THE DEBT PROBLEM REVISITED

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86M00886R000800020019-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 18
• Document Creation Date: December 21, 2016
• Document Release Date: January 12, 2009
• Sequence Number: 19
• Publication Date: April 26, 1984
• Content Type: MEMO

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The Director of Central Intelligence
Washington. D.C. 20505
National Intelligence Council
NIC #02524-84
26 April 1984
MEMORANDUM FOR: Director of Central Intelligence
Deputy Director of Central Intelligence
Chairman, National Intelligence Council (4
National Intelligence Officer for Economics
SUBJECT: The Debt Problem Revisited
1. Attached is a typescript memo that I have prepared on the debt
problem. I have sent it to interested officials at the Assistant
Secretary and senior staff level. My objective is to stimulate the
policy community concerned with this issue, especially at Treasury, to
take another look at the debt problem on an interagency basis. The last
interagency study on this question is a year old. The study laid the
foundations for the current policy--essentially an ad hoc treatment of
country debt problems, with heavy reliance on the IMF. I believe that
this approach is still basically sound, but needs to be supplemented in
important ways because of growing political resistance to IMF-imposed
austerity in the debtor countries.
2. You may wish to send this study to your own policy counterparts.
Attachment:
As stated
All portions Confidential
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NIC #0254-84
26 April 1984
DCI/NIC/NIO/Econ:M.Ernst:bha(26 Apr 84)
Dist:
Orig - DCI
1 - D DC I
1 - DCI/SA/IA
1 - ER
1 - DDI Reg
1 - C/NIC
1 - VC/NIC (HM)
2 - NI0/Econ
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Introduction
About a year ago an interagency study of the debt problem was
prepared for the SIG-IEP. The study concluded that, although major
difficulties requiring complex US policy choices could be expected, the
debtor countries could, over a reasonable period of time, work themselves
out of the debt problem by rapidly expanding exports. The necessary
conditions for such an export-led recovery were defined as: reasonably
rapid economic growth (e.g., 3 - 4 percent a year) in OECD countries; the
absence of protectionist policies; and appropriate adjustment policies in
the debtor countries. This memorandum examines some of these judgments
and perspectives in the light of developments in the past year and draws
some tentative conclusions about the changing nature of some of the
issues related to the debt problem.
The major LDC debtors are unlikely to quickly work themselves out of
their debt problems through a rapid expansion of exports. Global
economic trends are not favorable enough to bring this about, and the
economic, institutional, and political barriers to the necessary shift in
LDC resources are too great.
While the necessary changes in economic structure will take years,
the debtor countries have had to drastically curtail imports to make ends
meet, and these import cuts have been accompanied by severe declines in
economic activity and per capita expenditures.
Political dissatisfaction with severe and continuing austerity is
growing in the debtor countries, as is resistance to IMF-sponsored
programs designed to aid also in longer-term restructuring. These
reactions vary greatly among countries and are likely to become even
stronger in the future, even as the economies begin to improve.
The willingness of the key institutions in the creditor
countries--including banks, governments, and regulatory agencies--to
provide or support continuing assistance to the debtor countries, is
being linked increasingly to the implementation of IMF-sponsored
austerity programs. Although these linkages provide a certain policy
coherence, they also impose a great burden on the IMF and tend to reduce
its flexibility in dealing with countries with vastly different economic
and political circumstances. While specific countries' problems call for
great flexibility, the IMF must be concerned about its credibility
because of the impact on all its other programs. So far the IMF has done
an excellent job steering a difficult course between competing objectives.
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If ways are not found to ease pressure on the IMF, however, there is
high risk that likely future confrontations between debtors and
creditors--with the most likely near-term confrontation being with
Argentina--cannot be satisfactorily resolved.
Macroeconomic Trends
Global macroeconomic trends in 1983 and projected for 1984 have been
mixed--better than expected in some respects; worse in other respects.
o OECD GNP grew more than 2.5 percent last year, about 0.5 percent
better than expected a year ago, pushing up the volume of LDC
exports, and should be around 4 percent in 1984.
o In 1983, the terms of trade worsened for the oil exporting LDCs
and stabilized or improved a little for other developing
countries. Future trends in the terms of trade are highly
uncertain. Although prices of some metals and other commodities
have firmed in recent weeks, stocks, and in some cases excess
capacity, remain ample.
o Interest rates, after declining substantially in the latter part
of 1982 and the first half of 1983, have risen in recent months,
with LIBOR rising to above 10 percent. If interest rates
continue to rise, at least through the first half of the year as
many market analysts expect, the effective cost of loans to many
developing countries could, given the large spreads, return to
close to the 1982 average level, and the ratio of interest cost
to export earnings could also equal the 1982 levels of 30 - 40
percent for major debtors (table 1).
o Beyond 1984, most forecasters expect a slowdown in OECD economic
growth to a rate of 2 - 3 percent, and some expect a recession
in 1985-86. If growth slows substantially, there may not be
much if any improvement in the LDC terms of trade.
Economic Adjustment
The debtor countries have had to make a massive adjustment to the
changing economic environment. Fundamentally, they must adjust to what
seems likely to be a lasting increase in real interest rates and a
lasting decline in the size of current account deficits that can be
financed. To make these adjustments without declines in income and
output would have required a substantial shift of resources in the debtor
countries to products which can be exported or can efficiently substitute
for imports. Although any attempt to measure this necessary reallocation
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Table 1
LDC Interest Burden
Ratio of Interest Obligations to Exports of Goods and Services
1978
1981
1982
1983
All LDCs
9
14
15
14
OPEC LDCs
8
11
11
11
Non-OPEC LDC5
10
16
17
15
Argentina
13
45
43
35
Brazil
23
37
53
42
Chile
19
43
40
32
Mexico
20
38
36
30
Nigeria
1
6
10
12
Peru
20
28
27
25
Venezuela
12
20
21
20
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of resources is arbitrary, it is probably in the order of 3 to 5 percent
of GNP and 30 to 50 percent of export earnings in the major debtor
countries, such as Brazil, Mexico, and Argentina. */ Resource transfers
of this magnitude are difficult and may take years, particularly because
of marketing difficulties for exports, institutional barriers, and the
fact that in many countries import substitution has already been pushed
very hard.
During the past two years or so the debtor countries have had to
adjust not only to what will probably prove to be longer term changes
such as the above, but also to cyclical and short-term circumstances,
which, for the most part, have been highly adverse. In addition to
depressed exports and high interest costs, the debtors have been faced
with massive capital flight in one form or another (estimated at over $40
billion in Latin America alone during 1981-83).
The adverse effect of these developments has swamped the emergency
and new lending from the IMF, the commercial banks and the United States,
and consequently debtor countries have been forced to adjust by
drastically curtailing imports. Between 1981 and 1983 in 15 debt-ridden
LDCs:
o Imports fell by $55 billion, or 40 percent for the group as a
whole, and by more than 50 percent in Mexico, Argentina,
Nigeria, and Chile (table 2).
o Exports fell by $14 billion, or more than 10 percent, mostly
because of lower prices.
o The trade surplus increased by over $40 billion.
o The current account balance improved by over $50 billion.
o And despite this enormous improvement on current account, these
countries lost some $10 billion in official reserves.
On the assumption, for example, that the longer term increase in real
interest rates in comparison with the late 1970s is 3 to 5 percent and
that financible current account deficits are about half of the level
during the late 1970s.
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Table 2
Imports of Debtor Countries
Billions of US Dollars
1981
1982
1983
% Drop
1981-1983
Argentina
9.5
5.4
4.5
53
Brazil
24.1
21.1
16.8
30
Mexico
24.1
14.6
8.2
66
Chile
6.4
3.6
2.8
56
Venezuela
12.1
12.7
6.3
48
Nigeria
17.4
13.2
7.8
55
Peru
3.5
3.6
2.4
31
15 LDC Debtors
135.2
111.2
80.1
41
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In 1983, imports apparently were at or near the lows of at least the
past decade in relation to GDP in the major debtor countries. There is
some evidence that shortages of imported goods have adversely affected
production, including production for export. Any further contraction of
imports would probably have even more serious effects.
These massive import cuts inevitably were accompanied by substantial
declines in economic activity and even larger declines in real income.
Between 1981 and 1983 (table 3):
o GDP fell 8 to 15 percent in Mexico, Brazil, Argentina, Chile,
Peru, and Nigeria.
o Because current account deficits were shrinking, real domestic
expenditures fell even more than GDP--by 10 to 20 percent in the
same countries.
o Per capita expenditures are down 15 to 30 percent since the 1980
or 1981 peak, and are also well below the average of the late
1970s in most of the debtor countries.
o Although investment has taken the largest cuts, real consumption
has declined substantially, as a result of falling real wages
and growing unemployment.
Debtor country exports should increase fairly rapidly this year and
perhaps next year, but there are large uncertainties.
o Exports appear to have turned up during the last two months of
1983 and US trade data indicate that the recovery has continued
in the early part of 1984.
o Some commodity prices have been firming.
o Several of the major debtor countries have achieved a
substantial real devaluation of their currencies since 1980-81
(figure 1). For Mexico and Brazil, the real exchange rate is
below the average of the mid 1970s. Brazilian exports jumped in
the first quarter. If these real rates can be sustained, or
further lowered, exports should be stimulated in the future.
However, the Chilean exchange rate is still too high and
Argentina is moving in the wrong direction.
o Venezuela and Nigeria, dependent as they are on oil exports, and
probably facing a soft oil market for several years, face a
particularly difficult task in achieving export diversification
and expansion.
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Table 3
Macro-Economic Trends in Major Debtor Countries
1981
= 100
1978-80 Ave
1981
1982
1983
Argentina 97
100
95
96
Brazil 96
100
100
95
Chile 88
100
86
85
Mexico 86
100
100
94
Nigeria 99
100
97
92
Peru 100
100
101
90
Venezuela 101
100
101
98
Expenditures *
per capita
Argentina 104
100
89
87
Brazil 100
100
97
87
Chile 86
100
76
66
Mexico 87
100
90
80
Nigeria 97
100
96
79
Peru 102
100
95
88
Venezuela (1980) 96
100
102
73
* GDP plus imports, minus exports, per capita.
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 \ninr'i r1 I 1aht- Irni thinr1 I I)(a'
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Trends in InTIuTuon-HUjUSwu LIIUt:IIVR; LA~ttuttyv i.utds
Indexed on 1974-77 Average = 100
Argentina
70 -1
1974 1975 1976 1977 1978 1979 1980 1981 1932 1983
YEARS
Figure 1
m
1974 1975 1976 1977 1978 1979 1980 1981 1982 1983
YEARS
LEGEND
f.: kL YR
74-7 7 AVERAGE
70 1 9 1 1 T 70
1974 1975 1976 1977 1978 1979 1980 1981 1982 1 83 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983
YEARS YEARS
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Mexico
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The decline in imports may be ending in most debtor countries, but a
rapid recovery of imports cannot be expected for at least another year or
two.
o Interest payments are rising.
o The net flow of capital to the debtor countries is unlikely to
increase and may shrink further.
o Some earnings will have to be used to replenish foreign exchange
reserves.
Even under favorable circumstances, it will take several years for
major LDC debtors--perhaps until the late 1980s in Brazil--to regain
pre-recession levels of per capita real income.
Credits, Assistance, and Conditionality
In an effort to protect their exposure and other interests in the
debtor countries, and to stimulate economic adjustment in these
countries, creditor banks and governments have increasingly linked their
new credit and rescheduling programs to the IMF, which has become the
linchpin of the entire system.
o New IMF funding has been made conditional on net new lending
from the banks to several LDCs.
o The banks in turn make disbursements on their loans contingent
on the debtors' observance of IMF conditions.
o Bank regulators, at least in the US, are making the existence
and observance of an IMF program a critical factor in
classifying outstanding loans on which some terms are not being
observed.
o The US Government has made negotiation of a program with the IMF
a condition for some of its loans.
The linkages to the IMF are not as strong in the case of debt
reschedulings as in the case of provision of new credits.
o In Venezuela and Nigeria, neither of which apparently will
accept IMF conditionality, the banks are in the process of
rescheduling outstanding debt to protect their interest.
o In the countries which have accepted IMF programs, and
consequently are receiving new money however, reschedulings,
although separate, are influenced by the degree of success in
following the IMF program.
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The IMF's involvement in a large number of programs, each of which is
closely linked to the programs of creditor banks and governments, while
providing a degree of policy coherence to debt rescue attempts, also
tends to reduce flexibility. In 1983, 34 IMF arrangements were
initiated, compared with 19 in 1979. Although the programs differ, they
generally involve similar quantitative performance criteria, such as an
increase in international reserves, and reductions in foreign public
sector borrowing, and the public sector deficit. Obviously, in
negotiating these conditions, and especially in reacting to failures to
meet these conditions, the IMF must worry both about the impact of its
decisions on other creditors to the country in question, and about the
precedent for its other debtor country programs. In short, the IMF must
preserve its credibility, but this limits its flexibility in dealing with
the unique conditions of particular debtor countries.
While the IMF will have increasing difficulty balancing the need for
flexibility with the need to maintain credibility, the banks are likely
to be increasingly reluctant to increase their exposure to LDCs with
serious debt problems.
o Most of the net new bank lending to Latin American countries in
1983 (about $14 billion) was involuntary, consisting of loans by
the major banks negotiated as part of a package with the IMF.
o Participation of regional US banks and many foreign banks in new
loan packages is declining; many banks with only small exposure
have pulled out what they could.
o As the debt problems persist, and regulatory pressures grow,
banks will have to take losses to reflect the reduced real value
of their LDC assets. In the US this has already occurred for
private debt, and the process is just beginning for sovereign
debt. In Western Europe and Japan, banks have been reserving
against questionable LDC and East European loans for some time.
o Under these circumstances, it will be difficult to induce even
the large banks to provide the several billion dollars in new
funds likely to be needed in Argentina, Brazil, Chile, Peru, the
Philippines, and other smaller countries in the next year or so.
Political Reactions in Debtor Countries
The political reaction to economic decline and to attempts at
initiating structural changes in the debtor countries has been extremely
diverse, reflecting each country's political traditions and institutions,
as well as the structure of its economy and the severity of its economic
problems. In general, resistance to IMF conditionality has been growing
and some debtor countries have approached the fine line between
cooperation and confrontation with their creditors.
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Although the early impact of import cuts and other austerity measures
on the population was buffered by drawing down stocks and drastically
cutting investment, in some countries most groups of the population are
now substantially worse off than they had been earlier.
o Argentina and Brazil are in the fourth consecutive year of
recession or stagnation.
o For the oil exporters the decline has been sharp, but relatively
recent--beginning early in 1982 for Mexico, late in that year
for Nigeria, and in mid-1983 for Venezuela.
o In the Philippines, the government has postponed adjustment as
long as possible, and living standards are just beginning to be
affected.
Although the economic decline has caused widespread dissatisfaction,
it has been efforts at initiating structural change that have caused the
strongest political reaction.
o Initial austerity measures generally took the form of drastic
import cuts by means of tight exchange controls. These measures
were widely accepted because there was no other choice--reserves
and credit having run out. And although the measures were
discriminatory, in most countries they tended to favor
politically sensitive groups.
o Austerity policies became more vulnerable to political attacks
when exchange rates and monetary, fiscal, and income policies
began to be changed to allow for an easing of direct control and
a shift of resources to exports. Changes in tax laws, wage
indexing, subsidy levels, etc., are far more visible than
exchange controls and often require legislative action, or at
least political consultation with a wide range of interest
groups. The consensus building process has generally been more
difficult the more "democratic" the political system.
In Argentina, the new civilian government is pressuring the creditors
to accept its judgment as to the political necessity of expansionary
economic policies and to adjust debt servicing terms accordingly.
o Although elected unexpectedly by an absolute majority, the
Alfonsin government's political base is not firm. To govern
effectively, the government needs considerable support from
organized labor, and consequently it must weaken the hold of the
Peronist party over the unions.
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o The government also must cope with the widespread
dissatisfaction which was caused not only by the impact of the
debt crisis, but also by economic mismanagement going back many
years.
o The government believes that it must show some results quickly,
especially an increase in real wages, if it is to retain a
working political coalition. Moreover, Argentine economic
nationalism has deep historical roots and the Argentines do not
take kindly to economic policy conditions seemingly imposed from
abroad.
o This means that the Argentine government may be unable to show
much flexibility in negotiating conditions for an IMF program
and may engage in confrontation tactics.
In contrast to Argentina, the Brazilian government is trying hard to
cooperate with the creditors, but may be unable to implement all aspects
of IMF mandated programs.
o Brazil is going through a transition from a military to a
democratic form of government. Most of the military want to
withdraw from government and there is no evidence that the
economic crisis has changed their minds.
o As the transition has progressed, major decisions hve been made
increasingly by consensus, with the legislature playing a
growing role, at least in being able to block action. Although
pressure for direct election of the President is growing, the
chances are that the military will insist on indirect elections
next November, which will mean a consensus candidate from either
the government party or a coalition of moderate opposition
parties.
o A new indirectly elected Brazilian President and his
administration would probably make few important changes in
economic policy and would continue cooperation with the IMF and
the other creditors.
o There is, however, widespread unhappiness in Brazil over
economic conditions and adjustment programs. Last year wage
indexation was modified only with great difficulty, and it is
highly unlikely that further major adjustments would be accepted
by the legislature. Moreover, although the occasional food
riots are probably not a serious threat to political stability,
they are a signal to politicians to resist any further increase
in austerity.
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Mexico has been a success story for economic adjustment, but at an
economic cost that cannot long be sustained. So far the government has
given priority to rebuilding its international credit and has been
willing to bear the domestic costs entailed.
o In contrast to Argentina and Brazil, Mexico went from an intense
boom to a deep recession in a few months.
o Indeed, the adjustment went well beyond what was called for in
the IMF program, as imports at one time fell by 75 percent,
enabling a rebuilding of reserves and early repayment of some
arrears.
o Organized labor, the backbone of the ruling party, has been
remarkably cooperative. Wage increases were sufficiently
smaller than the growth in the cost of living, not only to cut
real wages, but also to permit some slowing of inflation.
Evidently, labor leaders became convinced that wage moderation
was essential to prevent a much larger increase in unemployment.
o Despite falling real incomes and growing unemployment, the
sharpest reaction has come from the private business community,
which was badly hurt by its low priority in access to foreign
exchange and domestic credit, and whose confidence in the
government was shaken.
o Although the Mexican political system is under unprecedented
pressure and the ruling party has been riddled with corruption
and has lost several local elections, the government has been
able to adopt coherent policies and to take decisive action.
o The Mexican political system has a certain fragility, however,
because it is highly dependent on effective leadership at the
top. Should de la Madrid leave the Presidency prematurely or
lose his touch as a leader, serious factionalism could develop
within the PRI, with potentially disastrous results.
The political fallout of the debt problem also varies enormously
among other major debtor countries.
o In Chile, where the military government has held on to power
despite opposition from most socioeconomic groups, largely
because of the lack of an alternative on which there could be
broad agreement, economic austerity is being eased to help
reduce the level of political tension.
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o In Peru, the Belaunde government's attempts to follow IMF
prescriptions have engendered growing opposition and recently
forced an easing of austerity as well as cabinet changes which
portend more expansionary economic policies.
o In the Philippines, Marcos has done everything he could to
minimize the impact of the debt crisis on incomes and
employment, hoping to get through the elections due in May
before the inevitable steep economic recession sets in.
o In Venezuela, the new moderate left government is coping fairly
well with the immediate foreign exchange crisis through exchange
controls, but there is little political support for the drastic
steps, starting with a major devaluation, needed to begin
reducing the country's excessive dependence on oil exports.
o In Nigeria too, the military government has been unwilling to
risk a major devaluation for fear the negative impact on urban
living standards would trigger a new coup from lower ranking
officers. The Nigerians are more likely to try to improve their
economic situation by increasing oil exports, although it would
be difficult to get OPEC agreement on this so long as the oil
market is soft. The Nigerians are negotiating with the banks to
pay off arrears and reschedule existing debt.
The political fallout of the debt problem does not seem likely to
spawn the establishment of a "debtors' cartel," even though individual
debtors will push the creditors hard, probably successfully for an easing
of debt service terms.
o The economic interests of the debtors varies greatly.
o The small debtors could benefit from joint action because they
have little clout.
o The large debtors can probably negotiate improved terms on their
own, and have more to gain than to lose by tying themselves to a
cartel.
o Each of the large debtors, however, will try to take advantage
of any concessions the others may gain, and at least some of
them are likely to informally discuss how these debt strategies
can serve common interests.
In general, the creditor countries and institutions may not have the
flexibility to deal effectively with the increasingly diverse needs of
the debtors.
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o Programs for new funding by banks and governments are closely
tied to IMF conditions.
o The IMF has limited funds and, because of all the interactions,
and the problem of precedent, limited flexibility.
o Many debtor countries are likely to need new funding for several
years at least because of the difficulty of major structural
change. A period of adjustment will in any case be
substantially longer than the two to three year programs of the
IMF.
o Debtor country financial needs and the possibilities for
changing their domestic economic policies to facilitate
adjustment will vary enormously because of varying political
conditions.
o The beginning of economic recovery in the debtor countries is
likely to make them more, not less inclined, to engage in
confrontations with creditors. The creditors, the IMF and the
US in particular, will be accused of holding back the upswing.
Some specific problems which are likely to put severe strain on
debtor-creditor relations are:
o A likely confrontation this spring between Argentina and the IMF
over terms and policy conditions for new loans.
o Later in the year, increasing slippage by Brazil on some key
domestic financial conditions, especially inflation and the
fiscal deficit.
o Increasing demand for adjustment of conditions and terms in
Chile and Peru.
Even if payment of the interest obligations of debtor country
governments can be negotiated on mutually acceptable terms, this may be
at a heavy cost to the private sector in the debtor countries, and to its
creditors.
o Servicing of private debt has been given a low priority and
there have been large writeoffs in creditor banks.
o Private firms in debtor countries generally have had a lower
priority than public corporations in allocations of foreign
exchange for imports and of domestic credit. This is unlikely
to change quickly in countries such as Brazil and Mexico, where
public enterprises have far more political clout than does the
private sector..
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o With the private sector suffering a severe squeeze, direct
private foreign investment, far from becoming a substitute for
bank lending, is likely to continue declining.
Should OECD economic growth falter after 1984--a slowdown to a rate
of 2 percent or less--the debtor countries would be able to finance their
interest obligations only by holding imports and the domestic economies
at severely depressed levels. Almost certainly the debt would have to be
renegotiated on much easier terms. This could happen in any event, but
is far more likely if the world market outlook became unfavorable.
Implications for Policy
This analysis suggests that the creditor countries will need not only
considerable new funding, but also broad flexibility to deal effectively
with LDC debt problems in the next year or two. Some possible steps
would be:
o An expansion of World Bank lending for multi-year structural
adjustment--to relieve the IMF of some demands and provide
stimulus for a larger adjustment period.
o For the near term consideration of ways to enhance trade
financing.
o Greater emphasis in IMF programs on external (i.e., trade and
balance-of-payments) objectives and less emphasis on internal
(i.e., inflation, wage policy) objectives to avoid unessential
political conflicts.
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