THE CURRENT LDC DEBT SITUATION: RISING FRUSTRATIONS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T00586R000500520003-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 16
• Document Creation Date: December 22, 2016
• Document Release Date: August 18, 2010
• Sequence Number: 3
• Publication Date: October 1, 1985
• Content Type: REPORT

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Directorate of Confidential
~_~_?~-
The Current LDC
Debt Situation:
Rising Frustrations
An Intelligence Assessment
State Dept. review completed
Confidential
GI 85-10255
October 1985
425
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G785-10155
October 1985
Directorate of Confidential
Intelligence
The Current LDC
Debt Situation:
Rising Frustrations
This a er was repared by
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Office of Global Issues. Comments
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and queries are welcome and may be directed to
the Chief, Economics Division, OGI,
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The Current LDC
Debt Situation:
Rising Frustrations
Key Judgments Dissatisfaction with chronic financial problems is growing among debt-
/r~(ormation available troubled LDCs. Heightening debtors' frustrations, moreover, is their
as oj26 September 1985 inability to convince creditor nations that compliance with IMF-supported
was used in this report.
austerity programs is politically risky. 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 multilateral finan-
cial 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 States and Saudi Arabia, are be-
coming net users. The financing of industrial country and OPEC current
account deficits has become a significant factor that will influence 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,
short-term adjustments-devaluations and cuts in subsidies and wages-
are being made, while the fundamental inefficiencies and rigidities of the
debtors' economies go unaddressed. For example, LDCs must reduce
iii Confidential
CI 85-10255
October 1985
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government involvement in business and industry, strengthen private-sector
enterprise, adopt export-oriented policies, 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 just beginning to develop a more catalytic role for the Bank,
including cofinancing with commercial banks, more structural adjustment
loans, loan guarantees, and encouragement of direct private investment.
These initiatives, however, are somewhat constrained by the Bank's limited
resource base. Meanwhile, the 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 fi-
nancial relief by demanding that industrial countries:
? Implement sound economic policies to promote world growth and lower
real interest rates.
? Resist protectionist tendencies and thereby provide open markets for
LDC exports.
? Boost multilateral development resources, particularly for the World
Bank and Inter-American Development Bank, to increase development
lending.
? Reform some European regulatory environments, which currently re-
strict 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 credi-
tor 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 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 IMF program has been suspended, and
economic and political pressure, which could intensify if oil prices continue
to fall, could lead that country to be the first of the big three debtors-Bra-
zil, Mexico, and Argentina-to confront creditors with alternate solutions
to the LDC debt problem.
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Current Account Positions Deteriorating
Development Process Stagnating
Increasing Politicization of the Debt Issue
Cartagena Moves to Center Stage
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The Current LDC
Debt Situation:
Rising Frustrations
The LDCs made marked improvements in their cur-
rent 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 meet 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
w
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 overlap-
ping conditions-the new era of extreme financial
constraints and the shift from global recession to
global recovery. Specifically:
? 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 Mexi-
co. The sharp adjustments (due to reduced credit)
required by these borrowers were reflected in their
import levels, which showed a steep decline starting
in 1982.
? 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 ex-
ports and reduce interest payments during 1984.
This year, however, LDC current account perfor-
mance 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 to 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,
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 in-
creased their reserves by 56 percent to $32 billion.
LDC reserve positions are worsening this year, howev-
er, as countries 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 be
increasingly hard pressed to maintain their current
level of imports. We believe import coverage ratios,
which had improved dramatically through 1984, are
now unlikely to be sustained.'
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
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' Because reserves are used primarily to make interest payments or 25X1
finance imports, the financial community uses import coverage
ratios to determine how many months of imports can be funded by
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Table 1
Key LDC Debtors: Exports, Imports, and
Current Account Balances, 1981-85
Exports
Imports
Current
Account
Exports
Imports
Current
Account
Exports
Imports
Current
Account
Exports
Imports
Current
Account
Exports
Imports
Current
Account
Total
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
9.5
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
16.3
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
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Table 2
Reserve Positions of the Key Debtors
Yearend Yearend
1983 1984
South Korea 6.9 7.6
Egypt
India
Nigeria
Chile 1.9 2.3
Malaysia
Algeria
Thailand
e End of May figure.
n End of April figure.
End of March figure.
d End of January figure.
economies and LDC adjustments, the debt-troubled
countries have neither returned to the robust growth
rates of the 1960s nor si nificantl boosted economic
development. 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 pay-
ments, LDCs have fewer resources available to fund
development projects. Net financial outflows from
Latin America last year totaled almost $30 billion,
End of June Percent Change,
1985 1984/85
16.7
28.6
66.7
10.5
- 6.2
Significant changes in the global economy are ad-
versely affecting LDC access to new money. An
important shift occurred during 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
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softened and Saudi Arabia and other members 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 will
significantly influence the availability and cost of
funds for the generally riskier LDC borrowers.
[n addition, commercial banks remain reluctant to
lend to debt-troubled LDCs until they are better able
to service their interest and principal payments. Long-
term bank lending is down from $41 billion in 1983 to
$25 billion in 1984, and, according to OECD data,
short-term bank lending to LDCs fell $5 billion.
At the same time, other sources of financing-official
transfers and credits and direct investment-have
been relatively stable (see figure). In our view, these
sources of funds are unlikely to grow for most debt-
troubled LDCs because:
? The bulk of official development assistance will
continue to be directed toward poorer countries that
do not depend heavily on Western bank financing.
? 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.
? 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.
? LDC bond financing is only a minor source of funds,
and investors will continue to be reluctant to pur-
chase these bonds in view of poor LDC creditworthi-
Net Financial Flows to LDCs in Selected
Years, 1975-84
Official non-
concessional Ilows
onicia~
development
assistance
pressure to obtain new financial agreements with
creditors to ease their foreign debt burden and to
boost economic growth. For example:
? President Sarney of Brazil is reluctant to make
additional cuts in government spending because of
intensive domestic political pressure to continue the
economic recovery. On the opening day of the UN
General Assembly, he called for "concerted political
action" on the debt issue.
Hess.
Increasing Politicization of the Debt Issue
? President de la Madrid of Mexico is facing increas-
ing pressure from the public against new govern-
ment cutbacks and for finding an alternative to
Mexico's present debt arrangements.
The LDC financial situation remains serious, and
political frustrations are more and more evident.
Balance-of-payments troubles, the lack of a dialogue
on debt with creditor governments, and IMF compli-
ance difficulties are heightening debt-troubled coun-
tries' disgruntlement. Many governments-especially
in Latin America-are under increasing political
? President Lusinchi of Venezuela is under strong
pressure from the political opposition and labor
groups to abandon the multiyear rescheduling
agreements.
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? President Garcia of Peru has refused to negotiate
with the Fund because he fears the potential eco-
nomic and social consequences. He threatened in his
recent UN speech to withdraw from the IMF if
LDC demands for international monetary system
reform are not listened to, according to press report-
ing.
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 strength-
ening of their political democracies. They believe that
multiyear debt reschedulings only postpone repay-
ments and do not provide along-term solution to their
problem. Moreover, there is little enthusiasm for an
indefinite transfer of resources from debt-troubled
countries, even under global conditions that make
export surpluses feasible. 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 act collectively arose in
June 1984, when 11 Latin debtors formed the so-
called Cartagena Group ~ at a meeting in Cartagena,
Colombia. The group, consisting of foreign and eco-
nomic 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 prob-
lems. 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
' The Cartagena Group consists of Argentina, Bolivia, Brazil,
Chile, Colombia, Dominican Republic. Ecuador- Mexico, Peru,
aspects of Latin America's foreign debt problem,
according to Embassy and press reporting. In recent
meetings, the group's attention has centered on prepa-
rations 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 has come out strongly advocating increased fund-
ing for the multilateral institutions, particularly the
World Bank and the Inter-American Development
Other Calls for Action
Numerous individual proposals also have been made:
? President Garcia's move to link debt-service pay-
ments to exports and to restructure Peru's bank debt
without seeking IMF support has not gone unno-
ticed by other Latin debtors, according to Embassy
and press reporting. Some financial observers be-
lieve this approach could foreshadow similar actions
by additional debt-troubled LDCs. However
Peru could follow the
rgen me expertence; rgentina 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, Gar-
cia's statements put other Latin leaders in the
difficult position of explaining to their constituents
why they have taken the more orthodox route.
? 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 to antagonize US relations with the region.
These conferences have generated extensive diplo-
matic and media attention.
? Colombian President Betancur and most Latin lead-
ers reject Fidel Castro's idea of a debt moratorium
as unworkable and outside the system of interna-
tional cooperation, according to Embassy and press
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reporting. Betancur, however, supports a call for an
OECD-financed "Marshall Plan" for Latin Ameri-
ca and has offered two other methods of relieving
Latin debt burdens. One idea calls for each industri-
al 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.
? Mexican Finance Secretary 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 trade-off is the
driving force behind the growing Latin sentiment
for some kind of interest payment relief. One
scheme recommended by several financial experts
would effectively reduce interest paid to the real
interest rate by capitalizing the portion of the
interest payment that reflects US inflation. This
would provide debt-troubled countries with more
funds to stimulate economic growth.
? Antonio Ortiz Mena, the President of the Inter-
American Development Bank, wants to use part of
the interest paid by debtors to commercial banks to
set up a fund administered by his bank and the
World Bank to provide long-term development as-
sistance, according to press reporting. Under his
proposal, Latin American debt would be classified
to identify a category of "bad debt"-money bor-
rowed for military or pure consumption purposes.
Half of the interest due on this debt would go into
the trust fund to be loaned to debtors for projects
designed to earn foreign exchange.
We believe the key to overcoming LDC financial
problems remains a cooperative effort among the
LDCs, commercial banks, their regulators and gov-
ernments, and the multilateral financial institutions.
Even so, the resolution of these problems presupposes
a number of favorable world economic conditions:
? Sustained OECD economic growth of at least 3
percent during the next several years.
? Steady or falling dollar interest rates.
? Open markets in major industrial economies.
? A gradual fall in the value of the dollar against
European currencies and the yen.
? An increase in the availability of medium- and long-
term foreign credit.
? 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, according to the OECD Secretariat.
This slower growth will reduce demand for LDC
exports and probably will fuel increased OECD pro-
tectionism. At the same time, xpect
interest rates to trend upward, and oil prices could
well fall substantially-hurting such oil-exporting
countries as 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 finan-
cial 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. An alternative plan for interest capitaliza-
tion would weaken debtor discipline and wreak havoc
with US accounting practices,
Needed LDC Action
We believe that LDC financial adjustment measures
such as devaluations and cuts in subsidies 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. Structural reforms, however, are extremely
difficult to undertake because they represent attacks
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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 con-
tain public-sector spending. Creditors believe that the
current level ofpublic-sector borrowing has crowded
out investment in the private sector; they are urging a
reallocation of savings to strengthen private enter-
prise.
LDC government leaders have shied away from state
enterprise reform, however, because of the high poten-
tial 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 asso-
ciates, who provide support for his administration.
Fear of unrest arising from public-sector unemploy-
ment also can inhibit reform.
The political sensitivity of domestic structural
changes has resulted in only superficial reform ef.I-orts
by many LDCs, causing them to fall out of compli-
ance 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-sector reform just one of the structural
changes encouraged by the international financial
community-illustrates the dil.~culties LDC govern-
mentsface in implementing such adjustments.
on entrenched interest groups whose support is usually
essential to LDC leaders' maintenance of political
power.
Financial Community Response
The adjustment efforts of the LDCs will require the
support of commercial banks, multilateral organiza-
tions, and industrial donor governments. We believe
the challenge currently facing the international finan-
cial 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 inefficien-
cies and rigidities of the debtors' economies go unad-
dressed. Commercial banks, creditor governments,
and the multilateral institutions agree that LDCs will
not be inclined to undertake politically sensitive struc-
tural changes until such actions are tied to financial
assistance.
Voluntary lending by commercial banks to most debt-
troubled countries-including Brazil, Mexico, Argen-
tina, and the Philippines-is unlikely to occur in this
decade. Only a few Latin American countries-those,
like Venezuela and Colombia, in better financial
shape~ould 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 re-
sumption 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 invest-
ment banking,
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
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mercial banks, structural adjustment loans, loan guar-
antees, aid coordination, collaboration with export
credit agencies, and the encouragement of direct
private investment. Attention is focusing on using
more of the Bank's resources to finance structural
adjustment loans, which are longer term lending
programs designed to achieve gradual changes in the
debtors' economies rather than the more abrupt belt-
tightening required by the IMF. The World Bank is
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Large-scale capital flight has contributed signkficant-
Iv to LDCfinancial troubles, exacerbating the deb-
tors'financing needs and forcing them to borrow
simply to balance their international accounts. Ac-
cording to various sources, one-third to one-haUof
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 ol~theirforeign borrowings.
Capital flight is usually associated with several
factors:
? Overvalued exchange rates make foreign assets
more attractive and spark domestic fears of
devaluation.
? Repressive,hnancial policies hold interest rates at
negative levels during periods of high inflation and,
as a result, cause domestic assets to lose their
value.
? Political and economic instability leads individ-
uals to seek a sctfehaven for their assets.
? Corruption in government circles funnels money
out of the country.
Under /MF-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 offdramatically in 1983
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, according to a variety of
sources. If capital.flight continues to increase and as
reserves are drained, the.~inancing needs of the LDCs
will undoubtedly exceed projected levels.
also developing a special fund to provide economic
assistance in Sub-Saharan Africa. These initiatives,
however, remain somewhat constrained by the Bank's
the Fund will resist expansion of its scope of responsi-
bility through enhanced surveillance programs, which
creditor governments and commercial banks have
encouraged, because Fund officials have said they do
not want to be viewed as the "policemen" of the
international financial community. 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 currently has a record
amount-about $35 billion-of financial assistance
outstanding, and substantial repayments are due to
begin during the next two years. Scheduled repay-
ments 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. Conse-
quently, 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,
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:
? Implement sound economic policies to promote
world growth and lower real interest rates.
? Resist protectionist tendencies and thereby provide
open markets for LDC exports.
? Boost multilateral development resources, particu-
larly for the World Bank and Inter-American De-
velopment Bank, to increase development lending.
? Reform some European regulatory environments,
which currently restrict commercial bank lending to
LDCs
limited resource base.
While the World Bank attempts to increase its medi-
um- and long-term assistance to LDCs, the IMF
remains the focal point for short-term financial assis-
tance. During the next few years, however, we believe
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 consider-
ation at the upcoming IMF/World Bank annual
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G-24 Proposals for Improving
the International Monetary System
Renewed LDC dissatisfaction with current interna-
tional monetary arrangements has bolstered Third
World resolve to urge reform during the IMF/World
Bank annual meetings next month in Seoul. For the
.first time, LDCs have submitted proposed modifica-
tions for formal consideration by the IMF Interim
Committee in response to the recommendation pro-
posed by the G-10 countries in June:
? "Volatile exchange rates have discouraged world
trade and investment in developing countries needed
to service foreign debt. "Although LDCs favor
eventually establishing target zones for exchange
rates, they intend, in the meantime, to press major
industrial countries to coordinate macroeconomic
policies by submitting to an explicit, two-stage
consultation process with the IMF.
? "Increased economic interdependence has placed
the burden of international adjustment on develop-
ing countries. "The Third World believes that the
Fund should tighten surveillance over the monetary
and fiscal policies of industrial countries and pro-
mote economic growth as an integral part of LDC
adjustment, partly by easing conditionality of inter-
national lending.
? "International liquidity is inst4hicient. "LDCs favor
augmenting the loan base of the IMF and the
meetings in Seoul. These include coordinating indus-
trial countries' exchange rate policies, easing condi-
tionality of international lending, and increasing in-
ternational liquidity with an additional special
drawing rights (SDR) allocation. Moreover, the eco-
nomic and foreign ministers of the Cartagena Group
also plan to meet soon, 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; its IMF-supported
Although the industrial countries share LDC concern
about key features of the monetary svstem-especial-
ly exchange rate volatility-most remain unwilling to
support extensive reform. The majority of G-]0 coun-
tries oppose the adoption of target zones at this time
and have reached no consensus on an additional SDR
allocation. Instead, they hope to reduce exchange
rate fluctuations by improving the efJectivenes.r of
existing, irEformal arrangements to coordinate macro-
economic policies-a strategy they jointly approved
this summer. Consistent and sound macroeconomic
policies in industrial countries also would foster
greater private lending to LDCs, argue the United
States, West Germany, and the United Kingdom,
easing pressure to increase international liquidity
LDCs, however, may try to exploit difjerences of
opinion existing among individual industrial coun-
tries to garner international support for monetarv
reform. France and Italy, in particular, have support-
ed the concept of target zones. Only a brief discussion
of the G-10 and G-24 reports is expected at the
October meeting, withlurther in-depth discussion to
be held at the spring Interim Committee meeting.
program has been suspended, and economic and polit-
ical pressures, which will intensify if oil prices contin-
ue 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. At a minimum, the recent earthquake
and publicity on Mexico's options on debt enhance its
negotiating position with creditors.
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