OUTLOOK FOR THE INTERNATIONAL DEBT STRATEGY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86M00886R000800020018-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 17
• Document Creation Date: December 21, 2016
• Document Release Date: December 10, 2008
• Sequence Number: 18
• Publication Date: May 1, 1984
• Content Type: REPORT

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MEMORANDUM FOR: SA/DDCI P'
This typescript is an advance
copy of an IA scheduled for publication in
mid-June and was sent to key Summit partici-
pants for their background use.
Acting Chief
International Finance Branch
Economics Division
Office of Global Issues
I Date 30 May 1984
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Outlook for the International Debt Strategy
Summary
Over the last two years, rescue packages coordinated by the IMF have forestalled
default by debt-troubled LDCs and East European countries and averted a major
disruption in the international financial community. Debtors and creditors have
negotiated these packages on a country-by-country basis. In return for complying with
an IMF economic adjustment program, debtors have obtained debt restructurings, new
commercial bank and IMF loans, and official emergency short-term loans and export
credits. This strategy has assumed that as world economic recovery proceeds and LDC
adjustments are undertaken, the financially troubled countries would reeain normal
market access to new loans and be able to service their debt on time.
Although Western economic recovery is underway and debtor country external
accounts are steadily improving, we believe that serious problems still could arise under
the present debt strategy.
o Some US regional and European banks are becoming increasingly
reluctant to participate in new loan packages for these financially
troubled countries. This implies an increased burden on the larger
banks; the financial community is already concerned about high loan
exposures to troubled debtors.
o Governments of many financially troubled countries face intense
political and social pressure to abandon or weaken austerity measures.
Reduced subsidies, wage restraints, and sharp import cuts are
provoking widespread discontent and in some cases, such as Costa Rica
and Bolivia, are directly responsible for recent political turmoil
o Global economic conditions may not improve enough for these
countries to attract suffi eir debt and to
finance development needs.
Many observers are concerned that Western economic recovery may falter and
interest rates rise further and believe new proposals should be considered for dealing
with the international debt problem. Already a number of proposals have been put
forward - including capitalization of interest, multi-year restructuring, and a new SDR
allocation. While these proposals conceptually would make more foreign exchange
available for imports and help spur economic growth in the LDCs, there are several
disadvantages.
o Some would require legislation that would be time-consuming and
perhaps not feasible.
o Some would treat all debtors identically and fail to recognize the
uniqueness of each debtor's situation.
GI M 84-10098
May 1984
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o They may reduce the incentive of debtor countries to continue
implementing austerity measures.
o They could reduce the willingness of commercial banks to extend new
credits to the debtors in the future.
Debtor countries are also calling for new proposals that would share responsibility for
solving the debt problem and assuming losses with creditors. As a result, we expect
tougher stances in negotiating with creditors this year. Moreover, recent reaction to the
rise in interest rates suggests closer coordination of debt policies by the debtors.
We believe demands for alternative solutions to the debt problem increasingly will
be heard from LDC debtors, academics, and some Western allies. The political strains on
the debtor governments are growing, and we cannot rule out more hardline demands or
radical actions. While in some cases calls for action may simply be rhetoric, Washington,
nevertheless, could be forced to find a way to respond to creditor and debtor concerns in
the months ahead. Moreover, foreign pressure could build rapidly if a major roadblock
were hit in financial dealings with a major debtor. In this regard, the Argentine situation
probably bears the closest watching; US banks may face another nonperforming loans
problem the end of June as IMF negotiations drag on.
This memorandum was prepared byl (Economics Division, Office of Global
Issues. Comments and queries are welcome and may be addressed to Chief, International
Finance Branch
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Outlook for the International Debt Strategy
Prelude to the Current Problem
The debt burden of the LDCs and East European countries has become extremely
large. Spurred by grand development plans and the easy availability of foreign bank
credit, international financial statistics show that these countries boosted their combined
medium- and long-term debt from only $55 billion in 1970 to $650 billion at yearend 1983
(see figure 1). By the late 1970s, the LDCs and East European countries were adding
more than $50 billion a year to their medium- and long-term debt burden. In addition,
these countries have at least $175 billion in short-term debt
The structure of these countries' external debt shifted dramatically in the past
decade. In the early 1970s, these countries borrowed mostly from multilateral
institutions on concessionary terms; only 40 percent of their borrowing was from
commercial banks. By the late 1970s, the ratio had reversed with private sources
providing nearly two-thirds of these countries' external loans; the Latin American
countries rely on private sources for almost all of their financing needs. This shift has
made the cost of financing more onerous for the debtor countries, because the majority
of commercial bank loans are tied to market interest rates, whereas official credits
carry lower, fixed interest rates. In addition, bank loans have to be repaid more quickly
While these trends set the stage for the debt problem, the crisis actually came
when countries such as Poland, Mexico, and Brazil were no longer able to repay their
debt as scheduled. We and other financial observers believe several factors were
responsible:
o The size of the annual interest and principal payments owed by the
LDCs and East European countries mushroomed, growing from only $9
billion in 1970 to $150 billion by late 1982 (see figure 2). Much of the
increased burden resulted from a dramatic rise in interest rates as
industrial countries fought inflation with tight monetary policies.
o Concurrently, recession in the industrial countries and low commodity
prices weakened debtor countries' exports so that the LDCs had less
income with which to service their debt. As a result, several key Latin
American countries-Argentina, Brazil, and Chile-saw interest
payments alone as a share of export earnings rise to more than 40
percent in 1982. A
o Finally, given world economic conditions, international lenders
perceived grdwing risks in the LDCs; as a result, they cut back new
lending and refused to refinance maturing debts, especially short-term
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FIGURE 1
LDC AND EAST EUROPEAN MEDIUM- AND LONG-TERM DEBT
700
Source: CIA estimates based on
IMF, World Bank, BIS, and OECD data.
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FIGURE 2
LDC AND EAST EUROPEAN DEBT SERVICE
(medium- and long-term principal repayments and all interest payments)
0
J
J
NO'
EASTERN EUROPE
OF-
1`11; 41'J" ,h1D4a1
1141
YEARS
1'- \141
NO"
Source: CIA estimates based on IMF,
World Bank, BIS, and OECD data.
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Current Strategy for Coping with the Debt Problem
A review of country rescue programs shows that over the last two years
creditors have dealt with LDC debt servicing problems on a case-by-case basis.
Generally, when a country has fallen behind in payments, creditors have agreed to
temporary delays of payment while the debtor country began discussions with the
IMF. Within a month or two, the debtor country has adopted an IMF-supported
economic adjustment program which is monitored quarterly. In return, the debtor
country has obtained new financial assistance from creditors and a restructuring
of its debts. The strategy assumed that as world economic recovery proceeds and
LDC adjustments are undertaken, the financially troubled countries would regain
normal market access to new loans and be able to return to servicing their debt on
This case-by-case approach has been publically articulated by the United
States and other industrialized countries as a five-point debt strategy, which
includes:
o Encouragement of continued bank lending.
o Continued willingness of Western governments and institutions to
provide bridge financing when necessary.
o Strengthening of international financial institutions such as the IMF.
o Adoption of policies by industrialized governments to promote
sustained non-inflationary growth.
o Encouragement of sound economic policies within LDCs.
So far under this strategy, no countries have repudiated their debt, and there has
been no major liquidity crisis. Most of the financially troubled countries have
implemented IMF-supported austerity measures. In addition, the resources of the IMF
have been increased. Finally, Western governments and commercial banks have
restructured a large portion of maturing debt and have agreed to lend additional funds to
several countries as part of their debt-relief packages.
Economic Impact on the Debt-Troubled Countries and the United States
While cooperative efforts have prevented major disruptions to the international
financial system, the impact of adjustment programs on the debt-troubled countries has
been severe. Austerity, measures, such as restraints on wages, government spending, and
domestic credit, as well as foreign exchange constraints, have led to steady declines in
the debtor ' economies. According to official government, IMF statistics, and our
estimates, the largest debt-troubled LDCs have seen their real GDP actually fall during
the past two years, a sharp turnaround from the 4-5 percent growth of 1979-80 (see
figure 3). Imports have even fallen below levels originally targeted in IMF-supported
adjustment programs. The imports of Argentina, Chile, and Mexico have fallen by at
least half in the last two years (see figure 4).
Moreover, it is not only the major debtors who are having financial difficulties and
undertaking economic austerity measures. Close to 40 countries currently have or are
seeking IMF-supported programs. Last year 25 countries obtained debt relief totaling
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 FIGURE 3
REAL GDP GROWTH: SELECTED DEBTOR COUNTRIES
-4 ~-
1979
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1980 1981
TOP 8 DEBT-TROUBLED LDCs
000
1982 1983
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FIGURE 4
IMPORT TRENDS IN KEY DEBT-TROUBLED COUNTRIES
Legend
? 1981
- 1983
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about $55 billion (see figure 5). We expect that 35 countries will ask for debt relief this
year in the amount of $70 billion.
The US economy has not been immune from the fallout of the LDC debt problem.
The sharp drop in imports by the debtor LDCs has aggravated the US trade deficit.
Trade statistics show, for example, that US exports to Latin America declined from
roughly $42 billion in 1981 to $22 billion in 1983. In addition, US banks are highly
exposed to debt-troubled countries. LDCs and East European countries owe US banks
nearly $150 billion, with the 9 largest US banks accounting for roughly $90 billion.
Moreover, the exposure of large US banks is highly concentrated in a few large debt-
troubled countries; Argentina, Brazil, Mexico, and Venezuela together owe the nine
largest US banks over $40 billion, which substantially exceeds these banks' net worth.
This vulnerability of the large US banks to the debt problem is reflected in the decline in
their stock prices relative to the overall market. press reporting
indicate that many investors fear that these banks may have to write off a large portion
of their foreign loans, which would depress bank earnings and could raise depositors'
concerns over the solvency of these institutions.
Potential Problems under the Current Debt Strategy
Although Western economic recovery is underway and LDC external accounts are
steadily improving, we believe that serious problems still could arise. In the past six
months, there are signs that many commercial banks have become increasingly reluctant
to lend new money to debt-troubled countries. For example, about 30 smaller US and
foreign banks, according to press reporting, refused to participate in the recent $3.8
billion loan to Mexico. While most of the large, heavily exposed US banks are willing to
make new loans in order to get back their interest payments on existing loans, a growing
number of US regional and European banks are refusing to go along. Financial observers
state that US regional bank reluctance is part of a strategy to limit exposure to troubled
debtors. European banks operate under less stringent accounting rules and do not feel
compelled to lend new money to keep interest payments current on existing debt. Under
current US regulations, when interest payments are past due by more than 90 days, US
banks - unlike their European counterparts - generally must place their loans in a
nonperforming category and deduct interest not received from income.
As the foreign and smaller US banks drop out, the large US banks are forced to
take on even more of the burden of new lending. In the four big Latin American
countries, the nine largest US banks already account for roughly two-thirds of total loans
made by US banks, according to Federal Reserve Board statistics (see figure 6). Concern
about regulatory and stockholder reactions to increased LDC loan exposure hinders these
banks' ability to assume this greater burden.
For this reasons we believe there could be shortfalls in meeting new money
requests later this year.- According to press reporting, Argentina will need over $2 billion
to keep interest payments current, and we believe raising that amount could be
difficult. The Philippines is already seeking over $1.6 billion in new money from banks,
and some banks are indicating reluctance to participate, according to press reporting.
We believe Brazil could require more than $3 billion in new loans from banks to meet
1985 financing needs, but many European and smaller US banks have already said that
they will not participate in a third package
A second problem area under the five-point strategy is that the governments of
many financially troubled countries are having an increasingly difficult time maintaining
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I I
FI3URE 5
LDC AND EAST EUROPEAN DEBT RESTRUCTURINGS
SELECTED YEARS 1976-1984
Legend
? NO. OF COUNTRIES
=BIWONLOS $
Source: CIA estimates based on OECD and
IMF data.
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FIGURE 6
US BANK EXPOSURE IN LATIN AMERICA, BY SIZE OF BANK
AS OF JUNE 1983
MEXICO
Legend
MALL OTHER RANKS
- NEXT 13 LARGEST BANKS
? NR4E LARGEST PAWS
Source: Federal Reserve Board data.
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austerity programs. As wages and subsidies have been cut in response to IMF
conditionality requirements, political resistance to austerity programs has grown. Such
resistance has caused several key debtors to fall out of compliance with their IMF-
supported programs leading to interruptions of new money disbursements and the buildup
of arrearages. Once such a disruption occurs, renegotiation of new IMF terms becomes
even more politically difficult for the incumbent governments. Argentina, the
Philippines, and Bolivia have all been declared out of compliance with IMF agreements
and relations with creditors are fragile. Efforts to negotiate new agreements have
dragged on for months largely because of political constraints these governments face in
implementing measures to satisfy the IMF. The Bolivian Government's decision last
month to devalue its currency and to increase food prices as preconditions for an IMF
agreement spurred widespread labor strikes, including disruption of the banking system.
In Argentina, continued sporadic strikes make it increasingly difficult for President
Alfonsin to move forward on economic issues. In the Philippines, creditors are concerned
that new opposition strength in the Assembly will make it more difficult to implement
austerity measures and conclude IMF negotiations.
Over the last year, favorable economic trends have helped improve debt-troubled
countries' external financial positions; since mid-1983 OECD real GNP has risen 4.5
percent annually. In addition, interest rates and oil prices have remained steady. It is
not clear, however, that the coming months will be as favorable. According to a number
of forecasters, economic growth is expected to slow - perhaps as soon as fourth quarter
this year -and interest rates could rise further. Moreover, if the situation in the Persian
Gulf worsens, oil prices could rise.
These economic trends would have the following kinds of impacts:
o Each one percentage point drop in OECD real growth cuts more than $2
billion from non-OPEC LDC export earnings.
o Each one percentage point rise in US dollar interest rates boosts non-
OPEC LDC's annual interest payments by about $2 billion; such a rise
costs Brazil and Mexico over $500 million each.
o A $5 per barrel oil price increase raises import costs for an oil-
importing debtor such as Brazil by at least $2 billion; while an increase
would improve the financial situation of oil-exporting debtors such as
Mexico, Egypt, and Peru, on balance, we believe an runup in oil prices
would be destabilizing for those banking centers and countries with
high loan exposure to non-oil exporting LDCs.
Smaller amounts of official assistance could also hamper the present debt
strategy. The capability and willingness of Western nations to provide emergency bridge
financing is uncertain. US Government resources are constrained; available Commodity
Credits Corporation and Eximbank credits are relatively small. Western governments did
help to bolster the IMF's pool of funds last year. The IMF, however, provides only
temporary and generally limited balance of payments relief to financially troubled
countries. Many of these debtors require longer term investment-related capital to spur
economic activity.
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New Proposals
Concerned that Western economic recovery may falter and interest rates remain
high, many observers believe new proposals should be considered for dealing with the
LDC debt problem. Even with a sustained recovery, debt restructuring and new bank
credit are likely to continue to be necessary for many LDC debtors over the next couple 25X1
years. Moreover, consensus is growing among debtors and some Western governments
that LDC economic adjustments have been rigorous and that new policies are needed to
enable debtor countries to finance growth and investment. There is also the concern that
as IMF assistance nears the debtors' quota limits over the next 18 months, these debtors
will not be suffieip itworthy to attract needed capital in the market place.
New proposals under discussion - including capitalization of interest, multi-year 25X1
restructuring, and a new SDR allocation - vary widely in the amounts of debt relief they
would provide and who would bear the costs (see table 1). Some would require banks to
take larger losses, while others would require substantially more aid from Western
governments. According to financial observers, these proposals present other
difficulties:
o Some would require legislation that would be time-consuming and
perhaps not feasible given current Western political environments.
o By providing across-the-board relief, some would treat all debtors
identically and fail to recognize the uniqueness of each debtor's
situation and economic adjustment performance to date.
o A new initiative will require the approval and cooperation of
commercial bank and official creditors, which have divergent views
between and among themselves.
o They could reduce the willingness of commercial banks to extend new
credits to the debtors in the future. 25X1
o By shifting the responsibility for the debt problem to commercial
creditors and Western governments, debtor countries will have less
incentive to undertake needed economic adjustment measures.
The debtor countries are also calling for ways that would share responsibility for
solving the debt problem and assuming losses. Latin American governments are already
giving signals that they will insist on easier loan terms, including lower interest rate
concessions and longer grace periods. For example, press reports indicate that Argentina
is considering asking creditors to reschedule its debt repayments over 11 years, including
a four-year grace period. In addition, Economic and Foreign Ministers of Argentina,
Mexico, Brazil and Colombia have publically announced they plan to meet in the near
future to consider new options for easing the debt burden. In addition, the Organization
of American States Special Committee on Finance and Trade is currently studying the
possibility of tying debt servicing to economic growth rates.
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New Proposals for the Debt Problem
Lower bank interest rates
Banks reduce interest rates charged on loans
to LDCs below their cost of funding
Capitalization of interest
Banks add all or part of interest payments to
the principal amounts owed by debtors
Multi-year restructuring
A debt relief package that restructures
principal for more than one year
SDR allocation
The IMF creates new money to build up debtors'
foreign exchange reserves
One year grace period
Immediate hiatus of all debt payments for one
year with the amount being rescheduled
Exchange Participation Notes
Debtor governments service debt based on a set
share of export earnings
Debt Discounting Corporation
New institution issues bonds to banks in
exchange for banks' loans and the institution
reschedules loans on softer terms
Debt Corporation
New institution purchases problem loans from
banks, sells loans to private investors, and
guarantees debt servicing
o Reduces future borrowing requirements
o Frees up money for LDC imports to spur
economic growth
o Burden is distributed more evenly among banks
o Frees up money for LDC imports to spur
economic growth
o Spreads bunching of maturities over many years
o Could improve the creditworthiness of debtors
o Reduces costs of restructuring
o Helps to rebuild LDC creditworthiness
o New money for imports to spur economic growth
o Frees money for imports to spur economic
growth
o Debt repayment linked to ability to pay
o Encourages creditors to invest in export
industries
o Interest losses must be assumed by banks or
Western governments
o Requires changes in banking regulations
o Could reduce banks' desire to lend new money
o Requires changes in banking regulations
o Effects willingness of banks to lend new money
o Increases overall level of debt
o Reduces creditor influence over LDC economic
policies
o Provides no relief from high interest charges
o Could be inflationary
o Across the board relief to all IMF members;
does not distinguish debtor economic perfor-
mance and reduces debtor's incentive to adjust
o Disincentive to take economic adjustments
o Requires changes in banking regulations
o Increases overall level of debt
o Difficult to accurately measure export
earnings in LDCs
o Hinders LDCs' ability to plan and adjust for
future changes in economies and world markets
o Requires funding from the United States and
its allies
o Reduces bank responsibility to debt problem
o Lbes not provide substantial interest payment
relief to debtors
o Requires funding from the United States and
its allies
o Reduces bank responsibility to debt problem
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Implications for the United States
We believe calls for new initiatives to the debt problem increasingly will be heard
from LDC debtors, academics, and some Western allies. If not responsive, the United
States could be criticized for being insensitive to longer term growth and development
needs of LDCs.
o The United States already came under fire at the latest OECD meeting
where other industrial nations urged formulation of a medium-term
approach to the problem, even though they offered no specific
suggestions.
o At the June Economic Summit, France, in particular, may ask heads of
state to support a "medium-term solution" to the LDC debt problem.
EC Summit proposals call for consideration of new initiatives to rebuild
debtor foreign exchange reserves and spur economic recovery.
o Rising US interest rates will likely continue to provoke LDC political
opposition to US economic policies and strengthen calls for easier
repayment terms or a new solution to the debt problem.
Moreover, the political strains on the debtor governments are growing, and there
is much uncertainty over debtor-creditor positions in upcoming debt negotiations. In this
environment, we cannot rule out more radical demands or actions by debtors. For
example, a major debtor such as Argentina could refuse to cooperate with the IMF;
Argentina or Mexico could call for a global debt conference; or a major debtor could
insist on substantially easier terms from commercial banks, resulting in deadlocked
While calls for action may simply be rhetoric, Washington could be forced to find
a way to respond to creditor and debtor concerns. The Argentine situation bears close
watching. US banks again may face another non-accural loan problem the end of June.
In addition, negotiations between Argentina and the IMF are dragging. And even when an
Argentine letter of intent is accepted by the IMF Managing Director, we believe
negotiations between Argentina and commercial banks for the restructuring of 1982-94
maturities and new money will be difficult and prolonged.
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