SIG-IEP REVIEW OF U.S. APPROACH TO THE INTERNATIONAL DEBT PROBLEM

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP90B01013R000300530001-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 40
• Document Creation Date: December 22, 2016
• Document Release Date: November 10, 2010
• Sequence Number: 1
• Publication Date: April 27, 1983
• Content Type: MEMO

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EXECUTIVE SECRETARIAT
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April 27, 1983
MEMORANDUM FOR THE HONORABLE
WILLIAM P. CLARK
ASSISTANT TO THE PRESIDENT
FOR NATIONAL SECURITY AFFAIRS
-----------------
j ? cacu iva Ftyg:~*7
f 83-1.457/1
Subject: SIG-IEP Review of U.S. Approach to the International
Debt Problem
As directed by NSSD 3-83 and your memorandum of March 14,
1983, the Senior Interdepartmental Group on International Economic
Policy has completed its review of the U.S. approach to the inter-
national debt problem. Its report is attached.
Donald T. Regan
CC: The Vice President
The Secretary of State
The Secretary of Defense
The Secretary of Agriculture
The Secretary of Commerce
The Director, Office of Management
and Budget
The Director of Central Intelligence
The United States Trade Representative
The Assistant to the President for
Policy Development
The Chairman, Council of Economic Advisers
Attachment
As stated.
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DECLASSIFY: OADR
April 25, 1983
A P P R O A C H T O T H E
I N T E R N A T I O N A L D E B T P R O B L E M
A P O L I C Y O V E R V I E W
Final Report of the
Senior Interdepartmental Group on
International Economic Policy
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DECLASSIFY: OADR
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NSSD-3
APPROACH TO THE INTERNATIONAL DEBT PROBLEM,
A POLICY OVERVIEW
Executive Summary
1.
Dimensions of Debt Problem and Implications for the
United States
A.
B.
C.
Mandate and Previous Work
Scope of Problem
Implications for United States
2.
The Current Strategy and Operational Difficulties
3.
Basic Assessment
A. Progress in Applying the Strategy
B. Future Prospects and Potential Problems
i. Macro-economic
ii. Political
iii. Trade
C. Alternative and Fundamentally Different Approaches
A. Prospects.for Success of the Strategy
B. Suggested Measures.to Strengthen the Strategy
i. Trade Policy
ii. Strengthening Framework to Deal with Debt Problem
iii. Improvement of Data Systems and Dissemination
Appendices: (Executive Summaries of Working Group Reports*)
A. Political and Security Considerations'
B. Implications of Alternative Scenarios for
Global Recovery and U.S. Domestic Economy
C. Implications for International Trade and Trade
Policy
D. Alternative Proposals for Dealing with the Debt
Problem
(Other)'
E. Evolution of the G-10 Approach to Debt-Problems
*Reports circulated separately.
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Executive Summary
Although the first phase of the international debt prob-
lem on the whole has been successfully dealt with, major diffi-
culties requiring complex U.S. policy choices can be expected
in the coming months as debtors implement adjustment plans and
as external financial difficulties reach crisis stages in
additional countries.
? Additional countries, especially oil exporters like
Venezuela and Nigeria, are seeking debt relief and
other financial assistance.
Banks here and abroad will continue to be reluctant to
add to their exposure in a long list of countries.
? The combination of internal adjustment and loss of
financing may cause a further contraction of debtor
country imports and consequently of U.S. exports.
Problems such as these will-require difficult U.S. policy
decisions, sometimes involving tradeoffs among policy objectives.
Specifically, the U.S. Government may have to consider:
? Whether and how to meet further requests for signifi-
cant bilateral emergency financial assistance.
? To what extent continued cooperation from other govern-
ments, central banks, and the private banking system
can be counted on to assure availability of needed
financing.
? In particular, how to deal with the likelihood that
governments will have to increase their assistance
in the face of reluctance of banks to maintain their
high relative share of financing, and with associated
problems of burden, sharing.
? How to react if debtors resort to export subsidies in
lieu of adequate domestic economic stabilization in
order to achieve balance of payments objectives.
How to deal with the possible need of some debtor
countries to renegotiate their IMF-approved stabili-
zation programs.
There appears to be no good alternative to handling prob-
lems such as these on a flexible, country-by-country basis.
More radical proposals to deal at one stroke with the short-
term liquidity problems faced by all or groups of debtor coun-
tries fail to discriminate among country situations, which
differ enormously, and generally would weaken both the incen-
tive of borrowers to adjust and the willingness of creditors
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to continue lending, as well as entailing costs to governments
of prohibitive economic and political dimensions. Moreover,
these alternative proposals appear to have no official support
in the industrial countries and as yet little support even in
those LDCs with large debt problems.
We believe, therefore, that adapting the current strategy
to changing circumstances is the best way to proceed. Improve-
ments should be sought, however, in the availability of data on
debt problems and in U.S. and international monitoring procedures,
including exploration of use of the G-10, G-5, the IMF, or
other fora to monitor and review debt and financing problems.
The debtors' ability to resume economic growth while servic-
ing their debt depends mainly on a rapid expansion of exports,
which in turn will depend on the strength and soundness of
their internal adjustment programs. This growth of exports can
be achieved if there is reasonable, sustained growth in the
industrial countries, as seems likely, and if their markets are
kept generally-open. Nevertheless, there are uncertainties,
including risks of political instability in countries of special
concern to the United States:
? The Western recovery may not be as strong and sustained
as expected;
? Major oil exporters, such as Mexico and Venezuela, face
the prospect of a painful, multi-year adjustment process
if oil markets remain soft;
? A few LDCs, Brazil in particular, may have to accept
several years of austerity if they are to reduce sub-
stantially the debt service burden;
? There will be political resistance in the industrial
countries to a rapid expansion of imports from LDCs.
In the debtor countries, political resistance to necessary
but distasteful adjustment may build over time and become better
organized. Although the odds are strongly against a full-scale
revolution or an outright repudiation of debt in any of the
major debtor countries, there is a risk of both political dis-
order in the major countries and attempts to achieve reschedul-
ing agreements. that provide relief from some or most of the
interest payments due, e.g., by capitalizing them.
In view of these uncertainties and the large U.S. economic,
political, and security interests at stake, the United States,
in cooperation with other major industrial countries, needs to
closely monitor evolution of the international debt problem.
The operation of the strategy in the near-term is likely to be
turbulent. It should be assessed on a continuing basis, and
adaptions made flexibly in light of specific problems,-in the
framework of the basic approach. Success in the medium-term
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will depend importantly on effective adjustment by borrowers
and achievement of reasonable, sustained growth in the in-
dustrial countries. The prospect for such growth now appears
good. Should this prospect not materialize in the medium term,
examination of basic alternatives to the strategy might be
warranted. But persistence and policy predictability will be
required to permit the strategy to work; attempts to undertake
further work on basic alternatives within the U.S. Government
in the nearer term would raise unwarranted expectations. This
could create disincentives for borrowers to implement the
economic adjustments that are essential and for banks to supply
the financing that will be required while adjustment takes place,
undermining fundamental elements of the strategy.
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U.S. APPROACH TO THE INTERNATIONAL DEBT PROBLEM
A POLICY OVERVIEW
1. DIMENSIONS OF THE PROBLEM AND IMPLICATIONS FOR THE UNITED STATES
A. Mandate and Previous Work
.This study was mandated to review the U.S. approach to the
international debt problem outlined as follows: "The current
international economic environment and financing constraints are
requiring substantial economic adjustments by borrowing coun-
tries entailing in part reductions in the pace of.economic
growth, and inhibiting their ability to adjust through export
expansion. The consequences and management of the current
world financial situation affect other areas of critical concern
.to the United States and other industrialized democracies,
including the international trading system, economic recovery
and employment prospects and. international political stability."
The starting point for this review is the analysis and
strategy developed under the auspices of the SIG-IEP entitled
International Debt Situation and Its -Impact on the World
Economic/Financial -stem. Using this as a base, four working
groups were established to consider and prepare reports on:
(a) political and security considerations; (b) implications of
alternative scenarios for global recovery and the U.S. economy;
(c) implications of the debt situation for international trade
and trade policy; and (d) alternative proposals for dealing with
the debt problem. Executive Summaries of the reports prepared
by each working group are attached.
B. Scope of the Problem
This memorandum provides a policy overview in the context
of a burgeoning increase in the debt of a number of developing
countries and their inability to service it. This includes
borrowing from both official and commercial sources. In recent
years, the share of bank lending increased, and there was a run-
up in the short-term debt of many major non-OPEC developing
countries (LDCs). By way of historical perspective, new net
borrowing by these countries from banks increased from a cycli-
cal low of under $15 billion in 1977 to about $48 billion in
1981. By the end of 1982, the stock of debt owed to private
Western banks by non-OPEC developing countries totalled about
$270 billion, of which roughly $180 billion was.owed by Latin
America. If Venezuela and Ecuador (OPEC countries) are included,
the Latin American-debt to private banks exceeds $200 billion.
U.S. banks have about 40 percent of total bank claims.on these
countries.
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In the 1970s, a combination of oil price shocks, inflation,
ample liquidity, and ambitious growth policies added to the
.LDCs' debt levels. In the 1980s, high interest rates, world
recession, reduced export earhings and disinflation in Indus-
trial countries served to increase the debt servicing burden of
many LDC borrowers, which nonetheless had resisted taking
necessary adjustment measures. The results were predictable.
However, some countries, particularly in Asia, did make adjust-
ment and are not currently experiencing debt problems; most of
the countries in Latin America, East Europe and Africa did not
begin adjusting until faced with a financing problem.
In the period 1976-1980, 11 countries completed debt relief
negotiations with official and/or private creditors. Since then,
25 countries have completed such negotiations and another 5 to
10 countries are negotiating arrangements. The earlier restruc-
turings involved smaller, low income countries (except Turkey).
Those in 1982 included some of the largest borrowers (Mexico,
Brazil and Argentina). Reschedulings in 1983 will include
some OPEC members (Ecuador, Venezuela and probably Nigeria).*
The exposure of U.S. banks to Mexico, Brazil and Argentina
exceeds $55 billion. Bankers report that the only country in
Latin America that is "current" with debt payments is Colombia.
Eastern Europe (including Yugoslavia) is also having difficul-
ties servicing debt, but the magnitude of the total commercial
bank debt outstanding is less, about $65 billion; U.S. banks
have less than ten percent of total bank exposure.
C. -Implications for the United States
(i) Political and Security
In some cases, the adjustment effort required of the LDCs
could so strain their political systems as to create pressures in
key countries that could trigger civil unrest, possible changes
in government, or adoption of policies inimical to U.S. interests.
The seriousness of the potential impact will of course differ.
for each country. There is need to examine the potential of
selective country-by-country U.S. responses for the furtherance
of U.S. foreign policy and national security goals.:.
(ii) Macro and Financial
The difficulties experienced by some LDCs in servicing
their debt in turn could pose problems for the U.S. economy in
general and the financial system in particular. The attempts
of LDCs to improve their trade balances have contributed to the
temporary widening of the U.S. trade deficit, possibly with
some effect in delaying the recovery. More important, the
large exposure of major U.S. banks in all problem LDCs together
* See Appendix E.
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-- often exceeding 100 percent of capital -- means that, in
the worst case, a crisis leading to de facto repudiation of
debt by some major borrowers could threaten the solvency of
major U.S. banks and, potentially, the stability of the U.S.
financial system. Maintenance of the integrity of the-financial
system is crucial for the long-run health of the U.S.'economy.
(iii) Trade
The international debt crisis has implications for both
U.S. trade and the international trading system. For example,
in 1982 U.S. exports to the six major debtors in Latin America
fell by $8.7 billion and are continuing to decline. If financ-
ing is not available to permit smooth adjustment, the sharp
drop in U.S. exports to those markets (which totalled $22.7
billion in 1982) will continue.
As for the implications for the trading system, there is
some danger.that the debtor countries will adopt further protec-
tionist, discriminatory trade measures, although those countries
obtaining IMF programs must agree not to adopt new restrictions
or intensify existing ones. Any trend toward such measures would
prompt protectionist actions by developed countries, setting
back U.S. efforts to liberalize world trade. .
2. THE CURRENT STRATEGY AND OPERATIONAL DIFFICULTIES
The core U.S. strategy is designed to deal with debt
problems in a flexible manner. It is based on adjustment,
reasonable economic expectations and financing adequate to
allow orderly adjustment and avoid triggering political prob-
lems and reactions that could damage U.S. interests.
The IMF plays a key role in providing official medium term
assistance to troubled borrowers, and its resources need to be
increased.
Commercial banks, must also increase their own lending in
borrowing countries following appropriate adjustment programs,
though many are reluctant to do so.
Central banks and treasuries must be willing to provide
immediate liquidity support, when necessary, to aid selected
borrowers which are working out adjustment programs with the
IMF, but, with the likely reduction in the growth of commercial
bank lending, official and governmental lenders will be called
upon to provide a larger proportion of total finance to LDCs.
The need in the U.S., Europe and Japan for resumption of
credible economic expansion is the final element in the existing
U.S. strategy to deal with LDC debt problems. As a concomitant,
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protectionism must be avoided to enable LDCs to find export
markets for their products.
Operational Difficulties
As noted, the magnitude of the difficulties far over-
shadows those experienced in the 1970s, and there is no single
formula that meets every debtor's case or needs. Several more
countries are likely to seek rescheduling, IMF assistance,
and/or bridge financing. A number of those which have estab-
lished IMF adjustment programs will probably fail to meet some
IMF targets.
There will be a series of "phase two" reschedulings that
will . put?strain on the willingness or ability of the existing
private sector participants to further increase exposure to
troubled borrowers. However, if they did not increase exposure,
they would be less likely to receive interest payments and
would probably have to increase provisions for bad debt, thus
suffering reduced profits.
In some LDCs, the public sector has received preferential
access to foreign exchange for servicing external debt. The
private sector has not been able to obtain foreign exchange to
keep current even on interest payments. This development
obviously is making foreign lenders and suppliers-reluctant to
advance new funds. It also raises concern about the private
sector's future access to funds, vis-a-vis public sector
borrowers.
Shortfalls in supplier credits and trade finance lines
could affect country financial packages and handicap the ability
of some debtors to carry out normal trade transactions, weak-
ening their ability to fulfill key IMF targets.
Belt tightening -- adjustment -- by LDCs cannot be avoided,
but there also could be requests for additional financing for
troubled LDC borrowers that might have to be met from official
sources (governments, IMF, IBRD, etc.).
If the alternative to such financing is even further belt-
tightening, there is a danger that there could be still greater
pressure for adoption of non-market orientated trade policies.
Up to the present, the major countries have coordinated
their approach to debt problems in an ad hoc fashion centered
on the Paris Club in which official and officially-guaranteed
credits are rescheduled. The limitations of the Paris Club
approach began to be visible in the case of Turkey in 1980,
and became more apparent in the case of Poland in 1981. Then,-
in 1982, the problem of Mexico and Brazil required an approach
by the major countries completely separate from the Paris Club
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because of the relative unimportance of official credits com-
pared to commercial bank credits. (A more detailed discussion
of the evolution of this approach is provided in Appendix-E.)
3. BASIC ASSESSMENT
A. Progress in Applying the Strategy
The initial elements of the debt strategy have been
successfully meshed for several major debtors. Adjustment
programs have been initiated, largely in cooperation with the
IMF, and financing arrangements have been made by official
institutions and private lenders.
In debtor countries, IMF agreements have entered into
force. In Mexico, Argentina, Brazil, Yugoslavia and elsewhere,
adjustment efforts are underway, but even more countries are
encountering problems in meeting their payments and obtaining
new commercial bank borrowing.
Agreement has been reached on a significant increase in
IMF quotas and GAB resources. The U.S. administration is making
a major effort to obtain Congressional approval -- which won't
be easy. IMF quotas will be increased by 47 percent,'an increase
from SDR 61 billion to SDR 90 billion (in current dollar terms,
an increase from $67 billion to $99 billion). The proposed
increase in the U.S. quota is SDR 5.3 billion ($5.8 billion at
current exchange rates) representing 18 percent of the total
increase.
The Group of Ten, working with the IMF's Executive Board,
has agreed to an expansion of the IMF's General Arrangements to
Borrow from the equivalent of about SDR 6.5 billion at present
to a new total of SDR 17 billion, and to changes in the GAB to
permit its use, under certain circumstances, to finance drawings
on the IMF.by any member country. Under this agreement, the %
U.S. commitment to the GAB would rise from $2 billion to SDR
4.25 billion (equivalent to about $4.7 billion). The target
date for entry into force of these agreements is November 1983.
This expansion and revision of the GAB offers several
important attractions and, as a supplement to the IMF's quotas,
greatly strengthens the IMF's role as a backstop to the system:
GAB credit lines are primarily with countries that have rela-
tively strong reserve and balance of payments positions. They
can provide more effectively usable resources than a quota
increase of comparable size. Since the GAB will not be drawn
upon in normal circumstances, this source of financing will be
conserved for emergency situations. By demonstrating that the
IMF is positioned to deal with severe systemic threats, an
expanded GAB should provide confidence to private markets to
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ensure that capital continues to flow, thus reducing the risk
that the problems of one country will affect others...
Official balance of payments assistance on a bilateral
basis from governments has also been provided in some cases
as a supplement to IMF programs.
With commercial banks, there is a new wrinkle; they are
being called on to agree to new commercial lending in conjunc-
tion with IMF programs. Our estimates suggest a decline in the
growth of net new commercial bank lending to non-oil developing
countries, from about $48 billion in 1981 to $20-25 billion in
1982. The outlook for net new bank lending in 1983 to these
countries is in the $20 billion range, of which over half --
about $11.billion -- already appears spoken for by Mexico ($5
billion), Brazil ($4.4 billion) and Argentina (about $1.5
billion). The IMF program in Yugoslavia will require roughly
another $600 million in new bank lending.
Unfortunately, some banks in Europe, possibly Japan and
U.S. regionals, have been unwilling even to maintain existing
exposure. As a result, other banks have had to increase their
exposure even more in order for the various adjustment programs
to be successful. There is a burden sharing problem: among
banks; between banks and official lenders; and among official
creditors.
Some Comments on Bank Lending
-- Most current data from the Bank for International
Settlements (third quarter 1982) show a pickup in international
interbank market operations -- the gross aggregates -- but a
sharp slowdown in underlying expansion of lending outside the
industrialized countries of the immediate BIS area (from $20
billion in second quarter to $4 billion in third quarter.
LDCs are having an increasingly difficult time in holding or
obtaining interbank deposits; their run-off has pushed Brazil
and Yugoslavia into liquidity problems. LDCs are also having
trouble in obtaining new loans.
-- Exporters are significantly scaling back the volume
of supplier credits granted to buyers in financially-troubled
developing countries. Apart from placing critical export tar-
gets in further jeopardy, a cut in supplier credits could lead
to an increased need for external bank loans.
-- More reschedulings can be expected, including addi-
tional countries or likely "second phase" difficulties; some
disturbing developments should be anticipated, but action to
deal with them must by nature be on a case-by-case basis,
although within the context of the main elements of the existing
strategy.
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-- In addition to rescheduling, commercial banks where
justified are encouraged to increase exposure -- i.e., in the
context of IMF programs and meaningful domestic adjustment pro-
grams in debtor countries.
Some banks have already written off portions of their
loans to Poland, Zaire and the Sudan. The extent of writeoffs
to these and other countries may increase. However, bank
regulators may have to make some allowance for loans by banks
to problem debtors that are made in conjunction with IMF adjust-
ment programs. Otherwise, the banks' managements could reach
a point where they no longer sanction such loans,.given the
obvious deterioration in many countries' economic performance
and,foreign exchange generating capacity.*
-- Some decline in the growth of commercial bank lending
is a natural concomitant to reduced LDC deficits, lower inflation
and interest rates, and increased banking prudence, but substan-
tial financing gaps are expected to develop that will require
further tightening of LDC adjustment programs and/or increased
official lending.
The likely increase in government involvement will bring
with it a greater degree of influence over commercial bank lend-
ing decisions. Governments will not willingly allow commercial
banks to reduce the growth or levels of their exposure to LDCs
while official lending is being increased. Experience with the
strategy points up the need for a clear idea of what constitutes
"fair burden sharing.." For the same reason, commercial banks
will increasingly insist on appropriate levels and categories
of official lending.
Central banks and Treasuries have been willing to engage
in short-term bridge finance on a selective basis, but the
availability of these funds may be limited in the future.
U.S. economic recovery is well underway, and there are
signs of an upturn in other key OECD countries. Several recent
developments will be helpful in easing LDCs' debt service prob-
lems. Interest rates have fallen substantially since last
autumn, which should reduce the interest payment burden.
Finally, prices of industrial raw materials, a major'-export
item for many LDCs, have risen rather sharply so far 'this year
and are likely to continue to rise in the near term.
* There is considerable desire in Congress for legislation
parallel to the IMF quota/GAB legislation which would impose
limits on foreign lending and require other measures in the
regulatory area. On April 11, the bank regulatory agencies
submitted to Congress a package of measures they proposed
to institute so as to take these concerns into account
without legislation, but they were also asked to prepare,
and have prepared, draft legislation.
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However, the debt
us for However, time. problem is not resolved and will be
u for somr Further restructurin in countries be ne y. Already? questions are raisedsabe t the with
Argentina and Chile to about well e in the world econom meet their IMF targets. the ability
prices, while c nerallas not yet taken firm hold; An upturn
help most generally has
and counter lower oil
will r en
the situation most problem debtor countries e worsen
the tuati n in a few. Case-by-case analysis rather than
The
adjustment important element
tment s te tan e- in the strategy
improvement
by it,
; without is adequate
Improvement in their situations. Ye t t,the y d y d there cannot
their growth or on't want be an.
take unpopular domestic measures.
The debt burden of LDCs will
Venezuela, fexample Poli
, has engender
It e u, for
proposed tical problems.
y that a coordinated debtors, moratorium will
occur or that a major borrower will repudiate of interdependence among nations is too greaat debt; the degree
would be barter and autarky, . The resoft for
repudiation has appeal in some but the
Political idea quarters in LatiAmerica.
n'
There obviousl
within y is room for improvements
tith nmothe parameters of.the strate and refinement
coort
and finance creditors and strengthening such ra greater
Officials. some
cooperation betweenarade
n Moreover, some. observers
which a higher g financing will be adequ Whether existing
of official su po and the degree to
res s suggest that the strategy as presently ctrl to
ult
a satisfactor prestl needed;
Planning is therefore required. supplementary cotin
In sum, however, the strate
contained the damage and started gy so far has worked;
programs in connect
the major debtors it has
with IMF and other official lendin~stment
B. Future Prospects and
Potential Problems
(i) Macroeconomic
as offerin alternative strategies, g the best the one chosen is agreed although ngis result prospects of a satisfactory on
although
problems by no_means assured. There re will
co 1984. in implementing it, at ldastthroula
through the end
In 1983 and 1984, most observers
programs and financial' agree that many While subndfinl arrangements will have adjustment
thin, tst nis progress has been made tong mIMF odified.
a high Probabilit In meeting that both Brazil and Mexico
co
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will require additional financing in 1983. Failure to meet
internal targets is likely for 'several countries. The result
will probably be renegotiation of IMF agreements and further
rescheduling of bank debt. There is always a risk, however,
that such renegotiations will not succeed because of unwilling-
ness of countries to make adjustment or of creditors to-provide
sufficient additional liquidity,_
In the medium term (1985 through 1987), prospects for a
substantial improvement in financial positions of major debtors
are quite good. The major reason for this is the expectation
of a sustained recovery in the industrial countries; as slack
capacity is taken up, these countries should grow at around 3-4
percent for several years, allowing rapid growth in the exports
of major debtors provided that there is not a turn towards pro-
tectionism. Medium term scenarios suggest that, with an indus-
trial country recovery and growth in the range of three to four
percent, growth in exports will be sufficient to allow both a
steady reduction in debt service ratios and a resumption of
growth in debtors, albeit.at rates below that of the 1970s.
Failure of the industrial countries to achieve a sustained
recovery, on the other hand, would require major revision of-
the debt strategy.
(ii) Political
A primary continuing concern is the effect of the debt
problem on the political situation in debtor countries. Many
of the high debt countries experienced rapidly rising living
standards during the 1970s. They have already taken sharp
cuts in these standards, and will take further cuts in 1983.
Even with a resumption of moderate growth, it could take many
years before per capita consumption in Brazil and Mexico reaches
its pre-crisis levels.
The cumulative effect of this downturn in economic perform-
ance could be political instability. The longer the economies
of the debtors remain depressed, the greater will be the chances
of major political changes and unrest in these countries. As
signs of political resistance and unrest multiply, it will
become increasingly difficult for the IMF to hold the debtor
countries to their commitments. Although most of the major
LDC debtors have authoritarian governments, they nevertheless
must take domestic political interests into account' in. order to
reduce the risks of violent unrest and to build popular support.
The above comments pertain primarily to Latin America.
The political dimensions of the debt problem are different in
Eastern Europe. The impact on the U.S. economy of Eastern
European debt problems is minimal.
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(iii) Trade
Even if the strategy results in a satisfactory outcome,
the U.S. trade balance with the countries experiencing debt-
servicing problems will deteriorate further. a"result, the
Administration will face pressures to restrictALDC imports.and
to facilitate exports. U.S. efforts to liberalize world trade
and investment will be made more difficult. To the extent the
strategy is unsuccessful in making possible smooth adjustment
.by the debtor countries, these trade problems will be intensified.
If the six major debtors in Latin America (Mexico, Brazil,
Argentina, Venezuela, Peru, and Chile) hit their trade targets,
the U.S. trade balance with these countries will deteriorate by
at least $5 billion in 1983..* The dislocation in U.S. export
and import-competing sectors caused by this swing will generate
protectionist pressure.**
To date, such pressures have been muted because most of the
trade swing has been due to reduced U.S. exports, and exporters
are less prone to call for retaliatory actions than import-
competing industries. However, U.S. exporters have suffered
not only due to lost sales, but because of problems in receiving
payments for goods already shipped.
If adjustment programs in the LDCs are successful, the
future deterioration in the J.S. trade balance is likely to be
Department of Commerce reports that, due to financing probl
s,
Mexico, Brazil and Argentina are currentl y importing at level
well below those implied by IMF adjustment programs. -Resides
s
causing further contractions in trade, this may adversely
affect each country's ability to sustain export capacity at
the necessary levels. The Defense Department concurs. Other
agencies agreed that such a trend in their imports, if it con-
tinued, could adversely affect export capabilities but that
it is too-early to extrapolate full year 1983 results and
that the link between imports and export capability is
difficult to specify.
** OMB believes that focusing on bilateral trade with specific
LDC debtors is too narrow a measure of the impact of current
problems on the U.S. economy. offsets are possible-in world-
wide trade, e.g., a reduction'in exports,to one county, group of countries, can easily be made up by higher exports
elsewhere. While these offsets may be small over the next
year or so, they are likely to be quite significant over the
longer term. Other agencies agree with OMB that bilateral
trade analysis can be misleading but believe: (a) concurrent
declines in import demand by many LDCs will reduce total
demand for U.S., exports; and (b) there is no automatic offset
to this decline.
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primarily on the import side, thereby heightening pressures.
Moreover, since the export subsidies and the import restrictions
now being used by countries with large external debt. may be
grounds for the imposition of import restrictions under U.S.
trade laws, the Administration will have to deal with specific
requests to restrict-imports from the debtor countries. In some
cases, such as foreign subsidies, the President has virtually
no flexibility. Increases in U.S. trade barriers as a result
of these laws will be seen by the debtors as protectionist
U.S. measures hampering their adjustment measures. There is
thus a strong likelihood of trade conflicts with the debtors.
Contractions in the availability of trade finance will
lead to difficulties in normal trade transactions and to the
use of such measures as countertrade and clearing arrangements.
Another area of tension will be international trade dis-
cussions. The continuing vulnerability of the debtors, which
include some of the major LDC traders, will make them more
strident in demanding special treatment for LDC exports, and
even more wary of U.S. initiatives to negotiate further trade
liberalization (such as the proposed North-South round) and to
extend GATT disciplines.
C. Alternative and Fundamentally Different Approaches
A number of proposals have been made in recent months for
alternatives for dealing with the current debt situation, some
of which are perceived as supplemental to the current strategy,
and some of which address perceived shortcomings of the basic
strategy. As such, these proposals can be separated into two
categories: (a) those that deal with the immediate liquidity
problem faced by debtor countries and which might be needed
should the current strategy fail; and (b) those that deal with
the longer-term structural deficiencies which some believe
have been highlighted by the current crisis, but which are not
addressed by the current strategy.
The proposals in the first category would provide temporary
debt relief, or lengthen the maturity of existing debt, on the
assumption that once economic recovery is underway in the OECD
countries, debtor countries will be able once again to-service
their debt. These proposals are somewhat labking in that they
are not selective, treating all LDCs equally rather than on a
case-by-case basis. In addition, several of these proposals
neglect or miscalculate the potentially adverse effect on
commercial banks, which is especially relevant in light of the
element of the basic strategy which calls for maintenance of
commercial bank lending.
Proposals made in the longer-term structural context assume
that
even
i
,
w
th an upturn in world economic activity, many
debtor countries will be unable to meet their debt payments.
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12
These proposals range from relatively simple mechanisms, such
as encouragement of a secondary market for LDC debt, to creation
of new institutions, such as a developing country debt corpora-
tion, to entirely new approaches to debt restructuring, such
as a system of Exchange Participation Notes.
The shorter-term and some of the longer-term proposals
lack country-by-country selectivity and adequate assessment of
the impact on commercial banks. In addition, the longer-term
proposals have more serious administrative difficulties and
political complexities than the short-term proposals, which
make successful negotiation and implementation particularly
unlikely. Although there is broad support for reform among
the LDCs, none is pushing for radical measures, and there is
no evidence of official interest in industrial countries for
any of these schemes.
Finally, the alternative solutions proposed to date assume
that the creditors must bear a substantial part of the princi-
pal burden of enabling LDCs to survive the current debt crisis.
As such, these alternatives would entail-a departure from the
present strategy's premise that the crux of any effort to remedy
the debt problems of LDCs in a lasting way must be domestic
adjustment efforts by the countries themselves.
4. CONCLUSIONS
_Prospects for Satisfactory Outcome of the Strategy
In the near term (through end-1984), the working out of the
debt strategy, although it has a reasonable prospect for a satis-
factory outcome, is likely to be turbulent.
miss targets in IMF-sponsored adjustment programs, countries may
financing will prooably be required from both official additional
from governments as well as the IMF) and private sources. PThe
risk of an unravelling of the strategy cannot be dismissed. The
most likely outcome, however, is that a series of case-by-case
measures will succeed in avoiding a global crisis.
In the medium term (1985-1987), prospects debtors' financial positions are quite efor an improvement
tion of a satisfactory outcome in the neargterm.unAerecoverysinp
industrial countries should allow rapid growth in LDC exports,
providing.an opportunity. simultaneously to reduce debt service
ratios and resume economic growth. This estimate will, however,
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change sharply if-industrial countries fail to achieve a sus-
tained recovery. And even with a steady recovery there will
be a risk of political instability in LDCs.*
B. Suggested Measures to Strengthen Strategy
(i) Trade Policy
Domestically, the Administration, recognizing the need for
the debtors to improve their current balance, should continue to
emphasize its commitment to maintaining an open U.S. market, while
assuring U.S. interests that U.S. trade laws will be applied
fairly. Given general U.S. trade policy and limitations imposed
by trade law, special trade treatment should not be given to
countries because of debt difficulties.** Rather, decisions
involving trade with debtors should continue to be made on
traditional trade policy grounds such as the standards in our
countervailing duty law.
Internationally, our trade policy objectives are (a) to
discourage any increase in market-distorting import protection
and export subsidies by the debtors or the developed countries
that could create long-term distortions in world trade, and (b)
to ensure that the liberalization that should be possible once
.the adjustment programs begin to work does in fact take place
and becomes the basis for further liberalization of world
trade and investment, and improvements in the trading system.
With these goals in mind, the United States is proposing
joint meetings of trade and finance officials to re-emphasize
the link between their areas of responsibility, emphasizing
the importance of adequate finance to avoid unnecessary trade
restrictions and the need to avoid protectionism.
The Summit and the OECD Ministerial also will be used to
discourage protectionism and to begin to:lay the groundwork
for future liberalization. In addition, the United States
will work on improving coordination among the IMF, World Bank,
and GATT on trade matters.
* The NSC and Defense Department believe that medium term pros-
pects for an improvement in debtors' financial positions are
poor, due to new bank attitudes and regulations, the continu-
ing inability to fund past balance of payments loans and the
additional burden of repayment of bridging and refinancing
loans.
** USDOC feels that the steps these countries will take to meet
the financial objectives of the adjustment strategy (trade
balance improvements) could increasingly result in policies
that conflict with U.S. trade policy objectives (i.e., man-
dated counter-trade, import restrictions, export subsidies,
etc.).
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'..yly L' .L LC, LV 11tSL
(ii) Strengthening The Framework for Managing Debt Problems
Procedures developed over the years for coordinating official
measures to address the debt problems of individual countries --
largely in the Paris Club framework for official debt reschedul-
ings -- have worked reasonably well most of the time. Since
mid-1982, however, there has been a sharp increase in the number
of debt problems, in their magnitude and potential significance
to the international.monetary system, and in their complexity.
The'approaches worked out (and still being worked out) in the
Mexican, Brazilian, Argentine and Yugoslav cases, for example,
reflect the dominant role of private financing and the marginal
role (if any) played by official reschedulings of the type tra-
ditionally handled in the Paris Club framework. To one degree
or another, these cases have involved arrangement of short-term
"bridge" financing by monetary authorities in the major coun-
tries; the negotiation and adoption of major IMF-programs; tem-
porary stand-stills on principal payments on commercial bank
debt; longer-term restructurings or reschedulings of maturing
commercial bank debt; provision of net new financing by the
commercial banks; and programs of extraordinary longer-term
official financing to complete.the financing package.
Rapid responses, by both monetary authorities and commercial
banks, have frequently been required; the complexity and inter-
related nature of the financing packages have at times made it
difficult to proceed on individual elements without assurance
that all elements were reasonably in place; and there have been
frictions among governments, among commercial banks, and between
governments and banks related to issues of "burden sharing." The
Paris Club framework* is not appropriate to these cases and has
not been used; and the increasing number of official debt resched-
.ulings and the need at times to integrate them into more complex
.financing packages raises questions about the continued ability
of the Paris Club structure to manage official reschedulings.**
* The initial purpose of the Paris Club was to provide an infor-
mal process or procedure -- not creation of an institution,
which was not wanted -- to facilitate the negotiation of debt
relief loans extended by or guaranteed by the leading creditor
governments (i.e., basically the G-10). The Government of
France offered to provide meeting facilities and secretarial
services for such negotiations, and the other G-10 countries
accepted.
** The State Department believes that this conclusion is not
justified. The Paris Club has not been used in these cases
because the borrowing countries did not request reschedul-
ing of their official debt. There is no evidence. that the
increased number of reschedulings has taxed Paris Club
resources; nor is 'the need to integrate official reschedul-
ings into larger packages germane to the issue of the Paris
Club's ability to manage official reschedulings per se. In
State's view,.the Paris Club has functioned efficiently,
and such problems as do exist (e.g., data collection) would
not be solved by a change in venue. .
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These problems, and the expectation that there will be
similar new cases and/or repeats of old cases, have suggested
the adoption of more systematic arrangements among the major
creditor countries for anticipating future problems, Stealing
with them as they arise, and assessing the management of indi-
vidual cases. The existence of more formal arrangements could
provide greater assurance to the markets that individual debt
problems would be managed smoothly, and thus inhibit actions
by the commercial banks that would precipitate such crises.
Such arrangements could provide a channel for rapid official
transmittal of information and decision-making, for communi-
cations between the IMF and the monetary authorities of the
creditor countries, and, possibly, for organized communications
between official creditors and the private banking community.
At the same time, in considering the establishment of more
systematic creditor arrangements to address debt issues, there
is a need to avoid creating incentives for undue recourse to
such arrangements; to maintain the capacity for'speed and
flexibility in dealing with problem cases; and to assure main-
tenance of the IMF's role as the central source for official
balance of payments financing.
On the basis of these considerations, it is suggested that
the United States explore with officials of other major creditor
countries possibilities for more organized creditor consulta-
tions and decisions on key debt issues, as they relate both to
questions of general policy approach and to individual problem
cases. The G-10 is one possibility, consisting of the finance
ministries and central banks of the United States, Belgium,
Canada, France, Germany, Italy, Japan, the Netherlands, Sweden,
the United Kingdom and recently Switzerland. This group
includes the countries with principal interests in and responsi-
bilities for the international monetary system; those in a
position to provide the bulk of any official balance of payments
financing that may need to be mobilized; and those countries
whose banks are most involved in international lending. The
G-10 is also the entity for any decisions on activation of the
General Arrangements to.Borrow.
Other possibilities include the "G-5", a smaller and less
formal group consisting of France, Germany, Japan, the United
Kingdom and the United States, which meets from time"to time at
deputies and ministers (including central bank governors) levels
to consider current international financial rid economic issues
and attempt to formulate coordinated views within the group
for use in larger forums; and reliance on the IMF as a main
locus for coordination among creditors.
Among the steps. that could be pursued by creditors are the
following:
--Review the various data collection efforts under
way in the IMF, the BIS, the OECD and the World
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16
Bank in the lending/debt area; determine whether
there are significant omissions in the collection
effort and recommend any desirable improvements.
-- Monitor and assure rapid transmittal to creditor
governments of relevant information, with a view
to anticipation of emerging problem cases and-pro-
viding data needed for decisions.
-- Review developments in the bank regulatory and
supervisory area and problems of consistency in
regulatory treatment that may need to-be addressed.
Review the experience with individual cases, and
consider policy questions arising from such reviews.
-- Coordinate creditor approaches to individual prob-
lem cases, maintaining contact as appropriate with
the IMF and other major elements of borrowers' financ-
ing arrangements.
The need for speed, discretion and flexibility in decisions
on financing arrangements in some cases may argue for a division
of responsibility: for example, use of the G-10 structure for
actions in the data and review area, and contacts focused within
the G-5 or the IMF.for coordination of creditor action on
financing programs.
v"` "1 ua~a 5 stems and Dissemination
A number of developments are in train that will increase
the quality and availability of information on debtor countries
which the U.S. should strongly urge G-10 members to support.
Efforts-to construct debt profiles of individual countries
are presently handicapped by the difficulty in synthesizing
the various reporting systems in place. For instance, data
collected by the World Bank generally leave out all short term
debt, and also omit medium/long-term debt of the private sector
that is not guaranteed by the debtor's government. .,The IMF is
pursuing a major effort to identify and eliminate the gaps in
reporting, but it will not be possible to achieve rapid progress.
Availability since the mid-1970s of information on bank
lending by banks in the BIS area has added a new dimension. A
large part of the IMF's effort is aimed at expanding the report-
ing area beyond the participating BIS countries. One of the
BIS systems will be shifted to a "consolidated" basis of report-
ing, which means that countries report the global
their indigenous banks wherever located, rather thanonlynthose
s
banks within their borders. This system will improve our
ability to identify the country at risk in bank lending.
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17
The newly formed Institute for International Finance (IIF)
is expected to devote most of its efforts to improving the flow
of information from individual debtor countries to the banking
community. The IMF should be encouraged to make available to
the banking community non-sensitive data on debtor countries.
Such data flows should entail much more timely information than
what is now collected by the World Bank from these countries..
An important point is that, in addition to debt data, statistics
on growth, prices, trade/current account balances and trade
finance are essential elements in making appraisals of a coun-
try's prospects.
C. Future Work
The evidence is that the existing strategy is working,
although some aspects of that strategy could, and should, be
strengthened as indicated above. To date, no proposals have
been made which could improve on the current strategy, in par-
ticular as we have recommended it be strengthened. Specifi-
cally, none of the alternative proposals meets the fundamental
criteria of a desirable strategy -- that they deal with the
problem on a country-by-country basis; that they involve the
commercial banks in such a way as to encourage their continued
participation in the international financial system; and that
administrative and political difficulties not be such as to
render negotiation or implementation virtually impossible.
More fundamentally, none of the alternatives proposed suffi-
ently meets the underlying criteria of encouraging LDCs to
adjust. Some alternatives would, in fact, enable LDCs to
avoid adjustment altogether.
This is not to suggest that the strategy being followed is
certain to produce acceptable results. As noted above, the
operation of the strategy in the near term is likely to be
turbulent. It.should be assessed on a continuing basis, and
adaptations made flexibly in light of specific problems, in the
framework of the basic approach. Success in the medium term
will depend importantly on effective adjustment by borrowers
and achievement of.reasonable, sustained growth in the indus-
trial countries. The prospect for such growth now appears
good. Should this prospect not materialize in the medium term,
examination of basic alternatives to the strategy might be
warranted. But persistence and policy predictability will be
required to permit the strategy to work; attempts to undertake
further work on basic alternatives within the U.S. Government
in the nearer term would raise unwarranted expectations. This
could create disincentives for borrowers to implement the
economic adjustments that are essential and for banks to supply
the financing that will be required while adjustment takes
place, undermining fundamental elements of the strategy.
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Appendix A
Political and Security Considerations
Executive Summary
The adjustment effort required of the LDCs is placing an
unavoidable strain on their political systems with implications
for many of our foreign policy objectives, including matters of
regional peace and security, North-South economic relations and
cooperation with our European allies.
Of particular concern is the danger that the pressures on
the political/economic systems of key countries could spark
changes in governments, changes in policies, and/or changes in
a country's ability to influence events. To the extent these
countries are unable to resolve their problems, or find the
solutions excessively painful, or perceive that the industrial-
ized nations are unable or unwilling to provide needed resources,
they may begin to look for alternative solutions inimical to
U.S. interests.
For instance, in the Middle East, Egypt plays a key role
in the peace process, but unless the Egyptian Government takes
strong remedial action, it is likely to undergo severe balance
of-payments difficulties in the next few years. As a result,
Egypt's economic difficulties are going to make its participa-
tion in the peace process more expensive for the U.S.. and, if
it is required to seek assistance elsewhere, possibly more
unpredictable.
In the Caribbean and Central America, U.S. and Venezuelan
foreign policy has coincided in recent years. Venezuelan aid
has provided many countries of the region with much needed
balance of payments support and has supported the move towards
a democratic government in El Salvador. While Venezuela's current
economic and debt problems probably do not affect that country's
stability -- at least in the short run -- they will limit the
resources available to Venezuela to continue to play its positive
role in the region.
In addition many of the LDCs are going to look for solu-
tions to their problems on a collective basis throughchanges
in the international economic system. Pressures from the LDCs
for greater concessions by the industrial nations on North-South
issues are likely to increase, particularly if their debt
situation remains unresolved. We can, for example, expect
increased demands in UNCTAD for new and more generous commodity
arrangements. We may also see increased demands for a debt
moratorium perhaps unilateraly declared by the LDCs.
Many of the consequences of the current situation will be
country specific. We will continue to receive many requests
for assistance, and with a limited resource capability to respond
to those requests we are likely to see increasing and often
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A-2
unpredictable strains in bilateral relationships. Roth the
Philippines and Liberia may use their economic difficulties to
try to extract a higher price for our facilities based in
their countries. Even when our direct bilateral interests are
less involved, we cannot be indifferent to the possibility that
internal disorders arising out of economic difficulties-in a
given country could cause disruption in several others. Nor
can we ignore'the possibility that some governments might try
to divert public attention from internal difficulties by
external adventures. Nigeria is a possible candidate for the
first concern, while Argentina is a good candidate for both
possibilities.
A solution to these problems is beyond the abilities and
resources of the United States and will reqire assistance from
our allies.
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Macroeconomic.-Aspects of LDC Debt
Executive Summary
Many developing countries now face serious problems in
servicing their external debt. In large measure these problems
are part of the severe worldwide adjustment to disinflation,
which led to high interest rates and a decline in the price and
volume of the LDC exports. However, some nations have come
through the adjustment period relatively well, while others
have fared more poorly.
The basic cause of individual difficulties lies in the
failure of some countries to pursue sound fiscal and monetary
policies. This led to extraordinarily high rates of inflation,
not adequately offset by exchange depreciation, and a loss of
competitiveness on world markets. When the external environment
temporarily worsened due to disinflation in the industrial
countries, the current account deficits of these countries
widened. By 1982, private lenders became unwilling to finance
further rapid growth in debt. As a result, a number of count-
ries have sought official financing and/or rescheduling of
private and public debt.
Short-Term Financing and Adjustment _
Most problems debtors have entered into agreements with
the IMF and their creditors. These agreements combine a plan
for adjustment by the debtor with a financing package consisting
of both.official and private lending. Thus the initial elements
of a resolution of the debt problem have been successfully
meshed.
Some problems remain, however, and 1983 and 1984 are likely
to be marked by many small crises. Several additional countries
are likely to request IMF programs and/or rescheduling of pri-
vate and public debt. At the same time, many of these countries
with existing adjustment programs will probably fail to achieve
their targets. Mexico and Brazil, in particular, are likely to
require additional financing in 1983 even though they have made
substantial improvements in their external position. several
countries will probably fall short on their targets for internal
measures, such as reducing budget. deficits.
It is likely that these problems will be worked'out in a
"second phase" series of reschedulings. Additional bridge
financing may be necessary in some cases to avoid a payment
moratorium during negotiations with. the IMF or the commercial
banks. The possibility of a serious unravelling of the agreements
cannot be ruled out,, but does not appear to be the most probable
case.
Effects of the Economic Recover in the Industrial Countries
A resolution of the debt problem requires effective adjust-
ment by debtors, but it also depends on a sustained recovery
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in industrial countries which allows debtors to increase their
earnings of foreign exchange.
The Working Group concluded that the most likely medium-
term prospect for the industrial countries as a group is for
recovery compatible to that envisioned in the Administration
forecast for the United States: that is, for several years of
growth at about four percent, as slack capacity is brought into
use. A recovery at this rate would permit a growth in debtor
country exports sufficient to combine gradual improvement in
debt service ratios together with a resumption of growth in
the debtor countries themselves -- albeit slower growth than,
that of the 1970s.
A failure of the industrial countries to achieve a sustained
recovery, on the other hand,. would imply much slower export
growth. A major revision of the current debt strategy, probably
involving a significant writedown of debt, would then become
inevitable.
Effects on the U.S. Economy
The major U.S. economic stake in the debt problem is
financial. Major U.S. banks hold extensive claims on problem
debtors, in some cases exceeding 100 percent of capital. A
crisis leading, in the worst case, to a de facto repudiation
of some substantial part of these claims could threaten the
stability of the U.S. financial system.
The other major effect is the forced improvement in LDC
trade balances, a substantial part of which is reflected in the
U.S. trade balance and which thus contributes to the temporary
widening of the U.S. trade deficit. LDC debt problems helped
delay the beginning of U.S. recovery. If contractions in
trade continue, the external sector could continue to be a
drag on U.S. GNP growth. However, if the adjustment process
is successful,. LDC import should increase in the medium term
from current levels.
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Implications for International Trade and Trade Policy
Executive Summary
A. Trade Flows
The United States has important trade interests with major
LDC debtor countries, most of which are Latin American.
Those debtors will have to improve their current account
balances; the U.S. will absorb about half of the swing in
their trade accounts, primarily because of the large U.S.
share of Mexican trade. (The debt problems of Eastern
Europe and Africa will more directly affect Europe.)
-- U.S. exports to Mexico, Brazil, and Argentina this year
may be reduced more than envisioned under their IMF
programs. Apparently, private, short-term trade finance
is drying up, hampering U.S. exports, delaying or preventing
payments to.suppliers and increasing Exim bank loan loss
risks. U.S. subsidiaries are having difficulty in importing
necessary inputs.
- There is therefore a possibility that the debtors will import
considerably less than planned as part of IMF adjustment
programs. Resides reducing U.S. sales, this may hamper the
debtor's ability to export at necessary levels.- The import
and export problems are encouraging more distortive trade
policy measures (i.e., counter trade,. import restrictions,
etc.).
- Substantial trade adjustment took place in 1982. U.S. exports
to the six major Latin American debtors were $22'.7 billion,
a decline of $8.7 billion from 1981. As a result, the overall
U.S. trade balance with these countries declined from a
surplus of $4 billion in 1981 to a deficit of over $4 billion
in 1982.
In 1983, the projected increase in the trade deficit with
those countries is about $5 billion, compared to projected
overall increase in the U.S. trade deficit of about $30
billion.
-- As the adjustment programs in these countries'take hold and
the U.S. economy recovers, U.S. imports from these countries
should increase while U.S. exports to them should recover
more slowly.
Should there be additional adjustment or financing problems,
the trade balance loss would be greater than the one
projected above; U.S. exports could be hurt drastically,
with trade deteriorating to a cash-and-carry basis or barter.
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CONFIDENTIAL
B. Dangers of Present Situation
-- In their efforts to cut back imports. and increase exports,
the debtors could adopt additional import restrictions,
and export subsidies, further distorting trade. By creating
vested interests, such measures threaten to become long term.
--
The
increasing sense of vulnerability by major LDCs will make
them
more strident in their demands for preferential
treatment
and
more wary of U.S. efforts to liberalize trade and
improve
the
trading system (such as the proposed North-South
Round
and
the services and high technology. initiatives).
-- To date, the protectionist pressures against debtor LDCs
have been muted, perhaps because most of the trade impact
has been on the export side, and exporters are less prone
to call for protection than are import-competing sectors.
There are, however, increasing pressures to facilitate
payment *for exports.
-- As the debtors' adjustment shifts-from import reduction to
export expansion, protectionist pressures will be more
likely, particularly if the LDCs don't begin to open their
markets.
Since the export subsidies and import restrictions adopted
by debtors may justify imposition of import restrictions
under U.S. trade laws, the Administration will have to
deal with specific cases filed under these laws. In some
cases, such as those against foreign subsidies,?the President
has virtually no flexibility.
Should the U.S. take action to restrict their trade, the
debtors will see this as U.S. protectionism frustrating
their efforts to adjust.
-- There is thus a strong likelihood of increasing trade
disputes on individual products with the debtors.
C. Policy Proposals
1. Domestic
The Administration, recognizing the need for debtors to
improve their current account balances, should: .
? continue to emphasize its commitment to maintaining an
open market,
?.assure U.S. interests fair application of U.S. trade laws.
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- Given general U.S. trade policy considerations and limita-
tions imposed by U.S. trade law, special trade treatment
should not be given to countries because of their debt
difficulties. Rather decisions involving trade with debtors
should be made on traditional trade policy grounds."(If,an
important economic partner gets into major difficulties,
this policy may have to be reconsidered.)
-- Trade objectives should be one element considered by the
U.S. during the negotiation of bilateral bridge financing.
2. International
While continuing to pursue our broader trade policy
objectives, our international objectives with high debt
countries should be to:
? discourage increases in import protection and export
subsidies by the debtors or developed countries that
could create long term distortions in world trade,
? ensure that trade liberalization in debtor countries
actually takes place once the adjustment programs
create the necessary economic conditions.
? seize the opportunity created by the debtors' eventual
trade liberalization to further open and improve the
world trade and investment system.
We should get finance and trade officials of the major
countries together to discuss the linkages between
adjustment, open markets, and finance, thereby reemphasiz-
ing their mutual responsibilities to maintain the inter-
national economic system.
In addition, we should develop policy proposals:
? to improve GATT/IMF/World Bank cooperation,
? to liberalize North-South trade.
To discourage those LDCs experiencing debt-servicing.prob-
lems from adopting additional trade distorting measures
and to encourage liberalization when possible, we should
use our influence in the IMF, GATT, and World Bank.
The OECD Ministerial and the Summit provide further oppor-
tunities to advance U.S. policy.
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Appendix D
Alternative Proposals for Dealing with the Debt Situation
Executive Summary
The Working Group on Alternatives for Dealing with the
Debt Situation reviewed a number of proposals for supplementing
the current debt strategy, with a view towards describing
those proposals and providing a brief analysis of the advantages
and/or disadvantages of each. The Group was not requested to
reach a final conclusion or make any recommendations regarding
further work on any of the proposals. The Group did not examine
all possible alternatives, but dealt only with certain proposals
which have been cited frequently in recent months. '
kbrief description of each of the proposals studied by
the Group follows:
(1) One Year Grace on 1983 Debt: Two proposals have been made,
one for public debt and one for private debt. Both would
provide a one or more year grace period on principal and
possibly on all or some portion of interest, with a
balloon payment due in 1989 or later.
(2) Retroactive Terms Adjustment: As already authorized under
1961 Foreign Assistance Act as amended, dollar-denominated
principal and interest due on official U.S. assistance
would be converted to local currency.
(3) Large-scale Debt Restructurin : Commercial bank credits to
developing countries would be purchased at a discount by a
new international instituion and rescheduled into longer-term
claims at a reduced rate of interest.
(4) Buyout of Small Creditors: Official sources of finance.would
be used to pay off small regional banks anxious to withdraw
from foreign markets.
(5) Exchange Participation Notes: Debtor country central banks
would issue negotiable notes with repayment tied to future
foreign exchange earnings.
(6) Developing Country Debt Corporation: Future lending to
developing countries would be in part through a new quasi-
public institution that would package and guarantee LDC
obligations for sale to private investors, such as non-
bank financial institutions.
(7) Safety-Net for Commercial Banks : Banks would contribute
amounts equal to a small percentage of foreign loans to
a central fund,'to be drawn on if a loan goes bad and
the bank encounters financial difficulties as a result.
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(8) Debt Commission: A neutral body, with representatives
from creditor- and debtor-country governments, would
monitor debt conditions, establish uniform criteria for
debt rescheduling, and help prevent debt crises by?encour-
aging appropriate advance actions.
(9) Secondary Market for Trade Paper: Guarantees by national
export credit insurers and an international institution would
be used to provide sufficient backing for paper to be
resold on capital markets.
Although each of the proposals reviewed had its own parti-
cular set of advantages and disadvantages, many of these advan-
tages and disadvantages were, in fact, common to all or a
majority of the proposals. The advantage of removing uncer-
tainty and building lender confidence, for example, was cited
as an advantage of the proposals for a large-scale debt restruc-
turing, buyout of small creditors, developing country debt cor-
poration (although this proposal is meant as a device for healthy
borrowers), safety-net for commercial banks, debt commission, and
a secondary market for trade paper.
Likewise, an important disadvantage common to many of the
proposals, as described, was that they did not require economic
adjustment on the part of the borrowers. For example, the
proposals for a one-year grace on debt, retroactive terms
adjustment, large-scale debt restructuring, buyout of small
creditors, safety-net for commercial banks, and secondary
market for trade paper are actions that would be implemented
by creditors. Although these proposals would not preclude
inclusion of some means of leveraging debtors to adjust, this
is an area in which several of the proposals need more work.
Finally, some of the proposals were seen to be inappro-
priate because they would be little more than a bailout of the
commercial banks. (Some observers, of course, believe that
virtually any actions taken to ease the current LDC debt burden
would be a bank bailout.) Proposals falling in this category
include large-scale debt restructuring (unless bank debt were
purchased at a substantial discount, in which case the banks
themselves might be reluctant to participate), buyout of small
creditors (albeit a bailout of smaller banks only), and .a
safety-net for commercial banks.
There are a number of factors which need to be addressed
in any analysis of supplementary or alternative proposals.for
dealing with the LDC debt situation, such as selectivity
(countries should be addressed on a case-by-case basis), ease
of negotiation or implementation, and cost. Some of the,
proposals studied by the Working Group did, in fact, address
these concerns; others did not.
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Ultimately, the decision to proceed with any new proposal
will depend on the current financial situation, an assessment
of the current debt strategy, and the need to have or desira-
bility of having supplementary or alternative mechanisms in
place before the situation becomes a crisis. Advantages and
disadvantages acquire different weights depending onthe
nature of the problem one is addressing.
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Appendix E
Evolution of the G-10 Approach to Debt Problems
It is possible to distinguish four stages in the evolution
of the G-10 approach to the debt problems of specific countries.
STAGE I: Rescheduling Export Credits, 1956-65
The first debt crisis of the post-WWII era was that of
Argentina in 1955-56. The other countries that sought debt
relief in this period were also among the most advanced LDCs:
Turkey, Brazil, and Chile. (See Table.) In each case, except
Brazil's, debt servicing problems followed a period in which
credits from the G-10 countries, primarily export credits had
expanded rapidly. In the late 1950's, adverse cyclical export
trends were also an important factor leading to debt-servicing
difficulties. In the early 1960's, however, export trends ?
were generally favorable, and the problems related to bunching
of debt service payments and to poor economic management.-
The procedure created to ensure equitable burdensharing
among the various export credit agencies came to be called. the
"Paris Club", an ad hoc forum chaired by. an official from the
French Treasury, in which payments falling due on direct credits
and guaranteed credits were rescheduled over seven to 12 years.
(The Turkish rescheduling was handled in the OECD aid consortium
rather than in the Paris Club.) Concessional credits were
explicitly excluded from rescheduling. There was little parallel
relief from commercial banks, except in the 1961 case of Brazil
where additional credits were arranged informally.
STAGE II: Aid Reschedulings, 1966-76
The second stage was dominated by rescheduling operations
involving India and Pakistan. In both of these cases, export
credits were explicitly excluded. Payments on ODA loans were
rescheduled on highly concessional terms, i.e., a grant element
of up to 62 percent. Another innovation was the use of debt
relief deliberately as a.substitute for aid, since in several
instances the countries were not in a position of default or
imminent default.
This stage. also brought the first large-scale debt "work-
outs." Indonesia's debt was rescheduled over thirty years,
with no interest charged on the rescheduled amounts. Ghana's'
debt was rescheduled over twenty-eight years. Institutionally,
the India and Pakistan reschedulings were done in aid consortia,
and the rest were mostly done in the Paris Club.
The countries involved were generally not the most advanced
LDCs, but they were. all in the upper half. During this stage,
foreign aid from the G-10 countries and from multilateral
institutions was growing rapidly and was being coordinated
within consultative groups or aid consortia.
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E-2
While some countries had sought relief from a small number
of banks prior to the mid-1970's, there do not appear to have
been any significant commercial bank reschedulings during this
stage. ..
STAGE III: Mixed Rescheduling, 1976-1980
Zaire developed serious debt problems in 1976; it presented
the first case in which burdensharing between official and
private creditors became a serious issue. The commercial banks
(led by Citibank) argued that they should be preferred creditors.
The G-10 governments refused to accept this position and con-
ditioned debt relief in 1979 upon "comparable" debt relief
from banks. The banks finally gave in.
This period saw a rash of reschedulings linked to the OPEC
oil-price increases, related OECD recession, and economic mis-
management. The first of a long line of small, low-income
commodity exporters from Africa came to the Paris Club: Sierra
Leone, Togo and Liberia. Most of the countries encountering
debt problems in this period sought relief in the London Club
as well,as the Paris Club.
The big rescheduling of this period was Turkey: the
first in which the G-10 countries rescheduled more than $1
billion in official credits, the first in which "special pledg-
ing" of balance of payments assistance from donor governments
was required, and t-he first in which- commercial banks had to
provide as much debt relief as the governments (although they
were not required to provide new financing). The burden of
coordinating the inter-related financing operations (including
almost $900 million of structural adjustment loans from the
IBRD) fell primarily on the IMF, but the job as facilitated
by the OECD which provided a forum for both the special pledg-
ing and the official debt relief.
During this period, both the Paris Club. and the London
Club, "hit their stride." Some modest improvements in Paris
Club procedures were adopted which preserved, however, its ad
hoc case-by-case character in the face of LDC demands for
institutionalizing debt relief. Significantly, the existing
approach to debt relief received a form of international
endorsement in a debt resolution adopted by the UNCTAD Trade
and Development Board in 1980.
The approach to Nicaragua's debt problem was an important
departure from the usual approach in this period. On the offi-
cial side, the G-10 could not agree to linking debt relief to
an IMF arrangement, and three countries proceeded to negotiate
bilateral relief arrangements. On the commercial bank side, the
London Club agreed for the first time to capitalize some interest
payments.
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STAGE IV: Problems Everywhere Except Asia, 1981-1983
In Stage III, 11 countries completed debt-relief.. negotiations
with official and/or private creditors. Since then, 25 countries
have completed such negotiations, and another 5 to 10.,.countries
are negotiating arrangements. More importantly, some of the
world's biggest debtors experienced difficulty in this period,
notably Mexico, Brazil, Argentina, and Poland.
Up to this stage, an informal and ad hoc approach has
been adequate, and preferable to a more organized approach
that could encourage countries to seek recourse to debt relief.:
The number of negotiations underway, and the amounts involved,
now appear unmanageable without a more coordinated approach.
On the private bank side, an important step has been taken
with the establishment of the Institute of International Finance.
The major shortcoming at the present time seems to exist on
the official side.
The only existing mechanism for coordinating official
action in response to debt problems is the Paris Club. In
theory, the Paris Club could be upgraded,to assume a larger
role. This possibility was discussed at length within the
Paris Club in February 1983, but strong resistance to the idea
was expressed. In particular, it was felt that the Club would
be most effective if it remained as a technical body with a
"debt-collection" orientation. It was pointed out that decisions
on debt relief and decisions on new aid tend to be made in
different parts of the creditor-country governments. Further-
more, it was considered important for the official creditors
to negotiate separately from commercial banks since the interests
of each group could be quite different.
There are also administrative considerations. As the
frequency of negotiations has increased, the burden of preparing
for them has multiplied. This burden now falls entirely on
the French Treasury which has difficulty coping with the present
workload. In particular, it has not been able to analyze
options or establish.an effective exchange of debt-servicing
information in advance of negotiations. A final concern is
that the Paris Club gives the government of France a dispropor-
tionate influence over the outcome of debt negotiations.
An approach which allowed different countries to take
the lead in the more complex cases, and which was supported by
a staff undistracted by other responsiblities, could provide
more effective coordination of action by G?-10 countries,. leav-
ing the Paris Club to handle the "normal" cases where the debt
problem could be solved without bridging operations or special
.aid pledges or coordinated action with private banks, or extra-
ordinary debt relief.
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t;-4
Debt Problems Since 1956
COUNTRY YEAR
STAGE I: Rescheduling
Argentina: 1956
1962
1965
OFFICIAL RELIEF BANK RELIEF
is ,.,:,,.___.
Export Credits, 1956-1965
$500
$240
$76
Turkey: 1959
1965
Brazil: 1961
1964
Chile: 1965
4 countries 8 negotiations
$400
$220
$300
$200
$76
$2012
STAGE II: Aid Rescheduling, 1966-75
1966
1968
1970
1974
$170
$100
$25
$290
Indonesia: 1966 $247 M
1967 $95
1968 $85
1970 $2100
Peru: 1968 $58* 1969 $70*
India: 1971
1972
1973
1974
1975
Pakistan: 1972
1973
1974
Cambodia: 1972
Chile: 1972
1974
1975
7 countries 22 negotiations
* = atypical for the stage
$92
$153
$187
$194
$167
$234
$103
$650
$258* +S
$462*
$230*
$5972
($ m,il lions )
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COUNTRY
YEAR
OFFICIAL RELIEF
BANK RELIEF
($ millions)
($ millions)
STAGE III: Mixed Rescheduling, 1976-1980
India:
1976
$200*
1977
$110*
1976
$270
1977
$210
1979
$1040
1980
$402
Sierra Leone: 1977
$39
1980
$37
Jamaica:
1978
$63
1979
$300
$149
-Turkey:
1978
$1300
1979
$1200
$2760
1980
S3000
.
Peru:
1978
$420
$386
1980
$487
$340
Sudan:
1979
$480
Togo:
1979
1980
$69
Liberia:
1980
$35
Bolivia:
1980
-
Nicaragua:
1980
(bilateral)
11 countries
23
i
$562
negot
ations
$8608
$4887
STAGE IV: Problems Everywhere Except Asia, 1981-1983
Nicaragua: 1981
-
Jamaica: 1981
$180
-
A
Bolivia: 1981
$89
-
Pakistan: 1981 216
$416
Togo: 1981 232
1983 100e
* = atypical for the stage
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COUNTRY
YEAR OFFICIAL RELIEF
BANK RELIEF
($ millions)
($ millions)
Poland:
1981
$2300
1983
$2300?
Madagascar:
1981
$140
1982
$107
1983
$195
CAR:
1981
$72
Zaire:
1981
$500
Senegal:
1981
$75
1982
$74
Uganda:
1981
1982
$30$19
Liberia:
1981
$30
1983
-
$50e
Turkey:
1982
-
$2900
Sudan:
1982
$80
$400e
1983
$536
Guyana:
1982
$14
Romania:
1982
$234
$1600
Malawi:
1982
$25
$42
Mexico:
1982
$18500
Costa Rica:
1983
200e
Brazil:
1983
-
$4700
Cuba:
1983
-
$1000
Ecuador:
1983
-
$2050
Argentina:
1983
-
$9000
Chile:
1983
$2600
Yugoslavia:
1983
-
$1400
25 Countries
38 negotiations
$4870
$49813
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