DDI SEMINAR: ANALYSIS OF INTERNATIONAL FINANCIAL ISSUES 21-23 SEPTEMBER 1983

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September 1, 1983
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Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Directorate of Intelligence DDI Seminar: Analysis of International Financial Issues, 21-23 September 1983 Selected Readings GI M 83-10226 September 1983 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Seminar on the Analysis of International Financial Issues 21-23 September 1983 Headquarters Auditorium Wednesday, 21 September 08:45-10:15 - The International Financial Crisis: Evolving US Policy Speaker: Martin Feldstein Chairman Council of Economic Advisors 10:30-11:45 - US Concerns In International Finance: The Problems and Policy Responses Speaker: Roger Robinson Director International Economic Affairs National Security Council 13:15-14:45 - International Financial Issues: Congressional Perspectives and Policy Responses Speaker: Casimir Yost Professional Staff Member Senate Foreign Relations Committee 14:45-16:00 - Trade - Monetary Linkages: North-South Trade and LDC Financial Prospects Speaker: Mike Liikala Special Assistant to the Undersecretary for International Trade Administration Department of Commerce Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 International Banking US Senate Banking Commitee, February 1983 State of Paul A. Volcher The Banker, July 1983 US Banks: New capital rules US Senate Committee on Foreign Relations, January 1983 Statement of William R. Cline Latin American External Debt, 1982 The Rate of Return to External Borrowing Euromoney, May 1983 Where the Banks Put Their Bad Debts US Senate Banking Committee, February 1983 Risks in International Bank Lending The Rescheduling of Country Debt: Is a More Formalized Process Necessary? Fortune, July 1983 The War Among Brazil's Bankers Forbes, June 1983 South American debt -- now look at the assets Euromoney, June 1983 The Loan Drought Hits Africa Eurocredit US Senate Banking committee, February 1983 Trends in Eurocurrency Credit Participation 1972-1980 Euromoney, July 1983 From Brazil? Just a Minute, sir. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Welcome Statement Schedule Selected Reading Balance of Payments and Finance Fortune, August 1983 The World's Missing Billions Business Week, July 1983 The IMF's Dilemma On World Debt Gets Worse The Banker, June 1983 Where should the fund go from here? US Senate Committee on Foreign Relations, February 1983 Statement of George P. Shultz The Banker, July 1983 International debt crisis: the next phase International debt crisis: the practical lessons of restructuring The Banker, June 1983 A new approach to international indebtedness Euromoney, June 1983 Aid the Debtors The World Bank Paradox The Banker, July 1983 Indonesia tightens its belt Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Country Risk Harvard Business Review, March-April 1983 You're the best judge of foreign risks Euromoney, July 1983 How Big a Risk is Indonesia? Japan's Bank Assess Asian Risk The Money Lenders, 1982 Country Risk Recent Developments STAT Businessweek, September 1983 Brazil could make or break a Latin American "Debtor's Cartel" Euromoney, May 1983 Can't Pay? Will Pay, But in Sultanas Forbes, August 1983 Can Mexico pull through ? Euromoney, July 1983 Is Mexico Making a Comeback ? Euromoney, June 1983 Tracking The Big Projects Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Thursday, 22 September 08:45-10:15 - The International Financial Crisis: Impact on Trading with the LDC's STAT 10:30-11:45 - Eximbank and the International Financial Crisis Speaker: William Draper President and Chairman of the Board Export-Import Bank of the United States 13:15-16:00 - The International Financial Crisis: Update on Commercial Bank Problems and Prospects STAT Friday, 23 September 08:45-10:15 - The International Financial System: Lingering Problems and Prospective Scenarios Speaker: Maurice Ernst NIO-Economics 10:30-11:45 - The International Financial System: Lingering Problems and Prospective Scenarios STAT Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 THE WORLD ECONOMY/FINANCE/VIVIAN BROWNSTEIN o Find the missing $100 billion. The rules are quite simple. At the end of every year economists around the world figure up how much each country has paid out to foreigners for goods and ser- vices, and as earnings on investments. They then compare this figure with how much the coun- try received and calculate the country's current-account balance. One country's import being another country's export, if you add up all the surpluses and deficits around the globe, you would expect them to net out to a big zero. But here the plot thickens. They don't. When all the current accounts for 1982 were added up, the total came to a mysterious $100-billion deficit. The shortfall, known as the world current- account discrepancy, is no joke. Its size casts doubt on the current-account balance report- ed by every country. Those current accounts are the basis for many international econom- ic forecasts and p.licies-who might need fi- nancial aid, whose exports or imports ought to be curbed, whose currency will be strong and whose weak. For example, the dollar is hanging high today despite a reported $11- billion U.S. current-account deficit in 1982. The effect of a deficit that size, economists thought, would be to weaken the dollar. S RECENTLY AS 1980, the jigsaw puzzle of world accounts fitted to- gether rather neatly. In a year when they sold nine billion barrels of oil for around $31 a barrel, OPEC countries amassed a surplus of $114 billion on current account, while the rest of the world reported deep deficits totaling $144 billion. The result: a world current-account discrepancy of a mere $30 billion. By comparison, the picture for 1982 looks bizarre. The industrial nations were in better shape, with smaller deficits on average. The developing areas were still in trouble, how- ever, and OPEC reported deficits too. As a glance at the chart at right shows, there were thus no surpluses to offset the minuses hanging below the zero line. It's no trick to figure out that something's wrong--the whole world can't be in deficit. The world current-account numbers rare- ly balance out to zero, as the chart on the fac- ing page indicates. Illegal imports don't usu- ally find their way into the official accounts, OPEC's once huge trade surplus vanished lastycar..Vo othergroup of countries reporfed... ME ACC?UNTS 1:1X( DOY 1'T QALACU ICE Surplus or deficit on international trade and payments Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 one thing-no one expects a cocaine im- ground economy. U.S. residents who park porter to stop off at his local customs office money offshore don't necessarily report on the way from the airstrip. As long as the their earnings to official data collectors. discrepancies were relatively small, though, The underground economy works both few analysts got excited about them. ways, however, and some payments from But $100 billion is significant, even by the the U.S. are probably missing too. An esti- standards of global trade-well over $1.5 mated $30 billion to $35 billion of foreign trillion last year. Economists, who are used capital poured into this country unreported to second-guessing incomplete statistics, are last year. While capital flows are not included in disarray on this one. They do agree that in the current accounts, income earned on most of the 1982 di::crepancy can be attribut- the capital is. At least part of what's missing ed to underrecordcd or hidden receipts for from U.S. current accounts is interest and services and investment income. So in dividends paid to foreigners on capital searching for the missing funds, analysts stashed here. At last year's interest rates, start with the biggest service exporters, the this could amount to as much as $5 billion. industrial countries, and especially the Papa How far the U.S. accounts are off the track ' s chief Bear of them all, the U.S. is hotly disputed. Morgan Guaranty According to the reported statistics, the international economist, Rimmer de Vries, is U.S. bought $294 billion in foreign merchan- convinced that about $20 billion should be dise and services in 1982; paid foreigners added to U.S. current-account receipts. In- $57 billion for rent on their U.S. real estate stead of a deficit last year, there would thus holdings, profits on U.S. businesses they have been a surplus of about $10 billion. Not owned, and income on other U.S. invest- likely, according to Bame at Commerce. ments; and transferred $8 billion in dona- Though he's the first to admit that the tions, government grants, and pensions to in- current-account numbers he has to work dividuals living out of the country-a grand with have a lot of holes, he argues that there total of $359 billion. Earnings from abroad is no reason to assume that they've suddenly ame to $348 billion, according to the best gotten a lot worse. All the pluses and mi- figures the government can come up with. nuses, Bame speculates, could reduce the n T T e AM ;,4 i LS_ deficit by $5 billion to $10 billion at most. T h 1 , billi hus t at $ o If the U.S. deficit is indeed overstates, tough economic policy choices. Extra lar. Currency traders are seeing a lot more a available when the demand for dollars than foreign exchange _ d ll _- T o ern buys more abroad than it sells, forecasters had led them to expect. Last Jan- S U . . and the value of the dollar should fall as for- uary, Wharton Econometric Forecasting As- eigners become more reluctant to add to sociates, along with many others in the field, their dollar holdings. So a severe deficit estimated that the dollar would drop by might require the U.S. to hold interest rates about 8% in value relative to foreign curren- h to attract foreign capital into dollars. cies between then and now. It has risen hi g This creates a dilemma for many economists about 7%. Wharton says that foreigners' de- who are advocating that Uncle Sam, in the sire to keep investments in the safest of safe person of Fed Chairman Paul Volcker, keep havens, the U.S., has overwhelmed the extra interest rates down to continue encouraging supply of dollars made available by the economic recovery and to ease the burdens current-account deficit. But Wharton's ana- of debtor countries. Lawrence A. Veit, lysts add that they wouldn't have forecast as Brown Brothers Harriman & Co.'s noted ex- much of a decline if they had suspected, as pert on international finance, complained re- they now do, that the deficit was badly over- cently, "Perhaps the strangest aspect of the stated. In its latest forecast, Wharton again discussions of the issues is the extent to expects that the dollar will drop, but not until which the debate has been knowingly based next year. Whatever the U.S. deficit actually on misinformation." is, Wharton assumes that it's getting larger. Most observers think that the U.S. cur- If the U.S.'s portion of the world's discrep- rent-account deficit is overstated. According ancy comes to $10 billion or even $20 billion, `.o Jack Bame, the Commerce Department's there's a lot left to account for. Among other l industrial countries France is considered a ceipts should probably be ascribed to the debtor countries. Mexicans, for example, who hold an estimated $30 billion of private assets abroad, don't bring home much of the income on that capital, so it's not recorded in Mexico's current account. Attempts by individual countries and by in- ternational organizations such as the OECD to straighten out the statistical mess have made little headway. The U.S., for one, has been cutting back on money for collecting data on international accounts. But worries about the $100-billion mystery are mounting. As the Bank for International Settlements says in its ponderous prose, "... to the ex- tent that policies are influenced by countries' perceived current-account balances, overre- cording of deficits or underrecording of sur- pluses may result in policy stances being more restrictive than they otherwise would have been." When government policies af- + $25 billion T ; B ! o Tar'-1T Ai-; V!crld currenl%_ c^,?nini ... a surplus that could balance the world's account. The missing billions, once just a nui- sance, now confound policymakers. fecting a country's economy are too tight, people and businesses hurt. a associate director of mternation econom- ics, several billion dollars paid U.S. firms for likely candidate for a piece of the pie. ^ Most businessmen understand that the fig- consulting and engineering services to oil- Frenchmen, unhappy with the Socialist gov- ures economists give them are freighted exporting countries probably goes unreport- ernment, have probably contributed to the with a bit of uncertainty. When these figures ed. For one thing, budget limitations prevent capital secretly flowing west, which makes are off by $100 billion, however, the discrep- government surveys from reaching most of for unreported income that should be show- ancy calls for a degree of caution greater u_ :.. rPrPintC even than that normally employed with the the small and mid-sin Approved For Release 2008/01/23 : CIA-RDP97R00694R000200870001-3 J science. 0 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ULJ3SP~Ll fit o Q~ toy 25 o0, $ nearly h s alf o n the its Third up billion debt. interest ern- razilian workers struck ogovern- uts de dlopt stringent cmeasures that borrowers V~D I S ment-owned oil refinery L. and muddled finances. World's total debt of $600 billion is con- by At sam .'_ Sao o Paulo in July, joining thou- their economies cen ationary pay thetIMFdcan pushAthemeriregionca, and in Latin sands of others walking out of near measures al oe help time,guarathe Ford, General Motors, and other auto ments ee protesting wage more importa tsomething e hundreds of bil- omiesTis fast becomh gna key internation- plants. ordered unions Wmuc cuts ordered by y President Joao de Figueiredo to satisfy demands by the lions of dollars in private debt extended al policy question. The more eat International my ht American otherwi and be written off, ciansL outhTof the Rio Grande feelothe anon in Monetary Fund to flaIn in exchange nt , for emergency loans. g banking walk awayefrdanger that one or more Will om their foreign debts alto- In Argentina, workers rs threatened by ecwith onomy and the results greater social x- face petted vote from the IMF eF are e to o vo vote the populist Peronists into system. "Conditionality is essential be- ~ get her then rather than relaxes on setting ponds power in upcoming elections. A strong cause with a sovereign debtor, its levera group within the Peronists pledges to no other way of making it pay," says tions, it loses are moving town a aecfor re--22 declare a moratorium on Argentina's Federal Reserve Board Governor Henry form. billion Western-mostly takes it continues "You with its policies, that will House officialayIf high-level Americann-banks nks once the party American-banks a office. make it unable to pay." major debtor are unrealistic, then either In Mexico, unemployment is soaring, The debt crisis is not limited to Latin the IMF eases off and loses credibility, or it insists and the debtor stops paying." crime is rising, and the exodus of illegal America. Yugoslavia and Nigeria, For debtor nations, the penalty for immigrants to the U. S. is up sharply as among others, are in financial straits, would be harsh. government measures to clamp down on and Poland's creditors, mostly European outright refusal to pay the economy-again, demanded by the banks, are relending as trade credits Borrowers who declare a moratorium, { r '" ti Imo FIN n 77-127. If it eases loan terms, it loses credibility. But pushing too hard could fire up social turmoil IMF-lead to lower growth and the de- cline of the private sector. The confrontation between social and financial demands reflected in these cri- ses came to a head in mid-July when the Bank for International Settlements (BIS), headquartered in Basel, demanded that Brazil repay a $400 million short-term credit. That heated up the pressure on Brazil to comply with IMF demands for tough economic austerity policies in re- turn for $4.5 billion in emergency loans. 'NO OTHER WAY: Everywhere in Latin America, the choice between social sta- bility and economic restraint is becoming a heated political issue. Caught in the middle is the global lender and financial cop, the 1M F' headed by Jacques de Laro- siere. By insisting on "conditionality," or severe restraints on domestic economies, the IMF tries to ensure that the emergen- cy loans it extends to troubled nations .4 #rf ....~^S ,,,._ , wr lf:" l~ , V't13..e ? _ .~ . ~.. .; 3 AFTER WORKERS TOOK TO THE STREETS TO PROTEST UNEMPLOYMENT AND WAGE CUTS. BRAZIL INTERNATIONAL MONEY MANAGEMENT a" it, - 5aaUSNESS'N_EK-J Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 unless it is accepted by creditors, "would impose on themselves the worst reces- sion they have ever seen," says a U. S. banker. Such an action would reduce the debtor country to little more than a bar- ter economy and make its ships and air- craft vulnerable to seizure by the banks. Nowhere is this conundrum more striking than in Brazil, which owes $90 billion. Unless it reaches a surprise agreement with the IMF for more money or cuts a deal with the U. S. government for an emergency bridge loan by mid- July, the country may have little choice but to declare some kind of moratorium. It could be for a brief 90 days, following the example of Mexico last year, or it could be a demand for relief of all debt for five years or even longer. American banks could live with a 90-day halt in payments on principal if that led to an orderly rescheduling of debts but not with a long delay, which would force them to take massive write-downs of their assets. The underlying fear, of course, is that if the IMF miscalculates and triggers a serious default, it could easily force the Federal Reserve to rush in and rescue the banks with massive injections of funds that might reignite inflation in the U. S. and unhinge the current economic recovery. Like Samson, the debtor nations have grown so powerful by their accumula- tion of IoUs that they can bring the en- tire global financial temple down with them. Even if that does not occur, tight- ening up on all Third World debtor coun- tries at once, as the IMF is doing, means lower economic growth, fewer imports from the U. S., and fewer jobs in Ameri- can factories. QUICK FIX. Just months ago, it appeared that Brazil had worked out a complicat- ed rescheduling of its debt with Western bankers. Fed Chairman Paul A. Volcker began stitching together rescue pack- ages last August when it appeared that Mexico was on the verge of defaulting on its $80 billion debt. The crisis resulted from the sharp 1981-82 global recession, which squeezed Latin American export markets and from the huge runup in American inter- est rates, which hiked the region's al- ready enormous debt repayments and devastated commodity prices. By getting the Bls and Washington to offer quick funds, persuading the IMF to provide me- dium-term money, and pressuring U. S. banks to keep lending, Volcker was able to prevent disaster. The IMF's role in the bailout packages, as always, was that of tough guy. All the other moneylenders had premised their loans on debtor governments' fol- lowing stringent economic and financial policies laid down by the fund. For Brazil, it did not work. An agree- ment was reached in February on a pro- gram to prune state companies' capital expenditures by 20%o in real terms, cut subsidies for gasoline and wheat, and start unlinking salaries and prices. Com- mercial banks agreed to chip in a further $4.4 billion if Brasilia went along with the IMF. And the BIS, a central bank for central banks, committed $1.2 billion in short- term loans to be doled out in four install- ments. But Brazilian workers took to the streets of Silo Paulo in April and again in July, protesting against unemploy- ment and the deindexing of wages-a disaster to families in an economy where inflation is expected to hit 180%o by year- end. After that, Brazil began to stall on implementing the IMF conditions. In May the fund responded by stop- ping payment of the second portion of its loan. An IMF team looked at the coun- try's books again and disagreed on just how big Brazil's public-sector debt really was and how fast to deindex wages and inflation. With the IMF delay, commercial bank money began drying up. The BIS agreed to roll over its bridge loan twice, but on July 11, BIS President Fritz Leutwiler announced that the bank would refuse a third time. "I still expect to receive the money by July 15," Leutwiler said. Eduardo Wiesner, head of the IMF's Brazilian mission, is in Bra- silia for a last-minute attempt to work out another deal. SPLIT IN THE RANKS. NOW the question is how tough the IMF can really get with Brazil. If it "goes soft" and offers mon- ey on easier terms, it will set a prece- dent for other debtor nations around the world. But if it does not modify its strin- gent terms, will it risk setting off politi- cal turmoil and possibly a declaration of default? Ulisses Guimaries of the oppo- sition Brazilian Democratic Movement Party says that "by early August a par- ty proposal for longer terms and lower interest rates plus a grace period will be presented in Congress." The Reagan Administration has made a major shift on the issue of conditional- ity. When it first came into office, it RTED STALLING ON r-rc ,*,r or cr~r-r v-n roc.rcwrr rrrrr cl-nwrnk.rrn ocrn- 1 .. ?...7 .......1..... L.-s than strict IMF Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 terms for lending money, and it opposed expanding the fund's financial re- sources. Monetarists feared a renewed inflationary surge if great quantities of new money were created just to bolster flagging debtors. But in August, 1982, faced with the imminent crisis in Mexico-a country critical to U. S. security-the Adminis- tration did an about-face. Secretary of State George P. Shultz began working quietly behind the scenes to help debtor countries. "The combination of INIF man- agement under de Larosiere, with help from Tom Clausen [president of the World Bank], Paul Volcker, and Don Re- gan and their counterparts, plus the banks around the world, has done a ter- rific job," says Shultz. Administration officials believe that E S 5. LES TURIXE 1 I JT0 607S r7lhe world debt crisis threatens to put a serious crimp in the Penta- gon's expanding role as arms supplier to the Third World. Washing- ton has been lending billions of dollars to finance purchases of weapons by countries on which the U. S. relies heavily to wield' geopolitical influence and military clout in world trouble spots. But now, "the LDCs most depen- dent on our loans are having a very bad time with their indebtedness," says a U. S. official involved in arms-sales policy. Adds another official: "It is in- creasingly likely that some countries will not be able to meet their [arms debt] payment schedules or will have to cancel or defer weapons orders." To help prevent such a development, the U. S. has begun scaling down loans and stepping up outright grants, in- stead, to financially shaky arms cus- tomers. "Our policy of favoring loans over grants won't hold up much longer with respect to several countries we simply have to keep supplying," says a U. S. official. The list of nations on the precipice makes U. S. military planners and for- eign-policy makers shudder. Among 43 countries ordering $23.5 billion worth of U. S. arms and military assistance this fiscal year, fewer than a dozen are in-or heading for-debt-repayment straits. But they include Egypt, Tur- key, Pakistan, Morocco, Somalia, Su- dan, Tunisia, Zaire, and even Israel- all viewed as crucial buffers against military or political encroachment by the Soviet Union or its surrogates. COBALT SUPPLIER. Scheduled repay- ments of interest and principal on weapons loans to those debt-deluged nations will add up to nearly $20 billion from the start of the current fiscal year through 1992. Israel accounts for half of that total, or $9.8 billion, fol- lowed by Egypt at $3.7 billion and Tur- key at $2.5 billion. Turkey already has been forced to reschedule its repayments. And Zaire, in hock to the U. S. for $170 million, has declared a moratorium on repay- ment. Under U. S. law, this action makes Zaire-important for its cobalt and its strategic location in Africa- ineligible for further arms credits. In- stead, the U. S. has switched to out- right grants to Zaire, totaling $20 mil- lion over the past two years. Arms gifts to other countries have also become more prevalent. Grants to Tunisia and Morocco will total a com- bined $60 million this fiscal year, while Sudan will get $75 million and Somalia $40 million. For Turkey, proposed arms grants total $230 million for fiscal 1984. And the Administration may have to decide whether to give Pakistan $1.1 billion worth of F-16 fighter planes. Saudi Arabia had planned to finance the purchase, but it may back out of the deal because of the slump in oil revenues. STOPGAP PAYMENTS. Israel and Egypt are also benefiting more and more from U. S. grants, thinly disguised as "forgiven loans." Since 1974, the U. S. has let Israel out of repaying $5.5 bil- lion of loans, and it now is doing Egypt the same favor. This year, Israel and Egypt are receiving $750 million and $400 million, respectively, from the U. S. under no-payback terms. Congress far prefers to authorize loans instead of grants because it must appropriate funds for the latter. The loans are backed by the Defense Dept.'s Guaranty Reserve Fund, which contains about $800 million. If a U. S. arms customer falls into arrears on a loan, Defense dips into its fund to make stopgap payments. Now, with the world debt crisis threatening to swamp some U. S. arms customers and perhaps to spread, a se- nior Pentagon official warns that "our reserve fund could be depleted over- night." Gloomily, he adds: "We are get- ting very close to the margin." Play with and against former stars of the Yankees, Dodgers, Giants and Celtics in actual game conditions. November 13-20 January 22-29 St Petersburg, Florida November 6-13 January 22-29 Celtics September 18-25 Atlantic City, New Jersey $2,595 includes airfare, deluxe accommodations and much more! Contact: GREAT AMERICAN SPORTS CAMPS (212) 926-4299 (617) 437-0700 (213) 859-1815 (415)924-8725 COLON AND RECTUM CANCER IS THE CANCER TELL ME NO ONE WANTS WHEN YOU'RE TO TALK ABQUT. FINISHED. WELL THEN, AT LEAST READ ABOUT IT... ABOUT A SIMPLE TESTING PROCEDURE... ABOUT HOW EARLY DETECTION CAN SAVE LIVES... ,T WHY DIDN'T WE TALK ABOUT THIS BEFORE? LET'S TALK. For a free booklet on colon & rectum cancer, contact your local ACS office. l Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 icer Society Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ------ is more hardline than is the -reasury Secretary Donald T. Regan - ist influence i lli f l n a ng y the U. S. recovery and slow , terest rates will rescue Third World State Dept., which is concerned about w hould be doing a lot more to avert what debtors by boosting demand for their political stability in Latin America, or they see as an explosive debt crisis. 'xports and lowering their interest the Fed, worried about the U. S. banking "You've got a Treasury Dept. that has a osts. The White House now supports system. Beryl W. Sprinkel, Treasury Ur?- pretty conservative view on how to deal expanding the IMF's resources, and Con- der Secretary for monetary affairs, in- with all of this," says a senior Adminis- gress is expected to vote on hiking the sists that "it is very important that the tration diplomat. Adds another: "Sooner U. S. share by $8.4 billion this summer. IMF sticks to strict conditionality." or later, Brazil will have to declare a Yet divisions remain in the Administra- Other members of the Administration moratorium. The only question is wheth- tion. The Treasury, still under monetar- feel the White House and especially er it will be long- or short-term." EDE" Fl 1125 K112VO(WAS Ti or multinational corporations, the k 7 financial abstractions of world debt U translate into decimated markets, blocked currencies, and a starvation diet of raw materials and essential parts for subsidiaries representing billions of dol- lars' worth of investments in less devel- oped countries. "We're just pumping in cash to keep our subsidiaries alive," complains the harried treasurer of a ma- jor U. S. multinational. By continuing to supply faltering sub- sidiaries in countries such as Brazil and Mexico-despite their inability to pay for If they don't keep pumping in cash, their Third World subsidiaries could go under imports-and by pushing those coun- tries' products in world markets, the multinationals are helping debtor na- tions stave off defaults to creditors in the U. S., Europe, and Japan. But most LDCS give top priority to repaying banks while stinting on hard currency for for- eign corporate investors and suppliers. COPING OR SELLING our. Says a U. S. offi- cial: "We are the dominant supplier to [Latin America], and we are bearing the brunt of the adjustment. Here we are endorsing IMF rescue packages that in effect call for substantial cutbacks in imports to achieve trade surpluses, and that is coming out of our own hides." Brazil's stunning 3 billion trade surplus so far this year has been achieved large- ly by slashing imports, while Mexico cut imports, mostly from the U. S., by one- third in the first four months from the corresponding 1982 level. To cope with the harsh new condi- tions, multinationals are doing every- thing from demanding cash on the bar- relhead from some customers to extending credit to others in order to sell products and maintain market share. A few, such as Sears Roebuck, Revlon, Gerber, and Campbell Soup in Brazil, have simply sold out. But others are scrambling for financing in local curren- cy and struggling to find locally made substitutes for essential equipment and components that used to be imported and paid for with hard currency. Some are resorting to barter and nearly all are hustling exports to earn hard currency for subsidiary operations. Some are even stepping up their shareholdings in joint ventures, particularly in Mexico, by con- verting subsidiaries' debt to equity. Paradoxically, most multinationals are more sanguine than the bankers about prospects for the debtor countries, par- ticularly in Latin America, where North American and European investors have been building up productive assets for a half-century or more. "I believe in Bra- zil. They have a wealth of resources equal to anywhere in the world, and that's real money," says Robert P. Si- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 mon, treasurer of Brascan Ltd. in Toron- to. "In the final analysis, money is some- thing you print. You don't print gold, iron ore, and forests. Those are real. And you don't print productive people." Such faith is sorely needed to sustain multinationals through their current tribulations. In markets that once held out the promise of booming expansion and fat profits, multinational executives relate tales of woe. To the chagrin of Detroit's Big Three auto makers, car sales in Mexico, where all have plants, are off 33% this year, while truck sales have fallen 50%. Volkswagenwerk Chair- man Carl H. Hahn concedes: "In 1983 we will be unable to break even in Mexico." Despite layoffs and other cost-cutting measures, Japan's Komatsu Ltd. reports that its operations in Mexico-where it has a 40% stake in a government-con- trolled joint venture-will lose money this year because of the construction market's collapse, with bulldozer sales to private contractors running two-thirds behind last year's. In Brazil, Italy's Fiat is fighting desperately to turn its joint venture around after losing $40 million nior partner, Fiat injected an additional $300 million in 1982 and expects to drop $100 million more before the year is out. The depressing news reaches across the product spectrum. "We expect Mexi- can consumer spending to be down 3% in real terms this year with some recovery in sight next year and private invest- ment to be off 25%," says John A. Ur- quhart, executive vice-president and head of the international sector at Gen- eral Electric Co. in Fairfield, Conn. As a result, refrigerator manufacturing is off 50% in Mexico-to balance inventories- and the company has temporarily shut down its clothes-washer and water-cool- er production. ARM-TWISTING. Compounding the sales slump that has engulfed Latin nations from Argentina to Mexico are severe corporate financial problems. In subsid- iaries' local markets, consumer credit is in short supply, collections often require ugly arm-twisting, price controls restrict the ability of managers to keep prices abreast of rampant inflation, and capital equipment is so expensive that custom- ers demand a long time to pay. Pay- there in 1982. m no+~ o, ,.,;+>, ;+~ dsn ;n. i munte that "amen to rnma ;n Him rlnol-_ I lame T ;++n? T.,.i-+res Inc., for example, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 work" now arrive six weeks late or more, treasurers complain. For parent companies, the story is much the same. An executive at Frank- furt chemical giant Hoechst reports: "We're seeing more payment defaults on deliveries, particularly in Brazil and Venezuela, but we haven't gone out to any customers to get back goods we delivered." Rival BASF is less patient with what it euphemistically calls "nega- tive export sales"-goods delivered to customers who cannot pay. "In a few cases we have gone out to customers and retrieved goods, hoping to find someone else who could take them right away," concedes a BASF executive. Other corporations feel they cannot afford to play so tough. "Multinationals are lending money to customers to keep markets and long-standing relationships, especially if they're in up to their eye- balls in receivables," says a U. S. bank- er. "You have to make sure the guy you have receivables from stays afloat." This is particularly true for equipment such as agricultural machinery sold on a consignment basis, with the seller repaid out of crop sales. TODAY'S BIG STICK. For subsidiaries in Latin America, many parent multination- als face the Hobson's choice of letting their offspring go out of business or shelling out more cash for debt service and for imports of needed materials and equipment. In Mexico, for example, an important subsidiary of Becton, Dickin- son & Co. manufactures health care products. "On intercompany accounts, we are letting [the subsidiary] run up arrears. We have also gotten coopera- tion from some of our suppliers, who are willing to wait for payments from Mexi- co," says Willard D. Andrews, president of the Latin American Div. of Becton Dickinson, in Paramus, N. J. "We carry a big stick because we buy a lot of sup- plies around the world." A major financial headache for multi- nationals is complex currency-exchange controls, coupled with massive devalua- tions that make it nearly impossible for companies to repatriate monetary as- sets. Many corporations had become lulled by the common Latin American practice of maintaining an overvalued exchange rate. While most multination- als had adjusted to Brazil's periodic cru- zeiro devaluations, Mexico's three successive devaluations-dropping the peso 82%o against the U. S. dollar since mid-February, 1982-caught many short. "We had always had a practice of fi- nancing [Mexican] operations with dollar debt because it was cheaper," regrets the senior financial officer for a major Midwestern manufacturing company. Likewise, exchange restrictions com- pound multinationals' financing prob- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 'j . suddenly discovered last summer that the Mexican government had converted about $1 million it had on deposit in Mexican banks into pesos. The maneu- ver amounted to "a little private-enter- prise subsidy for the economy of Mexi- co," says Fred M. Sullivan, Litton assistant controller in Los Angeles. 'SPECTACULAR TERMS.' Stung by such measures, nearly all multinationals now try to borrow locally. But it is costly: While Brazilian inflation is high at 130%, the going rate on cruzeiro loans is a staggering 205%. Such differentials, says a Canadian executive, "give rise to the most lovely opportunities. People will pay through the nose for cruzeiros; you get some spectacular terms." The crisis for some multinationals has developed into a bonanza, in fact, for others whose treasuries are overflowing with local currency. Italian tiremaker Pirelli, for example, lends out its Brazil- ian profits locally instead of repatriating all the dividends it is entitled to. "A cru- zeiro loan could kill you," says Andrea Travelli, Pirelli's worldwide financial di- rector in Milan. To avoid costly borrowing, Tenneco Inc. arranged for its subsidiary, Marlin Drilling Co., to lend $10 million worth of cruzeiros from its Brazilian operations to the Brazilian subsidiary of J I Case Co., Tenneco's construction equipment manufacturer. "Luckily we had another division in a profitable situation in Bra- zil," says Robert T. Blakely, Tenneco's chief financial officer in Houston. Without hard currency for imports, many multinationals are cutting produc- tion. Nissan Motor Co., for one, imports 40% of the parts for the trucks and cars it assembles in Mexico. "We cannot make as many vehicles as we want," complains a Nissan executive. Thus, many subsidiaries are scrambling for lo- cally manufactured substitutes, even though they are often inferior in quality. "Indirect government pressure is creat- ing substitute suppliers in Brazil, which is exactly [Brazil's] game plan," says the chief Latin expert for one U. S. compa- ny. "The question is how much substitu- tion is a structural change in trade pat- terns," he adds. He wonders whether the multinationals will ever regain their lost markets-and whether the new local suppliers will grow to become global competitors. PAYING BANKS FIRST. A few companies have managed to pry hard currency out of Latin central banks by threatening to close plants and lay off workers. But local authorities usually favor paying off foreign bank creditors first. Because of a need for massive infusions of fresh capital and debt i reschedulings, debtor nations are particularly dependent on the commercial banking community. Af- ter Mexico's near-default in August, 1982, "bankers were creating the impres- sion that it was official U. S. and IMF policy that banks be paid first," com- plains a lawyer for a U. S. multinational. Adds a U. S. government official: "The companies say: 'When push came to shove and we went in to get money we needed for spare parts to keep our plant running, the government told us it was fresh out of money. Yet Chase got paid off on a loan that was due."' There is considerable resentment among multinational corporate execu- tives over the speed with which the n r ------------ ~:~~-tr`"`'~`"a~-`-mot'-''' ~.~ VOLKSWAGEN EXPORTS BEETLES FROM BRAZIL TO EARN MORE HARD CURRENCY banks took care of themselves. "There's a perception that there's a lot of weep- ing while counting money in the back room" at the banks, says one U. S. exec- utive. Adds a Canadian, referring to the increasing bank practice of insisting that multinationals guarantee loans to sub- sidiaries: "Banks like to have it both ways: a parent-company guarantee on one side and pricing that reflects a Bra- zilian risk on the other." Despite their huge stake in the out- come of the debt crisis, U. S. multina- tionals have been slow to organize a re- sponse. Only now, under the auspices of the New York-based Council of the Americas, have they begun to collect in- formation about the impact of the crisis on multinational corporate finances. "Bankers by practice know each other well and organized more quickly," says the lawyer for the multinational. "They all participate in jumbo syndications and have each other's phone numbers." He adds: "The day after [Mexico's August crisis], the chairman of Chase knew the damage." By contrast, "in many cases it took six to nine months for a multina- tional's chairman to get an assessment of the damage." One way around the hard-currency shortage and exchange controls, for some multinationals, is to increase equi- ty in their LDC subsidiaries. Last year, instead of waiting an unknown length of time for a $20 million payment from its Mexican diesel-engine joint venture, Cummins Engine Co. increased its share to 40%, with the government's Diesel Nacional retaining 60% ownership. De- spite Mexican policy of encouraging or forcing foreign investors to take on ma- jority Mexican partners in most busi- nesses in recent years, the administra- tion of President Miguel de in Madrid says it is willing to be more flexible in permitting majority foreign control. A goal of the Council of the Americas is to push Washington to persuade Latin nations that they would benefit by in- creased foreign equity in their indus- tries. And in a July 8 speech in Geneva, International Monetary Fund Managing Director Jacques de Larosiere noted: "Given their large needs for external re- sources, the developing countries would be well advised to place greater empha- sis on policies to attract foreign direct investment as part of their development strategy." 'STAY LOOSE' Multinationals are turning in the meantime to other techniques for coping with the crisis. One is to push exports from LDCs as hard as they can, knowing that the more they export, the higher they will move on government waiting lines for hard currency. Volks- wagen exports Beetle cars from Brazil and operates a cattle ranch there, ship- ping frozen beef back to Germany. And in Mexico, the company recently took coffee in payment for local auto sales, then sold the coffee in Germany. GE, on the other hand, found LDC markets for locomotives and hydraulic turbines so depressed it switched to making boat hulls at its Campinas pk.nt in Brazil. Despite the problems, most multina- tionals insist they are in Latin America and other debt-ridden LDCs for the long haul. "It requires a very dynamic ap- proach," says John F. Beck, General Mo- tors Corp. vice-president for North American vehicle operations. "You can't make a decision now and sleep with it for the next two years." Beck's advice to others doing business in Latin America: "Stay loose." o Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 luable :llents es to ration ce the ntact 15, Dr. Iford. Where should the Fund go from here? Alena Weis New York Various ideas are being canvassed for reforming the international financial system but no consensus has yet emerged. Improvements, /MF managing director Jacques de Larosiere argues, should be preceded by a period for 'maturation and gestation' The severe international liquidity crisis has cast the spotlight on the International Monetary Fund and the slim, dapper and logical Frenchman, Jacques de Larositre, who is the Fund's sixth managing director. He began his second five-year term, with the unani- mous support of the Fund's members, this month. For the 53 year-old Mr de Larositre - the quintessential French bureaucrat who spent four years at the head of the French treasury, had been chairman of the deputies of the Group of 10, participated in the work of the Committee of 20 and served as chef du cabinet of former French President Valery Giscard d'Estaing when he was finance min- ister - the spotlight is by no means unwelcome. As Mr de Larositre put it recently, `increasingly the eyes of the international financial community have turned toward the Fund as the central element in the search for a constructive solution to the current international financing and indebtedness difficulties'. Mr de Larositre, said C. Fred Bergsten, who heads the Institute for International Economics, stepped into the breach in a very decisive and effective way. `He and Fed chairman Paul Volcker are the heroes of the story'. Another long-time American observer of the Fund's operations observed that the managing director `has done quite well in building a global awareness of the Fund. He has done a great deal to strengthen the separate image of the Fund from the US and any other single country'. The perception that the Fund is a tool of the US, which has always played a leading role in the organisation, has proved a major handicap in dealing with developing countries in the past. On the other hand, the US remains the strength of the Fund, and Mr de Larositre, as an impeccable civil servant, must see himself as the instrument of its `most important minister'. The US administration wanted him in the spotlight. Will he remain there when the current debt crisis is resolved and how will the role of the IMF evolve? The French treasury official attracted the attention and won the respect of the Americans when he and the then US undersecretary of the treasury, Edwin H. Yeo III, worked out a compromise between the French and the American positions on the role of gold, the exchange rate regime and surveillance that was embodied in Article IV of the amended articles of the Fund. He retains that respect still. While his immediate predecessor H. Johannes Witteveen, a former Dutch finance minister, had no trouble with the Americans, Pierre-Paul Schweitzer, who held the post for a decade before him, was barely tolerated. Deeply pessimistic about his ability to stop the collapse of the Bretton Woods system and stem the disorder in monetary affairs that followed, Mr Schweitzer angered the Americans by urging them to devalue. He was told unceremoniously that he could not expect a third term. His predecessor, Per Jacobsson, an adviser to the Bank for International Settlements, was a crusader for the free enterprise system. Main input If Mr de Larositre's public positions would appear to have swung from a more liberal approach during the Carter years to a more conservative one currently, he vehemently denies it. He says now that his first action when he came to the Fund in 1978 was to insist on the importance of adjustment. He made a very strong plea to stop the sort of trust funds, oil facilities and other unconditional recycling mechanisms that had been developed in the wake of the first oil shock. There was to be no more sales of gold to buy the international community out of its problems, no more oil facilities. The abundance of money stemming from the sur- pluses of the oil producing countries between 1978 and 1981 did, however, postpone adjustment by the deficit countries. If the adjustment had been taken INE 1983 THE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 41 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 earlier, he now believes, it would have been less painful and more acceptable. Payments deficits would not have soared to $100 billion for the non-oil developing countries in 1981 and external debt would not have mounted to $600 billion at the end of 1982, a whopping 132% of their exports. The easy habits of financing would not have caught on. He is said to view the main input of the Fund in the system as getting minds as well as countries to adjust. He wants to dispel the notion that a debt conversion scheme, similar to those under discussion in academic and other circles, would pave the way for a return to what he likes to call `the old, old game'. If member countries have unanimously given him the oppor- tunity for a second five-year term, they presumably agree with having a managing director of that persuasion. He, in any event, thinks so. Another American close to the Fund says simply that the managing director has taken a `sensible view of the financing problem. He has, moreover, got the support of the right people'. Mr Witteveen, this observer comments, was well suited to the kind of philosophical and analytical problems that engaged the Fund during his tenure. Mr de Larositre may be better suited to dealing with the practical problems now facing him. Surveillance It is particularly significant that it would have been on the US initiative that the managing director would have been invited to participate in the meetings of the inner group of industrial countries that now consult on the implications of their economic policies on the international system, an idea that emerged from the Versailles summit. The five countries, whose currencies make up the SDR, the US, Germany, Japan, Britain and France, have a major impact on the world economy. The five are joined in their discussions by Canada and Italy, the other two partners in the summit meetings. Better compatibility and consistency of policy among the major actors is viewed both at the Fund and within the US government as an important element in the recovery of the world economy and the establishment of a better economic environment. The concept of surveillance among a small group of industrial countries has not had time to mature and serious doubts have been expressed over the ability of the international community to influence the policies of the US, the most flamboyant player on the world stage. It has been said also that there is an absence of a mutually accepted economic framework, making it difficult to consult on economic matters much less seek some degree of economic collaboration. Mr de LarosiPre's position is that it is essential that the modest but gradual recovery now anticipated in the industrial world be realised and sustained. The central objective of economic policy, he said in a recent speech at Neuchatel, Switzerland, is achievement of sustainable growth. He continues to Jacques de LarosiPre: no return to the old game say that a durable recovery depends on the continuing credibility of anti-inflation policies. He is particularly concerned that budget deficits in the US be brought down so that prospective deficits do not `cast their shadow' in the form of high interest rates that would hinder the process of recovery. Mr Bergsten and others worry that Mr de Larosi2re may be `sticking with deflation longer than is needed and this could turn out to be very costly'. But the managing director said at Neuchatel that there is no satisfactory alternative to the general strategy of bringing down inflation and tackling structural rigidities and imbalances as the right course for a lasting recovery. He remains apparently unmoved by the calls for coordinated economic stimulation even when they come from his mentor, Valery Giscard d'Estaing. The former French president told a meeting of the Council on Foreign Relations that Europe should be prepared to take up the gauntlet next year when the economic stimulus in the US begins to weaken as it surely will if real interest rates are not brought down appreciably. No short cut Mr de Larosi@re asserts that it is still imperative to continue the fight against inflation despite con- siderable progress in that area because, if the message now were changed, policy-makers would be doing an enormous disservice to the chance for recovery and growth. The flexibility of the world economies have been so weakened by more than a decade of uncontrolled inflation that it is an illusion to think that a little bit more stimulation, a little more reform and a little more liquidity will solve the world's economic problems. He is convinced that the chance for economic recovery will be enhanced and the problems of the Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 indebted countries ameliorated if there is a more constant set of economic policies in the world. But it requires great skill to promote changes in the economic policies of major industrial countries that will conform to a model of multilateral consistency. He is apparently ready to try his hand. He believes that the IMF has been successful in setting the general tone of anti-inflation efforts. He is also convinced that IMF surveillance had discouraged members from manipulating their exchange rates in order to get competitive advantages. However there is a general dissatisfaction with the exchange rate regime and its inability to reflect underlying economic conditions. Mr Bergsten believes the Fund has been unable to push hard enough to correct exchange rate imbalances largely because of US indifference. In his New York speech, Giscard d'Estaing was impatient with loose talk about the need to return to more stable exchange rates. He believes that the time has come for the major indus- trial countries to decide whether they want to return to fixed exchange rate parities. If they do agree to this objective, they must decide whether to. pursue a theoretical or empirical approach. The latter approach, which Giscard d'Estaing clearly favours, would involve 'the convergence of mutually reinforcing actions'. These would include the strengthening of the European Monetary System, the strengthening of the European Currency Unit and the establishment of target zones for the ECU, dollar and yen with wide margins that would gradually be reduced. This would involve some coordination of monetary policies and mutually agreed intervention in the foreign exchange markets. If the answer is negative or mildly positive, Giscard d'Estaing continued, there would still be a need for better management of exchange rates. That necessitates adequate intervention in which the Federal Reserve participates. r Approach to reform Mr de Larositre senses that there is a desire in the US administration as well to explore ways and means to stabilise the monetary system. The time may have come to overhaul the system but the managing dir- ector is said to agree that there is a need for an understanding and agreement on the basic objectives to be pursued. The founders of the IMF understood that they wanted to restore an open trading system and that they needed an international organisation to facilitate financing. The question that Mr de Larosi@re will be facing in his next five years is the nature of the system that is needed for the 1980s. Reforms and improvements in the system, he explains to associates, have to be preceded by a period of maturation and gestation. An academic conference held at the IMF in March weighed the benefits and drawbacks of the floating rate system. The general conclusion was that floating rates have not worked well, having contributed to 20 C1IISWELL STREET LONDON EC1 110,500-55,000?q.t't. a New (,'ece?'dod,et (9 Irox. "J0- Lang 00 0 KaNHousTa-W0* 01-M 6W yoo~y*LmNOn EC~A71 'J Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Healey& Baaker /1Vy M1/n~w 17$ Old Brood stn I at~on2dB London N W T.NphOM Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ally be tion of ,ention ;wer is ?staing better ssitates teserve in the means iy have ng dir- for an jectives erstood system ition to qtr de s is the 1980s. :m, he Ir d March floating floating uted to excessive ' movements in real exchange rates, inef- ficient adjustment and misallocation of resources. On the other hand, the participants saw little prospect of an early return to fixed exchange rates. Nor did they see an enhanced role for the SDR in the system unless the unit is made more attractive and usable in the private market. This would involve the same kind of government and institutional support that the Euroj,eans are giving to the ECU. Nor did the academics present view the IMF as an incipient world central bank. Warning against excessive ambition, Federal Reserve chairman Paul Volcker told more than 10,000 foreign exchange traders at a dinner in April, that `we can constructively do something to help stabilise exchange rates within the general framework of the floating system . . . nations should be in a position to accept in the formulation and execution of monetary policy and, in the fiscal-monetary mix, a degree of discipline implicit in the desirability of greater exchange rate stability'. In this context, he concluded, intervention might have a modest sub- sidiary role to play. Irving Friedman, a consultant to First Boston with extensive experience at the IMF and World Bank, insists that there is a major need for a more precise definition of where the Fund ought to be going and what basic principles should guide it. The Fund must have a clear mandate from its members on the areas members would like to see considered and decided. He believes that it is important that the members decide whether currency stabilisation, for example, should be the objective of a global body or of a smaller group of industrial countries like the Group of 5. There will be tension and ambiguity in this area until this is resolved and it will make management of the Fund very difficult, he says. Contacts with banks A decision must also be taken as to whether the increasing contacts between the commercial banks and the Fund, which has sprung from the debt crisis, should be institutionalised in some way. Mr de Larosii re's trip to New York to address the major multinational banks at a rapidly convened meeting at the New York Federal Reserve bank last November was a milestone in this relationship. As he recalls it, he did nothing more than explain the problems facing Mexico and Argentina and that it would be impos- sible to solve their liquidity problems without the cooperation of the banks. He made clear that the banks were perfectly free to make their own decisions but he left the impression that the IMF adjustment programmes would fail unless the banks put up substantially more in new funds. Current LMF projections suggest that the non-oil developing countries will have a current account deficit this year of $70 billion, down from $90 billion in 1982. The Fund expects the banks to increase their net contribution by 7-8% over the last year to about $20 billion to help finance that deficit. Some $50 billion will come from grants, direct investments and long-term official lending. The IMF will provide a further $12 billion. Mr de Larosiere said in Neuchatel that the assumptions concerning commercial financing flows were `both critical and uncertain'. He said further that the projections for bank financing will depend on a 'reassurance that sound adjustment policies are underway in the borrowing countries. ... If confidence in Fund-supported programmes were to diminish because of a weakening of conditionality, an abrupt curtailment of bank lending would seem to be inevitable'. Projected capital flows, he contends, would be broadly consistent with an increase in the volume of imports by these countries of 21h%. Mr de Larositre is very sensitive to charges that the conditionality of the Fund programmes may be too harsh and that it may be detrimental to the world economy as a whole to sharply curtail demand in the developing countries which are major markets for the industrial world. Conditionality works The IMF has reviewed the overall performance of developing countries that entered into upper tranche stand-by arrangements in the period between 1971 and 1980 and found that they achieved significant improvement in their balance of payments while broadly maintaining their real economic growth. To be sure, the past few years have seen a deterioration in the world economic environment with growth rates declining in industrial and developing countries alike. But real growth rates may actually improve, even during the first year of the Fund programme, for most of the 23 countries that have recently approved and the three that have proposed standby and extended arrangements with the Fund. Mr de Larosii re contends that the Fund's adjustment programmes are designed to be `outward oriented'. Of the most recent 26 programmes, 19 assume an increase in imports in the first programme year as compared with the previous two years. Mr Bergsten believes it is important for the Fund to `calibrate' conditionality to take account of the world economic situation. In reality, Mr de Larosi@re has countered, Fund programmes have protected the chances of recovery in the major developing countries. Actions that do not make sense for individual economies should not be taken simply for the sake of international recovery. The managing director continues to point out at every opportunity that he cannot guarantee the effectiveness of the Fund's adjustment programmes or the quality of their implementation. Thus banks must continue to lend at their own risk. He refused to consider the provision of any sort of guarantee to the banks nor does he have any interest in the numerous schemes that are being proposed to consolidate the debt of the developing countries. Even Giscard Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 d'Estaing raised the possibility that a market for bank claims be established with some official support. Some partial guarantees might be provided by a multinational organisation, he said. Mr de Larositre, on the other hand, is impatient with what he believes to be easy answers, noting that a bad debt will not disappear with the wave of a magic wand. It is noteworthy that most bankers do not like these ideas, either, because they generally involve the discounting of their developing country assets. Mr de Larosiere has said publicly that it may be desirable for the Fund to issue explicit warnings where external financing problems seem likely to emerge. But the Fund remains cautious about requests to increase the flow of confidential information to the banks. Nor is the IMF noticeably anxious to develop a closer relationship with the US regulatory authorities. The pressure, however, is building up. Anthony Solomon, the president of the Federal Reserve Bank of New York, told an audience in Geneva that bank regulators in creditor countries should be able to consult with the IMF so as to avoid an excessive build-up of credit in the future. Some cooperative approach, he believes, would avoid the competitive inequities and convince borrowers that the authorities are serious about moderating the amount of bank lending in the future. The American regulators made a series of proposals to accompany the legislation for an $8-4 billion expansion in the US contribution to increased IMF quotas and the enlarged general arrangements to borrow. These urged the Fund, in its consultations with member governments on their economic poli- cies, to intensify its examination of the trend and volume of external indebtedness of private and public borrowers in the member country. The regulators want the Fund to report to the executive board on such borrowing from the viewpoint of its con- tribution to the economic stability of the borrower. Of even more significance, however, is the request that the IMF consider the extent or form that these comments might be made available to the inter- national banking community and the public. Further, as part of any member's stabilisation programme, the regulators want the Fund to place limits on public sector external short and long-term borrowing and publish information on the trend and volume of international lending in the aggregate as it affects the economic situation of lenders, borrowers and the smooth functioning of the international financial system. For its part, the IMF has generally held the view that there is a limit to the amount of information that the Fund, on its own initiative, could make available that bears on the economic and financial performance of a member. The danger is that the Fund's rela- tionships with the members would be harmed if the IMF were to publish its reports and evaluations of member countries economic policies and prospects. Some bankers contend that the Fund protests too much since any enterprising banker with good contacts can learn of the Fund's assessments. Early warning system? Many bankers believe that the Fund should develop its symbolic relationship with the private market, evolve objective criteria for appropriate levels of borrowing and act as an early warning system. Is this possible? Irving Friedman thinks not. The IMFs concerns, he explained, are of a macroeconomic nature, ranging from balance of payments, inflation, fiscal policy and the establishment of realistic exchange rates. Bankers are interested in all these things, but for them country risk is less of an abstraction. They have their own exposures, balance sheets and responsibilities to their shareholders to consider. Therefore, they must be well informed about the social and political environment in the country in which they hope to lend. Those are questions that the Fund cannot explicitly consider. Can you conceive, Mr Friedman asks, of a situation in which the Fund, having become aware of the heavy short-term exposure of the Mexicans in early 1982, were to have told the banks not to lend. Mr Friedman cannot. That would have meant that the IMF was prepared to take the responsibility for the level and composition of international lending. It has neither the authority given it by its members nor the expertise to do so, he asserts. Said another observer, you need it here, now So you rns money for you ' , s success ea When your company can preserve liquidity while you accelerate rgowth. Read the full story in our booklet, `Factoring.' A Just ask for your copy. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ANGLO FACTORING SERVICES LIMITED Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 n public ?ing and fume of Tects the and the financial the view tion that available prmance d's rela- ;d if the }tions of rospects. bests too Fh good should private ite levels 'stem. Is to IMF's Ct tic nflation, realistic 311 these s of an , balance ilders to nformed t in the lose are insider. situation he heavy iy 1982, ,riedman MF was evel and neither nor the bserver, '\tiY LIMITEI) `the borrowing countries would be very troubled if the world banking community were to coalesce around the Fund and the institution were to be able to turn credit on and off like a faucet'. While there is a growing recognition that closer cooperation between the Fund and the banks might help to keep credit flowing in the short term, people are very sceptical as to how far this cooperation should be allowed to go. The new Institute for International Finance, established in Washington by the major international banks, might provide one channel for such cooperation. But it is not very clear yet to most observers what the institute intends to do. To this observer, the institute is still an `abstraction'. Meanwhile, the staff of the Fund is severely strained in attempting to put together plausible adjustment programmes and to monitor the perfor- mance of the borrowing countries. They find Mr de Larosiere demanding and sometimes capricious. They must often face hostility and deviousness in the borrowing country. Their calculations might be severely disrupted by a further decline in oil prices, the failure of US interest rates to decline or the dollar to fall from present levels. But events that would harm one country would benefit another. The Eastern European countries, for example, would benefit if the dollar remains strong because the bulk of their debts are in Swiss francs and German marks. Primary objective Mr de Larosiere's primary objective, he tells those around him, is to introduce more rationality into economic decisions. He views the world dis- passionately as a hard one, where resources are scarce and often over-extended. The challenge is to sit down with debtor countries, examine their future and the resources available and decide what must be done to return them to creditworthiness. The path is a narrow one. On the one side are the debtor countries that are increasing their sacrifices and reducing their growth paths while, on the other, are the banks which are often over-extended on a number of key countries. But it is the considered opinion of the staff and the managing director that the type of adjustment that will be required to meet the 30% debt service burden envisaged for 1983 is poli- tically and socially acceptable and does not ask for impossible sacrifices. It is the nature of the situation that some, especially in the developing countries; would not agree. The creditworthiness of the banks will also improve if the programmes are successful, the IMF contends. As Mr de Larosiere has been explaining to the banks, it is better to have a restructured or rescheduled debt on major borrowing countries with the prospect of recovery, even if it is in the medium term, than for the banks to slip away in a disorderly fashion and let the situation deteriorate further. Mr de Larosiere has been saying in recent months that the current crisis is manageable if three basic conditions exist. If the borrowing countries `stick to their guns', if the bankers live up to their respon- sibilities, and if the mix of policies in the major countries allow for a durable recovery in the world economy. It will be extremely difficult for the heavily indebted countries to continue servicing their debts if world trade does not pick up. The Fund's responsibility in assuring that this will happen is also three-fold. It must devise with the borrowing countries stabilisation programmes that are workable and convincing, it must develop an understanding with the banks and it must continue its surveillance of the major countries to assure that their economic policies are correct for a sustained recovery. Fund resources It also goes without saying that the IMF must have adequate funds to meet the unprecedented demands on its resources. It was agreed at the Interim Com- mittee meeting in Washington in February that the Fund's quotas should be increased by 47.5% to SDR 90 billion or just short of $ 100 billion. There has also been a pledge to increase the resources of the general arrangements to borrow to SDR 17 billion or $ 19 billion and make these funds available to all members of the IMF. This would roughly double the IMFs available resources. However, the legislation to approve the $8.4 billion US contribution could get bogged down into a widescale debate on how banking regulations should be amended to assure that debtors and their banks do not become over-extended in the future. Despite Mr de Larosiere's assurances that his intention is to `bail- in' the banks, some in Congress persist in viewing the IMF bill as some sort of `bail-out' for the banks. The IMF will be short of funds this year, whether or not the quotas are approved quickly. It has only $8 billion uncommitted and expects outlays in the $9 billion to $10 billion range. More funds will be forthcoming from the Saudis but other sources of financing may also be necessary. The Group of 30 has argued that international confidence would be enhanced if the IMF were to be allowed to borrow from the private market. The Japanese and Germans are very sceptical about a market approach, much more so than the Americans. There are those in the US who feel that such an approach would drastically change the character of the institution and they are not yet ready to see that happen. That may mean that the Germans and the Japanese will be approached for more funds. Since such borrowing would also be at market rates, sources within the IMF see little difference between that and borrowing from the private market. In any event, the major sources of funds will have to continue to be subscriptions from the member countries. And, as usual, increases in these subscriptions will continue to be hostage to the US Congress' suspicion of foreign aid. TH_ Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 GLOBAL ECONOMIC OUTLOOIK TUESDAY, FEBRUARY 15, 1983 UNITED STATES SENATE, COMMITTEE ON FOREIGN RELATIONS W , The committee met, pursuant to notice, at 10:30 ~a.m., n~ room SD-419, Dirksen Senate Office Building, Hon. Charles H. Percy (chairman of the committee) presiding. Present: Senators Percy, Lugar, Mathias, Boschwitz, Pressler, Pell, Biden, Sarbanes, and Dodd. The CHAIRMAN. The committee apologizes to all of you. There was a Cabinet session called by the President so that the Secretary of State could report to the leadership of the Senate and members of the Cabinet. We were delayed getting over here. Secretary Shultz, we very warmly welcome you not only back to the United States but for your first public appearance before this committee in 1983. We are particularly pleased that you will be fo- cusing your attention on the range of international economic issues which affect the conduct of U.S. foreign policy today. No one in this room need be reminded that you bring to these issues a wealth of experience and expertise absolutely unique for a Secretary of State, coming at a crucial time in American history when international economic affairs are of greatest concern to all countries throughout the world. It will be our good fortune to have the benefit of your thinking in this area. Senator Mathias conducted a series of hearings in January and early February in the International Economic Policy Subcommittee on the stresses and strains in the international financial system. Today we continue the hearings at the full committee level. The subcommittee received testimony from 15 witnesses including three former Secretaries of the Treasury, the former Chairman of the Council of Economic Advisers and the former Comptroller of the Currency. I wish to particularly commend Senator Mathias for the great leadership and creativity that he and his staff have offered in fo- cusing attention on the critically important economic factors which so influence our Nation's security, and certainly, the timing of it now, as the President this week sends forward his recommenda- tions on IMF. In these hearings we do not have to start the work, then, of de- termining what the nature of the problem is, what the burden is going to be. If the crushing debt incur red by these nations all come together, will it lead to a world collapse of the economic system? (369) Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 We now have 2 solid months of hearings anticipating this action and recommendation by the President and action by the IMF. The subcommittee hearings, together with the testimony we will receive today from you, Mr. Secretary, and the testimony of Secre- tary of the Treasury, Don Regan, who comes before this committee next week, will form the basis for our consideration of authorizing legislation for an additional U.S. contribution to the International Monetary Fund. We welcome your views, Secretary Shultz, on the need for addi- tional resources for the IMF. In addition, this committee is charged with authorizing the expenditure of U.S. dollars for foreign mili- tary and economic assistance. We want to hear from you on how such assistance is in the national interest of the United States. We have, in short, a full plate of issues before us. I can assure you that this committee will move with great dispatch in getting these issues forward so we stay on schedule. We have already scheduled a discussion with Howard Baker so we can move right along on them, and we look forward to hearing from you today. Senator Pell? Senator PELL. Thank you, Mr. Chairman, and welcome. Today's hearing before our committee on the state of the international economy is, I think, symbolic of the importance which internation- al economic issues have come to play in the formulation of our policy. It is particularly fitting that our Secretary of State, George Shultz, himself a distinguished economist, should appear here today to provide us with his assessment on the state of the world economy and his recommendation for coping with the stresses of the economic system brought on by the severe recession in the in- dustrial West. I am sure you are aware, Mr. Secretary, that a number of indi- viduals have raised questions about the $8 billion-plus contribution to the International Monetary Fund at a time when 12 million Americans are jobless, and expenditures on domestic programs have been cut to the bone. I think it is necessary for the administration to articulate a strong and credible case as to why it is in our interest to greatly increase the resources of the IMF and provide funds for foreign as- sistance programs in these difficult times. When I was on the hustings these past weeks, this question came up more often than anything else: Why should we send all this money abroad when our people at home need employment, shelter, food, and fuel? I think it would help us, the American people, if you could give specific reasons why it is to the advantage of the United States for these expenditures to be made. Why is it a good investment for the taxpayer? Why is it a good idea that the aid re- quest from the administration will go from $5 million to $6.3 bil- lion; that the contribution to IMF will go from $16 billion to $24 billion. I think these are tough questions, ones that I find are very diffi- cult to answer to my constituents when they press me in my State of Rhode Island, and I hope that today you could give us some spe- cific reasons as to why it is to the advantage of the taxpayers of the United States to move ahead with these expenditures. 1f Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Than!: The C: these sii comment Senator Secretac' nary ros very de(,,- formatio: stand chi It is im sentence. live in an in the Ur trade witl to the whi are going deal of det I think program t message, s on the sub The Cii Secretary agricultur( the buildir ing comm(-, tor Dodd, Senator ings. I and been held I hope y< the budget involved it From the crease the Are you Secretary Senator I The CHA have any cc Senator L The CHAI from you. STATE if F.\ Secretary this commit your invitat the ramific., sponsive to ject. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 s anticipating this action I action by the IMF. ith the testimony we will d the testimony of Secre- Ies before this committee sideration of authorizing tion to the International tz, on the need for addi- his committee is charged dollars for foreign mili- hear from you on how f the United States. before us. I can assure reat dispatch in getting dule. We have already. r so we can move right ing from you today. , and welcome. Today's to of the international ince which internation- the formulation of our Mary of State, George , should appear here the state of the world with the stresses of recession in the in- :hat a number of indi- Ilion-plus contribution time when 12 million n domestic programs 'ation to articulate a ur interest to greatly funds for foreign as- Cs , this question came ,uld we send all this employment, shelter, American people, if :he advantage of the ide. Why is it a good idea that the aid re- million to $6.3 bil- m $16 billion to $24 I find are very diffi- ress me in my State Id give us some spe- of the taxpayers of )enditures. 371 Thank you, Mr. Chairman. The CHAIRMAN. I wonder, Senator Mathias, having conducted these subcommittee hearings, whether you would care to make a comment. Senator MATHIAS. Mr. Chairman, I would rather hear from the Secretary, but I would take the opportunity to thank the extraordi- nary roster of witnesses that we had come to this committee with very deep preparation, who brought us an enormous amount of in- formation so that we have a record, as you say. I think it will with- stand challenge on this subject. It is impossible to summarize all those hours of testimony in one sentence, but the message they brought us very clearly is that we live in an interdependent world economy in which unemployment in the United States is very definitely tied to the lower levels of trade with the developing world. The availability of capital is tied to the whole question of the world debt and how we manage it. We are going to have to proceed with great prudence and with a great deal of determination to resolve these problems. I think the answers to Senator Pell's questions lie in the kind of program that the President alluded to in his state of the Union message, so I am anxious to hear what Secretary Shultz has to say on the subject. The CHAIRMAN. We will try to adjourn close to 12 o'clock. The Secretary has an appointment at 12:30, but because he dealt with agriculture and just met briefly for a few minutes as he came into the building with some agricultural leaders, if you have any open- ing comment you would like to make, Senator Boschwitz and Sena- tor Dodd, we would be happy to hear from you. Senator BoscHWITZ. I am sorry I missed Senator Mathias' hear- ings. I understand they were among the better hearings that have been held in quite some time. And I share Senator Pell's concern. I hope you will deal, Mr. Secretary, with the differences between the budget authority and the outlays that, as I understand it, are involved in contributions to the International Monetary Fund. From the way I understand it these contributions would not in- crease the deficit, though they would increase borrowing. Are you going to cover that aspect of it? Secretary SHULTZ. Yes, sir. Senator BOSCHWITZ. Good. Thank you, Mr. Chairman. The CHAIRMAN. Thank you very much. Senator Dodd, do you have any comments? Senator Donn. Not at this time. The CHAIRMAN. Secretary Shultz, we would be happy to hear from you. STATEMENT OF HON. GEORGE P. SHULTZ, SECRETARY OF STATE Secretary SHULTZ. Mr. Chairman and distinguished members of this committee, I am very pleased to have a chance to respond to your invitation to testify on the international economic system and the ramifications of it for the United States. So my ject testimony re- sponsive to your invitation and the questions is focused on this sub - Approved Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 372 I would like to say at the outset, however, that you should not infer from that that I think this is the only subject of interest in foreign policy matters, and in particular, I 'would like to say that the general program of security assistance and economic assistant is of great importance to us in our foreign policy. I am delighted to learn that you are going to push ahead rapid], on your markup in this area, and I know that Under Secretary Schneider is due to testify, I think, on Thursday. I simply want to lend my support to what he will be telling you. Restoring prosperity and stability in the world economy is one of the fundamental goals of the President's foreign policy. Progress toward that goal reinforces our other fundamental objectives-safe- guarding peace and security and expanding the benefits of democ- racy and freedom. I am going to divide my remarks on the international economic system into three sections. First, a discussion of the U.S. stake in the international economy-where do we come in. Second, an ex- amination of the antecedents of the current situation and the chal- lenges that it presents; and finally, a description of some of the ac- tions that the administration is taking and my thoughts about them, to re-invigorate the world economy. This country began as a trading nation. The legend of the Yankee Trader has faded with time, but no matter how remote the image, there are still plenty of Yankee traders among us, and I think partly as a result, foreign trade is now more important than ever to the vitality of our country. In 1981, the United States represented about 25 percent of the world gross national product. One out of five U.S. jobs depends in some way on trade, and 40 percent of our cropland is devoted to production for exports. In the last decade, U.S. merchandise exports, as a percent of our GNP, have doubled from 4 percent to over 8 percent. Much of this increase is attributable to the growing interdependence of the world's market economies in the 1970's. Non-OPEC-leave the oil out of it-non-OPEC developing na- tions, for example, accounted for roughly 20 percent of U.S. exports in 1970. The same nations now account for nearly 30 percent of U.S. exports, which happens to be more than either the European community or Japan. On the other side of the trade ledger, the non-OPEC developing countries supply about 25 percent of the goods we import for use by our factories and consumers. Since the counterpart to interdepend- ence is dependence, it is not surprising that the Third World sup- plies more than half the bauxite, tin, and cobalt used in American industry, and virtually all the natural rubber, coffee, coca, and hard fibers used by American consumers. The North-South trade connection is important but it should not be overstated. We should remember that Japan is our second larg- est trading partner, and our neighbors, Canada and Mexico, are first and third, respectively. Moreover, in the aggregate, the Euro- pean Community is our single largest trading partner. Indeed, in 1982, U.S. trade with the EC totaled $46 billion as compared with $32 billion with Canada. t T; . TN in the fur-t1: Re'poi very that t The nanci \Vorlc mobil tion, The I not a ity ar nanci In side, t cant- cifical States the in velopc Bev, more viabili goverr mome inspir( In fore, i we she The sion ft has le dustri, ery, al now st their period expans The nearly 1982. I from Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 you should not ct of interest in like to say that Tonic assistance ~h ahead rapidly :rider Secretary simply want to .onomy is one of policy. Progress objectives-safe- nefits of democ- tional economic ie U.S. stake in Second, an ex- in and the chal- some of the ac- thoughts about legend of the how remote the Hong us, and I )ortant than percent of the obs depends in i is devoted to percent of our t. Much of this ndence of the ieveloping na- of U.S. exports 30 percent of the European EC developing Dort for use by :) interdepend- rd World sup- 1 in American ?ee, coca, and it should not r second larg- I Mexico, are ite, the Euro- er. Indeed, in impared with Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 373 On the financial side, the United States has traditionally been a large investor abroad, and conversely, has attracted a great deal of foreign investment. In the 1950's and 1960's, returns to investment were higher abroad than at home, and the United States was a heavy net foreign investor. The counterpart to this foreign investment was a persistent sur- plus in our merchandise trade. By the 1970's, the demand for new capital abroad had decreased, as had the U.S. supply of savings. Thus, the United States ceased to be a net capital exporter and usually incurred a deficit in merchandise trade. This history is described in greater and more informative detail in the "Economic Report of the President," so I will not develop it further here. There is a very interesting chapter in the "Economic Report on the United States and World Economy" that I think is very well worth reading. There are a number of points in there that they develop well. The United States is also a significant factor in international fi- nancial institutions, as you all referred to. Our support of the World Bank and the International Development Association helps mobilize capital for vital projects in the developing world. In addi- tion, we are a major factor in the International Monetary Fund. The IMF is an instrument of collective action and although we are not a borrower, we still benefit when it supplements global liquid- ity and provides members with temporary balance-of-payments fi- nancing. In sum, whether looked at from the trade side or the financial side, the U.S. stake in the international economic system is signifi cant-significant in terms of jobs, income, and opportunities. Spe- cifically, we can infer from this brief overview that the United States has a clear stake in the promotion of trade, in the vitality of the international financial system, and in economic stability in de- veloped and developing countries alike. Beyond pure economics, however, we also have a stake that is more political in character. The demonstration of the strength and viability of market-oriented economies and the democratic form of government with which they are associated. We should seize this moment to prove the potential of the open market mentality that inspired the Yankee traders. In so doing, however, our own system will be put on trial. There- fore, if we urge other countries to adopt market-oriented policies, we should be sure to adhere to those policies ourselves. The world is now coming through a period of painful decompres- sion from the severe inflationary surge of the 1970's. That period has left us with serious problems: High unemployment in the in- dustrial countries, large public sector deficits that constrain recov- ery, and the heavy debt burden of some developing nations that now strains the international financial system. These problems had their origin in the decade of the seventies. An analysis of that period reveals that they may have a common solution-economic expansion in the 1980's. The level of developing countries' total debt, which now stands at nearly $700 billion, increased more than sevenfold from 1972 to 1982. In the same 10-year period, debt to private lenders jumped from 40 to 60 percent of outstanding LDC debt. The conclusion Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 drawn from these facts by those who wish to fix blame is that either the banks overlent during the 1970's or countries overbor- rowed. The truth is that many bad judgments were made. But it is also true that after the oil price increases of 1973-74, lenders and bor- rowers acted on a set of assumptions; buoyant export growth and low interest rates, that though proven false, were thought reason- able at the time. The recycling of petrodollars from the OPEC na- tions to the nonoil LDCs was a highly profitable business for the banks. And since the loans were in inflation-depressed dollars, the LDCs assumed that today's loans would be repaid with cheaper dollars tomorrow. In this environment, indebtedness mounted. It would be wrong, however, to characterize the legacy of the oil shock years as a debt problem. Rather, in its broadest aspect, it is an income-earning problem. True, LDCs borrowed a lot in the 1970's, but our domestic corpo- rations borrowed a lot, also. The difference is the corporations invest in productive capacity to generate income to repay their debts. Some LDCs, however, tended to invest in consumption rather than production, borrowing to finance internal income transfers. This strategy, although of questionable wisdom, was tol- erable as long as LDC export earnings grew fast enough to service their debts. That was, indeed, the case from 1975 to 1979 when LDC exports grew 22 percent annually, roughly keeping pace with the 25 per- cent annual growth of LDC debt. In response to the second oil shock in 1978-79, however, the major industrialized nations adopted more restrictive monetary policies which slowed inflation, boosted interest rates and set in motion a retrenchment from the economic excesses of the 1970's. High interest rates and a strong dollar increased LDC debt serv- ice costs. Simultaneously, LDC export earnings declined as the re- cession reduced the demand for the slashed prices of LDC commod- ities. Indeed, nonoil commodity prices fell 28 percent between 1980 and 1982, increasing debt service ratios and eroding the terms of trade. As Tanzania's President, Julius Nyerere, has put it to buy a heavy truck in 1981, Tanzania had to produce 10 times as much tobacco or 4 times as much cotton, or 3 times as much coffee as it took to purchase the same truck just 5 years earlier. The problem faced now by Tanzania and other high debt develop- ing countries is not so much a debt problem as an income-earning problem: Rising debt service costs consume an ever-increasing pro- portion of declining export earnings. Many LDC's are now under pressure to increase exports and curb imports. This comes at a time when the industrialized countries face rising unemployment, declining real income and deteriorating trade balances. As a result, the international financial, trade and monetary systems are under serious strain. I recognize that is kind of a shorthand summary of much of your hearings, Senator Mathias. The only lasting solution to the income-earning problem of the LDCs, as well as the serious problems of the industrial countries, is sustained economic growth without renewed inflation. The key to stimulating the 1970's of th Today, for ex ized West and has been estir in 1983 rather countries woulc West, a figure service payment The industri:i an expansion c States is on the is just a persona dent's fiscal yea down, inflation expansionary SE States and other are positioned to The recent dr course, an oil p sudden unanticil tions. An oil pric tries, especially ezuela. But assume fo tion-I underline enough case so s magnitude invoh 40-percent drop. would, in the ag., 2-year period: Real growth ra percent, and devc the United State: the 1983 oil-impo billion, and that count balance wo of $17 billion. Si; cutting their cur; cant oil-price dec proportional to th Now, I say this all of the handwri of oil-price declir. happen. And this involved in the dii Senator BoscHv in your testimony' Secretary SHUL'1 The salutary of come about auton nations, must wor seized. In turn, th four objectives. F Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 blame is that ntries overbor- But it is also nders and bor- )rt growth and hought reason- the OPEC na- isiness for the !ed dollars, the with cheaper mounted. gacy of the oil Est aspect, it is omestic corpo- e corporations to repay their consumption ternal income sdom, was tol- ,ugh to service i LDC exports th the 25 per- however, the monetary and set in of the 1970's. ,DC debt serv- ned as the re- LDC commod- veen 1980 and arms of trade. buy a heavy much tobacco as it took to debt develop- come-earning icreasing pro- ?e now under comes at a iemployment, ;. As a result, .-ns are under much of your oblem of the al countries, ion. The key to stimulating that growth lies in the interdependence forged in the 1970's of the world's economies. Today, for example, the economic linkage between the industrial- ized West and the developing world is tighter than ever. Indeed, it has been estimated that if OECD GNP were to grow by 4 percent in 1983 rather than the projected 1.8 percent, the nonoil developing countries would earn an additional $15 billion on exports to the West, a figure equal to 14 percent of their estimated 1983 debt service payments. The industrialized countries in my opinion are now poised to lead an expansion of the world economy. In particular, the United States is on the road to recovery. It appears to me personally-this is just a personal opinion-that the growth projections in the Presi- dent's fiscal year 1984 budget will be exceeded. Interest rates are down, inflation is down, inventories are depleted. Basically, a very expansionary set of policies are in place. In short, the United States and other industrialized nations that have reduced inflation are positioned to play a vital role in world economic expansion. The recent drop in oil prices may also stimulate expansion. Of course, an oil price decline is not unambiguously good, for any sudden unanticipated change in the world economy causes disrup- tions. An oil price decline may, for example, harm individual coun- tries, especially net oil exporting LDCs such as Mexico and Ven- ezuela. But assume for the sake of illustration, as distinct from predic- tion-I underline that-but I want an illustration, and I take a big enough case so we can really kind of get an idea of the orders of magnitude involved here: a decline, say, to $20 a barrel which is a 40-percent drop. It has been estimated that such a price decline would, in the aggregate, have the following catalytic impact over a 2-year period: Real growth rates in industrial countries would increase 1 to 11/2 percent, and developing country rates 2 to 21/2 percent. Inflation in the United States and elsewhere would decline 11/2 to 21/2 percent; the 1983 oil-import bill for industrial countries would drop by $90 billion, and that for LDCs by $9 billion. The OECD current ac- count balance would swing from a deficit of $18 billion to a surplus of $17 billion. Simultaneously, LDC exports would rise 3 percent, cutting their current account deficit by $18 billion. A less signifi- cant oil-price decline would have similar positive effects, roughly proportional to the reduction from current prices. Now, I say this not as a prediction but just to point up that with all of the handwringing you sometimes hear of about the possibility of oil-price declines, there is a very positive side if that should happen. And this just gives some notion of the orders of magnitude involved in the direction and the effect. Senator BoscxwITZ. Are you going to make a prediction later on in your testimony? Secretary SHULTZ. No, sir; I have one, but I am not talking. The salutary effects of the world economic expansion will not come about automatically. The United States, together with other nations, must work to insure that the opportunities for growth are seized. In turn, this means that we must concentrate our efforts on four objectives. First, insuring sufficient liquidity in the interna- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 376 tional financial system; second, preserving open markets; third, im- proving the international monetary system; and, fourth, insuring political stability in the developing world. In working toward each of these objectives, which I shall address in turn, cooperation will be essential. Cooperation between the public and private sectors, between the developed and developing worlds, between business and Government, and between the execu- tive branch and the Congress. The basic elements for successfully dealing with the liquidity problems of the high debt developing countries are known and in place. The so-called debt bomb can be defused through emergency, short-term bridge financing, leading to adjustment programs imple- mented in conjunction with the IMF and with the cooperation of commercial banks. Private banks, however, are now reducing their rate of new lend- ing to the developing world. Net new bank lending was flat be- tween the first half of 1981 and the first half of 1982. estimates for the second half of 1982 show a precipitous drop in new lending, which we have to say it is not surprising that that should happen under the circumstances. Such an abrupt contraction in new lending obviously would im- peril the recovery of the debtor countries. Moreover, reduced lend- ing in the face of increased debt-service costs would also retard our own recovery by contracting LDC imports from the West. Indeed, as Rimmer de Vries recently testified, a Morgan Guaranty Trust Co. study estimates that if capital flows into the LDCs were cut by $25 billion, OECD growth would drop at least a half a percentage point. With OECD growth in 1983 expected to be only 1.8 percent, half of a percentage point represents a significant cut in growth. The Morgan Guaranty study is hypothetical. But import cuts are already a reality. A dramatic case in point is Mexico whose 1982 imports from the United States dropped 36 percent from the 1981 level. Consequently, in the course of a single year, the U.S. balance on merchandise trade with Mexico swung from a $3.7 billion sur- plus to a $4.5 billion deficit. The international economy is too vulnerable to this kind of con- tradiction to permit a continued decline in lending to the Third World. Private banks have a collective interest in extending suffi- cient new money to permit the developing countries to service their debts. Western governments, including our own, have a similar stake in seeing that the LDCs have sufficient capital to pay for im- ports of goods and services that will enhance LDC productivity and contribute to world economic expansion. The United States, I believe, stands ready to do its part in this effort. Where appropriate, we will provide funds, as was the case with Mexi,to, through bridge financing, CCC credits, Eximbank loans or swap facilities. This administration will also be seeking congressional support for the expansion of IMF resources, coming directly to Senator Pell's question. In just-concluded negotiations last Friday, member countries agreed upon a quota increase of 47.5 percent. The U.S. share of this increase will be approximately $5.8 billion. I might note that the quota increase is not a U.S. budget item-this, I think, is going to be responsive to your point, Senator Boschwitz- for it for n c l J1or nation off old are th. with t vate I(. incre:rr age wo Anot gener;,i 10 indc upon sc Howc with th the GA is $2.6 quoted that $8 Unlik not be I try wh( whole. 'Our s totals $t approve the poin Ifull ys Don Ret: minister outstand here and Let m, lending in LDC I depend c veloping export g Therefor, serve the The re derstand; gress wil and other hard-hit These and econ( barriers r currency ports. Cor ductive ,- That do nations' t Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 narkets; third, im- 1, fourth, insuring ich I shall address lion between the ,d and developing etween the execu- ?vith the liquidity .ire known and in rough emergency, t programs imple- .he cooperation of rate of new lend- ding was flat be- 982. Estimates for in new lending, .at should happen viously would im- ver, reduced lend- Id also retard our the West. Indeed, ? `:uaranty Trust s were cut by half a percentage only 1.8 percent, at cut in growth. it import cuts are exico whose 1982 at from the 1981 the U.S. balance 1 $3.7 billion sur- this kind of con- ing to the Third i extending suffi- ~s to service their , have a similar tat to pay for im- productivity and 3 its part in this as was the case edits, Eximbank ?essional support ectly to Senator Friday, member ercent. The U.S. billion. I might ,et item-this, I ator Boschwitz- 377 for it represents an exchange of financial assets; cash in exchange for a drawing right on the IMF. More importantly, our quota represents an investment in inter- national financial well-being. The purpose of the IMF is not to pay off old debts, but to encourage sound policies. Indeed, indications are that a borrowing country's creditworthiness tends to improve with the successful implementation of an IMF program, and pri- vate lending then generally increases rather than declines. A quota increase is thus an inherent component of any program to encour- age world economic growth. Another component of such a program is the expansion of the general agreements to borrow. A GAB was initially established by 10 industrialized nations as a backup line of credit to be drawn upon solely by the 10 contributing countries. However, late last month in Paris, the United States, together with the other nations of the group of 10, agreed to almost triple the GAB from $7 billion to $19 billion. Our share of this expansion is $2.6 billion. I think, incidentally, the number that is being quoted is the sum of the $5.8 and the $2.6 billion. That is where that $8.4 billion figure comes from. Unlike the traditional GAB, access to this expanded fund will not be limited to the G-10 alone, but will be accessible to any coun- try whose liquidity problems threaten the financial system as a whole. Our share of the IMF quota increase and the GAB expansion totals $8.4 billion. This is the amount we will be asking Congress to approve before the end of 1983. Anrl Secretary Regan, of course, is the pointman in presenting that to you, but I want to say here that I fully support what he is doing, and I think the combination of Don Regan s efforts and Paul Volcker's efforts with other finance ministers, and central bankers, and Jacques de La Roussiere, an outstanding international civil servant, has been very important here and effective. Let me turn to the trading system. Even if the sustained bank lending and increased IMF resources prevent a sharp contraction in LDC liquidity, the success of our financial efforts will ultimately depend on adjustments in the trade accounts of developed and de- veloping countries alike. Import cuts can provide only so much; export growth must lead the way in the recovery of the LDC's. Therefore, we must resist protectionist pressures and seek to pre- serve the system of open trade we helped to build. The recession and high rates of unemployment in the West un- derstandably have increased protectionist pressures. The 98th Con- gress will probably confront local content legislation, agricultural and other subsidies and a host of protectionist proposals directed at hard-hit sectors such as steel and autos. These protectionist moves threaten to impede our own recovery and economic expansion generally. Quotas, tariffs, and other trade barriers raise costs to us and deny borrowing countries the hard- currency earnings needed to service their debts and buy our ex- ports. Conversely, open trade speeds resources to their most pro- ductive uses and creates more jobs than it destroys. That does not mean, however, that we should acquiesce in other nations' trade-distorting practices, expecially those imposed on sec- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97ROO694ROO0200870001-3 tors such as agriculture and services, in which we enjoy a compara- tive advantage. This is what we were discussing just before coming here, Mr. Chairman. Subsidized agricultural exports from the EC, for example, have enabled European farmers to expand their share of third country markets at the expense of U.S. farmers. In response, we recently sold subsidized wheat flour to Egypt. Temporary, trade-distorting measures such as the wheat flour transaction can be justified on the ground that "when all the world is mad, 'tis folly to be sane." But we should remember these are insane things to be doing. Temporary measures tend to become permanent; and retaliation has an inherent tendency to escalate. Constructive negotiations-in which we meet unreason with reason-present the only lasting so- lution to protectionist problems such as export subsidies. We have a situation emerging where, for example, through this competitive subsidy program various countries in the world will be producing butter, and as the butter gets sold in the world market and winds up in the Soviet Union, through this insane system of subsidies butter will be produced and sold to the Soviet housewife at about one-quarter the price the American housewife pays for it. Can anyone explain why that makes sense? I do not see it. We will, therefore, work within the GATT to remove barriers to the export of U.S. services and agricultural products, In addition, we will work on a bilateral basis, as I did on my trip to Japan, to roll back trade barriers. Difficult but important negotiations with the EC on agricultural trade subsidies are now in process. Finally, we will seek concrete ways of implementing the open trade pledges made by the major industrialized countries at the Versailles Summit and the GATT Ministerial. Turning to the monetary system, trade is encouraged by stability in exchange markets-something we have not had in recent years. The instability of relative currency values over the last decade is basically a reflection of turbulent economic conditions. But several developments have created recent problems for the trading position of U.S. producers. Financial flows, for example, are having a powerful effect on ex- change rate movements. This presents difficulties from the stand- point of trade. During 1982 financial flows into the United States led to the greatest appreciation of the dollar since the beginning of floating rates in 1973. The strong dollar increased the price of U.S. exports and decreased the cost competitiveness of U.S. industry. Consequently, the U.S. trade deficit in 1983 is expected to widen. Moreover, if large outyear budget deficits are not reduced, they will consume U.S. national savings, which already accumulate at the lowest annual rate in the industrial world. A shortage of sav- ings would drive up both real interest rates and the dollar, thereby further widening our trade deficit. In other words, what is happening to us here is we suddenly find ourselves in a kind of Switzerland position where big financial flows are having an effect on the value of the dollar. The market is behaving just right. I mean it is reflecting what is happening. How- ever, when you look at trade, that strong dollar is making our goods muc real trade An addi system is tween Mal 230 ven t( Japan and nese impoi the ven ha This poii of Caterpil to knock C is not beca not know I mendous ii The soli. clear. Who study by tl- Finally, ing relative markets, a, ficult-in veloping cc West and curbing ec, will be abo tries have I exports of tempted by LDC ausi dangers U.; culties thrc States. Eco hundreds o difficulties terest in M: In short, While LDC place withi cient finan growth. This anal its implicat dening the LDC debt- growth in t the debt bu become mar The key t creased exp, dependent c industrialize everywhere- Approved For Release 2008/01/23: CIA-RDP97ROO694ROO0200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 rich we enjoy a compara- )efore coming here, Mr. EC, for example, have r share of third country n response, we recently uch as the wheat flour hat "when all the world lld remember these are manent; and retaliation ructive negotiations-in sent the only lasting so- ort subsidies. example, through this ?ies in the world will be ,ld in the world market 1 this insane system of to the Soviet housewife n housewife pays for it. I do not see it. I' to remove barriers to l products, In addition, in my trip to Japan, to it negotiations with ww in process. Finally, the open trade pledges ?ies at the Versailles encouraged by stability of had in recent years. )ver the last decade is conditions. But several or the trading position powerful effect on ex- ulties from the stand- nto the United States since the beginning of used the price of U.S. less of U.S. industry. is expected to widen. are not reduced, they Iready accumulate at Id. A shortage of sav- nd the dollar, thereby ?e is we suddenly find where big financial dollar. The market is it is happening. How- lollar is making our 379 goods much less competitive in third markets, thereby presenting a real trade problem to us. An additional problem we face in the international monetary system is the great volatility in exchange rates. For example, be- tween May and November of 1982, the yen depreciated from about 230 yen to the dollar to 276, raising the price of U.S. exports in Japan and third country markets, and reducing the price of Japa- nese imports in the United States. By the end of the year, however, the yen had swung back to its previous level of 230. This point was made very vividly to me by Lee Morgan, the head of Caterpillar Tractor. And the effect of the big swing was basically to knock Caterpillar out of a whole set of third-country markets. It is not because something was wrong with management or they did not know how to sell in third markets or whatever. It was the tre- mendous impact on them of the swing in exchange rates. The solution to such excessive exchange rate volatility is not clear. What is clear, however, is that the problem warrants close study by the major currency countries. Finally, even if we succeed in increasing LDC liquidity, preserv- ing relatively open trade and decreasing volatility in the exchange markets, adjustment for many developing countries still will be dif- ficult-in some cases, testing what the social fabric will bear. De- veloping countries have had to accommodate the recession in the West and their own financial problems by cutting imports and curbing economic growth. Aggregate real LDC will be about 1 to 1.5 percent-the lowest since 1950. African coup tries have been especially hard hit because of their dependence on exports of primary commodities. Increasingly desperate, they are tempted by repressive strategies and radical panaceas. LDC austerity can, if excessive, risk political instability that en- dangers U.S. strategic interests. In this hemisphere, economic diffi- culties threaten to increase illegal immigration into the United States. Economic troubles were a factor in the recent expulsion of hundreds of thousands of Ghanians from Nigeria. And economic difficulties in the Sudan could, for example, threaten the U.S. in- terest in Middle East stability. In short, our own strategic interests dictate the following rule: While LDC adjustment is necessary, such adjustment must take place within the limits of the politically possible, and with suffi- cient financial support to maintain stability and spark renewed growth. This analysis has, by necessity, been quite general. Yet I think its implications are straightforward. The problems currently, bur- dening the international economy-recession, high unemployment, LDC debt-all have a common solution: economic expansion. If growth in the world economy resumes and real interest rates fall, the debt burden of even the most heavily indebted countries will become manageable. The key to recovery from the debt problems, however, lies in in- creased exports from developing countries. That increase is in turn dependent on an expansion of our own economy and those of other industrialized countries. Economic expansion anywhere can help everywhere-but not necessarily. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 380 For if we expand, while simultaneously erecting protectionist barriers, neither the LDC's nor the industrialized countries will benefit from that mutually reinforcing boost to recovery provided by open trade. In shutting out goods from the rest of the world, we will incur not only the usual costs of protection-higher prices to consumers and jobs lost in the export sector-but retard our own recovery and threaten the world economic system as well. Our challenge, therefore, is to revitalize the international finan- cial system; preserve and extend the benefits of open trade; im- prove the monetary system; and insure political stability in the de- veloping world. This administration is working hard to achieve these four objectives, all of which contribute to leading orldn econthat is expanex-- pansion. Our own economy will P Y a sion. As a result, we have an opportunity to demonstrate the con- tinued viability of our market-oriented economy, and the democrat- ic institutions it supports. Thank you, Mr. Chairman. The CHAIRMAN. Thank you very much, Secretary Shultz. Because of the number of Senators here this morning and the time constraints we are working on, without objection we will go on a 7-minute rule. farm Mr. Secretary, just before we came in here the met with of the leaders, and they put the question to you problem United States being a stable supplier and supported strongly ac- tions taken by the administration in contract sanctity. There was a position taken on those pipeline sanctions, which we appreciate, a position of leadership that you and the President took. Could you say something about long-term contracts with the People's Republic of China, and longer than a 1-year has been already committed with the Soviet Union? Are we work- ing toward a longer term agreement so we can destroy this image that we are not a reliable supplier? for any Secretary SHULTZ. First I think it is very important we will do trader to be viewed as reliable, so that when we say something or I as a private businessman or farmer or whatever say I will do something and I sign up to that, that the person I am signing with can count on it. That is an essential ingredient trade, so we have cthat make it necessary to breakea~ contract. But t things happen as BI think that we should view that as something that happens a last resort and under the most extreme circumstances. Other- wise, we lost our position in the trading world. As far as agricultural sales in China and the Soviet Union are concerned, of course, those represent both large potential markets for our farmers. Both from the standpoint of our farmers' role' in our own markets and from the standpoint of the attitude of people to whom we are selling, reliability is an important ingredient. desir- Other things reasonably equal, long-term able because they tend to give information about what is happen- ing to the marketplace and provide a level of assurance a to beota suppliers and consumers about what can happen. proposition I think they are desirable. In order to move forward that is congenial to t the expectations I think we need 'an implied by longter P m agreement upgrade t! is a great with it. Iii The Cii in, the ii in,,, the m Secreta tiation, ri seen. the agric, member, ability. i1 The Cii lem that exports. From you pediment From y first be d could be the yens market, c closer pai Secrete do with take the I did n underval ing is the rencies a and then A few land be 11 the char: have bet the last into the portant i The n, you cans market the into fact that down is chandist heads pi There the valu Treasur: along th I wou is a vei dollar o Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 protectionist )untries will ery provided he world, we -:er prices to and our own tional finan- n trade; im- ty in the de- l to achieve economic ex- that expan- -ate the con- he democrat- iltz. ling and the a we will go !t with farm )blem of the strongly ac- ns, which we President with the :tension that ,re we work- y this image ant for any we will do vhatever say person I am ngredient in ies, unfortu- i a contract. t happens as nces. Other- t Union are tial markets ners' role in .de of people edient. is are desir- t is happen- tnce to both is a general d an atr^os- y long-term agreements; so it is an important part of our diplomacy to try to upgrade that atmosphere. Obviously it takes two to do that, and it is a great big broad problem, and I hope we can make headway with it. But it is a difficult situation to predict. The CHAIRMAN. Will consideration be given to not only increas- ing the limits at the bottom-6 million tons now-but also increas- ing the maximums? Secretary SHULTZ. All of these things would be part of any nego- tiation, and just where one would come out would remain to be seen. Right now there seems to be an atmosphere of surpluses in the agricultural field. It isn't always that way, as we can all re- member, and nature tends to have a way of imposing some vari- ability. And so you have to be ready for both types of situations. The CHAIRMAN. In your statement you touch briefly on a prob- lem that the strong dollar creates for the competitiveness of U.S. exports. We hear not only from farmers but manufacturers on this. From your view or our view the overvalued dollar is a critical im- pediment to increased exports. From your own perspective as an ex-budget director should we first be doing more to reduce the future budget deficits; what else could be done? Second, do you think with resepct to the yen that the yens value as against the dollar is entirely set by the free market, or there are things that Japan could do to bring the yen in closer parity to the dollar? Secretary SHULTZ. Two different questions there, one having to do with the monetary system and the other the budget. Let me take the first and then the second. I did not say that the dollar was overvalued or that the yen was undervalued. The market has made an evaluation. What is happen- ing is that we have tended historically to think of the dollar or cur- rencies as reflecting sort of trade flows and relative inflation rates, and then the values sort out to bring about some stability there. A few countries have had a rather different problem, Switzer- land being the outstanding one, because it has in a sense as much the characteristics of a bank as it does of a country. Financial flows have been very big there for a couple of reasons. Particularly in the last couple of years there have been very big financial flows into the United States, and they have tended to become very im- portant in setting the value of the dollar. The market has correctly reflected these flows, so in that sense you cannot say it is overvalued or undervalued or anything. The market has been reflecting these facts: That money has come to the interest rates here and, I believe, seeking a safe haven. The fact that money keeps coming even though interest rates are going down is a measure of that fact. But it poses problems for our mer- chandise trade, and that is something that we have to scratch our heads pretty hard about. There is no evidence that the Japanese have been maneuvering the value of the yen; and that has been looked at very hard by the Treasury, and they see no evidence for that whatever. It is more along the lines of what I suggested. I would point out also in the President's Economic Report there is a very interesting chart that shows the cross rates with the dollar of the yen, of the Deutsche mark, of some other currencies, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 382 but the yen and Deutsche mark are the two principal ones there. The track is rather parallel, so you have a broad influence here. On the budget side, I think the outyear deficits are the thing to focus on. Personally, I think that the deficits in the current fiscal year and 1984, while it would be desirable to compress them some- what, are nevertheless ones we can live with. It is the outyear defi- cits that are frightening to financial markets. Just what they will turn out to be, of course, remains to be seen, and I do not have total confidence in our ability to project exactly what our economy will look like 5 years from now; but people have done the best they can, and we see that there is a substantial defi- cit. The President's contingent tax proposal I think is a good one and a way of addressing that, and of course, the spending side needs to be worked on continuously and hard. The CHAIRMAN. Thank you, Mr. Secretary, and congratulations to you on a much-needed and I think an outstanding trip to the Far East. Senator Pell. Senator PELL. Thank you, Mr. Chairman. In connection with the exclusive economic zone, under which you know, we would have the exclusive right to all living and mineral resources within a 200-mile area on a line from our shores, what are the plans of the administration? Do you plan to move ahead with a unilateral declaration on that, or would you be willing to wait until we have had a hearing on the matter? Secretary SHULTZ. You catch me unprepared, Senator Pell. I have thought about the Law of the Sea Treaty a lot, and that is a point that I have not registered on. I know that we feel that the 200-mile limit that is established in the Law of the Sea Treaty is something that we would claim for ourselves and do claim for our- selves. Certainly a hearing is fine, but I am not sure what the jux- taposition of a formal declaration in a hearing is. I would have to get back to you on that. Senator PELL. Let me submit that in writing, if I may, sir. Secretary SHULTZ. Certainly. Senator PELL. I thought your statement was excellent. I found that even though I am no economist myself, I understood it and its thrust. But I speak to you as a representative of an administration which is terrific in communication, headed up by a great communi- cator, and in this regard I want you to imagine yourself not having a group of friendly Senators here but having as I had a couple of weeks ago, 500 very angry individuals without enough fuel, cold, not enough food, some of them depending on soup kitchens, some of them looking for lodging. Many people are very upset at the foreign aid program and its corollary, the IMF. When you add these figures up, they really are tremendous. How would you in very simple terms explain to people who have no college degrees, half of them no high school degrees, what the advantages to the American poor and unemployed and cold and hungry Americans are of the aid program? Secretary SHULTZ. There is a lot of variety in the programs being spoken of. There is the support for the IMF and the General Ar- rangements to Borrow. There we essentially have asset trades in the interest of n from breaking dh Senator PELL. Secretary SHC; The question is pands, that can people will be at process of job cre I think the evi ing system and f pansion of trade in history, not or everyone has ber risen. That is the nation. It is also true t the developing cc matic, we see wha stake in keeping c are a member of healthy, not just c Senator PELL. question of jobs or petitive ability th Japanese are pro, salaries, when you employment and wages from the sc, to them that we takes more than a What I am real ments that can be ing, fair trading, ment, as you know Secretary SHULT in the fact that 4( Those exports havc lands are dependec tries that export h, by imports, to be some sense of pace In the textile ca., that imports shoul( market itself grow: been a negotiation At the same time we have an indust 1970's than in mane the problem. I thin this very courageou time I think we ha produced off the U.; the ones of 3 or 4 vc the times, they are Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ncipal ones there. Lid influence here. s are the thing to the current fiscal npress them some- s the outyear defi- emains to be seen, to project exactly w; but people have a substantial defi- iink is a good one the spending side id congratulations anding trip to the under which you living and mineral i our shores, what an to move ahead 'u be willing to d, Senator Pell. I i lot, and that is a ,t we feel that the the Sea Treaty is d do claim for our- sure what the jux- is. I would have to 'I may, sir. excellent. I found iderstood it and its an administration a great communi- ,ourself not having I had a couple of enough fuel, cold, p kitchens, some of d program and its up, they really are s explain to people igh school degrees, I unemployed and m? he programs being d the General Ar- Lve asset trades in the interest of maintaining the health of the system and keeping it from breaking down. Senator PELL. To these people the system has broken down. Secretary SHULTZ. Well, it has broken down but not irreparably. The question is to keep things together so. that as our economy ex- pands, that can take place with as much flourish as possible; and people will be able to get their jobs back or get other jobs, so the process of job creation can proceed. I think the evidence for the importance of the international trad- ing system and financial system to that is overwhelming. The ex- pansion of trade has been accompanying one of the greatest booms in history, not only for ourselves but for our trading partners. So everyone has benefited from that. Their standards of living have risen. That is the line along which I would try to make the expla- nation. It is also true that if our trading partners suffer too badly-and the developing country examples I gave, such as Mexico, are dra- matic, we see what that has done to us in many ways. So we have a stake in keeping other people healthy, just as we have a stake if we are a member of a community in keeping the whole community healthy, not just ourselves alone. Senator PELL. When it comes to explaining to our people the question of jobs or the lack of jobs here and the difference in com- petitive ability that we face-automobiles, for example, where the Japanese are producing cars with fewer work people, where the salaries, when you check into it, the benefits of permanent lifetime employment and the side benefits are not that much different in wages from the scale that we have here-it is very hard to explain to them that we are losing our competitive edge. And I think it takes more than a theoretical explanation. What I am really groping for here are for some specific argu- ments that can be used as to why the aid program and free trad- ing, fair trading, is a good idea; because the protectionist senti- ment, as you know, is building up very hot and heavy. Secretary SHULTZ. I think you have to point, if you are a farmer, in the fact that 40 percent of our cropland is devoted to exports. Those exports have to go somewhere, and the people who till those lands are depended on that trade. Similarly, there are many indus- tries that export heavily. There are other industries being affected by imports, to be sure, and some balance there is important and some sense of pace as imports increase is important. In the textile case, for example, there has been a determination that imports should not increase faster than the rate at which the market itself grows, at least for now. And the result of that has been a negotiation to try to bring that into some kind of balance. At the same time you mentioned the case of automobiles. There we have an industry where wages rose much faster during the 1970's than in manufacturing generally, which accounts for part of the problem. I think the auto union and industry has confronted this very courageously in the last couple of years. But at the same time. I think we have to take note of the fact that the cars being produced off the U.S. assembly lines now are definitely superior to the ones of 3 or 4 years ago, in my opinion. They are more suited to the times, they are smaller, they are lighter. I think the quality Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 has been improved greatly, so the U.S. consumer is getting some- thing better. One of the reasons is that our manufacturers saw that if they are going to stay around, they have to compete, and they have to make a product better; so we are getting benefits from that kind of competition. We have to keep remembering that. And thinking about the consumer, too. Senator PELL. Thank you. Thank you, Mr. Chairman. The CHAIRMAN. Thank you. Senator Lugar. Senator LUGAR. Thank you, Mr. Chairman. Mr. Secretary, in the debate that is shaping up on the IMF, sug- gestions were made that restrictions ought to be placed on U.S. banks with regard to amount of foreign lending or other guidelines by our own banking system. It has also been suggested that there ought to be some rediscount window or facility created in which U.S. banks might discount some of the paper that they have abroad, get out of the international lending business, take a loss and write down uncollectible loans so that we are not jeopardized continuously by this overhang of $500 or $600 billion. What comments do you have on either the guideline issue-that is, whether we ought to be having guidelines on our banks-and whether the banks should either simply mark down these loans or we should create a facility to handle some rediscount of its paper? Secretary SHULTZ. Well, on the guidelines, probably that is a good idea if the enactment is not too specific. When you start new regulations, you generally wind up sorry 5 years later, because there are all sorts of unanticipated results, if you give too little op- portunity for those who are going to administer them to adjust them to the circumstances. Basically, however, I would have to say this is a subject on which I would defer to the Treasury. They have thought about it a lot more than I have had the opportunity to do. As far as creating some sort of goveYnmental discount window through which our private banks can unload their debt, I am very dubious about that. I think that it is desirable for our banks to be in the international lending business. It is a good business for them, and they should take their part in financing the internation- al economy. I think it is a problem that there is a retreat going on now. We need liquidity in the current situation. The answer to these debt problems, as I tried to develop in my testimony, is to get the system healthy and expanding; and while I do not want to be advo- cating price increases, certainly there are many primary commod- ities right now that are very depressed in their prices. So if we saw some comeback in those prices and we saw world expansion coming along, I think a lot of these debts would look different and could be handled. I would rather see them worked out that way. Senator LUGAR. Mr. Secretary, in your testimony you stressed this thought: that as opposed to a debt repayment problem we ought to be thinking in terms of income earnings for many coun- tries that are growing. But is this not primarily a political problem in the sense that even if IMF or other loans are made is not the problem their e, ment cent rn H come ,. No arr: turn t}, Could might `, Secre that the ernmen can do- the idea portant Now, ditions think t} econom' with it people, they wa commod food bei prices. So Ic somethi should I whole, I Senat( certainl: at home in India planted will hay Secret Senate ently is parts an On the attempti State th; or wewi Secret. and pros ly what do is dif and hea that is p from the Senatc The Cr Senatc Senatc Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 r is vetting some- saw that if they and they have to from that kind of nit. And thinkingg p on the IMF, sug- be placed on U.S. or other guidelines ggested that there created in which r that they have siness, take a loss ire not jeopardized lion. ideline issue-that in our banks-and own these loans or count of its paper? )robably that is a 7 you start new later, because i give too little op- er them to adjust a subject on which ght about it a lot I discount window sir debt, I am very or our banks to be good business for ig the internation- going on now. We ,wer to these debt any, is to get the >t want to be advo- primary commod- ,rices. So if we saw expansion coming erent and could be t way. nony you stressed ment problem we gs for many coun- 3 political problem e made is not the problem of growth within those countries essentially the nature of their economic systems? In other words, what kind of encourage- ment could we give to private enterprise in those countries whose centralized economies have rather poorly used their assets and come up with horrendous debts. Poland is a good example of this: No amount of IMF lending or private lending would apparently turn this around at this point. Could you address yourself to the political dimensions of what we might be able to do? Secretary SHULTZ. One of the advantages of the IMF, I think, is that the IMF is able to develop conditions for loans with the Gov- ernment better than we ourselves or any other single government can do-and certainly far better than private lenders can do. So the idea of so-called conditionality with IMF loans I think is an im- portant idea to preserve and enhance. Now, then, you have to come to the question of what are the con- ditions and how much sense do they make. Broadly speaking, I think the IMF has tried to develop conditions that will help the economy involved regain its momentum and its capacity to deal with its debt. However, the IMF just cannot dictate things to people, and different countries have their own ideas about what they want to do with their tax system. Many have prices of basic commodities that are controlled at a very low level-energy and food being two big examples-and it is difficult to let up on those prices. So I do not think that a standard of perfection by our lights is something that we can see imposed everywhere; but I think we should like to see things moving in the right direction. And on the whole, I think the IMF is trying to do that. Senator LUGAR. Let me just add a comment to that. Senator Pell certainly has had an experience similar to those of each one of us at home during the recess. I would say on behalf of my constituents in Indiana that we appreciate that 2 out of every a acres being planted in our State will be exported, and we hope that someone will have the money to pay for it. Secretary SHULTZ. Well, that is what we are talking about here. Senator LUGAR. One out of every eight manufacturing jobs pres- ently is for export-goods and services, machinery, mechanisms, parts and so forth. Without export we are dead in the water. On the employment side-and I think this is the point we were attempting to make-I would say simply that it is clear in my State that we will have to have export financing facilities available or we will have higher unemployment. Secretary SHULTZ. I think export financing facilities is one point, and providing some funds to the IMF is another point; but basical- ly what we are trying to do, it seems to me, or should be trying to do is different. We should be trying to help provide an expanding and healthy world economy so it is that fundamental expansion that is providing the market into which we are selling, as distinct from the particular stimulative devices that are talked about. Senator LUGAR. Thank you very much. Ti'e CHAIRMAN. Thank you very much. Senator Sarbanes. Senator SARBANES. Thank you, Mr. Chairman. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Mr. Secretary, I am a little concerned about a possible implica- tion of your statement. You are not asserting, I hope, that no loans were made to countries now in difficulty at a time when careful and prudent analysis of their situation would have argued against making the loans. I understand your point about the assumptions under which people were proceeding in the mid-1970's with respect to export growth and low-interest rates, which you outline in your state- ment, but are you suggesting that all of a sudden one morning we woke up to discover, to our great surprise, that we had a difficult problem which no one could have seen coming if he had taken a more careful look? Secretary SHULTZ. No, sir. I think I say that many bad judgments were made. Senator SARBANES. If that is the case, should not the request for an increase in the IMF quotas involve some process to assure that we will not again find ourselves in the situation we now face, oth- erwise, won't we be back for another increase in IMF quotas some- time in the future because in having gone down this path without some way to raise early warning flags? Secretary SHULTZ. Well, of course, the market has provided a kind of censure to people, and there have been a lot of bad loans that people have had to record. Quota increases are now associated dramatically with this problem, but of course historically as the world economy expands and the need for world liquidity expands, you would expect there to be a larger IMF facility. So it isn't all simply related to this particular problem. I do think the assumptions that turned out to be wrong were very widely held. It is true that some people were saying watch out, this is not going to go on this way and so on. And probably most of us could find some statement that we made somewhere that said that. So with hindsight and second-guessing, you can look much wiser than a lot of loan officers look right now. That does not mean they should be taken off the hook. That is their job to make those judgments, and when they make bad ones, they have to pay for it. Senator SARBANES. They invariably will be taken off the hook, will they not? The consequences that would normally flow from such judgments will not be allowed to happen when the debtor is a country and when the size of the debt is so large that if we fol- lowed the normal course, we would give a major shock to the inter- national financial system. Is that not simply a given? Secretary SHULTZ. I think what we are saying is something like this: We have a choice. We can say that all you countries around the world, including our own, and banks, including our own, made some mistakes, so that you are going to have to live with those mis- takes, and we are not going to do anything about it. Let the world system go down the drain. We would rather have it go down the drain and then pay for their mistakes than to try to help work the situation around so that we do not go down the drain. Senator SARBANES. That is right. You are not advocating the first approach, I assume. Secretary SHULTZ. I am advocating the exact opposite. Senato cause its Secret. Senato should down th For in: vate bar comment happenir accumul; Secret; this coun doing. W Senato make the the prix; banks. B whole fir, Secret; sonally, I central b think th ments h; are bette other wa Senato ty," how Secret; I am jus time a p stitution, the IMF true for countries Now, t regulator accept tl- would bE rather re Senato represen ing the I to assur( back ag; once aga should n Secret; perience. money. I back es desirable ing to th Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 at a possible implica- I hope, that no loans a time when careful I have argued against notions under which ith respect to export )utline in your state- dden one morning we lat we had a difficult ng if he had taken a many bad judgments Id not the request for )rocess to assure that ion we now face, oth- in IMF quotas some- wn this path without irket has provided a en a lot of bad loans es are now associated historically as the liquidity expands, acility. So it isn't all at to be wrong were e were saying watch so on. And probably we made somewhere uessing, you can look it now. off the hook. That is they make bad ones, taken off the hook, normally flow from when the debtor is a large that if we fol- ir shock to the inter- og is something like Iou countries around ding our own, made I, live with those mis- Out it. Let the world leave it go down the :ry to help work the 17 drain. advocating the first Senator SARBANES. No one does advocate the first approach, be- cause its consequences are too heavy to bear. Secretary SHULTZ. Right. Senator SARBANES. In the course of trying to work this out, should we not set up procedures to help assure that we will not go down that path again? For instance, what would be wrong with requiring that all pri- vate loans to governments be submitted to the IMF for review and comment-let us leave aside approval-so that we know what is happening and have some sense of how much in private lending is accumulating? Secretary SHULTZ. Well, we have through bank regulation, in this country anyway an ability to know what the banking system is doing. We do not have a lack of that kind of information. Senator SARBANES. Other countries do not require that, and they make these loans. And in a great many instances, a good part of the private debt is owed not to American bank's but to foreign banks. But the international banking system is interrelated, as the whole financial system is, as you point out. Secretary SHULTZ. It is interrelated, and at the same time I, per- sonally, would not be ready to put into the hands of a kind of world central bank a regulatory authority over the flow of loans. I do not think the evidence is strong at all, granted that some bad judg- ments have been made, that on the whole, government judgments are better than the sum total of private judgments. I think it is the other way around. Senator SARBANES. When you use the word "regulatory authori- ty," how do. you define that? Secretary SHULTZ. I suppose you are saying that you would-and I am just taking your suggestion, which I thought it to be-any time a private loan is made outside the country of the lending in- stitution, that loan should be registered or somehow run through the IMF for comment. Presumably you mean that that should be true for U.S. private loans and also for those originating in other countries. Now, that sets the IMF up as a central functioning, virtually a regulatory agency. It is not at all clear that other countries would accept that. I do not know what our country's attitude toward that would be. But I think it is something that I would personally be rather reluctant about. Senator SARBANES. What assurance can we give the people we represent, as we are n-)w confronted with the question of expand- ing the IMF quotas, that some safeguards have been put into place to assure that this situation will not reoccur, that we will not be back again seeking another increase in the IMF quotas because once again a number of loans were made that everyone now agrees should not have been made? Secretary SHULTZ. We can hope there is some learning from ex- perience. We can see that some people were caused to lose some money. I think myself that the private banks have been drawing back as a matter of fact from international lending faster than is desirable and that if it goes on too far and too fast will be damag- ing to the general interests of the private banks. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 But at any rate, it suggests that there has been caution imposed. Senator Lugar has raised the question of some guidelines insofar as our own banks are concerned. And no doubt, that will be consid- ered and should be. But I do not see that anyone can give an assur- ance that governments will never engage in the excesses that bring about and encourage the sorts of problems that we have had. If you come right down to it, where did this originate? Govern- ment is responsible for the inflation. The Government of the United States put on wage and price controls. I was there kicking and screaming, but I was there. It was a catastrophe. We kept the price of oil down. It was only when President Reagan came in that finally the controls were taken off. And we see how healthy that result is. So governments made mistakes all through this process that have helped create an environment where lots of other people made mistakes, too. I do not know that we can lay down a guarantee that Government will never make a mistake again. Senator SARBANES. Mr. Chairman, my time is up. I just want to make an observation. I think the administration ought to be giving some constructive thought to coupling their request for an increase in the IMF quotas with some procedures to provide assurances that we will not go down this path again. In saying that, I am not using the debater's device juxtaposing extremes, either that we should assure that governments will never make a mistake in the future as they have in the past, or that the alternative is to suggest that the system should just be al- lowed to collapse, et cetera, et cetera. But it does seem to me that there is a range where we can work toward some constructive proposals to link this request for an in- crease in the IMF quotas to some process-whether it is a review process, and how it involves other countries, are questions to be worked out-that will provide assurances in the future that if we start down the same path, there will be some early-warning flags raised. Otherwise, we are just leaving it open for a repeat of the current performance. The CHAIRMAN. Thank you. Senator Mathias. Senator MATHIAS. Mr. Chairman, I would like to pursue the theme that has been raised by Senator Sarbanes and Senator Lugar of the private sector banks' involvement in this process, be- cause I think that it is very close to the heart of the whole remedy. Senator Sarbanes says that the banks will escape the conse- quences of their poor judgment. During the course of the hearings that issue was dealt with at some length, and one of the witnesses said, we are not bailing out the banks, we are bailing them in. And this, of course, is the fact. The President's request and the IMF increase of quotas by 47.5 percent is not going to do this job. If that is it, in my judgment, we have a failure on our hands. Another necessary ingredient is that the commercial banks stay in and live with the consequences of their prior judgments. And more than that, that the banks increase their lending on an annual rate of something like 7 percent until we get through this very shaky period. And it is going to require this joint acti( through a roc' Secretary you are absolt Senator M.?.. The commerc! some cases o, of objective of in. Are we a: much? :Many Secretary S private banki money, as yot dividual bans banks, which going on very Senator M; gional banks. Secretary S and work aro that take the like to retrea let out, then kind of a run So I think 1 it is not aski; to measure u particularly I holding peopl Senator M. seem to be w the time beir well as their tic view of right. Secretary There are pl But I do not the problems we do about t Senator M: Secretary in the whole have the con economy wil: world econon Senator M. back again f the projectioi may get thrc But you wou does continu review of IM Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 as been caution imposed. ome guidelines insofar as ,ubt, that will be consid- nyone can give an assur- n the excesses that bring that we have had. this originate? Govern- 'he 'Government of the rols. I was there kicking tastrophe. s only when President were taken off. And we cents made mistakes all create an environment too. I do not know that went will never make a me is up. I just want to ation ought to be giving request for an increase provide assurances that ter's device juxtaposing that governments will ~y have in the past, or 'm should just be al- ige where we can work this request for an in- -whether it is a review 3s, are questions to be i the future that if we ne early-warning flags en for a repeat of the Id like to pursue the ;arbanes and Senator ant in this process, be- t of the whole remedy. 'ill escape the conse- 2ourse of the hearings i one of the witnesses bailing them in. And ease of quotas by 47.5 in my judgment, we 3ry ingredient is that the consequences of at the banks increase r like 7 percent until it is going to require 389 this joint action of the private sector and the public sector to get us through a rocky time in the world's financial condition. Secretary SHULTZ. I agree with that entirely, Senator. I think you are absolutely right. Senator MATHIAS. The question, of course, Mr. Secretary, is this. The commercial banks in the United States consider themselves in some cases overextended on foreign loans. Maybe in the judgment of objective observers, they are overextended. But they have to stay in. Are we asking too much of the banks, not too little but too much? Many of the regional banks I think would like to get out. Secretary SHULTZ. I think it is very much in the interest of the private banking system as a whole to stay in and to provide new money, as you suggested. When there is difficulty, of course, an in- dividual bank may want to get out, and particularly regional banks, which many feel they really do not understand what is going on very well and have become part of the syndicate. Senator MATHIAS. And that is a big group. There are 1,500 re- gional banks. Secretary SHULTZ. And they do not have the capacity to get out and work around the world. They have to rely on the larger banks that take the lead in the syndicate. So when there is trouble, they like to retreat. But it is very hard to manage this, because if one is let out, then everybody wants out and all of a sudden you have a kind of a run on the bank, in effect. So I think that it is important to hold these groups together, and it is not asking too much. It is asking the private banking system to measure up to its responsibilities and its interests. And so far, particularly the big banks have been doing a pretty good job of holding people together. Senator MATHIAS. I concur with that. And the regional banks seem to be willing to stay and seem to be willing to go forward for the time being. I agree with you that it is in their self-interest as well as their general interest to do. But you take a rather optimis- tic view of where we are going economically, and I hope you are right. Secretary SHULTZ. I do not want to be a pollyanna about it. There are plenty of problems, and I have tried to identify them. But I do not think that we can just sit and wring our hands about the problems. We have to say, well, there they are, now what can we do about them? Senator MATHIAS. You have to go forward. Secretary SHULTZ. There are things to do about it, and no doubt, in the whole picture the most important thing to do about it is to have the conditions created in the United States whereby our own economy will expand. That is the key. We are 25 percent of the world economy. Senator MATHIAS. The question was asked, will you have to come back again for another quota increase? And I would think that if the projections of growth are accurate, if they are realized, that we may get through on this quota increase for the foreseeable future. But you would not suggest, would you, that if the world economy does continue to stagnate, that there may not have to be another review of IMF capacities? Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Secretary SHULTZ. I would not say that, nor would I say that if things work out well, there would never be another review of IMF capacity, because that capacity has to reflect the general scope and size of the world economy. So if 10 years from now or 5 years from now things have worked out well, we will have a much bigger en- terprise, in effect, to try to manage. Senator MATHIAS. I think clearly the consensus agrees with you that we have to have growth, No. 1. That is the essential ingredi- ent. And if we have it, we have a fair chance of avoiding further immediate difficulties. One thing that you mention in your statement about which there is not yet a consensus is the question of exchange rate stability. Clearly, the poor relationship between the dollar and the yen, as you have described it very vividly, is the root of many of our trade problems with Japan. It has swung wildly in the recent past. When our inflation rate should have been pushing it one way, it went the other way. Should we have some kind of international arrangement that at least controls the far end of the swing, perhaps not the day-to-day fluctuation, but the wild swinging of currency rates, something like the European "snake," which I do not pretend to fully understand but which seemed to work. Secretary SHULTZ. Some very exotic terminology. Back in the early 1970 s we had the tunnel and then we had the snake in the tunnel and a lot of jargon like that. It was great. Senator MATHIAS. But do we need something of that kind? Secretary SHULTZ. Well, this is a question that is raised a lot, and I would not lay down an answer. I think that it is important. Senator MATHIAS. You have a lot of company in not being willing to lay down an answer. Secretary SHULTZ. I think it is important that the system be flexible. The par value system of the 1960's basically .broke down because there was no wav for the dollar to get itself adjusted to what was happening. Other currencies all could play off against the dollar, but the dollar was frozen. The floating system now opens that up. The extremes of volatility I think have reflected the fact that we have had a tremendous amount of turbulence connect- ed in considerable part to the big swings in oil prices. And if the situation becomes less turbulent, there will be more stability. So in that sense, the exchange market is more a thermometer registering the heat than it is a producer of the heat itself. Wheth- er or not now there should be some effort to give the system some additional constraints is a question that I am sure is being consid- ered. And I would not want to leave it at that. I would think the way to approach it is to think in.terms of just a few currencies rather than the whole world currency system. The currencies that are in the SDR basket are the main curren- cies. And if the relationship among them or even among, say, the dollar, the yen, the Deutsche mark, the French franc and the pound were a little more stable, then everything else kind of re- lates itself to that, and it may be that something can be done to bring that about. There has been a study of the effects of intervention that is about completed. And I do not know what the results of that are. Secretary P tell you abo that intervc< that it is ahir The CHA1r< Senator iii Senator Bi Mr. Secret fact that has has gone on the question; equally as it the cause. O1 have in doing the request Democratic-F constituencie floor of the L And what but I would when Goverr stockholder taxpayer, the But when banks who ai and I do not with banks "had" and t people are "b My first qr for any of the Secretary c if one person erybody gets seeking to av, Senator Bii fruitful discus not the bank: being done a The fact of the banks ju! that one coul there is not n thing, on the know that we us do, that w, disaster. Now, my way-I think is there any tions upon th the catastrop ing about soil Could you sa., ~k Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 would I say that if )they review of IMF e general scope and low or 5 years from a much bigger en- ;us agrees with you ie essential ingredi- of avoiding further t about which there ange rate stability. ar and the yen, as many of our trade recent past. When ne way, it went the rrangement that at not the day-to-day rtes, something like to fully understand )logy. Back in the .d the snake in the f that kind? raised a lot, and mportant. n not being willing hat the system be sically broke down t itself adjusted to d play off against 'ating system now have reflected the urbulence connect- prices. And if the _)re stability. ire a thermometer heat itself. Wheth- e the system some re is being consid- I would think the a few currencies the main curren- n among, say, the ch franc and the g else kind of re- ig can be done to .ervention that is z~sults of that are. Secretary Regan will be testifying, and he will be in a position to tell you about those results. I would be surprised if the study shows that intervention can really affect basic values. It does not figure that it is able to do that. The CHAIRSMAN. Thank you, Senator Mathias. Senator Biden. Senator BIDEN. Thank you very much. Mr. Secretary, what we need is a mongoose in that tunnel. The fact that has been mentioned time and again in the discussion that has gone on here about imprudent bankers making decisions raises the questions whether the Government makes decisions that are equally as imprudent or maybe even more imprudent and who is the cause. One of the problems that folks like us on the committee have in doing what I think has to be done-and that is, acceding to the request you are making-is a purely political one. Not in the Democratic-Republican sense, but in terms of explaining it to our constituencies and explaining it to some of our colleagues on the floor of the U.S. Senate. And what concerns people-I think I know the answer to this, but I would like to hear you say it-what concerns people is that when Government makes a mistake, they know they are sort of a stockholder and they lose. But everybody loses in the country: The taxpayer, the stockholder in a sense. But when a private enterprise makes a mistake, particularly banks who are not really well liked anyway-in my State, at least, and I do not come from a State that is unaccustomed to dealing with banks and corporate entities-they feel like they are being "had" and that only a relatively few people, relatively wealthy people are "being bailed out." My first question is: Is it practical from an economic standpoint for any of the banks to get out? Secretary SHULTZ. Well, if it is just one bank, it is practical. But if one person gets out, everybody else wants to get out, and if ev- erybody gets out, then you bring about just the situation you are seeking to avoid. Senator BIDEN. The reason I ask that is I do not think it is a very fruitful discussion for us in the Senate to be discussing, whether or not the banks want to, are doing us a service by staying in or are being done a service by staying in. The fact of the matter is, we are all in this mess together, and the banks just purely from their own economic standpoint know that one could get out but that might cause a run so they know there is not much they could do if the Government does not do any- thing, on the one hand. On the other hand, we sit here and we know that we have to do something, at least I think the majority of us do, that we have to do something to prevent what is a potential disaster. Now, my question is: Is there anything, would there be any way-I think I know the answer to this, but I just want to ask it- is there any way that the U.S. Congress could so construct condi- tions upon this additional money that would result in helping avoid the catastrophe we are worried about; that is, doing its job, bring- ing about some stability without any profit accruing to the banks? Could you say, to be bizarre about it, we will come up with the ad- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ditional money that we think we need but there will only be princi- pal paid back by these countries to the banks; the banks have to swallow their interest; they are not going to make any money? I know that sounds ridiculous, but those are the kinds of ques- tions I get asked by my constituents. As I said, I think I know the answer, but I would like to hear you respond to that question. If you were at a town meeting in Dagberg, Del., what is the answer to that question? If it goes beyond 60 seconds, they do not listen. Secretary SHULTZ. I think it is unwise to approach it as a puni- tive matter. The way to approach it is to try to make the system healthy, and then everybody can prosper. Senator BIDEN. Well, I will be the devil's advocate. Let's say I do not want those banks to prosper. I do not care if they are going to prosper. They are going to take my tax dollars. Is thei e any way we can prevent it from being a disaster but make them pay the price for having made the bad judgment they made? Secretary SHULTZ. Well, I think that when people approach our financial system with minds made up that says no one should pros- per in our financial system, you have a fundamental problem there. Senator BIDEN. No one should prosper for their mistakes. Secretary SHULTZ. Well, they are not prospering from their mis- takes. They are suffering from their mistakes. The question is how drastically and how catastrophic do you want to make it? Senator BIDEN. That is good enough answer. I will try that one next time. [Laughter.] Secretary SHULTZ. I think with a little thought, I could do better. Senator BIDEN. I am going to ask you to maybe write a speech for me to justify what I am about to do. Let me say on a more serious note, all of your proposals relating to the amount of money we are talking about here are premised upon certain assumptions with regard to economic growth not only in this country but around the world, that we are going to be coming out of this recession, which is not only U.S. recession but a worldwide recession. Have you calculated how those numbers change if, in fact, we do not have an economic growth for fiscal year 1984 that the Presi- dent is predicting in terms of U.S. economy, which is, as you point- ed out, 25 percent of the whole ball game, and the world economy generally, or just take the big three, four, or five nations? Secretary SHULTZ. I have not tried to run through the economet- ric models of what happens to this, that, or the other. But obvious- ly, if our economy fails to grow and the other industrial economies fail to grow, that is very bad news, and that tends to make borrow- ings and debts look worse. And you can say that that shows that the judgment was bad to make the loan in the first place, but I do not know that that is necessarily the case. Senator BIDEN. I would not argue that, just for the record. Secretary SHULTZ. It is just like saying if things go bad and some- body has to foreclose on the debt for a farm, say, that the judgment was bad to have made the loan in the first place. That is not neces- sarily the case. Senator BIDEN. The reason I asked the question is along the same lines I thought Senator Mathias was pursuing, and that is that I would thin: our colleagues anti making this infusi be back at it again say, this is what is And my time is in this committee this time, apparent I just do not thi quarter of a billio The CHAIRMAN. Senator Boschwi Senator Boscnw We find, Mr. SE myself, who are n tions, have a grea system, though I banks from both rr However, as Sci understand that 1, eign trade. But the an explanation, w type of situation ' dized so heavily tl farmers. I am careful in larly wild-eyed, bi some of the legish the 98th Congress agricultural and c I have indeed i that some of our other fields, parti subsidies or some rather blatantly that we will act si They have not 1 eral salvos alrea( world markets. Sc flour to Egypt. In had sold in the er to the entire worl( But my question these countries h; on doing the sam( It has taken alms to some of these c legislation that ridding the world imposed upon it 1- they impose again Secretary Stied from closing up i; do to get them o Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 " only be princi- banks have to any money? he kinds of ques- think I know the that question. If t is the answer to o not listen. each it as a puni- make the system ate. Let's say I do they are going to is there any way tke them pay the ,ple approach our t, one should pros- amental problem mistakes. tg from their mis- ie question is how ake it? will try that one I could do better. ae write a speech proposals relating ,ere are premised "rowth not only ?e going to be ;-). recession but a if, in fact, we do l that the Presi- 0 is, as you point- e world economy 1ations? 1'gh the economet- her. But obvious- Rustrial economies to make borrow- that shows that tit place, but I do he record. to bad and some- pat the judgment that I would think we should be realistic with the folks and with our colleagues and with the country and be saying, look; we are not making this infusion conditioned on the notion that we will never be back at it again. I think we should be more honest about it and say, this is what is needed now, we may need more. And my time is up. One last question, like everybody always does in this committee when their time is up. We are not going to do it this time, apparently. OK, I will not ask it. [Laughter.] I just do not think you should be increasing aid to Turkey by a quarter of a billion dollars this time. But I will get back to that. The CHAIRMAN. Thank you very much. Senator Boschwitz. Senator BOSCHWITZ. That was an afterthought, Senator Biden. We find, Mr. Secretary, that Senator Biden, Senator Pell, and myself, who are more imminently facing our constituents in elec- tions, have a greater interest in not intellectualizing the banking system, though I must say I have learned something about the banks from both my colleagues from Maryland. However, as Senator Lugar pointed out, our farmers certainly understand that large portion of what they produce goes into for- eign trade. But they do not have an explanation, or we do not have an explanation, when our country gets involved in the bilateral type of situation with Brazil, as we recently did, when they subsi- dized so heavily their agricultural exports in competition with our farmers. I am careful in the legislation that I introduce. I am not particu- larly wild-eyed, but I am one of the Senators who has introduced some of the legislation you warn us about in your statement, that the 98th Congress you said will probably confront legislation in the agricultural and other subsidies, a host of protectionist proposals. I have indeed introduced such legislation' because I do not feel that some of our trading partners in the agricultural field or in other fields, particularly Japan, are going to lower some of their subsidies or some of their tariff barriers unless we confront them rather blatantly and straightforwardly with the understanding that we will act similarly. They have not fired the first shot of a trade war; they fired sev- eral salvos already. And we find ourselves being excluded from world markets. So I was very approving with respect to the sale of flour to Egypt. In that one sale we sold more wheat flour than we had sold in the entire preceding year of the entire year before that to the entire world. But my question is, Mr. Secretary: Our negotiations with some of these countries have not been very productive, and they just keep on doing the same old things and referring the cases to the GATT. It has taken almost a decade so far in trying to get the resolution to some of these cases. Would you respond to the necessity of such legislation that several of us have introduced for the purpose of ridding the world trading place of some of the subsidies that are imposed upon it by our so-called allies or some of the barriers that they impose against our trade? Secretary SHULTZ. I think it is very important to keep things from closing up further and at the same time do everything we can do to get them opened up more. We do have to shake people and Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 394 say, wake up, world, if this continues and we really get into a com- petitive protectionist subsidy game, it is bad for everybody. And if the United States really gets into it, we can have a devas- tating impact because we have a very deep pocket, when you get right down to it. And if we start a big agricultural subsidy war and that becomes the common way in which agricultural products are marketed in the world, no doubt, we will be able to do our share. But the nut of it all will not be good; we will in effect, be, giving product away. So I would say that the wheat flour sale that I referred to in my testimony and that you mentioned was on the one hand designed, of course, to sell some of our product but also to say to people that we are serious about this problem and we think that the negotia- tions to resolve these problems better be taken very seriously by everybody or this whole thing can slip out of control. Senator BoscHWITZ. Well, perhaps that is the answer then to leg- islation-that our Government exerts its seriousness in that manner. Perhaps this also includes that butter sale you spoke of since we sell the butter at about the world market price. Since it has sold at about half of the price that was taken to remove it by the CCC, I am sure that the butter would not be sold at one q a r ter of what the American consumer would pay for unless they do subsidize it. But the last time we sold a Communist nation some butter, they objected because it is salted, and that is not particularly desirable. Secretary SHULTZ. Not only did they want to cut price but they want to have it to their specifications. Senator BoscHWITZ. Well, there is not much you can do with salted butter in the world market unless you melt it down. I see you also mentioned services. I am aware that that is becom- ing a very significant element in our exports. And also I am aware that there were never really any considerations given to service ex- ports, and as a result, rules or barriers have not previously arisen. But those barriers are now arising. Service exports I think have a very promising future for this country, and I would hope our Gov- ernment would take a very firm viewpoint with respect to the erec- tion of barriers in that regard as well as with respect to agricul- ture. Secretary SHULTZ. We have been taking the lead in trying to get attention to that in the GATT, and there now is at least, a study under way of that general area. Of course, services is a word that covers a gigantic arra:' of things that are very unlike each other, and in the end as this process proceeds I am sure there will have to be a breakdown of that word and much finer categories introduced. Senator BoscHWITZ. Mr. Secretary, I know that you are very short on time, and it is 12:15 and there are still a couple of Sena- tors who yet are to question you. I agree with your statement about the positive effects of a de- cline in oil prices to $20 a barrel-you give that as a for-instance, ce, I think that if open market principles were to play a part, wil cer- tainly would be at that price or lower. And I believe vtha t the will reach those prices, and I do not have much sympathy you are those right. I hope your example correct. countries I hope countries I hope also thy make the loans while it makes feel sorry for the sorry for the guv self on the court Secretary SHt~ way. Senator BOSC} oil prices will do covery. The CHAIRMAN Senator Dodd. Senator Donn. Mr. Secretary, to be extremely N have said here. January and tra most of our time of international i $190 billion betty billion in worldw Briefly, let me agree, that our going to make it Mexico. Mexico has soi international oil whelming major; obligations, giver and its depender covery program, cations in terms place on our fron But let me bri pretty much this nomic recovery ance request tha along with its su My concern is about economic not just in term: cal implications It is something I And yet, as I I ing some $13.5 bi vious year, the h billion is in secui Now, I am not tary assistance I goes to Israel a. crease in milita: ment assistance Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3. 'ally get into a com- everybody. e can have a devas- cket, when you get ral subsidy war and iltural products are ble to do our share. in effect, be, giving I referred to in my one hand designed, o say to people that ik that the negotia- n very seriously by ntrol. answer then to leg- eriousness in that r sale you spoke of irket price. Since it ken to remove it by be sold at one-quar- y for it in Russia- n some butter, they rticularly desirable. ,it price but they h you can do with alt it down. that that is becom- ,nd also I am aware given to service ex- )t previously arisen. )orts I think have a ;ould hope our Gov- respect to the erec- respect to agricul- ead in trying to get is at least, a study vices is a word that unlike each other, -e there will have to tegories introduced. that you are very 11 a couple of Sena- ive effects of a de- . as a for-instance, I )lay a part, oil cer- believe that it will ipathy with the oil- -nade loans to those nple is correct. 395 I hope also the increase in economic activity that will result will make the loans of many of the banks now in jeopardy much better while it makes others much worse. I feel sorry for the banks that feel sorry for the oil-exporting countries. It is kind of like feeling sorry for the guy who kills his mother and father and throws him- self on the court for mercy as an orphan. Secretary SHULTZ. I had not really thought of the analogy that way. Senator BOSCHWITZ. Well, I have. And I think that the decline in oil prices will do a great deal in treating our general economic re- covery. The CHAIRMAN. Thank you, Senator Boschwitz. Senator Dodd. Senator Donn. Thank you very much, Mr. Chairman. Mr. Secretary, let me quickly state that I found your statement to be extremely worthwhile, and I agree with an awful lot that you have said here. Senator Glenn and I took about 10 or 12 days in January and traveled to Central and South America. We spent most of our time in Mexico and Brazil, principally on the question of international indebtedness. As you know, there is approximately $190 billion between those two countries alone, of the some $700 billion in worldwide debt obligations. Briefly, let me tell you, and I am sure Senator Glenn would agree, that our assessment was that both Mexico and Brazil are going to make it. Brazil is probably in a little better position than Mexico. Mexico has some serious problems, and the question of reduced international oil prices, while it is very encouraging to the over- whelming majority of nations in terms of their ability to meet their obligations, given the existence of a 2,000-mile border with Mexico and its dependency on oil sales -for a good part of its economic re- covery program, this price reduction could have catastrophic impli- cations in terms of immigration and the stress and strain it would place on our frontier. But let me bring up one other point here. We have concentrated pretty much this morning on the question of the IMF and the eco- nomic recovery program. I would like to turn to the foreign assist- ance request that the administration has made for fiscal year 1984 along with its supplemental for 1983. My concern is this. I could not agree more with your statements about economic stability in the world and how important that is, not just in terms of economic recovery but also because the politi- cal implications associated with economic stability are so profound: It is something I think you would agree with wholeheartedly. And yet, as I look at the request that has come before us, total - ing some $13.5 billion, an increase of almost $2 billion over the prc vious year, the bulk of the program as $9.2 billion of the the $13.5 billion is in security and military assistance. Now, I am not one who suggests that we ought to eliminate mili- tary assistance programs. And I understand that a good part of it goes to Israel and to Egypt. But when you see a 20.8-percent in- crease in military aid and only a 3.3-percent increase in develop- ment assistance for fiscal year 1984 is seems to me that our actions Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 in terms of providing funds for economic recovery are clearly unsatisfactorv. I would also point out to you that historically the coalition in this body and in Congress generally that have supported foreign as- sistance has been formed of those who generally agree with the de- velopment assistance programs and have had some concerns about military assistance. Increasing dramatically as we are the amount of military assistance jeopardizes that coalition in Congress at a time when we may need it most. I wonder if you might address that general observation and the concern that I have both with respect to the increase in military assistance worldwide; and also the concern that I have that the co- alition in Congress may evaporate if, in fact, this trend continues. You have heard Senator Pell, Senator Boschwitz, Senator Biden, and others as well talking about constituent concerns regarding foreign aid generally. And when we see the increase in military as- sistance, I think that concern becomes even more alarming. Secretary SHULTZ. Our request is for $14.5 billion all together, and represents an increase of 4.6 percent in current dollars from our request least year. In other words, in real dollars, it is about a wash. Now, the way it was broken down between security assist- ance and economic assistance is not precisely the way it looks in those categories. As we tabulated in the security assistance pro- gram of $9.2 billion, $6.2 billion is strictly military aid, and the bal- ance,.$3 billion,-is essentially economic growth-oriented money. Senator Donn. Economic support funds, balance-of-payments funds. Secretary SHULTZ. In the economic assistance program, you have a total of $5.3 billion, so if you add economic support funds and the economic assistance together and compare it with the military, you have a little over half in economic support and less than half, 4:3 percent of the total, is military aid. Senator DODD. Isn't it a fact historically that the economic sup- port funds and funds that they are given in grant assistance, are generally used by nations to buy military equipment, which is hardly what many of these countries need to be doing. If they hope to achieve some economic stability, they ought to be investing those dollars in economic development programs at home. Secretary SHULTZ. I think in the countries involved, being able to get themselves some stability is an essential ingredient for econom- ic development, and if they are being attacked and ravaged by a guerrilla movement that is being supplied by arms from the out- side, and they do not have the capacity to contest that, and thereby to try to create stability within their own country, they are not going to get anywhere in economic development. You cannot expect there to be development in the context of a kind of military harassment. Senator Donn. I am not suggesting to you that I am opposed to all military assistance. It is merely when we were talking about limited funds, growing domestic concern, the protectionist, isola- tionist mentality that is very strident in the country, when the major thrust of your remarks of this morning, ones which I agree with, emphasize economic stability and the danger of some econom- ic collapse, then it seems to me at this very hour our limited dol- ought to b. _ares :ire cc0rr percE r cr,~:i-ze in develkr Now, it seems in terms of wh, trarv to the deci Secretary Slit the President's needed for the volved, and obvi not have the ni Mr. Schneider which way and But as a gene balance betwee package, and I the way to get sure you agree nomic growth it tions of the cowl Senator DODD the thrust of m,, Secretary SHt Senator DODD time is up.Mr.( The CHA1RMA; Senator Press Senator PRESS Many of the what has been foreign policy. I South Dakota, meetings, and spend less on fc The foreign pol you are well aw But the point the world of thi Foreign Relatio: are coming to t ready answered you can expand business, the fa feeling from sor of it. In the 25 1 tarily raised in But in any e, commented. If on to some of th Secretary Slit feels that these up to us and tt Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 c recovery are clearly )rically the coalition in ve supported foreign as- rally agree with the ?e- id some concerns about as we are the amount lition in Congress at a ,al observation and the he increase in military that I have that the co- .t, this trend continues. ;chwitz, Senator Biden, ?nt concerns regarding increase in military as- more alarming. 1.5 billion all together, n current dollars from ,al dollars, it is about a ,etween security assist- ~ly the way it looks in ecurity assistance pro- ilitary aid, and the bal- th-oriented money. - balance-of-payments nce program, you have support funds and the with the military, you and less than-half, 43 :hat the economic sup- i grant assistance, are equipment, which is be doing. If they hope it to be investing those home. involved-, being able to ingredient for econom- ked and ravaged by a )y arms from the out- itest that, and thereby country, they are not ,nt. rat in the context of a that I am opposed to ie were talking about ie protectionist, isola- te country, when the g, ones which I agree anger of some econom- hour our limited dol- lars ought to be focused in the economic development area. If my figures are correct, they show a 20.8-percent increase in military aid, a 2.3-percent increase in Public Law 480, and 3.3-percent in- crease in development assistance. That is how it breaks down. Now, it seems to me if these percentages are correct, our actions in terms of where those scare dollars are going seems to be con- trary to the declared policy. Secretary SHULTZ. Well,' ell, the figures represent our judgment and the President's judgment about the kind of help that is most needed for the stability and economic growth of the countries in- volved, and obviously there is a balance. As we have discussed, I do not have the numbers classified the same way you do, but when Mr. Schneider is here. Thursday, he will have it classified every which way and can respond a little more directly to your questions. But as a general proposition, we have sought to have the right balance between military and economic matters in the overall package, and I agree with you that having a healthy economy is the way to get stability in these countries. At the same time, I am sure you agree with me that it is hard to imagine that kind of eco- nomic growth if you not have some stability in the military condi- tions of the country. Senator DODD. I was not speaking specifically of El Salvador. as the thrust of my question. Secretary SHULTZ. But you probably had it in mind. Senator DoDD. I have another question on that one, but I see my time is up. Mr. Chairman, I gather my time is up. The CHAIRMAN. Thank you, Senator Dodd, very much. Senator Pressler? Senator PRESSLER. Thank you very much. Manv of the areas have been covered, but I would just reiterate what has been said so well here today regarding the two worlds of foreign policy. I just returned a few hours ago from my State of South Dakota, where I had 25 listening meetings or open door meetings, and almost every one was volunteered. Someone said, spend less on foreign aid. The big bankers are getting bailed out. The foreign policy establishment is working against us. I am sure you are well aware of that. But the point is, we have to somehow have a marriage between the world of the Foreign Relations Committee and the Council on Foreign Relations and the conference in the State Department. We are coming to a head on this budgetary matter, and you have al- ready answered that or responded to it, but is there any way that you can expand on your public statements to explain to the small business, the farmer, the wage earner that there is a great deal of feeling from some of the TV reports. I am sure you are well aware of it. In the 25 which were held over the last 10 days, it was volun- tarily raised in every meeting that that is the feeling. But in any event, I pass that on to you, and you have already commented. If you want to comment further, fine. If not, I will go on to some of the other questions that I have. Secretary SHULTZ. I think it is a very good point. The President feels that these requests are appropriate and needed, but it is also up to us and to all of us here to convince people in our country Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 398 that these programs are good for them. That is the ultimate test. What is good for the United States? We are saying that we are in a boat with a lot of other people, and we will prosper or go down together, and these are things that we think will be helpful in that regard. I agree with you, we have to get out and sell this program, and I am going to try and do it. Senator PRESSLER. In your recent trip to Japan-Japan is very reliant on the Persian Gulf oil. I have been concerned about burden sharing both in aid and defense. Does the concept of the Japanese helping to defend the Persian Gulf ever come up in any discussions you had with them? Secretary SHULTZ. There has been a lot of discussion between ourselves and the Japanese about their own effort in defense, and the new prime minister, Mr. Nakasone, has taken a somewhat more forthcoming leadership stance on that subject. We have to re- member that Japan by its constitution, which we had a lot to do with, has certain restrictions placed upon itself militarily. Nevertheless, I think within that framework there are more things that they can do, and I see evidence myself that they are trying to do those things. Senator PRESSLER. As I understand it, and this is not a question on the banks, but it is related to aid, the administration's request would reduce the forgiven military assistance program for Israel by $200 million from last year, from $750 million to $550 million. What are the reasons for this reduction? Secretary SHuLTZ. Well, again, we have tried to put forward a balanced program which looks at the needs of Israel and the needs of other countries around the world, and within a framework of what we think is doable, to divide that up accordingly. The overall share of these total funds that goes to Israel is very substantial. I do not have the proportion right in my head at this point, but at any rate, the numbers are, in the judgment of the President, the appropriate numbers. Senator PRESSLER. The fiscal 1984 military aid request for El Sal- vador is more than three times the amount contained in the fiscal year 1983 continuing resolution, from $25 to $85 million, yet the economic assistance request has been reduced by $20 million from last year. Does this indicate that the administration is inclined toward a military solution to the problems of El Salvador? Secretary SHuLTZ. The solutions in El Salvador have to emerge from a country that has political stability and is able to attain eco- nomic growth. The military situation in El Salvador is such that our judgment is that they need the military boost that those number represent. Senator PRESSLER. In that region, should we be prepared to take special measures to assist Mexico should oil prices drop further? Secretary SHuLTZ. Well, we have talked about the Mexican situa- tion. I think we have to keep watching it. It is obvious that if oil prices drop further, the countries that are the big exporters will be the ones that will be affected adversely. I believe, as I said in my testimony, that the world economy generally will be affected very positively. We have to look at the Mexican situation, thinking of not only their interests, but our interests, and certainly I think we should Mexico Sena from ti are no much forts, Seer flow o of ass( They how Ti Arabi: are in have exert At t about foreig able t Sen on th made Sec impac that pledg Ser al qu, Thy make your Mr nomi 11 0' or co vote Whit nom his i time Do l Sc were have I fec that fort: win! hel' mer Sior oug Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 with a lot of other people, and these are things that I agree with you, we have ani going to try and do it. p to Japan-Japan is very we been concerned about e. Does the concept of the Gulf ever come up in any lot of discussion between own effort in defense, and te, has taken a somewhat .hat subject. We have to re- which we had a lot to do n itself militarily. ?amework there are more lence myself that they are and this is not a question e administration's request .ance program for Israel by i million to $550 million. tried to put forward a of Israel and the needs id within a framework of p accordingly. The overall srael is very substantial. I head at this point, but at nent of the President, the ary aid request for El Sal- int contained in the fiscal ?5 to $85 million, yet the luced by $20 million from idministration is inclined s of El Salvador? Salvador have to emerge 1 and is able to attain eco- El Salvador is such that ailitary boost that those I "d we be prepared to take it prices drop further? about the Mexican situa- ~t. It is obvious that if oil the big exporters will be [ believe, as I said in my E:illy will be affected very an situation, thinking of and certainly I think we should look at it very sympathetically in trying to be helpful to Mexico. Senator PRESSLER. Another country that is suffering somewhat from the decline in oil prices is the Saudis, and I am told that they are not fulfilling their previous financial pledges to Lebanon. How much they expected to contribute to the Lebanese construction ef- forts, and is this likely to be affected by the falling oil revenues? Secretary SHULTZ. Well, obviously, they have had the greatest flow of oil revenues. On the other hand, they have very large total of assets that have piled up, so they are not broke by a long shot. They have the ability to provide additional funds. The question of how much for Lebanon comes forward from the Arab world, Saudi Arabia in particular, no doubt will depend on how successful we are in our efforts to get the foreign forces out of Lebanon and to have emerge an independent Lebanon able to govern itself and exert its sovereignty. At this point, we are not there yet. So, people who are thinking about putting money in there are waiting to see what happens. The foreign forces are still there, as we all know, and there is consider- able turmoil still in southern Lebanon. Senator PRESSLER. Could the decline in oil prices have any effect on the Saudis' ability to carry out some of the pledges they have made during the sale of the AWACS? Secretary SHULTZ. Well, the declining oil revenues have an impact on them, obviously, but the assets they hold are so large that they do not have any real problem with fulfilling any past pledge, I am sure. Senator PRESSLER. I see I have a red light. I will submit addition- al questions for the record. The CHAIRMAN. Thank you very much, Senator Pressler. We will make a phone call, if you would like, that you are a little tardy to your next appointment. Mr. Secretary, before you leave, we have two very important nominations I would like your judgment on. Tomorrow morning at 11 o'clock we will be available for opening statements for Senators or comments on Director Adelman's nomination. We will have that vote at 11:45. We received notification, an announcement from the White House last year that our colleague, Ed Derwinski, would be nominated to be counsel to the State Department. We understand his papers will be arriving in the very near future, today some time. Would you care to comment on both of those nominations? Do both of those nominations have your full support? Secretary SHULTZ. Absolutely. I have known both before they were nominated, and thought very well of them. In each case, I have had a fair amount of contact since they were nominated, and I feel that both will do a first class job; in the case of Mr. Adelman, that he will contribute significantly to the extremely important ef- forts in the field of arms reduction, and in the case of Ed Der- winski, an across the board kind of counselor role can be extremely helpful to us, and it would not hurt us at all in the State Depart- ment to have somebody there in addition to our excellent congres- sional relations staff, but somebody in our top group who is thor- oughly familiar with the workings of the Congress and knows what Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 listening to the grass roots is all about from his personal experi- ence. The CHAIRMAN. Well, I concur completely with you. I have known Ed Derwinski for decades. I think he can be of invaluable assistance to the Department at this particular time. And I will an- nounce tomorrow the significant progress that Ambassador Adel- man has made, including his last appearance, but also subsequent- ly to that. Thank you very much. Secretary SHULTZ. Thank you, Mr. Chairman. The CHAIRMAN. We will leave the record open for questions and for the Secretary to reply to them. [Additional questions and answers follow:] STATE DEPARTMENT'S RESPONSES TO ADDITIONAL QUESTIONS SUBMITTED BY SENATOR PRESSLER Question 1. Secretary Shultz, what are your thoughts about the role of tourism in our economy and our foreign relations? Answer. Clearly the tourism and travel industry occupies a prominent position in our economy. In 1982 it became the second largest retail industry in America in terms of gross sales and employment. Travel in the United States now accounts for more than $200 billion in domestic and foreign visitor spending, about 6 percent of our gross national product. It generates substantial employment, accounting for 18 percent of all new jobs in 1981. The industry employs directly 4.6 million Americans at every level of skill and an additional 2.3 million workers indirectly, generating over $40 billion in wages and salaries annually. Tourism can play an important role in enhancing our foreign relations. Increased and less inhibited international travel of people from all nations for the purpose of cultural exchange, recreation and trade leads to understanding, friendship and ulti- mately to greater prospects for world peace. Tourism and travel to the United States is a valuable method of fostering appreciation of the values of democracy, freedom and human dignity. Question 2. Would it be possible to designate at least one officer in each of our foreign embassies to work for an increase in travel and tourism trade to the United States? Some of the specific responsibilities of these officers would include the pro- motion of travel to the United States, informing foreigners about all that the United States has to offer, and facilitating and expediting foreigners' U.S. travel plans? Answer. In accordance with the significant economic and foreign relations impact of tourism and travel to the United States, our ambassadors and their staffs are and will remain involved in tourism promotion and facilitation. Scarce resources preclude assignment of individual officers at our posts abroad as tourism attaches to devote full time to the tourism promotion effort. Commercial, economic and consular officers now are jointly responsible for this function in addi- tion to their other duties. In the 66 largest markets for American goods and services, officers of the Foreign Commercial Service (FCS) of the Department of Commerce have principal responsi- bility for tourism promotion with support as required from consular and other mis- sion sections. State Department economic/ commercial officers have the lead in pro- moting increased travel to the United States in the remaining 73 countries. We will be pleased to explore with the Commerce Department the feasibility of designating a specific officer at each embassy or consulate as principal tourism promotion offi- cer along with his or her other responsibilities. In six key countries in which the U.S. Travel and Tourism Administration oper- ates field offices, staffed by travel promotion officers with wide regional responsibil- ities, our missions provide administrative support, while commercial, consular, ec,} nomic and information officers work closely with their USTTA colleagues to coordi- nate overall, program activities. Question 3. If such designation was made, could we also implement a training pro- gram to help these officers in the performance of their duty? Answer. Whether or not specific officers are designated, it would be desirable for the U.S. Travel and Tourism Administration to develop a training and operational manual for the guidance of all officers involved in tourism promotion and facilita- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 tion. We will priate Foreig Question 4. international foreign trade Answer. Ir creased tour: eliminate h,s. tourist and The St::;:. time has was part of House in the procedures :I the Louisiun The Unit, Cooperation define major tual eliminat Also, we si USTR is cur analysis of is stacles inhibi Question 1. not to issue ing all living our exclusive may have m: the OES Bur any particula Answer. A: mouslv recon mile Exclusi' We have c reason to bel note that aln Economic Zor I believe t: critical time sions in the law and wit; oceans usage desire to ester Question . time as Cone Answer. TI gress and the the results of not to proclai Question. I Congress last partment? Answer. W international well as our agreements Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 International debt crisis: the next phase Dr Wilfried Guth Deutsche Bank, Frankfurt Bank lending to developing countries is likely to be limited by the growth in each bank's capita/base. Other contributions will have to come from the public sector, including the IMF and the World Bank, and from private direct investment We surely all agree that the grave international pay- ments and financing problems, which began last autumn with the Mexican debacle, have confronted the world financial system with its greatest challenge in the post-war period. There is also no disagreement that this debt crisis, which is mainly concentrated on a number of countries in Latin America and Eastern Europe, is the cumulative effect of a prolonged reces- sion, extremely high interest rates (nominal and real), and growing protectionism in the industrialised world. In addition, certain countries have had specific, `home-made' problems, such as the Falklands conflict in Argentina, or the massive capital flight in Mexico, whereas a country like Brazil became more or less a victim of these adverse developments elsewhere, which caused a sudden decline of international lending to the third world. At the same time, it should be noted that a number of problem countries have not made sufficient efforts to adjust to deter- iorating world economic conditions. Some of them have taken greater recourse to short-term credits, thus increasing further their vulnerability to fluctuations in market confidence. At this juncture a total of over 40 countries who owe the greater part of their combined external debt to commercial banks, have agreed to or applied for debt reschedulings or have accumulated de facto sub- stantial payment arrears. At mid-1982 the total exposure of international banks in these problem countries amounted, according to BIS statistics, to about US$240 billion. This sum represented about 55% of all outstanding loans by banks to non-in- dustrialised countries, or 15% of all international bank credits recorded by the BIS (that is including credits to industrialised countries). These facts notwithstanding, we can say today, with some satisfaction, although not with com- placency, that any disruptive effects of these debt problems on the entire financial system have been E Ra. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 successfully prevented through the unprecedented co- operative effort of the debtor countries, the Inter- national Monetary Fund, governments and central banks of creditor countries and commercial banks. The rescue `packages' were put together with speed and efficiency, thus preventing a breakdown of the, debtor countries' economies. Apart from the injection of badly needed funds, the IMF has played a crucial and highly responsible role in coordinating this concerted action to stabilise the international financial system. And I should also like to mention the extremely useful contribution of the BIS, which on various occasions has provided bridg- ing finance to countries negotiating adjustment and medium-term financial support programmes with the IMF and the banks. Fresh money The commercial banks' contribution towards re- storing the financial viability of the debtor countries consists in the rescheduling of the repayments on outstanding credits and, in most cases, the provision of fresh money through medium-term credits (in addition to maintaining or restoring short-term trade credit facilities and interbank lines). For the three largest Latin American countries alone, the banks have agreed to extend more than $10 billion in new assistance, that is to increase their exposure by this amount; in addition, bank loan repayments falling due in 1983 will be rescheduled in the order of $35 billion. This great cooperative financial effort of the various creditors can, of course, only be help towards the self- help of the debtors. Restoration of their financial viability depends on the successful implementation of the stabilisation programmes agreed upon with the IMF. This is by no means an easy task and we should not ignore the inherent risks. The rescheduling countries have to undergo an often painful adjust- ment process implying considerable strains on their Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 DEBT CRISIS: NEXT PHASE economies and, in some cases, their social and political fabric. Yet as there are many who like to play the role of Cassandra, we should also take note of some en- couraging developments. In the first quarter of 1983 there has been a pronounced further improvement in the trade balances of the three largest Latin American debtor countries, which together account for one- third of the developing world's public and private debt (of $700 billion). The marked decline in dollar interest rates since mid-1982 (by about 6 percentage points) has also helped to alleviate the debt service burden of these countries (in the cases of Brazil and Mexico each by around $700 million annually for every one percentage point). Nevertheless, there is general agreement that a sufficient strengthening of the rescheduling coun- tries' debt service capacity - perhaps one should even say the very feasibility of the stabilisation programmes - will depend decisively on a sustained recovery of economic activity in the industrialised world. In addition, it is essential that the industrialised countries refrain from any further restrictions on trade with developing countries and that they embark on removing protectionist barriers to third world exports. It is reassuring that in their Williamsburg declaration the leaders of the major- industrial nations stressed their commitment to these aims but of course, as in other respects, it will be the enactment of such high level intentions which counts in the end. Much as we all hope that the economic upswing will proceed in line with the moderately optimistic forecasts of international institutions like the IMF and the OECD, we cannot expect that this will speedily resolve the critical situation of some debtor countries. We will, therefore, have to face - and to master - several more difficult years before we can hope to see the `light at the end of the tunnel'. The question now therefore is how the successful `first round' of cooperative rescue efforts can best be continued and eventually transformed into longer- term policies to stabilise the structural situation of debtor countries. But first I would like to make a few brief comments on some of the lessons to be drawn from recent experience and on the implications of the debt problem for the international banks. Maturity extension There are in particular two aspects which, to my mind, give cause to further consideration. The first is the question of the maturities to be included in debt reschedulings. Most of the recent arrangements were restricted to bank loan repayments falling due in 1983; in a few cases (such as Mexico and Chile) maturities for 1984 were included. These payments obligations have been rescheduled over a six to eight- year period, a maturity extension which would seem to be realistic in terms of the debtor countries' basic situation. I am not so sure, on the other hand, whether it would not have been wiser to include the maturities of some further years in these reschedul- ings. Dealing with the problem on a year-to-year basis (as in the special case of Poland) does not seem to be in the best interest of either the debtor countries or the creditor banks for practical as well as psycho- logical reasons. Speaking very generally, I would like to add that it makes little sense to tailor the `rescheduling costume' too tightly, all the more so as the projection of the debtor countries' cash flow cannot have the precision of a mathematical equation. The arrangements should also leave sufficient scope for flexible reaction to unforeseen developments which are beyond the debtor country's control; on the other hand, they should not allow for any new inflationary deviations. My second point relates to the impact of the debt crisis on the interbank market, which the banks use to balance their short-term assets and liabilities. Over the past twelve months this highly sensitive world- wide market has emerged as a critical element and potential problem area in a two-fold sense. Interbank market Banks of some highly indebted developing coun- tries last year raised increasing amounts of very short- term money on this market through their foreign branches, using this money for the funding of longer- term loans to debtors at home; in the final analysis, and in contrast to the underlying logic of this market, bank-to-bank deposits were thus used to finance balance of payments deficits. On the other hand, creditor banks reacted to emerging payment dif- ficulties of debtor countries or to debt problems in neighbouring countries with substantial cuts in interbank lines, thereby adding to the countries' worsening foreign exchange situation. The maintenance of interbank lines - and in the case of Brazil the restoration of lines to the higher levels of an earlier date (the by now famous Project IV) - has been an essential ingredient in several of the recent debt rescue `packages'. Although under the given conditions there may have been no alternative, this aspect of the rescheduling exercises has given rise to unease among the banks and to criticism such as `coerced interbank lending is a contradiction in terms' or `abuses of the market are being institutionalised'. And even in official central bank quarters the attitude towards this ambiguous interbank problem seems to- day to be divided. The interbank market will, at any rate, remain highly susceptible to fluctuations in confidence and to any official intervention in the international banks' liquidity management. This should be taken into account by all parties involved, since this market must be kept fully intact as an essential cornerstone of our international financial system. By the same token, banks and banking supervisors alike all over the world ought to be fully aware of the potential dangers of excessive short-term borrowing in this market. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 I think it is evident to everyone today that the position of the commercial banks in the rescheduling process is a very difficult one. A number of big international banks have accumulated rather high exposures in problem countries - high in relation to their capital and reserves and in some cases to current earnings - and the same presumably applies to some of the regional and smaller banks which have in recent years increasingly participated in international lending. 'Punishment' Of course, voices can now be heard to the effect that the banks should not have entered the whole field of balance of payments lending in the first place. But, quite apart from the fact that the same people cannot explain how the recycling of petrodollars could have been achieved without the major contribution of the commercial banks, this kind of critical reasoning on past events is of no help when it comes to solving our present problems. And it becomes even counter-pro- ductive when politicians, in order to `punish' banks for alleged past mistakes, feel tempted to block necessary contributions from the public sector. I shall refer to this question later on. But let it be said here that `punishment' for imprudent banking, if there has been any, invariably comes by itself; it need not be imposed by anyone. How then should the banks today act vis-d-vis the problem countries? On the one hand, there can be no question that beyond the stretching of maturities, which is the core of rescheduling agreements, most of these countries need fresh money to achieve a moderate rate of growth; otherwise social peace might be endangered. Nobody can say that the commercial banks of industrial countries - with very few exceptions - have not responded very constructively to this undeniable necessity. I have given some illustrative figures on this earlier. Yet there is another side to the coin. It is equally obvious that the commercial banks cannot ignore, even for the best of reasons, prudential limits to their country exposure. In many countries, supervisory authorities have begun surveilling these country exposures and the boards and credit committees of the banks themselves (not to mention shareholders at general meetings) are keeping a close watch on country exposures. But even if these bodies were to take a very lenient attitude bank management, which carries the main responsibility, cannot allow certain ratios to be surpassed. It is true such ratios should not be defined too rigidly - and nobody can give exact proof that one ratio or another is the right one - but we would have a distinct feeling of insecurity if some exposures became too great in relation both to total lending and to capital and reserves. Loan provisions It can be argued that such insecurity can be overcome if new lending to rescheduling countries ]NOMW A.;, gamma HOUSE BASINGSTO -E lO Acre L scapezl Office Campus Scheme 45,000sq.fte 400 car park spaces Available forocr-upation now Contact Joint Sole Agents Edward -Bright E~~ a Willis Surveyors Industrial & Commercial 6 Grosvenor St.. London W1X OA[) 29 Newhall St., Birmingham 83 3PW Telephone: Qt 629 8191 Telephone: 021-2361049/5441 THE BAnivco n n v 100-2 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 DEBT CRISIS: NEXT PHASE were accompanied by parallel increases in existing loan loss provisions for these country risks. And this is indeed what most banks have already done. We should not overlook, however, that this represents a somewhat unusual method of banking, the normal and logical attitude being that exposures against which loan loss provisions have to be made are not to be increased, but rather decreased if possible. What conclusions can be drawn from all this? I would like to stress three points: ?. Adequate provisions for possible loan losses from sovereign risk lending are an absolute necessity, no matter what sums fiscal authorities might accept. By the same token, finance ministers ought to be aware that they are apt to put their own responsibility for the soundness of the country's banking system in question if they allow the attitude of fiscal authorities in this matter to be determined by budgetary needs rather than by an objective risk analysis. I would like to add that I am not in favour of uniform, fixed and inflexible percentages for such provisions prescribed by supervisory authorities. I clearly prefer a system in which banks have the freedom to fix those percentages according to their own judgment. All I venture to suggest is that the minimum percentage to be set aside ought not to be so small that it becomes meaningless in the moment of need. ? While there will be strong reasons for banks not to withhold their support for the debtor countries during the critical years of rescheduling - to some - extent out of solidarity with the world banking community, but mainly to bring their debtors `out of the woods' - additional inputs of fresh money, if at all necessary, can only be moderate, given existing exposures, capital ratios, and other factors. To my mind, it makes no sense, therefore, when some observers today want to determine what they call the `necessary contribution of commercial banks' by estimating the needs of the debtor countries for such credits. Onbnglands .1 .pia Salistxrv R. sand : 'e -a-,".,;: y` us- -_~~- ?r,;,-.:, ranaifu of Mans early r_ i,_~. .-~?,,V: --- ,~y t-? .?_?- . att- to UndCStand his Lgnv Social welfare is a subject of serious consideration in most modern societies. Man in the twentieth century accepts his responsibility to bequeath to the next generation a society better than his own. Daiwa Bank is not unique in accepting this responsibility, but Daiwa is unique in making acceptance of this role in society an integral part of their banking service. Daiwa is the only Japanese city bank to combine banking and trust business. Daiwa is thus a fully integrated banking institution, comprising banking, international financing, trust, pension trust, and real estate business. This integration is part of our effort to fulfil our social responsibility consistent with society's needs in a contemporary environment a fully integrated banking service Head Office: Osaka, Japan New York Branch: 140 Broadway, New York. N.Y. 10005 Los Angeles Agency: 555 South Flower St., Suite 4040, Los Angeles, Calif. 90071. Branches: London, Frankfurt, Singapore and Hong Kong Representative Offices: Sydney, Sao Paulo, Houston, Paris. Panama, Bahrain, Mexico, Vancouver, Jakarta and Seoul Subsidiaries: Daiwa Bank Trust Company, 75 Rockefeller Plaza, New York N.Y. 10019; Daiwa Bank (Capital Management) Limited, London Affiliates: P.T. Bank Perdania, Jakarta; Daiwa Overseas Finance Limited, Hong Kong Uncomfortable logic Such assessments of needs ought to proceed in a different manner. Starting from the Fund's estimate of foreign exchange requirements of debtor countries, in the framework of their stabilisation programmes, a realistic figure for the commercial banks' possible contribution should be deducted in order to arrive at the `necessary contribution from the public sector'. Governments and parliaments should not close their eyes to this uncomfortable logic and take appropriate steps to ensure greater public contributions in one way or another. They ought to be aware that the ultimate costs for them are likely to be higher if a crisis is allowed to develop. ? Creditors and debtor countries alike must have one overriding interest: to make sure that scarce foreign exchange, that is the `fresh money' supplied by the IMF and the commercial banks, is utilised in 1 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 the most productive manner so as to strengthen the countries' repayment capacities. On the other hand, commercial banks are hardly in a position to ensure the proper use of those credits; they might even find themselves in a dilemma if they were confronted with financing requests from export firms in their own countries for purposes which did not appear very convincing in terms of structural balance of payments improvements of the debtor countries. In fact, there seems to be an urgent need for advising on and sur- veilling the most efficient use of the new credits in rescheduling countries. One would think that the World Bank, with its great experience in project selection and monitoring, is well suited to assume this role in close cooperation with the IMF. Most urgent tasks After these general remarks on the problems of the commercial banks I want to return to the basic ques- tion of how the problems of highly-indebted third world countries can be resolved in such a way that they can become creditworthy again. It was certainly clear from the beginning to everyone involved that only in the most favourable - and unfortunately un- likely - circumstances (rapid world economic re- covery, dismantling of protectionism) would the `first aid' packages for some of these countries be sufficient to achieve this aim. But little thought, if any, was given during this heavily strained period to the way in which inevitable follow-up measures ought to be conceived. Today, however, we are confronted with clear evi- dence that crisis management will have to continue in a number of cases. How then should `the second round' be tackled, for instance with respect to Brazil? Estimates differ widely as to the extent of the additional foreign exchange requirement likely to arise for 1983. But, whether it is $2 billion or $3 bil- lion, we should say right away that the commercial banks cannot be counted upon to fill this gap by themselves. While it may be necessary for all banks engaged in Brazil, including those which are still lagging behind on the old programmes (Projects III and IV), to act in solidarity and provide a certain percentage of `fresh money' for the second time, such new credits must be matched by additional contributions from public sources. Naturally, our eyes are primarily directed towards the IMF in this context. As the Fund has already committed the maximum amount available for Brazil under the present enlarged access policy, that is 450% of its quota, it is argued that the only way in which the IMF could help in the given situation is by accelerating disbursements. This may well be advisable, but it will in all likelihood not be sufficient nor will it satisfy the banks as a `matching formula'. The same would be true for another stopgap measure, namely a roll-over of the bridging loan from the BIS. Accelerated disbursements under an existing loan agreement or the extension of bridging loans only make sense if, to extend the metaphor, there is firm ground at the other end of the bridge or, to put it in terms of the actual case, if Brazil's external cash flow is expected to improve sufficiently or if the country can be eligible for market loans after such operations. Unfortunately this state of affairs is not yet in sight and cannot be safely assumed, unless the world economy sees a very vigorous upturn. In order to ensure an appropriate contribution of official funds towards debtor countries' additional borrowing needs, the speedy enactment of the proposed increase in IMF quotas and enlarged General Arrangements to Borrow is essential. Besides providing the IMF with adequate resources the quota increase should also be reflected in the Fund's lending policy. At the very least one half of the quota increase ought to be made available to problem countries on the same basis as under the present Fund guidelines for members' enlarged access which specify maximum assistance of 450% over a three- year period, as already mentioned. Wrong setting As we know, the more restrictive attitude of some governments or parliaments towards increased IMF lending is largely based on fears of inflation. This is certainly legitimate and in principle by no means unfounded. Yet in my opinion the rescheduling countries facing negative growth rates and social tensions are today the wrong setting for the curtailment of international liquidity. Furthermore, it SENIOR FI NAPk CIAL ANALYST Montagu, Loebl, Stanley wish to recruit a high calibre individual with proven ability, possessing a detailed knowledge of financial markets, capable of leading a specialist team producing regular, in depth reports on clearing banks, merchant banks, discount houses and Far Eastern financial institutions, and communicat- ing investment ideas to clients. This represents an excellent opportunity to join a successful, expanding firm in a senior capacity within a well established sector. A highly attractive salary package will be offered together with prospects for advancement. Interested applicants should contact: John Toalster, Head of. Research, Montagu, Loebl, Stanley, 31, Sun Street, London, EC2M 2QP Tel: 01-377 9242 THEE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 DEBT CRISIS: NEXT PHASE is the very essence of the stabilisation programmes probably be rather reluctant to grant loans for general _ ,ation voidance of budget or balance of payments purposes and (will rPm _- the especially the financing of capital goods exports. a In this context, the World Bank's introduction of new co-financing schemes for high-priority projects in developing countries, designed to provide greater risk protection for the banks while at the same time accommodating those countries' need for longer-term maturities, is to be welcomed. One possible idea worth considering is to extend co-financing to the broader programme loans of the World Bank. Co- financing should also be intensified by the regional development banks, such as IADB and ADB, which are also becoming increasingly active in this field. ? One of the most important lessons of this crisis period is the confirmation of the crucial importance of the two Bretton Woods institutions, the Fund and the Bank. Rather than pondering over the need for new institutions, governments and parliaments ought to do everything to keep these well-established and highly efficient institutions intact, and to assure the adequacy of their capital base; endless negotiations for every capital increase would appear rather anachronistic after the events of 1982-83. ? This is by no means to say that the share of public lending ought to remain at the high level indispens- able during the present period. On the contrary, there is no other policy aim of such fundamental importance than to attract a large flow of private funds in all possible forms to the newly in- dustrialising countries of the third world. Direct investment Promotion of private direct and equity investment, whose importance in the overall transfer of resources to the developing countries has decreased over the past decades, represents an ideal way for these countries to expand their growth potential without increasing their debt burden. Foreign private in- vestment could make a significant contribution in helping to develop new primary product sources, and by transferring technology and marketing skills. In many countries such a change in development financing strategies would imply a revision of the hitherto often restrictive and even hostile attitude of governments towards foreign risk capital. Another member of the World Bank family, the International Finance Corporation, could be called upon to assist these countries in improving productive investment, particularly by medium-sized and smaller firms from industrial countries. The guiding principle must be no more public funds than absolutely necessary. This is all the more important as scarce budgetary contributions of the industrial countries will continue to be urgently poorest needed for supporting growth in the developing countries. Dr Guth is joint spokesman of the Board of Managing Directors of Deutsche Bank. a wor This has nothing to do with 'early warning', a term currently often misused; it is rather to be seen as a joint effort to avoid a situation where market lending comes to an abrupt end. ? There is little doubt that after the deep shock which the debt crisis has caused, the role of private banks in the financing of developing countries will take on a somewhat different character in the re- mainder of the 1980s. Banks will, in my opinion, be concerned in future that the expansion of their international lending will, as a rule, not proceed faster than the growth of their capital base. They will the IMF to keep m In search of other contributions from the public side to ease the balance of payments situation of rescheduling countries one is inclined to think of the debt incurred on guaranteed export credits of the industrial countries, for which no rescheduling has been arranged so far. Although the amounts involved might not be very substantial, it would in my view represent a fair 'burden sharing' if the debtor countries in question were to call on the official creditors of the Paris Club to agree to a rescheduling. Needless to say, parallel to such operations, the creditor governments' extension of new export credit insurance must go on - just as the commercial banks have been prepared to provide fresh money in addition to rescheduling the maturities of non- guaranteed loans. Another. way - indeed a very natural one - of increasing official contributions is, of course, to intensify World Bank and regional development banks' lending to problem countries. In fact, the World Bank and the InterAmerican Development Bank have already responded to this challenge and have greatly increased their commitments to Brazil and Chile. Financing future growth As I indicated at the outset, the immediate task of continued crisis management must not detract from the more far-reaching basic problem of how to ensure the necessary financing of future growth and develop- ment of third world countries under the world econ- omic conditions of the 1980s. On this broad subject I would like to make only a few concluding observations: ? The great progress in international cooperation of public and private creditors, which has been achieved during this difficult period, ought to be maintained. The main purpose of such cooperation should then be crisis prevention. To achieve this aim, the Fund will have an important role to play within the framework of its surveillance function, which it must exercise strictly wherever necessary. But ways and means should also be explored to assure that the commercial banks in their lending to the various countries do not t 'cross purposes' to the Fund's intentions. k carne.l out - +1 Lion under better control. 30 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ~? Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 International debt crisis: the practical lessons of restructuring M. S. Mendelsohn London In the past year, some 25 developing countries have been renegotiating the terms of about $ 100 billion of external debt to the markets. Borrowers, banks and the authorities have all learned in this 'crucible of recent experience' The past year's concentration of sovereign debt restructuring has taught a few new lessons, driven home again some half-forgotten truths, but has also revived some popular misconceptions. Since Mexico abruptly interrupted full service of its external debt last August, some 25 developing countries have followed or returned to the bargaining table to renegotiate the terms of about $100 billion of external debt owed to the international banking system and other private creditors, or about 20 times the amount of cross-border debt to the markets renegotiated in any previous year. About three-quarters of that total is being renegotiated by five borrowing countries alone - Mexico, Brazil, Argentina, Venezuela and Poland. This is a new phenomenon, representing the realisation of a fear long felt. Of about 80 debt relief agreements signed in the 25 years up to 1982, nearly 70 covered debt owed by the governments of developing countries to the governments and the officially-supported export credit agencies of the leading industrial countries. Relief agreements with the banking system were isolated events until the mid-1970s and only nine countries restructured such debt even in the six years up to 1982. With the excep- tions of Turkey, which renegotiated $3 billion of market debt in 1979, and Poland, which renegotiated $4.8 billion in 1982, most such market relief agree- ments were with smaller African and central American countries and the sums were relatively small for the creditor banks though not, of course, for the countries concerned. So far, it is the macro-economic lessons and impli- cations that have received most attention, but a study published this month by the Group of Thirty concentrates, instead, on the practical experience of cross-border debt renegotiation gained over the years and `in the crucible of recent experience'*. The economic aspects need therefore be rehearsed here only briefly. Much comment on the present `debt crisis' of developing countries has suggested, or at least implied, that borrowing on the part of economically developing countries is a recent phenomenon, that it is intrinsically unsound, that the banks lent recklessly during the 1970s and that the borrowing countries squandered the proceeds. It is impossible not to detect in all this a thinly disguised strand of xenophobia and, indeed, racialism, tinged with a certain schadenfreude that matters have apparently gone so very wrong. That attitude was summarised in a question put recently by an intelligent television interviewer in the United States who asked her panel, `why did our banks lend all this money of ours to foreign countries and how will the countries ever pay back their debts?' The same question is being asked by legislators, especially in the US Congress, echoing Calvin Coolidge's celebrated observation, `well, they hired the money, didn't they?' Classical process The recycling of oil surpluses during the 1970s was novel only for the enlarged part played by the banking system in the classical development process, by which poorer countries augment domestic savings with imported capital to finance their economic advance until they join the ranks of capital exporting countries, a transition which the United States made only at the turn of the present century and countries like Switzerland and Sweden later than that. Indeed, the same process takes place within sovereign states, where unrecorded imbalances of payments between regions are adjusted by flows of short-term banking funds, longer-term capital, the built-in redistribution of the tax system and, in the last resort, all else failing, by migrations from poorer to richer regions. So far from squandering the capital they borrowed 'Commercial banks and the restructuring of cross-border debt, Group of Thirty, New York, July 1983. THE 8 Approved-For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 during the 1970s, the advanced developing countries responsible for most market borrowing used the money wisely and productively. Taken as a group, they achieved an impressive record of export-led growth by concentrating much of their investment in ways that increased their net foreign exchange earning capacity, as pointed out by the World Bank recently in `an unfashionably positive view of the external indebtedness of developing countries". Yet the successful use made by advanced developing countries of borrowed capital during the 1970s has caused almost as much dismay as the recent suspension of full debt service by some of them, including the biggest borrowers. The resentment created in the older industrial countries and especially in their declining industries by the growth of compe- tition for world export markets by the newer indus- trialised countries and the advanced LDCs explains at least in part the covert pleasure now felt in their plight and that of their bankers. For the most part, the foreign debt taken on at minimal or negative real interest rates in the 1970s seemed manageable to the countries and their creditors and actually was in the circumstances in which the debt was contracted. There were certainly inefficiencies at the all-important margin, but the main cause for the difficulties of sovereign and other borrowers has been the global disinflation of the past three years with its undue emphasis on monetary restraint, which steeply increased the real cost of borrowed money while severely restricting the ability of domestic and sovereign borrowers to earn enough for the maintenance of full debt service. Paris club The plight of sovereign borrowers is only one symptom and not the most important of the economic difficulties from which the world is just beginning an uncertain recovery and, even on the most hopeful outlook, many sovereign borrowers will be returning to the bargaining table with their bankers this year, next year and quite possibly for several years. The first shock of sovereign market debt restructuring has been absorbed more smoothly than many dared hope in the panic of the late summer and autumn of last year, but the difficulties are by no means over. What, then, has been learned from earlier and more recent practical experience? Some lessons have undoubtedly been absorbed from the Paris club in which developing countries have been renegotiating since 1956 the terms of public sector debt owed to the 17 members of the DAC, or Development Assistance Committee of the OECD. The `club' has been notably shy about publicising its workings or even existence from the very first, for fear that this might encourage more relief applications, and it hesitated until 1974 before appointing a small secretariat at the French treasury where it meets. Yet a set of procedures has evolved by trial and precedent over the years. With few exceptions, creditor governments have tried to confine relief to the stretching out of principal repayments falling due within a `current period' of up to 21h years. These are commonly allowed to be stretched out over 8-10 years, of which the first half is usually conceded as a grace period during which no principal is repaid, although interest payments must be kept up at a `moratorium' or market rate which is usually, but not always, above the rate at which the loans were contracted. Equal treatment Over the years, Paris club agreements have tended to incorporate provisions intended to provide equal treatment for all creditors. These require debtor governments to renegotiate debt to non-DAC govern- ments and also to private creditors, mostly banks, on terms no more favourable to the creditors than those DEBT RENEGOTIATIONS WITH COMMERCIAL BANKS 1982-83 $ billion d i i n ate Amounts being renegot Public sector Private sector Total liabilities to inter- national banks debt debt Gross Net Mexico 19.5 15.0 59-0 48-5 Brazil 4-7 ... 56-0 51-8 Argentina 5-5 6.0(Estl 22-2 16.4 Venezuela 16.3 n.a. .22-7 9.7 Peru 2-0 0.3 5-2 3-3 Chile 3.4 ... 10.5 8.0 Uruguay 0.8 n.a. 1.2 0 Ecuador 1.2 1.3 4-1 3.3 Jugoslavia 3-4 n.a. 9-3 7.3 Romania 0-6 n.a. 4.0 . 3-7 Poland 7.0 n.a. 13-4 12-4 Cuba, Costa Rica, Nicaragua, Honduras 2-1 n.a. 2.5 2-1 66-5 22.6 210.0 166.5 Estimated by authoritative supervisory sources. Source for end-1982 liabilities to banking system: Bank for International Settlements. n.a.: not available or applicable. ... Some private sector debt included in public sector total. (Est) : estimated. agreed with the Paris club governments. In practice, however, the debtors are required to show only that they have sought to restructure such other debt, not that they have actually succeeded in doing so, and the requirements to restructure debt to all creditors are not, therefore, always mett. The difficulty faced by the Paris club and, indeed, *World Debt Tables 1982-83, February 1983. tAn exception in all cases is the World Bank, whose loans are always serviced in full because of its inflexible policy of treating any interruption of service as a default, which would bring the borrower into default to all creditors under cross-default clauses. That threat has never yet had to be carried out. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 have cipal :)f up o be alf is h no must ch is 1 the nded equal =btor vern- s, on :hose 'r- ,ahks Net s8-r 51 16.4 9.7 3.3 80 0 3.3 73 3.7 12.4 2_1 66-5 :e for tonal :tice, that not i the s are ns ;, .atmg ig the aUSCS. all creditors, is to discover the fine point between conditions which are too lax to induce a sufficient adjustment by the borrower or too harsh to be met. The result in either case is a fresh round of negotia- tions, as shown by the number of `recidivists' who have returned to the Paris bargaining table three, four and even five times, in many cases in successive years. However, a common sense approach to that difficulty has evolved over time and, like all evolutionary solutions, seems for that very reason to be the best of the alternatives available for reconciling the legitimate differences of interest between those involved. It consists of a `goodwill clause' under which creditor governments undertake to consider favour- ably fresh relief applications in succeeding years, provided that debtor countries can show that they are continuing to meet the performance targets agreed with the International Monetary Fund for the adjust- ment of their balances of payments. This is, indeed, the criterion by which the Fund itself disburses conditional assistance to member countries. Precedent That may be the most important practical lesson learned from the experience of intra-government debt renegotiation and it has crept into the renegotiation of cross-border debt owed to the commercial banking system although it has not been and is unlikely to become a formally acknowledged practice for fear of DEBT CRISIS: LESSONS setting a precedent. Nor is it without some dangers, unless the creditor banks show their determination to see actual performance rather than mere promises. At least one small developing country has repeatedly renegotiated its external debt to the banking system for several years past without meeting any of its performance targets and its debts are so small for the creditor banks that they would gladly write them off, excepting for the dangerous precedent which that would create. Indeed, they are troubled by the precedent already created, which amounts to default by attrition (as distinct from outright default, which most bankers still think unlikely). Corporate debt Some practical experience of corporate debt renegotiation in the United States has likewise been applied to the renegotiation of cross-border debt owed to the international banking system. In the US, it is more usual for companies to have several bankers and corporate debt is common syndicated in the domestic market. As in other countries, the restructuring of corporate debt is a routine experience but, because US banks have more experience than many others of restructuring syndicated corporate debt, they are perceived by many other bankers as being especially good also at renegotiating syndicated international debt, their alleged `bullying tactics' evoking, on the whole, more admiration than resentment among European bankers. Fi000doQ Programmes Senior Executive Positions Our client, a major U.S. Bank related subsidiary is actively seeking staff to take executive responsibility within its fast expanding European operation based in London. Senior Marketing Executive #28,000 + Car To qualify for this senior marketing role you should havea thorough knowledge of European Financing Programmes for high technology industries and an ability to understand complex financial structures. 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Please listany companies to whom you do not wish your application to be forwarded. All applications will be acknowledged. LAYiZ1J11OWf Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 DEBT CRISIS: LESSONS t Euromoney July 1983 53 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 sovereign debt is supported by former Chase vice Chairman, William Ogden, now chairman of the interim board of the Institute of International Finance. "I don't believe in these radical solutions," he asserted. "They deal with problems which don't yet exist, namely LDC insolvency. They would not maintain sufficient flows of funds to LDCs." Assume permanent insol- vency and you certainly don't get an adequate flow, he maintained. And he added: "It's naive to lump together all the problem countries with their very different economies into a single global problem." That is also the view of de Larosiere: "There can be no generalized solutions to the debt problems," he said in May at Boca Raton, Florida. What are needed are "forceful and well crafted adjustment programmes geared to the individual circumstances and problems of each debtor country and supported in each case by judicious and coordinated financing arrangements." Heimann, too, was sceptical of the need for far-reaching reform: "To bail out the banking system is neither necessary nor moral. We already have the central banks in place to deal with any liquidity or solvency problems the banks might encounter." Wilfried Guth, chairman of the managing board of Deutsche Bank, believes that the existing financial institutions can tackle debt problems. In a speech in Stock- holm, he said: "Banks should not ask for or be given a bail-out or a lifeboat. I agree with the public opinion that we must ourselves carry the consequences of earlier lending policies ... these [sweeping reforms] are contingency plans which would be taken out of the drawer only if the situation were to deteriorate dramatically." Advocates of this ad hoc system stress that the banks have an orderly approach to reschedulings and are not muddling through. Laurence Brainard, senior vice president and chief international economist at Bankers Trust said: "An understanding has developed among the banks on the methods of approaching reschedulings. No- where is it codified, but there are under- stood priorities. For example, trade debts should be kept out of reschedulings, so that countries can continue to have access to trade finance. And we've learnt; on Poland we made the mistake of ignoring the short- term lines, so everyone tried to pull out on them. So, subsequently we've tried to ensure the short-term lines are kept open." Proponents of radical change accept that the piecemeal approach has worked so far, but doubt if it can satisfy the funding needs How the Ditchley initiative is becoming reality "We've found a beautiful location, just institute's dual purpose: "The data collec- opposite the US Treasury Department. lion is for the banks, the missions will be From one side we can took right down on the White House," said Bill Ogden, chair- man of the interim board of the Institute of International Finance (HIF). In April the institute picked a permanent HQ, in downtown Washington DC, and sent out about a thousand application forms, inviting banks to join the institute. Recently, the interim directors chose Andre de Lattre, a former deputy governor of the Banque de France, to be the insti- tute's first managing director. Conceived at Ditchley Park, in the UK, last August, the institute should begin operations by the end of this year. The IIF will gather country informa- tion, to be used by second-tier banks, which don't have their own large research departments. This should allow smaller banks to evaluate credit risks better, so that they may become less reluctant about cross-border lending. It will also engage in an on-going dialogue with borrowing countries, on a voluntary basis. The HF will discuss borrowers' economic plans, assumptions and borrowing needs. The discussions will include missions to the borrowing countries, though the IIF is not keen on that word because of its IMF connota- tions of browbeating. L One interim director described the for the borrowers." One difficulty for the IIF is that many bankers, even some of those associated with it, are unclear about what it will do. While it is now generally understood that the IIF will not act as an equivalent of the Paris club for bank reschedulings, some bankers believe it will have access to IMF information which it could relay indirectly to the banks. That is not the case. One IMF official said: "We cannot pass on to the institute information given to us on a confidential basis, unless the countries concerned agree. So I don't think Ditchley will make a great deal of difference." The most common criticism levelled at the IIF by commercial bankers is that it won't make much difference now, because the small banks it is aiming at have already- left the sovereign loan market. One senior vice president of a US bank said: "It's missed the gun by five years. It's a good idea five years too late." But criticism is unfair; the I1F's founders are aware that it will not solve contemporary problems of sovereign lending. "The institute is not really designed to deal with today's problems, like Mexico and Brazil," said Ogden. "We'll only be able to test how successful the institute has been in five to 10 years SOVEREIGN LENDING of borrowers like Mexico and Brazil over the next few years. Mexico is paying about $12 billion a year in interest, and will have to find $20 billion to repay principal due at the end of next year. According to IMF calculations, Brazil's annual repayments of principal will reach $16 billion by 1987, together with about $10 billion a year interest. Even some of the most conserva- tive bankers recognize that the big debtors are going to keep coming back for resched- ulings, each time demanding more fresh money so that they can meet interest payments. Would the system be able to survive this? A British bank economist stressed the diffi- culty of persuading commercial banks to increase their exposure to the rescheduling countries: "We've gone along with arm twisting this far. But at each rescheduling of reschedulings, the central banks will have to twist harder, and more banks will drop out of the net. It's not likely to work more than once or twice." The Bretton Woods institutions have already begun to increase their contribution to Third World deficit financing. In January, the World Bank launched a scheme for cofinancing under which the bank will encourage more commercial bank project-lending by guaranteeing or partici- - from now. Its major task is to prevent these sorts of crises from happening again. If countries choose to approach us for consultations, they will be able to adjust voluntarily on their own, before they are forced to go to the Fund." Although some have reservations, most leading international banks support the establishment of the institute. Deutsche Bank was the only leading bank which turned down the invitation to be one of the 35 founding members. Ogden hopes the despatch of country information to member banks will dissuade them from the extreme swings which, in the past, have sometimes resulted in all the banks rushing into a country, only to suddenly rush out again. Said Ogden: "As I see the institute's role, it shouldn't put up red lights or green lights, but rather it should put up yellow precautionary lights and point to the speed limits." Ogden is particularly pleased that the initiative behind Ditchley has been private sector. "The private sector has come up with a better mechanism for tackling these problems. No one told us we had to do this. It's a good argument to use against the regulators who don't trust us." Ogden has made it clear that he does not wish to be the institute's first managing director - but he wouldn't mind being the first non-executive Euromoney July 1983 55 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 SOVEREIGN LENDING Laurence Brainard: Trade debts should be kept out of reschedulings. pating in normal syndicated credits. In February, World Bank President Tom Clausen announced a special action programme of accelerated disbursements on project lending, and more structural adjustment loans. The IMF has achieved a quota rise of 47.5%, and an increase in the general arrangement to borrow from SDR 6 billion to SDR 17 billion. But these new funds for the IMF are unlikely to be approved by the various national assemblies until at least the end of the year. According to a study published in March by the Group of 30, the IMF had only $9 billion of spare resources to lend. Considering the likely demands on IMF funds, the Group of 30 estimated that the IMF would need to borrow an extra $9 billion on world capital markets before the end of the year. The IMF and the World Bank will take a bigger share of LDC financing this year, but, even if the IMF starts to borrow in the loan market, they will lack the resources to supplant the banks, if the banks will not provide the 7% increase in exposure requested by de Larosiere. Supporters of sweeping solutions maintain that increasing the resources of the IMF and the World Bank will not preserve stability in the world financial vstem, nor keep an adequate flow of -apital to LDCs. The most radical idea is to stretch out the maturities on existing LDC loans by con- verting them into long-term bonds. Variations on this idea have been canvassed by Peter Kenen, Professor of Economics at Princeton; Felix Rohatyn, a partner of Young, chairman of Morgan Grenfell. They believe a stretch-out would act as a bulwark against the threat of default, and would reduce the need for new bank loans to LDCs, by diminishing debt service burdens and easing current account deficits. Kenen and Rohatyn suggest that govern- ments of developed countries should set up a new agency. (Kenen suggests the name International Debt Discount Corporation.) This would buy LDC loans from the banks, at a , discount of, say, 90%, and issue in return guaranteed long-term bonds in its own name. The agency would reschedule its loans to problem borrowers on a long-term, low interest, and final basis. According to Rohatyn: "The reality of the situation is that a significant part of the approximately $700 billion now lent to the Third World and the eastern bloc will come back, if ever, only over a long period." Geoffrey Bell, a director of Schroder International, expressed a general criticism of the Kenen/Rohatyn model: "These schemes don't address themselves to the real issue, which is how to get new money to these countries, rather than dealing with existing debts." (Bell has himself proposed an international lending facility, linked to the IMF: banks would place funds in the facility, which the IMF would lend along- side its own loans). Rohatyn and Kenen assume new lending to LDCs on a normal commercial basis. But Mackworth-Young's idea tackles Bell's criticism. LDCs would fund their deficits by issuing bonds, carrying an international guarantee. from now on must be incurred outside the international banking system," said Mackworth-Young. "It's right for banks to finance trade and projects, but you shouldn't ask a bank to lend if it's not clear how and when it'll be paid back, and if it has no control over the financial manage- ment of the borrower." Mackworth-Young wants this principle to be applied retrospectively. Balance-of- payments assets should be stripped off the banks and put into the capital markets with a guarantee. "The LDC bonds need to be guaranteed, so that if there is a default the whole developed world bears the weight, and not just the banks, because if banks lose their capital it's a catastrophe." Mackworth-Young said he did not want to boost bank profits, but to strip assets from them, to free them for new lending to LDCs of the right sort. "I know of projects in some countries, for example a good copper mine project, where the banks won't finance it because they are full up on country limits. That's a shame; it's the sort of lending banks should do." At the moment these stretch-out schemes are politically unacceptable to the govern- ments of the developed countries. The US Congress would not vote money to bail out the banks. The practical difficulties of setting up such a scheme would be enormous: for example, how should the cost be borne by the various participants? Which debts should be included and which should not? So far the schemes have won little support from commercial bankers. George J. Clark, executive vice president in charge of international lending strategy at Citibank said: "Not only do lenders not want to discount loans at 90 cents to the dollar, but the borrowers don't want it either. If, say, Chilean paper circulates at a discount, that's a severe impediment on Chile's ability to borrow anew. Nearly all these ideas are written by people outside the rescheduling process, like academics and politicians." Clark believed the ad hoc system could maintain an adequate flow of funds to LDCs. He maintained that the biggest threat to this flow was not the borrowers, but the legislators and regulators, who may impose country limits that are too restrictive. Yves Laulan, chief economist of Soci6t6 G6n6rale, is concerned about the impact of plans like Rohatyn's on confidence in the financial system. "They could be very dangerous and counterproductive," he said. "Instead of forestalling a crisis of confidence, they could actually create one." He thought the other major draw- backs about the plans was that "they address only the problem of outstanding debt, not what happens in the future." Laulan himself has a plan, with what he calls upstream and downstream procedures. Lazard Freres; and V'?"?-- "- " ? - - - consultations - `o .-_.. .. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 SOVEREIGN LENDING on annual country-by-country reviews between commercial banks, the IMF and the World Bank, to provide better data on Third World debt. The latter proposes a degree of risk sharing in lending to the Third World by commercial banks and the World Bank, possibly through greater use of cross- default clauses to co-financings, and by risk sharing between the banks and the IMF, possibly by opening a new window. Through this facility, Laulan believes international banks could, under certain conditions, enjoy an indirect guarantee from the fund. If the fund were unwilling to go that far, be thinks the banks themselves might be able to organize multi-bank guarantees. His proposals raise legal and confiden- tiality problems, but they have the merit of working within the existing framework of relationships between the multilateral institutions and commercial banks. The idea proposed by Peter Leslie, senior general manager of Barclays Bank Inter- national, tackles the criticism that bankers should not be bailed out. He suggests that commercial banks should discount problem loans with central banks, to clear them off their balance sheets. Central banks would buy the loans on condition that, for each loan discounted, the commercial bank should make a new loan to a more healthy borrower in the Third World, perhaps in the form of export credits. The commercial banks would still be liable for the risk on the loans they discounted; the discounted loans would appear as contingent liabilities on their balance sheets. The discounting facility is meant to boost banks' liquidity. "I don't think some new scheme, such as the discounting facility, is necessary to avoid disaster, or maintain confidence in the financial system," said Leslie. "But we will need some new initia- tive to maintain an adequate flow of funds to LDCs." Leslie said that the place of immobilized debt on the balance sheet is insufficiently appreciated. "Even if a bank such as our- selves has, say, less than 3% of its assets out to problem borrowers, those assets will make up a much bigger proportion of our Eurocurrency book. The funding of bad loans can become quite significant, as you will have less cashflow coming in as repay- ments of principal from problem borrowers. So if you don't want your Eurocurrency book to grow, you may not be able to do any new lending for several years, especially as you may have undrawn loan commit- ments being drawn down in the future." Manfred Meier-Preschany, who is a member of the managing board of Dresdner Bank, has put forward a similar proposal: the World Bank, rather than central banks, should take problem debts off the banks' balance sheets, while the banks retain the risk. The debts should be converted into long-term loans or bonds. Felix Rohatyn: A debt discount corporation should be set up to buy LDC loans. Meier-Preschany, like Leslie, wants to encourage new bank lending to LDCs. Other bankers dispute whether the banks have a liquidity problem. Said Dr Kurt Richolt, deputy manager on the board of managing directors of Commerzbank: "Lack of liquidity on the part of the lenders is certainly not the reason for the slackened flow of credit funds to LDCs." A British bank executive agreed: "We've had no problems funding ourselves in the interbank market. We could probably raise another 25% in deposits if we saw the com- mercial outlets. It's for other reasons that we prefer a lower growth of assets." He said that the discounting facility involved more risk. "We've too much risk. Any scheme which assumes we'll voluntarily increase our risk is being unrealistic." Clark of Citibank agreed that funding rescheduled loans did not create liquidity problems: "Rescheduling principal isn't a very big problem - you're just maintain- ing your exposure, instead of making new loans to refinance the maturing ones." There are no signs that central banks are willing to offer discounting facilities; the discounting facility, like the stretch-out models, has so far attracted very little support from commercial bankers. The one radical solution to win some support is the state guaranteeing of new LDC lending. Its advocates include Harry Taylor, president of Manufacturers Hanover Corporation, Hans Baer, chairman of the management committee of Bank Julius Baer, and a number of senior UK clearing bankers. They wish to overcome the problem of supporting LDC current account deficits. Baer explained: "New sovereign lending should be guaranteed by institutions or governments. Without this carrot it will be difficult to achieve the $20 billion We Larosiere has asked for]. In the interests of making LDC economies grow, some risk should be taken off private shoulders." Baer believes that the potential losses which governments might suffer from guarantee- ing new loans would be preferable to the increased amounts of unemployment bene- fits they would have to pay if LDCs were forced to cut back imports from developed countries. "The problem is not so much to get one or other scheme adopted, but rather to get banks to agree there is a problem, which is greater than a liquidity crisis, " said Baer. "Many American bankers won't talk about the problem, and just hope it will go away." Taylor agreed that the banks needed a larger carrot. In a recent speech, he said: "Can those banks which have stayed put accept an even larger burden on top of the involuntary new loans we are now required to make? I think not ... One possibility would be a new application of the guarantee mechanism." A senior executive with a London clear- ing bank asserted bluntly: "We won't increase our risk to problem borrowers without guarantees. Governments have been cowardly since 1974. They encouraged the banks to take on difficult problems like recycling. It's the public sector's problem." He added that his bank would say nothing in public on guarantees, because there would be a clamour about the bank wanting a bail out, which was not the case. "I don't particularly want a guarantee scheme, but I'd prefer it to the Bank of England calling us in again and telling us to increase our exposure to Mexico by another 8%." Those who dislike radical change could regard guarantees as an extension of export credit guarantee schemes to balance-of- payments loans. The guarantee would be less than 100%, to make bankers keep their wits about them. Compared with the stretch-out ideas, it would be very cheap for western govern- ments: they would only have to underwrite new loans to problem borrowers, rather than all past lending. But that is also the plan's disadvantage for those who think it insufficiently radical. It offers LDCs no relief on the burden of debt they have already accumulated, or on the heavy cost of servicing it. As with the stretch-out models, there would be political opposition to the use of public funds to help bankers. But a guarantee scheme, like the discounting facility, could be implemented unilaterally by one or several countries, without all developed countries having to follow. The debt nightmare may have to become far more disturbing before the majority of bankers are prepared to consider seriously any radical plan for changing the relation- ships between commercial banks, official bodies and sovereign governments. The existing system will probably hang on for the moment. But for how long? "The ad hoc system may not work the second time around," Mackworth-Young cautioned. "We may not be so skilful or so fortunate next time." Euromoney Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 A new approach to international indebtedness Yves Laulan Paris Servicing existing debt is not the main problem: it is maintaining the flow of capital finance to developing nations. To help banks play their part in that, the IMFand the World Bank could undertake two additional functions The problem of international indebtedness will not disappear by magic. A first major crisis was narrowly avoided last autumn, but the problem is still there. By this coming September, Mexico, Brazil, Argentina and other countries will be experiencing further financial difficulties and possibly face default. The problem has both short-term and long-term aspects. In the short term, it is important for the various sources of international financing, namely the banks and official financial institutions, to come up with the means required to avoid a liquidity crisis. The long-term problem is different, since it entails finding a way to prevent the depletion of financing sources from threatening the fundamental economic health and stability of the third world. A drop in average income a head, however necessary to restore order in the economy, is acceptable for only a limited period of time. Over a five or ten-year span, such a drop might have a strong destabilising influence. That is precisely what might happen should banks - through caution in the face of an economic crisis - sharply reduce their financial flows to the third world (not by 10 to 15% but by 50% or even more). It appears inevitable that small and middle-sized banks, especially in the United States where they account for 15% of the total exposure US banks have in the third world, will withdraw from the market. The tighten- ing of international lending control procedures which is currently occurring in the major banks can be expected to lead automatically to a drop in the volume of loans to the third world. The practice of debt rescheduling is clearly growing. It is natural for borrowing nations to reschedule since there is no immediate punishment involved. Under the twin pressures of the IMF and governments, banks have readily gone along with this practice, especially because they claim to be getting a profit of 2% or more from it. But, just as the banks precipitated the crisis last year by shortening the maturity of their loans (in 1982 50% were short-term loans), one may well wonder whether they are not going to precipitate a new crisis by increasing the cost of refinancing these loans. The borrowers too are taking a tougher line. One may well wonder whether a `cartel' of borrowers in difficulty may emerge, ready to threaten default, similar to the `cartel' of oil-producing countries. A worldwide recovery, with higher commodity ex- port prices and lower interest rates, will certainly moderate the harshness of the crisis. But it would be a serious mistake to suppose that it will cause it to disappear. Even with recovery, debt servicing/exports ratios will remain unfavourable (between 70% and 100% for Latin America and other deeply indebted countries) in the next few years. A laissez-faire or free- market approach alone cannot be expected to solve this problem. It is necessary to come up with a more strategic and convincing remedy. Shared burden Another kind of solution which at times is put forward consists of saying that `the banks should pay' out of their reserves or their own funds - an approach which is reminiscent of the famous adage of the 1920s that `Germany will pay' and history has shown us the consequences of that approach. The banks are scarcely capable of paying. The total equity of the major banks (capital plus reserves) amounts to about 5% of their total outstanding assets (some $200 billion), and is about equivalent to the amount of the doubtful claims on the third world. The mere match- ing up the two figures should suffice to demonstrate how questionable any solution would be which consists of asking the banks alone to bear this burden. It should be realised that banks are essentially financial intermediaries. In the final analysis, the burden will have to be shared between lending and borrowing countries, with a proportional breakdown THE BANKE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 25 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 INTERNATIONAL DEBT to be determined by an initial arbitration. A second arbitration will be required among the creditor nations, who will be forced to make consumers carry part of the burden through inflation and/or interest rates and/or make tax-payers do their part through taxation. Expressed in these terms, the problem consists merely of providing a smooth, untraumatic transition towards a more healthy state of affairs. It is also worth dispatching the widely-held belief that the debtors should pay back their debts. A country never pays back its debts, except over a very long period (for example, the US in the nineteenth century). The problem for the third world is simply to provide for regular and balanced growth of debt (in accordance with the world's inflation rate and their real growth rate) so as to be able to service their debt regularly. No more and no less is involved. It is a matter of confidence as well as of. good financial management and proper utilisation of the funds borrowed. Last but not least, it is worth bearing in mind that the nature of the problem varies from one country to another. Some people have argued that the current crisis is above all a matter of `liquidity problems'. That is the well-known assertion of Walter Wriston, chairman of Citibank. Others, on the contrary, have claimed it is essentially a crisis of `insolvency'. The truth is that it is a bit of both, in a mix that varies with the country concerned. The Citibank position is hard to accept; part of the funds have been wasted. Never- theless, for Mexico, the crisis seems to indeed involve `liquidity' and much less `insolvency'. Exactly the reverse situation applies however to the Sudan. More- over, at present, everything is a matter of `liquidity' whereas in the long run, especially in a time of inflation, any problem of insolvency can be resolved. Debt discounting ... Rather than get caught up in a theological quarrel, one is better off recognising that it is difficult to conceive of solutions that can be applied broadly to every case. On the contrary, solutions must be prag- matic and flexible. They must vary from case to case and must be tailored as closely as possible to the par- ticular conditions of the creditors, the banks, and the debtor nations of the third world. On the basis of these introductory remarks, it is possible to examine the solutions which are currently being put forward, particularly in the United States, to provide a remedy for the crisis*. We will purposely avoid dealing with the bills currently before the US Congress which are designed to control banking activities and which are only indirectly relevant to our topic. The common feature of these plans is the removal *Among others, such plans have been proposed by Norman Bailey of the National Security Council, Professor Peter Kenen, Congressman Clarence Schumer, Senator Bill Bradley, and by Felix Rohatyn of Lazards. of bad debts from the balance sheets of the lending banks so as to stabilise their position and provide them indirectly with new liquidity. The idea is that these debts would be bought back at a price less than their nominal value (a discount of 10% to 15% for instance) either by some newly created agency, for example some international debt retire- ment fund, or by the IMF (or the central banks according to some versions), or even by investment mechanisms on some secondary market (to be set up for the purpose). The authors of these plans believe they have two virtues. They make it possible to restore a certain truthfulness to balance sheets and they also improve bank liquidity at the cost of limited accounting losses. Moreover, consolidating these debts over a very long time period (up to 30 years) and with a very low interest rate would reduce the borrowers' debt servicing costs. . not the answer However good their intentions, these plans have serious flaws. They are dangerous in the short run inasmuch as they would be likely to precipitate the very crisis they aim to avert. They are counter- productive inasmuch as the long-term side effects, even assuming an immediate crisis is avoided, would make the cure worse than the disease. Implementing them would be very likely to damage the reputation of the lending institutions, whose real or supposed management errors would thereby be revealed in broad daylight, and at the same time ruin the credit of the debtors, whose solvency troubles would be cruelly brought to the fore. If such plans were applied, they would undoubtedly help to make the loans granted to the third world in the 1970s go down in history alongside the notorious `Russian loans'. Expressed more systematically, the main objections to these plans may be summarised as follows: ? It is doubtful under present circumstances that institutions or individuals operating on a secondary market would be inclined to buy bad debts with just a 10% discount. A discount of 50% or more would seem more likely. That would be enough to cast a shadow over the reputation of the debtor nations and cause the creditor banks to withdraw permanently from this kind of operation. ? As for the possibility of having the IMF or some other financial institution buy these debts with a reasonable `discount', the objections are of another kind. First, one can well imagine the difficulties involved in defining which bad debts are eligible. Even if this delicate issue were resolved, an opportunity of this kind would bring about a vast shift in debt positions, first on the part of small US banks and then by the larger banks under pressure from their shareholders. Indeed, they would be sorely tempted to unload much of their third world port- folios in the rediscount institution. Since countries with debt rescheduling problems Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ar bE re In In rr U. air ft Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 INTERNATIONAL DEBT account for about half of the medium-term and long- term debts declared by the banks (that is about $320 billion), one can readily imagine how much money the IMF would need to handle this influx of debts. The IMF is currently lending no more than $ 10 to 12 billion a year and Congress has already been baulking at the prospect of increasing the IMF quotas in 1983. Needless to say, the practical obstacles such plans would encounter would be considerable. New approach The real problem is not so much to deal with the outstanding debt as to give priority to new debt. The current problem of indebtedness can be solved satisfactorily over time if it is possible to find reasonable conditions under which banks will be willing in future to help third world nations borrow money. In other words, handling the future problem would make it possible to provide a solution to all the problems. Banks have always had to carry bad debts on their books. The most striking recent example was the experience with real estate loans in the mid-1970s which weighed heavily on the accounts of US banks. The problem today of course is much bigger. Never- theless, the prospects for an economic recovery allow one to think that banks, by wise long-term provisions, may gradually manage to rehabilitate their own balance sheets. For such a process to occur, it will be necessary to re-establish confidence at two levels. First, a way must be found to make sure that in future the best possible use is made of the funds made available to borrowing countries. The current crisis is to a large extent due to poor resource allocation. Far more credit was granted than was reasonable over and beyond the normal absorptive capacity of the borrow- ing nations. Mexico figures as a classic example, with a foreign indebtedness rate that rose to more than 30%. A lot could also be said about the utilisation of these resources in some countries (some African countries built fancy edifices or even schools). One need not be a specialist to realise that, however justifiable such programmes may be, they do not call for commercial-type financing. Yet that is what was attempted all too often. There must be an end to such practices and a return to more realistic and rigorous modes of financing. Secondly, bankers must be able to recover their confidence in reasonable operations in the third world so that they do not give in to a panic reaction or mere distrust as far as this kind of operation is concerned. On the basis of this sort of reasoning, it is possible to envisage `upstream' and `downstream' solutions for bank loans. The purpose of both would be to re- organise the relationship between the leading inter- national banks, the IMF and the World Bank. Upstream. Banks should promise to provide systematic information about their intentions to grant loans to any borrowing nation, to be sent to the IMF for general loans and to the World Bank for project financing. There would thus be a systematic form of consultation and analysis before the loans were made. That would put an end to `telex lending' which has contributed considerably to increasing indebtedness. Banks cannot carry out such prior studies because they lack the technical facilities to do so. But the IMF and the World Bank have well-staffed technical departments capable of providing this service. That will not be easy to achieve. The Fund and World Bank people like to keep secrets and they are wary of banks. They will not open up their files willingly but, over time, their distrust may be overcome. Downstream. In return for this prior examination, the commercial banks might be given a guarantee of some sort. Their main concern nowadays is to get their money back. They do not always succeed in doing so. The present spate of rescheduling arrangements, even if the result does not immediately show up as losses on bank balance sheets, entails a serious future threat for the banks' operating accounts and they are aware of that. So their chief concern today is security rather than a return on investment. That is why the intervention of the Fund and the World Bank could prove valuable. Banks must have more confidence if they are to continue to engage in an adequate amount of lending. They must be sure that, under certain conditions, part of the risks involved will be borne by some international in- surance system, comprised of a network of inter- national institutions. Implementation While the principles behind such measures may be clear, there are awesome problems involved in putting them into practice. The implementation process must therefore be examined carefully. Upstream. -Clearly there would be no point in asking the 15,000 banks which are directly or indirectly involved in international financing operations to go knocking on the door of the IMF or the World Bank every time they grant a loan to some developing country. But it is worth noting that the Fund is already consulted when rescheduling arrangements are made. That amounts to a precedent which may perhaps prove valuable. An annual country-by-country review system of sorts could be set up under the auspices of the Fund, which could provide a forum for exchanging information of two kinds. First, this annual review would make it possible to learn more about present conditions in any given debtor country and their likely future evolution, on the basis of the loans under consideration. It would then be possible to find out if a country's rate of debt increase is in keeping or not with its capital absorptive capacity. Opinions vary about absorptive capacity. Nevertheless certain guidelines could be used which take into account both the country's real growth rate and the worldwide inflation rate. Any Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 de PC he project corm of made. ich has cdness. because ac IMF clinical -. That World wary of ly but, ination, intee of to get ceed in eduling diately ntails a ccounts :oncern stment. tnd the tst have g: n be ,ure e risks trial in- f inter- may be ved in ntation oint in :tly or lancing ;MF or o some .tat the '':duling decedent annual Fuld be It could I of two ;ible to given ion, on V, Id of .1t capital rptive uld be I's real F. Any Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 debt growth greater than the sum of these two percentage figures could be deemed excessive and hence potentially dangerous. Determining the volume of a nation's debt would in itself be an advance on the previous state of affairs, as has been evident when rescheduling occurred. Beyond that, however, it is worth considering whether investigations should not go further, to the point of making an assessment of the various factors (the budget, investment programmes, the balance of payments situation, export prospects, and so on) likely to influence a country's overall solvency. It would be important for the analysis to deal with world economic trends as well since certain parameters, such as the price of oil, raw materials and so forth, can have an important bearing on a country's future prospect. In addition to these annual reviews, it would be necessary to have constant discussion of technical and financial matters among specialists, especially with officials from the World Bank when it comes to examining the financing of certain projects. Such discussions have already begun to take place concerning co-financing. Downstream. Establishing a degree of risk-sharing between international banks and international institutions is perhaps a more delicate problem to resolve. It appears dangerous and useless to set up new structures, as the Rohatyn plan proposes to do. It also seems venturesome to seek to initiate new procedures, especially for the IMF. Having the Fund buy up certain kinds of debts, as has been suggested, would require an amendment to its by-laws. Given the current state of thinking, it is doubtful whether such a change could readily be achieved. Yet a third pitfall to be avoided would be to make a large-scale appeal for government financing. This approach would run up against the opposition of the US Congress and perhaps that of other governments as well. It would therefore seem preferable to operate within the existing or already known procedures, while adjusting them as need be. Cross-default For the World Bank one could, for instance, consider using a cross-default clause under appropriate conditions. This clause would entail linking loans granted by the World Bank to those agreed by banking establishments. Once again, it should be pointed out that this is only a limited innovation. The extension of cross-default to co- financing, as the banks have requested, has so far not been agreed under conditions that the banks find acceptable. If the World Bank agreed to allow a cross- default clause to apply to loans issued by international banks for some financing projects, the result would be the very risk-sharing scheme which is sought. For the IMF, the problem is similar. It appears quite unreasonable to put the IMF into a direct relationship with banks. That is entirely outside the scope of its legal jurisdiction. Nevertheless, interesting possibilities could well be explored within the framework of existing procedures. As an example, the IMF in recent years has set up various 'windows' to meet the needs of member states - for example, the compensatory financing facilities. One might consider opening another 'window' for member states which would allow them to draw on the resources of the Fund, in accordance with procedures and under circumstances which should be very carefully deter- mined, to meet difficult deadlines for payments to banks that have respected the prior consultation procedures discussed above*. International banks would thus benefit, under specific conditions, from a kind of indirect guarantee from the Fund, thereby providing a means of re- storing confidence. It should be noted in passing that the help which the Fund currently provides for debt rescheduling is in many respects based on the same principle, albeit under exceptional circumstances. This proposal would merely make systematic use of an existing exceptional procedure. Objectives These proposals naturally encounter a number of criticisms which should be examined. The first objection is that they would meet reservations on the part of banks for whom 'upstream' consultation procedure would be tantamount to sacrificing part of their 'sovereignty' and independ- ence. One answer to this is that a loss of independence is already a fact of life, especially when it comes to massive debt rescheduling. The governments of debtor and creditor countries and international institutions are quite often led to force the bankers' hands. A second objection involves the debtor countries themselves which might refuse to go along with such consultations or might prove reluctant to supply the data required to make the right diagnosis. This objec- tion does not stand up under analysis. This time when Mexico was capable of choosing between loans offered by different banks which often took the stance of petitioners is now past. The situation today is the reverse: it is the scarcity rather than the overabundance of credit that is feared. Debtor countries are thus likely to be concerned to protect their reputation for solvency under the best conditions. A third objection may come from the Fund and the World Bank, since they might not wish to have to share their knowledge with international banks. Their concern for confidentiality must obviously be re- spected, but one is entitled to wonder whether it is still meaningful today. After all, confidentiality failed to prevent the excessive increase in international debt levels which led to the present crisis. One may well wonder Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 INTERNATIONAL DEBT whether confidentiality is not the very opposite of the concern which should now be uppermost in people's minds. It is the broadest possible circulation of information about the ears desirable in order to avoid countries which appears repeating the errors of the past. One should not overlook the fact that one major difficulty stems from the habits and traditions of the which until now staff of international l to be discreet about publishing have been required certain information. In addition to the institutional or political obstacles, there are psychological barriers that are just as formidable. Certain behaviour patterns will undoubtedly have to be altered to meet the new circumstances. Another objection concerns the impossibility of increasing the resources of the IMF and the World Bank to allow for risk-sharing in the form of direct or indirect guarantees. Three points can be made in this regard. ? The first is that, although the US Congress may currently be very hostile to any increase in the sources of these agencies, attitudes may change in the future- s The solution put forward would in the final yalysis be infinitely less wasteful of resources than fly of the other plans mentioned above, especially those that call for the IMF or some other institution to buy banks' bad debts. ? The purpose of prior consultation would be to reduce or even eliminate the volume of claims. If good loans are granted under proper conditions, the use of guarantee funds would be only marginal. Advice not finance A massive increase in IMF or World Bank re- sources does not seem to be desirable or necessary. It would be indeed be unfortunate if these agencies became so gigantic that they experienced troubles in maintaining their internal balance or operating correctly. In any case the IMF and the World Bank should develop their advisory function as much or more than their financial role. It is as advisers as much as lenders that they make make a useful contribution to international economic recovery. Over the last 30 years both the Fund and the Bank, by virtue of remarkably qualified staffs, have managed to acquire an unequalled store of knowledge about developing countries, the techniques of financing, and the preparation of economic and financial diagnoses. Yet this store of knowledge is not utilised generously for the benefit of the international community. The time has perhaps come to draw upon it much more fully now that a radical change in the ways and means of international financing seems to be required. Under such conditions, one should consider whether such procedures could not be established within the framework of existing resources, without there being any need, at least in the short run, to increase the resources of the Fund or the Bank. This would moreover make it possible to give a categorical reply to the standard objection that 'the Fund must not bail out the banks'. As for the specific problem of the guarantee that the IMF might provide, the relevant objections may be put as follows: ? There is no need to change anything whatsoever since economic recovery, if it is sharp and long- lasting, will take care of the problem by increasing raw material prices and reducing interest rates. ? If the banks obtain any kind of guarantee, they will lose interest in making adjustments because they will no longer feel required to do so. ? Similarly, guarantees may discourage debtor countries from making efforts and their public may think it unnecessary to accept the sacrifices that an adjustment policy would demand of them. ? No one single remedy can apply everywhere inasmuch as the situation varies a great deal from one country to another. The Sudan is not Mexico. Effectiveness Some of these criticisms have already been answered, especially the first and last. Some additional remarks may be made, however. As for the differences between debtor countries, the guarantees would obviously also vary so as to fit each particular case. A guarantee can be provided only to deal with an unforeseen liquidity problem and not to handle probable insolvency. A similar reply may be given to the argument that banks would cease to be motivated. Any guarantee would be subject to making the extra effort to engage in prior consultation. On the other hand, there may indeed be a problem concerning the adjustment efforts required from debtor countries. Very serious difficulties will certainly crop up when implementing the stabilisation plans which the indebtedness of these countries will require, whatever solution is decided upon. The new feature will be that not only the Fund but also the banks will make their help subject to respecting certain conditions. People should not delude themselves; they should realise that, whatever happens, the banks will in future not be in a position to shell out funds as easily as in the past. That is precisely the key to correcting successfully the current situation. Finally, a worldwide recovery is not necessarily sure to occur. Even a strong and long-lasting recovery, although it would ease the problem of old debt, would not make it possible to handle the problem of new debt. It is essential that future financing be offered under conditions which allow for an increase in its economic effectiveness. Only this effort at rationalisation will allow international financing to be provided more satisfactorily than in the past and will prevent the recurrence of problems which marked the beginning of the 1980s. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ECV ;.C.S. aris nne .fires ique )urg iano ited S.A. ON. t av iced AS S.A. iced Ltd. ced i WE America's once-troubled savings and loans associations are set to become an important force in international capital markets. From this month they have been allowed to invest in seasoned Eurobonds. New issue managers expect the S&Ls to favour top quality FRN issues because of the match with their hugely successful money market and Super NOW accounts. Since the beginning of this year almost $150 billion has flooded into the S&Ls - $112 billion through- money market accounts alone. One result of the thrifts' new freedom will be to strengthen the position of major US investment banks in the Euromarket. They have the regional networks and distri- butive experience to capitalize on this new source of funds. Salomon Brothers demon- strated this two months ago with its privately-placed floating-rate issue for BF Goodrich. That was priced over Libor but placed in the US, mainly with S&Ls. The company repeated the formula with an equally successful issue for the Kingdom of Denmark: 29 thrifts came into that deal. The boost to US investment banks won't come amiss. Last year they profited as issuers streamed from the States to the Eurobond market. In 1982, two thirds of the issuers of all listed Eurobonds were based in the States. This year that has changed. So far, US issuers have accounted for barely a third of all new Eurobonds. And that trend looks set to continue. The influential Morgan Guaranty Survey predicts that US corporations' need for external finance will remain weak this year. Morgan's economists cite "the dramatic rise in corporate profits [they are looking for an increase of over 30% this year] inventory liquidations and weak investment demand" as reasons for "the decidedly modest need for external financing". They also point out that corporations have taken advantage of the booming stock markets to restructure their balance sheets and replace debt with equity. So far the yawning US budget deficit seems not to have deterred those institu- tions that want to issue debt. But that doesn't mean crowding out won't happen. David Maxwell, chairman of America's second largest borrower after the Treasury, the Federal National Mortgage Association, hinted that the possibility of being crowded out toward the end of next year had prompted Fannie Mae's efforts to start ARE D" TE E D 9 1 WEI There were as many lay-offs in the US because of declining sales to Mexico in 1983 as there have been in three years of depres- sion in the American automobile industry. That's according to Jeffrey Garten of Lehman Brothers Kuhn Loeb at the International Monetary Conference in Brussels last month. The point being developed was this: can the world economic recovery be fostered while exports from the industrialized countries are being limited by the austerity programmes imposed as a result of the sovereign debt crisis? Can the Third World, in Particular Latin America, export its way out of crisis when its natural markets are themselves in crisis? Brazil, for example, before the crisis emerged, had fixed on four key markets for its exports: Argentina, Chile, Mexico and Nigeria. All four are now deep in their own troubles. Even if the economic recovery does bloom fully and sweep the world back into prosperity, it will be 1984 or later before the effects filter through to the poor nations. Can ad hoc arrangements hold the fort until then? The IMF quota increase cannot come into effect until the end of 1984, and that Approved increase is already inadequate for the level of support needed for the problem countries. Some of the rescue packages are already foundering. More money will be needed soon for those, like Mexico, who so far have showed determination to haul them- selves back to recovery. All this means that more cash will be needed to shore up the LDCs than will be available this year or next year. It's estimated that some $15 to 20 billion of new commercial bank funds are required by LDCs in 1983. True, that's only 7% more than the 1982 exposure, but it's probably out of reach, as the smaller banks pull out of sovereign lending and the interbank market shrinks. So where's the cash to come from? Not the Bank for International Settlements, for sure. Central bank governors at the IMC in Brussels displayed a common wariness of further bridging finance for countries crippled by debt. The problem, as Fed Chairman Paul Volcker rightly identified it in the same forum, is "getting longer term credits in here from other sources". EDITORIAL borrowing in the Eurobond market. But the unshackling of the thrifts is also likely to have wider and more important effects. This year has seen an unprece- dented boom in floating rate note and floating rate CD issues in the United States. Most have been priced over Treasury Bill rates, again to appeal to the S&Ls and regional banks' money market accounts. This makes them substantially cheaper to the issuers than Libor-based funds - a vital point, when most of the issuers have been banks. Regional banks have launched floating rate CD issues in the US at rates well under Libor. And last month Swiss Bank Corpor- ation became the first European bank to issue a floating rate CD in the US. The spread it paid was a mere 55 basis points over the three-month Treasury Bill rate. At the time of issue, that was 31 basis points under Libor. The increasing investment power of the S&Ls and the regional banks - because of the success of the money market accounts - will draw more banks to the United States for their funds. It will also erode the hegemony of Libor in bank funding. More and more, the base will be the T-Bill rate. In the present environment those longer term credits can come from only one kind of agency, an aid agency. That implies that industrial governments should be prepared to be far more generous in the coming decade than in the last two, not for any altruistic reasons but out of naked self- interest. The United Nations' target of 0.7% of GNP in official development assistance has only been met by one or two of the smaller industrial nations. It's time that record was improved, both on a bilateral basis and through multilateral bodies like the IMF and World Bank. The alternative is to let the commercial banks sort out the mess as best they can with the indebted nations. That way, the taxpayers in the west may eventually face a higher bill - one that can't be measured in terms of dollars or pounds. Commercial banks should not expect to be rescued from the consequences of their own lending folly, if indeed that is what they have indulged in. But they are entitled to point out that their lending to Latin America bolstered exports and jobs in their home countries. Euromoney Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 support to Nigeria's Moslem rule will continue. After the ,ncv to sacrifice the nation to r present shadow of an army ed up by the political elite, ker who said: `All your con- .in oil was not exploited until rule. Now the government s opportunities so great that to lose them through lack of is the parliamentarians, who brated their return by voting id allowances'.21 curbs is that of the army. ljo Danjuma both talked warning them not to misbe- iew early in 1979 Obasanjo tire that the military did not Brigadier Shehu Yar' Adua, s, went farther. He said in an ollege that the military, being excluded from the political ested that the country should ,d civilians; such an arrange- . and other aspirations of the s proposal. But Nigeria's his- s in the next stage some kind can expect. Meanwhile it is on with the rest of the Third n-style democracy. 8 The World Bank paradox In the preceding chapters an attempt has been made to demonstrate that cultural constraints in the Third World block significant socio- economic change. Limitations of demand, as in India, constitute a further, secondary obstacle; and it follows from the social rela- tionships that have been described that the relatively few Indian workers who may be caught up in any industrial expansion are unlikely to be paid much more than the present pittances - an officially estimated average of Rs 3,139 (#174) per year for factory workers in 1973. If widespread, socially beneficial development is to take place, it must be from the village upwards, not from urban centres, in all Third World countries - except small islands in which foreign capital and Western influence are concentrated. As a fundamental policy this principle is neglected, because it offers little or no profit to either the elite of the poor countries or the economies of the industrialized. It would certainly not benefit the West to the extent apparently imagined by Edward Heath when he said in a BBC interview that the richer countries could make the equipment to help the others; for in the only useful development that is possible - and it is doubtful whether even this will occur - the tools needed are negligible. Few people who talk about Third World development under- stand what it entails. The Brandt Commission's report is an ex- ample.' Slogans such as `mutual interests' and `partnership' between North and South are accompanied by no more than a vague, token reference to the problems raised in this book.' The commission sees a new approach to international finance and re- form of the monetary system as playing a major part in helping both the Third World and the West. Its recommendations are what one would expect from a body consisting of Western politicians, with little experience outside Europe, and shrewd representatives of the wealthy Third World elite. What the commission's rec- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ommendations amount to is a transfer of wealth from the indus- trialized to the non-industrialized countries, to the ultimate benefit of all. But, even if we ignore the all-important cultural impedi- ments, it may be seen that the proposal is not practicable. The amount of capital transferred could never be sufficient to provide jobs to match the expectations aroused. And if it were enough, the shortage of skilled workers and of teachers to train them would make it impossible for the funds to be assimilated constructively. As it is, large amounts of Western aid remain unused. The commission's main proposals would not alleviate poverty, but would accelerate the disturbance of Third World structures, which are unable to withstand the shocks of an aggressive, alien culture. To see development problems as they are it will be useful to look at an example of what is happening in the villages, where most of the Third World people live. Such an opportunity is afforded by an illuminating experiment which was made in the 1970s among the Hausas of Northern Nigeria. A report on the project by the Dutch sociologist, Bert Huizinga,3 contrasts two conflicting ap- proaches to rural development, one of which aims at helping the poor to help themselves, while the other, in practice, abandons them as a lost cause and concentrates on increasing the output of the few who are already relatively prosperous; common to both is the recognition of formidable cultural impediments. Not least, the report reveals sterile World Bank thinking. The experiment, called the Guided Change Project (GCP), was carried out in the Zaria Emirate, Kaduna State, by the Department of Agricultural Economics and Rural Sociology of the Institute of Agricultural Research (IAR), Zaria. The GCP aimed to find the best possible use of development funds, both to raise production generally and to benefit the very small farmers, who form the majority. It had been apparent for years that successful experiments with IAR crops were not being repeated significantly in the villages. Because of this the team sought ways of fitting certain Western techniques into village life, leaving the social structure intact, for the time being. The target was the village, not the privileged or exceptional individual. This required an entirely new approach to fieldwork. The policy that the team rejected is known as Research, Devel- opment and Diffusion (RDD). This presumes a need determined by the planner. The developer, not the receiver, takes the initiative in designing a pro doing the physica know virtually no about achieving it ted to laziness, s' aspiration; those more able than th Huizinga and hi that the failure c disinterestedness frozen by the soc that, as Polly Hill tively rich farmer; poorer4 - a poini Third World pros] economic aims of performance woul level that was dict From the outset that have been ide lems, although for teenth century fai practices. Access t remains limited to descendants of a v British weakened t taxes and forbidd: tration, torture an rise to the Hausa of patronage, soc belief, characterist the supernatural, The less fortunate mighty, to whom - luck of occult on off to monopolize or 20 per cent carr inputs.' Large nun richer, under a sys kind. But the const Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 r of wealth from the indus- tries, to the ultimate benefit -important cultural impedi- .)sal is not practicable. The ever be sufficient to provide 1. And if it were enough, the achers to train them would e assimilated constructively. i aid remain unused. The not alleviate poverty, but iird World structures, which an aggressive, alien culture. y are it will be useful to look t the Villages, where most of op. tunity is afforded by s made in the 1970s among eport on the project by the )ntrasts two conflicting ap- f which aims at helping the 'ther, in practice, abandons on increasing the output of sperous; common to both is impediments. Not least, the king. Change Project (GCP), was na State, by the Department Sociology of the Institute of ['he GCP aimed to find the is, both to raise production all farmers, who form the s that successful experiments .1 significantly in the villages. s of fitting certain Western e social structure intact, for illage, not the privileged or in entirely new approaLh to known as Research, Devel- resur^~s a need determined rec. r, takes the initiative The World Bank paradox in designing a programme and promoting its adoption. Apart from doing the physical work, the farmer is passive and is presumed to know virtually nothing about what he needs or how he should set about achieving it. Failure of the programme to take root is attribu- ted to laziness, stupidity and such psychological factors as low aspiration; those who profit from it are considered to be simply more able than the rest. Huizinga and his colleagues belong to that school which believes that the failure of the majority to participate results less from disinterestedness or innate incompetence than from their being frozen by the social structure. At the same time they recognized that, as Polly Hill found, the economic aspirations of many rela- tively rich farmers are vastly different from those of many of the poorer' - a point of great importance in any attempt to assess Third World prospects. They realized that they could not meet the economic aims of all farmers and that the measure of the project's performance would be the extent of participation `at the benefit level that was dictated by the strategy that the project followed'.' From the outset the team took note of certain cultural factors that have been identified by anthropologists. The Hausas are Mos- lems, although forcible conversion in the Fulani jihad of the nine- teenth century failed to eliminate all their animistic beliefs and practices. Access to the highest ranks of traditional state authority remains limited to those of noble birth; by the same principle the descendants of a village chief may never become commoners. The British weakened the traditional pattern by abolishing occupational taxes and forbidding slavery and punishment by mutilation, cas- tration, torture and death. But the attitudes and values that gave rise to the Hausa structure persist, notably in an elaborate system of patronage, socially decisive subservience to authority and a belief, characteristic of West Africa, that man is powerless before the supernatural, which constantly intervenes in human affairs. The less fortunate attribute their lot either to the will of the Al- mighty, to whom they frequently refer, or to their lack of arziki - luck of occult origin. The tradition of deference enables the better off to monopolize loans from credit organizations; and the top 10 or 20 per cent carry off 60 to 70 per cent of the scarce agricultural inputs." Large numbers of the poorer are obliged to work for the richer, under a system known as Palle, to repay loans received in kind. But the consequences of debt can be worse than this seasonal Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox bondage; in the Katsina Emirate Polly Hill found that just before a harvest in 1967, 64 per cent of sample households were suffering either `somewhat' or `severely' from hunger; they had sold their grain stocks to pay debts and were obliged to buy subsequently at higher prices.' Yet amid all this poverty such is the respect for status that farmyard manure swept up in the smaller compounds is regularly transferred to the larger. Looking at the general social picture in Hausaland Huizinga sees `the development of an historically grown and culturally main- tained status-stratified society into a [economic] class-stratified one',' So far the process is taking place largely outside agriculture, in which traditional techniques and social patterns have undergone little change. But the combination of trading, credit arrangements and use of patronage constitutes `an extremely efficient instrument' that enables a minority to advance economically in both village and district communities. Huizinga adds: `The danger thus exists that the agricultural modernization process itself merely reinforces the existing tendencies towards class formation and thus accelerates the unmistakeable trend towards proletarianization of the peasant population.' One would need to take an extremely Darwinian view of life to be happy about such a prospect. For, as has been made clear in other chapters, there is no prospect at all that this shattering of an old structure would be part of a larger development that would bring the benefits of an industrialized society. The outcome would be that a very poor majority would be almost totally dependent on a relatively rich minority - a situation similar to that which has evolved in India (see chapter 5). The GCP sought to establish a development policy that would improve the lives of the majority, rather than worsen them, while at the same time providing the highest overall return on the funds invested. It was necessary, therefore, to overcome the constraints of the social structure. Adopting the line of C. J. Zwart, the team aimed at `bypassing the impeding aspects of the socio-cultural system ... without on the other hand causing an abrupt disorgan- ization of the system'.9 Beyond that it appears to have been hoped that eventually such projects would themselves lead to social re- construction by removing the underlying production constraints. In the meantime it was considered sufficient to neutralize the effects of the present hierarchic. of peasant families. The IAR's Departme Sociology designed the economy for nearly sevc experiment in small fa: words are important, si rigid plan, but was co techniques, to ascertain the logic of traditional twelve villages of Giw; 7,638, during 1974-8. team, led by Europeans work. It consulted the. credit arrangements, di; ga says that their advi, attitudes were indispei perform various admin some of the meetings I nominated men of their present. In such circu which in any case had of the question. Here consulting the commui the team imposed cei should personally colle graphs to prevent botl came to pay for mater: opinion at this stage o in the project area do thrive.i10 These consultations such as the origins, ag wives per farmer, ed belongings were spre distribution of inputs plexity of the initial I right temperament tr techniques, would pe Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 id that just before olds were suffering ev had sold their iy subsequently at is the respect for nailer compounds and Huizinga sees I culturally main- .icj class-stratified utside agriculture, s have undergone edit arrangements ficient instrument' lly in both village day thus exists E met iy reinforces nd thus accelerates ion of the peasant Tian view of life to een made clear in is shattering of an pment that would he outcome would tally dependent on to that which has policy that would 'orsen them, while eturn on the funds me the constraints J. Zwart, the team the socio-cultural n abrupt disorgan- o have been hoped lead to social re- uction constraints. utralize the effects - Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox of the present hierarchical structure in order to involve the majority of peasant families. The IAR's Department of Agricultural Economics and Rural Sociology designed the GCP after having studied village socio- economy for nearly seven years. The project was described as `an experiment in small farmer development administration'. These words are important, since they emphasize that the team had no rigid plan, but was concerned, while teaching farmers Western techniques, to ascertain their felt needs and to learn more about the logic of traditional methods. The project was carried out in twelve villages of Giwa, with a total male adult population of 7,638, during 1974-8. To gain the confidence of the villagers, the team, led by Europeans, tried to involve them in all aspects of the work. It consulted them from the outset on the formulation of credit arrangements, distribution of inputs, and extension; Huizin- ga says that their advice and opinions and a knowledge of their attitudes were indispensable. When committees were set up to perform various administrative tasks, tradition made itself felt: at some of the meetings held to elect members, village heads simply nominated men of their choice, apparently with the approval of all present. In such circumstances the setting up of co-operatives, which in any case had already failed throughout Nigeria, was out of the question. Here the team felt obliged to intrude. Instead of consulting the community, which usually meant the village head, the team imposed ceilings on inputs, insisted that each farmer should personally collect his allocation and issued passport photo- graphs to prevent both abuse and denial of receipt when the time came to pay for material issued. As Huizinga kindly put it: `In our opinion at this stage of its socio-economic development village life in the project area does not allow for the cooperative spirit to thrive.'10 These consultations and the establishment of important variables such as the origins, ages and relationships of villagers, numbers of wives per farmer, education, size of landholdings and personal belongings were spread over about two years. The subsequent distribution of inputs covered two years of cropping. The com- plexity of the initial task alone, with its demand for men of the right temperament trained in the necessary statistical and other techniques, would perhaps sober those who appear to think that Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox the effective transfer of wealth from North to South requires little more than a bank operation. The basic Hausa social unit is the extended family, which lives in a compound consisting of huts surrounded by a fence made of guinea-corn stalks or a mud wall, to shield N, omen from the eyes of unrelated males. It is socially prestigious for a man to have more than one wife. In a sample of villages 95 per cent of compounds had fewer than ten male adults; the largest single category was those with only one, but one compound had twenty-seven. Some compounds are partitioned to separate nuclear families. Irrespec- tive of these subdivisions, a group may be distinguished by the fact that its members work together and eat from the same pot; the mean number of persons, including women and children, in 248 sampled pots, as sociologists call them, was 6.9 (median 6.0); the lowest was 1 and the highest 23. The compounds are grouped into wards and the wards into villages. Since a tarred road cut through the project area, giving some villages access to markets, the inhabitants would have been more prosperous and less resistant to innovation than those more iso- lated. In a sample of four villages the average cultivated area per compound was 2.99 hectares (median 2.17). Twenty-two per cent of adult males, however, cultivated 36 per cent of the total area." In the eight villages where baseline studies were made 95 per cent of households (pots) possessed (at least) one hurricane lamp, 63 per cent an iron bed, 73 per cent a cotton mattress, 42 per cent a wireless, 42 per cent a wristwatch and 60 per cent a bicycle. Many farmers did other work, such as building, smithing, carpentry, trading of a kind and Koranic studies, which some considered to be an occupation and some not. In most households at least some of the food crops were sold and women earned extra income, mostly by preparing and selling food and by spinning, weaving and embroidery. Some men were obliged to work to pay Palle debts, but going out to earn wages was disliked because it reduced status. These activities returned a mean annual income of 89 naira (probably worth about #30 in real purchasing terms) per person or 151 naira (probably about #50) per adult, with a household consisting of an average of 6.9 persons (or 4.1 adults). But the average is misleading, since 10 per cent of households received 27 per cent of total income.'2 The aim of those several years of dedicated research, of which Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 only a sketch h scheme, regardl among the glos wanted to find c be obtained by bags of fertilize millet, Guinea those in Hausal, team offered a reasons, on suc plained the use interference wit farmer solve the After the pre into three groin inputs, those in were to be pros membership fig improve prodw joined the sche extension-credit tralized social f variables such a ownership of p influence on w' other hand hid language, writti of the cash sch4 The unexpec provided strikir ploratory, rath, confining it to they applied it consequent inci make good rea would have bet sively. But Hui use of fertilizer siderably highe ing methods a Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox South requires little family, which lives by a fence made of omen from the eyes a man to have more cent of compounds single category was twenty-seven. Some it families. Irrespec- nguished by the fact i the same pot; the .nd children, in 248 .9 (median 6.0); the ids are grouped into t area, giving some uld have been more an those more iso- cultivated area per wenty-two per cent t of the total area." re made 95 per cent hurricane lamp, 63 ttress, 42 per cent a :ent a bicycle. Many mithing, carpentry, some considered to eholds at least some rued extra income, r spinning, weaving work to pay falle 1 because it reduced income of 89 naira g terms) per person with a household 4.1 adults). But the iseholds received 27 research, of which only a sketch has been given, was not to launch some grandiose scheme, regardless of the social consequences, such as is found among the glossy brochures of the World Bank. What the team wanted to find out was the most socially beneficial result that could be obtained by providing each farmer with no more than a few bags of fertilizer and packages of pesticides and seed - mostly millet, Guinea corn and groundnuts. The farmers, like most of those in Hausaland, were using the African hoe to till the soil. The team offered advice, which was sometimes rejected for sound reasons, on such matters as distances between ridges, and it ex- plained the use of the packages; but in general it did not press any interference with traditional methods. The aim was to help the farmer solve the problems that he encountered. After the preliminary studies, the twelve villages were divided into three groups of four - those in which farmers paid cash for inputs, those in which they bought them on credit and those that were to be provided with inputs, credit and extension advice. The membership figures show both the need for credit and a desire to improve production. In the cash villages 36 per cent of farmers joined the scheme, in the credit villages 54 per cent and in the extension-credit villages 74 per cent. The GCP seems to have neu- tralized social factors in villages in which credit was available, for variables such as the number of fields owned, labour expenses paid, ownership of personal items, and education had an insignificant influence on whether or not farmers joined the scheme. On the other hand higher economic level and literacy in the Hausa language, written in Arabic script, were significant in membership of the cash scheme. The unexpected way in which the farmers used the fertilizer provided strikingly useful information and justified the GCP's ex- ploratory, rather than merely technocratic, approach. Instead of confining it to the package crops, as the project team proposed, they applied it to pepper, tomatoes, rice, cowpeas and yams. The consequent increases in farmers' incomes were not high enough to make good reading in the usual kind of developer's report and would have been much higher if the fertilizer had been used inten- sively. But Huizinga and his colleagues found that less intensive use of fertilizer was more economical; returns per bag were con- siderably higher. The explanation of this result is that Hausa farm- ing methods are so rudimentary that a low or medium use of Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox physical inputs, especially fertilizer, achieves a higher production per unit of inputs than more intensive application; above about 100 kg of fertilizer per hectare, marginal increases decline.13 While the GCP provides the first hope of genuine rural advance to be offered in Nigeria, it is difficult to imagine that the consider- able number of teams required for widespread development on similar lines would ever be trained. The project designers realized that their main task was to convince the government that a change in its development policy, in so far as it has one, would pay. But apart from the tendency of the urban Elite to support its rural counterpart's attitudes to the lower strata, it is inconceivable, in view of what has been written in chapter 4, that a desire to help the poor, or even to raise production, would be strong enough to overcome civil service lethargy. And without enthusiasm and in- spiration from the top, the scheme would not work. It is possible that managers could be trained under an arrangement like that being carried out by the UNDP in Bangkok. But even if this hap- pened, most of the graduates would soon be in the power of district and village leaders. Probably of equal importance, but still an open question, is that Hausa subservience to authority may have a deep psychological origin. As it is, the team's conclusion that small farmers, adequately guided, could as a whole produce more food than the larger, inevitably received a cold response from the state government, which is under the influence of the World Bank. Since 1974 the bank has been sponsoring the Funtua Agricultural Development Project (FADP), which adjoins the area in which the GCP was carried out. In a letter to the GCP dated 15 May 1978 the FADP Planning Unit said:14 I think your paper underestimates the influence of vested interests and the local hierarchy. A project on the scale of FADP would not take off at all unless we had their support. This in turn means working through the system rather than outside it. I am not sure whether your GCP approach would work on a FADP scale; purely because those in power would resent their loss of patronage. It is not our job to start social revolutions. Elsewhere the letter said:15 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 We doubt Without sr groups ten approach f thereby be] concentrate organizatic reasonably This is a cynic `trickle down which is wha get richer whi estimating the it. And if cre World Bank i projects that bay, mention knew that th necessary pro The letter i like paradox for its yield-i lament, on tl nearer. The even if the their per c maintainer absolute it differences groups. The doublin? of disaster ii hundred, or The bank I poverty', 800 will be reduc figures are n( Even then, tl Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox ,roduction ove about ine.13 al advance e consider- )pment on rs realized it a change .d pay. But rt its rural :eivable, in ;ire to help enough to sm ---I in- is Z. Bible it like that if this hap- r of district till an open ',ave a deep adequately the larger, overnment, ?e 1974 the evelopment GCP was 3 the FADP 'ested ale of support. her than ch would ver would :art social We doubt the long-term effectiveness of group extension. Without suitable glue - like the offer of credit for fertilizer - groups tend to split up. Instead we prefer the `trickle down' approach from farmer to farmer, accepting that some will thereby benefit later than the others. As a consequence, we concentrate on our notorious `progressive' farmers. For organizational and administrative reasons we must choose a reasonably small section at first. This is a cynical communication. It is common knowledge that the `trickle down' rarely takes place and that the RDD approach, which is what the FADP is pursuing, enables a small minority to get richer while the majority, at best, remain poor. Far from under- estimating the force of patronage, the GCP succeeded in bypassing it. And if credit is all that is needed to hold groups together, the World Bank might well supply it, instead of lending huge sums for projects that are often socially destructive, like the one near Bom- bay, mentioned in chapter 6. As Huizinga says, the FADP men knew that their model was not working, but failed to draw the necessary professional conclusions.16 The letter is a useful document; for it helps to explain the Zeno- like paradox of the bank's thirty-five years of proclaiming success for its yield-raising projects, on the one hand, and its incessant lament, on the other, that the end of Third World misery is no nearer. The bank's 1979 report said:'7 even if the developing countries were to manage to double their per capita growth rate, while the industrialized world but maintained its, it would take almost a century to close the absolute income gap between them, so great are the differences in the capital and technological base of the two groups. The doubling of Third World growth is inconceivable; and short of disaster in the West, the inequality will continue not for a hundred, or a few hundred, years, but indefinitely. The bank believes that the number of people living in `absolute poverty', 800,000,000 in 1978, excluding those in People's China, will be reduced to 600,000,000 by the end of the century. If these figures are not a confession of failure, they are a description of it. Even then, the bank's projections are sometimes as overdrawn as Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox would be expected from a money-lending organization, staffed by ambitious and prosperous men, which is constantly trying to ex- tend its scope and influence. According to Professor H. W. Arndt, who in general favours the bank's approach, one of its most im- portant forecasts - for Indonesia - `strains credulity'.18 The bank presented its projection at a special meeting of Western countries called in May 1975 to buttress the country's finances after the notorious state oil company, Pertamina, had gone bankrupt to the tune of US $10,500 million - a sum greater than the total 1976- 7 national budget and two-thirds of the Gross Domestic Product. The company's financial collapse resulted from the chronic corrup- tion and incompetence of its directors, whose numerous, futile enterprises included an extravagant and uneconomic steel plant, bought from hard-selling Germans in what was described as `the biggest order of all time'. The bank sought and obtained increased aid to rescue Indonesia's ruling junta, which the United States saw as a bastion of its dwindling influence in South-East Asia. This may have been justified strategically, but it had little to do with the bank's ostensible task of `helping to raise living standards in developing countries'. Political interests, however, do not always, or even most often, predominate directly in bank policy. Generally the sine qua non is that the granting of aid, as it is called, must be consistent with Western economic needs, which are usually seen in the short term, although the overall concept purports to be long-term. Huge con- struction contracts provide profits and jobs for the West. That much is certain; what is left unexamined is the social and economic effects on the people among whom they are planted. Somehow it is hoped that `the economic nucleus we are establishing will fan out through the rest of society' - words used by a World Bank man, who was asked in Jakarta what the bank was really trying to do. But for cultural reasons of various kinds the nucleus does not fan out. A few get richer while traditional society is destroyed or damaged, without anything creative being put in its place. The World Bank's activities rest on the fallacy that Western systems can be grown in or imposed upon any culture. This is a common error; but it is a little less obtusely perpetrated in Europe than in the United States, some of whose diplomats and their families were so overwhelmed by unexpected attitudes in the Third World that in 1978 the State Department engaged a psychiatrist, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Dr Elm cultural astounc Educati divertcc explain Lndone: general ernerS t consegi ma, Vi, was on author 1960s that str The to B try t lend mon not rnak In its I shift i farmer factory `small' each m credit bank's has ali and is Econo those cant nr of def; credit. nothin Zaria Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox by ex- ldt, im- ank ties the the 76- uct. .up- itile ant, ,the ised say rhis with .s in ten, )n is with rm, con- rhat )mic 1w it fan lank ig to not d or ;tern is a rope their -bird trist, Dr Elmore Rigamer, to treat them for what was described as acute cultural shock. An American working for UNESCO in Jakarta astounded his European colleagues by writing to the Ministry of Education, requesting it to arrange for a mosque amplifier to be diverted, because the early morning prayers woke him up; this, he explained, left him unfit to perform his task of helping to educate Indonesians. Trifling though it is, this anecdote emphasizes the general insensitivity towards alien cultures, which blinds West- erners to the inapplicability of their development plans. The serious consequences of this defect brought criticism from Dr A. S. Chae- ma, Vice-Chancellor of the Punjab Agricultural University, who was on the staff of the World Bank for fourteen years. He told the author in Ludhiana that the surge of Punjab agriculture in the 1960s (see chapter 9), with which he was associated, had shown that small-scale methods were best for India. Dr Chaema said: The World Bank do not see this. They do not try to apply it to Bihar, Eastern Uttar Pradesh, Maharashtra and so on. They try to impose a capital-intensive model. They are interested in lending; they create a borrower mentality. Everybody thinks money is cheap. This leads to inefficiency and waste. But I do not mind aid in technology and in equipment we do not make. In its 1978 report the bank said that it had achieved a `significant shift in the orientation of Bank lending towards the small farmer'.19But the statement was insufficiently detailed to be satis- factory for other than public relations purposes. In Guatemala `small' appears to include the top three per cent of landowners, each with 112 acres or more, who are to receive one-half of the credit granted under a joint FAO/World Bank programme.20The bank's attitude to the social consequences of its financial operations has already been described. In general the bank remains a bank and is obliged to minimize risk. In one of its reports, quoted in the Economic and Political Weekly, the bank said:21 `Lending only to those with investment opportunities sufficient to produce a signifi- cant marketable surplus is perhaps the best way to reduce the level of default.' In other words, it is wise to select the less needy for credit. Such a policy is essential to the bank's solvency, but it has nothing to do with helping the world's poor. The bank's man in Zaria was simply echoing its general policy when he wrote that it Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The World Bank paradox was important to respect the `local hierarchy'. A bank paper says: `In many countries, avoiding opposition from powerful and influ- ential sections of the rural community is essential if the Bank's programme is not to be subverted from within.'22 Dr Chaema's disillusionment with Western concepts of Third World development was shared by Dr A. S. Kahlon, Dean of the Faculty of Basic Science and Humanities at the Punjab Agricultural University. He said (to the author): I was influenced by Western ideas at Kansas University. It takes a long time after being exposed to Western models to see things differently. The basic error is that the cultural matrix is completely neglected. The difference is not marginal. In my earlier work, as an econometrician, I wrote of capital- intensive models. Most of our teaching in the university was nothing more than those models.... Somehow at no stage of my training was I told that those models were developed in Western conditions, particularly those in the United States, and had very little application to the economic and social conditions of developing countries. Nobody said: `It may not work in your country'. Perhaps I should have questioned the professors; this shows failure on my part. Perhaps we didn't have much time for thinking, with so many courses. I developed rigour there, then had to apply it here. But it was a dozen years before I realized that the models did not apply. Whichever way it is tackled, socially beneficial rural development in the Third World presents formidable problems. Even cash crops can be agriculturally counterproductive, and monetization can pro- duce social disruption. Writing of the Ivory Coast, Alland says: The Abron, however, are now perched on the edge of violent, perhaps catastrophic change. Since the introduction of cash crops forty years ago, they have decreased their fallow to ten years on the savanna and seven years in the forest. It is already too short for adequate regeneration of the land.... The money economy has affected the Abron in other ways as well. Most significant has been the breakdown of the lineage system and the development of private property. There is evidence that this has increased social tensions and the frequency of witchcraft. Western develops destroy. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 I hierarchy'. A bank paper says: )sition from powerful and influ- iunity is essential if the Bank's from within.'22 vith Western concepts of Third y Dr A. S. Kahlon, Dean of the inities at the Punjab Agricultural eas at Kansas University. It :posed to Western models to error is that the cultural The difference is not marginal. Dmetrician, I wrote of capital- :eac ; in the university was Is.... Somehow at no stage of se models were developed in y those in the United States, to the economic and social ries. Nobody said: `It may not I should have questioned the n my part. Perhaps we didn't iith so many courses. I d to apply it here. But it was a at the models did not apply. My beneficial rural development cable problems. Even cash crops ctive, and monetization can pro- the Ivory Coast, Alland says:23 perched on the edge of violent, nce the introduction of cash c decreased their fallow to ten i years in the forest. It is regeneration of the land.... ed the Abron in other ways as the breakdown of the lineage private property. There is sor -' tensions and the The World Bank paradox Western development policies not only fail to develop; they can destroy. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Indonesia tightens its belt Richard Cowper Jakarta Hit by lower oil demand, Indonesia has been forced to undertake a series of stringency measures. Economic growth will be much slower than in the recent past, threatening to push the country back into the ranks of /ow income earners In recent months Indonesia has had to introduce a series of crisis measures. On 30 March the govern- ment was forced to devalue the rupiah by 27.5% after more than US$1 billion in capital fled the country in the space of less than four weeks. In the middle of May the government announced that it was postpon- ing four of its most cherished and costly investment projects worth just over US$5 billion in a bid to ease the growing pressure on the nation's balance of payments. The key problem is that Indonesia's economy has become overdependent on earnings from petroleum. Last year oil and natural gas accounted for almost 85% of the country's US$20 billion gross export earnings and 65% of the government's budgetary revenues. When the oil price was set on a seemingly endless upwards spiral Indonesia was the boom economy of south east Asia - a goldmine for foreign bankers, contractors and traders. But in 1982 the country was badly hit by slumping demand for its oil and non-oil commodities, and earlier this year a sharp decline in the international price of crude dealt the economy what is now agreed was a stunning blow. With record international reserves in the central bank the government was able to muddle through in 1982 without a sharp change in its expansionary course. But the pressures built up steadily. Last year oil production slumped by almost 17% to 488 million barrels and exports of crude and condensate fell by a similar proportion to 319 million barrels. The result was that in 1982 Indonesia recorded its biggest ever balance of payments deficit and a sizeable shortfall in government budgetary revenues. Economic growth slumped by more than half to a 17-year low of around 3.5%. The deficit on the current account of the balance of payments in the 1982/3 fiscal year ending in March increased almost threefold to an estimated US$7 billion. In the last 12 months or so total foreign exchange reserves are believed to have fallen by about 40% to less than three months of non-oil imports. Early in the year, as bankers began to express grow- ing concern over Indonesia's ability to finance future balance of payments deficits, the government's first reaction was to try to borrow its way out of the problem. In January Indonesia appointed Morgan Guaranty Trust of New York to arrange a US$1 billion syndicated loan (Asia's second largest commercial credit) and in February asked Dai-Ichi Kangyo bank of Japan to lead manage a syndicated loan worth the yen equivalent of US$325 million. This was well over the US$1.2 billion or so raised by the Indonesian Government last year, and was part of a strategy to double straight commercial borrowing to over US$ 2 billion in 1983. Second thoughts Bankers felt that such an increase in borrowing was just about within acceptable limits. Indonesia's foreign public and private debt - now estimated at around US$23 billion - makes the country the third largest borrower in Asia after South Korea and India and according to Dr J. E. Ismael, managing director of Indonesia's central bank, the sixth or seventh largest developing country borrower in the world. But despite its high ranking Indonesia had a number of things in its favour. BALANCE OF PAYMENTS US $ billion Exports (fob) total oil $ LNG Imports (fob) total Current account balance 1978-79 11.4 7-4 8.4 -1-16 1979-80 17.5 11.3 9-8 +2-20 1980-81 21.8 16.2 13.2 +2-13 1981-82 23.1 18.9 18.2 -2-50 1982-83 est. 19.9 16-5 20-5 -6-80 Source: Indonesian monetary authorities and IMF. TH Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Disbursed and outstanding public debt 8.0 10.0 11-7 13.1 13-2 15-0 15.7 19.0 Debt service2 0-5 0.8 1-3 2.1 2.1 1-8 2-0 2-5 Commercial and concessional 3.3 3.1 1-T 3.3 4.3 3.8 4-1 4-2 borrowing3 0-5 1-2 2.4 2-6 4.1 6.5 6-2 4-1 Official reserves4 Debt service as % of net exports 10-3 11.4 15-9 3 On a signed commitment basis. Much of this will not be drawn down in the year of signing. For example Indonesia's disbursed and undisbursed debt at end-1981 was $26.8 billion, of which only $15.7 billion or 59% had actually been drawn down. 4 Includes gold, use of IMF resources and loans from foreign commercial banks of less than one year maturity. Source: World Bank, IMF, and Indonesian authorities. 1 Unofficial estimates 2 Amortisation plus interest. The country is considered politically stable, has little short-term or private overseas debt and its borrowings are still widely regarded as relatively light. Indonesia's debt service ratio, measured as a proportion of exports taking oil and gas on a net basis, is now running at around 24%, less than a fifth of that being run by countries in Latin America which are being forced to reschedule. Unlike many Latin American countries Indonesia has little private overseas debt. Estimates range from US$5 billion to US$3 billion. A doubling of straight commercial borrowing to over US$2 billion in 1983 was, bankers felt, an achievable target though at considerably higher rates than were achieved in 1982. Should Indonesia require more than this, however, many felt that it would meet with some considerable resistance following world-wide nervousness amongst bankers after the Latin American debt crisis and a general flight to quality. Foreign exchange problems As a further cut in the oil price seemed more and more likely bankers became increasingly concerned as to whether even a doubling of commercial borrowing would be enough to finance the deficit. `Indonesia is facing serious foreign exchange problems. The cur- rent account deficit in 1982, 1983 and 1984 will be in the US$6 to US$8 billion range, even assuming a modest recovery in the US economy in the second half of 1983 . . . further measures will have to be taken', said the senior economist of one leading foreign bank in February. Unpalatable measures The banker was right. With official reserves down to just over US$4 billion at the end of December Indonesia clearly could not afford a repeat per- formance in 1983, and when Opec was forced to accept a sharp cut in the international price of oil in March Jakarta was compelled to undertake a series of unpalatable . measures to head off what everyone agrees was a looming economic crisis. The govern- ment hurriedly began to make contingency plans for a sharp cut-back in its budgetary spending, and fol- lowing the appointment of a new cabinet in March, devalued the rupiah from 702.5 rupiahs to the US fou Oan BE-Inic va*%n Us For Help Being one of the country's most experienced banks, we have branches in every Taiwan population centre and nearly 2,000 correspondents in the major cities of the world. No matter what your banking requirements-commercial or financial, national or international-we always stand ready to help. We are your helpful banking partner. BANK OF TAIWAN P.O. Box 305, Taipei, 100, Taiwan, Republic of China. Tel: 371-9111,371-7171 TPIpx- TP11201. TP1 1202. TP1 1637 Cable: TAIWANBANK. TAIPEI Chairman: S. C. Liu President: C. D. Wang THEE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 growth 1978 9,483 6.9 1979 9,990 5.4 1980 10.954 9.6 1981 11,810 3.5 1982 unofficial estimate 12,220 3.5 1983 unofficial forecast 12,460 2.0 dollar to 970 rupiahs. Many felt the devaluation was long overdue. The rupiah had been significantly overvalued for some time, tied as it was so closely to an appreciating US dollar. In the event the government was given little choice. Following the Opec price cut the currency came under intense pressure as the balance of payments outlook worsened and domestic and foreign business confidence in the economy nosedived. Predictions of a devaluation had been rife for months but in late March capital flight turned into a veritable stampede with at least US$1 billion leaving the country under Indonesia's free foreign exchange system in a period of less than four weeks. IMF facilities At the same time the Indonesian government continued to consider actively the possibility of making formal request to the International Monetary Fund for loans of up to US$600 million. In January fashioned standards are complemented by a totally professional organisation. For business meetings, social visits, client enter- tainment, in the bustle of the city or in the beauty of rural England. A call to our office will bring you your chosen vehicle, on time, and in immaculate condition. TEAMED FOR STYLE AND COMFORT - Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 the IMF had agreed to lend Indonesia 69 million SDRs from the country's contribution to the IMF buffer stocks for tin and rubber, though it is as yet unclear whether this has been drawn down. The government is now debating whether to ask the IMF formally for further loans under the organisation's compensating financing facility (CFF) as well as drawing a first tranche of 25% of the 720 million SDR deposit it has with the IMF. Jakarta has provided the IMF with export figures for the Fund to make a decision as to whether Indonesia's financing problems qualify it for a US$389 million drawdown under the CFF facility. In addition Indonesia is now looking hard at the possibility of taking a first tranche facility of US$194.4 million - 25% of its total IMF SDR deposit. Many believe that Jakarta may avail itself of these facilities some time later this year. Investment postponed The latest, and perhaps the most dramatic policy measure to be announced by the government, came on 6 May when Professor Ali Wardhana, the country's economics co-ordinating minister, told the nation that four of the country's largest investment projects were to be postponed and a host of smaller projects put under close scrutiny. Despite the fine words of 'rephasing' it was a heavy blow to the goyernment's ambitious plans to build up a large petrochemicals industry. Effectively put on ice were a DI SARDEGNA Public law bank and Associated Sections - AGRICOLTURAL CREDIT SECTION - MORTGAGE CREDIT SECTION - PUBLIC WORKS CREDIT SECTION ANNUAL REPORT: Summary 1982 (million Iles) Total deposits 11) 4,079,317 (+ 30,72961 - Liabilities with customers 3,266,997 1+ 27,10%) - Cre dit balances with cust omers Net pr ofit for the year 12,724 (+ 71,07%) Funds and reserves 361,640 (+47,89%) - Monetary adjustment reserves (Law n. 72 of March 19, 19531 Branches in Sardinia 63 Other peripheral offices in Sardinia 299 Main branches outside Sardinia: Roma 2, Livorno 1, Milano 1, Genova 1. Ill Including mortgage, other bonds in circulation, funds of credit institutions and other funds. (2) Including loans to customers. balances with credit institutions, debentures and other minor items. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 OIL OUTPUT AND SALES Million barrels Production Exports Domestic (crude) consumption 1978 597 462 112 1979 580 411 124 1980 577 379 139 1981 585 383 153 1982 (preliminary) 488 319 150 1983 (unofficial forecast) 450 280 150 Exports are of crude and condensate, and do not include some 45 million barrels a year of products. Domestic consumption is for products only. Source: Ministry of Mines and Energy, and industry sources. US$1.5 billion aromatics chemical plant at Plaju in south Sumatra, a US$1.6 billion olefins petro- chemicals complex in northern Sumatra, a US$1.35 billion oil refinery at Musi in south Sumatra, and a US$600 million alumina plant which was due to provide the feedstock to a recently completed US$2 billion aluminium complex at Asahan, also in Sumatra. No alternative Contracts for all these plants had already been awarded and their postponement clearly shows that the government has been prepared to take the tough measures necessary to deal with the changed economic outlook. The project delays have been widely welcomed by both foreign and local econ- omists who believe that a number of important gains will result. These include: a much reduced import bill which will help cut the balance of payments deficit; an essential shift away from capital-intensive low employment investment at a time when many of the nation's 155 million population is experiencing severe economic hardship; and lastly an important reduction in budgetary outlays at a time of much reduced government revenues. Jakarta's new financial stringency seems set to depress further the state of the Indonesian economy at a time when growth is already low, but few believe that a responsible government had any real alterna- tive. In the next couple of years both foreign and domestic investment is likely to slow and the in- evitable decline in government spending, which in the past has had such an important effect on the overall level of economic growth, will also have a GOVERNMENT FINANCE Billion rupiahs Fiscal years to 31 March 1979 1980 1981 Revenue 4,339 7,016 10,405 Expenditure 4,461 7,175 11,504 Deficit -122 -159 -1,099 Financed by: Domestic borrowing ... 2 40 Foreign borrowing 111 302 1,023 Cash balance 11 -145 36 Source: IMF HEAD OFFICE III FOREIGN DEPARTMENT 53 HUAI NINE STREET. TAIPEI. TAINAN. A leading bank of Republic of China handling all banking transactions, nationally and internationally. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 debilitating effect. Such measures however will ensure that Indonesia does not run into the awesome problems faced by such spendthrift oil economies as Mexico. In 1981 Indonesia managed to pull itself up into the ranks of the middle income countries as classified by the World Bank. But some now fear that the decline in the oil price could push Asia's largest oil exporter and Opec's most populous nation back into the ranks of the low income countries. Few economists believe that growth will be more than 2% in 1983 - a sharp contrast to the average of around 7.5% recorded over the last decade. With 2 million new jobs to find each year and 3 million new mouths to feed this is bound to bring increased hardship for the 60 million or so Indonesians still living below the poverty line in this the world's fifth most populous nation. It will also mean smaller pickings for foreign bankers, contractors and traders many of whom over the last few years made enormous profits in a country which seemed to come up with a never-ending supply of multi-million dollar projects. Amidst all the gloom, however, there is perhaps one glimmer of light. The government has now been forcibly made to realise that it has to plan the development of a much less lopsided (oil-dependent) economy and reduce its unrealistic ambitions of setting up a massive capital-intensive industrial base which left many of the nation's poor peasant farmers and urban unemployed out in the cold. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ;unction wth any loan, tiny of a number of in our case the si'crs and security lily of earnings. scoots an earnings t stance will be f'ees in those cases rated. by the end of 1982. ,bt. Four-fifths .utions. Is this 91 markets will be ure? 31 bank lending is y to be a slowdown niess there is an overall amount of only moderately. slowly, the share INTER .IIO'',_+IJ I)ED'I' THURSDAY. FEBRUARY 17, 198:, U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, SUBCOMMIII"I'EE ON INTERNATIONAL FI- NANCE AND MONETARY POLICY, Washington, D.C. The committee met, at 9:30 a.m. in room 538, Dirksen Senate Office Building, Senator John Heinz (chairman of the subcommit- tee) presiding. Present: Senators Heinz, Gorton, Mattingly, Hecht, Proxmire, Riegle, Dodd, Sasser, and Lautenberg. OPENING STATEMENT OF SENATOR HEINZ Senator HEINZ. Today the subcommittee will hold the third of its oversight hearings on the international financial situation and the participation of the United States in the International Monetary Fund. So far we have heard from the administration, bankers, and bank critics. Today we will receive testimony from the bank regula- tors. Our witnesses are distinguished, and it is an honor to have them here today. The role of the Nation's bank regulators in the current crisis is direct and significant. Indeed, many critics have argued that the U.S. bank debt problems would not have gotten to their present dangerous stage had our bank -regulators not been asleep at the switch. The primary mission of our bank regulators is the safety and soundness of our banking system. Yet, we have been told of bank after bank whose entire capital is exposed in one or two or three countries, shaking international borrowers. To say the least, therefore, this has hardly been bank regulation's finest hour. This committee has received information that countries that are now in deep financial trouble have been using the agencies and branches of their banks to draw billions of dollars out of our Feder- al funds market to finance their own foreign exchange imbalances. In clear violation of the purpose of this market, the Federal funds market as it is called, those foreign agencies withdrew as much as $10 billion, while both U.S. regulators and banks were either igno- rant of these transactions or failed to respond to the risks that they posed. On Tuesday, Mr. Martin Mayer testified and described this epi- sode as "a disgraceful spectacle of the big New York banks and, indeed, the Federal Reserve, leaning on our regional banks to con- tinue the dangerous practice of selling Federal funds to foreign purchasers who were using them for purposE>a quite illicit by the generally accepted terms and conditions of this market." (237) Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 This regulatory failure, if the record is accurate as described not unique. What we have is an international financial cn~' brought on by a failure to stop at the prudential limits, et?~. though the purpose of regulation is to determine just what th prudential limits are. Mexico did not get into as much financial ficulty with its first 10 or ?50 billion of debt as it did with its i 810 or 820 billion of debt. Likewise, it is hard to believe that t? aJ: is anything that could be celled an effective country limit if we discover, as we did on Tuesday, that our largest bank in United States has 100 percent of its capital exposed in just o^~ country, Brazil. Having noted this, h_'wever, I must add that if our regulator. aren't clear on the fact that the mission that we have charter them to achieve is that of safety and soundness of our bankin system, then clearly Congress is going to have to take some addi- tional steps to make what we thought was apparently clear more clear. And several of my colleagues and I do plan to introduce leg. islation. Indeed, we have introduced legislation, in addition to an- legislation that will come before us for the IMF increase, to direct bank regulators toward these kinds of problems. Yesterday Senator Proxmire and I did introduce a bill that targets what we believe to be three of those needs. Let me comment briefly on that legislation. First of all, the bill would empower the Federal Reserve to establish firm guidelines on country lending limits. The legislation does not attempt to arbitrar. ily assign those limits itself. It would allow the Fed to do that. That is in keeping with advice we received from Secretary Regan earlier this week where he agreed that it is appropriate for Congress to require the Fed to establish loan limits but warned against Con- gress doing it. Second, the bill would mandate that the Federal Reserve require banks to establish special loan loss reserves to be charged against bank capital whenever the Board determines that the aggregate amount of external debt incurred by the public and private borrow- ers in a country is at a level where there is a substantial likelihood that such debt cannot reasonably be expected to be repaid. Again, that would be left to the Federal Reserve Board's judgment as to when such a point is reached and what the amount of those re- serves shou'd be. Finally, the bill calls upon the Federal Reserve to promulgate regulations to require that fees resulting from loan reschedulings should be amortized over the life of the loan rather than taken and recognized as one-shot earnings. This provision would insure that earnings statements more accurately reflect the quality of both the bank earnings and assets and would minimize the incentive for bank syndicators to continually be under pressure to make one syndication after another in order to make profits look better and better. These provisions, I believe, will make it clear to our bank regula- tory agencies, including the Fed, what congressional intentions are, while still giving them the flexibility to implement these directives according to their special knowledge and experience. I would like to emphasize that I and Senator Proxmire and the other members of this committee are open to suggestions for better ways to deal th these issues. But my prin ,,solving our current crisis, we "I icz not repeated. Let me yield at this point ~,. to I w lerstand has in ,nd Senator Proxmire has ?re that committee will this op( -ate if we don't get turn on the microphones. GPENING STA senator PROX`.IIRE. Yes, I f ake a pitch for more spendi;. Mr. Chairman, I want to morning of our hearing sched concerning the foreign lendin me that regulatory changes III to be approved. For that reas troducing the International have introduced. Let me cite just a few facts adequacy of our present regul First, the nine largest U.: their capital to the non-oil de Second, these same nine b their capital to just three Brazil, according to the Fed eating the figure is 130 perce At least one large U.S. ban tal loaned to Mexico alone. Even though danger signa obtuse, U.S. banks Increases ' first half of 1982 by 83.4 bil increase of 21 percent. Over the last 4 years, our oil LDC's at an annual rate banks increased by only 9 I , Mr. Chairman, as we go t get the answer to a very si tors? How is it possible for posed on foreign loans with As far as I can tell, the rci lem. They advised, they mo in fact, they did everythint that is to regulate. One reason for this ab\ - the division of authority agencies. When authority i and energy of the regulate When authority is divided for the total foreign debt p one agency can be held acs Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 rrcord is accurate as described, is an international fin uncial crisis p at the prudential limits, even is to determine just what those not get into as much financial dif- Iion of debt as it did with its last -e, it is hard to believe that there in effective country limit if when .iv, that our largest bank in the f its capital exposed in just one must add that if our regulators mission that we have chartered and soundness of our banking ;oing to have to take some addi- ~u ;ht was apparently clear more ?s and I do plan to introduce leg- ed legislation, in addition to any s for the IMF increase, to direct s of problems. Yesterday Senator I that targets what we believe to gislation. First of all, the bill ?e to establish firm guidelines on ion does not attempt to arbitrar- Id allow the Fed to do that. That Ld from Secretary Regan earlier is appropriate for Congress to imits but warned against Con- hat the Federal Reserve require reserves to be chared against determines that the' aggregate the public and private borrov~- there is a substantial likelihccd e expected to be repaid. Again. Zeserve Board's judgment as to what the amount of those re- ederal Reserve to promulgate ilting from loan reschedulings he loan rather than taken and is provision would insure that reflect the quality of both the ld minimize the incentive for under pressure to make one make profits look better and ke it clear to our bank regula- t congressional intentions are. to implement these directives and experience. I would like ,mire and the other members is for better ways to deal with these issues. But my principal concern is that, in addition to resolving our current crisis, we must do our utmost to insure that it is not repeated. Let me yield at this point to my colleague, Senator Prox,;re. who I understand has an opening statement. And then I under- stand Senator Proxmire has to go to the Rules Comin i'tee to make sure that this committee will be operating at the first of March. It won't operate if we don't get any money from the Rules Committee to turn on the microphones. OPENING STATEMENT OF SENATOR PROXMIRE Senator PROXMIRE. Yes, I feel pretty h ocriti l I' yp ca . m going to make a pitch for more spending. Mr. Chairman, I want to congratulate you for devoting a full morning of our hearing schedule to hear from the bank regulators concerning the foreign lending issue. I think you will agree with me that regulatory changes are needed if the IMF quota increase is to be approved. For that reason, I was glad to join with you in in- troducing the International Bank Lending Reform Act that we have introduced. Let me cite just a few facts that raise serious questions about the adequacy of our present regulatory system. First, the nine largest U.S. banks have loaned 222 percent of their capital to the non-oil developing countries as of mid-1982. Second, these same nine banks have loaned over 112 percent of their capital to just three cou t i A n r es- rgentina, Mexico, and Brazil, according to the Fed figures. I have seen other reports indi- catin th fi i 1 e gure s 30 percent. g At least one large U.S. bank reportedly has 78 percent of its capi tal loaned to Mexico alone. Even though danger signals were apparent to all but the wilful'v obtuse, U.S. banks increased their exposure in Mexico during the first half of 1982 by $3.8 billion. This represents an annual rate of increase of 21 percent. Over the last 4 years our bank i , s ncreased their loans in the non- i oil LDC's at an annual rate of 21 percent, while the capital of these banks increased by only 9 percent a year. M r. Chairman, as we go through these hearings, I th;nk we must get the answer to a very simple question: Where were our regula tors? How is it possible for our banks to have become so overex- Posed on foreign loans without the regulators blowing the whistle? As far as I can tell, the regulators were not unaware of the prob- lem. They advised, they monitored, they cajoled, they encouraged- in fact, they did everything except what they are paid to do, and that is to regulate. One reason for this abysmal failure of our regulatory system is the division of authority among a three separate and independent gencies. When authority is divided three ways. much of the time and energy of the regulators is spent bickering among themselves. When authority is divided three ways, no agency feels responsible for the total foreign debt position of U.S. banks. And in the end, no One agency can be held accountable by the Congress. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 One of the key features of the Heinz-Proxmire legislation is that it assigns authority over international lending to a single vagency that has the greatest expertise' in international I,, nance-the Federal Reserve Board. I am convinc,d that we wil' never get the job done unless we assign responsibility to ors agency, give it a clear mandate to regulate foreign lending, a hold it strictly accountable. Mr. Chairman, I look forward to hearing the testimony from today's witnesses and to developing a continuing discussion of the legislation we have put forward. I will be back shortly. Senator HEINZ. Senator Lautenberg. Senator LAUTENBERG. I have no opening statement. Senator HEINZ. Senator Dodd. Senator DODD. Nothing. Senator HEINZ. Chairman Volcker, this is the second time the committee within about 24 hours has had a chance to welcome you. Welcome back. STATEMENT OF PAUL A. VOLCKER, CHAIRMAN, FEDERAL RESERVE SYSTEM Mr. VOLCKER. Thank you. I wonder if it's worth reading even the relatively short statement I have after you have had the testimony that you have had. Let me just pick out a few points. I outline, in the first few pages of my statement, the general approach toward this problem of pres- sures in the international financial system. I have gone over that before, and I'm sure others have, with this committee or with other committees. I submitted to the committee earlier the statement that I deliv- ered before the House Banking and Currency Committee which dis- cussed at length some tentative ideas in connection with the super- visory area. I did not plan to review that in my preliminary state- ment today because you have that material. But let me just say, in connection with this problem that has arisen, that I think much of the lending of banks over this past decade has reflected a constructive response by the financial system to the need to ease adjustments associated with the world oil crisis. International lending will continue to have to play an im- portant role in a developing world economy. Of course, there can be excesses, and some of the lending pro- ceeded on assumptions that, in retrospect, seem invalid. None of us enjoys perfect foresight, and it remains central to our financial and economic system that the individual lenders reach their own credit judgments. But it is the responsibility of government to establish and main- tain ground rules and procedures that, without stifling the market, provide assurance that the stability of the system as a whole can be protected against the dangers of excessive concentration of risk, and that the element of risk is appropriately weighed. While our present supervisory approaches are aimed at that objective, the rapid development of international lending and today s problems do point to the need for careful review of present policies. Possible modified or new approaches-touched upon in my earlier state- anent-are under intensive re I expect to be able to repor weeks. Al, the ame time, the citcn~':y an abrupt lord fact is few borrowers, 5,1hstantial debts accumulatt- -,rocess would be doomed to i s nake the adjustments to ear ccess. What may seem lob, bank in demanding paymci strain on the system as a within it, could only be damn As I noted earlier, the par ing the international debt pry ments and the private lendir nizations-have been acting points of pressures to the fir center of this effort, and it ship. The remainder of my state ing with the IMF need fo course, is a matter that I he early date. I do not think th ers, financial, political, and t escape the responsibility of particular effort, if we want terest that it succeed. It is it here this morning- I might say, too, Mr. Chai tance of safety and soundne tors, and I very much welcor fully accept that. It is not areas. At the same time, it system work. There has be air. I think Congress has be looks at problems of this sc suppose, before they begin. developed in full-blown fora Let me just say in that cc actions last year in other were not very happy about, considerations. I can think legal lending limits for Am that you think is relevant area of export trading coin trading companies, but we soundness considerations w as banks got into that area ly, did not reflect our Coll, future in that area. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Proxmire legislation is that (ending to a single a.-ency- cpertise in internati-rnal fi- am convinced that we will issign responsibility to one ';;uLite foreign lending, and iearing the testimony from continuing discussion of the )e back shortly. int., statement. this is the second time the id a chance to welcome you. CIRIRMAN, FEDERAL i:M1 it's worth reading even the have had the testimony aline, in the first few pages oward this problem of pres- !ern. I have gone over that its committee or with other the statement that I deliv- ericy Committee which dis- connection with the super- A in my preliminary state- inl. ith this problem that has ig of banks over this past esponse by the financial associated with the world nue to have to play an im- ny. some of the lending pro- seem invalid. None of us ,ntral to our financial and ers reach their own credit 'rit to establish and nmain- thout stifling the mar net, le system as a whole can give concentration of risk. ately weighed. While our ed at that objective,. the rng and today s problems present policies. Possible in my earlier state- ment-are under intensive review: by the super-is, ;ry a-eu.cies, and I expect to be able to report conclusions to you in a matter of weeks. THE DANGER OF OVERREACTION At the same time, the danger of overreaction-of encouraging in- advertently an abrupt retreat from lending-is equally real. The hard fact is few borrowers, at home or abroad, can suddenly repay substantial debts accumulated over years. An attempt to force the process would be doomed to failure, because borrowers need time to make the adjustments to earn the funds or to restore their market access. What may seem logical and appropriate to an individual bank in demanding payment, if generalized, would place such strain on the system as a whole that it, and the individual banks within it, could only be damaged. As I noted earlier, the parties immediately at interest in resolv- ing the international debt problem-lenders and borrowers, govern- ments and the private lending institutions, and international orga- nizations-have been acting cooperatively to deal with the major points of pressures to the financial system. The IMF stands in the center of this effort, and it has responded with force and leader- ship. The remainder of my statement discusses the importance of deal- ing with the IMF need for additional resources. And that, of course, is a matter that I hope this committee will act upon at an early date. I do not think that the United States-we are the lead- ers, financial, political, and economic, of the rest of the world-can escape the responsibility of leadership and participation in this particular effort, if we want it to succeed, and it is in our own in- terest that it succeed. It is in that context that I am delighted to be here this morning. I might say, too, Mr. Chairman, you have emphasized the impor- tance of safety and soundness and the responsibility of the regula- tors, and I very much welcome your statement in that connection. I fully accept that. It is not only relevant in this area but in other areas. At the same time, it has to be balanced against letting the system work. There has been a certain deregulation wind in the air. I think Congress has been involved in that as well. When one looks at problems of this sort, the time to worry about them is, I suppose, before they begin. It is a little late when the problem has developed in full-blown form. Let me just say in that connection, the Congress itself took some actions last year in other areas that we in the Federal Reserve were not very happy about, in terms of future safety and soundness considerations. I can think of a very considerable expansion of the legal lending limits for American banks. That seems to be an area that you' think is relevant in the international area. And in the area of export trading companies, we were not opposed to export trading companies, but we wanted to make sure that safety and soundness considerations were clear in the minds of the Conti ess as banks got into that area. The legislation that was passed, frank- ly, did not reflect our concerns as to what might develop in the future in that area. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 I suspect you will be faced with legislation this year sponsored i? part by the banks which are looking for additional powers. I this; some of those will be well justified. I don't know precisely they are going to ask for, but I would suggest you look at th,V areas with some care in connection with your obvious coneJJ about the future implications for the safety and soundness of banking c-.,stem. I think you might want to look at the reverse, tr. to nonbanking institutions, nonregulated institutions, that in sense are getting into the banking business through the back da,4 and going around the regulatory structure. I think this is an area that we have to work on, and I share tl concerns that you expressed at the start, not just in this area in other areas. Senator HEINZ. Mr. Chairman, the process you have just d, scribed from the export trading company legislation which was en. acted in September or October-I think the President signed it in early October of last year-the increase of the lending limit wa. also something that carne in very late last year-- Mr. VOLCKFR. That is correct. Senator HEINZ [continuing]. Clearly antedated the kinds of prob. lems we are talking about with the international banks. Mr. VOLCKLR. Yes. Senator HEINZ. When we had Secretary Regan before us on Monday, he was asked a very direct question, exactly the one you raised: With deregulation in the wind, did some of this deregula? tion spill over in any way into international bank lending? And he said no, absolutely not. The main spirit of deregulation, he pointed out, had been aimed at deregulating the retail depositors' kinds of concerns, and he indicated very clearly that in terms of interna- tional bank lending there had been no signals sent and no legisla- tion sent down or acted upon, other than those two you mentioned at the very end of last year, that in his judgment had any influence on this. Would you agree or disagree with that? Mr. VOLCKER. If I understand you correctly, the regulators, to the, best of my knowledge, have not requested any legislation hereto- fore on this international lending area. We have, obviously, among us, been working on this problem and, indeed, we have been rather intensively involved in recent years, reflecting some of the con- cerns that you suggested. Someone can look back and say-I look back myself and say-"Were we forceful enough? Were we aggres- sive enough?" That is obviously a legitimate question in retrospect. I don't think it's correct to say we had no concern. We have spoken about it in public as well as in private in connection with banks. We have not asked for additional legislative authority, that is quite clear. What we have under review is whether we need additional legisla- tive authority or not; whether we can use our other regulatory su- pervisory instruments is a matter which is under consideration right at the moment. Senator HEINZ. Well, clearly, you are taking seriously the ques- tion of whether our system has resulted de facto in some kind of Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 failure of bank regulatic some kind of failure, wi'tl red or the FDIC-- `.ir. VOLCKh:R. No, no, Se;;ator HCINZ icontr. ive- the general ua . can = ome about in ~~ne know how to regulate regulators, or the rr gul:1 Of the two, which '.Quid lem? Mr. VOLCKER. YOU s.i' Sense we are not in the in the business of instrc:a Senator HEINZ. Instru Mr. VOLCKFR. All rig First of all, you say that erything is relative in t' part of the world in wh to play in the world ecc the United States, and United States. One is t, suppose, and how to stri eral philosophy that in belong to the banks. Bu exercise of discretion. I think we can learn of this experience, and future; that is our coma Senator HEINZ. Wha' liked to have had bette, in any way, you don't a tion, you don't admit tl- problems. From our po, derstand that given the other regulators with, conclusion would to us t Mr. VOLCKER. We arc Since I have already in other points. Senator HEINZ. I the statement. Mr. VOLCKER. I have. Senator HEINZ. Let's view, there are four. I statement. But let's sta To expand a little bit who on Tuesday testifib of the Federal funds n banks. Funds borrowed as "445 billion on one Mayer, in 1981-82, br: used their access to th change deficits, and soi Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 :'at:un this year sponsored in or additional powers. I think i dent know precisely .~ to finonce a continuing 'w Mr. VOLCKER. I hatetl't focus is probably yvron is They were short-ti rill t:c Senator HEINZ. Verb' Mr. VOI,CKER. But I nl although I'm sure they American banks are. ;,... posits. Senator HEINZ. This till: those very short funds. Mr. VOLCKER. I am sups But the problem is the sa it or overnight Federal fu Senator HEINZ. Surely ternational lending systel ments things that are ver Mr. VOLCKER. All bank; is the diversification on having appropriate liquid I can sit here, and asl; quidity? Was there adequ operations in the United risky countries you know this thing is you ve got to Senator HEINZ. I afire down this practice, becat in fact, $10 billion was o overnight deposits-- Mr. VOLCKER. That is I- Senator HEINZ. Mr. Ch plain to you my concern cans or the Brazilians tli gentinians, I guess, act u sorry, we are just not think that that might h: ticular market? Mr. VOLCKER. Yes. Senator HEINZ. All rig Now, your second poi this. This is an intern:i only players in the gam it doesn't seem to me th in dangerous practice. Mr. VOLCKER. Well--- Senator HEINZ. I'm j1 stand where I'm coming Finally, it seems to nl propriate authority to you-and this is my qu something about this? :.Ir. VOLCKER. We nl:i' may, and that is certain Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 h 'Mexican-Brazilia-.. hat practice seem iv'. and clearly this i is it's not suppos,, countries, and n; t ricted solely to & ct Federal funds in n Federal funds as a I(,d. But I think Mr. I would refer to as e interbank lending s interbank deposits. eneral have expand- Ts, that banks from in that expansion- he situation now, as inches and agencies ey had a large pro- entries. I think that ' ferring to. stions about the s; that is certainly ` to be looking at. I ory authority over )ervised directly by e supervision, and onal Banking Act. the other Federal )wn up rather rap- )reign banks to op- -f this that needs a general banking ice whether those Los Angeles, Chi- Cayman Islands. waking broadly- ins to their oper- k that there is in at in the interna- got to get cooper- untries, and that a sound or un- )reign exchange. rns, use the ulti- mate in short-term borrowing, overnight deposits and transactions, to finance a continuing long-term problem. Mr. VOLCK :a. I haven't got a statistical analysis, but I think y our focus is probably wrong if you're talking about overnight deposits. They were short-term deposits, no doubt about that. Senator Hxu z. Very short. Mr. VOLCKER. But I'm not so sure they were so much overnight, although I'm sure they are in the Federal funds market like the American banks are. Basically they were financing with bank de- posits. Senator HEINZ. This question is directed principally at the use of those very short funds. Mr. VOLCKER. I am suggesting that that focus is probably wrong. But the problem is the same, whether it's a short-term bank depos- it or overnight Federal funds. Senator HEINZ. Surely you don't agree that it's good for the in- ternational lending system to finance with v h ery s ort term instru ments things that are very long-term ones. Mr. VOLCKER. All banks, I'm afraid, do that. I think the problem is the diversification on the other side of the balance sheet and having appropriate liquidity. I can sit here, and ask in retrospect: Was there appropriate li- quidity? Was there adequate diversification on these foreign banks' operations in the United States? When they get in trouble or are risky countries you know you have a problem. But the nature of this thing is you ve got to worry before they get to be risky. Senator HEINZ. I agree with you, but I think we have to nail down this practice, because I believe it's a very dangerous one. If, in fact, $10 billion was on loan to just two countries in the way of overnight deposits-- Mr. VOLCKER. That is not true. Senator HEINZ. Mr. Chairman, just a minute. Let me try and ex- plain to you my concern so you can react to it. And if, as the Mexi- cans or the Brazilians threatened to do on one occasion-or the Ar- gentinians, I guess, actually did do it for a few days; they said, "I'm sorry, we are just not going to pay anything back"-would you think that that might have a somewhat chilling effect on this par- ticular market? Mr. VOLCKER. Yes. Senator HEINZ. All right. That's the point. Nov, your second point was, "Well, other people will be doing this. This is an international financial situation. We are not the` only players in the game. Our banks have to be competitive." But it doesn't seem to me that being competitive is a license to engage in dangerous practice. Mr. VOLCKER. Well-- Senator HEINZ. I'm just making my observations so you under- stand where I'm coming from. Finally, it seems to me you have said you don't think this is ap- propriate authority to do something about this, and I'm asking you-and this is my question-do you want some authority to do something about this? Mr. VOLCKER. We may. I am not certain that we need it, but we may, and that is certainly one of the areas I want to look at. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 we now have a cooperative venture among the three regulator, bank agencies. Arthur Burns, who was a long-time critic of three-agency regulatory structure, said the system causes compe.: tion in laxity. REGULATORS NOT FORCEFUL ENOUGH WITH BANKS It's clear from your own statement and the GAO report that tl;, regulators may not have been forceful enough over the years wit4. the banks in foreign lending concentration. What is your reaction to our proposal to provide guidelines or, country risk lending in the Federal Reserve exclusively so that yot. don't have this division of authority? Mr. VOLCKER. I think on the face of it putting the authority it one agency has advantages, whatever agency that may be. Looked at from that point of view, it's very straightforward. I think the only question that arises is whether you feel that that is consistent with the more general approach toward banking regulation and whether it could be fit into the existing division of authority. 1 think you could do it either way. Looking at this problem in isolation, I think there are advan. tages in the approach of centralizing. But the question doesn't stop there; it's whether you want to accept or reject the more general banking supervisory structure, because I think we can work it-- Senator PROXMIRE. Well, we have made exceptions to the divi- sion-the bank holding companies, for example, are concentrated in the Federal Reserve Board. Mr. VOLCKER. That is correct. There were exceptions made before. Senator PROXMIRE. That has worked very well. I don't think any- body now argues that ought to be divided between the three agen- cies. I haven't heard too much of that. I suppose there is some of it. Mr. Chairman, loans to the lesser developed countries run into the hundreds of billions of dollars. Most of the economies of these countries are in poor shape. How realistic is it to think that a pro- gram such as the IMF has, with $40 billion of additional capital, is going to allow those debts to be repaid? Isn't it more realistic to face the fact that some of those loans will have to be written off as a loss to the banks and others? Mr. VOLCKER. No, I don't think -so, for the major borrowers we are talking about. The IMF programs and approaches and re- sources in and of themselves, are not going to lead to those debts being paid off; that is not the purpose of the IMF resources and the IMF lending. What will enable those loans to be moderated, if not paid off, by and large, is to have the debtors growing into a strong creditworthy position; they don't have to pay off all their debts. You want to have a climate in which those countries are so evi- dently creditworthy that they can finance themselves in the market, not one in which they will get themselves in difficulties in the future. You want to return to a more normal market climate with a debt burden that they can readily service. That gets you into questions, over time, of the growth of the world economy, on the one side, and their own policies on th,: other side. Senator PROXMIRE. I don't get some kind of cave to at least write Mfr. VOLCKER. If you tl,,'n you imply an ('no,enator PROXMIRE. c rates raises the pint. The impact is l97Os remain un- 'h past experience ate implicit in the hout - 4% for the if deflator and fu- \verage real rates ms. And there is tied, it will yield )ns in infrastruc- ve investment- Dital in Brazilian d rates that are The debt in the of course, make :ralized concern Brazilian debt. old requirement d paid in foreign t-term elasticity s. The larger the ominal interest iris and the en- e 13 is the share of tan value added is latter approximate rate is I F-,. What capital share, and 7. Latin ,-American External Debt 153 In sum, long-term positive returns on borrowed resources do not guar- antee the foreign exchange when needed in the short term. The time pro- files of benefits and costs are likely to diverge, requiring continued financ- ing until returns are realized over a longer horizon. If additional external loans are not available, short-term obligations may not be met, or only at the expense of other imports and consequently of economic growth. Ex- ports are unlikely to satisfy immediate foreign-exchange needs even with rapid growth. But they are also an essential element to avoiding a debt trap. The short-term liquidity problem has its counterpart in a medium- term transformation problem: the capacity to divert increased productive capacity to export. Debt can only be repaid, or its rate of growth slowed, through a growing merchandise surplus. An adequate supply of new loans and liberal access to markets are not assured in the present difficult international economic environment. In addition, nominal rates of interest :a 1980 and 1981 are at peak levels and show little sign of consistent decline. They are likely to lag behind reduc- tions in inflation. Oil-poor countries have the gloomy prospect of de- teriorating terms of trade as future oil prices outstrip export prices. To- gether these factors could cause a real debt problem: the costs of the new loans in the 1980s necessary to meet the short-term liquidity requirements of the debt of the 1970s could very well begin to outstrip real returns. A fundamental limitation of a model of debt finance is that it requires a con- tinuing supply of credit on favorable terms for its advantages to be real- ized. Debt in the 1970s could turn out to be more expensive than it seemed. We expand upon this theme in the next section, examining in quantita- tive terms the near- and medium-term foreign-exchange requirements of Latin American debtor countries, with special emphasis on the case of Brazil. IV. PROJECTIONS OF LATIN AMERICAN FINANCING NEEDS The dynamic of the debt is best understood quantitatively by embed- ding its required continuing service within a structure that also projects the merchandise balance. The simplest model for so doing is one that re- lates import requirements to product growth. Despite its abstraction from real-economy complexity, such an approach-because of its orientation to the future-is more informative than reliance upon static debt service ratios or similar measures. It also is more accurate than regression- derived estimates of current account deficits that ignore the mounting role Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 BANKING/ACCOUNTING WHERE WE BANKS PUY THEME BA n Accounting methods vary; on net income, but distort inter-country the ratio of recoveries or write-banks to comparisons of interest margins and loan charge-offs should be much greater than so do legal requirements. losses. The US system lowers interest for a bank using the specific provision By Roger Taillon income but does not affect the loan loss method. How are problem loans treated in provision or charge-off figure; the German other countries? In Great Britain banks set The financial statements of banks are system increases loan loss provisions, and up two types of provision for loan losses, affected by differences between countries in perhaps ultimately charge-offs, while specific and general. The treatment is the accounting treatment of problem, or leaving interest income at a higher level similar to that of banks in a number of non-performing, loans. A non-performing until the loan is charged off. The Italian other European countries, except that the loan is any loan on which interest or method leaves interest income, loan loss British clearing banks provide a higher level principal is not (or is not expected to be) provisions and charge-offs all unaffected. of disclosure. paid in full and on time. This includes loans If the non-accrual method is used, a There has been some discussion about the on which there has been outright default, further decision must be made as to what to appropriateness of the general provision - whether declared by the bank or not; loans do with interest actually received on loans some people see this as a reserve, which is on which amoratorium has been declared; on a non-accrual status. Some banks take not allowed under British accounting loans which have been rescheduled; and the cash interest received as interest income. standards. But the view that it is not a loans which have been converted into stock Others use cash received to reduce the reserve seems to have prevailed and all because of the borrower's difficulties. principal amount of the loan (for book major banks continue to make them or Loans which remain current are regarded as Purposes, not for the borrower's benefit) have resumed doing so. non-performing if there is substantial doubt either for all non-accrual loans or for those For specific sovereign risk, British banks about the ability of the borrower to where it considers collateral insufficient. are now allowed to make tax deductible continue to pay -if, for example, the For rescheduled and renegotiated loans, provisions and some are doing so. borrower has defaulted on other loans. virtually all banks recognize interest in Germany two kinds of tax-deductible This broad definition leaves room for according to the new terms either on a cash loan loss provisions are made-. general pro- subjective judgement on whether a parti- or an accrual basis. Although these loans visions based on a formula established by molar loan is non-performing. For example, might be written down or provided for if tax authorities and the Bundesbank, and is a loan non-performing if it is only 30 days loss of principal is expected, they are not specific provisions. Non-tax deductible overdue and the bank expects the borrower normally adjusted to bring the effective general provisions, considered by most to catch upon the payments? Is rescheduling yield up to a realistic risk-adjusted rate. The banks to be a type of loan loss provision, a normal extension of maturity, or the same is true with foreclosed assets and can be made above the formula amount at result of the borrower's difficulties? Do the shares received in exchange for debt. The each bank's discretion. The balance sheet terms of the rescheduled loan fully reflect practice of writing down assets to provide a amount to provisions is not disclosed, and the risk of lending to the borrower? If more realistic yield was tried in a few the income statement amount can be payments are current and the loan is well isolated instances by US banks in the combined with provisions for reductions in secured, but the borrower has defaulted on mid-1970s, but never became widespread, value of securities holdings and reduced by unsecured loans, will the borrower remain though it seems to make economic sense. realized securities gains, according to the current on this particular loan? For losses of principal, banks in most principle of compensation. The specific Some banks recognize loans as non- countries establish provisions, which may provisions are the banks' estimates, made performing according to strict numerical be specific or general, according to the laws on conservative lines, of probable losses on standards. Many US banks consider any of the country. Loan losses may be charged problem loans. Provisions have been made loan over 90 days overdue non-performing, to these provisions, or directly to earnings. for risk on certain country credits. Unpaid and put it in a non-accrual status. Other The method used in. most European interest is provided for and ultimately banks have a totally subjective process, and countries is to establish general provisions charged against the specific provision. still others use numerical standards as a to the extent tax laws allow, and specific In France, banks can make tax- guide, though the final decision is provisions based on estimated losses on deductible specific provisions against short- subjective. For some types of loans, such as loans regarded as problems. Loans are term loans, and have a choice between a rescheduled loans, the criteria must almost normally charged off against the specific, 0.5074 formula provision and specific always be subjective. not the general, provisions when the final provisions against medium and long-term Once a loan is recognized as non- amount of a loss has been determined loans. In recent years, most major banks performing, interest that already has been, (usually when bankruptcy or reorganization have chosen the specific provision, as it has or is to be accrued, must be dealt with. proceedings have been completed). One of been larger. Although the three largest Previously accrued but unpaid interest can the advantages of this system is flexibility. French commercial banks have been state- be reversed out of interest income and the A provision appears to be a less drastic owned since 1946, and all major ones now accrual of interest stopped. This is the measure than a write-off, so many banks are, banks have made their own decisions method in the United States. US banks will make generous provisions relatively about provisions, subject to a periodic tax continue to accrue interest on loans to early after a borrower's problems have been audit. They have been making substantial Mexico, but some have placed certain discovered, particularly if they can gain tax provisions against country risk for years. Because of Securities and Exchange private loans to Mexico on non-accrual. advantages by so doing. German (and some other) banks accrue The less common method, which is used Commission (SEC) regulations, US bank interest, but make specific loan loss in the US, is to make partial charge-offs of holding companies provide the fullest provisions of an equal amount. In Italy, loans where there is a significant risk of loss disclosure of problem loans. Bank holding separate provision is set up for unpaid of principal. The loans are reviewed companies disclose the totals of loans on interest. periodically. An additional charge-off may non-accrual, other loans over 90 days All three methods have the same impact be made, or, if the borrower's condition is overdue, renegotiated loans and foreclosed b k f the is Most banks use the 90-day standard o rise t The author is vice president, international ratings, at Standard and Poor's. . e- ac improving, there may be a wn loan. If a bank is conservatively applying to place the loans on non-accrual, although this method of accounting for loan losses, this is not required. Adequacy of loan loss' Euromoney May 1983 161 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 BANKING/ACCOUNTING provisions, or reserves as they are called in the US, is determined by the bank and its auditors. The reserves are generally larger for book purposes. The tax-allowed reserves have decreased as a percentage of loans since a 1969 tax law change, and in 1983 dropped to 0.6% of loans. The reserves are, technically, general. The SEC requires an allocation of the reserve to different categories of loans, but this is not the same as true specific provisions, and any portion of the reserve is available for losses on any loan. When banks recognize a probable loss on a loan, they are supposed to charge off all, or a portion of, the loan. Although bankers sometimes speak of "reserving" for a particular loan, this is no more than an internal allocation of the general reserve, and is usually done only on an interim basis. US bank holding companies are required to disclose major exposures to problem sovereign credits, but few have included these in their non-performing loan total, or charged off any portion of the loans. The reason why banks have differed about private sector companies is that some of these companies - in Mexico, for example - have been prevented from paying interest on loans by government bans on foreign exchange. Canadian banks will make specific loan loss provisions when they think it is appro- priate, but they will also charge off loans directly. The total of the net increase in the specific provision and the direct charge-offs each year is considered to be a bank's loan loss experience. Loan losses are charged to income based on a five-year moving average of loan loss experience divided by loans, which is then applied to the year's average loans. The difference between a year's loan loss experience and the amount charged to income based on the five-year moving average formula is taken from, or added to, a reserve for contingencies. The reserve for contingencies is nourished by an allocation from net income. Because loan loss experience has been rising in recent years, the charge to income has tended to be signi- ficantly less than actual loss at most banks. Canadian banks cease to accrue interest when its payment is in doubt. In Japan, as in the US, the loan loss provision allowable for tax purposes has been decreasing as a percentage of loans. Technically banks are not required to decrease the balance sheet amount of these provisions from previous levels, but some have done so, apparently with official encouragement. Non tax-deductible provisions are also allowed, but, to date, the provisions for book purposes have not been very different from the provisions for tax purposes. Most of the provisions are general, and Japanese banks are required immediately to charge off all loans classified as loss by the regulators and the estimated loss on those classified as doubtful. These charge-offs are made directly from the income statement, as an expense item, and not out of the provision. Specific provisions can be made, but only where the loss cannot be closely estimated, and the loan should be written off, in whole or in part, soon thereafter. Specific provisions are not differentiated from general provisions in the income statement, except that, because of the decrease in provisions allowable for tax purposes, very few banks have made any general provi- sions in recent years. When a loan on which a specific provision has been made is written off it is written off against the specific provision rather than directly through the income statement. The Ministry of Finance recently decided to require a third type of provision, for sovereign risk, which in effect will be some- where between general and specific. At present it is not tax-deductible. It is to be established as 1 to S% of loans to countries experiencing repayment difficulties, with the individual banks formally responsible for working out the percentage. Individual banks will decide which countries are in difficulties, but they have to use criteria established by the Ministry of Finance. S020 COMMERZBANK FINANCE COMPANY B.V. U.S.$ 100,000,000 11% Notes due 1991 COMMERZBANK Commerzbank Aktiengesellschaft Goldman Sachs International Corp. Kuwait Investment Company (S.A.K.) Banquelndosuez Credit Lyonnais Daiwa Europe Limited LTCB International Limited Manufacturers Hanover Limited Merrill Lynch International & Co. S.G. Warburg & Co. Ltd. Morgan Guaranty Ltd Morgan Stanley International Orion Royal Bank Limited Salomon Brothers International Swiss Bank Corporation International Limited Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 1 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 187 Risks in International Bank Lending 1. COUNTRY RISK The large increase in international bank lending since 1973-74 has been accompanied by significant changes in the nature as well as the relative magnitudes of such activity from the standpoints of both borrowers and lenders. One of the distinguishing characteristics of many international loans during this period has been their purpose - the funding of current account deficits. Countries have resorted to overseas borrowing on an unprecedented scale to cushion the impact of adverse changes in their external circumstances - notably spiraling energy costs - and to finance industrialization and economic development programs. The result, for a number of borrowers, particularly some LDCs, has been a rapid increase in debt burdens, aggravated by high interest rates. For example, the ratio of debt service to export earnings for ten major LDC exporters of manufac- tured goods is estimated to have jumped from 13 per cent to 21 per cent between 1974 and 19811. The outstanding debt owed to banks by four groups of major borrowers - smaller European countries, OPEC, Eastern Europe and non-oil LDCs totalled nearly $400 billion at the end of 1980.2 Moreover, whereas balance-of-payments financing needs were form- erly viewed as short-term, cyclical, liquidity problems, current payments imbalances are often structural in nature. As a result, many borrowing countries now face periods of basic structural readjustments. Thus, greater demands are being placed on domestic management, capabilities of bor- rowing countries to devise and implement the necessary economic ad- justment programs. While borrowers' debt burdens have grown, so have the relative mag- nitudes of banks' international loans in loan portfolios. Recent U.S. data ' IMF: World Economic Outlook, June 1981, p. 135. BIS Annual Report. 1981, p. 105. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 highlight the growing importance of LDC borrowers: the aggregate expo- sure of the nine largest U.S. banks to LDCs has increased from 1 times total capital in 1977 to more than double capital in 1980, and by the end of 1980 there were 80 instances of U.S. banks with exposure to single LDCs greater than 30 percent of capital funds. More generally, foreign assets and liabilities now account for a large proportion of total assets and liabilities of the banking systems of many OECD countires: for the OECD as a whole, the ratio nearly doubled during the 1970s, from 12 per cent to about 22 per cent. Risks and Concerns The extension of credit across national borders in non-local currencies complicates the traditional assessment of a borrowers ability to repay because "country risk" is a factor. Under the rubric of "country risk," most analysts distinguish "transfer risk" from "political risk".` "Transfer risk" is the danger that a country may impose restrictions on remittances of capital, dividends or interest payments to foreign investors as part of its economic policy. In addition, repayment may be endangered by political develop- ments, like civil or local wars. Recently, concern about country risk has increased. There is a general belief that, at the same time as more and more banks are involved in international lending and the relative magnitude of the international por- tions of loan portfolios has been growing, the actual risk inherent in such activity has grown. At the same time, there is skepticism about the efficacy of approaches that banks have taken to country risk assessment The concerns suggest two lines of inquiry. 1) Have the risks of international lending increased? If so, how? 2) How are banks managing those risks? What is the supervisor's role? ' A few definitions of terms may be useful to the reader. Country risk is taken to refer to the possibility that sovereign borrowers of a particular country may be unable or unwilling, and other borrowers unable, to fulfill their foreign obligations for reasons beyond the usual risks which arise in relation to all lending. Country risk assessment, following on from the above, refers to the methods used (by lending banks in particular) to evaluate the risk of an interruption in the servicing or repayment of obligations by borrowers of a particular country. Country exposure is taken to refer to an individual bank's or banking group's exposure in its total claims on borrowers in individual foreign countries. Measures of exposure to a particular country may take account of guarantees or other factors that could shift risk to a different country from that of the borrower. Country indebtedness is taken to refer, in an international context, to the sum total of external borrowing by a particular country from all sources. Sovereign risk arises from the special risk associated with a sovereign loan, which is a loan to, or guaranteed by, a government (and some government-guaranteed bodies). The special significance of such lending lies in the risk that it might prove impossible to secure redress through legal action i.e. the borrower might claim immunity from process or might not abide by a judgment Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The second area, that of risl of subsidiary questions: ? What techniques of i ? Is country risk asses ? Are some banks bet Gauging the Overall Risks The most frequently us, the loan loss record whict particular categories of lent tional banks engaged in inte loss statistics for the large: measure, the record appear far lower for international tt record has been improving. loan losses as a percent of record 039 per cent in 197E losses relative to total Iosse: cent in 1977 to 153 percent the less direct costs of rescl those indirect costs in man quality have not been high The views expressed in riskiness of international bar dents expected a 'substant lending over the next five yei 'no significant change' or a 'r ings Involving large sums o seen as the most serious tt-. How Banks Assess Countr Existing systems for a complexity from bank to ba that nearly all banks have inc analysis (it also confirmed th country risk assessments b) spondent banks).' However the economic and the politi ? "How Bankers See the World Fir Appendix I summarizes nine syste Canadian, and European banks. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 gate expo- s 1 Vi times r the end of Ingle LDCs assets and liabilities of as a whole, ,out 22 per currencies .y to repay risk," most sfer risk" is s of capital, economic al. develop- is - neral in _d in Tonal por- ent in such the efficacy ent w? isor's role? of a particular I their foreign lending. hods used (by - servicing or pup's exposure exposure to a i shift risk to a )an, which is a I bodies). The ,ible to secure ~cess or might The second area, that of risk management practices, in turn raises a series of subsidiary questions: ? What techniques of risk management and/or reduction are employed? ? Is country risk assessment effective? What are its flaws? ? Are some banks better positioned than others to assess country risk? Gauging the Overall Risks The most frequently used indicator of the risk of bank lending activity is the loan loss record which can be used to assess risks in relation to particular categories of lending. Across-the-board data for major interna- tional banks engaged in international lending are not available, but the loan loss statistics for the largest U.S. banks may be representative. By this measure, the record appears to be reassuring since loan losses have been far lower for international than for domestic activities. Moreover, the loss record has been improving. For the ten largest U.S. banks, international net loan losses as a percent of average international loans dropped from a record 039 per cent in 1976 to 0.10 per cent in 1980. International net loan losses relative to total losses have also dropped, from a peak of 293 per cent in 1977 to 153 per cent in 1980. However, such statistics do not reflect the less direct costs of reschedulings to banks. Although most banks say those indirect costs in management time, liquidity, income and portfolio quality have not been high to date, many believe those costs may grow. The views expressed in the accompanying banking survey' on future riskiness of international bank lending were mixed: 40 per cent of respon- dents expected a 'substantial increase' in the riskiness of international lending over the next five years to the end of 1986, but a majority expected .no significant change' or a'modest increase'. A large number of reschedul- ings involving large sums or a default by a major country borrower were seen as the most serious threats to the system. How Banks Assess Country Risk and Manage Exposures Existing systems for assessing country risk vary in approach and complexity from bank to bank. The study group's bank survey confirmed that nearly all banks have increased the resources dedic::ted to country risk analysis (it also confirmed that smaller banks rely more than larger ones on country risk assessments by others, such as syndicate leaders and corre- spondent banks)' However, there are acknowledged problems with both the economic and the political sides of country risk assessment systems. ' "How Bankers See the World Financial Market", Group of Thirty, May 1982. ' Appendix I summarizes nine systems which have been used or are in use at some major U.S., Canadian, and European banks. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The more serious problems on the economic side stem from the deficien- cies of the data. True, the quality of data has improved somewhat in recent years, and additional efforts at improvement are currently under way. (For example the IMF and BIS have recently been discussing efforts to expand and improve banking information.) Nevertheless, there remain some signif- icant deficiencies in both the quality and availability of the data." Lags in data reporting can be quite serious, sometimes rendering the available statistics virtually useless. There is much evidence that many banks simply did not know the magnitude of the debts of either Turkey or Poland, before the crises in those countries erupted Even assuming reliable and current economic data, however, there are still differences of opinion regarding how well banks use and interpret the data. There are past instances, for example, of banks' enthusiasm for lending being based on a country's natural resource endowments without a concomitant realistic appraisal of the country's ability to manage its natural resources. Currently, most country risk analysis systems utilize a number of economic indicators to develop measures that serve as indicators of coun- try risk While the ratio of debt service to exports is widely acknowledged as an important measure, opinions differ as to the significance of a number of other measures often used to predict the ability to service debt Recently, banks have placed increased emphasis on assessing politi- cal and social factors in borrowing countries. A number of banks have hired political experts and incorporated political considerations in their analysis in new ways, including attempts to develop lists of socio-political "early warn- ing indicators." However, such judgments are no doubt even more prob- lematical than economic analysis. Despite new attempts to take political factors into account, such analysis has often failed to detect important trends, such as political developments which, for example, in the case of Poland, may have contributed to the need to reschedule. In the end, of course, even very sophisticated country risk assessments may be overridden by other considerations. Final action may run the range from voluntary decisions, based for example on perceptions of marketing opportunities, to those that are less than fully voluntary. Examples in the latter category would include situations where the bank is afraid of jeopar- dizing a large existing exposure if it withholds new loans or instances of strong external pressure from the bank's home government arising from foreign policy motivations: one quarter of banks responding to our survey believed that lending had been significantly affected by such pressures. Also, since a bank's competitive status depends importantly on the regard ? Country debt service data, for instance, do not capture all annual amortization requirements; military debt, which is often large, is usually excluded from official statistics; and statistics on short-term debt (up to one year) are frequently deficient of others in the system, some cooperating with other lender out of a sense of responsibil international lending market Competitive pressures i sessments and engage in imf of country lending, competitit that new money will continue even though signs of econ( instance, in the cases of Peru beginning to feel more cautiot able to sustain the inflow of fu excessive debt. Debates about the effica, systems notwithstanding, ba undue risk concentrations In means by which banks reduc particular lender. These inclu with multilateral institutions, i agencies, or securing home g port banks or agencies. Most importantly, banks t) ing loan portfolio diversificatio, tional risk exposure. Nearly all tries, sometimes as a proporti total assets. To arrive at limits, elaborate country risk analyses Most banks can follow strategic monitor quite closely their cot: Supervisory Practices Supervisory practices also risk In general, the principal roll individual bank carry out the t< responsibility and to satisfy thef evaluates country risk and mon not entirely clear how and to authorities currently fulfill this ro bank's country risk systems doe! Also, supervisors follow more ci dons of risk in their banking systt ing statistical reports on country Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 he deficien- tat in recent er way. (For s to expand .ome signif- ta? ndering the that many r Turkey or ?r, there are iterpret the usiasm for is without a its natural number of rs of coun- viedged as rii, '-er of t. sing politi- have hired analysis in .arty wam- ;ore prob- .e political important ie case of essments the range narketing des in the of jeopar- tances of ;ing from ur survey ressures. ie regard juirements; statistics on of others in the system, some banks may feel pressured by the desirabilityof cooperating with other lenders. Finally, some banks may act, at least in part, out of a sense of responsibility to help maintain the longer-run stability of international lending markets. Competitive pressures may lead banks to override country risk as- sessments and engage in imprudent lending. Particularly in the early stages of country lending, competitive behavior tends to dominate. This can mean that new money will continue to pour into a country once it is in vogue," even though signs of economic difficulty may already be evident. For instance, in the cases of Peru, Turkey and Poland, even when banks were beginning to feel more cautious about further lending, those countries were able to sustain the inflow of funds. In such ways, a country can accumulate excessive debt Debates about the efficacy and actual use of country risk assessment systems notwithstanding, banks can and do protect themselves from undue risk concentrations in a number of ways. For example, there are means by which banks reduce or spread the risks of involvement with a particular lender. These include syndication of large loans, co-financing with multilateral institutions, insuring loans with either private or public agencies, or securing home government guarantees through national ex- port banks or agencies. Most importantly, banks typically follow policies and practices promot- ing loan portfolio diversification as the main method of managing interna- tional risk exposure. Nearly all banks set lending limits to individual coun- tries, sometimes as a proportion of capital and reserves or of external or total assets. To arrive at limits, subjective judgments (whether derived from elaborate country risk analyses or not) are translated into objective ceilings. Most banks can follow strategies that allow them to allocate, measure, and monitor quite closely their country risk exposures. Supervisory Practices Supervisory practices also play a part in the management of country risk In general, the principal role of the supervisory authorities is to help the individual bank carry out the task of country risk assessment on its own responsibility and to satisfy themselves about the ways in which the bank evaluates country risk and monitors its own exposure to each country. It is not entirely clear how and to what degree various national regulatory authorities currently fulfill this role. However, bank supervisory evaluation of bank's country risk systems does appear to be becoming more widespread. Also, supervisors follow more closely than formerly trends and concentra- tions of risk in their banking systems, and/or at individual banks, by collect- ing statistical reports on country exposure. In the U.S., because of the nature Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 and history of bank supervision, supervisory authorities make an indepen- dent judgment regarding the risk in lending to particular countries. The practice is not much in evidence elsewhere; but many countries apply requirements designed to prevent undue risk concentrations. (A description of supervisory systems in a number of G-10 countries is at present being prepared by Richard Dale of the Brookings Institution, to be published later this year as part of the overall work of The Group of Thirty. Meanwhile, a brief overview of relevant national regulatory arrangements is supplied in Appendix D). Conclusions There have been no major disasters for the international banking system arising from the growth in international lending activities. However, our survey confirms that most bankers believe that risks have increased and will increase more rapidly in the future. Evaluating the degree to which this may be true is of course no simple matter. For instance, there are factors which appear to mitigate the relative burden of debt for some borrowers. These include growing GDPs, higher levels of reserves, and above all improvements in economic policy-making in most debtor countries en- hancing their own ability to adjust to changes in external circumstances. Yet the rapid growth and relatively high level of international indebtedness has certainly increased borrowers' vulnerability to exogenous events which could impair their ability to service debt At the same time, the growth in the ratio of international to domestic assets in bank portfolios suggests that the system's vulnerability to 'shocks' may also have increased. The concerns generated by aggregate figures on debtor condition and country exposure are often exaggerated. A variety of official support func- tions are already in place. To the extent that ultimate country lending risks are borne by government or multilateral institutions which lend directly, co-finance with banks, subsidize, insure or guarantee bank loans, the actual risk of commercial banks is at least partly underwritten. More significantly, borrowers represent a range of risks, and banks manage their exposures with the intention of avoiding undue concentra- tions of risk. Especially in the last several years, banks and their supervisors have devoted considerable effort to improving management of interna- tional loan portfolios. The question remains as to whether these efforts are fully adequate at a time when the system has probably become more vulnerable to shocks - and perhaps more likely to experience them. Weighing these partly conflicting considerations, the study group believes the following observations are relevant: 1) Banks' decision-making sometimes appears to take place against a background of insufficient factual information. This is partly because Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 there remain serious In, assessments are based. are particularly deficient quality, timeliness and a, lenders. 2) To this end, me plored. Many members centralization of data anal decisions, however, shot 3) Risk assessment There is evidence that c banking market has some borrowers, leading subse 4) The study group be concerned with review, it is not yet possible to re such reviews. It is also th principle, supervisors shot assessments to the banks U.S. supervisors, who are r judgments). 2. RESCHEDULI The number and ma, creased considerably in th' official debt rescheduling: involving 13 countries have have been a party in reneg Peru, Nicaragua, Sudan, Ja way with Rumania, Costa R in these reschedulings hav $421 million for Sudan an( Nicaragua and $3 billion for repayments of capital due aggregate debt owed to bar different order of magnitu, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 there remain serious inadequacies in the data upon which country risk assessments are based. International debt data for short-term borrowing are particularly deficient Further efforts should be made to improve the quality, timeliness and availability of the basic economic data available to lenders. 2) To this end, means for centralizing data collection could be ex- plored. Many members of the study group believe that some degree of centralization of data analysis would be also be appropriate. Judgments and decisions, however, should be left to individual banks. 3) Risk assessments may be influenced by other considerations. There is evidence that competition for business within the international banking market has sometimes resulted in excessive debt accumulation by borrowers, leading subsequently to debt servicing problems. 4) The study group believes that bank supervisory authorities should be concerned with reviewing country risk management systems. However, it is not yet possible to reach firm conclusions about the effectiveness of such reviews. It is also the opinion of the study group that, as a general principle, supervisors should leave the task of actually making country risk assessments to the banks (while recognizing the special circumstances of U.S. supervisors, who are required by law and practice to make loan quality judgments). 2. RESCHEDUUNG The number and magnitudes of country debt rescheduling have in- creased considerably in the last six years. Since 1956, there have been 53 official debt reschedulings involving 20 countries. Twenty-two of these involving 13 countries have occurred since 1975. In the recent past, banks have been a party in renegotiations with seven countries - Turkey, Zaire, Peru, Nicaragua, Sudan, Jamaica, Poland. Discussions are currently under way with Rumania, Costa Rica, Senegal and Liberia. The amounts involved in these reschedulings have varied greatly: $518 million for Peru in 1978, $421 million for Sudan and $13 billion for Zaire in 1979, $580 million for Nicaragua and $3 billion for Turkey in 1980. Rescheduling of Poland's debt repayments of capital due in 1981 alone involved $22. billion. (Poland's aggregate debt owed to banks outside Comecon, at about $17 billion, is a different order of magnitude from that of any other country previously Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 involved in rescheduling).' Most of the banks' exposure to loans subject to rescheduling so far, however, have been relatively small in relation to their capital or earnings. Concerns The possibility of a substantially larger rescheduling, or a series of them, involving large numbers of banks, has created concern whether processes presently used will be adequate for the debt rescheduling of the 1980s. First, the rescheduling process is not codified and involves large numbers of participants - official creditors, banks and other private len- ders, multilateral institutions, the borrower, and sometimes, investment bankers who are advisors to the borrowers. Second, increasingly serious consequences may arise from the conflict between creditors' responses and debtors' needs. Again, the result of the G-30 survey are pertinent to these issues. Asked whether existing ad hoc arrangements would be adequate to deal with more frequent reschedulings involving larger amounts than in the past, 17 per cent said no, 54 per cent were uncertain, and 29 per cent said yes (i.e., were content with existing arrangements). The concerns point to two sets of questions: 1) What are the arrangements usually adopted for rescheduling, their strengths, weaknesses, and risks? 2) What have the terms of rescheduling been? What have the consequences been for lenders and borrowers? The Rescheduling Process The rescheduling of official debt is handled by the Paris Club, an ad hoc group of western official creditors which, since 1956, has met infor- mally when needed under the chairmanship of the French Treasury. Al- though there are no formal rules, the Paris Club has over the years adopted a set of unwritten procedures. The common practice is that the request for a meeting is initiated by the debtor country, generally the creditors have agreed to convene only after payments arrears have already occurred; and an agreement is concluded after the borrower has agreed to an IMF stabilization program. Since the only debt eligible for consideration is government obligations, the practice has been to include as participants at the meetings only the borrower and the principal OECD government Under an agreement signed in April, 1982, repayments of the $2.2 billion in capital that fell due in 1981 is to start in December 1985 and end in December 1988, with the interest rate for the sum rescheduled set at 1.75 per cent over LIBOR. creditors. Observers may inclu World Bank, the OECD and UN the amount eligible for reschec official debt over a 2-3 year pei Because of the changing banks have increasingly becor Hence troubled country borrow Club or private banks or both. There is no standard me( creditors; each case has require The numbers of bank creditors nationalities have been large an( in the case of Nicaragua, over 2C A small number of lead banks, steering committee that actually of the group may be selected t jointly. Bank reschedulings have b ments have taken from 6 month numerous loan syndications hav collection of basic data on outst ber of times the negotiations ha' Club rescheduling discussions added to delay. Even though banks begin pears imminent, there is still a tt banks to pull in different directio agreement on coherent strategy scheduling by extending a balan was undercut when some other term credit lines to Peru. Divisior to be along national lines. The d including relative levels of exI pressures from home governs and/or capital requirements. In most reschedulings the imposing needed economic ad since 1966 the Paris Club has ri the borrower has agreed to an I sometimes made their resched tance of IMF conditions. In the Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 )ans subject to elation to their or a series of ncern whether heduling of the involves large tier private len- es, investment asingly serious :ors' responses e issues. Asked to to deal with t in the past, 17 nt said yes (i.e., iris Club, an ad , has met infor- :h Treasury. Al- e years adopted the request for a creditors have y occurred; and eed to an IMF :onsideration is s participants at :D government on in capital that fell th the interest rate for creditors. Observers may include other government creditors, the IMF, World Bank, the OECD and UNCTAD. The unwritten rules extend also to the amount eligible for rescheduling (about 80 per cent of consolidated official debt over a 2-3 year period) and the repayment terms. Because of the changing composition of developing country debt, banks have increasingly become involved in the rescheduling process. Hence troubled country borrowers may have to seek relief from the Paris Club or private banks or both. There is no standard mechanism for rescheduling debt to private creditors; each case has required than an entirely new process be stated. The numbers of bank creditors involved in recent reschedulings and their nationalities have been large and growing -115 banks from 12 countries In the case of Nicaragua, over 200 creditors for Turkey, and 500 for Poland. A small number of lead banks, usually a dozen of fewer, have formed a steering committee that actually participates in discussions. The members of the group may be selected by the borrower or the major creditors or jointly. Bank reschedulings have been costly and time-consuming. Arrange- ments have taken from 6 months to 4 years to complete. Participants in the numerous loan syndications have had to be contacted; sometimes primary collection of basic data on outstanding loans has been necessary. A num- ber of times the negotiations have had to be coordinated with parallel Paris Club rescheduling discussions. Procedural quarrels have sometimes added to delay. Even though banks begin to "close ranks" once a rescheduling ap- pears imminent, there is still a tendency for individual banks or groups of banks to pull in different directions. Thus it has been difficult at times to get agreement on coherent strategy. A 1976 bankers' attempt to obviate re- scheduling by extending a balance-of-payments loan to Peru, for example, was undercut when some other banks simultaneously reduced their short- term credit lines to Peru. Divisions among banks during a time of crisis tend to be along national lines. The divergence may have any number of roots, including relative levels of exposure to a particular country, political pressures from home governments, or different accounting practices and/or capital requirements. In most reschedulings the IMF plays a critical part in devising and imposing needed economic adjustment programs. As mentioned earlier, since 1966 the Paris Club has refused to proceed with reschedulings until the borrower has agreed to an IMF adjustment program. Banks, too, have sometimes made their rescheduling contingent on the borrower's accep- tance of IMF conditions. In the case of Peru, banks discovered that they Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 alone did not have the sanctions to impose conditions for economic adjustment Poland's application to rejoin the IMF aroused expectations that such a move would facilitate the rescheduling of Poland's 1982 debt repayment The IMF can play a useful role as a catalyst exerting pressure on both sides to move towards a settlement Indeed, in the Nicaragua rescheduling, where the IMF was not itself involved, other multilateral institutions such as the InterAmerican Development Bank, World Bank, and Central American Bank for Economic Integration played a somewhat analogous role. Rescheduling Terms With few exceptions, rescheduling whether by Paris Club or private creditors has consisted of a lengthening of maturities of principal repay- ments at market rates of interest Banks have been particularly insistent on maintaining commercial terms and (except in the case of Nicaragua) have thus far upheld the principle that interest payments may not be resched- uled. Although borrowers have negotiated for lower spreads and fees, they have tended to accept lenders' determinations of grace periods and final maturities. For Paris Club debt the average maturity has lengthened only from 8 to 10 years since 1975. Bankers have rescheduled on similar terms with average terms of 7 to 10 years with up to 3 years grace at rates of LIBOR plus 13144 to 2 per cent Creditors have so far emerged relatively undamanged from reschedul- ing. Paris Club creditors have undertaken no concessional debt restructur- ings since 1971. In a present value comparison of official loans before and after the debt rescheduling over the period 1956-1980, Chandra Hardy estimated the loss to creditors at only about $2 billion or 0.5 percent of the total debt outstanding and noted that "since 1975, there has been no loss to the (Paris Club) creditors."' Although it is not possible to duplicate these calculations for bank debt, estimates indicate that private creditors have probably not suffered a financial loss on a present value basis either. From the borrowers' perspective, however, the terms have been quite onerous, failing to reflect their likely cash flows and essential adjustment plans. Short maturities and creditors' insistence on rescheduling only one year's debt at a time have increased the likelihood of subsequent liquidity problems and the necessity for a subsequent rescheduling. - Most members of the study group believe that the present ad hoc ? Chandra Hardy "Rescheduling Developing-Country Debts. 1956-80; Lessons and Recom- mendations" Overseas Development Council Working Paper. No. 1. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 mechanism may be insuffic that future reschedulings a complex, increasing the risi partly by creating intole4 t. ollectively to be better org, effectively. There also appears to I rescheduling terms are st opinions about optimum negotiators. In some case., reasonably satisfactory - t cited. However, in some ca: argued that the terms have term view by the banks on focusing solely on the triter creditors may either have economic and political re sometimes has been to s( problems later - an event banks nor the borrower. There are precedents f bank relationships with corl that the balance-of-paymen from long-term structural reschedulings will be to rea( medium-term interest of b realistically are able to resur an ideal the study group is r achieving an optimum arra subject to different national sion. "Equal" treatment fo could mean unequal treatr interested parties should debt-servicing difficulties. T play the leading role in gaini in a stabilization program. I- strong case for considerinc the banking industry to hel lenders, discuss issues rel expertise in this area that lenders (see chapter 7). Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 tations that such a debt repayment I pressure on both qua rescheduling, stitutions such as Central American flogous role. is Club or private A principal repay- :ularly insistent on f Nicaragua) have y not be resched- ads and fees, they p, Its and final k chened only i on similar terms at rates of LIBOR d from reschedul- jl debt restructur- loans before and 1, Chandra Hardy 0.5 percent of the as been no loss to o duplicate these to creditors have 'asis either. From 'n quite onerous, rent plans. Short one years debt at ity problems and present ad hoc Lessons and Recom- mechanism may be insufficient for the needs of the 1980s. They emphasize that future reschedulings are likely to be larger, more numerous and more complex, increasing the risks that the present system will prove inadequate, partly by creating intolerable delays. Most, then, see a need for banks collectively to be better organized to handle their role in rescheduling more effectively. There also appears to be a need for re-thinking the principles on which rescheduling terms are struck It is nearly always true, of course, that opinions about optimum terms for debt repayment will differ among negotiators. In some cases, the outcome appears thus far to have been reasonably satisfactory - the experience of Turkey and Jamaica may be cited. However, in some cases of sovereign debt reschedulings it has been argued that the terms have been based on an excessively narrow or short term view by the banks on their own best interest On this argument, by focusing solely on the criterion of reaching an agreement on market terms, creditors may either have failed to recognize or turned a blind eye to economic and political realities confronting the borrowers. The result sometimes has been to set in place conditions likely to result in more problems later - an eventuality that is in the best interest of neither the banks nor the borrower. There are precedents for less rigid approaches to debt restructuring in bank relationships with corporate borrowers. Given increasing recognition that the balance-of-payments problems of many borrowing countries stem from long-term structural development needs, the challenge for future reschedulings will be to reach terms that strike a better balance between the medium-term interest of banks and the timescale over which borrowers realistically are able to resume full debt service. While putting this forward as an ideal the study group is nevertheless aware of the practical difficulties of achieving an optimum arrangement Banks in international syndicates are subject to different national taxes and national regulatory laws and supervi- sion. "Equal" treatment for a borrower in an international rescheduling could mean unequal treatment for lenders. The essential point is that all interested parties should get together at an early stage in a country's debt-servicing difficulties. The study group feels that the IMF should usually play the leading role in gaining acceptance by all parties to the key elements in a stabilization program. However, in the group's judgment, there is also a strong case for considering the establishment of a representative body for the banking industry to help improve the flow of information available to lenders, discuss issues related to debt servicing difficulties and develop expertise in this area that would be of assistance to both borrowers and lenders (see chapter 7). Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 3. INTERNATIONAL. INTERBANK MARKET The international interbank market links banks to one another much as domestic money markets link banks within national markets. The market owes its existence to the need of banks to be able to bid for funds of a particular maturity to fund a loan of a similar maturity and their need to lay off unwanted deposits with other banks. Funds are thus shifted within the international banking system - and between the international market and domestic markets - as banks take deposits from and/or place deposits with one another. The market serves an important intermediary function between savers and borrowers on a global basis. By reallocating funds in the same currency among banks, it also permits participants to generate and/or manage liquidity. Initially limited to transactions among major multinational banks, the market has grown from a few hundred banks in the mid-1970s to well about 1,000 banks from more than 50 countries by 1981. According to BIS estimates, the size of the market grew from about $182 billion in 1975 to $522 billion in June, 1981. The world's largest banks play a predominant role in the international interbank market The banks to which they lend typically relend a certain proportion as well. Most banks participate actively on both sides of the market Reliance on interbank funding tends to be higher for smaller banks and newcomers in the interna- tional market, banks without a U.S. dollar base, and consortium banks. The market constitutes an indispensable source of funds for many banks' international activity, a recent study suggests that interbank deposits ac- count for between two thirds and three-quarters of total external and Eurocurrency deposits.' Two features deserve special mention - the practice of redepositing and the classification of banks according to perceived riskiness ("tiering"). It is not uncommon for funds from nonbank depositors to pass through a chain of interbank transactions before finding an ultimate borrower outside the banking system. Active trading on both sides of the market may accomplish one or more of the following purposes: (1) keeping the bank's name in the market; (2) enhancing the size of bank by increasing total footings; (3) establishing reciprocal relationships that will assure access to liquidity, or access at a reasonable price, in event of a squeeze (banks that only take funds are said to fare especially poorly when markets are tight); (4) gathering current market intelligence about both changing conditions of supply and demand in the market and the market's sense of the needs and 'J.G. Ellis, "Eurobanks and the Interbank Market" Bank of England Quarterly Bulletin. September 1981. conditions of individual participai banks re-deposit more than 40 pe the largest banks) of interbank de The perceived risks of placir been reflected in pricing tiers and/ differences in rate between therr uncertainty. The Herstatt collapse ing in the foreign exchange marke instance of pricing tiers; some bai However, the pattern of interbank months. In current practice, differentiati may be more significant than the study group's survey confirms, ban and overall limits for the funds the These are usually not disclosed, cot limits set by credit officers as para There are two levels of risk individual banks based on their par ity and risk for the system as a who sides of the market, they are confrc Second, and more importantly, thet of the interbank linkages even sow problem caused elsewhere in the s~ the case of the UK fringe banking cr suffered. The above-mentioned survey majority of banks feel that interban because of a change in the com proportion of interbank borrowing banks). And bankers rated "unava potential threat to individual banks, a major country debtor." The concerns that have been can be summarized as follows: ? Now have banks and bank SL the market? ? Has risk in international bar interbank market? Do the inl bute to its instability or stabii Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 MARKET > one another much narkets. The market bid for funds of a rnd their need to lay is shifted within the rational market and i/or place deposits ermediary function 'allocating funds in :ipants to generate rational banks, the 1970s to well about t grew from about r! rgest banks rkc.. The banks to well. Most banks nce on interbank ters in the intema- )rtium banks. The for many banks' sank deposits ac- )tal external and e of redepositing ciness ("tiering"). pass through a Borrower outside he market may :ping the bank's increasing total rssure access to ?eze (banks that ets are tight); (4) g conditions of -f the needs and conditions of individual participants. The bank survey shows that most banks re-deposit more than 40 per cent (nearly 60 per cent in the case of the largest banks) of interbank deposits. The perceived risks of placing deposits with particular banks have been reflected in pricing tiers and/or credit limits. The number of tiers and differences in rate between them tend to increase in times of market uncertainty. The Herstatt collapse of 1974, though originating in overtrad- ing in the foreign exchange market, appears to have provoked an extreme instance of pricing tiers; some banks paid as much as 2% above LIBOR. However, the pattern of interbank rates returned to normal within a few months. In current practice, differentiation among banks in terms of credit lines may be more significant than the minimal tiering in deposit rates. As the study group's survey confirms, banks in the market typically establish daily and overall limits for the funds they will place with (loan to) other banks. These are usually not disclosed, committed lines but are internally imposed limits set by credit officers as parameters for bank traders. Risks and Concerns There are two levels of risk associated with the market - risk for individual banks based on their particular characteristics and market activ- ity and risk for the system as a whole. First, since banks participate on both sides of the market, they are confronted with both credit and funding risks. Second, and more importantly, there is an underlying concern that because of the interbank linkages even sound banks might not be immune from a problem caused elsewhere in the system because of the knock-on effect. In the case of the UK fringe banking crisis of 1974, even perfectly sound banks suffered. The above-mentioned survey by the Group of Thirty showed that a majority of banks feel that interbank activity may be becoming more risky because of a change in the composition of the market (an increasing proportion of interbank borrowing being done by second and third tier banks). And bankers rated "unavailability of interbank funds" as great a potential threat to individual banks, though not to the system, as "default by a major country debtor." The concerns that have been articulated in the press and elsewhere can be summarized as follows: ? How have banks and bank supervisors responded to the funding risks in the market? g ? Has risk in international banking increased because of growth in the interbank market? Do the inherent characteristics of the market contri- bute to its instability or stability? Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Banking Practices In the past, banks were "often prepared to lend on an interbank basis with relatively little financial analysis or personal knowledge of the borrow- ing bank ... on the implicit assumption that a participant in the market possessed sufficient capital resources, support from stockholders (or par- ent bank) or a potential call on central bank assistance to be able to meet its obligations."10 In 'the aftermath of the international banking crisis of 1974, banks began to review this assumption, tightening and improving their credit analysis practices, utilizing stricter limits and controls, and developing more direct personal contacts. Many banks now treat deposit placement lines in the same way as credit lines, basing overall limits and individual transaction limits on as- sessments of creditworthiness, including consideration of country risk (99 per cent of respondents to the G-30 survey said that country risk played a significant role in determining interbank placement and credits). Four factors may influence decisions. First, financial statements may be analyzed. Some banks do a careful analysis of even the largest banks, supplemented by visits by bank staff. Banks without the resources to collect and compile financial information themselves can purchase balance sheet and income statement data along with some standard ratios from several outside sources. There are problems, however, in interpreting annual reports because accounting conventions and disclosure practices vary widely. For this and other reasons, banks themselves as well as some of the new credit informa- tion services, place a great deal of emphasis on a second set of factors. These are the ownership of a bank (and the nature of its relationship to its parent institution, if there is one) and the bank's national support systems - the quality and degree of bank supervision and consideration of lender of last resort facilities; 69 per cent of respondents to the G-30 questionnaire said that they evaluated the willingness of the other bank's government or central bank to come to its aid in adversity. Third, banks watch for unpro- fessional money market dealings and evidence of overtrading. (This, too has its limits since skillful liability management can hide problems, al- though for only a short time). Finally, banks, to varying degrees, strive for a qualitative assessment of management. However, not all banks exercise the same degree of care. Some banks omit or do only a cursory analysis of the very largest banks; some apply general rules of thumb, e.g., considering the largest banks in the world or in any country to be unquestionably creditworthy; and others appear to rely heavily on the judgment of their correspondents. The G-30 survey provides Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 some evidence to support f that all the banks with whicl be backed up by their ce countries. Although many banks commitment fees for these assured, and may indeed dr Many banks therefore take c overall relationships with of important Banks employ v, to gauge as well as possible and in different currencies a may be developed to recipe deliberately cultivated as w, Supervisory Practices As with banking practi( supervision of banks with n Beyond qualitative supervisi liquidity requirements or gu placing outside bounds 01 liabilities. (See Appendix D; survey reported that their t their bank's international int Support Mechanisms and The market as a whole shocks, as was demonstrate freeze. This may be partly t tional interbank market tend response to a shock, becat system. As a result, there i! adjusted rate differentials) a dente. However, it is always it mistrust In the case of serf rests critically on a rapid r depend also on the assure market's ultimate depenc heightened by the nature o discretionary, some degree crisis. To the extent that this Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 on an interbank basis wledge of the borrow- ticipant in the market stockholders (or par- to be able to meet its inking crisis of 1974, and improving their ,trols, and developing in the same way as action limits on as- n of country risk (99 ountry risk played a nd credits). 'a' statements may the largest banks, resources to collect hase balance sheet ratios from several al Irts because 'idc.,, For this and ew credit informa- )nd set of factors. relationship to its support systems ration of lender of 30 questionnaire s government or watch for unpro- ading. (This, too le problems, al- Irees, strive for a re. Some banks ks; some apply the world or in appear to rely survey provides some evidence to support the contention that some banks act on the faith that all the banks with which they place deposits are well regulated and will be backed up by their central banks, even outside the Group of Ten countries. Although many banks assure the availability of standby lines (paying commitment fees for these when necessary), interbank lines are not always assured, and may indeed dry up for any individual bank when most needed. Many banks therefore take great care to maintain and test lines and cultivate overall relationships with other banks. Diversification of sources is clearly important Banks employ various techniques to monitor their lines and try to gauge as well as possible how much they can tap from different sources and in different currencies and maturities. Additional business relationships may be developed to reciprocate for lines, and personal contacts may be deliberately cultivated as well. Supervisory Practices As with banking practices, it is difficult to make generalizations about supervision of banks with respect to their activity in the interbank market Beyond qualitative supervision of bank practices, the capital adequacy and liquidity requirements or guidelines of bank supervisors would play a role in placing outside bounds on the aggregate level of a bank's interbank liabilities. (See Appendix D). About one third of banks responding to our survey reported that their home supervisory authority does not monitor their bank's international interbank lending and deposit placement activity. Support Mechanisms and System Stability The market as a whole has so far been resilient in the face of external shocks, as was demonstrated by the moderate reaction to the Iranian asset freeze. This may be partly because the breadth and depth of the interna- tional interbank market tend to limit the damage when funds are switched in response to a shock, because that causes no net loss of liquidity to the system. As a result, there is a greater chance for a reflow of funds (with adjusted rate differentials) as long as there is no generalized loss of confi- dence. However, it is always important to prevent the spread of contagious mistrust In the case of serious shock, smooth functioning of the market rests critically on a rapid restoration of confidence and may therefore, depend also on the assurance of adequate support mechanisms. The market's ultimate dependence on official support mechanisms is heightened by the nature of market relationshps. Siiice deposit lines are discretionary, some degree of credit rationing appears likely in a general crisis. To the extent that this occurs, banks faced with a sudden unavailabil- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 16-632 0 - 83 - 14 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ity of funds and unable to obtain new funds by raising rates would be at least temporarily reliant on official support There are various forms official support may take - including lender of last resort and other, ad hoc arrangements. For the interbank market, the somewhat paradoxical role of these mechanisms in their dormant state, i.e., short of actually being called into action, is to maintain a degree of am- biguity as to when and under what circumstances an individual bank will be given support while at the same time sustaining confidence that shocks to the system will be controlled and neutralized. The ambiguity serves on the one hand to induce discipline on the part of market participants while at the same time fostering confidence sufficient to ensure that shocks will not trigger panic. Hundreds of new participants have entered the interbank market in recent years, many of them relatively small. The quality of supervision of a number of such banks from outside the major countries and uncertainty about access they might have to lender of last resort facilities in time of crisis leaves cause for concern. Conclusions The interbank market has functioned remarkably well; its considerable breadth, liquidity, and efficiency enable the international banking system to accomplish its enormous recycling task smoothly. The major change in the market is the proliferation in participants that has introduced second- and third-tier banks and banks from a number of non-GIO countries to the system. This bears on both the risks facing individual banks and the system risk and is the main reason why banks themselves feel that the riskiness of the market has increased. It appears from the survey results that banking practices have changed in response, although the extent to which this is true is difficult to gauge. The treatment of bank deposit facilities as credit lines is a positive development; it is just as important for banks to perform careful credit analysis when lending to other banks as when lending to non-bank borrowers. Similarly, effective monitoring and management of funding risks are highly desirable. For large, well known banks, taking interbank deposits may not pre- sent funding risks significantly different from other types of interest- sensitive, short-term liquid liabilities. However, smaller banks, newcomers, and banks without an established funding base are more vulnerable than the major multinational banks to increased tiering of rates or unavailability of funds in the event of a loss of confidence. The possibility of a re- emergence of steeper tiering or withdrawal of standby lines under adverse market conditions, which would naturally have a particularly marked effect on banks that are large 'net takers' of interbank funds, should add an element of self-discipline for all participants. Because of such consid- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 erations, and the lack o ascertaining the ultimat, inter-bank market bank F less than it appears to b It would seem approp market to exercise spec proach to interbank func increase in activity in Eun overall deposit-taking at funding obtained througl because it does not can relationships which man, It is worth emphasise risk than any other type o that supervisory authoriti continued stability of sucl to, or place deposits with. of the quality of manage concerned, the economic resides and a judgment c willingness and ability to i? support in an emergency 4. MATURITY TI While the practice of n its at one maturity and lend mediation, perceived cha have prompted renewed borrowers' market has at t the liability side, typical 0 been reinforced by rising other depositors as well to Competition in loan lengthening of lending ma putting pressure for extra same time, a shift in the U management of monetary accompanied by great vola Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ke - including lender interbank market, the heir dormant state, i.e., -lain a degree of am- individual bank will be fidence that shocks to nbiguity serves on the articipants while at the e that shocks will not entered the interbank small. The quality of e the major countries lender of last resort y well; its considerable nal banking system to ie major change in the roduced second- and GIO countries to the banks and the system el that the riskiness of actices have changed difficult to gauge. The positive development; credit analysis when borrowers. Similarly, s are highly desirable. eposits may not pre- er types of interest- ,r banks, newcomers, pore vulnerable than rates or unavailability possibility of a re- y lines under adverse cularly marked effect Inds, should add an ise of such consid- erations, and the lack of 'transparency of the market - the difficulty in ascertaining the ultimate sources and uses of funds - reliance on the inter-bank market bank placements as a source of effective liquidity may be less than it appears to be. It would seem appropriate for smaller banks and new entrants to the market to exercise special care and take a relatively more cautious ap- proach to interbank funding, but it is not clear that all of them do so. The increase in activity in Euro-market brokers may reflect a relative increase in overall deposit-taking and placing by less well established banks, and funding obtained through brokers may be less reliable in times of difficulty because it does not carry with it the backing of business and personal relationships which many banks have cultivated. It is worth emphasising that a bank is not necessarily a better or worse risk than any other type of borrower even though it is increasingly the case that supervisory authorities in each country pay special attention to the continued stability of such institutions. Decisions to extend credit facilities to, or place deposits with, a bank must therefore be made on an assessment of the quality of management and fundamental strength of the bank concerned, the economic and political condition of the country in which it resides and a judgment of the quality of supervision in that country. The willingness and ability to its central bank to provide "lender-of last resort" support in an emergency should not be taken for granted. 4. MATURITY TRANSFORMATION While the practice of maturity transformation, namely receiving depos- its at one maturity and lending at another, is an integral part of financial inter mediation, perceived changes in Euromarket conditions and practices have prompted renewed attention to the subject. On the asset side, a borrowers' market has at times produced a lengthening of maturities. On the liability side, typical OPEC preferences for short-term deposits have been reinforced by rising short-term interest rates which have induced other depositors as well to seek shorter terms. Competition in loan markets has at times resulted not only in a lengthening of lending maturities, but also a shrinkage of loan margins, putting pressure for extra income on other bank activities. At about the same time, a shift in the U.S. approach to monetary policy, emphasizing management of monetary aggregates vs. short-term interest rates, was accompanied by great volatility of U.S. rates 4and hence Euromarket rates, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 making portfolio management more difficult In 1980 and early 1981, substantial losses on mismatched Positions were reported by a number of major multinational banks. Others, however, profited from the new volatility of interest rates. This greater volatility increases both the risks and possible rewards of mismatching. It is important to try to distinguish the two components of risk in maturity mismatching - interest rate risk and funding (liquidity) risk-and to understand how Euromarket practices affect each. The interest rate risk component is to a great extent alleviated (but not eliminated) by floating rates and the rollover technique which pass interest rate risk on to the borrower. The effect in a period of rising interest rates is to increase credit risk. The extent to which a bank covers itself against interest rate risk depends for the most part on how closely it matches liability maturities to the rollover maturities in its assets. If a loan that is repriced every six months is funded with 30-day money, the bank's exposure to potentially adverse changes in market rates of interest is not fully covered. In addition, smaller, less well-known banks would continue to be vulnerable to increased tiering of rates even if liabilities were completely matched to asset rollover dates. The rollover mechanism does not, however, neutralize funding risk - that is, the possibility that a bank may be unable to tap resources to meet its continuing obligations. For the market as a whole, supply and demand are kept in balance by interest rates; however, the market response for particu- lar banks in different circumstances can vary considerably. Banks with established names can reasonably expect to tap even a large amount of funds, when needed, and at relatively advantageous rates. For smaller, less well known banks, particularly relative newcomers or ones without a con- nection to the U.S. dollar market, the funding risk may be a real one. Bank Practices In the 1970's many banks began to re-examine procedures for asset and liability management with an eye to greater global coordination. Most banks monitor their liquidity positions with some care. As in the case of foreign exchange positions, top management sets general policy for matur- ity mismatches and puts limits on discretionary decisions by lower manag- ers, based on assumptions about movements in rates. The range of practi- cal approaches to fund management runs from centralized global control to decentralized, local (profit center) control. Neither way is clearly superior, there are advantages and disadvantages to both. Banks' actual practices vary. About 40 per cent of banks participating in the G-30 survey indicated that they had reduced limits in reaction to greater risks posed by the current volatility of interest rates. Supervisory Practices Bank supervisors, ment that may arise fro parison of the approach difficult by the variety of wide institutional differe participating in the survr their mismatched posit, Because of the inz Banking Supervision an Mr. Peter Cooke has b, uniform reporting syster maturity mismatching, ness. A number of superv their banks to fund a pro with long-term foreign ci currency business, bank; who is itself the issuer of Conclusions Available maturity s conclusions about wheth, by bank supervisors to irr thus a positive developme is important that the cover worldwide business. Yet even if no worser place most bankers and. volatility has tended to inc This increased risk requir course, losses themselves greater discipline in bank sponsible for their own m concerned to ensure that 5. DISTRESSED The growth of the inrn potential range of problerr Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 )80 and early 1981, xrted by a number of rom the new volatility he risks and possible mponents of risk in (liquidity) risk-and The interest rate risk minated) by floating rate risk on to the is to increase credit ist interest rate risk !lability maturities to ed every six months potentially adverse In addition, smaller, to'-'reased tiering s, allover dates. alize funding risk - esources to meet its ply and demand are ?sponse for particu- lerably. Banks with a large amount of s. For smaller, less ones without a con- y be a real one. rocedures for asset coordination. Most ?. As in the case of ral policy for matur- es by lower manag- -he range of practi- lized global control is clearly superior, s' actual practices 10 survey indicated ased by the cuffent Supervisory Practices Bank supervisors are aware of special problems in liquidity manage- ment that may arise from banks' international operations. But direct com- parison of the approaches adopted by different supervisors is rendered very difficult by the variety of techniques used to measure "transformation" and wide institutional differences. It may be noted, that about one third of banks participating in the survey said that supervisors' performance in monitoring their mismatched positions was "poor' or "fair". Because of the inadequacy of existing statistics, the Committee on Banking Supervision and Regulatory Practices under the chairmanship of Mr. Peter Cooke has been working to try to encourage and develop a uniform reporting system to be used by the BIS to collect data on banks' maturity mismatching, particularly with regard to their international busi- ness. A number of supervisors (e.g., France, Japan) have increasingly urged their banks to fund a proportion of their long-term foreign currency assets with long-term foreign currency liabilities, partly at least because in foreign currency business, banks have no automatic lender of last resort to turn to who is itself the issuer of the currency in question. Conclusions Available maturity structure data make it impossible to reach any conclusions about whether the degree of mismatch has worsened. Efforts by bank supervisors to improve the collection of statistics of this kind are thus a positive development and for these statistics to be fully meaningful it is important that the coverage of data should embrace international banks' worldwide business. Yet even if no worsening of trends on a consolidated basis has taken place most bankers and study group members believe that interest-rate volatility has tended to increase riskiness of traditional mismatch practices. This increased risk requires banks to be more cautious. Furthermore, of course, losses themselves will tend to have the healthy effect of inducing greater discipline in bank practices. Whilst banks' managements are re- sponsible for their own mismatching practices, supervisors must also be concerned to ensure that these are prudently established and operated. 5. DISTRESSED BANKS The growth of the international banking system has increased the potential range of problems created by bank failure. The problems of a Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 single bank, unless contained, could have an impact through the interna. tional interbank market; banks and banking systems are always vulnerable to confidence crises. Moreover, the transnational structure of the interna- tional banking system and the potential global spread of contagion have enormously complicated the management and resolution of bank failures and distressed bank situations. Three different cases of bank failures in the last decade illustrate some of the international ramifications such occurrences may have, not only the unfolding distress of the bank itself, but also the nature, extent, and timing of crisis resolution by national banking authorities. ? In June 1974, the Bankhaus I.D. Herstatt, which had incurred large foreign exchange losses, was abruptly closed by the German Federal Supervisory Authority for Credit Matters. The collapse of the bank shocked the mar- kets, which had not previously demanded risk premia for interbank trans- actions. After the Herstatt crisis, rate tiering appeared, and many sound banks had difficulty getting access to funds simply on the ground of being small In addition, by closing Herstatt at the end of the banking day in Cologne but just after the beginning of the banking day in New York where scores of Herstatt's foreign exchange contracts were in the midst of settlement, the German authorities inadvertently interrupted the interna- tional payments mechanism. Herstatt's principal New York clearing bank, Chase Manhattan, froze the account Debit orders were not honored; credits coming in were not returned. A race for Herstatt's New York assets by its creditors from around the world ensued. ? At about the same time as Herstatt's problems were becoming more visible in the spring of 1974, U.S. banking authorities were in the midst of a protracted attempt to prevent the collapse of Franklin National Bank then the 20th largest bank in the United States. A decision by the Federal Reserve Bank of New York to provide emergency liquidity assistance in substantial amounts had as one of its two main objectives prevention of "the severe deterioration of confidence, at home and abroad, that would have resulted from an early failure of the bank" (Federal Reserve Bank of New York, Annual Report, 1974.) The same concern for international market stability, which was shared by other central banks as well, also prompted the Federal Reserve to acquire Franklin's foreign exchange book when the market, fearing the bank would fail to perform on contracts, began to refuse to sell foreign exchange to Franklin. Because Franklin had a large London branch, management of the problem required the Bank of England's cooperation at two junctures. First, during the months of liquidity assistance, the steadily increasing need for collateral for Franklin's borrowings from the Federal Reserve required the use of assets at the London branch. Second. the ultimate solution, a purchase and assumption transaction, required that the Bank of England help to secure the necessary approvals under English law for transfer of Franklin's London assets to the FDIC which acted as receiver prior to the sale to European-American Bank ? In the spring of 1980? Argentina's Central Bank ordered the liquidation of Banco Intercambio Regional (BIR), the country's second largest private bank The exposure of foreign banks was about $80 million. Foreign Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 currency deposits plan. Moreover, Arg, to accept responsit York State Banking be able to pay off c The liquidation nian banks. The Arg $2 billion to avoid meantime, the cow reserves had begun worry about the adc prolonged banking Concerns about distn international financial mart of interdependence amor doubts about the ability of ( and contain future crises A majority of bankers agreement with the prop( would be vulnerable to a c significant bank or group suggested that they considt two-thirds said, however, tt of lender of last resort fact Two distinct lines of c ? Do individual natior judgment) and willi ? Given the complex system, is there suffi responsible for whit Crisis Management Mech The organization of different national legislatic other countries, rescue re' that respond to illiquidity z tion, of course, is not easy sometimes required to mi central bank has responsit insolvency, though this is t latter countries there are ( Crisis management rr Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 erna- :rable :erna- have Silures some rly the ping of oreign rvisory e mar- t trans- sound f being day in c where lids' of n . 9 mored; (assets 3 more dst of a k, then Federal ance in ntion of ,t would Bank of ch was Reserve .ring the foreign t of the nctures. .reasing Reserve ultimate he Bank - law for receiver cation of .t private Foreign currency deposits were not covered by Argentina's deposit insurance plan. Moreover. Argentinian authorities, claiming lack of authority, refused to accept responsibility for claims on BIR's New York branch. The New York State Banking Department took possession of the branch, hoping to be able to pay off depositors and creditors by selling branch assets. The liquidation of BIR triggered a run on deposits at other Argenti- nian banks. The Argentine Central Bank was forced to inject an estimated $2 billion to avoid a collapse of the private banking system. In the meantime, the country's $10 billion accumulation of foreign exchange reserves had begun to drain away, leading some concerned observers to worry about the adequacy of Argentina's resources to meet a potentially prolonged banking crisis. Concerns Concerns about distressed banks and their impact on the stability of international financial markets spring from perceptions of the large degree of interdependence among banks from all over the world and market doubts about the ability of existing lender-of-last-resort facilities to manage and contain future crises of potentially global proportions. A majority of bankers participating in the G-30 survey expressed their agreement with the proposition that "the international banking system would be vulnerable to a chain collapse in the event of a crisis affecting a significant bank or group of banks", although supplementary comments suggested that they considered this eventuality to be improbable. More than two-thirds said, however, that there was "a need for clearer understanding of lender of last resort facilities." Two distinct lines of questions are raised by such firm comments: ? Do individual national authorities have the capacity (powers, resources, judgment) and willingness to act to avert an international crisis? ? Given the complex transnational structure of the international banking system, is there sufficient clarity of responsibility, i.e., which central bank is responsible for which banking institution? Crisis Management Mechanisms The organization of nations' crisis management systems reflects different national legislation and policies. In the United States and a few other countries, rescue responsibilities are divided among the institutions that respond to illiquidity and those that deal with insolvency. The distinc- tion, of course, is not easy to draw, and interaction of the two functions is sometimes required to meet emerging problems. In some countries, the central bank has responsibility for handling crises both of illiquidity and of insolvency, though this is by no means true of all. However, in some of the latter countries there are other institutions for dealing with insolvency. Crisis management mechanisms may take a number of forms, includ- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ing lender of last resort facilities, deposit insurance and ad hoc arrange- ments. Regardless of the original source or nature of an individual bank's problems, what triggers a crisis of confidence for the whole banking system is a liquidity crisis. In order to stave off or contain such a crisis, authorities must be able to provide needed liquidity quickly to avoid a panic run on deposits. Hence debates about dealing with distressed banks in an interna- tional context have tended to concentrate on lender of last resort facilities. In the classic view, a lender of last resort is an institution which has the responsibility to provide the residual liquidity needs of the financial system rather than to specific institutions. These may arise in day-to-day activity or in emergency situations. In the latter case, the lender of last resort may prevent and neutralize the impact of financial shocks by lending to institu- tions during periods of crisis and by acknowledging its duty to lend in the future. In fact, the presence of a lender of last resort alone may be sufficient to sustain public confidence. At the same time, the efficacy of lender of last resort and other kinds of support arrangements requires that they should not be viewed as providing an unconditional guarantee. Such a guarantee would have the perverse effect of encouraging some banks to take undue risks in the belief that if they got into trouble rescue by national authorities was assured. The development of lender of last resort facilities and other types of crisis management mechanisms is closely related to the degree of maturity of a country's banking system. Such facilities are usually not questioned for the G-10 and other industrialized countries. However, as already noted, the increasing participation in the international system of banks from develop- ing countries has given rise to some unease, in large part because the quality and commitment of their national support arrangements are not clear. The transnational structure of the international banking system poses additional questions of access to lender of last resort facilities for several types of banking institutions. These include foreign subsidiaries and par- ticipations and sometimes even foreign branches which, in a crisis, may be unable to obtain access to their parents' lender of last resort. Increasing numbers of multinational consortium banks add their own element of uncertainty. The Response of Banks After Herstatt Since 1974, the behavior of banks in the interbank market has re- flected varying perceptions of the support that may be made available to a distressed bank. Some banks treat possible unwillingness or inability of a central bank to support its national banks as part of country risk and may extend or withdraw credit lines as their analysis of circumstances dictates (See answer to Questi attempts to determine % large and/or govemmc believed to be in distre rests on the belief that t then continue to lend it avoid crisis while other. tinue to extend credit n take advantage of relatih from having proved the The Response of Major With the events of potential need for concc was considered at a me( 1974. The statement tl public concerns should available but, in order to stances under which sup specified. Specifically, th announced that, after cor Euromarkets, "they reco< advance detailed rules liquidity." But they were and will be used if and Conclusions The study group belie feature of a lender of last r and conditions under whic distress would have the c pline. At the same time, the need for clearer understan 6. COMPETITIO CAPITAL In explaining the nary greatest weight to supply ai by lenders seeking to enter Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 id hoc arrange- ndividual bank's banking system risis, authorities a panic run on ks in an interna- resort facilities. )n which has the financial system o-day activity or last resort may nding to institu- ty to lend in the iay be sufficient d other kinds of 'ed as providing re perverse h. lief that if sured. I other types of 3ree of maturity questioned for eady noted, the from develop- rt because the !ments are not 3 system poses ties for several iaries and par- r crisis, may be ort Increasing vn element of narket has re- available to a )r inability of a 1 risk and may inces dictates (See answer to Question 50 in bank survey). Such analysis may include attempts to determine whether rescue efforts might be forthcoming only for large and/or government-owned banks. Once a bank is actually known or believed to be in distress, continued extension of credit from other banks rests on the belief that the authorities will provide support Some banks will then continue to lend in an effort to maintain confidence in the system and avoid crisis while others withdraw deposits or lines; some banks that con- tinue to extend credit may be additionally motivated by the opportunity to take advantage of relatively high rates and the hope of benefiting, over time, from having proved themselves "friends in need". The Response of Major Central Banks With the events of 1973 and 1974 as a catalyst, recognition of the potential need for concerted action in the event of international problems was considered at a meeting of the world's major central banks in Basle in 1974. The statement they issued reflected the classical model, that is, public concerns should be put to rest with assurance that support is available but, in order to keep the markets disciplined, the exact circum- stances under which support would be forthcoming should not be formally specified. Specifically, the Governors of the G- 10 and Swiss central banks announced that, after considering the problem of lender of last resort in the Euromarkets, "they recognized that it would not be practical to lay down in advance detailed rules and procedures for the provision of temporary liquidity." But they were "satisfied that means are available for that purpose and will be used if and when necessary." Conclusions The study group believes that some degree of ambiguity is a necessary feature of a lender of last resort facility. Any move to spell out specific terms and conditions under which assistance would be made available to banks in distress would have the detrimental effect of undermining market disci- pline. At the same time, the strong views of commercial banks that there is a need for clearer understanding of lender-of-last-resort facilities were noted. 6. COMPETITION, PROFITABILITY AND CAPITAL In explaining the narrow spreads on international loans bankers give greatest weight to supply and demand conditions and to aggressive pricing by lenders seeking to enter new markets or expand market share. The entry Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 of new banks into the Euromarket and expansion of international activities by previously established institutions have obviously maintained intensely competitive conditions. For example, data on syndicated loans collected by the World Bank suggest that there may be as many as 10 times the number of lending institutions in the syndicated loan market today as there were in 1972. Of those that the World Bank identified by name (institutions in the first nine or ten manager positions), one-third of 1980's syndicated loan managers are headquartered outside Europe or North America, compared to only one-eight in 1973: See Appendix C. Concerns Perceptions of increasing risk in international lending are frequently accompanied by concern that, with spreads on loans squeezed by intense competition, returns are not commensurate with risk. Moreover, there is concern that the narrow margins lead to lower profits, thus impairing banks' ability to maintain adequate capital ratios. The remainder of this section will explore the following questions: ? What is the relationship between quoted spreads and bank profitability? ? How have banks responded to narrower margins? ? Does competitive pressure come particularly from some banks with competitive advantages? ? What has the supervisory response been? The Effect of Spreads on Profitability Quoted spreads are a guide to establishing borrower costs, not measuring profit margins, if only because banks' average costs of funds are usually below UBOR, front-end fees on loan agreements provide further compensation and there is the unquantifiable benefit of other business kept or gained. In general, large banks enjoy wider gross lending margins because of their lower average cost of bought-in funds. They and banks that take lead roles are more likely to gain more also from fees and related business. Participants that do not have such advantages - or have them to a lesser extent - have some offsetting benefit, however, since they do not incur as much indirect (non-funding) costs as the lead banks. The question of what level of spreads is "acceptable," i.e., likely to generate an adequate net return, is a very difficult question for any individual bank. Analysis of the profitability of international lending, and international operations generally, poses problems which include allocating indirect costs. It has been reported that many bankers have been dissatisfied with their own internal data and profit-center analyses. The difficulty of account- ing for the true economic cost of rescheduled loans, discussed earlier, further complicates the issues. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Follow-up interviews : "guesstimates" on profite true gross return at about estimated their breakeven elements of front-end fee The record shows 0 erosion of loan spreads. maintain market presence the line at a given "accept, of its loan portfolio. Sources of Pressure on I Some banks have co tory regime within which t relatively low margins an( because there is less emF banks or savings banks differences in reserve requ have an impact on comp( be manipulated to promc However, not all corn tory advantages. For exam more aggressive pricing times. Also, more recent ei aggressively to gain mark( the more established ins cutting price to increase n various groups of banks I Such competitive pr( The bank survey identifiec distorting competition, in were thought by a majori: competition. Supervisory Capital Regt. The continuing declii recovery, and perception: special attention to capita from the major industriz "The Outlook for Intematic na these guesstimates were highh to monitor efficiently their m allocate overheads. etc.. mad, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ies ely by Der !in the an -ed ttly ise is ks' riot are her e pt of :ad ss. ser to ual nal ect 'ith nt- ier, Follow-up interviews to a previous Group of Thirty survey yielded some -'guesstimates" on profitability from non-U.S. banks. Most estimated their true gross return at about 025 per cent above quoted spreads. Also, most estimated their breakeven point at about - per cent over UBOR plus some elements of front-end fees." The record shows that individual lenders are not able to stop the erosion of loan spreads. Since banks feel in many cases compelled to maintain market presence, the principal results of a bank's attempt to hold the fine at a given "acceptable" spread may be a deterioration in the quality of its loan portfolio. Sources of Pressure on Margins Some banks have competitive advantages that arise from the regula- tory regime within which they operate. Highly leveraged banks can lend at relatively low margins and still earn a reasonable return on equity. Also, because there is less emphasis on profitability, some government-owned banks or savings banks may have a similar pricing advantage. Finally differences in reserve requirements and other regulatory measures can also have an impact on competitive abilities of banks, especially if they were to be manipulated to promote or discourage international activities. However, not all competitive pressure comes from banks with regula- tory advantages. For example, sluggish domestic loan demand may lead to more aggressive pricing by banks from different countries at different times. Also, more recent entrants may at any given time be competing more aggressively to gain market share or carve out a special niche. Finally, even the more established institutions may adopt a competitive strategy of cutting price to increase market share. Waves of intense competition from various groups of banks tend to maintain the pressure on margins. Such competitive pressures in the market are expected to continue. The bank survey identified varying capital requirements as the main factor distorting competition, in the view of bankers. Differences in regulation were thought by a majority to be "somewhat" important factors affecting competition. Supervisory Capital Requirements The continuing decline in spreads, since 1976, in spite of some recent recovery, and perceptions of increased risks in the market, has prompted special attention to capital adequacy on the part of banking supervisors from the major industrialized countries. Germany and Switzerland, for " 'The Outlook for International Bank Lending", G-30, August 1981. It should be noted that these guesstimates were highly qualified since many respondents indicated they are not able to monitor efficiently their marginal cost of dollars, and most admitted that inability to allocate overheads, etc., made costing unreliable. -7 7 _777i Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 example, have recently widened the scope of their capital requirements in order to encourage their banks to increase provision for the risks they incur in their international activities. A brief outline of capital adequacy require- ments is given in Appendix D. To the extent that capital requirements are effective, they should ultimately constrain expansion of lending when returns are inadequate. Reportedly, some Swiss and German banks have reduced their interna- tional lending activity in reaction to new or proposed requirements, and some banks in London claim to have been constrained by Bank of England capital adequacy guidelines, although it is not clear whether this has had any direct impact on their international business. A previous Group of Thirty survey revealed that respondents' banks believe capital adequacy will be one of the more important constraints on future international lending, although not necessarily a very significant one. The BIS, in its April 1980 communique, listed capital adequacy as one of the three elements of international banking soundness to which the central bank governors attach "cardinal importance", and endorsed the efforts of the Cooke Committee in this area. It seems likely pressure by national authorities to sustain adequate levels of capital will continue, and will be beneficial for the protection of the earning capacity of the interna- tional banking system as a whole. This may be accompanied by some move towards convergence of different countries' capital adequacy standards, although this is likely to be a fairly long-term prospect Conclusions It is the opinion of the study group that supervisors should not attempt any direct action to increase loan margins. There may in any event be practical limits to the efforts of individual supervisors, because of possible disadvantages to their banks from prudential requirements that are signifi- cantly more stringent than their competitors'. For that reason, cooperative efforts among supervisory authorities are a very positive development The bank survey revealed support for the view that requirements should be harmonized - with a preference (perhaps not surprisingly) for achieving this by reducing rather than raising regulatory requirements. 7. FURTHER SUGGESTIONS FOR REDUCING RISKS IN BANKING The purpose of this concluding section is to explore two suggestions for reducing risk - through a requirement for banks to make provision for Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 rescheduled loans ar dealing with resche indebtedness. These preceding sections Provision For Resc' A recently topi should be obliged tc uled. The question i the making of some time of reschedulin indicates the existei presumably resolve, doubt that the lendii not been borne ou provision for oppo opinion of the stu( common, it would against reschedule, some general prov exceptional, superv Those who arc 1. There is littl and resche and differin concept of vidual regu safety and s more lenie 2. A second solved by b loans to c obviously r to the sam 3. A third arg creditors' i fulfill their has been On the positive Si( 1. The resch lems. Sucl the resche reality of d in reschec 2. Provisions Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 I requirements in e risks they incur 1equacy require- ve. they should are inadequate. td their interna- luirements, and lank of England ier this has had Group of Thirty 3equacy will be itional lending, 1equacy as one s to which the I endorsed the .ly pressure by continue, and o interna- nied by some ital adequacy ospect ild not attempt any event be ise of possible hat are signifi- ?i, cooperative lopment. The its should be for achieving )(ICING suggestions provision for rescheduled loans and, secondly, byway of improving the arrangements for dealing with rescheduling and the flow of information on international indebtedness. These are in addition to the recommendations made in the preceding sections of this report. Provision For Rescheduled Loans A recently topical subject has been the question of whether banks should be obliged to make provisions against loans that are to be resched- uled. The question is whether regulators ought to move towards requiring the making of some provision against a portion of rescheduled loans at the time of rescheduling. To put it another way, rescheduling - de facto - indicates the existence of a loan quality problem. Even if this problem is presumably resolved through an agreed rescheduling, there is no reason to doubt that the lending institutions' judgment at time of loan origination had not been borne out. Consequently, provision against possible loss or a provision for opportunity-loss seems prudent and reasonable. It is the opinion of the study group that, as reschedulings may become more common, it would be in, the interest of banks to make some provision against rescheduled debts either specifically or through the existence of some general provision of adequate size and, unless circumstances are exceptional, supervisors should encourage action on these lines. Those who argue against this point of view note the following: 1. There is little international uniformity in the treatment of non-performing and rescheduled loans. Obviously, the inequity posed by differing rules and differing standards can be used as an argument to frustrate the basic concept of provisions for rescheduled sovereign loans. However, indi- vidual regulators could proceed along lines they deem to be best for the safety and soundness of their banking system even if other regulators are more lenient 2. A second argument is that the requirement for rescheduling can be solved by bank refinancing. Rescheduling might be avoided by increasing loans to cover interest and/or principal payments. This technique is obviously nothing more than putting off the day of reckoning; it amounts to the same thing as a rescheduling and lacks conviction. 3. A third argument in opposition to provisioning has been that it weakens creditors' negotiating position and might tempt debtor nations not to fulfill their obligations, although there is little evidence to suggest that this has been a feature in rescheduling activities to date. On the positive side, the argument for provisioning is that 1. The rescheduling is, in and of itself, an indication of loan-quality prob- lems. Such quality problems should be recognized and some portion of the rescheduled loan should be reserved both as an indication of the reality of the loan quality problem and also because of the costs involved in rescheduling, not the least of which is the opportunity cost 2. Provisioning reinstills into sovereign lending one element of discipline Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 which may have diminished substantially over the past decade as losses in international lending have been contained due to rescheduling ac- tivities. Clearly, the problems concerning provisions for losses and reschedul- ing activities are substantial. On the other hand, a more rigorous approach could help improve discipline within the international banking system. In addition, it would discipline the sovereign borrowers and strengthen forces making for better balance of payment adjustments. In sum, the study group believes that it is appropriate for all supervisory and regulatory authorities to encourage banks to take action in this area, although it is recognized that it is unlikely that this will be possible at least initially in any uniform way. Inadequacies of Existing Arrangements The study group feels that the existing arrangements among banks to deal with country debt reschedulings are unsatisfactory, being almost entirely of an ad hoc nature. In particular, the period leading up to renegotia- tion has been extended, to the detriment of all parties, by the need for lending banks to be persuaded to join together, pool information and appoint negotiators (recent experience has shown that it can take a long time before the major banks even know what other banks are involved). Also, the study group notes that the assembly process in respect of gather- ing information on cross-border claims of commercial banks is incomplete and needs to be improved. A good example was that of Turkey where the first estimates of lending proved to be far lower than the total which emerged when banks and other creditors revealed their individual lending figures. The same happened in the case of Poland. The study group feels that it would be in the best interests of both debtor countries and creditor banks if it were possible to have a central unit in which statistics on international lending were kept complete, up-to-date and confidential. This might be undertaken by the BIS, building on their existing work, or conceivably by a new organization established by the banks themselves. Clearly, the combination of a prolonged recession, falling commodity prices and historically high levels of real interest rates in most major countries and especially in the United States could lead to further strains appearing in the banking system, especially if a number of reschedulings were to take place either simultaneously or within a short space of time. It might well be that the banks would react to an increase in perceived risk by cutting back international lending. If the same phenomenon applied to the inter-bank market, an individual bank could find it difficult to renew deposits in the inter-bank market, thus setting off a contraction in liquidity. While these risks exist whether arrangements for rescheduling of country debts are efficient or inefficit unnecessarily increasec activated mechanism fc lens. By contrast, it w creditors, once a coun convened and the govt unison to a common p The same point aF and the International M even informal) system e as a group and officer regularly to discuss mute that the IMF and the Wo initiate discussions with being accused by memt is felt strongly that this establish means of bette to establish a method o lending, namely the corn and government credito each other and with borr to react quickly in case A Consultative Group ft The study group felt dealing with a debt resc country could resolve its to a precipitous withdr severe domestic econoi such prompt action co consideration to initiative international financial cc One area in which ously in this report, is in ti on the liabilities of coun Data on intemation. Bank and the Bank for which could supplemer additional information frc increasing the 'transpar, information on the expos sovereign borrowers, lei Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 it decade as losses rescheduling ac- s and reschedul- lorous approach nking system. In trengthen forces . the study group ory authorities to ecognized that it uniform way. among banks to 1, being almost up to renegotia- by the need for nfo---ation and ca, ce a long s are involved). spect of gather- ,s is incomplete nates of lending ranks and other ie happened in be in the best sere possible to ding were kept fertaken by the ,w organization ng commodity in most major further strains reschedulings pace of time. It .rceived risk by i applied to the renew deposits liquidity. While country debts Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 are efficient or inefficient, the study group feels that the level of risk is unnecessarily increased because there is no generally accepted and readily activated mechanism for dealing with a potential escalation of such prob- lems. By contrast, it was noted that in the case of official government creditors, once a country finds itself in difficulty, the Paris Club can be convened and the government creditors are able to react quickly and in unison to a common problem. The same point applies to relationships between commercial banks and the International Monetary Fund and the World Bank. No formal (or even informal) system exists whereby representatives of commercial banks as a group and officers of the International Monetary Fund can meet regularly to discuss mutual problems. Naturally, the study group recognizes that the IMF and the World Bank would find it difficult, if not impossible, to initiate discussions with commercial banks on country problems for fear of being accused by member countries of favoring such creditors. However, it is felt strongly that this legitimate concern does not obviate the need to establish means of better communication. The overriding consideration is to establish a method or forum whereby the major actors in international lending, namely the commercial banks, the multilateral official institutions, and government creditors could find a way of working more closely with each other and with borrowers both to improve the flow of information and to react quickly in case of need. A Consultative Group for International Banking? The study group felt that the more rapid the action of the main actors in dealing with a debt rescheduling need, the more likely would it be that a country could resolve its problems in a timely manner without being subject to a precipitous withdrawal of credit and hence possibly unnecessarily severe domestic economic adjustments. Among various ways in which such prompt action could be encouraged the study group gave close consideration to initiatives that might be taken by the private sector of the international financial community. One area in which further improvement is required, as noted previ- ously in this report, is in the collection and timely dissemination of statistics on the liabilities of countries to the banking system and capital markets. Data on international bank lending is already gathered by the World Bank and the Bank for International Settlements, but a banking bureau which could supplement information from such sources by obtaining additional information from borrowers or lenders could play a useful role in increasing the 'transparency' of the market (for example, by gathering information on the exposure of banks from different countries to particular sovereign borrowers, lending by banks outside the Group of Ten and Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Switzerland, the positions of official and other non-bank creditors, and movements in short-term credit flows). Beyond such initiatives to improve information could come the estab- lishment of some forum (an "International Banking Consultative Group"?) in which leading international bankers would be able to discuss issues of mutual concern. It might also be able to liaise on behalf of bankers with official international and government agencies, providing these bodies with an additional forum for discussing problems concerning international capi- tal flows and market regulation. Equally important, it would be available as an additional channel through which borrowers would be able to convey their views more effectively to the international banking community at large. This role as a "channel of communication" might over time be found particularly useful in connection with international debt servicing problems. The body could not itself represent banks in rescheduling negotiations, but could in certain circumstances occupy a liaison role between bankers and borrowers, and between different banking interests in a problem loan situation. The possibility of conflicts of interest must be acknowledged, given that the group would be composed of bankers who are themselves active in the international field, but the group would be in a good position to look beyond such interests and focus on factors of longer-run importance. Past experience has shown that debtors as well as creditors have much to gain from improvements in the machinery for dealing with debt prob- lems. It would be for the "consultative group" to demonstrate through its actions that its role is a constructive one, and not narrowly sectoral in outlook It could provide the means for bringing involved banks together quickly once a rescheduling request had been received, and in due course could be expected to develop expertise that would be of great assistance to negotiators of both parties. A "consultative group" could not, of course, have legal powers to enforce decisions, but would derive its authority from the standing of its members, the expertise of its secretariat, and from the moral support given to its work by the international banking industry. It would certainly be important to discuss the objectives of the new body as widely as possible, to demonstrate the positive role it is intended to play, and to take full account of the views of sovereign borrowers. New patterns of international financial flows will be called for in carry- ing through the volume of international lending needed in the 1980's. These may include expanded use of co-financing, parallel lending and similar techniques. Progress in these directions, which has so far been disappointing, might well be facilitated if there was in existence an authoritative body amongst commercial bankers with which the interna- tional agencies could co-ordinate their thinking and establish acceptable ground rules for co-operation and joint development Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The study group full difficulties in setting up suc members should be form banking communities or sc consideration. On the one markets have developed or of interest along national lir best to avoid members bein (There is also the possibilit' this should not be exaggera would provide a more for perhaps strengthen its moi More generally, these problem if in the first instan( on an informal basis. It wou! helping to avoid the probler enjoy greater freedom to si sions indicate that a wide me industry and among interes sentative international body Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 -ould come the estab- Zonsultative Group"?) e to discuss issues of >ehalf of bankers with ding these bodies with ing international capi- would be available as uld be able to convey g community at large. ht over time be found bt servicing problems. uli- -iegotiations, but b. _en bankers and s in a problem loan ist be acknowledged, s who are themselves e in a good position to onger-run importance. s creditors have much !aling with debt prob- monstrate through its t narrowly sectoral in +olved banks together ,ed, and in due course of great assistance to could not, of course, !rive its authority from retariat, and from the t banking industry. It s of the new body as s intended to play, and wers. be called for in carry- eeded in the 1980's. parallel lending and hich has so far been was in existence an ith which the intema- I e lish acceptable it. The study group fully recognized that there are likely to be many difficulties in setting up such a group. For example, the question of whether members should be formally representative of their respective national banking communities or selected in another manner would require careful consideration. On the one hand, in view of the fact the Euro-currency markets have developed on a transnational basis and that sectionalization of interest along national lines could be counter-productive, it may well be best to avoid members being nominated by national banking communities. (There is also the possibility of anti-trust conflict to be considered, though this should not be exaggerated). On the other hand, national representation would provide a more formal element of structure to the Council and perhaps strengthen its moral authority. More generally, these areas of difficulty might be found less of a problem if in the first instance an experimental body were to be established on an informal basis. It would then grow when experience was gained, thus helping to avoid the problem of unrealistic expectations, and by this means enjoy greater freedom to set a style for future operations. Private discus- sions indicate that a wide measure of support exists, both inside the banking industry and among interested outside parties, for the concept of a repre- sentative international body of the kind discussed in this paper. I Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 The Rescheduling of Country Debt: Is a More Formalized Process Necessary? With the growing importance of commercial bank lending in interna- tional financial flows in the 1970s, it was inevitable that country debt service crises would take on a new flavor. The debt reschedulings that resulted from such crises were not new or unprecedented, of course. Reschedulings of official debt had become fairly commonplace ever since Argentina had asked its government creditors to reschedule in 1956; ten countries en- gaged in 31 separate reschedulings over the two decades 1956-75. Such multilateral exercises had, in fact, become fairly routine through the proce- dures of the Paris Club, an informal group of major Western creditor governments chaired by the French Treasury.' And, while the rescheduling of debt owed to private creditors was less frequent, it was by no means unheard oF, several countries - including Argentina, Brazil, and Chile - had rescheduled their private debt in the 1960s and early 1970s. What distinguished the reschedulings of the later 1970s, then, was not so much their novelty as their scope. Instead of the relative handful of banks, often from a single country that once had been involved in negotiations, there were now 100, 200, or more. (Poland is currently attempting to reschedule debts owed to some 500 separate institutions.) And where a few million dollars were once at issue, the stake had grown to the hundreds of millions, or, in some cases, billions of dollars. This increase in the scale of the reschedulings suggests a correspond- ing increase in their complexity - a complexity manifested both in the substance of the talks as well as the mechanics of a process involving so many participants. And it calls into question whether the ad hoc approach that has previously been taken toward the organization of these negotia- Richard Huff is Financial Analyst in the Strategic Analysis Division of the Office of the Comptroller of the Currency in Washington. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 tions will continue to be effective in the reschedulings of the '80s. That approach, to be sure, has thus far been adequate to the demands placed upon it No rescheduling talks have failed simply because of organizational difficulties in starting a new rescheduling process from scratch each time that banks and debtor governments decide to enter into negotiations. And the flexibility afforded by the absence of a more formalized process has perhaps aided in the resolution of difficult substantive issues.But "ad- hocery" has had its costs - notably the confusion and delay in resolving difficult organizational and procedural questions before substantive discus- sions can begin. And if reschedulings become more numerous and fre- quent in the years ahead - as many observers predict - it is well worth considering whether the process for conducting them ought to be more formalized and institutionalized. This paper will examine that question. We will begin with a review of the rescheduling experience of the past half-dozen years, focusing in particular on whatever recurring problems and difficulties have arisen. The paper will then consider the coordination of commercial debt rescheduling with the renegotiation of official debt and the appropriate role of the International Monetary Fund. It will conclude with a brief discussion of possible im- provements in the present rescheduling process. The Rescheduling Process Getting to the table. A recent IMF staff study2 examined the cases of six IMF members that rescheduled their obligations to commercial banks between 1976 and 1980. It noted that the rescheduling process was gener- ally a long and difficult one, taking from two to five years from the time a debt service problem first emerged until an agreement was actually signed. Generally, negotiations did not begin until one or two years after such signals as the emergence of arrears or the reluctance of banks to roll over maturing credits might have suggested that a rescheduling would be necessary, once begun, the talks themselves took anywhere from 18 months to four years to complete. One of the difficulties the parties to these negotiations faced surely was the lack of a well established means of resolving their differences. "While the modalities for the restructuring of official debt were fairly well estab- lished," comments the IMF study, "the restructuring of debt owed to commercial banks involved, to a large extent, the breaking of new ground." Previous commercial debt reschedulings had concentrated on the restruc- turing of short-term trade credits, but now the focus was on medium-term syndicated Eurocredits, which brought a host of complications. The hun- dreds of banks of many different nationalities involved in the various loan syndications had to be contacted. Basic data on how much was owed to whom had to be col (One country, whict to sending out a que owed.) And in four tions had to be cool who insisted that pr. terms." Ultimately, thoL the six cases were SL reached and signed adhere to the terms The actual hard bar dozen or so lead ba: nation (often assist( other. Also playing k, active participants, i World Bank. The n chosen from the leac lent money to the c largest individual ex were chosen on the each of the major ci Interbank tensi( sen, they faced the ~'~ i _i1 / 711_itl ilf f t (i .,t11( 'i11,+1 _r~%11111... - .. ~ .. i'1r } (ul ?nu~ lY.f,:.l_. ti7:.1r- i 111in11Plj :11 1 u( ii 1 n9 fiii1lit ^ W 111 is3. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 viduals. This permits the corporation to increase the dividends on its new shares and so attract new equity. After some investment is made by the corporation, the exemption might be extended to the old shares, too. If your President did that, I'm sure he'd recuperate the private sec- tor of your economy in short order." Argentina's Roberto Alemann would be equally stem on U.S. fiscal policy. "If I were your Secretary of the Trea- sury, I would reduce the deficit," he says. "I see in the U.S. a very substan- tial money-supply expansion through fiscal deficits. I don't see any correction of it. What Mr. Reagan really did was reduce income and increase expendi- tures. And therefore the deficit has never been as high as it is now in the U.S. And it's the Fed that's financing it. You'll have to adopt indexation if you keep it up. Cut back fiscal deficits, and you might have a small reduction in the standard of living for a while, but then there would be a significant increase. The dollar would be the strongest currency in the world. You'd have long-term money to invest. But instead you will go down the other road. You pump money into the economy. You get higher prices. Then you index, and you think you have corrected. But you have not."-G.S. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 SYNDICATED CREDITS V" MMAJ%mm m m I T S C A A Ew wjU T Wd 01 DI "'no deal was no exception and in the end only covers East Africa. "It's fifty-fifty whether Even the good African risks $123 million was raised. or not they reschedule this year." may reschedule as bankers Bankers were also alarmed by the debt Zimbabwe should still be able to boiro, hold off, service ratio of 34%, and the news that oil for projects, at the short end of the reserves were less than expected. But the medium-term market. It is not expected to By Charles Grant market's reluctance was not justified by any seek many commercial loans: most of this sudden turnabout in the Ivorian economy, year's current account deficit, which is not As they talked in Nairobi in the second which remained under the aegis of an IMF likely to be less than last year's 5500 week of May, African bankers and finance programme. million, should be covered by an IMF loan ministers attending the African Develop- According to the 1983 Ivorian budget, of $384 million agreed in March, together ment Bank meeting faced a major problem: the country will seek commercial bank with western aid. the drying up of Euromarket lending to loans of $183 million this year. A few banks Among the handful of countries which Africa. For many African countries, Euro- are still prepared to lend on an export- could borrow balance of payments loans currency loans had become an important related project basis. They point to the -without difficulty, Gabon and Botswana means of funding current account deficits. efficiently managed and diversified cash are unlikely to do so because of their The source is dwindling. Syndicated crop sector, and to the likelihood of oil extremely conservative economic manage. loans to African borrowers totalled $5 exports starting later this year. ment, while Libya is unlikely to do so billion in 1982, a drop of $2 billion from the "France wouldn't let Ivory Coast re- because of its radical politics. Libya does year before. Euromarket borrowing schedule, it's the jewel of French West not want to become enmeshed in the declined more drastically in the first quarter Africa," said an optimistic banker. "It can capitalist system, so is unlikely to repeat its of 1983, with the signing of only 17 loans continue to borrow from the French Euromarket sortie of December 1981, worth $609 million. Treasury, via the Banque Centrale des Etats unless oil output drops drastically. At a time when the syndicated loan de 1'Afrique de l'Ouest." Only Tunisia, Algeria and Cameroon market has been contracting worldwide, But other bankers are less confident that have sought or look likely to seek balance Eurobankers have needed little prompting French indulgence is unlimited. Some of payments credits this year. Fresh from to close their doors on African borrowers, banks will not lend any more to Ivory the success of its $125 million loan signed in many of which rank among the world's Coast. Inflows of new Eurocurrency funds February, which achieved an astonishing least solvent countries. Eleven of them have have fallen to a trickle this year. If more 50% selldown below lead manager level, recently rescheduled foreign debt or are in banks hold back new lending, a Tunisia is expected to borrow again. Falling the process of doing so: Central African rescheduling could be precipitated. oil output has widened the current account Republic, Liberia, Madagascar, Malawi, Morocco is another country which some deficit, not all of which can be financed by Sierra Leone, Senegal, Sudan, Togo, bankers have tipped for rescheduling in Arab aid. Tunisia should be able to hold the Uganda, Zaire and Zambia. 1983. Morgan Guaranty predicts that 65% very fire spread of '/2% which it paid in Three of Africa's biggest borrowers are of this year's export earnings will be used to February, thanks to the scarcity value of its possible candidates for rescheduling this service Morocco's $10.3 billion of foreign paper. Much in Tunisia appeals to bankers: year: Nigeria, Morocco and Ivory Coast, debt. Conservative Arab countries are political stability, up-to-date statistics, and which together owe $35 billion. Other expected to chip in over $1 billion of aid, diversified sources of foreign exchange, candidates include Kenya, Tanzania, but that may not suffice to cover the including tourism, and exports of olives and Mozambique and Ghana. (For analysis of current account deficit. citrus fruit, as well as oil. the Nigerian economy, see "Nigeria on the Morocco will continue to seek Euro- Algeria, like Tunisia, has been spurred to brink", Euromoney, April 1983.) market funds for the development of its borrow by falling demand for oil. The $500 Bankers polled by Euromoney believe phosphates industry. It has 75% of the million eight-year credit launched in April that only six African countries can still world's known phosphate reserves. Some met a warm reception in the market. borrow by a traditional syndicated balance leading French banks told Euromoney that American, Japanese and French banks of payments loan: Algeria, Cameroon, they had struck Morocco off the list of joined the five Arab coordinating banks at Tunisia, Botswana, Gabon and Libya. And countries they were prepared to lend to, but lead manager level and the amount was three of these favoured countries, other French banks believed the kingdom increased to $600 million. Botswana, Gabon and Libya, are unlikely could still raise project-linked funds, > The loan's success was despite a split to borrow in 1983. provided Arab banks supported the loan. spread of only ''A to 3 Ve, Algeria's However, several other African countries "Despite the grim economic situtation," alarming debt service ratio-of 35%, and its can still tap the Euromarket for project said a French banker, "the European and total foreign debt of $16 billion. The finance on a club basis, as long as the American banks which are already heavily explanation? Algeria has abstained from circumstances are favourable for foreign committed will provide the credits Morocco balance of payments borrowing for four banks. If part of the loan is export credit needs, because of its immense strategic years, its foreign debt has fallen, and it has guaranteed, or if the project contractor is importance; it has offered bases to the US started to diversify its exports away from an important customer of the lending bank, Rapid Deployment Force." crude oil towards LNG and refined etroleum products. a and o Ken f p y years ag foreign banks are more likely to join a Only a couple o project loan. Zimbabwe ranked among the brightest Cameroon, like Algeria, has borrowed No African country's creditworthiness credit risks in Africa. Now the ratings of little since 1979. But this March it returned has fallen more spectacularly in the last year both have entered a steep slide, in part to the market, with a $350 million loan, led than that of Ivory Coast. Up till last because of political instability. Zimbabwe is by Bankers Trust and Credit Lyonnais, for August, it borrowed regularly and easily on becoming a one-party state, while in Kenya the development of the Lokele oilfield. the syndicated loan market. On August 16 political opposition has been crushed Cameroon's enormous gas reserves of 100 Bankers Trust won a mandate to raise $150 following last August's attempted coup. billion cubic metres are still undeveloped. million. Two days later, Mexico announced "Kenya's gone downhill since Kenyatta but if President Paul Biya decides to launch that it would reschedule, and all sovereign died; mismanagement and corruption have an LNG industry, considerable external lending received a '"^^' r.,~cr flnuriehe 1 " said a British banker who finance will be required. C Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 SEI 1,0 GAS 12( Gill BIS tot Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 row the i to this not 000 loan ther ?hich cans Nana their 'tage- 0 so does the at its 981, croon lance from ed in shi^q ht,rg count ed by Id the id in of its hikers: and ange, fired to $500 April +arket. banks bks at t was split eria's and its The from . four it has from ?efned wed led led Of 100 launch tern3 W THE DOT STAC!S UP _?D a~~'.sir da`at?~ ah?~a~JS?sc`?oP?cc?~~?.?~~?~i~4?~~?~C~'ers~3?~J~~~?a1.?~1?~4~1b?~?c`~c-~tt~id~`~V?i!~ 6810 1.066 GAMBI 126 GUINEA BISSAU 106$ Debt service ratio x % % Togo 65- Madagascar 15 - Niger 9 Guinea Bissau 60- Mali 15 Sudan 9 Uganda 45- Mozambique 15- Angola 8 Guinea 41 Sierra Leone 15 Burundi 8 Morocco 40 Tunisia 15 Upper Volta S. Algeria 35 Tanzania 14 Gambia 7 Ivory Coast 31 Congo 13 Somalia 6 Egypt 30 Gabon 12.5 Zimbabwe 6 Zaire 29 Liberia 12.5 Nigeria 4.5 Malawi 25 Cameroon 12 Libya 4- Zambia 24 Ethiopia 11 Lesotho 3.5 Kenya 17 Benin 10 Swaziland 3.5 Chad 16 Mauritius 9-5 Botswana 1.5 Mauritania 16 C.A.R. 9 Rwanda 1-5 Senegal 15.5- Ghana 9 Seychelles 0.5 The percentage of a country's earnings from the export of goods and services used to pay interest and maturities on medium-term foreign debt in 1981. Sources World Bank debt tables. UNCTAO, NatWest, except where ? indicates a Ewomoney estimate ?Edirnm for 1982. except where (a) indicates IMF figures for 1981, Of where 1 IMF figure IN imk&tn eg,malg for for 1977 at W IMF figure for 1981 19of (c) 79 or MO IMF figure for 1978 ? SEYCHELLES 34 Countries rescheduling medium- term debt is 1982 or 1983 D Countries generally considered able to borrow medium-term funds on the syndicated loan market t u medium term disbursed debt, owed to official and penile creditors, at December 31, 1981. Figures based on World debt tables except where $ is indicated. which denotes a Eworrroney estimate, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 'omoncy June 1983 63 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Trends in Eurocurrency Credit Participation 1972-1980 The burgeoning Eurocurrency credit market exceeded $70 billion in publicized volume in 1980, compared to $9 billion in 1972. Today, the bulk of publicized Eurocurrency lending is done by bank syndicates rather than individual institutions. Although the financial press annually allocates syn- dicated Euroloan volume among managing institutions, identifying the world's top Eurolenders, no one has documented the steady influx of new loan participants into the Eurocurrency credit market or comprehensively considered the changing nationality of participants over time. Using World Bank data, Office of the Comptroller of the Currency staff were able to examine these non-volume indicators of the increasing breadth of the publicized Eurocurrency credit market' Analysis of the World Bank data shows that a relatively constant average of 66 independent financial institutions became first-time entrants into the Eurocurrency credit market each year between 1973 and 1980. By 1980, nearly 400 independent financial institutions were active in the mar- ket In the earlier years, the new entrants were largely European and North American banks and international consortium banks. More recently, Latin American, Middle Eastern and Asian institutions have entered the market in greater numbers. Further findings from the World Bank data reinforce the well-documented expansion of Middle Eastern financial institutions into Eurocurrency lending. For example, in terms of number of participating institutions, Middle Eastern institutions have increased their presence in the market from less than one percent in 1972 to an eight percent share of the total in 1980. However, in every year, European and U.S. institutions ac- Diane Page and Walter D. Rogers are Financial Analysts of the Strategic Analysis Division of the Office of the Comptroller of the Currency. C. Stewart Goddin, Judith A. Walter and Steven J. Weiss made valuable comments on earlier drafts of this paper. Vivian L Oyola did the necessary computer programming. The views expressed in this paper are the authors and do not necessarily represent the views of the Office of the Comptroller of the Currency. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 count for the bulk of total participating institutions as well as total loan participations. Analysis in this paper is restricted to publicized Eurocurrency credits. it examines financial institutions which were Eurocurrency loan participants between 1972 and 1980, considering their nationality, entry Into the Eurocurrency market, and number of yearly loan participations. Eurocurrency credits are loans and credit lines denominated in a currency other than that of the country in which the lending institution is located. Eurocurrency credits first appeared in the 1960s. At that time, they were almost exclusively fixed-rate loans to corporate borrowers underwrit- ten by specialized investment banks, notably the British merchant banks, which later sold participations to other banks. The Eurocurrency credit market began to take on its present characteristics in the early 1970s. Loans became floating rate instruments. Nations began to finance balance of trade deficits through Eurocurrency borrowings. And the world's large international commercial banks began managing large Eurocurrency cred- its through syndications. Syndication of credits reduced risk for the under- writers and brought together the large resources necessary to finance sovereign debt. With successive oil price increases in 1973 and 1974, the oil-producing nations developed trade surpluses while non-oil-producing less-developed countries faced growing deficits. The Eurocurrency credit market began to serve a vital function as a recycling mechanism, moving surplus capital from the oil-producers to the non oil-producing nations. Publicized Eurocurrency credits reached a volume of $70.4 billion in 1980, according to World Bank data. Publicized credits, which are medium- to long-term and usually syndicated, represent only a portion of international borrowing. It has been estimated that one-half of Eurocurrency bank lend- ing is short term, unpublicized lending used for private trade and interna- tional business financing.' International and foreign bond issues are an- other vehicle for international borrowing, and accounted for $41.8 billion in 1980.' Description of the Data Data collected by the World Bank cover publicized borrowing in inter- national capital markets in the form of Eurocurrency credits between 1972 and 1981.' Notice of Eurocurrency credits appears in a published an- nouncement known as a tombstone. The tombstone generally contains the name of the borrower, the amount of the credit, and the names of the financial institutions which participate in the loan. Often, but not always, Eurocurrency credits are led by a single large institution. Smaller volume credits are less likely more co-lead manat prospective borrower group. The lead manag making a commitme tion. On the tombsto the participation they 1972 8.8 1973 20.8 1974 28.5 1975 20.6 1976 28.7 1977 34.2 1978 73.7 1979 702 1980 70.4 first, followed by ma successively smaller alphabetical order. th an equal participatio order within manage Computerized V participants per indivi on the tombstone. I participants are identi participants is indicat tified, there is no way pated in all loans in e, number of named an and likewise to deterr Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 117- ,ncy credits. It n participants ntry Into the ons. minated in a institution is lat time, they is underwrit- chant banks, rrency credit 970s. Loans balance of vorld's large lrrency cred- rr f" under- nance id 1974, the l-producing rency credit sm, moving ng nations. ion in 1980, nedium- to ternational banklend- nd intema- ies are an- .8 billion in ng In inter- veen 1972 lished an- mtains the ies of the of always, er volume credits are less likely to have a lead manager, while some loans have two or more co-lead managers. The lead manager receives a mandate from the prospective borrower to raise funds and seeks to put together a managing group. The lead manager typically underwrites the entire amount of the credit, making a commitment to provide the funds before arranging the syndica- tion. On the tombstone, institutions are usually listed in order of the size of the participation they take in the loan. As a rule, the lead manager is listed Table I first, followed by managers, co-managers, and participants, which take successively smaller portions of the loan. When institutions are listed in alphabetical order, this generally indicates that each participant has taken an equal participation. Sometimes institutions are listed in alphabetical order within manager, co-manager and participant sub-groups. Computerized World Bank data identify by name a maximum of ten participants per individual Eurocurrency credit in order of their appearance on the tombstone. When a loan has more than ten participants, nine participants are identified by name and the number of additional, unnamed participants is indicated. Since these additional participants are not iden- tified, there is no way to ascertain how many individual institutions partici- pated in all loans in each year. However, it is possible to aggregate the total number of named and unnamed participations- for all loans in each year, and likewise to determine how many loans had unnamed (more than ten) Year Loan Volume (S billions) Total # Loans Total # Participations zUn am dth Participants %By U named Participants 1972 8.8 258 415 1 1 1973 20.8 402 725 1 1 1974 28.5 474 1027 1 1 1975 20.6 418 1482 5 6 1976 28.7 430 1827 8 9 1977 342 489 2360 10 10 1978 73.7 786 3781 15 20 1979 70.2 813 4329 16 22 1980 70.4 797 4913 18 24 Source: World Bank data. A small percentage of participants are listed as "syndicates" and thus actually represent more than one institution. Eurocurrency Credit Aggregates 1972-1980 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 242 participants. As shown in Table I, an increasingly significant proportion of total loan participations, 24 percent by 1980, have been taken over time by participants not identified by name in the World Bank data. The number of loans with unnamed' participants increases to 18 percent of total loans by 1980. The reader should bear in mind that, in most of the following discussions of participant nationality, new entry and loan participations, only named participants, those who took the first nine or ten listed positions on each loan, are considered. It was not possible to identify the unnamed participants or to draw any conclusions about their entry trends or national- ity patterns. In the following analysis, information has been provided on those institutions appearing as first listed participant for each loan in the World Bank data, i.e., institutions listed first on the loan tombstones. Although this information provides some indication of the nationality distribution of lead' managers, it should be interpreted with caution. As explained above, lead managers usually appear first on the publicized loan notices. However, since some credits have no lead manager, some credits have a number of co-lead managers, and some tombstones list all participants alphabetically, first participant position in the World Bank data is not a perfect proxy for lead manager. (World Bank staff estimate that about 20 percent of the Eurocurrency credit tombstones list participants alphabetically.) Nationality of the named participants is not included in World Bank data and was determined using a variety of almanacs, yearbooks and other reference sources. Institutions were grouped by nationality of ownership rather than country of charter, Euroloan activity of branch offices or sub- sidiary companies has been credited to the head office or parent institution. For example, Deutsche Bank AG, Deutsche Bank AG (London), and Deutsche Bank Cie. Fin. Luxembourg were all considered part of a single German financial institution when determining the number of German Euroloan participants, German entry into the market, and the number of German loan participations. Between 1972 and 1980, the number of publicized Eurocurrency credits tripled from 258 to 797 and their combined volume increased from $8.8 to $70.4 billion, according to World Bank data (see Table 1).5 The following analysis is based on a direct comparison between Eurocurrency credit activity in 1972 and 1980, since changes between 1972 and 1980 reflect trends which characterize the intervening years. However, the figures are also affected by specific factors such as the slowdown in U.S. Eurolend- ing dating from 1979 and government restrictions on foreign lending of Japanese banks in 1980. (See Appendix tables.) Number of lenders The number of nan institutions, nearly tripled shows a geographic brei (Consortium banks were I categories when their ow European or all Middle E geographic categories In over time. The predomin, of the total in both years Middle Eastern institution total share in 1972 and 8 institutions, on the other h share of Asian institution New enby Between 1973 and ticipated in any previous Eurocurrency credit ma constant, averaging 66 p Nationality of Paren Publiciz (First throuc Hn Source: World Bank data Consortium banks which did by European and Middle Ea! t Africa. Oceania and a very sir not be identified by nationali Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 portion of er time by camber of I loans by following cipations, positions unnamed, national- on those he World ough this m of lead' eve, lead However, umber of betically, pro-, for nt he rld Bank end other .vnership > or sub- stitution. )n), and a single German mber of urrency ed from I).' The urrency d 1980 figures rolend- ding of Number of lenders The number of named loan participants, consolidated into parent Institutions, nearly tripled from 133 to 386 between 1972 and 1980. Figure 1 shows a geographic breakdown of these institutions in 1972 and 1980 (Consortium banks were placed in the Asian, European and Middle Eastern categories when their owning institutions were identified as all Asian, all European or all Middle Eastern.) The absolute number of managers in all geographic categories increased, but relative shares of the total changed over time. The predominance of European institutions, well over one third of the total in both years, is evident, as is the growing importance of the Middle Eastern institutions, which represented less than one percent of the total share in 1972 and 8 percent in 1980. The share of U.S. and Canadian institutions, on the other hand, dropped by ten percent of the total, while the share of Asian institutions dropped by five percent of the total. New entry Between 1973 and 1980, 526 parent institutions which had not par- ticipated in any previous year for which data are available entered the Eurocurrency credit market The number of new entrants is relatively constant, averaging 66 per year (Figure ii). Figure I Nationality of Parent Financial Institutions Participating in the Publicized Eurocurrency Credit Market 1972 & 1980 (First through Tenth Listed Participants Only) Source: World Bank data ' Consortium banks which did not fit in any regional category, such as UBAF, which is owned by European and Middle Eastern institutions. t Africa, Oceania and a very small percentage (less than 1 percent) of institutions which could not be identified by nationality. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 First-Time and Eui # Institutions 400 r- 300 U First Time Par Financial Institutions Participating In the Euroloan Market 1972-1980 (First through Tenth Listed Participants Onty) Austria 0 0 4 4 4 11 5 7 14 Belgium 4 3 3 5 4 3 3 4 4 Luxembourg 3 3 3 4 5 7 11 7 7 Fed. Rep. of Germany 5 7 10 13 13 17 17 22 21 France 9 15 14 16 15 17 17 22 19 it* 3 5 6 5 8 9 18 12 15 Netherlands 0 1 3 4 5 5 5 6 5 Spain/Portugal 2 5 9 13 14 13 11 19 22 Switzerland 2 2 4 4 9 9 8 9 11 United Kingdom 18 24 20 18 19 18 18 19 18 Other. W. Europe 1 9 9 18 12 14 14 16 17 r- r-urope 1 2 3 3 2 1 1 2 5 Total 48 76 88 107 110 124 128 145 .158 Canada 3 4 7 9 7 9 9 10 9 USA 31 40 41 46 46 43 49 50 54 34 44 48 55 53 52 58 60 63 Mexico/Central/S. Amer. 6 3 5 6 5 8 8 12 23 Caribbean 3 2 5 3 4 3 2 4 3 Middle East 1 2 3 6 11 17 25 23 25 Africa 1 0 1 1 1 2 1 2 3 Japan 17 21 17 7 13 18 24 24 24 Other Asia 5 2 4 5 4 9 11 16 19 22 23 21 12 17 27 35 40 43 Oceania 2 0 1 2 1 1 3 5 8 Consortia 12 22 30 36 48 49 60 51 51 of which European 1 4 4 5 6 7 7 8 9 Arab 0 0 1 2 3 5 9 6 6 Asian 0 1 1 1 1 0 0 1 0 Other 11 17 24 28 38 37 44 36 36 4 6 5 7 6 5 7 5 9 133 178 207 235 256 288 327 347 386 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 I 5 7 14 ! 3 4 4 11 7 7 r 17 22 21 17 22 19 18 12 15 5 6 5 ! 11 19 22 8 9 11 ! 18 19 18 1 14 16 17 1 2 5 t 128 145 158 9 10 9 49 50 54 58 60 63 t 12 23 4 3 25 23 25 1 2 3 24 24 24 11 16 19 35 40 43 3 5 8 60 51 51 7 8 9 9 6 6 0 1 0 44 36 36 7 5 9 327 347 386 Figure H First-Time and Previous Participants in the Publicized Eurocurrency Credit Market* 1972-1980 M First Time Participants M ? Refers to first-time entry since 1972; data not available for previous years. 63 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Financial Institutions Entering the Euroloan Market for the First Time' 1973-1980 (First through Tenth Listed Participants Only) Austria 0 4 1 1 5 1 0 5 Belgium 0 0 1 1 0 0 1 0 Luxembourg 0 0 2 3 3 3 0 2 Fed. Rep. of Germany 2 5 4 1 4 1 4 2 France 7 2 4 2 3 0 6 1 Raly 2 1 1 2 5 5 2 1 Netherlands 1 2 1 2 2 1 0 0 Spain/Portugal 3 4 5 2 1 1 6 7 Switzerland 1 2 0 5 3 1 3 2 United Kingdom 9 2 1 1 0 1 0 1 Other, W. Europe 8 3 9 3 1 0 0 1 E. Europe 1 1 1 0 0 0 0 3 34 26 30 23 27 14 22 25 Canada USA 13 9 10 7 5 7 6 10 14 12 13 8 6 7 7 10 Mexico/Central/S. Amer. 2 2 0 0 3 3 3 10 Caribbean 0 2 0 0 2 0 3 1 Middle East 2 3 2 6 9 11 .7 3 Africa 0 0 0 1 1 0 2 1 Japan 4 1 0 1 2 4 1 1 Other Asia 2 1 2 1 6 4 5 10 6 2 2 2 8 8 6 11 Oceania 0 0 1 0 0 1 4 2 Consortia 13 14 13 14 7 15 6 5 of which European 3 0 1 2 1 0 1 0 Arab 0 1 2 1 1 4 0 1 Asian 1 1 1 0 0 0 0 0 Other 9 12 9 11 5 11 5 4 Unidentified 4 4 3 2 3 4 4 5 GRAND TOTAL 75 65 64 56 66 63 64 73 ? Refers to first-time entry since 1972; data for previous years not available. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Nationality of Paren Eurocurrei t Yew E W. N. Am 1973 37 14 1974 26 12 1975 31 13 1976 25 8 1977 28 6 1978 14 7 1979 23 7 1980 25 10 TOTE. 29 77 Sours Lr .aik data ' Relc = ? .r a entry sir 7arie r s`~ows the Ame-r3r: arG Other C owns 4 -rz fit neart rate ? ie. :-=y. This is the rres 17---national) enter '--e E_rocurren ests: c tarly as a m and Ivzda Estem ins time.,-iiar -ass would Japr_e r_.emment Jape--se e =j and pi: flucr.ze .tier Asian i Lion. V1-.:eE_ropean it in k=_ a 'seer numt regi_=Ydc s the gr Nurrl- T sn partic Imit e y loan pa Eta__-c :redit me nur-- i ir.cipatior fron-4 ? z 13 betwr tiott s+ -&-ad particil pert?.orized i Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 78 79 80 1 0 5 0 1 0 3 0 2 1 4 2 0 6 1 5 2 1 1 0 0 1 6 7 1 3 2 1 0 1 0 0 1 0 0 3 7 14 22 25 I ' 0 1 0 7 6 10 i 7 10 3 3 3 10 2 0 3 1 11 7 3 1 0 2 1 2 4 1 1 6 4 5 10 8 8 6 11 0 1 4 2 7 15 6 5 1 0 1 0 1 4 0 1 0 0 0 0 5 11 5 4 3 4 4 5 6 63 64 73 Table 11 Nationality of Parent Financial Institutions Entering the Publicized Eurocurrency Credit Market for the First Time' 1973-1980 Nationality Other Oth year Eur. N. Amer. Latin Amer. Asian M. East er Consortium 1973 37 14 2 2 7 9 4 1974 26 12 4 4 3 12 4 1975 31 13 0 4 3 9 4 1976 25 8 0 7 2 11 3 1977 28 6 5 10 8 5 4 1978 14 7 3 15 8 11 5 1979 23 7 6 7 6 5 10 1980 25 10 11 4 11 4 8 TOTAL 209 77 31 53 48 66 42 Source: World Bank data ? Refers to first-time entry since 1972; data not available for previous years. Table II shows the nationalities of the new entrants. European, North American and Other Consortium institutions (consortium banks whose entered the Eurocurrency credit market first Also, consortium banks were established early as a means of access to the market Latin American. Asian and Middle Eastern institutions exhibit increasing rates of new entry over time. (Asian rates would be more pronounced if not for the effect of periodic Japanese government restrictions on foreign lending, which caused Japanese entry and participation in the syndicated Euroloan market to fluctuate. Other Asian nations demonstrate steadily increasing participa- tion.) While European institutions continue to dominate the new entry table in terms of sheer numbers, the increasing entry of institutions from other regions indicates the growing breadth of the Eurocurrency credit market Plumber of Loan participations Total yearly loan participations by all institutions provide a measure of Eurocurrency credit market size distinct from dollar volume measures. The number of participations by both named and unnamed participants grew from 415 to 4,913 between 1972 and 1980, a twelvefold increase. Participa- tions by named participants, which grew from 412 to 3,723 in that time period, are categorized by nationality in Figure Ill. In terms of loan participa- i owners did not fit nearty into a regional category) demonstrate a declining rate of new entry. This is not surprising since institutions from countries with the most internationally active and highly developed banking systems Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 tions, European institutions increased their share from just over one third to almost half the yearly total. Again Middle Eastern growth is notable, from a less than one percent to a six percent share. Both the North American and Asian shares declined, by ten percent and five percent of the total respec- tively. Figure ID Publicized Eurocurrency Credit Market Participations by Nationality of Participant 1972 & 1980 (First through Tenth Listed Participations Only) Austria Belgium Luxembourg Fed. Rep. of German France Italy Netherlands Spain/Portugal Switzerland United Kingdom Other, W. Europe E. Europe Canada USA Source: World Bank data ' Consortium banks which did not fit in any regional category, such as UBAF, which is owned by European and Middle Eastern institutions. t Africa, Oceania and a very small percentage (less than 1 percent) of institutions which could not be identified by nationality. First listed participants World Bank's first listed participants can be used as a proxy, albeit an imperfect one, for Eurocurrency credit lead managers. It is evident that changes in national shares of total first listed participants are consistent with other share changes described in previous sections. Figure N illustrates that European institutions account for almost half of total first participants positions in 1972 and 1980. North American institutions moved from holding first participant position in almost a third of all Eurocurrency credits to a 22 percent share in the same time period. Asian institutions maintained a stable first participant share of approximately ten percent, while Middle Eastern institutions, which appeared in no first participant positions in 1972, had a seven percent share in 1980. Mexico/Central/S. Ame Caribbean Middle East Africa Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Japan Other Asia Oceania Consortia of which European Arab Asian Other Unidentified GRAND TOTE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 fist over one third to h is notable, from a orth American and of the total respec- s a proxy, albeit an a. It is evident that are consistent with figure IV illustrates al first participants ions moved from rocurrency credits tutions maintained cent, while Middle ipant positions in Euroloan Participations by Nationality of Participant 1972-1980 (Fist through Tenth Listed Participants Only) Austria Belgium Luxembourg Fed Rep. of Germany France Italy Netherlands Spain/Portugal Switzerland United Kingdom Other, W. Europe E Europe 72 73 74 75 76 77 0 0 5 16 7 42 12 6 17 28 12 35 8 9 15 11 27 31 11 15 59 115 108 219 27 67 125 100 92 103 9 25 22 7 11 15 0 2 8 27 28 45 5 7 29 32 36 41 2 4 9 20 32 47 65 106 113 127 156 207 2 15 16 35 48 47 3 4 7 11 6 1 144 260 42 5 529 563 833 78 79 80 15 31 41 49 106 110 51 70 45 254 300 254 162 223 395 39 55 98 81 78 67 38 77 100 63 74 76 280 357 416 46 71 81 2 6 17 1080 1448 1700 10 24 44 117 121 153 261 284 301 136 239 346 503 653 658 749 613 657 146 263 390 620 774 811 1010 897 958 10 3 8 29 19 22 29 60 95 9 10 12 3 5 3 2 4 9 1 5 4 19 19 48 106 80 113 1 0 1 1 3 2 2 2 5 51 99 37 14 32 97 355 466 258 6 4 7 14 11 24 36 42 80 57 103 44 28 43 121 391 508 338 2 0 2 3 1 1 5 5 25 36 70 128 161 233 284 373 386 467 4 9 25 14 19 37 45 55 72 0 0 1 4 8 12 50 54 92 0 1 1 1 1 0 0 2 0 32 60 101 142 205 235 278 275 303 6 6 9 15 9 6 9 9 13 412 720 1023 1408 1669 2131 3007 3399 3723 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Figure IV Total Publicized Eurocurrency Credits by Nationality of First-lasted Participants 1972 & 1980 +lustria Belgium Luxembourg Fed Rep. of Germany France halt' Netherlands Spain Switzerland United Kingdom Other, W. Europe E. Europe Source: World Bank data Consortium banks which did not fit in any regional category, such as UBAF, which is owned by European and Middle Eastern institutions. t Africa. Oceania and a very small percentage (less than 1 percent) of institutions which could not be identified by nationality. '? Totals do not match loan totals in Table I due to omissions in World Bank data. Canada USA Mexico/Central/S. Amer. Canlbean Middle East Africa Japan Other Asia Oceania Consortia of which European Arab Asian Other Unidentified GRAND TOTAL' First-listed participant in Worl, Totals do not equal Eurocurret World Bank data. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Number of Euroloans by Nationality of First-Listed Participant' 1972-1980 Austria Belgium Luxembourg Fed. Rep. of Germany France Italy Netherlands Spain Switzerland United Kingdom Other, W. Europe E. Europe 0 0 3 3 1 3 3 2 6 6 2 3 7 1 7 7 13 19 4 4 3 3 7 10 7 14 8 4 7 20 19 23 39 67 55 40 19 34 58 32 23 19 35 45 70 2 7 7 1 2 4 15 8 9 0 1 2 6 8 6 17 8 12 1 1 2 5 6 10 8 21 27 1 1 4 4 2 1 10 21 22 45 83 73 50 46 50 73 100 90 0 2 3 7 11 18 18 19 19 3 0 0 3 0 0 0 0 0 ich is owned which could later. Canada 6 12 7 14 10 14 35 55 45 USA 87 145 179 181 190 194 286 242 231 Total 93 157 186 195 200 208 321 297 276 Mexico/Central/S. Amer. 1 0 3 6 4 2 12 11 15 Caribbean 7 10 6 1 2 2 1 1 1 Middle East 0 3 3 1 2 6 34 17 28 Japan 11 33 12 2 5 12 45 66 24 Other Asia 1 2 3 8 5 4 4 2 11 Total 12 35 15 10 10 16 49 68 35 Oceania 1 0 1 1 0 0 2 2 5 Consortia 26 31 59 51 79 84 96 105. 114 of which European 1 1 3 3 8 11 11 15 21 Arab 0 0 1 2 4 1 16 10 14 Asian 0 0 0 1 1 0 0 0 0 Other 25 30 55 45 66 72 69 80 79 Unidentified 5 1 4 5 0 4 0 3 2 GRAND TOTAL' 230 379 455 410 427 489 776 810 798 First-listed participant in World Bank data usually refers to the lead manager. ' Totals do not equal Eurocurrency loan totals found in Table I in the text due to omissions in World Bank data. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Conclusion World Bank data, although identifying only ten participants per Euro- loan, can be used to provide some information on the pace of new entry into the Eurocurrency credit market and patterns of changing nationality among lending institutions. Conclusions drawn from the data become less certain in later years, because of the significant increase in the number of unidentified participants listed beyond position ten in individual loans. The picture resulting from a study of the data is one of a growing and broadening syndicated Eurocurrency credit market between 1972 and 1980. The growth in number and volume of loans has been accompanied by a growth in the number of institutions participating in those loans. Growth in total number of loan participations has outstripped the growth rate in number of loans; this is another indicator of increased market breadth. A steady average of 66 new institutions has entered the market yearly. Institutions headquartered in Europe and North America, active in the Euroloan market in earlier years by virtue of their well developed interna- tional banking presence, still accounted for the bulk of yearly participations, lending institutions and first listed participants (a proxy for lead manager) in 1980. However, new lender institutions from these countries are entering the publicized Eurocurrency credit market at a declining rate. In recent years, increasing numbers of new entrants are from Latin America, Asia and the Middle East. Institutions from the Middle East as a whole have increased their share of yearly loan participations, loan leadership and representation among lending institutions notably, from less than one percent of the total in 1972 to six to eight percent in 1980. This increased share has been balanced in part by the declining share of North American institutions. Endnotes World Bank data are limited, identifying a maximum of ten participant institutions per individual loan. This limitation becomes more important over time. See Table I for the number of loans with unidentified (greater than ten) participants on a yearly basis. Laurie Goodman, The Pricing of Syndicated Eurocurrency Credits,- Federal Reserve Bank of New York Quarterly Bulletin. Summer 1980, p 40. ' Morgan Guaranty Trust Company, World Financial Markets. ' The World Bank stopped collecting this type of data as of the second quarter of 1981, since it is now available from several other sources such as Caploan and the Euromoney syndication service. Volume of publicized Eurocurrency credits is available from many other sources including Morgan Guaranty Trust Company, the OECD and Caploan. Reported numbers differ due to differences in timing, coverage, etc. Compare, for example, the World Bank figures with those found in Morgan Guaranty's World Fuancial Markets: $6.9 billion in 1972 and $76.8 billion in 1980. ? Tables from which these charts are derived may be found in the following these notes. Overvie National authoritie bank safety and souni system as a whole. Thf into preventive regula schemes which offer p and support provided I: ing liquidity difficulties Preventive Regulation Among measures banks are those conce acy, permissible busine tion of loans and coun In virtually all natioi entry stage. Before the requirements which tyf minimum amount of formalized, varying fror USS10m (United Kingc branches of foreign ba endowment capital, alt quirement while Canac form. Several countries market entry may be re view to curbing excess In addition to a rr Richard Dale is currently a at the Brookings Institution Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 R041 a M QMMe199 J1? Q JIM ac'R'" . $ 0 G3 The interbank deposit markets are the Euromarket's most sensitive barometer. Here's how the climate's changed. By Tim Anderson "We realize we have had to prove our credibility," said George Gunson, general manager of Euro-Latinamerican Bank. "To reassure the market, we never ask to roll over an interbank deposit. That way the bank can prove it has the funds to repay them." In National Westminster Bank's Thread- needle Street offices, interbank deposit dealers do not take calls from Brazilian banks. If one of the direct lines lights up on a dealer's desk, he politely refers the caller to the Latin American division. There is no automatic trading, as there used to be. Neither would have happened a year ago. These changes are the everyday realities of the reshaping of the Eurodollar interbank market, which took place after the shocks which hit banking last year, and has con- tinued with Brazil's attempts to maintain its interbank lines. The flight to quality, most vividly seen during the autumn of 1982 in the Euro- dollar certificate of deposit market (Euromoney October 1982), when the yield on CDs rose to 300 basis points over T-bills, had an impact on the interbank market which many believe is permanent. US banks are offered more deposits than ever - so many that they may even be turning them down, thereby reducing the pool of funds available to other banks. For non-US banks, the market is now frag- mented. Greater caution, higher spreads, stricter bank and country limits, have reduced liquidity. The interbank market remains the main source of short-term funds for most international banks and its size depends, more than ever before, on the funds funnelled through the big US banks. Calm has returned to the Eurodollar CD market, and it remains an important source of funds for a select club of eight US banks. Euro-Latinamerican and other banks connected with Latin America have suffered the brunt of the changes because the shocks from the region have been the most severe. But no bank is unaffected. The shocks which undermined confidence in banks were worldwide; from Banco Ambrosiano in Luxembourg and Italy to Penn Square and Lombard-Wall in the US. And there is hardly a bank in the world without exposure to Mexico, Brazil or Argentina. As the lubricant of the international banking system, the interbank market is essential. Now there is grit in it. In 1973 the size of the market was just $150 billion. By the end of 1982 it had reached $1,000 billion, 12 times larger than the syndicated loan market. But in the last quarter of 1982 it grew by only $20 billion, as compared with the $63.5 billion increase in the same quarter in 1981. While the interbank market was expanding dramatically every year, it gained a confidence which pushed aside the memory of the Herstatt crisis in 1974. Now banks are more selective over which banks they deal with. Limits are tighter and more strictly imposed. Gunson of Euro-Latinamerican said: "There is a general decrease in liquidity. As a result there are very few banks which quote prices continually. We have learned who our friends are." Euro-Latinamerican has had to ask its shareholder banks to increase their interbank tines to it, to compensate for the cuts made by other banks. It is important for a bank's market credi- bility to be seen as a provider as well as a taker. Consortium banks generally use their tines from their shareholders, which they obtain at the finest rates, to lend in the market. They fund their books from what they can raise on the interbank market. Part of the decrease in liquidity comes from the fall in the Opec surplus. Last year Opec members were large net takers of funds, withdrawing $18.3 billion in deposits, whereas in the past they were enormous net contributors. The switch has hit liquidity and confidence. But what hits liquidity more is the increased selectivity in the market. While the biggest US banks are offered more dollar deposits than ever, other banks, including consortia, have to scratch around the market for funds. Carl Malmaeus, general manager of Toronto-Dominion Bank, said: "In prac- tice banks deal with those banks with which they do other business. Interbank has to be risk-free because the return is so low." As there is now a risk, banks want a good return, and they are insisting on the profit- ability of all interbank lending. Combined with strictly imposed balance sheet re- straints, this has further reduced liquidity. In the 1970s, spreads of 25 basis points were justified by the low risk and the high volume. With a new view of risk, volume does not appear so attractive. Mike Rice, head of Citibank's inter- national money markets division, said: "Profit, not growth, is the emphasis now. It is not attractive to turn money round at small spreads as before." This pattern of higher profits, from deals with more cautiously selected banks, re- stricts the flow of funds. For the big US banks, "the problem is not funding", according to Rice. He added: "People are so risk-averse that banks like Citibank are offered more deposits than ever. But we do not like taking money at a quarter under Libor to lend at Libor." The US banks, which supplied so much of the market liquidity in the 1970s, are now constrained by return on total assets ratios. Some US banks deny that these ratios have caused them to refuse deposits. In the secretive interbank market it is difficult to discern what is happening. But, according to the head of one US bank's treasury D Euromoney July 1983 63 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 THE INTERBANK MARKET section, the ratios are biting. "Increasingly you see banks trying to raise their fee income from bond, CD, and forex trading. If they can increase the income side of the ratio, they can then take on more assets. It is one of the giveaway signs." Last year US banks supplied 45% of the net increase in funds - $38.3 billion out of $85 billion, according to the Bank of International Settlements. In 1981 they supplied only 29% of the net increase, but the amount was greater - $47.7 billion in 1981, or $9.4 billion more than in 1982. Direct deposits have become more important, as US corporations have recognized the higher yields available in the Euromarket. US banks have also encouraged rich individuals to deposit with their London subsidiaries for the same reason. These are more stable sources of funds and are cheaper than the wholesale market. On the wholesale Euromarket the cheap- est funds available are Eurodollar CDs. It is a US-dominated market. Over 60% of the CDs outstanding in March this year were issued by US banks, according to Bank of England figures. Most of these were issued by eight US banks at as much as 75 basis points under interbank rates, the lowest available in the market. And the CDs of these banks make up 70 to 80% of those actively traded in the secondary market. The marketmakers are US investment banks and the buyers US investors - cor- porations, pension funds, money market funds, states and municipalities. These CDs are issued by a select club called the run, which enables those on it to issue CDs at the lowest rates. Once a bank is a member of this informal and unregu- lated club, its CDs are always issued and traded at the best rate. The club's CDs carry the same risk and investors buy them on a no-names basis. The run used to include nine banks, but Continental Illinois removed itself in July 1982 after its involve- ment with Penn Square was made public. For the banks on the run the liquidity of their issues is as important as the volume. This was undermined at the height of the debt crisis last year. Investors, who see CDs as one of the most liquid ways to invest money, began to fear for the acceptability of CDs. As these investors, and the traders of on-the-run CDs, are mainly from the US, the lack of confidence in some US banks was a reflection of the feeling inside the US. That confidence seems now to have been largely restored, and, with it, the liquidity of the market. The largest US banks also virtually monopolize the next cheapest source of 'unds, deposits by US regional banks. Early afternoon, London time, when the regional US banks enter the market, is often the busiest part of the day. This part of the interbank market is as secretive as the rest. But it is clear that regional banks are becoming more selective now prefer the large regional banks from their own areas to the money centre banks. One broker said: "The regionals are more careful, but the market is calm." Outside the Euromarket, US banks and a select number of European banks, which have the best rating from Standard and Poors and Moodys, obtain their funds by issuing bankers' acceptances and commer- cial paper in New York. Both are, at least in theory, trade related. They are a cheap source of funds, but an insignificant slice of the market. The Securities and Exchange Commission sets a limit on the amount of commercial paper a bank is permitted to have outstanding. NatWest's limit, for example, is $1.5 billion. The average life is 50 to 70 days, with a maximum of 270. For most international banks the shape of the Eurodollar interbank market is all. important. French banks make great use of floating rate notes and Japanese banks favour floating rate CDs, because of Ministry of Finance requirements. But it is the interbank market which provides both with immediate access to funds. One US bank treasurer suggested that the full consequences of the changes in the market had not yet been seen. "If the pattern continues, the top US banks will break away from the rest of the market and automatically obtain rates well under inter- bank." At the other end of the market, Brazil is already paying 1 % to 'ri 016 over interbank. Perhaps the change in the shape of the interbank market has only just begun. ^ - The Rates Banks Bid for Funds Eurodollar interbank market, six-month deposits subsidiaries Canadians Small Europeans Large Europeans (not French and German) 41 Certificates of deposit French Large Germans Load.. interbank offered rate London later bank bid rate This diagram is a guide to the shape of the interbank market. When the market is illiquid, even US regional banks could be forced to pay the offered rate. When it is highly liquid, French banks obtain the bid side of the market. Each transaction is an individual agreement between the bank offering the funds and the one taking them. This diagram shows the underlying positions of the groups of banks in the market. US majors. These are rarely takers in interbank. If they require wholesale funds they prefer issuing certificates of deposit because they are a cheaper source of funds. Large Europeans. Of these, the big German banks command the best rates, often at the bid rate of the market. French. These tend to move the market rate because of the size of their trades. US regionals. new hardly ever bid for funds. If they do, it is through brokers and they get the best rates. Japanese. The trust companies pay the highest rates. For big trades even the best names pay the top rates, near the offered rate. Canadians. Much the same as the big Japanese banks. They pay near the offered rate for size. Brazilian. These rarely raise funds through brokers. They have to rely on their direct relationships ?-Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 You're the best judge of foreign risks A guide to the best techniques for managing your international exposure without having to rely on outside experts Pravin Banker When the world returned from the almost In today's world, it is safe to say that unbelievable economic stability that nothing is sacrosanct. The France of d'Estaing, Pompi- characterized the 1950s and early 1960s to dou, and de Gaulle can quickly become the France of the more normal instability of the 1970s, Mitterrand. Even the once hallowed doctrine of sover- many international companies and the eign risk, under which commercial banks lent to coun- managers who ran them were hit hard. tries like Poland at rates equal to the prime plus They had grown their businesses in a hot- one-half of 1% because it was considered unthinkable house environment and all of a sudden saw that a communist regime, with its inbuilt power of their well-cultivated gardens flattened with monsoon-like ferocity perpetual control, could ever default, is now in disre- pute. As a consequence, nothing is more important to This turn of events brought into vogue the maintaining the profitability of international compa- idea that executives should make risk nies than the successful management of exposure to management part of their international political, economic, and financial risk. strategy. Despite the prominence of expo- Taking risks is, of course, a part of any sure management, many companies still business. Because of the larger number of unknown lack sophisticated strategies for coping factors, however, international business has always with the unpredictable environments they entailed greater risk than domestic enterprise. But face in international markets. In this arti- many companies have only recently come to realize cle, a financial expert gives readers the that the degree of risk to which they are exposed is benefit of his years of international experi- wi ence. His practical guide to exposure tech- gowing lust as fast as the complexity of doing daily niques shows where many that are considered sacred fall down and where Despite years of experience, most have more innovative methods might do a developed no precise guidelines for managing their better job. exposure to this risk. Many companies simply rely on techniques they have always used. They don't factor in Mr. Banker is an international treasury much of their own experience. Often they assume that consultant, responsible for exposure man- outside organizations can provide secret formulas or agement and international finance for cookbook solutions. Managers turn too often, for IBM's overseas branches and subsidiaries. example, to standardized risk ratings for quick solu- Employed by IBM for 17 years in numerous tions to the problem of matching countries with positions in engineering, sales, and finance, he has recently been promoted from his investment or operating plans, but these ratings do not position as manager, treasury operations, of include the sophisticated detail necessary for success. the Americas-Far East subsidiary of IBM's All countries have some element of risk as well as World Trade Corporation to his current some potential to produce profits. The difference is in position at the IBM corporate headquarters the degree of risk. i in Armonk, New York. Outside organizations and indices can at best provide basic information, but the manager Photographs courtesy of E.P. /ones and must know how to use it in light of his or her own Ivan Massar. experience. Remember that the track record of con- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Harvard Business Review March-April 1983 suiting and rating organizations is not good. The best illustration I have comes from my recent experience -h the Mexican devaluation. At the beginning of 12, I polled 11 experts for their opinions. Most of them believed the Portillo-Kolbeck assurances that the peso would be devalued by merely 18%. Only one cor- rectly predicted the actual extent of the devaluation (50%, on February 17,1982). To determine the degree of risk a com- pany can stand and yet sustain its profitability, a man- ager must understand the risk factors of the countries in which the company operates and develop tech- niques to handle each one. For its part, the company must create a focal point clearly charged with the responsibility of protecting its worldwide investment and profitability. The world is full of narrow windows of opportunity requiring quick entry; it does not suffer plodding bureaucracy. Responsibility must stay in- house. The involvement of senior line executives is critical, for without it, even the most brilliant plan can fail in execution. The following discussion, drawn from my experience with international business, serves as a guide to the various techniques needed to successfully implement a strategy to soften political, economic, and financial risks. Handling political & economic risks Because they are not as precise, the techniques developed to deal with political and eco- nomic risks are more difficult to apply than those deal- ing with financial risks. Managers should use them sparingly and only after identifying the potential for misapplication. Concession ; greements. Prior to mak- ing new commitments or adding to existing ones, companies (particularly in extractive industries) often reach agreements with host governments either through written legislation or through verbal under- standing. Such concession agreements define the rules under which multinationals can do business in local environments. Usually they include the concessions the government grants in the form of royalties, market share, tax incentives, tariff protection, and pricing flexibility. Historically, multinationals investing in less developed countries (LDCs) have favored such Rreements. But history has also shown that the devel- ed countries, with their tradition of orderly govern- mental change, are more likely to honor them. In LDCs, the risk of their emasculation or outright repu- diation is high. Insurance. Most industrialized coun- tries offer political risk insurance for MNCs' invest- ment in certain countries. The U.S. Overseas Private Insurance Corporation, for example, offers coverage against expropriation, war, revolution, insurrection, and blocked currency. This coverage is narrow, however, and useful only in extreme cases like the expropriation of assets by North Vietnam after the fall of Saigon. A more sophisticated kind of insurance used in an LDC is the currency swap agreement. With a central bank (often through a commercial bank inter- mediary) a company signs a contract whereby, for a fee, the central bank guarantees the future convertibility of a foreign currency investment at a fixed exchange rate. Swap contracts usually apply to foreign loans. Instead of making direct capital investment, multinationals therefore often offer subsidiaries "parent company" loans denominated in foreign currencies, which are then covered by swaps. Funneling the parent company loan through a commercial bank intermediary (via a partici- pation agreement) enhances protection and flexibility. One note of caution: if the country issues too many swap agreements, it may not be possible for the central bank to honor them on maturity. This is the dilemma confronting Argentina, which has more than $5 billion in such agreements maturing within six months. Organization & structure. MNCs are complex organizations that may make machine parts in Brazil, assemble them as engines in Germany, install the engines in bodies in Italy, and ship completed cars to the United States for sale. The manufacture of a sin- gle finished product may depend on three manufactur- ing plants located in three countries, and sales may depend on a fourth. Companies have fostered this strategy of "dependency" to neutralize the political risks of operating in one country. But economic risks grow with such dependency-a company agreeing to export a certain product volume in a concession agreement can get in trouble if demand in the country of sale falls and an alternative market is not available. The country in which a part is produced may be unreceptive to cut- backs due to falling demand. Instead, the multinational must often maintain full production and yet honor the country's export commitments. A recent innovation, called an export enhancement program, attempts to address this pi ob- lem. Host countries will allow the international companies to export less than the amount specified in their export contract if they will make up the shortfall by exporting other companies' products. MNCs have responded by exporting coffee from Honduras, crude oil and petroleum derivatives from Iran, machine tools from Brazil, and cacao from Ecuador. A multinational does not have to scatter its product manufacture to neutralize risk. .. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Foreign risks 159 Developing its worldwide marketing and distribution capability and control of transport facilities is just as effective. Because they cross borders, they are fairly safe from government action. During the political turmoil between Zambia and the then white-minority-controlled Rho- desia, an uneasy economic alliance continued because Zambia depended on the Rhodesian railroad to trans- port its principal commodity (copper) to the sea and European markets. The sacrosanct railroad enjoyed long tranquility during the guerrilla wars. Proprietary protection. Patent and trade- mark protection is the most common proprietary tech- nique used in exposure management. Another method, commonly used by pharmaceutical companies, is to locate research and development facilities in the home country. Today many countries oppose both tech- niques. Mexico, for example, forces companies to use trademarks that are geared to its culture and sold to local interests. India has introduced price controls on drugs and mandated the dilution of equity in foreign subsidiaries through its restrictive Foreign Equity Reg- ulation Act. Canada, Australia, Brazil, and Mexico all require companies to transfer technology if they wish to keep their access to these countries' markets. In light of these trends, companies that are dependent on proprietary protection should con- sider developing other kinds of protection. Phaseout. During the Allende years in Chile, the self-liquidation, or planned divestiture, of a potentially risky investment became popular. As an objective, however, it is very difficult to guarantee. Companies have chosen two. ways to accomplish it. The preferred approach is to structure the investment with a minimum of capital and a maximum of loans. Loans should come first from local government sources (incentive loans), second from international bodies, third from banks (preferably local), and last from parent companies. The loans should be short- term rollovers to limit investment risks. True, the loans constitute leverage, but they transfer some of the risk to the shoulders of organizations that are influen- tial enough to ensure companies' continued economic ".)fit'-I .)) _?~:(.1 -i Hedging: Make currency swap arrangements, and negotiate forward cover. 2 Remittances: Use leads and lags. 3 Capital structure: Remit surplus or convert to a parent company loan or a bank participation agreement. 4 Pricing: Use anticipatory pricing at the retail level; charge a manufacturing transfer pricing premium. s Uabilitles: Minimize strong currencies and maximize weak ones by prepaying strong currency liabilities, converting them to weak currency loans, and demanding confirmed letters of credit for strong currency imports. 6 Assets: Maximize strong currencies and minimize weak ones by floating external (strong currency) bonds and by making parallel market currency purchases and cross-currency, cross-company loans as welt as local exchange- indexed intercompany loans, preferably with bank guarantees. 7 Accounts receivable: Tighten collection procedures to transfer exchange risk to local finance companies by factoring local currency receivables. 8 Contracts: Bill in strong currencies (most commonly dollars); use a price escalation clause to take care of large devalua- tions, an index clause for accounts receivable, and a force maieure clause for protection against large devaluations. 9 Blocked currencies: Two methods. One, choose a blocked funds country as a site for an international convention or seminar and use local funds for expenses, including air tickets. Two, set up a barter arrangement whereby marketable goods are exported in lieu of a dividend, royalty, licensing fee, or other service; an offshore agent will handle the details and convert the goods to cash dollars for a fee. Approved For well-being. Companies can extend this technique by tapping local marketing outlets for advances or loans that can eventually be converted to local equity ownership. I remember a scene during the anti- American riots in Istanbul more than a decade ago when troops were posted in front of the Istanbul Hilton, where management had hung out a large sign clearly stating "Turkish ownership." Conrad Hilton had always stressed local ownership and invested not one nickel in his hotels abroad. His profits came through lucrative management and service contracts. Another phaseout approach is to sell a maiority investment to local shareholders-for the Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Harvard Business Review Marh-April 1983 future. The uncertainty of price and local investor 'vailability make this approach more difficult to take, MNCs discovered in Malaysia when they were forced to sell equity to "Bumiputra" (indigenous inves- tors). A company takes a chance when it agrees to negotiate a price in advance; governments have been known to renege. Even the much-vaunted shah of Iran revoked a contract to supply oil to India at a fixed price when the price of oil skyrocketed. Risk premium in profitability. As part of the evaluation of a potential investment in a country, managers often calculate how much more the invest- ment must return on capital in comparison with a sim- ilar investment in its home country. The difference is called the risk premium. Take, for example, an investment in a country with a low level of political risk at 1% (on a scale where Switzerland's risk is zero and Iran's or Zaire's 100%) but with an economic risk of a periodic (say, five-year) boom-and-bust cycle that translates into one exceptionally bad year out of five as well as a 40% risk of devaluation. First, we calculate the return on invested capital (ROIC) that a top multinational nor- mally requires: ROIC = interest + business risk = 18% + 12% = 30%. Then we use this ROIC to see what the ROIC for that country is: country ROIC = ompany ROIC + political risk x economic risk x devaluation risk = (30% + 1%) 1.2 x 1.4 = 52%. To be equal to an opportunity for that multinational in its home country, the investment in this country would have to command a 52% ROIC before taxes. This kind of premium is, of course, hefty and difficult to realize in a competitive environ- ment. Moreover, its calculation is based on the most subjective of assessments. Sophisticated companies therefore often factor political and economic risks into the profitability of their operations and relegate the responsibility for devaluation or financial risk to a cur- rency exposure management team. Their objective is to neutralize currency loss and maintain profitability in constant currency. Can you be ready for everything? Beyond these techniques, corporate strategy dictates that most companies be in business in host countries for the long run and live within the political and economic rules they set. During periods of prosperity, companies build up protected reserves. Nhen adversity strikes, they reassess, reorient, restruc- ture, and even retrench, but they don't immediately divest. It is possible tp weather most storms. Companies should of course be alert to the possibility that the adverse condition is permanent and requires action. A simple illustration is Costa Rica. Stable for decades with the only democratic gov- ernment in Central America, the economy of Costa Rica suddenly became turbulent in 1980. Its govern- ment unpegged the currency from its official mooring of 8.6 colones to the dollar in September 1980; the colon reached a level of 14 by year-end. Throughout 1981, the president and the legislature remained dead- locked on plans to redress the deteriorating economic situation. Costa Rica's supreme court interceded in mid-1981 with a decision that the floating rate, which by that time was up to 40 colones to the dollar, was illegal. Ignoring the court decision, customs con- tinued to impose duties calculated at the free rate, while the central bank offered dollars only at the free rate. The government reneged on its 1980 vow to settle dollar liabilities incurred prior to the colon float at the official rate. It offered government bonds to cover divi- dend remittances. High dollar interest rates and fear of Nicaraguan encroachment triggered flight of capital from the country-in short, economic conditions became chaotic. The situation turned into a nightmare. Imports were payable at the free rate, but companies could collect dollar billings only at the official rate. Companies had to limit price increases because of con- tractual obligations or because customers simply would not pay. The outlook for government payables, receivables, and even tariffs was riddled with uncer- tainty. The only alternative to ceasing business entirely was surgery. Many international companies would say that the speed with which events unraveled in Costa Rica prevented them from being forewarned and thus, forearmed. But I have found that an alert com- pany can be ready for abrupt changes and have in hand a number of ways to deal with crisis. Because financial risk is the most common operational risk encountered, the company that arms itself with sophisticated tech- niques to counter financial risk can protect its long- term profitability. The complexity of financial risk It has become fashionable to play down the importance of finance to the success of interna- tional companies, but this attitude is as shortsighted as that which gave finance undue importance in the first place. Unlike political and economic risk, which hits companies haphazardly, financial risk presents almost daily difficulties. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 In a financial market like the United States, the availability of capital is large, the flexibility of vehicles through which companies can find that capital is considerable, the costs competitive, and long- term stability almost ensured in the hands of a respon- sible institution. When a company leaves this country, however, the picture changes dramatically. While it is not possible within the context of this article to exam- ine all the variations in each environment, you can learn a lot from looking at one typical problem and the techniques used to solve it. The Peruvian headache At the beginning of 1980, the environ- ment in Peru changed-for the better, it seemed. A long period of socialist military rule gave way to an elected civilian government. Anxious to encourage foreign investment, implement the International Monetary Fund's recommendations, and secure the IMF pay- ments credit facility, the government refinanced its external debt and modified the onerous provisions of Decision 24 of the Andean Common Market (ANCOM). The trade balance had turned positive, and estimates of the potential surplus ran as high as $1.4 billion-quite a remarkable change from the flirta- tion in 1978 with bankruptcy. The total financing requirement of one U.S. multinational's Peruvian subsidiary was around $12 million, about $ 5 million of which was long term. The local financing environment the subsidiary faced had: ^ Limited local currency available for pri- mary customers. Five local banks could provide $6 million at an interest rate of 4% per month, but it was available for a maximum term of six months with one six-month rollover guarantee. ANCOM's rules forbade multinationals to borrow long term. ^ The prospect of a minidevaluation of 30% annually, bringing the effective costs of local loans to about 23% annually (interest at maturity). ^ Local dollar loans with no limit but a maximum of 180 days and an interest rate of New York prime plus 4%. ^ Offshore loans at the London interbank rate (LIBOR) plus 1/2% but with a 25% mandatory deposit required without interest. The central bank granted exceptions for capital equipment loans whose Foreign risks 161 After some debate, the company decided to maximize its local loans to obtain dollar loans. While the 23% net cost (including devaluation) was 7% higher than the 16% offshore loan cost, the company decided that this premium counted as insur- ance against a larger-than-forecasted devaluation. The subsidiary would not take out local dollar loans because of their expense and would use them only as a contingency buffer. Finally, the subsidiary turned to offshore dollar loans of $5 million but wanted to avoid making the expensive mandatory deposit. To do this, the subsidiary had to approach the Peruvian Central Bank (through a local bank) to determine the conditions under which it would grant an exception to the mandatory deposit requirement. The central bank stipulated that the loan term had to be three years and that the company had to pay a preferential interest rate no higher than what the country commanded in its international borrowing. (This rate was subsequently defined as LIBOR.) Research turned up three alternatives - a commercial bank loan at LIBOR that would absorb the 10% withholding tax and the differential compen- sation paid to the bank by the parent company; a direct parent company loan at LIBOR with the parent com- pany borrowing in the United States or Europe; and a bank participation loan at LIBOR with a 1/8% bank fee to be paid by the parent. The bank participation loan was attractive because it gave the parent anonymity at a nominal 1/8% cost and was more likely to gain the approval of the central bank as an external bank loan at LIBOR. It was also added insurance if the country's conditions ever changed for the worse since such a loan would be unlikely to be part of a debt mora- torium. Moreover, both the direct parent com- pany and the bank participation loans offered U.S. tax advantages. By providing foreign-sourced income, they allowed the parent to use up any excess foreign tax credit. For example, $5 million at 16% loaned to the subsidiary and borrowed at 13.5% by the parent would have an annual net benefit before taxes of $125,000 or $67,000 after taxes. For this company an annual for- eign source income of $800,000 gave a potential after- tax benefit of $324,000. The currency blues terms exceeded three years. MNCs must consider two kinds of fac- ^ Financing tax payments for 90 days at tors in managing their currency exposure -reporting the nominal interest rate of 12%. Because the subsidi- and operational. The reporting requirement is gov- ary had a $2 million tax bill to pay in March, this was erred by the U.S. Financial Accounting Standards an obvious "- Board IFASBI Statement 8_ Under this standard, a com- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Harvard Business Review March-April 1983 pany must translate its balance sheet at the current exchange rate and charge to the profit and loss state- ment any net gain or loss resulting from asset-liability ranslation. Fixed assets are carried at historical ex- change rates and excluded from the translation pro- cess. For reporting purposes, therefore, the key focal point is net exposed assets. From an operational view- point, however, the focus is the transaction itself, regardless of either time factors or other assets and liabilities. Most international companies restrict their concern about managing currency exposure to satisfying the FASB's reporting requirements. Their strategy is meant to manage the balance sheet (opera- tional hedging) to a zero net exposed asset position. Neither a revaluation nor a devaluation would cause any sudden exchange impact on the balance sheet. Other companies focus on daily transactions and hedge the impact of foreign exchange through currency swap arrangements or the purchase of forward cover (financial hedging). With the assumption that these two considerations run at cross-purposes, companies have debated which kind of strategy is most important. Opponents of FASB 8 contend that the reporting requirement penalizes current-year profitability by treating unrealized gains or losses as if they were real and thereby distorts the profit and loss statement. :xecutives are driven to make "reporting" decisions rather than sound "financial" decisions in multicur- rency environments. The debate led to FASB 52, which differs in two ways from FASB 8. It provides some flexibility by introducing the concept of "functional currency" Company management may now decide whether the currency in which major decisions are made is the local currency or the dollar. FASB 52 also permits the establishment of a special account on the balance sheet through which translation gains and losses can be directly charged against the surplus without first being reflected in the P&L statement. Companies that choose the local currency as their functional currency can follow this route. They must, however, translate all assets (including fixed) and liabilities. For companies whose functional currency is the dollar, the provisions of FASB 8 still apply. One important consideration should not be overlooked. The relief FASB 52 provides per- tains only to balance sheet gains or losses. The larger impact of revenue translation on profits remains. In fact, an increasing number of consultants have advised their corporate clients to hedge net aftertax earnings through a combination of operational and financial echniques. The recent increased exchange rate volatil- ity and the rapidly declining accuracy of exchange rate forecasts are probably, responsible for the increasing inclination of companies to listen. Putting out operational fires International managers have developed a number of solutions for currency problems. Most of these techniques are familiar (for a complete rundown see the ruled insert). Stemming from the kind of com- plex trading transactions and intercompany transfer mechanisms companies have developed to get around roadblocks like those put up by the Peruvian govern- ment in the example, these techniques have many pit- falls managers should avoid. Because they have been developed in a haphazard, mostly ad hoc fashion, . they need to be monitored carefully and controlled rigorously. Local currency loans and hedging tech- niques, for example, generally carry premium costs in weak currencies. Many companies operate entirely with this kind of local loan and include the premium with the product or service. For those that cannot and must use strong currency loans-either because of cost or local banking restrictions-managers must reli- giously follow the probability and timing of currency changes.. Strong currency loans carry additional difficulties. Many countries with exchange controls designate minimum periods for foreign loans. While such controls appear to constrain a manager's freedom of movement in minimizing strong currency liabilities when the company has excess cash, they do not neces- sarily do so. The central bank is the point of control in a country and, as the Peruvian example illustrates, hav- ing a dialogue with the central bank on important points is often possible. In my experience, the key peo- ple in these institutions have been intelligent, knowl- edgeable, and pragmatic. In one instance, we persuaded the cen- tral bank to permit a dollar loan "repass." This method allowed term loans of five to seven years to be repaid in two or three years, without a change in the country's balance of payments. With the assistance of Chase Manhattan Bank, we located a large Brazilian company with financing needs. With the permission of the cen- tral bank, the subsidiary paid the Brazilian company the cruzeiro equivalent of $30 million. The creditor bank changed the original loan agreement and replaced the name of the MNC subsidiary debtor with that of the Brazilian company. All other terms and conditions remained unchanged. The central bank transferred the future right to obtain foreign exchange to the Brazilian company, which in turn, compensated Chase Manhat- tan and the creditor bank for services, change in cred- itworthiness, and change in interest rates with a front- end lump sum payment in cruzeiros. The loan was "repassed" without currency having to cross borders or affect the balance of payments. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 third party is a commercial bank but quite happy to pany should quote the export price of a manufactured delay or refuse payment to a supplier. To minimize currency impact, a com- product in the currency of manufacture. One impor- tant exception: if the import content of the exported product is large and the import currency stronger than the export currency, the company may wish to reverse the currency of export billing. For example, a French plant importing from the Netherlands and exporting to Germany may wish to bill in deutsche marks. Many export houses also hedge their sales through forward cover for six to nine months and factor the hedge premium into the export price. Parallel market is a "semilegal" exchange market in a country with exchange control operating outside the venue of a central bank. In many of the smaller countries, such as Bolivia, Paraguay, and the Dominican Republic, it is the multinational's only source of foreign exchange. In others, such as Brazil and the Philippines, it is an alternate source for certain purposes. Most managers are familiar with the technique of making intercompany loans at preferen- tial interest rates with guarantees of the exchange rate. But companies should be open to variations on this theme. Two companies, for instance, had excess cash in El Salvador. Because of restrictions, they were unable to remit this cash in the form of dividends to the parent company. Both Company A and Company B, however, had subsidiaries in Guatemala. Company A loaned $2 million excess cash to Company B's subsidiary in Guatemala, while Company B loaned $2 million to Company A's Guatemalan subsidiary. The funds were then remitted to the United States from Guatemala. If a devaluation occurs, the exchange losses suffered by the El Salvadoran subsidiaries of A and B are offset on consolidated books by correspond- Anticipating currency changes The amount of a currency change is important, but its timing is critical. Deducing that a country must change the value of its currency on the international market is easy; economists forecast devaluation as a matter of course. Their formula is very simple. Over time, a country must adjust its currency to take into account the difference between its own inflation rate and the trade-weighted average rate of its trading partners. The term over time holds the key. Because each country responds according to different criteria, it could mean one, two, five, or ten years, or perhaps never. Brazil adjusts regularly; Argentina sub- stantially every five years; Venezuela hardly ever. France, under the Gaullists, absorbed inflation rate differentials and quite comfortably maintained a stable franc. Predictions of amount are rarely ful- filled. The extent of the two-year decline in several key currencies vis-a-vis the U.S. dollar was beyond the imagination of economists. The Argentine peso declined 2,500%, the Mexican peso 600%, and the French franc and the Spanish peseta more than 50%. Companies should look at five factors to try to understand the difference in each country's approach to currency change. They are instrumental in determining both its potential and its size: Balance of trade. Economists focus on the difference in inflation rates because they assume that a disparity in labor rates creates an imbalance in the trade position over time; a prudent country will change its currency to adjust. There are two weaknesses in this assumption, however. First, very few countries are prudent. Second, a country's trade balance may depend on a high-yield product such as oil or gold; the labor rate is irrelevent. This is Venezuela's secret. in many weak currency countries for the international A country's reserve position. The Inter- airlines, oil companies, and aircraft companies, most national Monetary Fund requires that member nations other companies must bill in local currency. These report each month on their reserves of gold, special companies must offset the impact of currency on prof- drawing rights, fund reserve positions, and foreign itability by anticipating price increases. In countries exchanges. International Financial Statistics, the where the rate bf currency adjustment is severe, monthly publication of the IMF gives clues to the companies can run into severe collection problems health of a currency based on the trend in a country's with dollar billings. One method that can help is reserves. Delayed reporting is an even better clue. financing through a third party like a commercial Argentina was four to five months behind in early bank. Debtor ' . . _ - t__.,_ _..L,._ A_ ,no, -4 T"----- - .,,, ,.t, -"- -,)nths. Rather Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ing gains in Guatemala. In this case, while regulations restricted dividend remittances to 10% of registered foreign investment in El Salvador, no such restrictions applied to loans. In order to ensure the approval of the central bank, however, the companies decided to lend to each other's subsidiaries. They chose the subsid- iaries located in Guatemala because its government had good relations with the El Salvadoran junta and had impo-;ed no restrictions on dividend remittances. While dollar billing provides protection Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Harvard Business Review Percentage of Gross national product Increase or decrease Cost of living tcumulauve increase, auJuaicv devaluation) Exchange rate at year end pesos per dollar Foreign Imports exchange in billions of Exports Import cover months for goods and services Argentina's cost of living index (Arg. COL) United States' cost of living index (U.S. COL) 1975 1976 1977 1973 1979 1980 176 175 160 101 0 14 35 108 199 331 510 61 $ 3.6 351 - 275 -S-2-.8 117 598 $ 3.8 68 1,004 $ 3.5 61 1,619 $ 6.0 23 1,993 $ 9.4 3.0 3.9 5.6 6.4 7.8 8.0 (0.6) 1.1 1.8 2.9 1.8 (1.4) (0.7) (0.5) (0.5) (1.1) (2.2) (3.4) (1.3) 0.6 1.3 1.8 (0.4) (4.8) 100 543 1,500 Arg. ( COL ) -1.0 x 100 Gap {expressed as a percentage) =100 U.S.C CO OL x EXCH Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 than risk releasing damaging information to the public domain, these countries withheld data. Note that the countries' reserve posi- tions, as stated by the IMF, may not all be liquid, since they include such things as receivables from other countries. Thus, a reported $2 billion reserve may actually contain a zero cash foreign currency position. External debt. The larger the external debt, the bigger the drain on the current account and the greater the country's vulnerability to interest rate changes and debt rollover. Peru's massive devaluations in 1978 were due to its inability to roll over maturing debt; the banking syndicates were unwilling to allow rollovers without IMF participation. The composition of the external debt is also important. If a significant percentage is short term, then the risk is high. As it entered 1981, Argentina had an external debt of about $27 billion, of which reportedly more than 50% was coming due in 1981. Interest rates. Differences in interest rates influence the movement of short-term money. Even in countries with tight exchange controls, the attractiveness of high yields, particularly in strong cur- rencies such as the dollar, influences money to cross borders-surreptitiously, if not legally. Politics. In most countries, politics is the most imps nrtant of these five factors. In japan domestic politics argue for weakening the yen; in France for defending the franc. In Venezuela a politi- cally vulnerable president would rather deplete his country's oil fund than follow his central bank's advice and devalue the currency. Often, as in Argentina, Mex- ico, and Ecuador, politicians allow their currencies to sink only when reserves are finally exhausted. Politics also plays a key role in inves- tors' confidence. The election of Mitterrand in France could have been anticipated. In fact, many French companies hedged against this possibility. Given the image of the 1950s that most French citizens conjured up, the subsequent run on the reserves and the decline of the franc was certain. Even at seven or more francs to the dollar, this decline may not have yet run its course. Foreign risks 165 the peseta. Stimulation of exports even at the risk of a "beggar thy neighbor" policy was part of their electoral platforms and known well in advance. Devaluation expectations are high for Venezuela and Brazil. In Venezuela the catalyst for change could be the near depletion of the oil fund or the presidential election, whichever comes first. In Bra- zil it could be the cumulative reluctance of foreign banks to participate in loan syndications and the need for a forced IMF rule. I correctly anticipated the 1981 currency change in Argentina. On the political front, I knew that the next president, General Viola, would take office on March 31,1981 and bring with him a new economy minister. It was uncertain what the minister's posture would be. Looking at the country's vital economic sta- tistics (see the Exhibit), I saw that the country had already had minidevaluations of the currency amount- ing to 3% each month. The statistics for 1980 bore striking similiarities to those for 1975. Both included negative balances of trade, declining reserves, and large current account deficits. I calculated the inflation rate differen- tial (the gap calculation) according to the formula in the ruled insert and monitored an increasing gap between the two countries. In fact, the cumulative gap was extremely wide and led me to conclude that the probability of a maxidevaluation was very high. It would be timed to anticipate the inauguration of the new president. As it turned out, my estimate of the timing was perfect. The first maxidevaluation of 10% took place in February, followed soon after by a 30% devaluation in April and a panic run on the peso. Carrying greater risks but with them the potential for big rewards, the world of tomorrow promises to be far more volatile than that of yesterday. The world outside these United States is not a mono- lith. Each country is different and the spectrum wide, ranging from the traditional safe haven of a Switzer- land to the turbulence of an Argentina. To be successful, it is important to understand each environment and the risks involved. A thorough understanding of them, coupled with your knowledge of your own business, could help you develop an exposure management strategy that would mitigate risk, protect your investment, and maximize the rewards. I have discussed many techniques that can serve as a basis for the development of a strategy. Once you have begun it, you will discover that many more techniques are developed and rediscovered each day. The process is a continual one, the horizon limitless. 8 oiinrnn eC Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Keep a sharp watch for the "catalyst" for timing currency changes. In France, the catalyst was the election of Mitterrand. In Mexico, it was the oil glut and the disastrous residual impact of the mid- 1981 confrontation with the oil buyers. In Argentina, it was the pending nomination as economy minister of Lorenzo Sigaut, who had very different ideas about devaluation than his predecessor, Alfredo Martinez de Hoz The elerrinn of socialists in Sweden and Spain Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ASIAN BANKING/INDONESIA is mmirEsm m1w, dop Even its tough policies can't cope with a $7 billion deficit. That's why Indonesia will be back to the markets soon. By Donal Curtin "Indonesia is not another Mexico," said the first foreign banker. "They have a very good economic team who have done a good job, and as long as there are no recession problems in the major economies Indonesia will pull through. They have been cutting back development programmes, they de- valued the currency, and they have a borrowing capability that people are not generally aware of." "If nothing had happened this country would have been in trouble," said the second foreign banker. "The fall in the oil price hit them badly, and they could have made the classic mistake of trying to continue spending rather than face the alternative. But they were real gutsy. They devalued, they rephased projects - precisely what they had to do. They have their troubles; who hasn't? But "We think the current account will be they are doing the right things." not much different from the $6.2 billion "The world economy is down, world deficit projected in the budget," said a trade is down, and there are winners and government economist. "Oil income has losers because of that," said the third gone down since that projection was made, foreign banker. "Indonesia is not a loser." but the policy adjustments bring the deficit Jakarta has a small foreign banking com- back to that level." munity, and these remarks are typical of the The World Bank's annual report on mood of guarded optimism among them. Indonesia, which was presented to the When Indonesia devalued the rupiah by government at the end of May, makes 27.5% against the dollar on March 30, and similar predictions. It expects a current followed up with what the Indonesians call account deficit of $6.5 billion in fiscal 1983, a "rephasing", or indefinite delay, of falling to $4 billion in fiscal 1984 and to major development projects, most $3 billion in fiscal 1985. observers reckoned that enough had been The government's tough decisions on done to tackle the country's widening devaluation, slower development, a balance of payments deficit. continuing freeze on public sector pay, At the beginning of the year, on highly lower subsidies - domestic fuel prices were optimistic assumptions, the Indonesian raised sharply in January - and a tight budget for fiscal 1983 (the year from April credit ceiling of 15% have disposed in- 1983) predicted a current account shortfall vestors to look kindly at Indonesia's of $6.2 billion. In fact, on more realistic prospects. In addition, the Indonesian views the gap was heading for between $8 government keeps a balanced budget and and $10 billion. The gap for fiscal 1982 was has a large volume of undisbursed debt $6.8 billion. available to meet its external funding needs. "These days, after the policy steps, an As developing countries go, Indonesia optimistic forecast of the balance of pay- presents an image of decisive, efficient ments deficit would be between $5 and government. $5.5 billion, and a more realistic estimate But have the numbers significantly would be between $6 and $6.5 billion," changed? according to an economist with a foreign According to the World Bank, even embassy in Jakarta. "From what visiting though the current account deficit will fall bankers tell me, a deficit around $6 billion steadily over the next three years, Indonesia its total foreign public debt will go up by $10 billion to over $30 billion, and the debt service ratio will rise from 22% now to 26014 in fiscal 1985. That forecast is based on fairly charitable views of probable Indo- nesian exports. If oil production rises to over 1.6 million barrels a day (the current Opec limit is 1.3 million); if liquefied natural gas exports double in three years; if non-oil exports grow by 9% a year in dollar terms (they fell by 10% in fiscal 1982) and if oil is $32 a barrel by 1985, all will be well. Indonesia's current account deficit might be a lot worse than the World Bank and the government expect. Oil is all-important. At present Indonesia produces 1.3 million barrels a day; accord- ing to sources in Jakarta it has been able to find buyers at $29.50 a barrel for the 900,000 barrels it exports. If demand picks up, and Opec production ceilings are raised, as the World Bank expects, Indo- nesia stands to earn over $2.5 billion a year in additional revenue (assuming 250,000 barrels of the extra 300,000 a day are exported at today's price). That is an optimistic guess. Oil prices are still falling - Japan, Indonesia's biggest oil market, has recently negotiated price discounts with Iran - and if the next Opec price meeting were to lower the benchmark price to $25 a barrel, Indonesia would lose some $L 3 billion a year. 1!1 F,,rmm~nnv Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 A statue in Jakarta commemorates freedom from the Dutch. Now Indonesia struggles to free the bonds of its payments crisis. prices and production quotas, Indonesia foregoes $2 to $2.5 billion a year, and the current account deficit stays where it is. According to some preliminary guesswork in Jakarta the current account deficit is running at around $7 billion annually. Taking a more pessimistic view still, if oil prices were to fall by $4 to $5 a barrel, the current account deficit would rise by about $1 to $1.5 billion. However, there is room for higher LNG exports to offset any decline in the price of crude oil. Japan, which takes all of Indo- nesia's annual LNG output of 7.5 million tons, has contracted to take a further 3.2 million tons a year from East Kali- mantan, starting in September this year, and a further 3.3 million tons a year from North Sumatra from January 1984. Korea is likely to take 2 million tons a year, according to an agreement signed in May. Together, new LNG contracts will double net LNG export income, which has been estimated at $1.5 billion in fiscal 1982. If the worst comes to the worst, and Indonesian oil sells for $25 a barrel, higher LNG revenues will maintain the net export income of the oil and gas sector at around $6 billion a year, but will not provide enough extra income to start closing the current account deficit. Will the March devaluation have any significant effect on Indonesia's non-oil exports? Again, there is room to doubt the optimistic figures now circulating in Jakarta. In 1982, Indonesia's non-oil exports came to around $3.9 bil lion (the latest incomplete figures show a total of $3.81 billion). This was down by over 9% from the $4.3 billion of 1981, and well below the peak income of S6 billion in 1980. The world recession hit Indonesia hard, since virtually all the country's non-oil exports are industrial raw materials, with prices determined by world market conditions. Lower world trade has meant lower export volume, and generally lower export prices, for almost all non-oil exports. The country's biggest non-oil earner, timber, was affected by a government decision to restrict exports of raw logs and to encourage the export of worked timber, such as plywood. Log exports fell, but ply- wood exports did not rise. Timber earnings were $1.9 billion in 1979 and 1980. They fell to $1.1 billion in 1981 and to $900 million in 1982. There are some signs that non-oil exports will do better in 1983 and 1984. Demand from the industrialized countries should be higher, and prices at least no worse. For Indonesia's second largest non-oil earner, rubber, prices are actually back to 1981 levels. For the time being, however, Indo- nesia faces a buyers' market for its non-oil goods, and foreign buyers appear to have been able to negotiate dollar price cuts for some commodities, exploiting the devalua- tion of the rupiah. "Our non-oil exports are still declining," said an economist with one of the large state-owned banks, "although I think for 1983 as a whole export revenue will be about the same as in 1982." Non-oil imports will certainly be restrained by the March devaluation, which raised the rupiah price of imports by 38%, and by government measures to restrict non- essential imports such as fruit. But the government is keen not to cut back too far. The one statistic every government official likes to quote is the 2 million new jobs that must be created each year to absorb the growth in Indonesia's labour force. Thus real growth must be 3% a year if the growth is concentrated on labour intensive sectors, or, more realistically, nearer 5% a year. For fiscal 1982, govern- ment economists reckon that growth was around 3%, and for the current fiscal year they predict a slightly lower 2 to 3%. That makes it difficult to squeeze imports hard. Consumption goods comprise only a small fraction of total imports, with capital goods and raw materials forming some 85% of non-oil imports. Imports are closely linked to doti,estic economic growth, and the country will be doing well if imports are cut back to $14 billion from the $15 billion of ASIAN 'BANKING/INDONESIA fiscal 1982. Putting together net oil and gas income of $6 billion, non-oil exports of S4 billion, imports of $14 billion and a services deficit of $2,750 million (only slightly up on 1982) gives an estimate for Indonesia's current account deficit of $6,750 million - un- changed from the fiscal 1982 level, and, unless there is a strong world economy coupled with firmer oil prices, unlikely to budge much from that level over the next two to three years. Can Indonesia finance it? Not out of reserves. "If you had told me a year ago that the foreign exchange reserves were going to be less than $5 billion, I would have been very surprised," one embassy analyst put it. Bank Indonesia's reserves are now little more than $3 billion - equiva- lent to about two and a half months' imports, and not easily reduced further without straining the country's liquidity. The state banks hold a further S3 to $3.5 billion in foreign exchange, and, according to one central bank source, it is hoped that restrictions on lending to lower priority sectors will induce the state banks to swap some of their foreign currency into rupiah. If that happens, the central bank might be able to spend up to another $1 billion to meet this year's current account shortfall. Running down the reserves can meet only part of the $6,750 million gap (and, in any event, is a one-shot weapon). Most of the funds will come from Indonesia's treasure chest of undisbursed foreign debt, which, according to the World Bank's resident staff in Jakarta, amounts to $12 billion. Of that, some $7 billion is on concessional terms from the 13 member countries of the Inter-Governmental Group on Indonesia, and the remaining $5 billion is a mixture of buyer and supplier credit and funds on international market terms. The World Bank's staff calculates that $4.2 billion of the undisbursed foreign credit lines will be drawn down by Indo- nesia during fiscal 1983, with the World Bank itself the largest single source. Projects supported by the Bank will receive between $600 and $800 million during the year. Another important component of the $4.2 billion is the outstanding amount available under the terms of Indonesia's March jumbo borrowing of $1 billion. A current account deficit of $6,750 million, capital inflows of $4.2 billion and a $500 million drawdown of foreign reserves would still leave Indonesia with $2 billion to find - a figure higher than most bankers in Jakarta expect. Representatives of the major banks know that Indonesia will have to borrow again later this year. The general feeling is that there will be another jumbo of between $700 million and $1 billion, although some bankers would prefer to see a gradual series of smaller borrowings. "A big borrowing is inevitable," said one banker, "and I think Bank Indonesia will' Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ney July 1983 165 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ASIAN BANKING/INDONESIA be leaning hard on its friends, although it will have to pay more - maybe 40 basis points over US prime, compared with the 20 points on the March jumbo." Indonesia is likely to approach the markets for more than the bankers expect - probably for $1.5 billion, possibly for $2 billion. That is not an indictment of the Indonesian administration. Bankers give it credit for its successive steps to tackle the deficit, especially the devaluation, which was a classic success. The rupiah strength- ened in the market immediately afterwards, and short-term capital outflows returned, sending short-term rupiah rates down from nearly 30% to under 2091i. Indonesia's need to borrow is structural. It was disguised fora time by the oil price rise in 1979, but the country has the arche- typal developing economy - dependent on a narrow range of natural resources with volatile prices, lacking manufactured exports (except a few textiles and electrical appliances) and needing to import many of its raw .materials and most of its capital equipment. In bad years, Indonesia even has to import the staple food, rice. Its natural pattern of development is to run current account deficits, financed by development aid and, as development pro- ceeds, by funds on commercial terms. At the end of 1981, 64% of Indonesia's debt was aid of one kind or another. Trade credits made up 10%. Market borrowings made up the remaining 26%, but that pro- portion is going to rise. 13 The world recession hit Indonesia hard, since virtually all the country's non-oil exportsareindustrial raw materials, with prices determined by world market conditions Indonesia is not another Mexico or another Venezuela. It is not even another Nigeria. Bankers trying to assess Indonesia may be wise not to look on it as an oil economy. Its appetite for capital is greater than its export revenue from oil or gas, and a $6 billion a year oil income, although some reassurance to lenders, tends to get eaten up by the import demands of an S85 billion economy. The 1983 payments crisis is not so much a crisis as the normal pattern from now on. The best pointer to Indonesia's future may well be what happened after the 1979 oil price rise. Within 18 months, Indonesia was Rachman of Wardley-Summa: Ideal links. restrictions on branch banks, leasing should make a lot of money for the newcomers. It is not hard to get in - the minimum paid- up capital requirement is Rupiah (Rp) 3 bil- lion ($3 million), though it is likely that the minimum will shortly be raised to Rp4.5 bil- lion ($4.5 million). There must be an Indonesian partner, an agreement that majority control will pass to Indonesian interests within 10 years, and arrangements for training Indonesians in the leasing business. The rewards look promising. The amount of business a leasing company can do is governed by a gearing ratio of 33 times capital. With a typical spread on lease con- tracts of 3%, it should not be hard to make a good return on equity. So far, not much leasing business has been done. Leasing companies are not yet required to report their results, so the size and distribution of the leasing business is unclear. According to estimates prepared by the Indonesia Leasing Association, lease contracts worth Rp27 billion (then worth S42 million) were written in fiscal 1980. That went up to Rp73 billion ($110 million) in fiscal 1981 and to around Rp95 billion ($135 million) in fiscal 1982. The three biggest companies - Orient Bina Usaha Leasing, an affiliate of Japan's biggest leasing company; Wardley-Summa Leas- ing, an affiliate of the merchant banking arm of Hongkong and Shanghai; and First Indo-American Leasing, an affiliate of Bank of America - have something like $65 million, or roughly half, of the market between them. That is partly because they have had a head start. But if the market is small and concen- trated now, it is likely to grow and widen in the future. "Indonesia is one of the last frontiers, at least in Asia," said Amir Abdul Rachman, assistant director with Wardley-Summa, pointing out that much of the country's private capital investment is financed by rolled-over short-term loans. "There is a lot of mismatching," he said, explaining the backinthered. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001 3 more reliable, longer-- TE A4YRASYC IXJ~r 9`* LA$] Indonesia's domestic banking system has been closed to foreigners for years. Now there's a way in through the back door: leasing companies. By Donal Curtin New leasing companies are starting up in Indonesia faster than fast-food franchises. For several years there were only five, all set up between the middle of 1975 and early 1976. In late 1981, however, three firms were set up, and in 1982, nine more. So far this year another five companies have been given operating licences, with a further eight at the halfway stage of provisional licences. And there is a long backlog of applications for licences at the Ministry of Finance. Why the sudden attraction? Belatedly, overseas banks, finance houses and leasing companies have discovered leasing as the back door into the profitable but inacces- sible world of Indonesian banking. In the late 1960s, the authorities closed off domestic branch banking; only 10 foreign banks and a joint venture involving Japan- ese banks had established operations before the door was locked. In the early 1970s access became even more difficult, when foreigners were also cut off from the non-bank financial institu- tion sector. Foreign banks that did not take a shareholding in one of the nine finance houses or in either of the development finance companies were left out of the boom in Indonesian banking in the late 1970s and early 1980s. Leasing companies are giving banks that missed the bus a new vehicle for their ambi- tions. "Foreign banks are really setting up what - in the US - would be called in- dustrial banks," said the chief executive of one of the new companies. Even for banks with existing branch operations in Indonesia, a leasing company is useful. It enables the bank to skirt some of the tight restrictions on foreign banks, especially the prohibition on lending to companies outside Jakarta. Recently, Indonesian officials have taken a tougher line on defining a Jakarta company. A leasing office is also an extra outlet for the branch banks, which are restricted to one main and one sub-branch. Apart from the advantages of getting Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ASIAN BANKING/COUNTRY RISK iLrs s ssss ~, SIAN Lusx Japanese investors prefer Europe to their neighbours. But they like Singapore, Malaysia and Thailand. By Donal Curtin "Quite frankly," said the syndication manager of a leading Japanese trust bank, "Japanese investors - the trust banks and the life insurance companies - don't like to have a portfolio in Asia, except in Malaysia and Singapore. "Some of the city banks are sophisticated enough not to mind a portfolio in Indonesia or Thailand, but the major institutional investors don't like it. That is the problem for Asian borrowers." Sentiment has changed significantly in the Tokyo market. The change is not easy to detect from the terms that borrowing countries obtain in Tokyo, because admini- strative guidelines compress the differentials in spreads that would otherwise discriminate between strong and weak borrowers. But from what syndication managers say, Asian borrowers have fallen out of favour. Some years ago the South-East Asian newly industrialized countries, such as Singapore and Korea, seemed to offer highly attractive lending opportunities. In a word beset by recession and default, they offered high growth, strong exports, firm government and tractable debt. Some of them - particularly Singapore, Malaysia and, possibly Thailand - still look good to Japanese lenders. But the Philippines, Indonesia and Korea are now distinctly unpopular. Taiwan is also out, but for a different reason. Since the normalization of Japan's diplomatic relations with the People's Republic of China in 1972, Japanese banks have not lent to Taiwan. At the bottom of every Japanese inves- tor's Asian list is the Philippines. Trade financing, buyers' and suppliers' credits, are still being arranged, but many bankers in Tokyo would avoid sovereign lending. "There are two sorts of risk in lending to the Philippines," said one executive with a city bank. "One is the general sort of country risk, the country's external position, its foreign exchange reserves and so on. And the other is what I call the Marcos risk." Above the Philippines, but still regarded with disfavour, are Indonesia and South Korea. "These are countries with very ambitious development plans, and big increases in foreign borrowing, which are now a handicap," said one city banker. Both countries are in the market for yen syndicated loans - Indonesia for #24 billion ($102 million) through the Industrial Bank of Japan (IBJ) and Sanwa Bank; and Korea through Korea Electric Power (KEPCO), looking for if 10 billion ($42 million) through Nippon Credit Bank and Sumitomo Bank, and through its Exim- bank, which is raising *10 billion ($42 million) through Yasuda Trust. Bankers were generally reluctant to parti- cipate in these borrowings. "For many of us, we are at our country limits for Indonesia, which has its problems with the oil price," said one banker. Others pointed to the large volume of trade-related loans raised for Indonesian borrowers in Tokyo. "If Indonesia's borrowing is finished smoothly, it will be because of the position of IBJ in this market, not because of Indo- nesia," said another banker. Tokyo lenders are worried by South Korea's high level of existing debt. "Korea is improving very much in various respects,'." said a syndication manager with a regional bank, "but its total overseas borrowing is so high - the third or fourth largest in the world. Even if its economy improves a lot, and inflation seems to be going down and growth improving, financial institutions will still be worried about its total borrowing." The surprise country in the country risk ratings in Tokyo is Thailand, which has risen in estimation as its neighbours have declined. "Thailand has been keeping a low profile for some time, and now it has a smaller level of external indebtedness than most Asian countries." "Thailand is one of our best customers," agreed a syndication manager with one of the long term credit banks. It is getting better recognition in the market because of the relatively low number of its borrowings in the past." Thailand's image in the Tokyo market has improved to the point that it can command the going market rate on yen credits, 30 basis points over Japanese long- term prime. Thailand has only one credit in the Tokyo market, a #5 billion (S21 million) cofmancing with the Asian Development Bank. "It's a bit too small to say anything about Thailand as a country risk," said one of the lead managers, "but it certainly seems to be quite popular." At the head of the country popularity stakes is Malaysia. "There is no doubt about their essential creditworthiness," said the chief manager of a city bank's syndica- tion department. .The balance of payments has deteriorated slightly recently, but it has basic strength from development of its natural resources, and Malaysia's management is good. Their civil service system is the best outside Singapore." Only one country would surpass Malaysia if it came to the Tokyo market - Singa- pore. "It's best," said a long-term banker, "but unfortunately we have had little opportunity to lend to Singapore as a sovereign credit." Other bankers echoed this complaint - proving once more that the way to get the best terms is not to borrow at all. ^ FORTHCOMING EUROMONEY CONFERENCES 1983 August 8-9 JOHANNESBURG International Finance for South African Companies: Source and Techniques September 14-.15 HONG KONG September 20 LONDON Default 83: The Problem Loan and the Bankrupt Borrower Interest Rates and Currency Swaps For full details contact: Susan Turner, Conference Administration Manager, Euromoney Publications Ltd, Nestor House, Playhouse Yard, LONDON EC4V 5EX Telephone: 01-236 3288 Telex: 8814985/6 EURMON G Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 . They had ithing they m Iran at a ompany in n per cent. he Iranians lably bitter t. he Iranian :e Banking lined their I not be a orative ac- her OPEC )e and the European take over not having lect that, if ;s of the ,ju don't .l intrigue,' d certainly ernational r one mo- bank and ociated his seen as a Chapter Eighteen COUNTRY RISK If I owe a million dollars, then I am lost. But if I owe fifty billions, the bankers are lost. Celso Ming (Brazilian Economist), 1980 THE revolution in Iran had taken nearly everyone by surprise, and it brought a new urgency to an old question: how do you measure the political risks in a foreign country? With some prompting from govern- ments and central banks, bankers began trying to assess more seriously the hazards of their operations. They turned not only to economists, but to diplomats, political scientists and intelligence experts to advise them in the fashionable new science called `country risk'. The problem was as old as banking, but the American banks had become more concerned since the late sixties when the influence of their own government over developing countries was visibly waning. `It really began in 1967,' according to one political scientist, Stephen Blank of Multinational Strategies Inc., `when Occidental Petroleum did their deal with the Libyan government which undermined the power of the big oil companies. In the next six years it became clear that American companies had lost the capacity to tell countries what to do: they had to begin studying what countries would do to them. By 1973, with the new power of OPEC, the transition was over.' The unpredicted success of OPEC had certainly undermined much of the confidence in the projec- tions of economists. When the futurologist Herman Kahn had written his book The Year 2000 in 1967 the words oil, energy and Saudi Arabia did not appear in the index, and after the price-increases which changed the balance of the world many economists still insisted that the price must come down. As the bankers lent more money to unstable countries like Zaire or Indonesia, they began to feel the need for political as well as economic assessments; and the collapse of the Shah revealed all the shortcomings of their information. There was something inherently comic about this attempt to measure Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 the immeasurable, to award credit-ratings to countries as if they were hire-purchase customers. The spectacle of bankers, with all their zeal for precision and objectivity, giving marks to nations for good behaviour could never be altogether convincing. What could they learn from their hotel suites of the gossip in the bazaars, the mutterings of revolution in the back alleys? How could these immaculate men wander inconspicu- ously in the souks of the Middle East or drink in the shebeens of Johannesburg? How could they calculate whether Bangladesh or Sri Lanka was the more ripe for revolution? They might think that they were establishing rational systems and yardsticks to measure the world; but they were always deeply influenced, directly or indirectly, by the assumptions of their foreign ministries and governments. They were still following some kind of flag. While each bank made its own assessment of country risk, the market revealed its own consensus in terms of the length and profit-margins of the loans (the `maturity' and the `spread'). The magazine Euromoney compiles its own `league table' of country risk, based on its statistical analysis of syndicated loans, grading sixty-six borrowing countries in order, and awarding them stars from seven to one. In 1979 the list began with three seven-star countries, France, China and Britain, and ended with six one-star countries (Gabon, Ethiopia, Guyana, Madagascar, Niger and Pakistan). It had some remarkable juxtapositions: the six-star countries included five communist countries - Russia, Czechoslovakia, Hungary, Bulgaria and East Germany - alongside western countries like Italy and Canada and newly-industrialised countries like Korea or Columbia. In the roll-call of three-star countries, White South Africa was sandwiched between black nations like Malawi, Cameroons and Tanzania. The market revealed no colour bar, no ideological bias.I 'I think I can say I was the inventor of the whole subject called country risk analysis,' said Irving Friedman, with characteristic modesty; and it was true that Citibank, after Friedman joined it in 1974, set up a more formalised and self-conscious study of risks than other banks, as we saw in Chapter 10. As Citibank began lending more to the third world, Wriston built up a team to assess credit risks, led by Friedman and the vice-chairman, Al Costanzo, and he insisted that they had independent powers to defy any pressure to lend. Other American banks took their own steps to strengthen their politi- cal analysis. `We're much more sophisticated on the economics side than on the politics,' admitted the senior international economist at Morgan's, Rimmer de Vries:' and in 1980 Morgan's tried to establish Institutional Investor produces a rival grading: see Chapter 1. Euromoney, July 1980. their own with their have to be 'once a COL pay.' The 13;tn system .ift` Banking n tive capaci factors was American classificatic, offices. It N Heller expl just one sin the form (ft The first capacity ins countries. cator' base( managers, sistency'. T cator', whic for social u `on-site knc Francisco. ' can't see th, tions (it see indicator lib excellent ec unrest. But all the benel The Chap officers to I already set t Kissinger, r into doubtfi economists, clean-shaves service to cf ' Robert Helle Conference on Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 countries as if they were r' , with all their zeal for .icon; for good behaviour ,uld they learn from th::ir uticrings of revolution in men wander inconspicu- rink in the shebeens of ether Bangladesh or Sri _y night think that they ks to measure the world; .:tly or indirectly, by the trnrnents. They were still country risk, the market ;th and profit-margins of ie magazine Euromoney based on its statistical borrowing countries in ne. In 1979 the list began and Britain, and ended Guyana, Madagascar, positions: the six-star Russia, Czechoslovakia, gside western countries countries like Korea or ies, White South Africa lalawi, Cameroons and io ideological bias.' -le subject called country cteristic modesty; and it it in 1974, set up a more Zan other banks, as we nore to the third world, ed by Friedman and the it they had independent strengthen their politi- the economics side than national economist at rgan's tried to establish their own careful rating of countries, so that they could compare them with their ratings of American companies in the same system. 'But we have to be very security-minded,' one man in Morgan's explained to me; once a country discovers that it's got a low credit rating, there's hell to pay.' The Bank of America was determined to set up a specially thorough system after the mistakes of Iran. As Richard Puz, the head of the World Banking Division, expressed it to me in California: `In Iran our predic- tive capacity was weak: at that time the visibility of non-quantifiable factors was secondary to hard numbers. We didn't realise how rapidly American support would disappear.' The Bank of America devised a classification to make full use of its worldwide staff and decentralised offices. It was unlikely, as their chief international economist Robert Heller explained, `that all relevant information can be compressed into just one single number';' so they gave countries a three-point rating, in the form (for instance) of 82AC. The first number, ranging from 1 to 100, expresses the `debt service capacity index' based on an international data bank covering eighty countries. The first letter represents the `judgmental economic indi- cator' based on questionnaires sent out to the bank's country or regional managers, which are then checked at headquarters `for global con- sistency'. The second letter expresses the `judgmental political indi- cator', which focuses on three areas - governmental control, potential for social unrest, and external factors, assembled from replies from `on-site knowledgeable officers' and revised by senior managers in San Francisco. `The country manager,' as Puz explains, `can get so close he can't see the wood for the trees.' But the difficulty with such classifica- tions (it seems to me) is that they can't see the trees for the wood. An indicator like 82AC might describe a country like South Africa, with excellent economic statistics and prospects but high potential for social unrest. But once the AC goes down to AE, the E can quickly cancel out all the benefits of the A. The Chase characteristically turned to ex-diplomats and ex-CIA officers to provide its political intelligence. David Rockefeller had already set up an International Advisory Group, which included Henry Kissinger, meeting four times a year; as the Chase moved deeper into doubtful countries, they took on more political scientists and economists, with beards and moustaches which stood out among the clean-shaven orthodox bankers. They even prepared a special new service to clients called `Chase World Outlook', full of computerised ' Robert Heller: `Bank of America's New Country Evaluation System.' Euromoney Conference on Country Risk Assessment, New York, October 30, 1980. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 THE MONEY LENDERS calcul ; tions about country risks; but it was Soon clear that they could not say candidly what they thought about (for instance) Saudi Arabia, whose deposits were crucial to the bank; after spending three-quarters of a million dollars they abandoned the project. Rockefeller's personal influence still prevailed. In 1980 he set up a three-man 'Country Risk Management Group', with their own patrician approval, headed by the former head of the western hemisphere division, Francis Mason, and including Archie Roosevelt, a former CIA officer, and Ridgway Knight, the ex-ambassador who had often accompanied Rockefeller on his journeys. `If you sat in on a meeting of the country risk committee,' said the Chase's chief economist, Robert Slighton, who also once worked for the CIA, `I think you'd be impressed by how much they knew, but appalled by the difficulty of transferring that knowledge into policies for loans. We can't afford to go into a country when it looks good, and pull out when it looks bad.... In retrospect, we overloaned in the seventies: there's a much more hostile environment projected for the eighties.' `Operational banking' (Slighton continued) `consists in a constant war, a continuous adversary process between credit officers and loan officers - it takes place at every level, and it can be very bloody. In assessing the country risk, the most critical questions are, first, the likelihood that the political consensus will be intact; second, can economic policies respond to a sudden shock? A country that doesn't redistribute its wealth is a bad risk; if a loan helps a country to redistri- bute, that's desirable. In. general, we'd rather lend to a country that's had its revolution.,I Why did the banks, with all their different systems and attitudes, still reach the same conclusions about so many countries, even when they were all wrong? Why did they still behave like starlings or lemmings? In the nineteenth century banks would take their own risks in lending to unreliable countries, as Barings backed the United States. But they were now much more reluctant to get out of line with each other: 'There's no opportunity so good,' as one Chase man explained, `that we want a hundred per cent of it.' `Facts make their own decisions,' Wriston told me at Citibank when I complained about this uniformity. 'If you all look at the same facts it would not be unusual to come up with the same answer.... In those days Mr. Rothschild made his fortune by getting carrier pigeons to tell him who won the battle of Waterloo. Now today, when the President frowns in the Rose Garden, it is in the rate of the dollar in thirty seconds. The information explosion puts the facts at everyone's command.' But ' Interview with author, March 12, 1980. others are more wor theory ,' Wilson Sch, institution feels the Indians looked to tl their economists. hu they can't predict together. And they both special inforn opinion - like the c;, The Iranian revolt, banks not only hcca, revealed the full iml terests. It was much h so little ability to inflt the vulnerability of tl can tell you that as a I Mexican authorities,' against Chase Manhat making certain that t European banks get th The American hanl were turning less to th World Bank and the I laxing their discretion of the seven veils,' one 1 more.' European bankers li calculations of country and hunches. 'They lik( tive,'said a British bank, atmosphere in Washing like waving a wand.' ?hways and car plants had been built on the assumption of unlimited cheap oil; and the four-fold increase wrecked the balance of payments and boosted inflation. A new President, General Geisel, sent ?Delfim into exile to be ambassador in Paris, but continued with expansionist policies, pushing ahead with new steelworks, shipyards and nuclear power stations, while inflation went over forty per cent. Most bankers found Brazil now much less attractive, but Wriston at Citibank saw the opportunity both to profit from the high returns and to cement the bank's relationship with Brazil. By 1977 Brazil seemed to be on the road to recovery, and other bankers including the Japanese again began piling in, bringing the margins down again. Citibank had been shown to be a good friend of Brazil, and the Brazi- lians appreciated it: 'We feel much safer with Citibank,' explained one government economist, `because we know they've got so much at stake.' By 1979 Delfim was back as economic overlord under the new Presi- dent Figueiredo. He was again bent on high growth, but the new oil crisis and strikes in Sao Paulo brought new dangers. Inflation was back to over eighty per cent, with growth of only six per cent. Delfim promised that Brazil would become less dependent on oil by financing a vast project to produce alcohol from sugar, on which Brazilians could run their cars: and when the bankers met at their annual meeting of the IMF in Belgrade in 1979 he persuaded them to raise a jumbo loan of 1.2 billion dollars for the new alcohol programme, backed by the Brazilian govern- ment itself. It was a historic loan, led by Morgan's and three other American banks, with a margin of less than one per cent above the standard rate of interest, running for twelve years. It was a triumph for Delfim who had personally persuaded many leading bankers against much of their current advice about country risk. But many big banks, including Bankers' Trust in America and the German Big Three, stayed out of it; and the Japanese banks, who had been warned to cut back their foreign loans, only contributed 125 million dollars. Brazil was still on a tight-rope and in February 1980 Delfim toured America and Europe to try to raise confidence; in New York he breakfasted with Wriston, and saw McNamara who had flown up from Washington. But most bankers were still sceptical and insisted on high margins or spreads: `I didn't expect to be greeted by a bunch of adding Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 machines,' r) precious rese IMF which '.' always show c new America next it was t Brazilians wL suggesting th benefit. Brazil rein governments, power? Or x( would make i international `it could well huge profits f others, or he( down? And government, The bankers I traditional `si, nightmare sin frontier of .th. supported by crisis to the nc early seventic remittances fr the country w imports furthc The potent I solidarity of i\ to lend move} where the De' American an margins. By terest rates t; banks, with C rushed in to t.- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 J the gross inequal- nara at the World =commercial banks; government, and s - argued against y looked bleaker. 'rid car plants had and the four-fold d inflation. A new be ambassador in ig ahead with new file inflation went ich less attractive, 'ofiit from the high zil. By 1977Brazil 'ankers including gins down again. il, and the Brazi- explained one o much at stake.' the new Presi- .e new oil crisis. was back to over m promised that a vast project to J run their cars: of the IMF in an of 1.2 billion ~razilian govern- ind three other cent above the is a triumph for )ankers against many big banks, g Three, stayed o cut back their Delfim toured New York he flown up from isisted on high inch of adding machines,' Delfim complained.' He was now having to dip into Brazil's precious reserves; and he dreaded that he might have to borrow from the IMF which would cut back on Brazil's bid for economic freedom. Brazil always showed two different faces to the world: one moment it was the new America, competing over-confidently with the rich nations; the next it was the most vulnerable of all developing countries. By 1950 Brazilians were again talking of being part of the third world, and suggesting that the world institutions should be restructured for their benefit. Brazil remained an expensive question mark for both bankers and governments. Would it at last stand on its own feet as a major industrial power? Or would the economic crisis bring about a political crisis which would make it unable to pay off its debts? `If there is a real threat to the international banking system,' one veteran London banker observed, `it could well begin in the slums of Sao Paulo.' Had Wriston made his huge profits from Brazil because he understood the country better than others, or because he knew that his government could not let Brazil go down? And who was really taking the risk - the bank, the American government, or the International Monetary Fund? TURKEY IN TROUBLE The bankers faced a more highly charged political scene in Turkey, the traditional `sick man of Europe', which like Iran had been a bankers' nightmare since the mid-nineteenth century, and which stood on the frontier of the western alliance with the Soviets. In the post-war years, supported by massive aid, Turkey had staggered from one economic crisis to the next, teetering between democracy and military rule. In the early seventies the economy made some recovery with help from remittances from Turkish workers in Germany, but the oil crisis soon hit the country with double severity: the workers were sent home while oil imports further wrecked the balance of payments. The potential bankruptcy of Turkey now looked like threatening the solidarity of NATO. The Bonn government pressed the German banks to lend money to this traditional sphere of German influence and trade, where the Deutsche Bank had spread itself a hundred years earlier; and American and other European banks were attracted by the high margins. By 1976 the Turkish government was guaranteeing high in- terest rates through convertible lira deposits and the big American banks, with Citibank and the Bank of America in the forefront soon rushed in to take advantage of the quick profits. ' Institutional Investor, August 1980. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 THE MONEY LENDERS By January 1978, when a new Prime Minister Bulent Ecevit was elected, the banks were losing their enthusiasm for Turkey as rapidly as they had acquired it. There was mounting violence between extreme left and right, the bureaucr-cy was corrupt, and the economy showed no sign of recovering. The government had borrowed three billion dol'ars in short-term loans which had to be renewed, but after one massive rescheduling the banks were reluctant to roll it over, and they were soon cutting off credits, leaving Turkey with little time to adjust. The Turks turned to the International Monetary Fund, which raised two massive loans - the second of which, for 1.6 billion dollars, was the biggest in its history, amounting to 625 per cent of Turkey's quota. The Fund hoped that their 'seal of approval' for Turkey's austere programme would reassure banks; but as the Fund moved in, so the bankers began moving out, stealthily withdrawing more of their interest and part of their capital; in 1979 they made net withdrawals of 340 million dollars.' The Bank of America, which had rapidly retreated, became a dirty word in Turkey and changed its name for its remaining operations. The mandarins at the Fund in Washington were bitterly critical: 'The banks overlent when the going was good, and now they show no re- sponsibility,' one of them complained to me, for once losing his cool: 'The IMF cannot act as the banks' debt-collector - we didn't go in to let them get out.' The Turks now had a total foreign debt of sixteen billion dollars, and half of their exports (including their foreign workers' remit- tances) went to repaying the debt; while the bankers were resisting the pressures from the IMF to reschedule their loans. Turkey - now once again under a military government - remained a crucial member of NATO: but the bankers, having made their quick profits, were glad to leave it to western governments and the IMF to cope with as best they could. THE POLISH PREDICAMENT Of all the frontiers between banking and politics, the most critical but unmapped were in Eastern Europe, where the bankers moved out of the protective system of the IMF and into the heart of the communist system. Since the Eastern Europeans had rejected Marshall Aid in the post-war years they had formed their own self-enclosed economic system of `Comecon', and their central banks had been closely in- terlinked with Moscow. The Soviets underpinned and supervised their lending more strictly than the IMF, with all the rigour of orthodox bankers, with no misgivings about usury, and with large supplies of gold ' Financial Times, Novernber 13, 1980. to fort with to hors in Fa had b in 1911 ubiglui with Amcri in M o, were t regarc really Rock, Rock(. ing cli risk,' 1 goverl Fro the cc reassu Sovici like th of the intere necti. ton. I Willy influc Kissir distar while cousit impri polici rcaso Bai ' Sec ( also F. Petri Signet ' !dart Sect Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ter Bulent Ecevit was or Turkey as rapidly as e between extreme left economy ?sho< ed no _d three billion dollar, but after one massiv-: er, and they were soon to adjust. The Turks ch raised two massive s, was the biggest in its iota. The Fund hoped re programme would )ankers began moving est and part of their million dollars.' The ecame?a dirty word in erations. bitterly critical: `The ow they show no re- once losing his cool: we didn't go in to let iebt of sixteen billion ;n workers' remit- ets were resisting the Turkey - now once t crucial member of profits, were glad to )pe with as best they the most critical but ers moved out of the t of the communist Marshall Aid in the enclosed economic Ad been closely in- ind supervised their rigour of orthodox trge supplies of gold to fortify the reserves. As the Eastern Europeans began to trade more with the West and to buy more western technology and food, they began to borrow to finance their trade. The first western bank to open a branch in Eastern Europe was the Credit Lyonnais, the French bank which had been the chief lender to Tsarist Russia in the 1890s, and which Lenin in 1916 had regarded as one of the key imperialist banks'. By 1964 the ubiquitous David Rockefeller was visiting Moscow, talking at length with Khrushchev, and soon afterwards the Chase became the first American bank to open a representative office, at 1 Karl Marx Square, in Moscow. The relationships between the communists and Rockefeller were the subject of continual amusement and irony. The communists regarded him as a king of capitalism, wielding far greater powers than he really enjoyed: `Nobody knows how to revere, blandish and exalt a Rockefeller,' said George Gilder, `half so well as the Marxists.'z Rockefeller on his side saw the communists as more reliable and endur- ing clients than many capitalist democracies: `In terms of straight credit risk,' he explained, `the presumption is that there is greater continuity of government in certain socialist states than in non-socialist states." From the late sixties the western banks began lending increasingly to the countries of Eastern Europe, including.the Soviet Union itself, reassured by the so-called `umbrella theory' which assumed that the Soviet Union would give its economic support to any country in trouble, like the IMF and the central banks in the West. With the great expansion of the Eurodollar market in the early seventies the banks became more interested in lending to Eastern Europe, independently of trading con- nections, encouraged by the political atmosphere in Bonn and Washing- ton. In West Germany the Ostpolitik, or opening to the East which Willy Brandt had initiated, encouraged the banks to extend their area of influence into the communist countries. In the United States Henry Kissinger and others maintained that western lending could help to distance the Eastern European satellites from their Soviet masters, while the Polish-Americans pressed for more liberal loans for their cousins. There was a general belief in the West that any economic improvement would have a liberalising effect on Eastern European policies; and many Marxists were suspicious of western lending for that reason.4 Bankers were inclined to see the whole of Comecon as coming into the See Charles Levinson: VodkaCola: New York, Gordon & Cremonesi, 1978, p. 28. See also Feis, p. 216 ff. 2 Peter Collier and David Horowitz: The Rockefellers (paperback edition), New York, Signet, 1977, p. 427. Martin Mayer: The Bankers (paperback edition), p. 483. See M. S. Mendelsohn: Money on the Move, p. 104. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 THE MONEY LENDERS same category of risk, assuming that one country would be helped by all the others; and they lent with almost equal confidence to Hungary, Czechoslovakia and the Soviet Union itself - as the credit ratings (see page 254) suggested. The bankers widely assumed, in the words of Institutional Investor, that `Moscow would not allow any Comecon member to default or even reschedule, for economic, political, strategic and image reasons. ..'.' Poland was always a special case. It had the richest resources of minerals of any of the six countries of Eastern Europe, including coal, sulphur, copper, zinc, silver and lignite. But it also had more headstrong leaders, more determined workers, and inefficient industries. Poland's industrial backwardness had long been the despair of bankers: back in the twenties the young Jean Monnet (later the father of the Common Market) had helped to arrange a loan to Poland and had found Polish industry `only just emerging from medieval conditions'.2 Now the Marxist ideologues had brought their own mismanagement both into Polish industry and agriculture. Poland had, in the words of one distin- guished economist, `a combination of wildly over-ambitious, gravely flawed, voluntarist economic policies; incompetent planning and man- agement; and an especially unstable body politic ...'3 When Gierek took over as Prime Minister in 1970, after food riots which had led to the fall of Gomulka, he looked to the western banks to help revive the economy. The Brandt government in West Germany pressed the banks to provide loans, and the American banks, as well as government agencies, followed with loans - many of them into very dubious industrial projects. The First Chicago Bank, in the midst of a Polish-American stronghold, was specially active in Warsaw, and set up its own office there. The western loans certainly helped to improve the standard of living, and Gierek presided over a boom which was very visible in the form of more cars, TV sets and consumer goods. But the industrial managers failed to achieve much improvement in industrial production, and behind the outward boom there was economic confu- sion, about which the bankers were allowed to know very little. The bankers still felt secure under the Soviet umbrella; but, by the same rules, they could do nothing to interfere with national sovereignty. By 1976 Poland looked much less attractive to bankers: there was a crisis in agriculture, and Gierek put up food prices which precipitated a new workers' revolt. Some American banks now felt that they had lent ' See Institutional Investor, July 1976. Also Richard Portes: `East Europe's Debt to the West, Foreign Affairs, July 1977. Jean Monnet: Memoirs, London, Collins, 1978, p. 103. Richard Portes: The Polish Crisis', Western Economic Policy Options, London, Royal Institute of International Affairs, February 1981, p. 8. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 quite enou Poland 'wc American were becot the debt, s accurnulat~ clearly left the Chase Europe, 11 informati0 Poland rai western b: Polish gov spected of By the another ha to Warsaw formed, at 1980, with unionists r The wes who abom of the Polio Polish goo cans presst wielding a had been t the IMF c country \ wage-clain disciplinar bankers n confidence and they supportint Why shot. `pay for th socialism" House T3., p. 721. ' Foreign .-I See Nora 13 November Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 )uld be helped by all idence to Hungary, e credit ratings (see -d, in the words of flow any Comecon political, strategic ichest resources of )pe, including coal, 3d more headstrong ndustries. Poland's of bankers: back in er of the Common d had found Polish litions'.2 Now the agement both into /ords of one distin- ambitious, gravely Manning and man- after food riots ..estern banks to in West Germany 1 banks, as well as )f them into very , in the midst of a 'arsaw, and set up -d to improve the n which was very er goods. But the nent in industrial economic confu- v very little. The gut, by the same sovereignty. leers: there was a ch precipitated a hat they had lent .urope's Debt to the ons, London, Royal quite enough; Alvin Rice, of the Bank of America, testified in 1977 that Poland 'would have a difficult time increasing term indebtedness to any American bank that I know of'.' And some international economists were becoming seriously worried. `We cannot simply continue to ignore the debt, supposing that it will go away as quickly and rapidly as it has accumulated,' wrote Professor Richard Portes in July 1977: 'We have clearly left it to the bankers for too long already.'2 Yet in the same year the.Chase Manhattan was leading a 600-million-dollar loan to Eastern Europe, including Poland, to finance a new gas pipeline with little information about how the money would be used.3 In the following year Poland raised a new syndicated loan worth half a billion dollars. The western bankers, after all, were short of reliable borrowers; and the Polish government negotiator Jan Woloszyn was one of the most re- spected of all international bankers. By the beginning of 1980 the Poles were negotiating to borrow another half a billion dollars and in April they invited western bankers to Warsaw to discuss terms, promising that Polish industry was being re- formed, and that the banks could monitor it. Then came the crisis of July 1980, with unprecedented strikes, the power struggle between labour unionists and the government, and the capitulation to higher wages. The western attitudes were full of paradoxes. American conservatives who abominated labour unions were now boundless in their admiration of the Polish strikers. American labour unionists were refusing to import Polish goods in support of their Polish comrades, while Polish Am?ri- cans pressed for more credits. The workers in this communist state were wielding a power enjoyed by few other workers in the world. If Poland had been under the IMF umbrella (as Romania and Yugoslavia were), the IMF could have been required to be thoroughly stern towards a country with such a huge debt which was now giving in to inflationary wage-claims. But it was Moscow, not the IMF, that was the ultimate disciplinarian in Poland; and the western governments were urging the bankers not to pull back but to make further loans. The bankers' confidence in Eastern European discipline was thoroughly undermined, and they could not be at all sure which side their loans were really supporting. Was it the communist government or the dissident strikers? `Why should the US or others in the West,' asked the Washington Post, `pay for the privilege of making Poland safe again for Soviet-style state socialism?' 4 ' House Banking Committee: International Banking Operations, Washington, 1977, p. 721. 2 Foreign Affairs, July 1977. See Nora Beloff'The Comecon Bumble-Bee', The Banker, London, May 1978. ' November 23, 1980. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Poland was now altogether a very doubtful proposition. Yet just as the Polish government was issuing a statement condemning the strikes in Lublin, bankers were meeting in the London offices of the Bank of America to approve the new loan. By August a consortium, including eleven American banks and the Moscow Narodny Bank, had signed the agreement. The loan had been reduced to 325 million dollars, at a higher interest rate and with strict terms of supervision; the bankers were insisting that the money must be prudently spent, and had at last extr;:_ted more economic information from Warsaw. But no one could be \- rv confident about where it would end up. In the meantime a German consortium led by the Dresdner Bank had raised a new jumbo loan in which other German banks felt compelled to join: 'We weren't forced to,' as one smaller participant told me, but we knew that if we didn't we would be left out of other good things in the future.' The Bonn government encouraged the loan, but could not guarantee it: it only undertook to use all its influence to create political stability in Poland. The total Polish debt was now alarming - twenty-four billion dollars, of which more than half was owed to commercial banks - led by the Germans, and followed by the British and Americans. The cost of repayments in 1981 was reckoned to be more than the total value of Polish exports. The commercial banks were now feeling much more aware of their insecurity in Poland, at a time when other big debtor countries like Brazil were also looking more doubtful. For no one could be confident of who would guarantee its debts, and enforce its financial discipline. Many bankers assumed that Poland would have to look towards the Soviets for much of their future borrowing; but they could no longer be sure that it was still under the Soviet umbrella, and the West was offering no more than a parasol. Several bankers privately admitted that they would feel much safer if the Russian tanks rolled into Poland. As for the Poles, they had little to show in exchange for their moun- tain of debt. The succession of loans had fed their economic expecta- tions and temporarily pushed up their standard of living; but they had done little to improve the basic economy, and had left the Poles apparently still more dependent on their Soviet money-masters. As for the theory that western loans would help to wean the Poles away from their communist loyalties, it had the most ironic consequence of all: for the Polish strikers had taken the idea of freedom altogether too literally, and the West was now as anxious as Moscow to damp them down. The western bankers, having made handsome profits out of indis- criminate loans, now looked to their governments to help them out. They had held long and tense discussions in the Paris Club - the tradi- tional casualty station of international banking - under the chairman- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ship of the the reschei impossible bankers. T the bleak t, realism. at worries as political to between tl By the e of the Po twenty-thr repayment telex that t western b: Lloyds an( the Bank undertake situation Montagno in this w; European speedy agi try to rev mindful of for a more forefront. The bank economy. and at the over the i the coma, Turkey countries without c in both Si more wo world ins lending l Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ,)position. Yet just as deriinin- the strikes in ftices of the Bank of :onsortium, including Bank, had signed the On dollars, at a higher n; the bankers were _nt, and had at last iw. But no one could In the meantime a I raised a new jumbo to join: We weren't t we knew that if we to future.' The Bonn ;uarantee it: it only stability in Poland. -four billion dollars, banks - led by the ricans. The cost of the total value of -cling much more ,n other big debtor d. For no one could ::nforce its financial ould have to look ink; but they could umbrella, and the bankers privately in tanks rolled into tie fo: their moun- :conomic expecta- ving; but they had ad left the Poles :y masters. As for Poles away from !quence of all: for ,ther too literally, them down. )fits out of indis- ) help them out. Club - the tradi- cr the chairman- ship of the French Treasury, while the Poles had to come to terms with the rescheduling - or as they preferred to call it, restructuring - of their impossible debt. It was now clearly too dangerous to be left to the bankers. The ultimate country risk lay with the governments who faced the bleak task of trying to bring Polish finances back on the road towards realism, and Washington, London and Bonn shared the same financial worries as Moscow. While the Polish crisis had created a dangerous political tension between the superpowers, it induced a common interest between their central bankers. By the end of March 1981 the crunch had come. The representatives of the Polish Central Bank met in London with representatives of twenty-three western banks, and explained that they could not make the repayments on debts that were due. A week later Warsaw confirmed by telex that they could not repay loans amounting to a billion dollars. The western bankers appointed a task force of twenty banks - including Lloyds and Barclays from Britain, the Dresdner from Germany and the Bank of America and Citibank from the United States - to undertake the painful process of rescheduling, while the political situation was constantly deteriorating: `Never before,' wrote Peter Montagnon in the Financial Times, `has a country on the financial brink in this way also been under threat of invasion from abroad.' The European banks, more heavily exposed than the Americans, wanted a speedy agreement to ensure that no single bank called a default and to try to revive the shattered Polish economy. The Americans, more mindful of lawsuits, wanted to freeze all loan agreements to give time for a more equitable agreement; and the Chase, which had been in the forefront, insisted that its loans to copper mines be treated separately. The bankers tried to insist on more information about the Polish economy, while the Soviets accused them of `economic blackmail'; and at the time of writing (July 1981) the threat of invasion still hung over the negotiations. The unhappy love affair between bankers and the communists was emphatically over. Turkey and Poland were both part of the same story. In both countries the bankers' herds had first fallen over themselves to lend without circumspection and then all retreated together. Their interest in both senses had been essentially short-term. Now, as they became more worried about their country risk, they looked again towards the world institutions - which had been left on the sidelines in the great lending boom. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 RISK MANAGEMENT It's as vital for manufacturing companies as for banks. But there are differences in approach. By Bharat Bhalla Foreign risk assessment is a term normally used to mean political risk assess- ment. It is a way of selecting countries of reasonable political stability and acceptable risk for investment. In its fuller sense, foreign risk assessment should enable management to devise and develop strate- gies for avoiding, accepting, transferring, and adapting risks present in the total foreign investment cycle, from planning and initiation to divestment. In this sense, assessment becomes management: a strate- gic response to an uncertain environment affecting international investments. Foreign risk involves defining, monitor- ing, and controlling risks. To be effective, foreign risk assessment must be linked with the specific business of each company, because the relevance and intensity of risk varies between industries and between pro- ducts. Specific risks and sources of risk relevant to a specific business must be identified. Once this is done, monitoring and controlling risks becomes easier. Risks are products of change in regulations, policies, practices, institutions and decision makers. Following the initiative of commercial banks in the US, multi-national manu- facturing companies are developing in- Bharat Bhalle is director of foreign risk management at The Continental Group, Inc. house expertise for foreign risk assessment. This effort is limited to major companies. Most manufacturing companies use input from outside agencies or commercial banks. This arrangement overlooks the uniqueness of individual industries and products. Banks deal in a homogenous product - money, a necessity for all nations. But manufacturing companies deal in hetero- genous products which are discretionary items for host countries. Banks lend liquid assets likely to be retrievable at any time. Manufacturing companies make permanent investments, mostly in fixed assets, which cannot be retrieved quickly without loss of value or ownership. As lenders, banks are primarily concerned with the creditworthi- ness or the debt-servicing ability of a borrowing country, which is not necessarily affected by the instability of its govern- ment, and is rarely damaged permanently. A manufacturing company is equally interested in creditworthiness, but is much more interested in assessing socio-political- economic factors which could threaten the safety and profit-making ability of its physical assets. For banks, these factors are incidental to a country's balance-of- payment situation. Foreign risk manage- ment is much more comprehensive and complicated for a manufacturing company than for a commercial bank. Foreign risk is defined as a change causing uncertainty about the business environment of a country. Economic un- certainties are changes in the environment that adversely affect the operational ability of assets. Political uncertainty embodies a threat to the safety of financial, human, and physical assets and emanates from changes in government or policies. Mon t policy ,changes are made in response to . socio-economic needs, so, for a manu- facturing company, foreign risk has both economic and political dimensions. According to its source, foreign risk can be classified as general or specific. General being risks originate outside the country assessed and vitiate its overall business environment. Their impact affects all foreign investors, in varying degrees. General risks include: ? War: regional or global. ? Economic shocks: from oil cartels, droughts, protectionism. ? Financial instability: LDC debt, oil dollar recycling. ? Corporate citizenship: UN and OECD sponsored guidelines. Specific risks are changes within the sovereign state, unique to that country and resulting from policy changes made by its government. There are three tiers of specific risks: 1 country risk, industry risk, and project risk. Country risk refers to the uncertainty caused by economic, political and social instability of a country and its ambivalent attitude towards foreign investment. It affects the initial foreign investment entry decision and the physical safety and owner- ship of assets subsequently. Industry risk is caused by a change in the host government policy towards foreign investment in a particular industry, which is considered vital to national economic inter- ests. Changes are expressed through official economic and budgetary statements and through institutions created to review, monitor and evaluate foreign investments. aI sul pa do ma rer 7 is tc cert invc stra H folk iden into four cons ? Fi ?C ? In ? Ft 71 at dc ing, risk inves declil INVESTMENT RISK EXPOSURE Political instability Analysis Military is willing to restore civilian rule after 10 years New constitution is being drafted and parliamentary elections are scheduled. Impact on proposed investment Transition to civilian rule likely to be frustrated by social disorder and military may be forced to retain some control. Expropriation Terrorism Analysis Did expropriate most foreign invest- Analysis Hiring of expatriates is limited to 10% of ments and nationalized basic industries. However, a company's total employment Normally, Government is anxious to allow foreign partici- expatriates cannot be employed for more than pation with local private and state enterprises. three years. Impact on proposed investment Remote Impact on proposed investment No threat to possibility of expropriation of joint ventures with expatriates' lives, but prudent to manage through minority oarticination lnval nersnnnel Co- Analys a maxis with ce particir Impact potenbr Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 - Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 A060n U __J1 Most nse to man- s both sk can eneral being usiness :ts all egrees. artels, it, oil OECD tin the try and by its risks: ct risk. rtainty I sral 1i' t ent. It it entry owner- e in the foreign which is is inter- official its and review, .ments. ,10%of tha n -eat to -hrough Project risks affect foreign investments in a particular project through a 100% owned subsidiary or a joint venture with a local partner. These risks relate to five opera- tional aspects of a foreign investment: marketability, operability, profitability, remittability and the integrity of assets. process is relevant for both new and existing investments. FIRM is used in the planning stage of an international investment decision, to avoid unnecessary risk by selecting countries which are relatively stable and offer a market potential. Banks lend liquid assets. Manufacturing companies make permanent investments which cannot be retrieved quickly. 19 The purpose of foreign risk management is to identify the nature and sources of un- certainties surrounding a particular foreign investment and to develop appropriate strategies. How can this goal be achieved? The following system has proved effective in identifying uncertainty and transforming it into manageable risk. This is achieved by a four-phase continuous iterative process consisting of: ? Foreign investment risk matrix (FIRM) ? Country risk profile (CRISP) ? Investment risk analysis (IRAN) ? Foreign investment risk audit (FIRA) These states are interdependent and aim at developing feasible strategies for accept- ing, transferring, adapting and avoiding risk inherent in four phases of foreign investment: entry, growth, maturity and decline. This foreign risk management In 1976, 114 market-oriented countries were evaluated for risk connected with the packaging industry. Each was rated on a risk matrix for short and long-term political and economic risks. Political risk was rated on an alphabetical, and economic risk on a numerical scale: Political risk: A Stability B Moderate instability C Volatile instability D Substantial instability Economic risk: 1 Acceptable risk 2 Moderate risk 3 Major risk 4 Unacceptable risk Political risk was assessed in terms of the stability of the government, judged by the Co-determination Analysis Workers allowed 10% profit sharing up to a maximum of 50% of equity. Law still applicable with certain exceptions. Workers' equity participation excepted in fishing and forestry. Impact on proposed investment Limits profit potential and management authority of enterprise. Price controls Analysis Food products are strictly controlled. Industrial goods producers are required to inform the Government only 24 hours in advance of price increases. Normally, cost coverage allowable. Impact on proposed investment Limited ability to support profits through increasing prices. RISK MANAGEMENT IS quality of its administration and the fre- quency and character of its change; and the legitimacy of the government, evident in public attitude towards and support for its leaders and political institutions. Economic risk, reflecting the market potential of a country, was measured by: ? Demographic structure: Size, growth and density of population; growth and quality of labour force; and urbanization. ? Infrastructures: Adequacy of financial, human (administrative, managerial and skilled) and physical (communication and transportation) facilities. ? Economic structure: Sectoral contribu- tion to gross national/domestic product and its changing character; extent of industrialization; and resource balance. ? Demand structure: Size, growth and density of per capita income, and regionat market potential. ? Economic growth: Level, rate, and quality of growth reflected in gross national/domestic product; the importance and changing composition of foreign trade. The level, growth, and density (distribu- tion evenness) of per capita income is the most critical variable in assessing economic and socio-political risks. of various countries. Per capita income reflects the character, quality and level of economic growth of a country, and also the quality of its economic policy makers and managers. There is a correlation between socio- political instability and uneven income distribution. As the per capita income (PCI) increases beyond a certain level, political risk starts declining, and economic risk begins to emerge and become domin- ant. Depressed economy Analysis IMF imposed an austerity programme. slowing down economic growth. Five year real GNP growth unlikely to exceed 2 to 3%. Debt service liability estimated S5 billion in 1985. Impact on proposed investment Austere environment will constrain consumer market growth. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 uromoney June 1983 67 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 RISK MANAGEMENT The per capita income of each of the 114 market-oriented economies was calculated by dividing the gross domestic product of a country by its population for each year. This series was calculated for 10 years (1965 through 1975) expressed in 1975 US dollars. The analysis of level, growth, and density of per capita income for these countries yielded specific results: Countries with a per capita income of up to $1,000 suffer from great inequality of distribution (5 to 10% of the population enjoying 25 to 50% of the national income). This was more pronounced in countries with a per capita income of up to $600 and in countries whose economies depend for growth on one, or few, staple products or resources. Economic inequality and social disparity becomes much more emphasized as these economies start growing and diversifying. These economies continuously threaten the survival of the government and political institutions of their countries. The government's response is repression, or inconsistent economic policies that appeal to popular nationalism. These countries offer the maximum economic and socio-political risks. Countries with a per capita income from $1,000 to $3,000, derived from a diversified economic base, show increasing balance in income distribution. The economic and socio-political risk of these countries is manageable. Countries with a per capita income of $3,000 and higher, from a diversified base and evenly distributed, generally enjoy a stable political system. But as the income level increases, economic risks increase. Economic constraints are expressed through policies aimed at protecting local interests; the social overtones of such policies often burden industry with increasing social costs and even allow Inflation Analysis Currently 70% but likely to slow down to 30% by 1984. Real wages are sustained through indexation adjusted frequently, more than once a year. Impact on proposed investment Cost impacted due to indexation, rising benefits, and subsidies. Country risk profile Internal: Political structure and institutions Power centres Ideological foundation Cultural foundation Bureaucracy External: Axis with superpowers (US and USSR) Regional economic and defence alliances Relations with neighbours Population density Demographic balance Level of education Family structure Ethnic composition Religious cohesiveness Labour and labour unions Income distribution Economic goals (attainable or ambitious) Economic policy and management Economic and structural growth Economic infrastructure Resource availability Energy independence Role of foreign investment labour participation in the management and profits of the enterprise. Within this overall distribution, countries experience growing economic and political turbulence during the transitional phase from one income level to another. Of the original 114 market-oriented economies, 26 countries with a population of less than 5 million and per capita income of less than $500 were dropped, as they lacked the market potential for packaging products. Fourteen countries with a popula- tion of less than 5 million and a per capita Devaluation Analysis Exports being supported through mini- devaluation. 40% devaluation in 1979 and 25% in the next two to three years. Impact on proposed investment Translation losses in the first three to four years. income of over $1,000 did not offer a market by themselves, but were considered as part of a regional market. Chart 1 shows the location of 88 count- ries on the risk matrix, their population range, income level, and the compounded annual growth rate in their per capita income from 1965 to 1975. (The allocation of countries on the risk matrix is somewhat arbitrary and is being further refined.) The risk matrix does not assign any specific priority for selection of countries by the product companies. However, it- Exchange controls Analysis No exchange controls but limited availability of foreign exchange due to large debt burden. Foreign investment covered under Decision 24 of the Andean Pact Impact on proposed investment Annual profit repatriation limited to 20% of capital. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 RISK MANAGEMENT helped product companies to select initially countries in which to concentrate diversifi- cation efforts during the plan period. The results of FIRM were reasonably accurate and reliable. In view of subsequent events, there were not many surprises. Once a country is selected and an invest- ment effort is initiated by a product com- pany, foreign risk management concen- trates on risk acceptance strategy. This is at the heart of foreign risk management, and is managed through the country risk profile (CRISP). CRISP develops an understanding of the total business environment of a country. The main emphasis is on identifying sources of external and internal tensions and their potential threat to the socio-political and economic structure of the country; and on identifying risks relevant to the entry and operation of the planned investment. CRISP is comprehensive but concise. It provides an analytical description of a country's business environment in its historical and future perspectives within the framework of the table on' page 69. Economic projections are made over a 10-year period based on a country's present state of development, realistic economic policies and goals, and external financial and resource dependence. Information developed at this stage is crucial. It enables a company to make a 'Go' or 'No Go' decision. It provides economic and other assumptions necessary to develop an investment project. It speci- fies risks to the proposed investment and indicates feasible strategies, including capital and ownership structures, and out- lines the basis for obtaining the host government's approval of the proposed investment. Information is available for monitoring investment after it becomes operative. Once a decision is made to proceed and an investment proposal is confirmed by a product company, the investment risk analysis (IRAN) is carried out to verify that the indicated return on investment is realistic and consistent with the economic assumptions included in the CRISP report; and that the investment structure (capital, ownership, management, etc.) is designed to insulate the proposed investment from anticipated risks. The exposure analysis is rigidly focused on risks already identified as ones to which a specific investment will be exposed in a particular country. The results of this analysis are summarized on pages 66, 67 and 69. The final phase of foreign risk manage- ment is foreign investment risk audit, FIRA, aimed at adapting and avoiding unnecessary risks. FIRA has three specific objectives: ? FIRA is a continuing process and is helpful in foreseeing changes in the local environment which affect existing invest- ments. It takes the surprise element out of the situation and enables management t take preemptive action. Although i o it impossible to anticipate or predict all changes, even a partial success helps to minimize the impact of an event The monitoring of the host country envt, ment is limited to changes already identifies through CRISP as critical for the company's investments. ? FIRA facilitates the monitoring of changes in the local market which may warrant no further investment, or an eventual withdrawal. This assessment is used in developing an exit strategy without jeopardizing re-entry prospects. ? FIRA assists the development of economic information, and monitoring and evaluation of critical issues which form the basis of strategic planning. These issues include: world and regional political stability energy outlook, international financial stability, economic interdependence or protectionism, and co-determination. These are reviewed and analyzed for a 10-year period, consistent with the company's strategic plan duration. FIRA may be difficult and time con- suming. However, it becomes manageable if, at an early stage of investment development (CRISP), areas of concern critical to one's business are identified. This allows operational and strategic signifi- cance of critical factors to be evaluated. Foreign risk management is a strategic - Foreign Investment Risk Matrix (Firm) Acceptable Japan Australia. Saudi Arabia Hong Kong Israel Cyprus New Zealand Kuwait France. Germany( Fed Rep),UK Austria, Belgium, Netherlands, Portugal , . . Singapore United States Denmark, Norway. Sweden, Libya 1T` Switzerland Iceland. Ireland Finland Luxembourg Canada , , Costa Rica. Jamaica. Trinidad & Tobagoi Uruguay Pop 53-215m Pop 5-23m Pop. 5-6m Pop Less than 5m PCI $4000-$7500 (2-0-7-0%/yr) PCI 55000- $8500 (2.7- 4-1 %/yr) PCI $1600-$2000(52%/yr) PCI Over $1000(1-9%/yr) South Africa Malaysia Mexico Algeria. Ivory Coast. Tunisia Ecuador Pop 9-56m Pop 26-60m Pop 6-16m Pop 139-633m PCI $2000-$3700(2.5-6.0%/yr) PCI $1300-$1500(2-4%/yr) PCI $600-$1000(2.7-5.5%/yr) PCI $140 $25011.6-4.6%/yri Pop 13-113m South Korea Morocco Colombia. Peru Pop 7-45m Philippines. Sri Lanka. Thailand Cameroon, Kenya. Zimbabwe Pop 7-45m Pakistan Angola. Ghana, Madagascar Mozambique. Senegal, Sudan. Tanzania Uganda, Zambia Haiti Pop 5-73m PCI $1200-$2500)0-6.5%/yr) PCI $500-$1000(1.4-8.0%/yr) PCI $225-$500(1-E%/yr ) PCI $175-$500(-5.0-2.0%/yr) Iran Iraq. Syria Turkey Bolivia. Central America (El Salvador Afghanistan Bangladesh Burma Chile Pop 8-41m Pop 38-68m . Guat nnala, Honduras. Nicaragua), Dominican Republic. Paraguay Pop 2-6m . . Nepal Ethiopia. Malt. Zaire Pop 6-70m PCI $800-S2000(-0-4-7-5% /V0 PCI $350-$800(264-47%/yr) PCI $375-$750(0.7-4.8%/yr) PCI L_ssthan $150(Negative) Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 RISK MANAGEMENT tool, and the method used for it is analytical. While political risk analysis is basically qualitative, economic risks are weighed heavily in quantitative terms. The end product is the outcome of informed judgement. The quality of this judgement is affected by one's experience in interna- tional business development activities. The basic premise underlying foreign risk management is that, without understanding a particular country, it is extremely difficult to identify precise sources of risk to a specific foreign investment. This requires knowledge of that country's political system, structure, institutions; power centres and their interaction; quality of economic management; social, ethnic, and religious cohesiveness; and regional and global position. There is no short cut to historical perspective. It requires patience and perseverance in investigating published literature and eye-witness reports. The comprehension of a country helps the assessment of one's business potential there, and the identification of specific risks to the investment. The historical perspective should always be supplemented by a visit to the country. A visit should be used to verify available economic data and to gather additional information helpful in making a realistic forecast of overall economic growth and of variables like labour costs, inflation and exchange rate, affecting the feasibility of the proposed investment; to establish the quality and size of infrastructure facilities necessary to support projected market growth; to assess the magnitude of income disparity and the rate at which this gap can be narrowed down; and to understand the quality of the current administration, its ability to manage the economy effectively in the future, and its ability to survive under pressure. The knowledge gained during a country visit is helpful in judging its overall investment potential and the specific risks to the proposed investment. This judge- ment can be biased if the visit is confined to contacts mainly with the official agencies. Certainly, they must be visited and heard to get the official view. But a conscious effort must be made to learn the dissenting or adversary view from various sources - leaders of the opposition parties, labour leaders, small or medium-sized business- men, academicians, and journalists. This method has proved effective in predicting events and their approximate timing, and helpful in managing risk exposure. The fates of dictatorial regimes in Nicaragua, Iran, and South Korea were predicted six to 12 months before they became historical facts. Changes in economic policies and events affecting investments in various countries were also predicted with reasonable accuracy. Foreign risk management is essential for all manufacturing companies already engaged, or planning to engage, in inter. national diversification through foreign direct investment. Growing uncertainty is caused by changing political relationships amongst 167 sovereign nations, their in- dependent and frequently changing eco. nomic policies supporting local or national interests, and the demand for establishing a new world economic order, in which resource-rich countries are guaranteed a true economic rent for their resources from consuming nations. This economic and political turbulence calls for a rigorous environmental assess. ment by multi-national companies to transform uncertainty into a definable, predictable, insurable, and manageable risk. Foreign risk management does this. As a strategic tool, it pays for itself. It helps companies avoid bad and un- profitable investments. It minimizes the risk exposure of committed investments, helps to avoid further risk exposure and develops the sense of confidence necessary for international diversification. ^ Has acquired The Churchill and Montcalm Hotels, London The undersigned has arranged and provided the finance for the acquisition The National Bank of Kuwait SAK London Branch Approved For Release 2008/01/23: CIA-RDP97ROO694ROO02008700 01-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Iq Next 6 Page(s) In Document Denied STAT Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 J EDITED BY SOL W. SANDERS 9 a C 0 U I D uO51LJcK ~ o~ 3&( cnraora h T?' CA(L'[' he specter of a "debtors' cartel"-a combine of countries that would call for a debt moratorium-is hovering over a meeting of the Organization of American States in Caracas on Sept. 5-9. Originally proposed by Venezuela, and opposed only by the U. S., the meeting will discuss "a Latin American response to the international economic crisis." U. S. bankers hope the meeting will serve only as a sounding board for debtor countries' complaints. So far heavily mortgaged countries have resisted a unilater- al repudiation of debts, because such a move would reduce them to cash-and-carry trade with the rest of the world. Bank- ers also count on divergent interests among the debtors to thwart any agreement. Mexico, for example, has swallowed the strong austerity medicine prescribed by the International Monetary Fund (IMF) and improved its credit position (page 49). Thus it is unlikely to go along with Venezuela, the most vocal advocate of a still-nebulous "global debt negotiation." Brazil, the most critical Latin country, has opposed a mora- torium, using belt-tightening to maintain access to new money by meeting payments on its $90 billion debt. But it is already more than $2 billion in arrears. And support is growing inside Brazil-and outside-for the argument that its economy can- not continue to carry its present debt load. If that view were to overwhelm the essentially conservative Brazilian bureaucra- cy, the world banking structure would face a crisis. A FRESH START. "Brazil is a developing country with serious internal imbalances and an external impasse, both of which require implementation of realistic economic policies," says an August newsletter of Banco de Boston, the Brazilian branch of First National Bank of Boston. "A good start would be ... am- ple renegotiation of the foreign debt, which is understood to be stretching out maturities with necessary rate adjustment." Without that, the report says, austerity will exacerbate Bra- zil's tw o-vear-old recession (BW-Apr. 8). A number of smaller foreign banks believe the latest IMF renegotiation was just another quick fix that, like an earlier one in February, will fall apart when Brazil cannot or will not implement its draconian measures. Their solution is a major restructuring of the Brazilian debt-at significant cost to U. S. banks, Brazil's biggest creditors. In May the IMF and foreign banks stopped paying out about $1 billion in new financing, because Brazil was not meeting commitments to reduce the public-sector deficit. Since then, however, Brazil has increased taxes, lowered consumer subsidies, reduced government in- A SHANTYTOWN IN THE STATE OF BAHIA: FOOD CONSUMPTION IS DROPPING. AND 40% OF BRAZIL'S WORKERS ARE UNDEREMPLOYED vestments, set caps on interest rates and rents, and stiffened price controls. Bankers are most heartened by a curb on salary increases, limiting them to 80% of the inflation index, although the measure still requires congressional approval But some argue that these tourniquets are causing gan- grene. Economists predict the gross national product will drop by as much as 4% this year, after last year's estimated 1% increase. Banco de Boston says that 40% of Brazil's 47 million workers are underemployed, and, despite an annual 2.5% popu- lation increase, food consumption declined for the third year. The impressive trade surplus of $3 billion through June was based on a 23% import cut. Industries are stagnating from lack of imports, and local banks are refusing to lend at artifi- cially low rates. Inflation is now at 142%; July's 13.3% was the highest monthly rise in history. The clamor is rising, with some businessmen advocating debt repudiation. Brasilia's technocrats have resisted, not only because they believe continued access to new credits is essen- tial but also because they feel that, as the largest debtor, Brazil has enormous leverage on world capital markets. This attitude is enhanced by Brazil's traditional aloofness from Latin American cabals. But the heady atmosphere of rhetoric and desperation in Caracas could generate new pressures. o ~11"23 A u l] (J L.a r 31TJ7 t--) L:3 b \J ~ L~ (~~ J 1`~L E1 L hina's leaders have switched from harsh repression to more benevolent rule in Tibet, hoping to demonstrate the benefits of autonomy within a reunited China-an ar- rangement they are also offering on even more liberal terms to Hong Kong and Taiwan. But a little freedom extended to the Tibetans is proving, from Beijing's point of view, a danger- ous thing. Tibet offers little evidence that Beijing's program has eased bitter resentments against Chinese domination. In 1951, Tibetans yielded to Chinese Communist pressures for more control over their country-beyond the traditional Chinese "suzerainty"-in return for pledges not to tamper with Tibet's Buddhist faith or impose a socialist economy. Although those promises were much less generous than those now being offered Hong Kong and Taiwan, the Chinese re- neged after an abortive 1959 uprising and began sacking mon- asteries and communizing the land. In 1950, after a fact- 52 BUSWESSWEEK/SEI Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 IERNATONAL C--- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COUNTERTRADE CMI'? PAST? WflLL Pi4Yj B&97 IAA SULTA1AS Barter need not bring you unwanted diesel engines. By Rupert Birley Barter is also known as compensation, buy-back, counter-purchase, switch, recip- rocal trading, pay-back, bilateral trading and parallel -transactions. The Indonesian Department of Trade calls it: "The imple- mentation of linking government pro- curements from imports with Indonesian export products, excluding petroleum and natural gas." To the Rumanians it's "parallel business"; to the Russians "compensation". Barter deals between east and west are now extremely rare, since western manu- facturers dislike being landed with a lifetime supply of Yugoslav hams. But between eastern European countries and developing countries, and among developing countries, barter goes on. Payments are effected in soft, non- transferable currencies, known as clearing dollars or clearing roubles. Imbalances often arise, because one partner cannot absorb goods equal in clearing units to those he has sold to the other. In the 1950s and 1960s, the heyday of these agreements, there developed a sophisticated trade in clearing surpluses known as switch (because it involved the switching of goods from a communist country to the open market). For example, an imbalance might build up in the Polish/Greek clearing agreement (which is defunct since Greece joined the EEC) because Poland had not bought from Greece as much as it had sold. A switch trader would buy the rights to 250,000 clearing dollars from the Poles for $225,000 (a discount of 10%). The clearing dollars would then be sold for $235,000 (a 6% dis- count) to a European sultana merchant who used them, through the Greek Foreign Trade Bank, to purchase Greek sultanas at a discount to what he would pay in hard currency. This multilateral use of bilateral agreements would reduce the imbalance between Poland and Greece - and generate trade which otherwise might not have taken place. Barter, countertrade or CT used to be an exotic feature of trade with eastern Europe. Experts in it had names ending in "owsky" and "nyi", and could usually be found in Vienna. Nowadays, information about CT is more widespread. Banks are hiring CT experts as fast as they can find them. The international trading houses such as Philipp Brothers, the Man Group, Marc Rich and Cargill should be ideal vehicles for transactions of this sort. They are secretive requires discretion. Rumours abound of CT deals involving the trading of New Zealand lamb for Iranian oil, and Thai rice for Brazilian maize, but nobody is prepared to be precise about who put these deals together. There are signs, however, that these trading houses are now coming out into the open. Andre, Lausanne, is one trading group which has for many years successfully run a CT department in conjunction with its mainstream trading activities. Others, such as the Man Group, are also beginning to adopt a more systematic approach to CT. Tradax, Cargill's subsidiary in Geneva, is now head-hunting CT experts. Barter trade has increased. But how important is it in terms of world trade? The US Department of Trade predicts that it will account for 10 to 20% of world trade in the 1980s. Reliable statistics are, however, non-existent. Western exporters are reluctant to divulge details about deals which have been condemned by western governments, by the IMF and GATT as distorting multi-lateral trade, and by Europe's trade unions as encouraging the dumping of goods on western markets with consequent losses of jobs. The Osteuropa Institut Munchen recently studied estimates of the share of CT in total east-west trade, which ranged from under 10% to 77%. CT has now expanded far beyond Comecon countries. The Indonesian government in 1982 made 100% CTs in non-oil and gas commodities obligatory for all government-awarded contracts. The penalty for non-compliance is 50% of contract value. According to sources in about what they do, as their business Indonesia, contracts signed on this basis already amount to $250 million. Other ASEAN countries are following suit - much to Japan's dismay - while oil producing countries, such as Venezuela, Iran and possibly Nigeria, are offering otherwise unsaleable oil in lieu of payment for capital imports. Mexico and Brazil are now refusing to discuss imports even of raw materials unless some form of CT is considered. CT, however, is not restricted to LDCs or countries with unmanageable foreign trade debts. As any aerospace executive will tell you, willingness and the ability to handle CT is often decisive in winning contracts in western Europe. In 1980, the Austrian Government decided to buy Mirage jets because the French accepted a measure of CT; Rolls Royce's sales to Finland entailed> j S tht idWo%9ica ( cdklh ,t'hat' 14,f g.s it fo /Qflla.l. --- Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 the marketing of various Finnish consumer items such as TV sets; Messerschmitt Balkow Blohm are now negotiating sales to Italy and Belgium, both of which will entail a large percentage of CT. During his state visit to Indonesia in January, Canada's Prime Minister, Pierre Trudeau, argued that contracts worth $160 million, won by Canadian firms for the $1.3 billion Bukit Asam Mining Development project in South Sumatra; should be exempt from CT. The Indonesian government, however, stuck to its guns, even threatening to retender contracts already awarded to Canadian firms. In late February the Canadian government notified Jakarta of its full acceptance of the CT policy. As governments have reconciled them- selves to what many consider a necessary evil, the advisory services they offer have improved. Before Trudeau visited Indo- nesia, the Canadian government had completed a fact-finding mission in Europe on all aspects of CF. The US Department of Commerce and the UK Department of Trade and Industry provide explanatory booklets. Perhaps the best service is provided in France, where in 1977, following prompting by Raymond Barre, then Prime Minister, ACECO (Association pour la Compensa- tion des Echanges Commerciaux) was set up by France's five leading banks and the Paris Chamber of Commerce and Industry. Funded by subscriptions from member companies, it gathers and distributes detailed information about developments in CT all over the world. A similar service offered by the Evidenz- bt ro, which was set up by the Austrian Federal Chamber of Commerce, the Ministry of Trade and Industry and Association of Industrialists. US and UK banks have been, with few exceptions, latecomers. Citicorp and European American Bank have recently set up their own CT departments. Three European banks, Kleinwort Benson, Credit Lyonnais and Creditanstalt Bankverein, have gone into the CT business in a big way. The Creditanstalt Bankverein, Austria's leading bank, has for many years owned AWT (Allgemeine Finanz-und-Waren- Treuhand), a trading subsidiary. AWT has had considerable success in negotiating and discharging CT contracts on behalf of the Creditanstalt's clients. Business in eastern Europe has dried up; it is now concentrat- ing more on its d forfait business. The Creditanstalt also has an 11014 stake in Hungary's Central European International Bank, the first western-financed bank to operate in Comecon. Credit Lyonnais has set up its own CT department, and participates - in partnership with France's other banks - in ACECO and in COOPINTER (Societe de Cooperation Internationale), whose speciality is CT in Rumania. Credit Lyonnais joined forces with the US-based Lissauer Group to form Greficomex in 1980. In addition to the Merban Corporation, which has had considerable experience with CT, Lissauer also owns Associated Metals and Minerals, New York, Leopold Lazarus, London, Metall & Rohstoff, Zug, and Oxyde, Amsterdam, all of which supple- COUNTERTRADE ment the financial expertise of Credit Lyonnais with solid trading back-up. This marriage of bank and trading group has been a success, because purchases in CT are handled within the group and are not farmed out to third parties (as is often the case with other CT subsidiaries of banks). The Centro Internationale Handelsbank (Centrobank) in Vienna was originally the brainchild of Kleinwort Benson. Founded in 1974 by a consortium of banks led by Kleinwort Benson (and including the Bank Handlowy, the Polish Foreign Trade Bank), Centrobank was conceived as a merchant bank in the historical sense of the word, with its banking and trading activities equally balanced. Centrobank has a reputa- tion for innovation. Under the joint management of Gerhard Vogt, a former grain dealer who syndicated sales of Austrian grain to Poland, and Kazimierz Glazewski (who was appointed president of Bank Handlowy in February this year) it has pioneered many new techniques in countertrading, such as the use of evidence accounts. It is now setting up an office in Jakarta to handle Indonesian CT. CT is often a vital element in a trade financing package for the Third World. Here the banks are useful. As sources of commercial knowledge and credit informa- tion, they complement the role of the traders. But problems arise when the banks try to go it alone through subsidiaries which lack focus and whose employees end up as jacks of all trades and masters of none. Because they can rarely act as principals to the CT deals under their supervision, they often play the role of the honest broker, with a consequent reduction in profit. D COUNTERTRADE VARIES FROM AIRPORT CONSTRUCTION TO COKE Countertrade or CT includes: of Foreign Trade for the construction of a and Winston cigarettes to Hungary on this A INDUSTRIAL COMPENSATION i) Buy-back agreements These are agreements not worth less than $20 million lasting from five to 25 years, that involve the delivery of industrial plant, with 100076 repayment in the resultant manufactured products. Examples: Occidental . Petroleum's agreement, signed in 1974, to supply the USSR with two ammonia plants, with repayment over a ten-year period in ammonia; Davy Power Gas and ICI's 1977 agreement to supply the USSR with two methanol plants, with repayment in methanol. ii) Co-operation agreements These do not entail CT in resultant products. Examples; PepsiCola's 1972 agreement with Nixon's help to sell the USSR Pepsi concentrate in exchange for vodka; and the agreement in 1977 between Cementa- tion International and the Polish Ministry complex at Warsaw airport. This involved the employment of Polish construction crews on CI's contracts with Third World nations, plus the purchase by CI of Polish construction material. iii) Joint venture agreements These involve western equity participa- tion with the partner. Example: Honeywell's joint venture with Yugoslavia for the manufacture of computers. .B COMMERCIAL COMPENSATION This covers the smaller transactions, between $10,000 and 1 million, lasting from six months to three years, with two separate contracts (one for the sale; the other for counter-purchases in non- related products). i) Pre-compensation The western supplier purchases before he sells. Whatever he purchases qualifies as a credit to be offset against subsequent deliveries. Example: R. J. Reynolds sells Camel basis. ii) Parallel transactions The counter-trade is carried out after delivery by the western firm. Example: The sale of machinery worth $250,000 to the Rumanians. The seller has to purchase Rumanian machinery products equivalent in value to 50010 of the sales contract within a specified period (usually 12 to 18 months). Failure to do so is subject to a penalty, anything from 5 to 100010 of sales contract value. iii) Framework agreements (goodwill or gentlemen's agreements) These are what every exporter hopes for. Whereas non-fulfilment of (i) results in no sale, and of (ii) a penalty, framework agreements rely on goodwill. Example: Rolls Royce supplies components without which Rumania's domestic airline would grind to a halt. The best endeavours clause in the sales contract merely refers to "Rumanian products". Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ,rmmnnv 1983 189 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COUNTERTRADE Although many banks offer a CT service to their clients, it is very rarely a profitable exercise. Centrobank is, perhaps, the excep- tion. "Most banks are not structured to handle these deals," said John Burge, general manager of Fendrake (a Kleinwort subsidiary involved in trade and trade finance) who is also Kicinwort's liaison man with Centrobank. "This is a trading business with trading risks. On the other hand, the banks do lend credibility to an esoteric style of business." The boom in buy-back deals in the late 1960s and early 1970s led to the setting up of trading units specialising in CT by large manufacturing and engineering groups. With characteristic over-saturation, the big Japanese corporations such as Mitsubishi, Marubeni and Nissho-Iwai set up permanent offices in all the Comecon capitals, which they have maintained ever since, long' after their European rivals decided that theirs did not justify the cost. The corporations' own CT subsidiaries have had experiences similar to those of the banks. The Germans, French, Austrians and Italians have had the most success. Industriehandel, Daimler-Benz's equiva- lent, has had success, not only in using CT as a means of maintaining sales to cash- strapped markets, but also in turning it into a profitable business exercise. Such is its expertise that it has been known to take over and discharge CT obligations on behalf of other companies. The UK and US groups have recently been making up for lost time. British Aerospace, Hawker-Siddeley and Rolls Royce are already CT veterans, while GKN, Courtaulds and Massey Ferguson have expanded their trading departments. Rockwell International Trading Com- pany has in the last two years educated Rockwell's various divisions in CT, and has already identified several areas where counter-purchases can be streamlined into the group's existing purchases. Tins of Ham & Ham & Ham One European ? telecommunications group was saddled with a CT contract in Poland. They established that the CT contract permitted purchases of copper wire, which was required in large quantities for their own manufacture of telephones. The Polish copper wire, however, required certain modifications. Research revealed that the cost of installing the machinery to modify the wire in the Polish factories more d administratively by the Third World countries insisting on it. Indonesia, the only country outside eastern Europe to introduce official CT regulations, has until now relied heavily on the expertise of specialized organisations such as Centrobank. Everyone is praying that they will not follow the eastern European example too closely (and particularly not the Yugoslav example, which is utterly chaotic). There was a scare in 1980 when rumours began to circulate that the Chinese were consulting the Yugoslavs on CT. Unofficially, the experts exist. Interagra is run by Jean-Baptiste Doumeng, the French Communist who grew rich by "exploiting flaws in the capitalist system". It is known for its sales of EEC surplus butter and meat to the USSR, and, it has just completed a barter deal with Vietnam, the newest recruit to Comecon. Companies associated with Italy's and France's Communist parties have built up profitable sidelines in the field of Cr. Many subsidiaries of eastern European trade organizations in the west have realized that linking their existing sales to CT obligations is an easy way of earning commission. This is fine for western suppliers, but negates the already dubious benefits of CT for those who imposed the system in the first place. In the 1960s and 1970s, CT in eastern Europe always involved counter-deliveries of shoddy, finished products which could not be marketed through normal channels. Raw materials, such as coal, sulphur or sugar, were never eligible for purchase within the framework of these contracts. Today the reverse is true with CT in Third World countries. Global recession and slumping commodity prices have forced these countries to offload their commodity surpluses by means of reciprocal trading arrangements: oil from Venezuela and Iran; cotton from Mexico and the Sudan; rice from Thailand, Pakistan and Burma; timber and rubber from Indonesia ... the list gets longer every day. than justified the vast savrngs ma e n , ? &, , , discharging their CT obligations internally. might be expected to possess a few skilled CT specialists themselves. The answer is officially "no", but unofficially "yes". efficiency, provides standardized CT con- tracts, and offers extensive guidance on Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Vietnam is on the other side of the world. Even El Salvador seems remote. But if turmoil comes to Mexico, there is no way the U.S. can avoid being dragged in. Here's why the current Mexican crisis, -so threatening to the U.S., goes deeper than the usual complaints about oil prices, foreign debt and corruption. By r:o'man Gall igin-A a la riad- rid: the L,resiaent as priest and !miafs. 'Muchas gracias, Senor Presidente, mudxrs gracias. " The president of the republic was seated in a crowded tent pitched on the small cattle fairground of the municipio of Tlaquiltenango in the dry hills of the Valle de Vazquez in the state of Morelos. Near here, seven decades ago, the guerrillas of Emiliano Zapata dodged federal troops during the bloodiest phase of the Mexican Revolution. Now the descendants of these guer- rillas were patiently waiting their turn to present their requests and make their complaints to the highest author- ity. Each of them would get just 30 seconds to present his or her case. The speeches are brief because the meeting has been very carefully arranged. "Senor Presidente: Valle de Vazquez covers 12,000 acres, of which roughly 11,000 are dry hills and only 1,000 can be farmed when it rains. We are 2,000 inhabitants. With the money you have given us, about U.S. $63,000, we have invested in fences and pastures and water troughs and a corral, benefiting our families. Lastly, we peasants of Valle de Vazquez ask you urgently to provide us with an irrigation system to better use our land. For all this, we thank you." Notwithstanding: the republican and revolutionary trap- pings of his office, the president of Mexico is a priest and a king. He travels often among the dusty villages of his realm, as do few of the world's heads of state, in a continu- ing ritual to renew the security and legitimacy of the rule of the Partido Revolucionario Institutional (PRI), which has governed Mexico for the past half century. The presidential pageant is accompanied by flags, flowers, mariac"hi bands, speeches, recitals of the con- quests of the Revolution and vows of support for the president of the republic, who brings gifts for his peo- ple. The pageant triumphantly passes through a blur of baked Indian faces on baked village streets, half hidden by banners and posters bearing portraits of Zapata, the Indian with glistening eyes who rose from the mass of peasants whose communal lands had been stolen. Za- pata refused to be bribed and had to be killed. In death as in life, however, then and now, he haunts the essen- tially conservative leaders of the Revolution, who have been unable to cure many of the sufferings that led him to rebel. All the more reason for the president to listen, and try to help. The populace must not think of the government as being remote and unresponsive. 'Senor Presidente: The lands of Morelos are turning to dust," announces Manuel Peralta Subdiaz over the loud- speaker in Tehuixtla, the next stop for the presidential motorcade. "We are the state that most needs conversion of dry farmland for irrigation. But the participation of the officials in charge of the irrigation programs has been FORBES, AUGUST 15, 1983 70 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 mean and devious. Please help us..Muclxrs gracias." Big problems and small ones, the president is expected to solve them all. The priestly and kingly functions of the Mexican president come from the Aztecs, whose emperor declared himself to be a god. The incessant presidential touring began in the reign of General Lazaro Cardenas (1934-40). This hulking, taciturn son of a small-town pool- room proprietor became the towering figure of the Mexi- can Revolution after he nationalized the foreign oil com- panies in 1938. It was Cardenas who established the ritual that, 45 years later, Miguel de la Madrid is now observing. In those days the provincial revolts and counterrevolts still had not ended, and a presidential presence in the interior was a political imperative. President de la Madrid does it somewhat differently, however, from most of his predecessors. Instead of giving a speech in each village, the newly inaugurated (December 1982) president listens with great care to the speeches of others in the ritual acted out before him. Behind his silence may lie the brutal fact that the president of Mexico now has little to promise and less to give. Nevertheless, small requests are made and often granted. Symbolism counts for much. In Tehuixtla the merchants of the municipal market asked the president for a desk and chair, filing cabinet, typewriter, 30 folding chairs and a roof for their stalls. In another request, Hipolito Garcia Albarran told the presi- dent: "Man does not live by bread alone. He needs enter- tainment. For this reason we have formed a brass band that we wish to expand with two trombones, four trumpets, three saxophones, a drum and a pair of cymbals." The requests were granted. The President has renewed his ties, and his party's ties, to the people. crisis since the armed phase of the Mexican Revolution and the Great Depression of the 1930s. But today we ar a bigger and more complex country. In 1930, after the ci. I war ended, we only had 16.5 million people. Today we are 75 million Mexicans. The size of our economy is much greater, and so are the dimensions of our crisis. For the first time in this century we are going through 100% inflation and economic stagnation at the same time. Nevertheless, I don't think you can compare Mexico with other countries where economic problems have led into social and political crisis. Although Mexico still is backward in several aspects of its economy and its soci- ety, it has been continually modernizing ever since the Revolution. We have a stable political system, very stable when you compare it with the rest of Latin America and political systems elsewhere in the world. Moreover, Mexico is endowed with large and diversified natural resources. We are the world's fourth-ranking country in oil and gas reserves. We have abundant mineral resources, most of them still to be discovered. We have abundant farming and cattle land whose productivity gives us a wide margin for improvement. Mexico already has reached 14th place in the world in fisheries production, and we are only beginning. For thousands of years, the presence or lack of water 1x-Ls been a matter of life or death in Mexico. Recently Mez-ico has been lacking water. De laMadrid: I agree that water is one of the great problems of Mexico. Our hydraulic resources are very unevenly distributed. They are concentrated in the tropical south- east, where the problem is flooding, swamps and runoff of valuable water to the sea. On the other hand, the central plateau and the north, where three-fourths of the popula- tion is concentrated, can be considered desert country by standards of rainfall. Over the past half century, one of Mexico's great achievements has been the building of gigantic hydraulic works-dams, irrigation canals and deep-draft wells-that have brought increasing amounts of land under cultiva- tion. Nevertheless, water remains scarce. Large areas of farming and cattle land depend on rainfall, and, as you have said, there is great scarcity of water in the cities just as the cost of extracting, transporting and distributing gravity of this crisis. water is increasing. De Ia .tl, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 exico. We must learn iguel de la Madrid: We shall overcome our difficulties. L The following are excerpts from an inter- view with Miguel de la Madrid, president of Mexico, conducted in Spanish by FORBES Contributing Editor Norman Gall: The US. ;and .tlei-ico are increasingly interdependent and so people in the US. are worried about aletico. Our people discuss the passibility tat .ti lento may become another Central America or another Iran. You yourself lxtte referred Horny times to the Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 how to use it better. In the future we must build more small dams and irrigation canals to maximize development of our water resources. The result will be a new culture of water that will create greater awareness in Mexicans of problems of scarcity by raising the price of water. Water is far from being the only necessity subsidized by the Mexican government. De la Madrid. One of our economic strategies is revision of our policy of subsidies, which have grown to be an impor- tant part of the budget and have put us under heavy pressure. Growing deficits, caused by artificially low prices of public goods and services, to a great degree explain the inflation we are now suffering. Adjusting these prices will imply some sacrifices and some important changes of co or the rest of the world. We are achieving this by increasing government income-raising sales taxes and prices of public sector goods and services-and by cutting public spending. This is an enormous sacrifice, painfully affecting living standards and expectations. But I am con- vinced that there is no other choice. In Mexico our deficit comes from a low tax burden, not because rates are low but because of inadequacies in ad- ministration of the revenue system. There still is much tax evasion. Mexico City has become the second most populous metropoli- tan area in the world. Isn't it cheaper and more viable to resettle people in other places? De laMadrid: The cost of the city's expansion is extremely high and it represents an injustice to the rest of the republic. Subsidies have made the city more attractive and have stimulated migration even more. In our new Devel- opment Plan for 1983-88, one basic goal is decentralization of national life. Within our system of freedom-of work and movement-we cannot impose coercive measures to block people from coming to Mexico City or to expel them. But we can take measures to encourage them to move to new poles of attraction that are being developed in other regions. Many millions of Mexicans do not produce or earn enough to live. This is wiry subsidies were started They seem to paper over a basic imbalance between population and resources. De la Madrid. We are convinced that we should reduce our rate of population growth. In the 1960s the population was growing by 3.5% yearly. Today the rate is going down, and we intend to reduce it to 1% by the end of the century. Over the past decade the government has been supporting family planning, and this will continue. It is true that many of our people live at the subsistence level. But many others have achieved standards of living that we could not have dreamed of a few decades ago. We also must take into account the improved capacity pro- vided by technological innovation, in Mexico and through- out the world. Thus, with better use of our own natural resources and with improved technology, we can continue aspiring toward dignified standards of living for all our people, even when this means changing many patterns of past behavior. habit. But it will bring us closer to economic rationality. At the same time, we must realize that Mexico was a much weaker country four or five decades ago than it is now. We have modernized and absorbed new population that has grown at the world's highest rates. Our school population is now 24 million, more than the whole Mexi- can population in 1940. We have taken great strides in education, health and housing in a country that, before the Revolution, was primitive, lacking institutional stability and internal communications. Mexico today has reason- ably good communications. Although the tasks ahead of us are great, I feel that our potential is sufficient to over- come these temporary problems. In the 1950s and 1960s Mexico became known internation- ally for its pr udent management of its public f nances. How did these finances get into so much trouble? De la Madrid: Our public sector deficit reached 18% of the domestic product last year, which is one of the main causes of our present inflation. Our program of economic reorganization for 1983 aims to bring this d "icit down to 8.5%. This is a gigantic effort, without precc:ient in Mexi- Some critics say the basic problem in Mexican economic policy is the domination of the public sector over the private sector. De laMadrid: Mexico wishes to continue living in a mixed economy and will take measures to ensure that the public and private sectors coexist. We are introducing more real- ism into pricing policies to ensure sufficient profitability for private business to work and invest. We are promoting a reasonable equilibrium between the public and private sectors by helping companies with their financial difficul- ties, by recognizing the realities of prices and by stimulat- ing private activity through fiscal, credit and tariff poli- cies. Over the next few months, once we pass the worst phase of our economic crisis, I expect the private sector to resume its role as a force for economic growth. As for prices, we cannot free them all at the same time because this would accelerate inflation. But I must remind you that in December, the first month of my government, we freed half of our price controls. Many thanks, Mr. President. De laMadrid: Your questions penetrated our reality. They are my questions as well. I ask myself them every day. FORBES, AUGUST 15, 1983 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 e o mean, stnppe its r investment and putting it into the stomachs and pockets Mostly they come to Mexico City, cradled in the central of the people. It has its virtues, but it also has its delayed valley of the country. This valley was once largely covered price. ' Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 th the basin's fertile "From the highways you can see groups of peasants in the open fields kneeling around statues of the Vir- gin, desperately praying for rain. It did not rain last year, nor this year either. If it does not rain by mid- June the crops are lost.... " eography is destiny. In interviews with reporters from the U.S., Mexican Treasury Secretary Jesus Silva Her- zog has repeatedly said: "I don't think Mexi- co is capable of living with a stagnant economy beyond 1984." He said it again in an interview with FoRBES in his spacious offices in Mexico City's colonial-era National Palace. He was giving a clear message to Mexico's credi- tors. It was: If you squeeze us too hard or too long, you will end up losing everything. Yet Mexico continues to struggle bravely to put its financial house in order-imposing tough sacrifices on business and consumer alike. To its credit, it is doing so with a will that the U.S. Congress has failed to display in curbing fiscal extravagance in this country. So why does the principal architect of this austerity, the urbane Silva Herzog, harp constantly on the limits to this austerity? Because he is aware of the political realities of his situation. It is easy enough to say that wasteful government spend- ing, egregious policy errors and shameful corruption are at the root of Mexico's current near-insolvency. All this is true, but it is not the whole story, nor does it get to the root of the situation. Where did Mexico go astray after 40 years of economic growth that was one of the wonders of the world? Why did its public sector deficit zoom from 3% of gross domestic product in 1970 to 18% in 1982, while inflation went from 5% to 100%? Inflation, swelling deficits and overcon- sumption are global problems today, but an event specifi- cally Mexican also contributed to the end of stable growth. This was the student demonstrations in several cities that preceded the 1968 Olympics. These uprisings led to the death of an estimated 200 people when the army and security forces attacked demonstrators in Mexico City's Plaza of the Three Cultures. The demonstrations shook the ruling politicians and brought shivers of terror to a people aware of the potential for violence that always lurks just beneath the Mexican surface. Novelists and poets have long recognized that there is an almost mystical tendency to violence penned up in Mexico-and sometimes it bursts out. The politicians responded by yielding more and more to "populist'' demands. And what does "populism" really ric ? It means taking money from d ,-Sc ; h t Mexicans now call the docena tragica (the tragic dozen years) under the presidencies of Luis Echeverria (1970-76) and Jose Lopez Portillo (1976-82). This is not to say that the ordinary Mexican was rolling in affluence during those years. He certainly wasn't. But with resources scarce and population soaring, the nation could ill afford populist demagoguery. Sacrificing investment for consumption is dangerous for any economy, but especially bad for Mexico. Why? In a word: Water. When writing about Mexico, most journalists concen- trate on the surface events-the price of oil, corruption, industrial inefficiency, the crushing burden of internation- al debt, the flight of funds abroad. They rarely mention water. And yet water is in the most profound sense Mexi- co's greatest need. The nation has plenty of land, but it is desperately short of water. It is for the most part an and land, lacking rivers and lakes. Short of water, it cannot wring from its soil sufficient food for its swelling popula- tion-75 million now, soon to be 100 million. Under Mexican irrigation conditions, it requires 3,000 tons of water to produce 11/2 tons of corn-enough to feed eight people for a year. The cost and difficulty of getting this much water severely limits Mexico's ability to raise food. This year Mexico will have to import half the grain it needs, thus losing precious foreign currency that could otherwise help service its debt, supply its industry and import badly needed capital goods. It's a vicious cycle. Lack of water drains away capital that otherwise might help solve the water problem. History records that, along with an international finan- cial crisis, internal drought was one of the factors that brought down the long dictatorship of Porfirio Diaz (1876- 1911) and brought on the bloody Mexican Revolution that began in 1910. But now drought has become a permanent curse, not only because of Mexico's natural aridity but also because the population has grown so much faster than water resources. Listen to Governor Tulio Hernandez Gomez of the tiny state of Tlaxcala, near Mexico City. "The absence of water changes people's moods. From the highways you can see groups of peasants in the open fields kneeling around statues of the Virgin, desperately praying for rain. It did not rain last year, nor this year either. If it does not rain by mid-June, the crops are lost because corn planted after that is killed by the autumn frosts before it ripens. Peasants either plant corn or move to the cities." Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 volcanic soils, made highly productive by large-scale irri- gation and drainage works, supported one of the world's largest urban centers by the 7th century A.D.-Teotihua- can, the ancient ancestor of Mexico City, with a popula- tion of 125,000. But now there are 16 million people, not 125,000, and each year Mexico City adds 900,000 people, more than its entire population in 1920. "This city is an absurdity," says Elias Sahab Haddad, executive director of the Valley of Mexico Water Commission. "We know this. But it is a fact, a reality." On the average, the inhabitants of this overcrowded absurdity sleep six to a room-and a lot more than that among the two-fifths of the population living in squatter settlements. Even on a subsistence basis, they require vast amounts of water. In the Valley of Mexico the excessive extraction of water from underground beds has led to a steady sinking of the land on which the city is built, by some 30 feet during this century, forcing aban- donment of important buildings such as the Basilica of the Virgin of Guadalupe, the national religious shrine. As for the ancient lakes, they are long vanished. Mexico's creditors and friendly nations would do well to remember all this when Mexico appeals for debt exten- sions and for fresh loans. The problems facing any Mexi- can government are almost overwhelming. One of the most highly regarded people in Presi- dent Miguel de la Madrid's cabinet is Silva Her- zog. A potential presidential successor, in 1988, Silva Herzog coolly analyzed the situation for FORBES and explained how the government faces grave risks in striving to bring consumption down to a level the econo- my can afford: "There is no consciousness or understand- ing among the [Mexican] people that the government needs income to meet basic social needs. They tell each other that their tax money goes straight into the pockets of corrupt politicians. "With oil and with the heavy foreign borrowing that the oil made possible, the government could avoid living with- in its means. The government could paper this over and still hand out more and more because lots of foreign money was coming into Mexico over the past six years: $50 billion in bank loans and $50 billion for oil exports. "But now the easy money is spent, and we are deeply in debt. We have become somewhat unpopular by decreeing big increases in taxes and in prices of gasoline and electric- ity, which have been kept artificially low by state corpora- tions for many years, and more steep increases are coming. "We intend to meet our commitment to the Internation- al Monetary Fund to cut our public sector deficit from 18% to 8.5% of GDP this year. This is an ambitious and extremely painful undertaking. Last year the Mexican economy shrank by 0.2%. This year it will continue con- tracting by between 2% and 4% of GDP, and in 1984 there probably will be no growth at all." But until Mexico regains its capacity to invest, it has little hope of dealing effectively with its hydraulic prob- lem. This will require billions of dollars. Gigantic schemes are being implemented to pump water uphill into the Mexico City metropolitan area from coastal or intermoun- tain valleys lying between 3,000 and 6,000 feet below the metropolis, over distances and on a scale never before attempted anywhere, in order to more than double the city's water supply by the year 2000. The first stage of this effort, the Cutzamala System, already is partially com- plete and, when finished, will pump 19 tons of water per second uphill to an additional height of 4,100 feet. But by the time it is fin'ished, Mexico will need yet more water and more water. 74 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 - Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 "He is talking about the possibility of bloodshed, of possible revolution, of the potential influx of millions of Mexican refugees into the U.S. Mexi- cans know only too well that when things go wrong in their country they can go very far wrong indeed." Technologically it is feasible to build such projects, but financially it is a crushing burden for a society that needs so many other things, too, and has so little capital avail- able. The capital and operating costs of these efforts are very hard to measure in money because the Mexican peso is so unstable now in terms of the world's major curren- cies. The energy costs probably are more meaningful. If gas or heavy fuel oil were used to pump 19 tons of water per second over these heights and distances, at prevailing efficiencies of oil conversion and pumping, then 4.3 mil- lion barrels of oil would be absorbed yearly at a cost, in terms of forgone exports, of $125 million at the current OPEC benchmark price of $29 per barrel. For the nearly 55 tons per second of new water flow now planned, the energy cost for pumping alone would be $362 million per year. "We cannot pay for the pumping of water to Mexico City," says Andres Moreno Fernandez, head of the city's water system. "Instead, we must stop the growth of the city." And not only Mexico City suffers. Some 16 million urban Mexicans live in squatter colonies where many depend for water, not on pipes or wells, but on a weekly visit by a water truck-and the truck doesn't always come. But still people pour into the cities, seeking food, water and a chance at earning a few pesos. The failure to manage water resources has helped to destroy many civilizations. It may sound melodra- matic to people in the U.S., who take water for granted, but many Mexicans are asking each other wheth- er the PRI regime, which has ruled Mexico for more than half a century, is now reaching that stage of hydraulic disaster. Water and food are closely related. Mexico's poli- ticians and technocrats have been very active on the food supply side. Over the past half-century they have more than doubled the area of irrigated land for farming. Howev- er, because of fast population growth, the irrigated acreage per capita is less than half what it was 50 years ago. Moreover, all the easy dam-building and irrigation projects have been done, while the population keeps growing. In other words, both in the city and the countryside, Mexico has entangled itself in the hydraulic trap while following the commendable and sensible goal of trying to keep Mexican bellies full. Food and water were not the only priorities in the post- 1968 surge of spending on subsidies to consumption. These were years of giant giveaways. To facilitate them, the government systematically enlarged its role in the econo- my. When they can't enlarge the bureaucracy anymore, politicians can do the next best thing for patronage by absorbing private business into the bureaucracy. In these years the number of state corporations grew tenfold, from 84 in 1971 to 845 in 1976 alone, while subsidies and transfer payments rose from 3% of GDP in 1970 to 15% in 1982. "Until recently each big-spending presidential administra- tion was succeeded by one of austerity that cleaned up the mess," a leading physician explained. "Since 1970 we have had two big-spending governments in a row." "Besides direct spending, there were vast price subsidies to keep the price of necessities in check. Our policies of excessive subsidies gave us the problems we have today," says Planning and Budget Secretary Carlos Salinas de Gor- tari a small wiry, 35-year-old political economist with a Harvard doctorate. These subsidies embrace a bewildering variety of goods and services-from corn and sugar and gasoline to water and electricity and rail and bus transpor- tation. There are even public coin telephones costing less than one-seventh of a U.S. penny per call ($0.00 13). Ramon Aguirre Velazquez, the presidentially appointed mayor (regente) of Mexico City, told FORBES that "these subsidies are part of a redistribution of national wealth to achieve social justice." At the cost, alas, of badly needed private and public capital investments and, ultimately, of national solvency. Such subsidies, improvident though they were, helped keep the political peace after the violence of 1968. So when Mexico's Treasury Secretary warns that there are time limits to his government's ability to impose austerity, he is not only complaining about the political inconvenience involved. He is talking about the possibility of bloodshed, of possible revolution, of the potential influx of millions of Mexican refugees into the U.S. Mexicans know only too well that when things go wrong in their country they can go very far wrong indeed. They are only too aware of the events that overwhelmed the long dictatorship of Porfirio Diaz and led to a civil war that dragged on for nearly two decades and killed or starved over 2 million Mexicans. It was a civil war in which U.S. citizens died. At one point, in 1914, U.S. troops occupied the port of Veracruz. Later the fighting spilled over into the U.S. Southwest when Pancho Villa's guerrilla forces raided New Mexico and General "Black Jack" Per- shing led U.S. soldiers across the border in retaliation. 11 this was long ago, but there are parallels between' then and now that are close enough to worry thoughtful people on both sides of the border. Too much, of course, can be made of historical parallels. Miguel de la Madrid is no Porfirio Diaz, and for decades Mexico has had one of the world's highest rates of econom- ic growth. The development of its oil resources provides a Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 "It is a flight from reality to expect countries like Mexico and Brazil to divert up to 5% oftheir annual nation- al incomes and a much larger share of their foreign exchange earnings to paying interest on foreign debts."_ huge new source of wealth. Since its revolution, whose vents the collection of a great mass of water.... Saline violence lingered on until the 1930s, Mexico has enjoyed a substances cover the surface of the soil. Through this political stability matched in the hemisphere only by the abundance of salt, the table land of Mexico bears a great U.S. and Canada. It is Mexico's good fortune that-in spite resemblance to many places in Tibet and the saline of the well-known larcenous tendencies among its politi- steppes of central Asia." cians-it has a trained, talented leadership, equal in some Humboldt was writing about a Mexico with 5.8 million respects to any in the world. The ruling party, the PRI, is to inhabitants-sparsely populated like Tibet and central the Mexican Revolution what the Vatican is to St. Peter. Asia. But this same and land today must support 75 The party rules in a direct succession from the middle- million people. This is not to say that Mexico cannot class leadership of the old revolution. The leadership is support a large population, but it cannot do so without continually renewing itself with young men and women. huge capital expenditures for hydraulic works, for agricul- President de la Madrid himself is only 48 years old. ture, for job- and capital-creating industry. Whence is the Several cabinet ministers and state governors are much capital to come, while at the same time keeping the younger, while party chieftains often are in their early 30s. populace minimally content? That is the grim geographic and financial reality. B But while there are some things to be grateful for in The foreign lenders who sent $81 billion to Mexico with present-day Mexico, anyone who thinks the crisis virtually no strings attached still delude themselves. It is has passed is deluding himself. President de la Ma- obvious that Mexico and other developing countries do drid, just nine months into his six-year term of office, not have, and never had, the cash-generating capacity to must move fast to restore solvency before the necessary repay the foreign loans they have piled up over the past austerity becomes intolerable. His task is made trebly decade. The money is gone. The interest burdens alone difficult by the ruling party's slackened grip on the reins of have become too big to manage. It is a flight from reality to power. After liberalizing the election law over the past expect countries like Mexico and Brazil to divert up to 5% decade-partly in response to protests after the 1968 mas- of their annual national incomes and a much larger share sacre-the long-ruling PRI has been suffering both losses of their foreign exchange earnings to paying interest on and unaccustomed close calls in state and local elections. their foreign debts continually over the next decade or One obscure town in Oaxaca state has actually come two. Payments on this scale would wipe out their chances under Communist rule, with backing from Salvadoran to earn an economic surplus that must be invested in peasants camped there. just last month the PRI lost con- meeting urgent national needs. Chih h trol of capitals in two key northern states- uaua and Durango-as well as Ciudad Juarez, a border city of exico is trying to meet its obligations and impose almost 1 million people. In these same northern states- a degree of discipline on government spending, where, not incidentally, the Mexican Revolution erupt- . but we in the U.S., should listen carefully to ed-the PRI faces a strong challenge from the conserva- Treasury Secretary Silva Herzog when he says: "I don't tive, Catholic-oriented Partido de Acci6n National (PAN). think Mexico is capable of living with a stagnant economy Conservative PAN maybe, but its growing strength limits beyond 1984. This would carry an additional risk of social the president's freedom of action. and political instability." Dealing from a declining position of power, with this Abstract words, those: "social and political instability." legacy of other presidents' mistakes and with the ancient What do they mean? They mean that decades of peace and problem of water, is a crushing job. Whether sitting under progress in Mexico could end in bloodshed and disorder, a tent hearing peasants' complaints or sitting in his air- with incalculable consequences for the U.S. In the long conditioned offices dealing with big problems of econom- run, helping Mexico to handle her horrendous problems is ics and politics, President de la Madrid is acutely aware much more useful to the U.S. than collecting bank loans to that hell hath no fury like a populace suddenly deprived of the last peso. And how can the U.S. help? By supplying the largesse it has grown accustomed to. food, technology and capital to our neighbor on favorable For nations, geography is destiny, and Mexico's geogra- terms. This wouldn't be charity. It would be simple com- phy is particularly grim. Writing nearly 180 years ago, the mon sense. Of the Mexican-U.S. relationship, John Gavin, German nary-?'" a 1a..-,rn pr vnn Hiimholdt reported: Ronald Reagan's ambassador to Mexico, recently declared: "n the w}__Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 once." That says Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY It stunned the world when its economy crashed 11 months ago. But now Mexico's economic team offers new hope that a gradual comeback may have begun. By Alan Robinson S ome bankers will remember August 20 1982 to the end of their days: they have a chilling recollection of the moment they heard the news that Mexico had announced it could no longer service repayments of principal. The months that followed brought one rescheduling announcement after another, including one that is at least as significant as that of Mexico - Brazil. The perception grew, and remains to this day at many banks, that Mexico, which probably triggered the Brazilian rescheduling, could be written off for the indefinite future. That perception may still be correct. But in Mexico itself foreign bankers are more hopeful, though their hopes may be based on faith as much as facts. "Mexico can come through this," said a British banker in Mexico City last month. "They have another 18 months on the tightrope, but they seem to have developed a good sense of balance." Most local bankers believe that the government of President Miguel de la Madrid has the right policies to contain the crisis. "The IMF says Mexico is on schedule in meeting the aims set out in the letter of intent," said a US banker. "That's good enough for me." A second US banker was even more hopeful. "They seem to be doing most things right," he said. "If nothing unforeseen hits them they could be back on the road to economic growth by the end of 1984." The unforeseen, however, worries many bankers. "I want to believe, but I don't believe, that OPEC will hold firm on [oil] prices," a Swiss banker said. "I also want to believe that if it doesn't hold firm the damage will be minimal, but I'm not sure about that. Any considerable drop in petroleum prices would be very damaging to Mexico. All calculations would have to be redone. I think the economic cabinet must be making frequent pilgrimages to the Shrine of Guadalupe [Mexico's national shrine]. I'm praying a little myself." Some bankers put their trust in President Reagan's strong sense of Mexico's strategic importance to the US. "Take the worst scenario we have got," said a foreign banker. "That would include oil prices falling to $18 or 20 a barrel, food produc- tion hit by the current drought, interest rates going up, the government failing to control inflation, massive unemployment, hunger marches and anything else negative you can think of. "I'm sure the US would do everything in its power to keep Mexico stable," he said. "And it can do a great deal. It isn't in the interest of the US or of banks to let Mexico go down to default. We cannot afford the economic and political consequences. Not that I think it's coming to that. It hasn't gone that far. Mexico could pull itself out of this hole, with a little help." Mexico had no economic growth in 1982, expects GDP to shrink between 2 and 5% this year, and will, at best, have marginal growth in 1984, according to the current consensus. "That is what worries me most," said a German banker. "True, the government has kept the lid on so far, but how long can it keep on controlling the pressures from labour for higher wages? - "When I think about the next two years my hair stands on end. The social risks of the IMF programme are enormous. On paper, the first quarter results are promis- ing: the Mexican authorities have been diligent and the IMF is happy. But I can't say that I'm happy. I'm worried. The Mexican Government is taking a calculated risk. I only hope it can contain the growing discontent." The Government's main financial aim is to keep the public sector deficit to pesos 1.5 billion (S10 million) or 8.5% of GDP, against 18% last year. In the first quarter, the public sector deficit was 23% lower than for the same period last year. "That's fine, just fine," one banker said. "We like to see a decent frugality. They are right on target, I would say. Now let's see what they can do about inflation." The National Consumer Price Index went up by 22.5% in the first three months of the year, with the monthly rate declining from 10.9% in January to 4.8% in March. But for a shopping basket of only basic items the average monthly increase was 13.1%. Finance Minister Jesus Silva Herzog has forecast an annual inflation rate of 70% this calendar year, against 98% for the last 0 calendar year. "I feel that inflation will reach at least 80% in 1983," a French economic analyst said. "It could be more, of course. The anti-inflation policy is working more slowly than is required. Although the government has raised the prices of its own goods and services, and will continue to do so, in an attempt to reach healthy price levels and thus slow inflation considerably, I don't think we shall see a great reduction in inflation this year." The private sector quickly jumped on the bandwagon of rising prices and the govern- ment freed many prices from controls. Even controls on products in the shopping basket of the index were slackened. The response from organized labour, which is one of the pillars of the ruling Institutional Revolutionary Party (PRI), was sharper than ever before. But the PRI's system of control was not changed and a wage demand of 50% was halved by the labour leaders. Even this had not been granted by early June. "To sum up," said the French econo- mist, "they are on course with the deficit and way off course with inflation." Preliminary estimates show a trade surplus of $3.4 billion for the first quarter of 1983, compared with a $708 million deficit for the first three quarters of 1982. Imports were cut to the bone, down 70.8014, with capital goods imports down 81.3%, consumer goods 71.5%, and raw materials 64%. Exports were $4.8 billion, up 11.1 % over the first quarter of 1982, with oil sales contributing 82.3% of the total. The share of non-oil exports were down 28.2% on the ...,.. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY first quarter of 1982. Border transactions and tourism provided a surplus of $379 million. Mexi- cans have been spending less abroad, but visitors in Mexico have also been spending less. "The results on the trade account are excellent," said a British banker. "The Mexicans have shown themselves capable of great discipline and sacrifice." But a German banker was less enthusiastic. "Good results on paper, again," he said. "Results achieved by cutting imports and eliminating economic growth. But these results also jeopardize jobs." then I would think the single rate would be subject to slippage," a Mexican Govern- ment economist said. "In that way we hope to keep the peso competitive and avoid the necessity for another brusque devaluation." A US banker commented: "Devaluation is out of the question for now. Last December they overdid their big devalua- tion in order to buy time - to get stability for the rest of this year. These rumours are uninformed, but none the less dangerous for that. I'm told that Mexican pesos are being taken out and exchanged for dollars, but I don't think the traffic is significant whole thing just keeps rolling along for as long as is necessary. That's life in the world of finance, my friend." Most foreign bankers in Mexico believe that the nation has options other than foreign borrowing. "You would be surprised," said a German banker, "if you knew how many very big international corporations are sniffing around for invest- ment opportunities. Given Mexico's potential and the current exchange rate, investment is much cheaper and likely to become more productive. In spite of my own reservations, I would agree that now is Last month Mexico shuddered with devaluation rumours once again. "It doesn't make sense," said the Briton. "The peso is undervalued by any system of measurement. What we are seeing is a kind of re-occurring psychosis." The special parity for dollar-denominated deposits was abolished on March 15, leaving a dual parity for the peso: a free market rate which has been stuck at 149.40 buy and 147.90 sell since last December, and a controlled rate with a daily slippage of 13 centavos and an average value of 106.20 pesos to the dollar during March. "The Government intends to continue the slippage until the free and controlled rates are united, near the end of the year, The Mexican challenge Mexico met the first quarter economic target set by the IMF, but there's a long and rocky path ahead. Total external debt is some $85 billion. At end-1982, $59 billion was public debt. And more than half the total matures before the end of 1985. Being negotiated now is the reschedul- ing of $19.7 billion of public sector debt maturing by end-1984 and $15 billion of private debt. Deadline: August 15 (that may be extended). The public sector rescheduling proposal is for an eight-year maturity with four years' grace at either I % % over Libor or 11/4076 over US prime. The private sector debt proposals are outlined in the inter- view. Remember that Mexico's debt burden is still being increased. yet." Most bankers agree that devaluation is unlikely in the near future. Mexico's foreign debt is close to $85 billion. "About 90% of the debt is in dollars, so you can imagine the effect of another plunge for the peso," an American banker said. "Sure, the debt burden remains despite rescheduling," he said. "If the worst happens we just have to find a way of pushing the problem further away. To the end of the century, if necessary, or further. As long as there is an outside chance that Mexico can pay we must give it that chance. That's my view. In the long term Mexico has everything going for it. And of course we keep collecting interest and fees and the Commercial banks advanced $5 billion of new money in March while the IMF granted a $3.9 billion extended fund facility. Repayment of the commercial loan begins in 1986. Disbursement of this loan and the IMF funds depend on Halfway to a cure ... the time to invest here if you are going to invest at all." "Invest?" a US banker said. "Sure I would invest in Mexico. There has never been a better time for it." "On balance I would recommend invest- ment . in Mexico now," said a British banker. "I know there is some interest in Britain and I'm sure the Americans are on to it. Of course, there are risks, some might say considerable risks, but that is what the game is about, isn't it?" "I would be extremely cautious about recommending investment at this time," said a Swiss banker. But he added: "I understand there is a great deal of interest." 10. Mexico meeting the targets set by the Fund. Keep your fingers crossed. ... with tough medicine IMF targets for Mexico %GDP Public sector debt by maturity date (S billion) 1982 16.5 1983 8 5 Before After 1984 . 5.5 rescheduling rescheduling 1985 3.5 1983 9.4 1.5 1984 5.4 1.3 1985 9.7 9.7 1988 5.1 5.1 1982 6.5 1987 7.5 12.3 1983 4.25 1988 4.7 9.5 1989 3.5 8.3 Inflation % 1990 1.1 5.9 1982 90-100 after 1990 4.3 4.7 1983 55 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY The Mexican Government, meanwhile, nas been saying repeatedly that its foreign investment regulations are "flexible enough" to allow majority foreign owner- ship in new projects, "if they are in Mexico's interests". In the long run, everyone agrees Mexico's economic recovery is possible only after economic recovery in the US and the other industrialized nations. "The signs seem to be good for a US recovery," the Swiss banker said. "But it won't be quick and the benefits will take time to filter through to Mexico. I see no escape from austerity in the short run." "I wish I was as sure as the Americans seem to be about their economic upturn," the German banker said. "If it does come, and if it lasts, Mexico will obviously benefit. At the moment Mexico wants to export very badly, but there are no markets for non-oil products." According to the Mexican Government economist, "we need to export our way out of the mess and so we need an economic revival among the industrial nations, especi- ally the US, which is our biggest trading partner." The new mood of cautious hope con- trasts strongly with the gloom-and-doom messages being put out by some of the same inkers only six months ago. "In my opinion, bank representatives don't stay long enough in one place to understand it," said the German banker. "We over-react; our head offices over- react; we frequently don't have the proper information and most of us lack a feel for the country we work in. Now there is some optimism about Mexico. I can only hope it is well-founded. A few months ago nobody had a good word to say. The judgements you hear today are coming from the same people. We can be very changeable, I'm afraid." Even if Mexico's public sector debt problem can be solved over time, there is still much concern over the treatment of the private sector debt. Until now (see inter- view) little has been published to show how Mexico will handle that. If bankers see Mexico in a more hopeful light, a major cloud on the world's financial horizon would disappear. It's still too early to judge, but so far this year Mexico has moved in the right direction. ^ 1 (71 LiInvest? Sure I would invest in Mexico. There has never been a better time for it F PE Along with Finance Minister Jesus Silva Herzog, it Is Miguel Mancera Aguayo, governor of Mexico's central bank, who is most often cited as an architect of any recovery in Mexico. Mancera has a formidable technical reputation at home. He is one of the strongest members of President Miguel de la Madrid's financial team and Is a close friend of the President. His colleagues, admittedly with a vested Interest, say he's brilliant. Mancera is also a very private man. Aside from obligatory public appearances, he avoids publicity. As an economist he is fundamentally opposed to exchange controls. In the waning months of the Lopez Portillo government, In the thick of an economic and financial crisis, he sensed the way the wind was blowing and produced a pamphlet telling Mexicans why exchange controls would not work for their country. It was a brave, last-ditch attempt to stem forces that were moving the Government toward a course that Mancera saw as disastrous. It cannot have been an easy decision for a man who likes his privacy. He and his pamphlet were attacked by the partisans of exchange controls. In the ensuing battle he seemed increasingly alone. Three months later, President Jose Lopez Portillo nation- alized the private banks, imposed a full range of exchange controls, and demanded Mancera's resignation. Carlos Tello, the architect of the new controls system, took over at the central bank. During the last three months of the Lopez Portillo administration, Mancera's arguments took on a prophetic look. Almost everything he had said would happen as a result of exchange controls happened. When President Miguel de la Madrid took office on December 1 1982 one of his first actions was to bring back Mancera to the central bank with the task of gradually and carefully dismantling the controls his Government had Inherited. It was a considerable personal triumph for Mancera, but he never succumbed to the temptation to say: "I told you so." He will discuss neither his departure nor his return. He simply went back to his desk and got on with the job. Mancera was born in Mexico (Sty on December 18 1932, studied economics at the Instituto Tecnologico de Mexico and took a master's degree at Yale University before going on to the Bank of England for a special course of financial studies. He has been a professor of economic theory at several Mexican institutions and at the Latin American Monetary Studies Centre. In 1957, he went into government work with the Presidency Commission on Public Investment. The following year he joined Banco de Mexico, where he held various posts, culminating in his appointment as director general. The generally-agreed prognosis is that he will stay there for the duration of the de Is Madrid administra- tion. Mancera refused to answer questions of a personal or political nature, declined to discuss economic theory - his own or anyone else's - and studiously avoided judgements on the IMF's strict adjustment programme for Mexico. 46 Euromoney july is Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY Miguel Mancera Aguayo, Mexico's central bank governor: "Moderate optimism." The drop in oil prices has cut Mexico's export earnings. How serious is that? It was an unfortunate development for us, since, given our export platform, it meant a loss of $1.4 to 1.5 billion in 1983. But, this loss will be compensated by the drop in market interest rates. The financial programme for 1983 was constructed in late 1982 on the basis of an effective average interest rate of 14'/4%. At present we have an effective average interest rate of about 12.2%. Since current public and private external debt is estimated at over $80 billion, this will be reflected in a substantial decrease in interest payments, and will yield some $1.4 to 1.5 billion in foreign exchange savings. So, as you see, in the short run the decrease in international interest rates will offset the reduction in oil prices. In the medium run, it is likely that lower energy prices will help to strengthen the economic recovery, which is under way in the in- dustrial world. Mexican non-oil exports, both commodities and manufactures, will benefit from that recovery. Will you need more credits this year? I do not believe we will require additional credits beyond those programmed. There are several reasons for this. First, and most important, we now expect a much stronger balance of payments position than origin- ally envisaged. Preliminary figures show a current account surplus for the first quarter of over $1.5 million, which contrasts markedly with the $3.4 billion deficit for the same period of 1982. This surplus is basically due to a strong positive trade balance of over $3.5 billion. Secondly, public expenditure is under tight control and the fiscal deficit is on target, eliminat- ing the need for external finance over and above that envisaged in the programme. Thus, short of unforeseen difficulties such as a collapse of the oil markets, we do not expect to return to the external credit market in 1983. How would you describe the progress made in meeting the terms of the IMF agreement? A few days ago, the Executive Board of the IMF made an evaluation of the com- pliance with the adjustment programme currently under way. They certified that Mexico has satisfactorily fulfilled all the requirements of the programme. The directors praised the determination and forcefulness with which the Mexican authorities have moved to implement the economic adjustment programme sup- ported by the extended arrangement with the fund. The size of the imbalances, both external and internal, that had been building up during recent years made a severe cutback in domestic demand un- avoidable. Fund directors recognized that the Mexican authorities had responded with the necessary resolve and that the adjust- ment programme was being carried out without hesitation. They noted that the results of the first few months of the year were encouraging and indicated that the programme was on track, though perhaps with higher inflation and lower growth than had been forecast. We are, therefore, able to draw $325 million of additional resources from the IMF and $1.1 billion from commercial banks within the next few weeks. While the first balance of payments results indicate that the external sector is adjusting rapidly, other results of the programme will take longer to become apparent. But we are sure the programme is appropriate to curb inflation, correct imbalances and lay the foundations for sus- tained growth in output and employment. Banco de Mexico has come up with a strategy to enable private companies to deal with their foreign debts. Can you explain it? The tight liquidity situation which we are undergoing has led us to devise several mechanisms to deal with the private debt. The first deals with interest past due to foreign banks, which could not be paid in the period August 1982 to January 1983, due to our precarious international reserve position. We entered into an agreement with creditor banks by which Mexican debtors will deposit in the Bank of Mexico the peso equivalent to the foreign exchange required to meet payments at the controlled rate. The Bank of Mexico opens a dollar account in the name of the foreign creditor, which earns a market interest rate, a pro- cedure by which foreign banks avoid having to list these loans as non-performing assets. p. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY These sums are being transferred abroad as foreign exchange becomes available. Over $90 million, or 15% of the total deposits, have already been transferred and another 5% is to be paid within a few days. The second mechanism, which is similar to the first, was established to deal with suppliers' credits. This allows the Mexican importers to pay pesos to the Bank of Mexico for an amount equivalent to their debts to foreign suppliers at the controlled rate of exchange, and to obtain in return a dollar denominated certificate of deposit which earns a Libor interest rate payable semi-annually. The dollar certificate of deposit issued in favour of the Mexican importer may be assigned or pledged in favour of the foreign supplier, allowing him to obtain other financing or to retain it as a security for payment. These CDs bear no maturity date and the regulations issued on February 28 state that the terms of payment of these debts will be defined by next August 1983. The reason for this delay in defining the terms of payment for these debts is simple: the Ministry of Trade is in the process of registering these suppliers' debts, the total amount of which is still unknown to us. The third mechanism is for special for- ward cover procedures for the repayment of obligations outstanding at December 29 1982 by the Mexican private sector with financial institutions, payable outside Mexico. This mechanism offers four procedures for settlement, based on coverage of the forward contract (principal only or principal plus interest) and on financing by private borrowers (from their own or borrowed resources). In all cases a prior agreement to restructure maturities by the foreign creditor is required. The forward cover scheme will be handled by the Fideicomiso para la Cobertura del Riesgo Cambiario (Fund for Exchange Risk Coverage), FICORCA, which assumes only the obligation to deliver the foreign exchange to the domestic borrower on the basis of a repayment schedule agreed between the local borrower and the foreign creditor. Does any of this imply a subsidy for private sector debtors? The FICORCA schemes are entirely voluntary, do not imply any subsidy and do not imply the absorption of commercial risks. FICORCA only assumes the exchange risk and, through the required restructuring, provides firms having - liquidity problems with the necessary breathing space to overcome them. To qualify for the various forward cover alternatives, the maturity of the outstanding loan or the refinancing loan should exceed six years, with three years of grace, when only the principal is subject to coverage, and eight years, with four years of grace, when both principal and interest payments are covered. The lead k in Adh ban domestic }loi'wegian bond issues. SPAREBANKEN AKERSHUS Fvrex and Treasury Section Tel.? Oslo 3185 28-30. Telex: 16463 sparx. Capital Market Section Tek? Oslo 3190 50. Telex: 19968 spark n. Tordenskiolds gt. 8-10, Oslo 1, Norway. Tel: 472 31 90 50. Euromoney July 1983 49 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY You mentioned various alternatives. What are they? There are four possibilities under the FICORCA scheme. The first offers im- mediate delivery by the Mexican debtor of the peso equivalent of the total value of the obligation abroad, converted at special rates that are more appreciated than the controlled market rate, depending on the maturity of the loan. The delivery of pesos guarantees access to foreign exchange to cover the amortization due from the Mexican borrower over a period of six or more years, with at least three years of grace. The rates applicable for transactions effected to June 5 1983 are these: The rate for the debtor Final Grace Exchange- maturity period rate (in years) (in years) (pesos per $1) 8 4 77 7 3 83 6 3 87 The second arrangement is like the first, except that FICORCA will provide financ- ing in pesos to local firms without sufficient liquidity to enable them to make the necessary delivery of pesos as in the first case. In this case, interest payments abroad are not covered and the local debtor must continue to pay these at the prevailing exchange rate for the peso in the controlled market on the date on which the payments are remitted. With the third arrangement there is immediate delivery of local currency equivalent to the total outstanding foreign obligation at the controlled market rate. But the forward cover includes principal and interest on the external liability. The fourth arrangement is like the third, except that FICORCA provides domestic financing for the local currency payment by the domestic borrower, as in the second arrangement. In all instances, the forward cover does not transfer the foreign liabilities to FICORCA and the domestic borrower remains responsible vis-d-vis the foreign creditor. Let me also mention that officially guaranteed private sector supplier credits present a special problem with which we are trying to deal. Our policy has been that, in every scheme, we consult with our creditors and establish mechanisms that are generally accepted. This was the case with our bank restructuring, for public and private sectors. It was virtually impossible with suppliers' credits, because there were thousands of creditors. Moreover, we are still determining the amounts. To deal with these credits, which are private for us but, because of the guarantees, are public for our creditors, we have pro- posed the following arrangements. The Mexican Government and the export credit or export guarantee institutions would jointly determine the amount of officially guaranteed commercial debt owed by Mexi- can private sector borrowers or importers to either financial institutions or suppliers in each country, derived from commitments made on or before December 20 1982. A financial institution of the creditor country would extend a line of credit for the full amount outstanding to an official institution in Mexico, which would enable it to pay in full all outstanding guaranteed debts matured, or that will mature, from commitments enter ed before December 20 1982 by the Mexican private sector. These lines of credit would be made available at market rates. These credit lines could be medium term, with an adequate grace period, and would be consistent with the terms of restructuring and with the availability of new money for the public sector. A minimum of six years, with three years of grace, is suggested, equal to SS bil- lion of new money. If a Mexican private company could not deliver the pesos to the Mexican public sector institution that had assumed the guaranteed debt from the foreign creditors, that debt would be covered by the original export guarantee agency of the relevant country. We have already adopted such a scheme with the Banco Exterior de Espana, Istituto Centrale per it Credito a Medio Termine Mediocredito Centrale U .S.$ 4090005000 Medium-Term Eurodollar Loan Arranged by: Morgan Grenfell & Co. Limited Managed and provided by, Arab Banking Corporation (ABC) Bahrain Middle East Bank (BMB) Bankers Trust Company Dai-Ichi Kangyo Bank Nederland N.V. The Gulf Bank K.S.C. Italian International Bank Limited Lavoro Bank International Morgan Grenfell & Co. Limited Agent Morgan Grenfell & Co. Limited whi( Thi< prol of rest, owr V to d esse Ir at $ S91 way met crec Cot $1 Inte T wol last incr put exp of t exp of low C 198 aca asc we set' Id cre r exto des liqi ant ha% sch ate ser ful all( wit he, bal im Im exi Th an wt ab im pr are of re 50 Euromoney July Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 COVER STORY These sums are being transferred abroad as foreign exchange becomes available. Over S90 million, or 15% of the total deposits, have already been transferred and another 5% is to be paid within a few days. The second mechanism, which is similar to the first, was established to deal with suppliers' credits. This allows the Mexican importers to pay pesos to the Bank of Mexico for an amount equivalent to their debts to foreign suppliers at the controlled rate of exchange, and to obtain in return a dollar denominated certificate of deposit which earns a Libor interest rate payable semi-annually. The dollar certificate of deposit issued in favour of the Mexican importer may be assigned or pledged in favour of the foreign supplier, allowing him to obtain other financing or to retain it as a security for payment. These CDs bear no maturity date and the regulations issued on February 28 state that the terms of payment of these debts will be defined by next August 1983. The reason for this delay in defining the terms of payment for these debts is simple: the Ministry of Trade is in the process of registering these suppliers' debts, the total amount of which is still unknown to us. The third mechanism is for special for- ward cover procedures for the repayment of obligations outstanding at December 29 1982 by the Mexican private sector with financial institutions, payable outside Mexico. This mechanism offers four procedures for settlement, based on coverage of the forward contract (principal only or principal plus interest) and on financing by private borrowers (from their own or borrowed resources). In all cases a prior agreement to restructure maturities by the foreign creditor is required. The forward cover scheme will be handled by the Fideicomiso para la Cobertura del Riesgo Cambiario (Fund for Exchange Risk Coverage), FICORCA, which assumes only the obligation to deliver the foreign exchange to the domestic borrower on the basis of a repayment schedule agreed between the local borrower and the foreign creditor. Does any of this imply it subsidy for private sector debtors? The FICORCA schemes are entirely voluntary, do not imply any subsidy and do not imply the absorption of commercial risks. FICORCA only assumes the exchange risk and, through the required restructuring, provides firms having - liquidity problems with the necessary breathing space to overcome them. To qualify for the various forward cover alternatives, the maturity of the outstanding loan or the refinancing loan should exceed six years, with three years of grace, when only the principal is subject to coverage, and eight years, with four years of grace, when both principal and interest Payments are covered. SPAREBANKEN OSLO AKERSHUS The lead ba ihlk domestic I~o~~vegi~~ bond issues. SPAREBANKEN AKERSHUS Fonx and Treasury Section Tel? Oslo 3185 28-30. Telex: 16463 sparx. Capital Market Section Tel? Oslo 3190 50. Telex: 19968 spark n. Tordenskiolds gt. 8-10, Oslo 1, Norway. Tel: 472 31 90 50. Euromoney July 1983 49 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 R COffSH'Y P Should a bank keep every dealer within limits? By Robert Winder Two slightly different ways of monitor- ing worldwide exposure have been deve- loped by the network operators Geisco of the US and I. P. Sharp of Canada. Both systems are based on a microcom- puter on the dealer's desk, into which all deals must be entered. Once the dealer has keyed in the facts about the deal, the com- puter will check all the limits which that deal may threaten - country, currency, counterparty or a dozen other limits. If the deal is good, it may be entered; if not, it may still be entered, but the computer will record the breaking of the limit and issue reports on the deal. The worldwide processing networks give the head office of a bank immediate access to information about the activities of all its branches. Said I. P. Sharp's Leo Bettes: "We're talking about the nervous system of a bank, the integration of its various opera- tions." Bettes estimated that 300 banks needed such a system. At Geisco, Peter Greenhill explained: "If a bank has branches in New York, London and Singapore, it's quite possible that the Singapore branch may have dealt up to its limit in a currency, and be turning down deals, when there is unused limit in the other two centres. The other two centres may not even be dealing at that time. It's a waste of a bank's resources at a time when they're looking to cut risks." Deutsche Bank has cut its overall limit by around 20% since taking the Geisco system in 1980. Most banks, however, have already invested a great deal in developing their own control systems in-house. And many bankers expressed reservations about the idea of global limits. One told Euromoney: "Limits are set locally because it's impor- tant to know the markets. It's hard for a New Yorker to set the limit for the Japanese discount market, and much better to have people in Tokyo who can do it." Another drawback of such systems is the pressure they put on dealers. Some dealing room managers insisted that-dealers should not be distracted by systems which query every deal. But Greenhill rejected this. "It's not really an extra screen and keyboard," he said. "It's a replacement for the bank's own in-house files, which the dealers update anyway. If you use Global Limits properly you can run your entire dealing room operation on it. It helps dealers because the information's live, they can ask it questions. And of course, once a deal is BANKING TECHNOLOGY made, all the limits are automatically adjusted." He added: "It's insurance. Every bank is thinking about ways to control risk, and consolidating information from all the branches is an essential part of their thinking." I. P. Sharp's system allows two dealers to deal with the same client simultaneously, but the Geisco system prevents this. Greenhill argued: "We want to avoid a situation where the same limit is being broken by two dealers at the same time. It's the same as the reason why dealers should enter the deals themselves. If they hand over to clerks there'd inevitably be a lag, in which time limits could be broken by accident." Essentially both systems operate on the basis that they give the banks a framework in which they can insert their own defini- tions of limits, and the size of those limits. They can then use the systems' real time, capability for dealer support, and their' reporting . facilities for management information. It is possible to limit deals maturing on a single day to avoid bunched payment schedules, as well as limiting them on a currency or counterparty basis. In the Geisco system, them is a moral twist. To prevent two deals being done simultaneously, dealers must not hesitate too long once they have begun to deal. If they do, a message comes up on the screen. It reads: "You have been idle too long." CKKIG THE BIG POJL1S EBC's new computer system helps reduce project finance risk. By Robert Winder generalized modelling systems in the extent and detail of its applications. The system is modular, so the functions can be used individually as well as collectively. It con- tains modules for scheduling productivity, pricing and costing, taxation and sensitivity analysis, as well as the facilities for all the standard economic parameters. The sensi- tivity analysis module assesses the inter- action between different variables, permitting the user to identify the effect of each adjustment to the whole project. The system is multiple currency, and contains pre-programmed routines for the US and the major European tax structures. But Andreas Crede, head of the Ebcore project at European Banking Company, said that Ebcore has creative uses: "In situations where you have a marginal development it's hard to structure a loan and remain confident. With Ebcore you can be much more precise about the computers are better suited to modelling specific projects. "Country risk is very difficult to quantify accurately, in economic terms," he said, "and often, strategic or psychological reasons for lending override the data, as in the case of Mexico. The advantage for computers in project financing is that it is coherent; a project has a natural logic and life of its own. Scientific analysis in these cases has much more value and importance, and you can be much more confident with the results." Crede is aware that even Ebcore remains a tool, dependent on the assumptions it is given. "It's actually quite a hard task- master," he pointed out. "But it's usefully hard. It forces you to be very careful about what you give it, and since it works by asking you questions, it makes you consider things you might prefer to neglect." The development of Ebcore is a sign that When William Blackwell became head of European Banking Company's project group in 1977, his first requirement was a computer modelling system, to help him control the immense risks involved in financing natural resource projects. Most banks use all purpose modelling systems like Visicalc or Micromodeller to track the effects of variables on a project's profitability. The biggest banks, though, have developed their own, more adaptable systems. Citibank's International Com- mand is used by over 60 companies for con- solidation of accounts, and for construc- tion of models for future performance. The bank is now working on refining the system. Blackwell was determined to evolve a package precisely tailored to the demands of natural resource projects. It took three years of work with Core Laboratories of -- etroleum ise in the d p expert who ha vulnerability of a project to adverse banks are becoming increasingly concerned conditions." with the control of risk. As Crede said: "In For many years bank economists have project finance the bank takes all of the used computers to construct models for downside risk and none of the potential for country risk, projecting the balance of pay- gain, as an equity investor would. In a 1Phrnr& is industry, before the system was ready. general contusions aoouc rncu crcuu- ouup-y ....? It is called Ebcore. and it differs from worthiness. But Crede argued that this kind of finance. June 1983 0 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 8uromoney 95