THE POLITICAL REPERCUSSIONS OF THE DEBT CRISIS IN MAJOR LDCS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87T00126R000100010010-7
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 8
• Document Creation Date: December 21, 2016
• Document Release Date: December 23, 2008
• Sequence Number: 10
• Content Type: REPORT

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N I E 3-84
THE POLITICAL REPERCUSSIONS
OF THE DEBT CRISIS
IN MAJOR LDCs
Volume I-Key Judgments
Information available as of 22 October 1984
was used in the preparation of this Estimate,
which was approved by the National Foreign
Intelligence Board on 30 October 1984. The
full Estimate is published under separate
cover as volume II.
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THIS ESTIMATE IS ISSUED BY THE DIRECTOR OF CENTRAL
INTELLIGENCE.
THE NATIONAL FOREIGN INTELLIGENCE BOARD CONCURS.
The following intelligence organizations participated in the preparation of the
Estimate:
The Central Intelligence Agency, the Defense Intelligence Agency, the National Security
Agency, and the intelligence organizations of the Departments of State and
the Treasury.
Also Participating:
The Assistant Chief of Staff for Intelligence, Department of the Army
The Director of Naval Intelligence, Department of the Navy
The Assistant Chief of Staff, Intelligence, Department of the Air Force
,The Director of Intelligence, Headquarters, Marine Corps
The Department of Commerce
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SCOPE NOTE
This Estimate examines some of the political repercussions of the
debt crisis in the developing countries. It focuses on seven countries-
Argentina, Brazil, Chile, Mexico, Nigeria, the Philippines, and Venezue-
la-whose debt to banks is large enough to constitute a potential threat
to the stability of the international financial system and the servicing of
which has created serious economic problems. Countries whose debt
problems may be serious but not threatening to the system, such as
Bolivia, are discussed only briefly. Countries that have been able to
manage large debts without severe economic difficulties, such as South
Korea, are not discussed.
The Estimate assesses the likely impact of debt-related economic
austerity on political stability and policies in the debtor countries. It
focuses particularly on whether and how much these political repercus-
sions will constrain the ability of debtor-country governments to
maintain economic adjustment policies and deal with their creditors.
For purposes of this paper we define political instability as that
which causes radical changes in a government's policy or in the
government itself.
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KEY JUDGMENTS
The severe economic repercussions of the debt problem in the
major LDC debtors-declines of some 10 percent in GNP, of 15 to 20
percent in per capita real incomes, and of 40 to 60 percent in imports-
have not yet caused serious political instability or basic changes in
policy orientation for the governments of these less developed countries.
But economic problems have generated political pressures that are
substantially restricting the flexibility of these governments to under-
take economic reforms and to,deal cooperatively with foreign creditors,
including the IMF.
If economic recovery proceeds in the next year or two, then
debtor-creditor differences can probably be worked out through ad hoc
adjustments by both sides. In the less likely case that economic recovery
in the debtor countries is prevented by highly adverse external econom-
ic developments-stagnant or closed markets, higher interest rates, or
reduced net capital inflows-the chances are that there would be
defaults, severe financial disruptions, and major changes in the manage-
ment of international debt.
Even if external economic conditions are reasonably favorable,
many debtor countries will face continued economic austerity for many
years in order to service their debt. These conditions will make political
conflicts more difficult to resolve and could thereby contribute to major
political upsets, such as a return to military rule in Argentina, the
fragmentation of political power in Mexico, and the growth of leftwing
violence in Chile and the Philippines.
Perhaps the key determinants of political reaction to prolonged
austerity are how much populations expect of governments and the
flexibility of any given political system. Where little by way of
economic benefit is expected of government and/or where the populace
is so cowed by its rulers that it dares not push for change, strong political
reaction to economic hardships is less likely
When governments can successfully deflect much of
the blame from themselves onto less reachable targets-their predeces-
sors, the bankers, the IMF, and so forth-they thus escape the fallout
that can lead to serious political pressures or to political instability,
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The greatest likelihood of political instability arises when the
sitting government is widely perceived as the main cause of the
problems, as in the Philippines, where the Marcos regime plays such an
enormous role in the nation's affairs. Likewise, the Nigerian Govern-
ment is proving less and less able to deflect the blame away from itself,
largely because the politically significant elites, particularly the mili-
tary, have come to expect so many government benefits, the funds have
dried u~
Although most of the debtor countries are likely to begin a slow
economic recovery this year or next, we think that their political
resistance to austerity measures will build. As the shock of the financial
emergencies of 1982-83 passes, and austerity measures are increasingly
designed to restructure the economy to lay better foundations for future
growth rather than simply to deal with the lack of foreign exchange, the
necessity for sacrifices becomes less obvious, more debatable, and
politically more difficult to implement.
Among the seven principal debtor countries that are having serious
debt problems, Brazil probably is best placed to work itself out of its
debt burden. Brazil is well positioned to sustain rapid and diversified
export growth if it can keep its exchange rate competitive and if its for-
eign markets are expanding. Domestic political trends-a gradual
process of democratization-reflect a broad public consensus and are
unlikely to be upset even if the economy does poorly. But democratiza-
tion does constrain the government's economic policy flexibility and
consequently could lead to major problems in negotiations with foreign
creditors. We expect the Brazilian Government to be able to continue a
generally cooperative relationship with the IMF if external conditions
permit economic recovery to proceed and the IMF continues to show
flexibility. But, if external economic conditions turn sour and necessitate
additional painful adjustment as political activity intensifies, Brazilian
policy could quickly turn nationalistic and confrontational.
Mexico has made the most effective adjustment to the debt
problem among all the major debtors. It has shifted from an enormous
current account deficit to a large surplus, permitting a substantial
buildup of foreign exchange reserves; it has also regained a degree of
confidence among the banks, most of which have agreed to extend the
period and ease the terms of rescheduling. Although it has started to re-
cover, Mexico's economy remains depressed because austerity measures
are restricting the public sector while low demand and lack of
confidence have sapped the private sector. Strong leadership from
President de la Madrid and effective use of the ruling party's organiza-
tion have kept public dissatisfaction and political pressures under
control. The government will not be able to tolerate for long, however, a
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situation in which economic recovery is held up by lack of demand
while foreign exchange reserves accumulate. Mexico is already begin-
ning to expand the public sector once again, a process that if continued
could lead to policy differences with the creditors. Moreover, during the
remainder of his term, de la Madrid will face rising pressures for
reforms in the political system even if healthy economic growth
resumes. Although the ruling party-the PRI-has demonstrated con-
siderable resiliency, there is a potential in the longer term for serious
political instability to develop in Mexico-in the form of fragmentation
of the PRI and growing opposition to the system-which would reduce
the government's ability to negotiate constructively on matters of
importance to the United States, such as trade, energy, and emigration,
and could lead to serious domestic polarization and violence.
In Argentina, the inability of the political system to develop any
sort of consensus on policy was the fundamental cause of poor economic
performance in the past and will be the principal barrier to a resolution
of the debt problem in the future. The Alfonsin government's dominant
priority is to establish a democratic political system firmly in Argentina
in hopes of eventually facilitating consensus. The nationalism, fractious-
ness, and impatience of the Argentines will make it difficult to forge
such consensus, however, and hence impair the government's ability to
implement conditions of the tentative IMF agreement. The difference
between IMF criteria and what the Argentines can live with can
probably be bridged, at least temporarily. There is a high risk of
miscalculation, however, which over time could lead to a direct
confrontation and perhaps to a breakdown of negotiations. The chances
of such a breakdown are low, however, even though Argentina would
be better able than other debtors to live with the consequences of
default-its exports being readily marketable without identifying the
source and some possibly shiftable to the USSR. Moreover, Argentina
will almost certainly be unable to meet the conditions required by the
IMF. Thus, debt crises will recur periodically. If interest rates do not in-
crease and foreign demand for Argentine exports is strong, there is a
reasonable chance that these crises will be worked out. In a less
favorable external situation, or if the government appears to have been
forced to take unpopular steps by its creditors, Argentina would soon be
unable to service its debt.
Chile, despite having made perhaps the most painful adjustments
among all the debtor countries, faces a severe foreign exchange
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constraint because its interest costs are growing more than its exports,
which are depressed by low copper prices. The military government,
although still able to impose its authority, has become more sensitive to
public opinion as a result of recurrent public demonstrations and
widespread discontent. It is following mildly expansionary economic
policies, which, if they are continued and if external conditions do not
soon improve, will put Chile out of conformity with the IMF conditions
for loans. In any event, the political opposition to the Pinochet
government (though badly split) is so widespread that it cannot be
bought off by the limited economic carrots available to the government.
And, if economic conditions do not improve, in the longer term, violent
leftwing opposition may grow.
Although Venezuela is going through a fairly severe economic
adjustment, it is buffered by a democratic political system that often re-
sults in weak governments but also in considerable stability in policies,
by still substantial foreign exchange reserves, and by a high standard of
living. The outlook is for continued economic stagnation, which could
cause some erosion of political stability, but is unlikely to trigger major
political upsets in the foreseeable future.
By contrast, Nigeria will continue to encounter highly unstable
political conditions and probably have a series of military coups.
Economic factors contribute to this instability-both the past oil boom,
which fed enormous corruption, and the present economic depression,
which is causing large-scale unemployment and declines in real
wages-and conditions are unlikely to improve substantially in the next
few years. Basic ethnic and regional rivalries and competition for a
stagnant economic pie will be the major factors fueling this instability.
In contrast to the other major debtors, which have already made
severe economic adjustments and whose economies have probably
bottomed out, the Philippines began its economic adjustment to the
debt problem only a few months ago and its economy is certain to
decline substantially more before it hits bottom. The debt crisis is not
the primary cause of President Marcos's political problems, but the
economic recession is creating rallying points for the opposition. Even
with an agreement with the IMF and debt restructuring, private sector
confidence will remain low, and it is highly unlikely that Marcos can
build a solid basis for future economic recovery. Moreover, as long as
Marcos retains power he cannot deflect most of the blame from the sys-
tem he established and controls. Thus, the potential for political
instability in the Philippines is probably almost as high as in Nigeria
over the next few years.
In general, we expect numerous conflicts between debtors and
creditors during the next year or so. Rather than let these conflicts lead
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to confrontation or ultimate default, debtors and creditors are likely to
agree on various ad hoc arrangements to ease the debt service burden.
Although there will be recurring crises and substantial arrears on
payments of interest, it is unlikely, except under highly adverse
international economic conditions, that any major debtor country will
formally repudiate its obligations or be called in legal default.
Neither the debtors nor the creditors want to run the high risks de-
fault would entail. But these risks might appear acceptable if external
conditions were unfavorable, especially for Argentina, which is less
vulnerable to creditors' actions than many other debtors.
We believe that debtor-creditor conflicts will be ad hoc and
bilateral. Debtor interests are too diverse to provide a basis for
formation of any sort of cartel except under extremely unfavorable
economic conditions, which might induce the largest debtors, Brazil and
Mexico, to cooperate. However, consultation and communication
among debtors will continue to grow, and political pressure on the
creditor countries to give a higher priority to debtors' needs in their fis-
cal, monetary, trade, and aid policies will become far stronger.
This political pressure will come mostly from the so-called Carta-
gena Group of 11 Latin American debtors (including all the large
debtors). We expect the Cartagena Group to work out common
objectives, strategies, and tactics to use especially in international
forums. Its major objectives include lower interest rates, open markets
for LDC exports, some sort of cap on the debtors' interest burden,
rescheduling repayments over long periods, and increased funding for
international financial institutions. Agreement on such objectives, how-
ever, does not limit any debtor country's freedom of action and is
unlikely to result in any joint actions on debt negotiations.
Even if, as we expect, major confrontations between debtors and
creditors are avoided and workable compromises reached, the United
States will continue to be blamed by many debtor governments for
contributing to their problems. This political fallout from the debt
problem will continue to complicate US relations with many of the
Latin American debtors, which have high and sometimes unrealistic
expectations of the US Government's ability to influence the IMF and
the banks.
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