OUTLOOK FOR THE INTERNATIONAL DEBT STRATEGY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00283R000600080006-8
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 13
• Document Creation Date: December 22, 2016
• Document Release Date: December 22, 2009
• Sequence Number: 6
• Publication Date: June 1, 1984
• Content Type: REPORT

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Directorate of Confidential
Outlook for the
International
Debt Strategy
An Intelligence Assessment
Confidential
GI 84-10104
June 1984
copy 4 4 9
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Directorate of Confidential
n ) Intelligence
Outlook for the
International
Debt Strategy
This paper was prepared by Office
of Global Issues. Comments and queries are welcome
and may be directed to the Chief, International
Finance Branch, OGI, on
Confidential
G/ 84-10104
June 1984
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Outlook for the
International
Debt Strategy
Key Judgments Over the last two years, rescue packages coordinated by the IMF have
Information available forestalled default by debt-troubled less developed countries (LDCs) and
as of 1I June 1984 East European countries and averted a major disruption in the internation-
was used in this report.
al financial community. Debtors and creditors have negotiated these
packages on a country-by-country basis. In return for complying with an
IMF economic adjustment program, debtors have obtained debt restruc-
turings, new commercial bank and IMF loans, and official emergency
short-term loans and export credits. This strategy has assumed that as
world economic recovery proceeds and LDC adjustments are undertaken,
the financially troubled countries would regain normal market access to
new loans and be able to service their debt on time.n
Although Western economic recovery is under way and debtor country
external accounts are steadily improving, we believe that serious problems
still could arise under the present debt strategy:
? Some US regional and European banks are becoming increasingly
reluctant to participate in new loan packages for these financially
troubled countries. This implies an increased burden on the larger banks;
the financial community is already concerned about high loan exposures
to troubled debtors.
? Governments of many financially troubled countries face intense political
and social pressure to abandon or weaken austerity measures. Reduced
subsidies, wage restraints, and sharp import cuts are provoking wide-
spread discontent and in some cases, such as the Dominican Republic and
Bolivia, are directly responsible for recent political turmoil.
? Global economic conditions may not improve enough for these countries
to attract sufficient capital to service their debt and to finance develop-
ment needs.F_~
Many observers are concerned that Western economic recovery may falter
and interest rates rise further, and they believe new proposals should be
considered for dealing with the international debt problem. Already a
number of proposals have been put forward-including capitalization of
interest, multiyear restructuring, and a new SDR allocation. While these
Confidential
GI 84-10104
June 1984
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proposals conceptually would make more foreign exchange available for
imports and help spur economic growth in the LDCs, there are several
disadvantages:
? Some would require legislation that would be time consuming and
perhaps not feasible.
? Some would treat all debtors identically and fail to recognize the
uniqueness of each debtor's situation.
? They may reduce the incentive of debtor countries to continue imple-
menting austerity measures.
? They could reduce the willingness of commercial banks to extend new
credits to the debtors in the future.
Debtor countries are also calling for new proposals that would share
responsibility for solving the debt problem and assuming losses with
creditors. As a result, we expect tougher stances in negotiating with
creditors this'year. Moreover, recent reaction to the rise in interest rates
suggests closer coordination of debt policies by the debtors.
We believe demands for alternative solutions to the debt problem increas-
ingly will be heard from LDC debtors, academics, and some Western
allies. The political strains on the debtor governments are growing, and we
cannot rule out more hardline demands or radical actions. While in some
cases calls for action may simply be rhetoric, Washington, could be forced
to find a way to respond to creditor and debtor concerns in the months
ahead. Moreover, pressure could build rapidly if a major roadblock were
hit in financial dealings with a major debtor. In this regard, the Argentine
situation probably bears the closest watching; Argentine negotiations with
the IMF and commercial banks could be difficult and prolonged.
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Outlook for the
International
Debt Strategy F
Prelude to the Current Problem
The debt burden of the less developed countries
(LDCs) and the East European countries has become
extremely large. Spurred by grand development plans
and the easy availability of foreign bank credit, these
countries boosted their combined medium- and long-
term debt from only $55 billion in 1970 to over $600
billion at yearend 1983 (see figure 1). By the late
1970s, the LDCs and East European countries were
adding nearly $50 billion a year to their medium- and
long-term debt burden. In addition, they have at least
$165 billion in short-term debt.n
The structure of these countries' external debt shifted
dramatically in the past decade. In the early 1970s,
these countries borrowed mostly from multilateral
institutions on concessionary terms; only 40 percent of
their borrowing was from commercial banks. By the
late 1970s, the ratio had reversed with private sources
providing nearly two-thirds of these countries' exter-
nal loans; the Latin American countries rely on
private sources for almost all of their financing needs.
This shift has made the cost of financing more
onerous for the debtor countries, because the majority
of commercial bank loans are tied to market interest
rates, whereas official credits carry lower, fixed inter-
est rates. In addition, bank loans have to be repaid
more quickly than official credits.n
While these trends set the stage for the debt problem,
the crisis actually came when countries such as
Poland, Mexico, and Brazil were no longer able to
repay their debt as scheduled. We and other financial
observers believe several factors were responsible:
Figure 1
LDC and East European Medium-
and Long-Term Debt, 1970-83
? Concurrently, recession in the industrial countries
and low commodity prices weakened debtor coun-
tries' exports so that the LDCs had less income with
which to service their debt. As a result, several key
Latin American countries-Argentina, Brazil, and
Chile-saw interest payments alone as a share of
export earnings rise to more than 40 percent in
1982.
? The size of the annual interest and principal pay-
ments owed by the LDCs and East European coun-
tries mushroomed, growing from only $9 billion in
1970 to $140 billion by late 1983 (see figure 2).
Much of the increased burden resulted from a
dramatic rise in interest rates as industrial countries
fought inflation with tight monetary policies.
? Finally, given world economic conditions, interna-
tional lenders perceived growing risks in the LDCs;
as a result, they cut back new lending and refused to
refinance maturing debts, especially short-term
credits. 7-1
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Figure 2
LDC and East European Debt
Service, 1970-83'
? Medium- and long-term principal repayments and all interest payments.
Source CIA estimate based on IMF, World Bank, BIS, and OECD data.
Current Strategy for Coping With the Debt Problem
A review of country rescue programs shows that over
the last two years creditors have dealt with LDC debt
servicing problems on a case-by-case basis. Generally,
when a country has fallen behind in payments, credi-
tors have agreed to temporary delays of payment
while the debtor country began discussions with the
IMF. Within a month or two, the debtor country has
adopted an IMF-supported economic adjustment pro-
gram that is monitored quarterly. In return, the
debtor country has obtained new financial assistance
from creditors and a restructuring of its debts. The
strategy assumed that, as world economic recovery
proceeds and LDC adjustments are undertaken, the
financially troubled countries would regain normal
market access to new loans and be able to return to
servicing their debt on time.n
This case-by-case approach has been publicly articu-
lated by the United States and other industrialized
countries as a five-point debt strategy, which includes:
? Encouragement of continued bank lending.
? Continued willingness of Western governments and
institutions to provide bridge financing when
necessary.
Figure 3
Real GDP Growth: Selected Debtor
Countries, 1979-83
? Strengthening of international financial institutions
such as the IMF.
? Adoption of policies by industrialized governments
to promote sustained noninflationary growth.
? Encoura ement of sound economic policies within
LDCs.
So far under this strategy, no countries have repudiat-
ed their debt, and there has been no major interna-
tional liquidity crisis. Most of the financially troubled
countries have implemented IMF-supported austerity
measures. In addition, the resources of the IMF have
been increased. Finally, Western governments and
commercial banks have restructured a large portion of
maturing debt and have agreed to lend additional
funds to several countries as part of their debt-relief
packages.n
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Figure 4
Import Trends in Key Debt-Troubled
Countries, 1981 and 1983
Economic Impact on the Debt-Troubled
Countries and the United States
While cooperative efforts have prevented major dis-
ruptions to the international financial system, the
impact of adjustment programs on the debt-troubled
countries has been severe. Austerity measures, such as
restraints on wages, government spending, and domes-
tic credit, as well as foreign exchange constraints,
have led to steady declines in the debtor economies.
According to official government and IMF statistics
and our estimates, the largest debt-troubled LDCs
have seen their real GDP actually fall during the past
two years, a sharp turnaround from the 4- to 5-
percent growth of 1979-80 (see figure 3). Imports have
even fallen below levels originally targeted in IMF-
supported adjustment programs. The imports of Ar-
gentina, Chile, and Mexico have fallen by at least half
in the last two years (see figure 4).n
Moreover, it is not only the major debtors who are
having financial difficulties and undertaking econom-
ic austerity measures. Close to 40 countries currently
have or are seeking IMF-supported programs. Last
Figure 5
LDC and East European Debt
Restructurings, Selected Years, 1976-84
Source: CIA estimates based on OECD and IMF data.
a Estimated.
year 25 countries obtained debt relief totaling about
$55 billion (see figure 5). We expect that 35 countries
will ask for debt relief this year in the amount of $70
billion.)
The US economy has not been immune from the
fallout of the LDC debt problem. The sharp drop in
imports by the debtor LDCs has aggravated the US
trade deficit. Trade statistics show, for example, that
US exports to Latin America declined from roughly
$42 billion in 1981 to $22 billion in 1983. In addition,
US banks are highly exposed to debt-troubled coun-
tries. LDCs and East European countries owe US
banks nearly $150 billion, with the nine largest US
banks accounting for roughly $90 billion. Moreover,
the exposure of large US banks is highly concentrated
in a few large debt-troubled countries; Argentina,
Brazil, Mexico, and Venezuela together owe the nine
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largest US banks over $40 billion, which substantially
exceeds these banks' net worth. This vulnerability of
the large US banks to the debt problem is reflected in
the decline in their stock prices relative to the overall
market. press reporting indicate
that many investors fear that these banks may have to
write off a large portion of their foreign loans, which
would depress bank earnings and could raise deposi-
tors' concerns over the solvency of these institutions.
Potential Problems Under the Current Debt Strategy
Although Western economic recovery is under way
and LDC external accounts are steadily improving,
we believe that serious problems still could arise. In
the past six months, there have been signs that many
commercial banks have become increasingly reluctant
to lend new money to debt-troubled countries. For
example, about 30 smaller US and foreign banks,
according to press reporting, refused to participate in
the recent $3.8 billion loan to Mexico. While most of
the large, heavily exposed US banks are willing to
make new loans to get back their interest payments on
existing loans, a growing number of US regional and
European banks are refusing to go along. Financial
observers state that US regional bank reluctance is
part of a strategy to limit exposure to troubled
debtors. European banks operate under less stringent
accounting rules and do not feel compelled to lend
new money to keep interest payments current on
existing debt. Under current US regulations, when
interest payments are past due by more than 90 days,
US banks-unlike their European counterparts-gen-
erally must place their loans in a nonperforming
category and deduct interest not received from in-
come.
As the foreign and smaller US banks drop out, the
large US banks are forced to take on even more of the
burden of new lending. In the four big Latin Ameri-
can countries, the nine largest US banks already
account for 60 percent of total loans made by US
banks, according to Federal Reserve Board statistics
(see figure 6). Concern about regulatory and stock-
holder reactions to increased LDC loan exposure
hinders these banks' ability to assume this greater
burden.F___1
Figure 6
US Bank Exposure in Latin America, by
Size of Bank, as of June 1983
-Next 15 largest
banks
Nine largest
banks
For this reason, we believe there could be shortfalls in
meeting new money requests later this year. Accord-
ing to press reporting, Argentina will need over $2
billion to keep interest payments current, and we
believe raising that amount could be difficult. The
Philippines is already seeking over $1.6 billion in new
money from banks, and some banks are indicating
reluctance to participate, according to press reporting.
We believe Brazil could require more than $3 billion
in new loans from banks to meet 1985 financing
needs, but many European and smaller US banks
have already said that they will not participate in a
third packag
A second problem area under the five-point strategy is
that the governments of many financially troubled
countries are having an increasingly difficult time
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25X1
maintaining austerity programs. As wages and subsi-
dies have been cut in response to IMF conditionality
requirements, political resistance to austerity pro-
grams has grown. Such resistance has caused several
key debtors to fall out of compliance with their IMF-
supported programs, leading to interruptions of new
money disbursements and the buildup of arrearages.
Once such a disruption occurs, renegotiation of new
IMF terms becomes even more politically difficult for
the incumbent governments. Argentina, the Philip-
pines, and Bolivia have all been declared out of
compliance with IMF agreements, and relations with
creditors are fragile. Efforts to negotiate new agree-
ments have dragged on for months largely because of
political constraints these governments face in imple-
menting measures to satisfy the IMF. The Bolivian
Government's decision last month to devalue its cur-
rency and to increase food prices as preconditions for
an IMF agreement spurred widespread labor strikes,
including disruption of the banking system. In Argen-
tina, continued sporadic strikes make it increasingly
difficult for President Alfonsin to move forward on
economic issues. In the Philippines, creditors are
concerned that new opposition strength in the Assem-
bly will make it more difficult to implement austerity
measures and conclude IMF negotiations.F_~
? A $5 per barrel oil price increase raises import costs
for an oil-importing debtor such as Brazil by at least
$2 billion; while an increase would improve the
financial situation of oil-exporting debtors such as
Mexico, Egypt, and Peru, on balance we believe a
runup in oil prices would be destabilizing for those
banking centers and countries with high loan expo-
sure to non-oil-exporting LDCs.F----]
Smaller amounts of official assistance could also
hamper the present debt strategy. The capability and
willingness of Western nations to provide emergency
bridge financing is uncertain. US Government re-
sources are constrained; available Commodity Credits
Corporation and Eximbank credits are relatively
small. Western governments helped to bolster the
IMF's pool of funds last year. The IMF, however,
provides only temporary and generally limited bal-
ance-of-payments relief to financially troubled coun-
tries. Many of these debtors require longer-term-
investment-related capital to spur economic activity.
New Proposals
Concerned that Western economic recovery may fal-
ter and interest rates remain high, many observers
believe new proposals should be considered for dealing
with the LDC debt problem. Even with a sustained
recovery, debt restructuring and new bank credit are
likely to continue to be necessary for many LDC
debtors over the next two years. Moreover, consensus
is growing among debtors and some Western govern-
ments that LDC economic adjustments have been
rigorous and that new policies are needed to enable
debtor countries to finance growth and investment.
There is also the concern that, as IMF assistance
nears the debtors' quota limits over the next 18
months, these debtors will not be sufficiently cre-
ditworthy to attract needed capital in the market-
place. F__-]
Over the last year, favorable economic trends have
helped improve debt-troubled countries' external fi-
nancial positions; since mid-1983 OECD real GNP
has risen 4.5 percent annually. In addition, oil prices
and, until recently, interest rates have remained
steady. It is not clear, however, that the coming
months will be as favorable. According to a number of
forecasters, economic growth is expected to slow-
perhaps as soon as fourth quarter this year-and
interest rates could rise further. Moreover, if the
situation in the Persian Gulf worsens, oil prices could
rise.
These economic trends would have the following kinds
of impacts:
? Each one-percentage-point drop in OECD real
growth cuts more than $2 billion from non-OPEC
LDC export earnings.
? Each one-percentage-point rise in US dollar interest
rates boosts non-OPEC LDC's annual interest pay-
ments by about $2 billion; such a rise costs Brazil
and Mexico over $500 million each.
New proposals under discussion-including capital-
ization of interest, multiyear restructuring, and a new
SDR allocation-vary widely in the amounts of debt
relief they would provide and who would bear the
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Lower bank interest rates: Reduces future borrowing requirements Interest losses must be assumed by banks or
banks reduce interest rates charged on Frees up money for LDC imports to spur Western governments
loans to LDCs below their cost of funding economic growth Requires changes in banking regulations
Could reduce banks' desire to lend new money
Capitalization of interest: Burden is distributed more evenly among Requires changes in banking regulations
banks add all or part of interest payments banks Effects willingness of banks to lend new
to the principal amounts owed by debtors Frees up money for LDC imports to spur money
economic growth Increases overall level of debt
Multiyear restructuring: Spreads bunching of maturities over many Reduces creditor influence over LDC econom-
a debt-relief package that restructures years is policies
principal for more than one year Could improve the creditworthiness of Provides no relief from high interest charges
debtors
Reduces costs of restructuring
SDR allocation: Helps to rebuild LDC creditworthiness Could be inflationary
the IMF creates new money to build up New money for imports to spur economic Across-the-board relief to all IMF members:
debtors' foreign exchange reserves growth does not distinguish debtor economic perform-
ance and reduces debtor's incentive to adjust
One-year grace period: Frees money for imports to spur economic Disincentive to take economic adjustments
immediate hiatus of all debt payments for growth Requires changes in banking regulations
one year, with the amount being resched- Increases overall level of debt
uled
Exchange participation notes:
debtor governments service debt on the
basis of a set share of export earnings
Debt discounting corporation:
new institution issues bonds to banks in
exchange for banks' loans, and the institu-
tion reschedules loans on softer terms
Debt corporation:
new institution purchases problem loans
from banks, sells loans to private investors,
and guarantee debt servicing
Debt repayment linked to ability to pay Difficult accurately to measure export earn-
Encourages creditors to invest in export ings in LDCs
industries Hinders LDCs' ability to plan and adjust for
future changes in economies and world
markets
Reduces risk to the banking system Requires funding from the United States and
its allies
Reduces bank responsibility to debt problem
Does not provide substantial interest payment
relief to debtors
Reduces risk to the banking system Requires funding from the United States and
its allies
Reduces bank responsibility to debt problem
costs (see the table). Some would require banks to take
larger losses, while others would require substantially
more aid from Western governments. According to
financial observers, these proposals present other
difficulties:
? Some would require legislation that would be time
consuming and perhaps not feasible given current
Western political environments.
? By providing across-the-board relief, some would
treat all debtors identically and fail to recognize the
uniqueness of each debtor's situation and economic
adjustment performance to date.
? A new initiative will require the approval and
cooperation of commercial bank and official credi-
tors, which have divergent views between and
among themselves.
? They could reduce the willingness of commercial
banks to extend new credits to the debtors in the
future.
? By shifting the responsibility for the debt problem to
commercial creditors and Western governments,
debtor countries will have less incentive to under-
take needed economic adjustment measures.
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Major banks and official creditors have announced
that they will consider a multiyear restructuring
package with extended grace periods for those debtors
who have adjusted their economies. This restructur-
ing, however, does not address the problem of higher
interest costs, and presumably would exclude debtors,
such as Argentina and Bolivia, who h ve not taken
sufficient adjustment measures.
The debtor countries are also calling for ways that
would share responsibility for solving the debt prob-
lem and assuming losses. The Latin American debt-
ors' conference on 21-22 June may provide a forum
for debtors' views. the
major debtors are unlikely to establish a formal cartel
or repudiate their debt, largely because of concern
that they would jeopardize access to trade credits and
world money markets. Nonetheless, collective action
will press creditors for debt servicing concessions and
the IMF for easing austerity measures. Even if specif-
ic proposals or more hardline positions do not surface
from the debtors' conference in June, the sponsors-
Argentina, Mexico, Brazil, and Colombia-will have
generated political pressure for a stronger stand in
bilateral negotiations with creditors.F_~
radical demands or actions by debtors. For example, a
major debtor such as Argentina could refuse to
cooperate with the IMF; Argentina or Mexico could
call for a global debt conference; or a major debtor
could insist on substantially easier terms from com-
mercial banks, resulting in deadlocked negotiations.
Implications for the United States
We believe calls for new initiatives to the debt
problem increasingly will be heard from LDC debtors,
academics, and some Western allies. If not responsive,
the United States could be criticized for being insensi-
tive to lo lon er term growth and development needs of
LDCs.
Despite new creditor flexibility on multiyear restruc-
turings, any further increase in US interest rates will
probably continue to provoke LDC political opposition
to US economic policies and strengthen collective
calls for easier repa ment terms or a new solution to
the debt problem.
Moreover, the political strains on the debtor govern-
ments are growing, and there is much uncertainty
over debtor-creditor positions in upcoming debt nego-
tiations. In this environment, we cannot rule out more
While calls for action may simply be rhetoric, Wash-
ington could be forced to find a way to respond to
creditor and debtor concerns. The Argentine situation
bears close watching. US banks again may face
another nonaccrual loan problem at the end of June.
Bankers are insisting that a letter of intent be ap-
proved by the IMF before an agreement can be
reached on interest arrearages. Meanwhile, negotia-
tions between Argentina and the IMF are dragging.
And even when an Argentine letter of intent is
accepted by the IMF's managing director, we believe
negotiations between Argentina and commercial
banks for the restructuring of 1982-84 maturities and
new money will be difficult and prolonged.F__1
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