CURRENT ASSESSMENT OF LDC DEBT PROBLEMS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T01058R000405170001-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 32
• Document Creation Date: December 22, 2016
• Document Release Date: January 25, 2010
• Sequence Number: 1
• Publication Date: September 23, 1985
• Content Type: MEMO

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State Dept. review
completed
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Central Intelligence Agency /
2 3 SEP 1985
MEMORANDUM FOR: Lauralee Peters, Director
Office of Monetary Affairs
Department of State
Acting Chief
Economics Division
Office of Global Issues
Attached is an advanced copy of an assessment done by our
Financial Issues Branch entitled The Current LDC Debt
Situation: Rising Frustrations. The paper looks at LDC debtor
reactions to the current economic environment of limited trade
growth and reduced credit availability. It also discusses ideas
currently being put forward for alternative strategies to the
debt problem. We hope you will find it useful especially in
preparation for the Seoul IMG/IBRD Meetings. If you have any
conments or questions feel free to cal
Attachment:
The Current LDC Debt Situation: Risin
Frustrations, GI M 85-10246
25X1
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
2 3 SEP 1985
MEMORANDUM FOR: Edwin Truman, Director
Division of International Finance
Federal Reserve Board of Governors
Acting Chief
Economics Division
Office of Global Issues
SUBJECT: Current Assessment of LDC Debt Problems
Attached is an advanced copy of an assessment done by our
Financial Issues Branch entitled The Current LDC Debt
Situation: Rising Frustrations. The paper looks at LDC debtor
reactions to the current economic environment of limited trade
growth and reduced credit availability. It also discusses ideas
currently being put forward for alternative strategies to the
debt problem. We hope you will find it useful especially in
preparation for the Seoul IMG/IBRD Meetings. If you have any
comments or questions feel free to call
Attachment:
The Current LDC Debt Situation: Risin
ML
25X1
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Central Intelligence Agency
2 3 SEP 1985
David Wigg
Senior Director for International Economic
Affairs
National Security Council
Acting Chief
Economics Division
Office of Global Issues
SUBJECT: Current Assessment of LDC Debt Problems
Attached is an advanced copy of an assessment done by our
Financial Issues Branch entitled The Current LDC Debt
Situation: Rising Frustrations. The paper looks at LDC debtor
reactions to the current economic environment of limited trade
growth and reduced credit availability. It also discusses ideas
currently being put forward for alternative strategies to the
debt problem. We hope you will find it useful especially in
preparation for the Seoul IMG/IBRD Meetings. If you have any
comments or questions feel free to cal
Attachment:
The Current LDC Debt Situation: Risin
Frustrations, GI M 85-10246
25X1.
I
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THE CURRENT LDC DEBT SITUATION:
RISING FRUSTRATIONS
An Intelligence Assessment
Information available as of 16 September was used in this report.
This paper was prepared by
Office of Global Issues. Comments and queries are welcome and
may be directed to the Chief, Financial Issues Branch, OGI, on
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Page
Key Judgments
LDC Needs for External Funds Increase
Current Account Positions Deteriorating
Reserves Being Drawn Down
Development Process Stagnating
Tightening Supply of Credit
Increasing Politicization of the Debt Issue
Cartagena Moves to Centerstage
Other Calls for Action
Outlook
Needed LDC Action
Financial Community Response
LDC Political Initiatives
N
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Ttie Current LDC Debt Situation: Rising Frustrations
Key Judgments
Debt-troubled LDCs' dissatisfaction with their chronic
financial problems is growing. Their inability to convince
creditor nations that restoring solvency by complying with IMF-
supported austerity programs is politically risky is heightening
debtors' frustrations. The perception among governments and
voters alike in these countries is that their financial
obligations have become overwhelmingly burdensome, that living
standards have suffered enough, and that multiyear debt
reschedulings only postpone, rather than ease, the repayments
burden. Thus, LDCs will continue to press industrial governments
to share the costs they believe are required to make their
external finances manageable.
With little significant economic improvement foreseen in the
coming months, mounting political pressure and economic troubles
have led the 11. Latin American nations of the Cartagena Group to
examine proposals for interest payment relief. Already, Peru has
chosen to limit its debt payments to a small percentage of export
earnings. Most debt-troubled countries--even those that have
been the voices for moderation during the past three years--are
advocating increased funding for the multilateral financial
institutions such as the IMF and World Bank and greater financial
participation by industrial governments.
Meanwhile, significant changes in the global economy are
adversely affecting the availability of funds to LDCs. Countries
that had been major net suppliers of funds such as the United
I&
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States and Saudi Arabia are becoming net users. The financing of
industrial country and OPEC current account deficits has become a
significant factor influencing the availability and cost of funds
for LDC borrowers through the decade. The reluctance of Western
banks to increase their loan exposure to many LDCs is another
contributing factor. Consequently, we do not expect the
resumption of spontaneous bank lending to many debt-troubled LDCs
until their overall debt levels are substantially reduced, which
is unlikely to occur in this decade.
We believe the challenge currently facing the international
financial community is to find a "carrot" that can be used to
reward debt-troubled LDCs that undertake substantial structural
economic reforms. At present, the adjustments made are of a
short-term nature--devaluations, and cuts in subsidies and wages-
-while the fundamental inefficiencies and rigidities of the
debtor's economy go unaddressed. For example, LDCs must reduce
government involvement in business and industry, strengthen
private-sector enterprise, and increase incentives for private
and foreign investment.
Many financial observers suggest that the World Bank's
lending must be expanded to help boost growth and development in
debt-troubled countries. Although continuing their efforts in
project financing, World Bank officials are pursuing a more
catalytic role for the Bank, including cofinancing with
commercial banks, aid coordination, collaboration with export
credit agencies, and encouragement of direct private
investment. The initiatives, however, are somewhat constrained
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by the Bank's limited resource base. Meanwhile, the
International Monetary Fund (IMF) remains the focal point for
short-term financial assistance. We believe, however, the Fund
will resist expansion of its responsibilities through enhanced
surveillance programs, which creditor governments and commercial
banks have encouraged, because it does not want to be viewed as
the "policeman" of the international financial community.
In our judgment, the debtors will use every available forum
to push for financial relief by demanding that industrial
countries:
o Implement sound economic policies to promote world
growth and lower real interest rates.
o Resist protectionist tendencies and thereby provide open
markets for LDC exports.
o Boost multilateral development resources, particularly
from the World Bank and Inter-American Development Bank,
to increase development lending.
o Reform some European regulatory environments, which
currently restrict commercial bank lending to LDCs.
Their requests could come to a head this fall. For the
first time, the LDCs have submitted proposed reforms--including
easing conditionality of creditor lending and increasing
international liquidity--for consideration at the upcoming
IMF/World Bank annual meetings in Seoul. Moreover, the economic
and foreign ministers of the Cartagena Group of 11 Latin debtors
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plan to meet soon. Given the current environment, we cannot rule
out more radical demands or actions by debt-troubled countries
such as making only partial interest payments to commercial
banks. In this regard, the Mexican Government bears the closest
watching; its political and financial troubles could lead that
country to be the first of the big three debtors--Brazil, Mexico,
and Argentina--to confront creditors with alternate solutions to
the LDC debt problem.
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The Current LDC Debt Situation: Rising Frustrations
LDC Needs for External Funds Increase
The LDCs made marked improvements in their current account
positions in 1984 and began to rebuild their reserves. Now,
however, the current account performance of the key LDCs is
deteriorating and some countries are drawing down their
reserves. Many debt-troubled LDCs need to obtain new loans to
make interest payments, bolster 'reserves, make principal
repayments, and develop their economies.
Current Account Positions Deteriorating
The positive adjustments in LDC current account balances
that occurred in response to the debt crisis were surprisingly
dramatic (table 1). According to International Monetary Fund
(IMF) estimates, the aggregate current account deficit of nonoil
LDCs was cut by two-thirds--from $113 billion in 1981 to $38
billion in 1984. The most impressive gains were made by Brazil
and Mexico.
Much of this improvement resulted from two overlapping
conditions--the new era of extreme financial constraints and the
shift from global recession to global recovery. Specifically:
o With the emergence of the debt crisis in 1982, voluntary
lending, other than for short-term trade finance, became
virtually unobtainable for many LDCs. This situation
proved particularly painful for active market borrowers,
such as Brazil and Mexico. The sharp adjustments, due
to reduced credit, required by these borrowers was
reflected in their import levels, which showed a steep
W
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Fly
,
'1S ,15
l--(billion U
05
$)-
1981
; "-1
5
?
982
1983
1984 c 198
`
/? 7J
Efforts
orts Account
Exports ~Qorts Account
orts Lnports Account Exports
orts Accounn t Exports I Current
Imports Account
1C7I'AL
191.1
203.4
-56.0
178.4
181.0
-60.6
179.7
162.2
-26.1
200.1
163.0
-7.5
190.4 162.7
-13.1
Brazil
23.3
24.1
-11.7
20.2
21.1
-16.3
21.9
16.8
-6.8
27.0
15.2
-0.1
25.5
13.5
-2.0
Mexico
19.6
24.1
-13.9
21.2
15.1
-5.7
21.8
8.0
5.2
24.4
11.3
4.0
.
22.2 15.0
-0.8
South Korea
21.2
26.1
-4.6
21.8
24.2
-2.6
24.4
26.2
-1.6
29.2
30.6
-1.4
29.5 30.0
-1.3
Argentina
9.1
9.4
-4.7
7.6
5.3
-2.3
7.8
4.5
-2.4
8.1
4.6
-2.5
7.7 4.6
-2.0
Indonesia
22.3
13.3
-0.6
22.3
16.9
-5.3
21.1
16.3
-6.3
21.9
13.9
-2.1
20.5 14.7
-1.8
Venezuela
20.2
12.1
4.0
16.5
12.6
-4.2
14.8
6.4
4.4
15.9
7.9
5.0
13.4 7.2
2.5
Philippines
5.7
7.9
-2.1
5.0
7.7
-3.2
5.0
7.5
-2.7
5.4
6.1
-1.2
4.8 5.5
-1.0
Egypt
3.2
8.8
-2.1
3.1
9.1
-2.2
3.2
10.3
-0.8
3.6
10.3
-0.9
3.6 10.4
1.3
India
8.7
15.5
-3.2
9.4
15.2
-3.0
9.6
15.3
-2.8
9.3
14.0
-2.1
8.8 13.3
-2.2
Nigeria
17.9
18.9
-5.8
12.1
14.8
-7.2
10.5
11.4
-4.2
11.9
8.9
0.5
10.5 9.0
0.1
Chile
3.9
6.4
-4.7
3.7
3.5
-2.3
3.8
3.0
-1.1
3.7
3.2
-2.1
3.8 3.3
-1.8
Malaysia
11.7
11.8
-2.5
11.9
12.7
-3.5
13.8
13.2
-3.1
16.1
14.3
-2.2
16.3 14.0
-1.9
Algeria
14.1
11.3
0.1
13.5
10.7
-0.2
12.7
10.4
-0.1
12.8
10.3
-0.1
13.4 10.6
0.0
Thailand
6.9
9.9
-2.5
6.8
8.4
-1.0
6.3
10.2
-2.9
7.3
10.3.
-2.1
7.3 9.5
-1.8
Peru
3.3
3.8
-1.7
3.3
3.7
-1.6
3.0
2.7
-0.9
3.1
2.1
-0.2
3.1 2.1
-0.4
VProjected ,
Sources: International Financial Statistics and CIA estimates.
p
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Reserve Positions of the Key Debtors
Billion US $
Yearend
Yearend
End
of June
Percent
1983
1984
1985
Change, 1984/85
Brazil
4.2
11.7
11.4
-2.6
Mexico
3.7
7.4
4.5
-39.2
Snutb Korea
6.9
7.6
6.6
-13.2
Argentina
1.1
1.3
1.2a
-7.7
Indonesia
3.5
4.9
4.9
0.0
Venezuela
7.3
9.1
9.9
8.8
Philippines
0.7
0.6
0.7
16.7
Egypt
0.7
0.7
0.9b
28.6
India
4.7
6.0
6.2c
3.3
Nigeria
0.9
1.5
1.2
-20.0
Chile
1.9
2.3
1.7
-26.1
Malaysia
3.6
3.8
4.0
5.3
Algeria
1.8
1.5
2.5
66.7
Thailand
1.6
1.9
-2.1
10.5
Peru
11-.3
1.6
1.5d
-6.2
aEnd of May figure.
bEnd of April figure.
CEnd of March figure.
1End of January figure.
Source: International Financial Statistics and CIA estimates.
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I I
decline starting in 1982.
o The improvement in the international economy--notably
rapid US-led OECD economic growth and lower interest
rates--that began in late 1983 also helped the current
account performance of many debt-troubled LDCs, allowing
them to expand exports and reduce interest payments
during 1984.
This year, however, LDC current account performance is again
deteriorating. Some LDCs such as Mexico and Indonesia have
increased imports to foster economic growth and bolster living
standards at a time when moderating OECD growth is slowing LDC
exports; we expect the exports of the key LDCs to decline by
$10 billion this year--after a $20 billion surge in 1984. Mexico
has moved from a sizable current account surplus in 1983 and 1984
into an expected deficit of almost $1 billion in 1985. Brazil
and Venezuela are also experiencing a significant worsening in
their current account positions.
Reserves Being Drawn Down
After registering a $6.4 billion buildup in 1983 and a
$13 billion increase in 1984, the reserves held by the nonoil
LDCs have begun to decline according to financial reporting. The
reserves of the nonoil LDCs as a group rose by 15 percent in
1984, the largest increase since 1980. The most dramatic gains
were made by the Latin American countries, which increased their
reserves by 56 percent to $32 billion.
Many financial observers suggest that the World Bank's
lending must be expanded to help boost growth and development in
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countries that are forced to finance their growing current
account deficits with little access to new credits (table 2). As
a larger percentage of reserves is used for current account
financing, LDCs will find it increasingly difficult to maintain
their current level of imports. We believe import coverage
ratios, which had improved dramatically through 1984, are now
unlikely to be sustained.1
Development Process Stagnating
For many of the countries experiencing debt-servicing
troubles, economic growth slowed during the first half of the
1980s. Despite the recent recovery of industrial economies and
LDC adjustments, the debt-troubled countries have neither
returned to the robust growth rates of the 1960s nor
significantly boosted economic development. According to the
World Bank, the average per capita incomes of many African and
Latin American countries are the same in real terms as they were
in the 1970s, and LDC economic growth over the last five years is
only one-half the rate achieved in the 1970s.
LDC exports in 1980-85 have grown close to 6 percent a year,
but due to interest payments, import growth has been little more
than 1 percent a year. As export earnings are increasingly used
to make interest payments, LDCs have fewer resources available to
fund development projects. The World Bank estimates that the
financial strains of the past few years have caused many LDCs to
iBecause reserves are used primarily to make interest payments or
finance imports, the financial community uses import coverage 25X1
ratios to determine how many months of imports can be funded by
reserves--at least three months of coverage is desirable.
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.lose at least a decade of development. 25X1
Tightening Supply of Credit
Significant changes in the global economy are adversely
affecting LDC access to new money. An important shift occurred
in the past several years as countries that had been major
suppliers became net users of funds. OPEC's huge infusion of
investable funds during 1974-84 ended as world oil markets
softened and the countries like Saudi Arabia slid into deficit.
The aggregate current account position of industrial countries
also deteriorated, although this trend masks large disparities
within the group; the United States has the largest deficit while
Japan is running a huge surplus. The financing of industrial
country and OPEC current account balances is significantly
influencing the availability and cost of funds for the generally
riskier LDC borrowers through the decade.
Another factor contributing to the tightening supply of
credit has been the decline in long-term bank lending--down from
$41 billion in 1983 to $25 billion in 1984. In addition,
according to OECD data, short-term bank lending to LDCs fell $5
billion last year. Commercial banks remain reluctant to lend to
debt-troubled LDCs until they are better able to service their
interest and principal payments.
At the same time, other sources of financing--official
transfers and credits and direct investment--have been relatively
stable (see figure 1). In our view, these sources of funds
remain unlikely to grow for most debt-troubled LDCs because:
I
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Figure 1
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o The bulk of Official Development Assistance will
continue to be directed toward poorer countries that do
not depend heavily on Western bank financing.
o Other official flows such as official export credits and
multilateral institution lending are not likely to rise
much, given budgeting constraints in both industrial
countries and OPEC.
o Foreign direct investment is not likely to increase
significantly during the second half of the decade,
primarily in light of economic problems in many LDCs.
o LDC bond financing is only a minor source of funds, and
investors will continue to be reluctant to purchase
these bonds in view of poor LDC creditworthiness.
Increasing Politicization of the Debt Issue
The LDC financial situation remains serious, and political
frustrations are more and more evident. Balance-of-payments
troubles, a lack of a dialogue on debt with creditor governments,
and IMF compliance difficulties are heightening debt-troubled
countries' disgruntlement. Many governments--especially in Latin
America--are under increasing political pressure to obtain new
financial agreements with creditors to ease their foreign debt
burden and to boost economic growth. For example:
o President Sarney of Brazil is reluctant to make
additional cuts in government spending because of
IL
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intensive domestic political pressure to continue the
economic recovery.
o President de la Madrid of Mexico is facing increasing
pressure from the public against new government cutbacks
and for finding an alternative to Mexico's present debt
arrangements.
o President Lucinshi of Venezuela is under strong pressure
from the political opposition and labor groups to
abandon the multiyear resp.heduling agreements.
o President Garcia of Peru has refused to negotiate with
the Fund because he fears the potential economic and
social consequences.
In response to these pressures, Latin leaders have publicly
stated that their external debt problem is far from being solved
and that it continues to be an obstacle to economic development
and to the strengthening of their political democracies. They
believe that multiyear debt reschedulings only postpone
repayments and do not provide a long-term solution to their
problem. Thus, these leaders support a two-track approach to
resolving their financial burden: servicing their debt to the
best of their ability, while concurrently seeking more
concessions.
Cartagena Moves to Center Stage
Latin American countries have occasionally met among
themselves during the last three years to discuss their debt
troubles and alternative solutions. The most serious effort to
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act collectively arose in June 1984, when 11 Latin debtors formed
the so-called Cartagena Group2 at a meeting in Cartagena,
Colombia. The group, consisting of foreign and economic
ministers, has met several times to try to arrange a political
dialogue on debt between Latin American and industrial country
governments, and to obtain more dramatic solutions to their debt
problems. By late 1984, some of the complaints of the Cartagena
had been diffused as dollar-denominated interest rates fell and
Latin trade balances showed substantial improvement.
Since August 1985, however, some Latin leaders including
Brazilian Foreign Minister Setubal and Uruguayan Foreign Minister
Iglesias have been seeking to strengthen the Cartagena Group
because they view it as the best forum to discuss the political
aspects of Latin America's foreign debt problem, according to
Embassy and press reporting. In recent meetings, the group's
attention has centered on preparations for a greater dialogue
with the European Community, which has shown a willingness to
listen to their concerns. The Cartagena Group has also begun to
examine proposals for interest payment relief and have come out
strongly advocating increased funding for the multilateral
institutions, particularly the World Bank and the Inter-American
Development Bank.
K
2The Cartagena Group consists of Argentina, Bolivia, Brazil,
Chile, Colombia, Dominican Republic, Ecuador, Mexico, Peru,
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Other Calls for Action
Numerous individual proposals also have been made:
o President Garcia's move to link debt-service payments to
exports and to restructure Peru's bank debt without
seeking IMF support has not gone unnoticed by other
Latin debtors according to Embassy and press
reporting. Some financial observers believe this
approach could foreshadow similar actions by additional
debt-troubled LDCs. However, many other observers state
that Peru could follow the Argentine experience;
Argentina attempted to skirt the IMF during most of 1984
but, due to pressure from creditors, was forced to
negotiate a new IMF arrangement in August 1985.
Nevertheless, Garcia's statements put other Latin
leaders in the difficult position of explaining to their
constituents why they have taken the more orthodox
route.
o Fidel Castro is attempting to exploit the debt issue,
giving numerous speeches and interviews. He has urged
Latin Americans to stage "a general strike of debtors"
to demonstrate their firmness, according to Embassy and
press reporting. Castro's crusade for Latin American
debt relief has also included a series of conferences
sponsored by Havana that are designed to gain broad-
based support for the issue and antagonize US relations
with the region. These conferences have generated
extensive diplomatic and media attention.
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o Colombian President Belisario Betancur and most Latin
leaders reject Fidel Castro's idea of a debt moratorium
as unworkable and outside the system of international
cooperation, according to Embassy and press reporting.
Betancur, however, supports a call for an OECD-financed
"Marshall Plan" for Latin America, and has offered two
other methods of relieving Latin debt burdens. One idea
calls for each industrial country to transfer
1 percent of its GNP annually as soft credits to LDCs.
The second proposal is a 5-percent tax on OECD military
expenditures to finance lower interest rates for loans
to LDCs.
o Mexican Finance Secretary Jesus Silva Herzog has stated
that an equilibrium must be found between the amount of
debt servicing paid to commercial banks and the debtor's
economic growth, according to press reporting. We
believe this tradeoff is the driving force behind the
growing Latin sentiment for some kind of interest
payment relief. One scheme recommended by several
financial experts would capitalize the portion of the
interest payment that reflects US inflation, paying only
the real interest rate. This would provide debt-
troubled countries with more funds to stimulate economic
growth.
Outlook
We believe the key to overcoming LDC financial problems
remains a cooperative effort among the LDCs, commercial banks,
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their regulators and governments, and the multilateral financial
institutions. Even so, the resolution of these problems
presupposes a number of favorable world economic conditions:
o Sustained OECD economic growth of at least 3 percent
during the next several years.
o Steady or falling dollar interest rates.
o Open markets in major industrial economies.
o A gradual fall in the value of the dollar against
European currencies and the yen.
o An increase in the availability of medium- and long-term
foreign credit.
o Slight or only moderate changes in oil prices.
During the next 15 months, however, we expect a much less
favorable external environment. OECD growth will probably not
average the desired 3-percent rate. This slower growth will
reduce demand for LDC exports and probably will fuel increased
OECD protectionism. At the same time, many observers expect
interest rates to trend upward, and oil prices could well fall
substantially--hurting oil exporting countries like Mexico,
Venezuela, and Indonesia.
The continued pressure on LDCs' trade balances will
exacerbate their need for external financing. We believe that
despite a reluctance to do so, the financial community will have
to address these needs and continue forced lending. Mexico, for
example, is likely to need at least $3 billion in new loans
within the next six months. In our judgment, the precarious
balance between debtors' adjustment measures and creditors'
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continued assistance must be maintained if the LDC financial
situation is to improve.
Needed LDC Action
We believe that LDC financial adjustment measures such as
devaluations and cuts in subsides and wages must be complemented
by fundamental structural reforms. To restore creditworthiness,
bankers say that debtors must strengthen the private sector,
reduce government involvement in business and industry, increase
incentives for private and foreign investment, and adopt export-
oriented policies. In our view, efforts in this direction will
also reduce rigidities of debtor economies, restore healthy
domestic economic growth, and improve foreign exchange
positions. Furthermore, these actions would make the domestic
financial environment more attractive, slow the rate of capital
flight, and could lead to the actual repatriation of capital.
Financial Community Response
The adjustment efforts of the LDCs will require the support
of commercial banks, multilateral organizations, and industrial
donor governments. We believe the challenge currently facing the
international financial community is to find a "carrot" that can
be used to entice LDCs to make structural changes in their
economies. At present, the adjustments made are of a short-term
nature, while the fundamental inefficiencies and rigidities of
the debtor's economy go unaddressed.' Commercial banks, creditor
governments, and the multilateral institutions agree that LDCs
will not be inclined to undertake politically sensitive
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sector reform--just one of the structural changes encouraged by
the international financial community--illustrates the
difficulties LDC governments face in implementing such structural
adjustments.
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Box 1
The Politics of Structural Adjustment:
The Case of Public-Sector Reform
The rapid growth of state-owned enterprises during the 1970s
and early 1980s was supported by large-scale external
borrowings. As a result of the debt crisis, many LDCs--including
Mexico, Brazil, and the Philippines--are now being urged to
reduce their involvement in inefficient public enterprises and
contain public-sector spending. Creditors believe that the
current level of public sector borrowing has crowded out
investment in the private sector; they are urging a reallocation
of savings to strengthen private enterprise.
LDC government leaders have shied away from state enterprise
reform, however, because of the high potential for political
fallout. Such reforms can severely interfere with the vested
interests of key political supporters. For example, in the
Philippines, the brunt of reform in the coconut and sugar
monopolies would fall heavily on two of Marcos's key political
associates, who provide support for his administration. Fear of
unrest arising from public sector unemployment also can inhibit
reform.
The political sensitivity of domestic structural changes has
resulted in only superficial reform efforts by many LDCs, causing
them to fall out of compliance with their IMF-supported
adjustment programs. This is a particular problem in democratic
countries, where newly elected leaders or those facing upcoming
elections are reluctant to alienate key constituencies. Public-
WO
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Box2
Capital Flight: A Serious Drain
Large-scale capital flight has contributed significantly to
LDC financial troubles, exacerbating the debtors' financing needs
and forcing them to borrow simply to balance their international
accounts. one-third to one-half of
the funds loaned to the LDCs between 1978 and 1983 flowed back
out in the form of capital flight. These outflows drained
official reserves and denied the countries productive use of
their foreign borrowings.
Capital flight is usually associated with several factors:
o Overvalued exchange rates make foreign assets more
attractive and spark domestic fears of devaluation.
o Repressive financial policies hold interest rates at
negative levels during periods of high inflation and, as
a result, cause domestic assets to lose their value.
o Political and economic instability leads individuals to
seek a safehaven for their assets.
o Corruption in government circles funnels money out of
the country.
Under IMF-supported programs, many countries have devalued
their currencies and raised interest rates in an attempt to make
their domestic markets more attractive and to stem capital
outflows. Capital flight peaked in 1982, falling off
dramatically in 1.983 and 1984; however, it is on the rise
again. In Mexico, capital flight during the first half of 1985
is already double the total for 1984,
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If capital flight continues to increase and as reserves
are drained, the financing needs of the LDCs will undoubtedly
exceed projected levels.
ffm
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I I
? structural changes until such actions are tied to financial
assistance.
Voluntary lending by commercial banks to most debt-troubled
countries--including Brazil, Mexico, Argentina, and the
Philippines--is unlikely to occur in this decade. Only a few
Latin American countries, those in better financial shape like
Venezuela and Colombia, could perhaps receive new voluntary loans
from banks within the next two years. In general, banks are
trying to contain their concentrations of LDC risk and to lower
their LDC exposure relative to capital, according to financial
reporting, and a resumption of voluntary lending is not expected
until overall LDC debt levels are reduced. Even when that
occurs, lending to LDCs will be less of a priority to banks. US
banks, for example, will be focusing on new opportunities in
interstate banking and investment banking, according to one
financial observer.
The lack of commercial bank lending to LDCs has led some US
officials and commercial bank officers to suggest that the World
Bank's role be enhanced to help boost growth in financially
troubled countries. While continuing their efforts in project
financing, World Bank officials are just beginning to develop a
more catalytic role for the Bank through new and expanded
programs, such as cofinancing with commercial banks, aid
coordination, collaboration with export credit agencies, and the
encouragement of direct private investment. The World Bank is
also developing a special fund to provide economic assistance in
a
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Sub-Saharan Africa. These initiatives, however, remain somewhat
constrained by the Bank's limited resource base.
While the World Bank attempts to increase its medium- and
long-term assistance to LDCs, the IMF remains the focal point for
short-term financial assistance. During the next few years,
however, we believe the Fund will resist expansion of its scope
of responsibility through enhanced surveillance programs, which
creditor governments and commercial banks have encouraged,
because it does not want to be viewed as the "policeman" of the
international financial conrnunity. Although the Fund will
continue to monitor and assess its members' economies, Fund
officials fear that their reports will be viewed as "on/off"
indicators of financing.
The Fund's role in assisting debt-troubled countries is
likely to diminish because of the current schedule of debtor
repayments due to the Fund. According to OECD estimates, the
Fund has a record amount of financial assistance currently
outstanding that is due to be repaid over the next two to three
years. Scheduled repayments will climb from $3.4 billion this
year to a peak of about $8 billion annually during 1987-89. The
two largest IMF debtors--Brazil and Mexico--are due to start
repaying their current loans in 1986. Consequently, the IMF
could well become a net recipient rather than a net provider of
funds unless repayments are rescheduled--a move the Fund strongly
opposes for prudential reasons,
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LDC Political Initiatives
The financial problems that are being experienced by many
LDCs are becoming a unifying concern for Third World leaders. In
our judgment, these leaders will use every available forum to
push for financial relief by demanding that industrial countries:
o Implement sound economic policies to promote world
growth and lower real interest rates.
o Resist protectionist tendencies and thereby provide open
markets for LDC exports.
o Boost multilateral development resources, particularly
from the World Bank and Inter-American Development Bank,
to increase development lending.
o Reform some European regulatory environments, which
currently restrict commercial bank lending to LDCs.
Their requests could come to a head this fall. For the
first time, the LDCs have submitted proposed reforms of the
international monetary system for consideration at the upcoming
IMF/World Bank annual meetings in Seoul. These include
coordinating industrial countries' exchange rate policies, easing
conditionality of international lending, and increasing
international liquidity with an additional SDR allocation.
Moreover, the economic and foreign ministers of the Cartagena
Group also plan to meet in October, according to press
reporting. Given the current environment, we cannot rule out
more radical demands or actions by debt-troubled countries. In
this regard, the Mexican Government bears the closest watching;
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its IMF-supported program has been suspended and economic and
political pressures, which will intensify if oil prices continue
to fall, could lead that country to be first of the big three
debtors--Brazil, Mexico, and Argentina--to confront creditors
with alternate solutions to the LDC debt problem.
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