and Eastern Europe (table 1). The London Inter-Bank Offered Rate (LIBOR) averaged nearly 17 percent in 1981, 5 percentage points above 1978 and the highest yearly average ever; each percentage point change in LIBOR translates into a change of about $2 billion in LDC interest payments. Moreover, borrowers have had to contend with the sharp increase in real interest rates that was largely brought on by the drop in US inflation. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 The East Europeans encountered similar problems meeting their debt obligations. The postcrises reces- sions in the West reduced demand for East European exports. Moreover, many of the investment projects undertaken in the 1970s to boost export earnings had either fallen behind schedule or never reached capaci- ty because of shoddy construction and poor manage- ment. Poland and Mexico Shock the System The financial problems of the LDCs and East Europe- an countries were not of great concern to lenders until Poland and then Mexico shocked the banking system. Until then, debt problems were increasingly prevalent but easily manageable. Before 1980 the most resched- ulings in any one year were five in 1979 and four in 1974 (table 2). These totals were dwarfed in 1980 and 1981 with 13 and 14 reschedulings, respectively. Nonetheless, the total amount of debt rescheduled paled in comparison with total debt outstanding: the largest percentage share was only about 2 percent in 1981 (table 3). Even chronic reschedulers such as Sudan, Togo, and Zaire were more of a nuisance than a problem and Turkey's rescheduling-the largest before Poland's-was handled smoothly because of its strategic importance to Western governments The debt problems of Poland and Mexico have shaken the international banking system. According to a European banker, before the financial difficulties of those two countries, bankers had a near-unanimous opinion that this was a safe world in which to expand international business. The few problems were among minor borrowers and easily managed by the banking system. Now, bankers face keeping a growing number of large debtors financially afloat with no assurance that these stopgap measures will improve the long- term likelihood of debt repayment. Poland. According to US financial experts, Poland's bankruptcy beginning last year shattered several as- sumptions that had boosted Western lending to East- ern Europe in the 1970s. The change in bankers' perceptions was reinforced when Romania joined Poland in the ranks of the reschedulers in mid-1981: ? Until recently, bankers regarded the dependence of these countries on the USSR as an advantage. The Soviet Union's refusal to bail out Poland disproves the so-called umbrella theory. ? The problems in Poland caused banks to reassess their lending policy to Eastern Europe as a whole. As a result, new credits to Eastern Europe nearly disappeared in 1981, and some banks have begun to write off portions of their Polish exposure. ? Formation of Solidarity and its contest for political power with the Polish regime, along with the Soviet invasion of Afghanistan and the subsequent deterio- ration in East-West relations, forced bankers to give more weight to political risk factors in lending to Eastern Europe. Mexico. In our judgment, Mexico's recent financial crisis called into question bankers' judgments in lend- ing sizable amounts nearly unquestioned to large, resource-rich LDCs. In particular, bankers learned that they had to look beyond the performance of a key export such as oil or minerals and assess the overall strengths and weaknesses-including government economic policies-of LDC economies. The magni- tude of Mexico's debt and the rapid deterioration in its financial position, coupled with the Argentine debt crisis, brought further changes in creditors' lending policies: We also expect that syndicated loan terms to several key Latin American borrowers-such as Chile, Peru, and Venezuela, as well as Mexico-will stiffen during the next six months. ? The concurrent debt problems of Mexico and Ar- gentina-two of the three largest LDC debtors- raised serious questions from financial analysts about the ability of banks to handle the financial needs of troubled debtors simultaneously. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Table 2 Debt Reschedulings (by Region), 1973-81 a Total 447 1,494 478 480 382 2,312 5,250 5,281 10,786 India 340 194 248 200 120 Pakistan 107 650 250 Turkey 1,100 3,200 3,000 3,200 Latin America Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Table 3 Selected Countries: External Debt a 4.3 11.6 23.5 25.0 Bolivia Brazil 0.1 0.1 0.2 0.3 4.0 6.9 11.0 12.0 0.6 1.0 1.2 1.3 Guyana 0.2 Jamaica 0.4 1.2 1.6 1.7 Liberia 0.2 0.3 0.6 0.7 Madagascar 0.1 0.3 1.4 1.6 Malawi 0.2 0.5 0.8 1.0 Mexico 8.5 33.6 52.5 55.0 Nicaragua 0.4 1.0 2.2 2.5 Nigeria 1.4 3.1 6.0 7.6 Pakistan 4.2 7.6 9.5 10.3 2.7 6.8 9.0 11.0 Philippines 2.0 6.8 11.3 13.0 Poland 2.6 15.6 24.3 23.7 Romania 1.3 3.8 7.7 9.0 Senegal 0.2 Togo Turkey Uganda 0.2 0.4 1.8 3.5 3.6 Yugoslavia 4.1 a Data are for medium- and long-term disbursed debt at yearend. b Estimated; does not include results of any rescheduling this year. Secret 6 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Major Debtor Countries: Status of Economic Policy Measures Argentina Taking steps to begin negotiations with IMF, but far from meeting IMF conditions. Unless willing to change policies, prospects are not good for an agreement. Brazil Self-imposed austerity measures have been successful but will need to be continued. Government is trying to lower public spending and further reduce imports. East Germany Regime is slashing imports and pressing harder for exports, but is unwilling to impose additional adjust- ment policies. Continued reluctance of Western bank- ers to roll over maturing credits could force formal rescheduling by next year. Chile Faced with political pressure, government has eased credit and spending limits in order to reduce unem- ployment and bolster domestic industries; could face problems if austerity policies continue to slacken. Mexico Has not seriously implemented austerity measures to comply with requirements of proposed IMF program; unlikely to do so before Lopez Portillo leaves office on 1 December. Peru Recent IMF agreement signed calling for ceiling on public-sector deficits and central bank purchases of government securities; over the next three years tar- gets will probably not be met. Philippines Government has stayed within guidelines of prior IMF agreement, but problems have arisen from an overvalued exchange rate, high tariffs, and underde- veloped local financial markets. Poland Austerity measures have permitted a record trade surplus, but the regime faces rescheduling for at least several more years. Romania Sharp cuts in hard currency imports have reduced substantially the current account deficit; even so 1982 rescheduling talks with bankers have bogged down. Without an agreement, arrears will mount and Ro- mania will need debt relief next year. Venezuela Central bank has recently injected additional liquid- ity into the financial system to stimulate a sluggish economy. Yugoslavia Stabilization program has cut growth and the bal- ance-of-payments deficit, but inflation remains high. Persistent adjustment problems could precipitate a payments crisis soon. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Prospects for Rescheduling Through 1983 The economic situation faced by LDC borrowers, we believe, makes it almost certain that the number of reschedulings will continue to increase during the next 12 to 18 months. OECD growth in 1982-83 will probably be insufficient to substantially boost demand for LDC commodity exports. Just as important, most analysts believe real interest rates will remain high. The decision to reschedule, however, ultimately de- pends on such variables as the attitude of countries' economic managers toward rescheduling, availability of policy alternatives such as devaluation and other austerity measures-and the political will to use them-and financial support from other countries or international agencies. Eighteen countries have already initiated reschedul- ing operations or have indicated to bankers that they will do so this year (table 4). These countries' com- bined medium- and long-term debt accounts for near- ly 25 percent of total LDC and East European debt, or $146 billion. About four-fifths of this is accounted for by Mexico, Argentina, Poland, and Romania: ? Mexico, with a total debt of over $80 billion, has undergone a rapid deterioration in its financial position and faces certain rescheduling in the next few months. Western banks and the US Govern- ment agreed to provide emergency funds to Mexico in mid-August, a decision aided by Mexico's agree- ment to initiate talks with the IMF. Creditors are extremely concerned about Mexico, However, banks did not refuse the recent Mexican request for a 90-day moratorium on principal repayments due in the next three months. ? Argentina, with a total debt of about $36 billion, has not yet recovered from the Falklands conflict, which was a drain on reserves and caused a dropoff in export revenues. lenders have been rolling over short-term credits, but the large amounts due in the next several months indicate that a rescheduling is inevitable. Table 4 1982 Debt Reschedulings Definite or Probable Reschedulers Before Yearend Argentina Nicaragua Domincan Republic Guyana Honduras ? Poland, with a $24 billion total debt, is renegotiat- ing its 1982 commercial bank obligations. The guidelines are similar to those of 1981, but Western banks are to extend short-term trade credits amounting to 50 percent of 1982 interest. This would, in effect, capitalize interest payments, a condition that a number of banks had originally rejected ? Romania is in the process of rescheduling its 1982 debt, although it is still in arrears on a portion of its 1981 repayments. Its 1982 debt is estimated to reach nearly $11 billion at yearend. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Table 5 Selected Countries: Prospects for Debt Rescheduling, 1982-83 Country Last Rescheduling Total Debt a Total Bank Debt b Bank Debt Due This Year Seriousness of debt problems emerging; possible in early 1983. Mexico 68 57 28 Certain by yearend 1982. Argentina 1965 34 25 12 Certain by yearend 1982. South Korea 31 20 12 No major problems through 1983. Venezuela 28 26 16 Some restructuring probable in 1982 or 1983. Poland 1981 25 15 6 In the process of rescheduling 1982 bank debt payments. Indonesia 1968 20 7 3 No major problems until possibly late 1983. Yugoslavia 1980 19 11 3 Possible in 1982 or 1983. Algeria 18 8 2 No major problems through 1983. Turkey 1981 17 4 1 Still receiving benefits of prior reschedulings. Philippines 16 10 6 Growing concern, but unlikely before late 1983. East Germany 15 11 5 Possible in 1983. Chile 1975 14 11 4 Unlikely before mid-1983. Peru 1978 11 4 3 Possible in early 1983. Romania 10 5 2 1982 rescheduling process under way; likely to recur in 1983. Hungary 9 8 3 Some chance during 1983. a Debt of all maturities as of yearend 1981. b Debt owed to Western banks as of yearend 1981. c Debt owed to Western banks with maturity of one year or less. Most of the other countries that will reschedule this year do not have large debts, and even together, their debts do not seriously trouble Western banks. Each of their medium- and long-term external debt is less than $6 billion; combined, they account for only about 5 percent of total debt, and only a small portion of that is owed to Western banks. Countries such as Togo, Uganda, and Zaire typically suffer from chron- ic economic mismanagement and slow growth, exacer- bated by the global recession and high interest rates. Others, such as Costa Rica and the Dominican Re- public have only recently gotten into financial trou- bles because of poor economic decisionmaking coin- ciding with depressed demand for their exports and high interest rates. I Ibanks are also closely watching the financial conditions of other large bor- rowers whose financial situation could deteriorate to the point of needing debt relief (table 5): ? Brazil, with total debt of at least $80 billion, had until recently stabilized its debt position. Largely because of the spreading worry about the Mexican and Argentine situations, Brazil is now having difficulty obtaining new loans and its foreign ex- change reserves are seriously low. ? Chile has attracted banker concern because of lower commodity prices (especially for copper) and a severe recession, and it may have to reschedule its Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 debt next year. Total debt currently stands at about Most of the bankers' concern is with the large size of $16 billion, and creditors have slowed new lending the debts, especially those of Brazil and Venezuela. to Chile. ? East Germany is cutting imports in the face of continuing unwillingness by Western bankers to extend credits and difficulties in increasing its hard currency export earnings. Such actions may still be inadequate to prevent a rescheduling request by early next year, if banks continue to reduce their exposure. Total debt currently stands at $14 billion. ? Peru's financial situation has deteriorated during 1982, and total debt is about $12.5 billion. Despite a recent IMF agreement, bankers are wary of Peru largely because of depressed commodity export rev- enues. A rescheduling could take place in the first part of 1983. ? The Philippines, with a total debt of about $18 billion, is being watched closely by lenders. The main concerns are low commodity prices, rapidly growing short-term debt, and government economic policies that have discouraged industrial efficiency. Several private Philippine corporations are in deep financial trouble, but we believe a rescheduling is unlikely before late 1983. cording to one authoritative tinancial journal, bankers worry that if global recovery does not take place, trade will continue to deteriorate and cause debt management problems for more countries Implications of Greater Rescheduling The Bright Side. Recently, some financial publica- tions have expressed concern that the international financial system will be unable to manage several simultaneous reschedulings by major debtors,F we believe t at multiple large reschedulings would not be insur- mountable if agreements are implemented smoothly without substantial interruptions in interest payments. Many of the rescheduling countries are repeaters- such as Sudan, Togo, and Zaire-and have been in financial trouble for the better part of the past decade. Creditors have generally determined that these countries will be unable to service their debt for the next several years, and rescheduling is a means by which the banks can write off these loans over time. Because most of these countries have relatively small external debts, banks are able to do this without ? Venezuela has been attempting to restructure a portion of its $29 billion debt to a longer term maturity. The Falklands conflict made some credi- tors leery of Venezuela and was partially responsible for a recent $2.5 billion loan falling through. A continuation of the soft oil market could put added financial pressure on Venezuela, but a formal re- scheduling seems unlikely during the next 12 months. ? Yugoslavia, with a total debt of $19 billion, faces possible rescheduling in 1983. The country has suffered from poor economic performance and has also been hurt by the credit squeeze in Eastern Europe. The leadership's inability to deal with economic problems, along with its refusal to consid- er rescheduling, has weakened its credibility among the Yugoslav people and has postponed key deci- sions until early 1983. sharply cutting profits. Most commercial bankers, according to a leading bank newsletter, view some reschedulings as benefi- cial when combined with properly implemented aus- terity measures because they allow a country to ease an immediate repayment problem without seriously damaging its longer term credit standing. For exam- ple, Chile (in 1974-75) and Peru (1978) underwent reschedulings that eased their financial burdens, and they wer ain borrowing heavily at favorable rates by 1980. 25 25 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Table 6 Estimated Share of Total Debt Held by US Banks Central African Republic 5 Chile 35 Costa Rica 25 Reduced Bank Lending. The increasing number of countries unable to service their debt obligations reduces the quality of bank assets and hence the ability of banks to expand lending. A growing share of Western short-term bank loans that were scheduled to be repaid this year is having to be restructured into longer term assets a move that decreases the banks' liquidity. Although we do not have any firm data on debt holdings of foreign banks, US banks are the major lenders to Latin America and Yugoslavia, and Euro- pean banks hold most other East European debt (table 6). Besides decreasing banks' ability to lend to LDCs and East European countries, there is a danger that borrowers' financial problems could trigger a "herd" instinct on the part of bankers that would reduce their willingness to lend. Certainly, lenders as a group are looking much more critically at individual trouble- some borrowers. Countries that were attractive to bankers several years ago now find lenders somewhat recalcitrant In the extreme, typica y conservative an ers cou decide that any new lend- ing to LDCs and East European countries is not worth Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Table 7 Potential Debt Problem Countries: Importance of Borrowing, 1982 a Trade and Services Balance Excludin Interest Payments b Scheduled Principal Repayments b Ex Ante Required Borrowing Net Borrowing as Share of Imports (percent) g Interest Gross Net Argentina 1.8 4.5 3.8 6.5 2.7 40 Malawi -0.2 0.1 0.1 0.4 0.3 90 Mexico 2.5 10.0 7.0 14.5 7.5 40 Nicaragua -0.5 0.2 0.2 0.9 0.7 80 Pakistan - 1.1 0.5 0.5 2.1 1.6 30 Peru -0.6 1.1 1.5 3.2 1.7 40 Togo -0.1 0.1 0.1 0.3 0.2 60 Unless otherwise noted, includes borrowing from all sources. Most, however, would come from Western banks. b Medium- and long-term debt only. Source: Prepared by CIA analysts on the basis of projections of trade and debt data for 1982. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 the risk. This reaction is likely to be strongest among the smaller banks, which watch very carefully for market signals from the major financial institutions. Lending Cutback Implications. A cutback in the growth of Western bank lending would have serious implications for a number of debtor countries and, in turn, for the international financial system. Specifi- cally, these nations would be forced to undertake or strengthen austerity measures to compensate for the reduced availability of foreign exchange. Such moves would slow economic growth and could stimulate political and social unrest in some countries, including changes in governments. In the extreme, to avoid this outcome, countries could simply stop payment on their external debt. In our judgment, a general reduc- tion in the growth of Western bank lending could force additional reschedulings and could push one or more of the large borrowers being closely watched by financial analysts beyond their debt management capability. is equivalent to over one-half Brazil's import bill. In the absence of new lending, Brazil would have to cut imports drastically to pay its debt service obligations or, alternatively, delay interest payments to maintain the level of imports. Depending on how an import shortfall is allocated between capital and consumer goods, Brazil's economic growth would be reduced, perhaps sharply. The resulting austerity would raise the risk of serious political instability. Debt Repudiation Risk. Although the likelihood is small, we cannot discount totally the possibility that one or more LDC leaders may declare an extended debt moratorium or repudiate their external debt. From an economic standpoint, a debt repudiation or an extended moratorium on repayment does not cor- rect a country's underlying economic management problems; it would, however, seriously disrupt that country's international trade, jeopardize access to credit, and run the risk of tying up whatever assets creditors could gain access to. Politically, however, an LDC leader may be tempted to refuse to honor debt obligations by frustration over the inability to solve the country's economic problems under a large over- hang of debt or by the need to salvage domestic support. If this were to occur, investors and depositors could lose confidence in several major banks and withdraw their funds; these funds would be reinvested in US Government securities and other instruments deemed safe. This could cause a liquidity crisis for banks and, in turn, could trigger a rapid reduction in world credit as major banks cut back lending. Such a yarticularly concerns bankers.I ome foreign banks are reducing the availability of short-term credits and demanding repayment of maturing loans rather than rolling them over. economic growth. While the seeds for such a collapse are present, we believe that appropriate and timely central bank intervention could check such a crisis without serious long-term damage to the Western Table 7 illustrates the importance of commercial borrowing to countries that have serious financial problems. Brazil, for example, would have required net new borrowing on the order of $12.7 billion this year to cover its current account deficit. This amount banking system. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 The increasingly dire financial straits of several key LDC debtors combined with the generally dismal economic performance of most LDCs over the past several years raise the prospect that harassed LDC policymakers may try as a group to confront bankers for some form of universal debt relief. The idea is not new. Generalized debt relief was formally raised to the level of a Third World "demand" in the North- South dialogue in 1976. Particular emphasis was on then-dominant bilateral and multilateral debt, but a scheme to reschedule private bank debt and create a new international aid institution to compensate bank- ers was discussed. Proposals for generalized debt relief fell victim to sharply divergent economic situa- tions and views of foreign debt among LDCs. The magnitude and preponderance of private bank debt in LDC borrowing portfolios now puts a new perspective on LDC demands for debt relief because of the bargaining power inherent in a collective blackmail of creditors. Still, we do not yet see any valid evidence of moves in this direction, and the underlying arguments against it essentially pertain: ? The largest LDC borrowers stand to make substan- tial economic progress over the longer term and have in the past evinced concern that radical pro- posals for debt relief could jeopardize access to needed credits. ? The most radical Third World leaders on debt relief as a North-South issue-such as Nicaragua and Tanzania-are not large debtors to private banks. ? The strongest early proponents of generalized debt relief that have relatively large debt burdens-such as Pakistan, Bangladesh, and Zaire-have viewed it simply as a resource transfer and would probably be just as pleased with increased aid. This argument is admittedly tempered somewhat, however, by the rapid rise of Venezuela and Nigeria into the ranks of problem debtors; both were strong proponents of generalized debt relief demands in the 1970s. Although we are reasonably confident that no work- able moves toward collective debtor action are immi- nent, we agree that it is an intelligence issue worth close watching. LDCs have in the past acted in ways we would have called contrary to their best interests. If external financial difficulties, domestic economic problems, and attendant political pressures reach some critical mass with no alternative relief in sight, the probability of a collective confrontation would increase. Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Secret Secret Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5 Approved For Release 2007/03/08: CIA-RDP83B00851 R000300060003-5