FINANCIALLY TROUBLED BORROWERS: PROSPECTS FOR DEBT RESCHEDULING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83B00851R000300060003-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 20
• Document Creation Date: December 20, 2016
• Document Release Date: March 8, 2007
• Sequence Number: 3
• Publication Date: October 1, 1982
• Content Type: REPORT

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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
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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
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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
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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
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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
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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.
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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.
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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.
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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
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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
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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.
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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.
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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
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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
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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
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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.
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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.
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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.
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