LDC DEBT PROBLEMS: OUTLOOK TO 1990

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP90T00114R000404400003-4
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 44
• Document Creation Date: December 22, 2016
• Document Release Date: February 22, 2012
• Sequence Number: 3
• Content Type: REPORT

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An Intelligence Assessment
This paper was prepared by Office of Global Issues. Comments
and queries are welcome and may be directed to the Chief_ International
Finance a...,
nch OGI
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LDC DEBT PROBLEMS: OUTLOOK TO 1990
Contents
Key Judgments .............................................
Preface .................... ............................
The Current Setting .......................................
The Record Since 1982 .....................................
Key Elements in the Future ................................
The Trade Problem .....................................
Weak Commodity Prices .................................
The Impact of Exchange Rates ..........................
Interest Rates ........................................
External Financing ....................................
The Role of Direct Investment .........................
LDC Domestic Policy Changes...........................
A Pessimistic But Manageable Scenario .....................
Effect on Debtor Countries ................
The Impact on Commercial Banks ........................
Downside Risks ............................................
A More Optimistic Scenario ................................
A New Risk ................................................
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Key Judgments
Brazil's unilateral suspension of interest payments has plunged the
international financial system into a new dangerous phase. Driven by a
rapidly deteriorating economy, a plunging trade surplus, soaring inflation,
and growing political pressures, Brasilia is confronting international
bankers with demands for sharply lower interest payments, some $2 billion
in new money, and no IMF conditionality. Other debtors, notably Argentina,
Dominican Republic, Chile, Ecuador, and perhaps the Philippines, may follow
suit. This situation will not necessarily end in a dramatic outcome or a
new approach to Third World debt problems, however. All parties have a
great deal to lose from a complete breakdown of negotiations, and strong
incentives exist to keep both sides at the table.
Even resolution of the current Brazilian imbroglio, however, will not
set Third World debt problems on a smooth path toward resolution. We
believe the best outcome that can be expected over the next few years will
be a lurching from crisis to crisis. While the odds are good that each
time a solution will be reached, albeit in many cases after further rounds
of brinksmanship by both debtors and creditors, there is a strong risk that
other actors eventually will balk, threatening a collapse of the debt
strategy and causing major financial problems for debtor countries and
creditor banks and governments. In our view, the risks of this outcome
will continue to rise, with banks becoming increasingly reluctant to
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provide new money or make concessions and debtors upping their demands for
If the current strains between debtors and creditors were based on
temporary economic conditions, we would be less concerned about the next
few years; as economic conditions improved, so would the debt negotiation
atmosphere. Our examination'of the factors that will affect the LDC debt
situation in this period, however, indicate the underlying trends will get
no better.
o World trade will not grow rapidly enough to alleviate LDC
debt service burdens. The IMF projects a 3.5 percent increase in
world trade in 1987, roughly the same growth rate as that
predicted for LDC debt and no more rapid than in 1985-86.
o Interest rates seem certain not to go much lower than current
levels and more likely will increase over the rest of the decade.
According to the major forecasting services, interest rates will
rise by two percentage points over the next three years, a
reversal of the downward trend since mid-1984.
o Commodity prices could recover slightly, but we believe they
will remain far below levels necessary to bring a major
improvement in LDC export earnings.
o Pressures for protectionism in industrial countries, particularly
in Europe, seem likely to grow rather than abate, which will
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continue to restrict LDC export growth, in our judgment.
At the same time, we anticipate that political constraints will prevent the
kind of reform needed to increase debtor country competitiveness.
Moreover, without tangible moves toward improvements by debtor governments,
commercial banks will continue to restrict the growth of new lending to
LDCs.
In addition to what we see as insufficiently favorable economic trends,
our concern about the outlook for the debt situation is heightened by our
belief that debtor attitudes and negotiation stances are hardening. In our
view, Brazil's actions are symptomatic of a generally changing attitude in
nearly all debtors. While debtor demands are not new, we detect a markedly
increased toughness and arrogance in their present stances. In our
judgment, these harder, more forcefully stated positions are not just
negotiation ploys; rather, they represent a growing general perception
among debtors that it is time for developed country governments and banks
to bear more of the burden of the debt. Even if the current problems with
Brazil are resolved, we do not see debtor's negotiating toughness ebbing.
Indeed, each additional bailout of a key debtor will harden these attitudes
further, making it more difficult to reach agreements on debt.
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Preface
This paper is part of an ongoing DI effort to monitor and assess the
status and implications of the international debt situation. In this
effort, the LDC debt situation is monitored both through cross-cutting
papers such as this one and through examinations of the debt situation in
specific countries.
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LDC DEBT PROBLEMS: OUTLOOK TO 1990
The Current Setting
Third World debtors and creditors appear to be on another collision
course. This time the crystallizing problem is Brazil, where rapid
economic deterioration, underscored by a plunging trade surplus and soaring
inflation, is accompanied by growing domestic political pressures. As
a result, Brasilia has taken a confrontational stance in negotiations with
commercial creditors by declaring an interest moratorium and demanding from
bankers a sharply lower interest spread, some $2 billion in new money, and
no IMF conditionality. Chile and Ecuador also have stridently demanded new
concessions such as retiming of interest payments; and Chile has received
much of what it asked for.
Argentina and. the
Dominican Republic also are actively considering moratoriums. At the same
time, completion of the Mexican package, which contains unique terms such
as a linking of debt payments to oil prices and economic growth rates,
continues to be held up by the reluctance of many regional US and foreign
banks to sign on to the agreement.
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The common thread in all the current negotiations -- including those
involving Brazil, Chile, the Philippines, Ecuador, and Venezuela -- is that
debtors are taking stronger stands while creditor banks and governments
increasingly are divided. In our judgment, the debtors -- best symbolized
by Brazil -- are being spurred by growing domestic protests over their
deteriorating economies as well as a perception that their leverage over
creditors is substantial. Threats of interest payment delays or reductions
are becoming bolder. Debtors probably reason that the commercial banks are
not in a strong enough position or united enough to deal with a major
writeoff of loans, while official creditors are unwilling to step in and
assume the burden from the banks. Moreover, recent publicity about banks
building reserves against future writeoffs probably is leading debtors to
conclude that their leverage will wane over time.
Even with these preconditions in place, an impasse or breakdown will
not necessarily ensue. Both parties have a great deal to lose from a
complete breakdown of negotiations, and strong incentives exist to keep
both sides at the table. In these circumstances, the skill of the
individual negotiators and the ability and willingness of the debtors and
creditor banks and governments to make the hard choices and compromises
will be pivotal.
The Record Since 1982
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The debt problem has changed in several aspects since it first emerged
as an international issue in 1982. To sustain debt servicing individual
debtors have undertaken economic adjustment programs under the auspices of
the IMF in exchange for debt restructuring and additional new funds from
creditor governments and commercial banks. This strategy has avoided a
default or repudiation involving a major debtor, as well as a collapse of
major banks, while slowing the growth of LDC debt. The basic debt problem
nonetheless remains. Almost every year, some major debtor has had to again
restructure its debt, often in a strained, crisis atmosphere. Last year,
creditors completed another arduous round of negotiations with Mexico; this
year, they face rigorous talks with Brazil and probably Argentina.
The most important factor that has prevented a solution to the debt
problems of the Third World, in our judgment, is that world trade has moved
sharply against LDCs; indeed, except for 1984, LDC exports have increased
below historical norms every year since 1980. As a result, instead of
being able to resume some import growth while maintaining their trade
surpluses, LDCs have had to continue to restrict imports because of reduced
export earnings. Even where volume growth occurred, prices fell so sharply
during the past few years that the increases in volume did not offset the
decline. The oil exporters bore the brunt of the burden, with a 46-percent
drop in export earnings this year, according to IMF estimates, but
non-oil-exporting LDCs also suffered from a 12-percent fall in their export
earnings because of weaker primary commodity prices and slower industrial
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country growth:- -Trade., protectionism--. industrial countries, particularly
restrictions on imports from LDCs, also contributed to LDC trade problems.
Although debtors have benefited substantially from declining interest
rates, these gains have been offset somewhat by reduced amounts of new
lending and restrictions on LDC access to international capital markets as
banks' concern over LDC financial problems grows. Voluntary lending now
goes to a limited number of LDCs that are the least risky, primarily in
East Asia. For countries with debt problems, new financing comes in the
form of involuntary lending as part of restructuring packages. Bank
portfolios are also being adjusted, with banks -- mostly US regionals and
foreign banks -- swapping, writing off, or converting to equity in debtors
countries some or all of their loans; such activity serves to limit the
banks' incentive for future lending.
(TABLE 1)
Meanwhile, debtor countries have borne almost all of the financial
adjustment. For example, the $37 billion improvement in the aggregate
Latin American current account position in 1982-85 was due primarily to
import declines totaling $21 billion, in contrast to export increases of
only $5 billion. As a result of this pattern, the pace of aggregate LDC
GNP growth also has fallen, from an average of 4 percent in 1977-81 to 2.5
percent in 1982-86. In addition, Latin America has experienced a net
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Table 1
Improvements in Current Account Balances, 1982-85
Total
Improvement
Increased
Exports
(Billion
Due To
Import
Cutbacks
US $)
Other
Changes*
Argentina
1.4
0.8
1.4
-0.8
Brazil
16.0
5.3
6.3
4.4
Chile
1.0
0.0
0.6
0.4
Colombia
1.7
0.6
1.7
-0.6
Mexico
6.6
0.6
0.8
5.2
Nigeria
8.5
0.5
6.6
1.4
Peru
1.6
-0.3
1.8
0.1
Philippines
2.9
-0.4
2.6
0.7
Venezuela
7.1
-2.1
6.2
4.1
* Includes changes in services and private transfers.
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outflow of funds over the past several years and has seen per capita income
levels fall to no better than late-1970s' levels. In contrast, most of the
major banks involved in Third World lending have continued to receive the
interest payments on these loans, albeit at occasionally reduced spreads
above base interest rates such as LIBOR or the US prime.
Key Elements in the Future
The variables that will most affect the LDC debt situation over the
next five years include: external trade, commodity prices, interest rates,
external financial flows, and industrial country and LDC economic policies.
we believe the collective
outlook for these variables will not be conducive to major improvements in
the LDC debt situation over the-next five years, and they probably will
leave LDCs not much better off in terms of debt service, capital balances,
and per capita incomes than they are today. Specifically, we expect slow
growth of world trade, limited improvement in commodity prices, higher
interest rates, continued slow growth of bank lending and foreign
investment, and less-than-optimal changes in debtor and creditor country
policies.
(TABLE 2)
The Trade Problem
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TABLE 2
Key Economic Trends: Average Annual Figures
197
9-82
19
8
3-86
1987-91*
Growth of World Trade
(Percent)
5
3
4
OPEC Oil Price
($/bbl)
29
27
20**
Real Non-Oil Commodity Prices
(Percent Change)
-3
-5
+3
Nominal Interest Rate- LIBOR
(Percentage Points)
14
9
7
Real Interest Rate- LIBOR
(Percentage Points)
6
5
4
LDC Net External Borrowing
(Billion US $)
91
47
40
Foreign Investment in LDCS
(Billion US $)
11
10
12
LDC Total Debt/Exports Ratio
(Percent)
100
150
140
LDC Total Debt/GNP Ratio
(Percent)
35
48
45
LDC Debt Service/Exports Rati
(Percent)
o
18
21
20
LDC Interest Payments/Exports
10
12
11
Ratio (Percent)
* Projected
** Market Prices
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We and other observers expect world trade to grow no faster over the
rest of the decade than it did over the last two years, an annual growth
rate of barely 3 percent in volume terms. Several factors will contribute
to this projected slow growth.
o The lack of a strong revival of trade in primary commodities, in
turn due to slower than previous OECD economic growth and
widespread structural changes.
o The threat of greater protectionist measures in industrial
countries, particularly with regard to trade in manufactures, an
important component of exports for many LDCs.
o An expectation of slow progress in LDC domestic adjustment, along
with limited support for that process from foreign creditors, that
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In our judgment, the weak outlook for world trade will be the key
external economic factor constraining resolution of the debt crisis. The
need for a large number of debt-troubled countries simultaneously to run
large trade surpluses will again put the onus on the developed countries to
run trade deficits. For this to be successful, however, other OECD
countries besides the United States will have to do more to absorb LDC
exports. In the event US growth slows from its present 3 percent pace or
the US trade deficit shrinks, possibilities that will become more likely
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over the next few years, the outlook for LDC exports will not be as
promising.
Weak Commodity Prices
Even with no increases in volume, the LDC trade picture could improve
if there was a rebound in the prices of LDC exports. The aggregate non-oil
commodity price index currently is almost 30 percent below its long-run
average in real terms, with most commodities at their lowest levels in the
past 40 years. Non-oil commodity prices fell by an estimated 18.5 percent
in real terms during 1986, according to the IMF. The weakness in prices
for agricultural commodities can be attributed largely to an oversupply of
many goods brought on by favorable growing conditions, the adoption of more
market-oriented pricing policies in many LDCs, agricultural subsidies in
industrial countries, and increased productivity in certain LDCs.[:]Metals
prices, on the other hand, have suffered from reduced demand as well as
increased mining capacity and substantial cost reductions in metal
production.
(TABLE 3)
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Table 3
Non-Oil Commodity Prices
Commodity
Unit 1979-82
198
86
3-
Key LDC Ex
ort
p
ers
Aluminum
Cents/lb 64
56
Brazil, Jamaica,
Cocoa
Guinea
$/lb 1.10
1.01
Ivory Coast, Brazil,
Coffee
Ghana
$/lb 1.41
1.44
Brazil
Colombi
Copper
Cents/lb 84
65
,
a
Chil
Z
Cotton
Cents/lb
82
68
e,
ambia, Peru
Egypt
India
Hardwood
$/Cu.Meter
160
142
,
Malaysia
Indon
i
Iron Ore
$/ton
25
23
,
es
a
Brazil
Indi
Maize
N
$/ton
120
117
,
a
Thailand
Ar
entin
atural Rubber
Cents/lb
53
40
,
g
a
Malaysia, Indonesia
,
Thailand
$/ton
563
494
Malaysia, Singapore,
Indonesia
$/ton
386
240
Thailand, Burma,
So
beans
Pakistan
y
$/ton
280
249
Brazil
Argentina
Soybean Meal
$/ton
243
194
,
Brazil
Ar
entin
Soybean Oil
$/ton
554
542
,
g
a
Brazil
Ar
enti
Sugar
T
Cents/lb
16
6
,
g
na
Brazil
Phili
i
ea
$/kg
2.09
2.42
.,
pp
nes
India, Kenya,
Tin
Sri Lanka
Cents/lb
672
488
Malaysia
Indon
i
Wheat
$/ton
167
140
,
es
a
Argentina, India
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Most observers do not expect a major recovery in commodity prices in
the near term. Many of the factors that led to the current oversupply and
weak demand will remain, including sluggish growth in industrial production
in developed countries, government agricultural subsidies in producer
nations, inventory reductions resulting from high real interest rates and
low inflation expectations, and foreign exchange shortages in many LDCs.
The Impact of Exchange Rates
LDC exchange rates should continue to depreciate if the US dollar
declines over the next few years, improving LDC trade prospects and their
ability to service debt; major econometric forecasting units, for instance,
foresee continued declines of the US dollar vis-a-vis other major
currencies as Washington seeks to reduce its trade and budget deficits.
According to a UN study, for example, a 20-percent fall in the nominal
effective exchange rate of the dollar over three years -- 1986-88 -- will
yield a positive growth effect on LDCs because of improvement in
dollar-denominated commodity prices, an increase in LDC exports to the
United States to replace exports from Japan and the EEC, and a lowering of
the burden of dollar-denominated debt. Depreciating LDC exchange rates,
however, will not be enough by themselves to substantially ease the debt
problem.
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Some improvement in this area already has occurred as LDC real exchange
rates declined sharply during 1985-86, a result of many LDC currencies
being tied to the dollar, or even depreciated against it. On a weighted
average basis, LDC real exchange rates have fallen by an estimated 20
percent since early 1985. We expect these declines to help improve the
external competitiveness of many of these countries. The gains will be
limited, however, by the fact that most of the increased competitiveness
has occurred vis-a-vis Europe and Japan, which are relatively less
important markets for these countries' exports. Competitiveness gains in
the much more important US market have been much less. Nonetheless,
exchange rate changes should help LDCs recover some losses in export market
shares that occurred when their currencies appreciated with the US dollar.
(TEXT BOX 2)
Interest Rates
Changes in world interest rates will continue to have a direct and
visible impact on LDCs; each one percentage point shift in major interest
rates -- LIBOR and the US prime rate -- equates to a $11-5 billion movement
in interest payments on debt. The largest debtors, Mexico and Brazil, are
the most affected, with an $800 million change for each percentage point.
Changes in interest rates also affect deposits held by LDCs in foreign
banks, although this impact is much smaller than that of interest payments
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TEXT BOX 2
THE IMPACT OF INDUSTRIAL COUNTRY POLICIES ON LDCS
The policies undertaken by the industrial countries will continue to
have a large influence on the outlook for developing countries, especially
as these policies affect trade, exchange rates, and interest rates. In the
short term, we believe industrial country governments will continue to
emphasize controlling inflation and reducing budget deficits, while trying
to maintain steady economic growth. The effect of these policies on debtor
countries will depend on how these restrictive policies are implemented
vis-a-vis maintaining growth and how stable exchange rates and sustainable
current account balances are attained, optimal
industrial country policies -- such as sca restraint, more flexible
monetary policy, and reduced trade barriers -- could add 1.75 percentage
points annually to major debtors' growth rates, while inefficient policies
could cut growth by 3 percentage points. Debtors that rely on official
financing will benefit much less because economic developments in those
countries generally reflect changes in domestic policies rather than those
of Indust,; ,i
F_ i
tr
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because of the limited amount of deposits held by government entities.
The forecasts vary as to the magnitude of future interest rates, but
none call for major declines similar to those that benefited debtors over
the past two years. In the short-term, most of the econometric forecasting
units show a slight decrease in interest rates in 1987, with rates
beginning to climb again in 1988. For the longer term, interest rates
generally are projected to rise until 1989 and then decline through the
mid-1990s.
(CHART 1)
External Financing
LDCs will remain dependent on external sources of funds, both official
and private. Despite the recent declines, foreign borrowing is second to
export earnings as a source of funds for LDCs. We believe the prospects
for major increases in lending to LDCs, however, are extremely poor, given
the ongoing financial problems of these countries and renewed emphasis by
banks on voluntary lending to only the most creditworthy countries. More
likely, debtor countries will receive at best a small increase in lending
from banks.
The most consistent source of funds will remain official lenders --
governments and multilateral institutions. The slow but steady growth of
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CHART 1
WORLD INTEREST RATES
NOMINAL
3-MONTH UBOR
REAL
3-MONTH UBOR
1978 79 80 81 82 83 84 85 86 87* 88* 89* 90* 91*
*Wharton estimates
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official loans has been the primary source of funds for most smaller
debtors, many of which have chronic economic problems rather than strictly
debt-related problems, and even for some of the medium-sized debtors such
as Bolivia, Egypt, and Morocco. Bilateral lending from OECD countries is
projected to increase at a rate of 2-3 percent over the next few years, or
about $1 billion annually; this rate is about the same as that of the
period 1982-86. Additional increases beyond this projection, in our
assessment, are unlikely because of developed country budget restrictions.
Multilateral lending is being counted on by some observers to assume a
greater role in LDC financing, both through greater loans and more
cofinancing deals with private lenders. The World Bank -- the largest
multilateral lender -- will be under pressure from debtors and some other
creditors for not doing enough to stimulate capital inflows to LDCs.
Indeed, the results for the fiscal year that ended on 30 June 1986 show
that total repayments from LDCs to the World Bank exceeded new
disbursements. One of the primary goals of new IBRD president Conable is
to strengthen the role of the World Bank and become more involved in
ensuring continued lending to LDCs. We believe it will take several years
to build up this capacity, however, and also will depend on a firm
commitment from member countries to underwrite a general capital increase,
a questionable proposition at best because of some budgetary constraints
that will restrain growth in bilateral lending.
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(CHART 2)
We see almost no chance that lending from private sources -- primarily
commercial banks and historically the largest source of funds for LDCs --
will rebound in the next few years. Since the onset of the debt crisis in
1982, the growth of bank lending has slowed sharply, in sharp contrast to
the LDC borrowing boom of 1978-81. Medium-term syndicated loans have
become scarce, except in the case of IMF-led rescue packages, with only a
limited number of countries like South Korea and Malaysia still considered
favorable credit risks. Short-term credit lines also have been reigned in
as banks seek to limit their exposure to manageable levels.
The banks probably will continue at a pace of a 3-5 percent increase in
lending each year, with as much as half of this amount made on an
involuntary basis, in order to allow the debt-troubled countries to remain
current on their interest payments. Trade-related financing will move in
relation to the volume of trade activity, but medium-term credits will only
be extended for specific projects. Even then, many lenders will insist on
some form of government or multilateral institution guarantee. Any
increase in the amount of loan writeoffs and loan loss reserves without
regulatory adjustments also will prevent a quick resumption of large scale
bank lending to LDCs.
The Role of Direct Investment
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T
CHART 2
PRIVATE SOURCES: NET NEW LENDING TO LDCS
80 25X1
1 Bllllon US $
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 ___ i LI L,I y. , II
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Foreign direct investment is viewed by some observers as a way to make
up for reduced lending flows from commercial banks. Investment flows,
however, usually follow those of bank lending, with investors tending to be
more cautious than banks in investing capital in LDCs. Direct investment
is more productive than bank lending from the LDCs' standpoint, but the
problem of net outflows still exists, and investment flows will not be
large enough to substitute for bank lending. Over the past ten years,
investment flows generally have been equivalent to only 10-15 percent of
bank lending.
Although many LDCs -- particularly in Latin America -- have embarked
on foreign investment promotion drives, IMF forecasts project only slight
growth in foreign investment over the next few years. Investment flows to
LDCs are expected to be $12-13 billion in 1987 and 1988, down from the high
mark of $14 billion in 1981. The reasons for the slow growth include:
o Limited economically viable investment opportunities. While
good investment opportunities exist in most countries, they tend
to be small-scale operations that are not well developed and
consequently hard to identify. Certain industries deemed to
be in the national interest, such as energy-related industries,
are usually the best known to investors but will remain
untouchable for foreigners.
o Foreign ownership restrictions. Many countries have laws
requiring majority local ownership. Mexican law, for example,
13
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requires that local ownership hold at least a 51-percent stake
in foreign investments in Mexico unless special exception is
made by the government.
o Exchange restrictions. The presence of restrictions on
access to foreign exchange for domestic firms along with
limits on repatriation of profits abroad also will hinder
new foreign investment.
o Long-term security. Prior actions or threats of government
interference such as nationalization or expropriation will turn
away foreign investors.
LDC Domestic Policy Changes
One positive outgrowth of the ongoing debt problem is that LDC economic
policymakers appear to be more aware of the importance of proper economic
adjustment policies. Several trends indicate that steps are being taken in
the right direction.
o LDC exchange rates are becoming more realistic, after being
overvalued for a number of years.
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o Domestic interest rates in LDCs are being adjusted to levels that
encourage domestic savings ahead of foreign savings.
o A growing number of countries are gradually loosening some of the
barriers to new direct foreign investment.
Although these steps are positive, in most cases we do not see them as
nearly enough to placate creditors and stimulate a return to voluntary
lending because problems with inflation and controlling the public-sector
budget deficit -- partly because of a reluctance to cut subsidies -- will
continue to hinder adjustment efforts of many LDCs. Moreover, creditors
remain concerned that debtor country governments will backtrack on
implementation of these policies as soon as their current accounts turn
around or if pressed politically for more populist economic policies. In
addition, continued capital flight indicates that local populations are not
yet confident of the ability of their governments to manage the economic
situation.
The privatization effort in LDCs, in our judgment, also is proceeding
on an uneven course. Debtors have long been burdened with large,
inefficient state-owned enterprises and, at the same time, have hindered
the growth of the private sector by implementing excessive government
controls and restrictions. However, the selling off or restructuring of
public-sector firms has been a domestically unpopular move politically for
most countries, and we expect that further changes will be slow in coming.
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In contrast to internal adjustments, debtors have been far more
successful in making external adjustments since 1982, but we believe they
will not be able, or willing, to do much more. The generation of large
trade surpluses has reduced financing needs but has come at the expense of
slower economic growth, higher inflation, and lower standards of living.
Moreover, the trade surpluses were brought about by sharply restricting
imports rather than boosting exports. These countries will be hard pressed
to spur economic growth without increasing imports and thereby eroding the
trade surpluses.
A Pessimistic But Manageable Scenario
Under the conditions outlined above, we believe the LDC debt situation
over the next several years will be marked by a lurching from crisis to
crisis. Although strong forces will encourage eventual agreement to end
each crisis, in many cases brinksmanship by both debtors and creditors will
occur. In these circumstances, we expect both sides to seek to do only the
minimum necessary to avoid any serious disruption. Nonetheless, each
individual country we have examined would continue to face debt servicing
requirements that stretch their ability to meet unless considerable new
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flows of funds become available.
Effects on Debtor Countries
If debtors and creditors are able to eventually work out each
subsequent crisis, we see little incentive for debtors to significantly
alter their slow movement toward economic adjustment over the next several
years. The short-term benefits from implementing serious economic reforms
still will not be great enough to offset the political risks for LDCs faced
with substantial domestic dissatisfaction, net outflows of capital, and
declining standards of living. LDC governments generally will concentrate
on the short run in their views; they will talk about long-term solutions
but will want immediate results. At the same time, most LDCs will realize
that they need to play the negotiating game with creditors,. although
domestic pressure could force debtors to take more drastic actions -- as
Peru has done -- such as debt payment limitations.
Prospects for individual debtor countries vary considerably. Each
debtor is unique, such that LDCs which are grouped by similar
characteristics -- such as oil exporters, middle-income countries, or large
debtors -- will have vastly different results. For example, the two
largest debtors, Brazil and Mexico, have nearly opposite medium-range
outlooks. Most financial observers believe that Mexico will continue to
face problems over the next five years because it will still be far too
dependent on oil earnings. Brazil, on the other hand, will have some
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developing their industrial sectors.
short-term liquidity problems, but its diversified economy makes the
long-term outlook much more encouraging. Debtors that are highly dependent
on commodity exports -- including Chile, Peru, and the Ivory Coast -- as
well as oil exporters will have to seek to reduce that dependence by
(TABLE 4)
economic outlook as debt restructurings become a regular event.
There also may be a spreading of debt problems to countries that
previously had avoided or had only occasional difficulties, in our
judgment. For example, a number of East Asian debtors, including
Indonesia, Malaysia, and Thailand, could require debt relief within the
next two years, largely as a result of low oil and other commodity prices.
Other countries such as Egypt and the Philippines face the prospect of
repeated debt problems over the next five years. In addition, sub-Saharan
African LDCs appear to have little chance of improving their already poor
Meanwhile, we believe political pressures within debtor countries also
will continue to build. Most Third World political observers expect
increased dissatisfaction with ongoing debt problems as LDC living
standards remain depressed; as perceptions build that the notion that
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Table 4
Key Debtors: Medium-Term Prospects
Floating Rate Manuf
Share of Debt Share
(Percent) (Perc
actures Oil Imports
of Exp /Exports
ent) (Percent)
General
Medium-Term
Outlook
Oil Importers
Argentina
82 .
18 6
Fair
Brazil
81
56 25
Fair
Chile
85
25 15
Fair
Colombia
53
15 11
Fair
Philippines
66
36 16
Poor
South Korea
63
95 18
Good
Major Problem Areas
Argentina
Brazil
Chile
Colombia
Philippines
South Korea
Domestic spending; large foreign debt
Overheated economy; short-term borrowing needs
Dependence on commodity prices; high debt level
Diversification of exports
Dependence on commodity prices; economic management
Large debt; susceptibility to world trade slowdown
Floating Rate
Manufactures
Oil Exports
General
Share of Debt
Share of Exp
/Exports
Medium-Term
(Percent)
(Percent)
(Percent)
Outlook
Oil Exporters
Egypt
32
18
38
Poor
Indonesia
37
8
67
Fair
Mexico
84
26
68
Poor
Nigeria
84
2
97
Poor
Peru
50
18
18
Poor
Venezuela
91
7
91
Fair
Egypt
Indonesia
Mexico
Nigeria
Peru
Venezuela
Major Problem Areas
Drop in oil, remittance revenue; domestic spending
Adjustment of spending to lower oil revenues
Diversification of exports; domestic spending
Diversification of exports; poor economic management
Relations with creditors and investors
Adjustment of spending to lower oil revenues
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 L u.
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these countries would only require a one-time dosage of adjustment measures
has proven to be false, this dissatisfaction likely will intensify. As
time goes on, making the necessary serious economic adjustments will be
much tougher for LDC leaders than if they had made them when debt problems
first broke out because of the built-up public resistance and the
requirement that the adjustment be much greater to resolve the added
problems built up during the interim period.
The Impact on Commercial Banks
In this scenario, we believe the international financial system will
remain vulnerable to LDC debt problems. Despite commercial banks'
concerted efforts to strengthen their balance sheets through increases in
capital and loan loss reserves, they remain heavily exposed to LDCs. A
payment stoppage by Brazil or Mexico -- or a combination of two or more
other large debtors such as Argentina and Venezuela -- would cause serious
earnings losses for banks and could threaten the solvency of some major
banks, particularly in the United States.
Meanwhile, we believe further confrontation will stimulate the
metamorphosis in the commercial banks' relationship with debtor countries,
even those LDCs that have not previously experienced debt problems. The
growing reluctance of commercial banks to provide any new medium-term, and
in some cases, short-term credits to many LDCs will be particularly
damaging to LDC growth efforts. Despite some cutbacks in short-term
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trade-related and interbank credits to LDCs, we expect banks to continue to
extend such credits because they are less risky than medium-term credits
and are very profitable. Any new medium-term loans, however, will be tied
to specific projects or guaranteed by a third party. A greater number of
cofinancing arrangements with multilateral institutions may help to resume
medium-term loans to debtors, but it will still be on a small scale. In
addition, many banks will seek to further reduce or even eliminate their
international exposure and will engage in additional debt-for-equity swaps,
sales of discounted debt, and debt writeoffs.
There also will be a continuation of the shift underway regarding LDC
financial rescue packages, in our judgment, resulting in an increased
concentration of bank exposure to LDCs among a fewer number of banks. Many
regional US banks, most of which have limited LDC exposure, will choose not
to participate in involuntary loan packages such as the recent Mexican $6
billion loan and upcoming packages to Brazil and Argentina. In past rescue
packages, these banks were pressured by the larger US banks to participate;
however, the experience of the Mexican deal will make it extremely
difficult for larger banks to use the same tactics again.
The split also will probably widen between US and non-US banks, in our
assessment. The Swiss banks, and more quietly the German banks, will call
for more alternative measures to new money for LDCs, including interest
capitalization, and could choose not to participate in new packages at all.
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The different set of banking and tax regulations governing non-US banks is
the primary basis for their views; these banks have more agressively set
aside reserves for bad loans and are in a stronger balance sheet position
than their US counterparts. European banks also generally will continue to
view Latin America as a US banking problem and will remain less willing to
become more involved in the region. We expect these attitudes to continue,
which will put added pressure on the large US banks to modify their
approach to LDC debt.
Downside Risks
There are some downside risks that could lead to a serious
deterioration of the LDC debt situation. Probably the most damaging event
would be a recession in the OECD countries, which could emanate from a
variety of sudden global economic changes,,such as a surge in interest
rates or sharply higher oil prices; in our judgment, a downturn in OECD
growth is probable during the next five years. A reduction of OECD growth
would be devastating to developing countries largely because of the
accompanying contractions of trade and financial flows. The situation
could ultimately deteriorate to a point that threatened the stability of
the international financial system, which then would require major creditor
government intervention in the system.
YYVUIU Ue
especially severe for Latin countries. Although all debtors would be hurt
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by reduced exports, the effects on individual debtors would hinge upon oil
price trends. Net oil exporters such as Mexico and Venezuela would be
additionally hurt if oil prices fell further, while Brazil and other oil
importers would receive benefits that would offset partially the damage
done by a recession. Meanwhile, new money requirements for LDCs would
increase by at least $19 billion in 1987-88 if a mild recession occurred,
but the total would jump to $30 billion in the event of a deep recession.
The debt situation could also worsen if debtors became convinced that
creditors were not doing enough to maintain the minimum flows of funds to
keep the debtors financially solvent. The incentive for debtors to service
their debts will diminish sharply if new money from creditors only covers
interest payments. An examination of 18 key debtors reveals that all but
three Asian countries paid more in interest than they received in new money
in 1985, the most recent year of data available; this is in sharp contrast
to the period 1980-82, when there were only two countries with so-called
vulnerability ratios above 1.0. We expect that ratios will remain above
1.0 for most key debtors over the next several years because of the
probable increase in interest rates and the slow growth of new lending,
which will make unilateral payment stoppages or limitations an increasingly
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attractive and viable option to the debtors.
(TABLES, TEXT BOX 3)
We believe radical actions such as these will be done only as a last
resort, but much depends on the perceived as well as the actual amount of
flexibility demonstrated by the creditors. Domestic political pressure in
debtor countries also will have a major influence on the governments'
actions. If a major debtor decided to take unilateral action such as
severely limiting debt payments, creditors almost certainly would have to
accommodate it through additional debt concessions because they would have
a hard time isolating the country's action. Most creditors probably would
be able to deal with writeoffs of one major debtor, but a combination of
several debtors would be too much to handle simultaneously..
Should a debtor or debtors decide to take unilateral action, they
generally are in a better position to deal with the expected credit
reductions or cutoffs than they were a few years ago. LDCs have bolstered
their foreign exchange reserves and accumulated greater stocks of imports.
In addition, countertrade and other barter arrangements have become more
common. Debtors also have made progress on import substitution as part of
their need to maintain trade surpluses. Individual country situations vary
widely, however, and most LDCs do not yet perceive themselves as being able
to withstand a break with international creditors.
A More Optmistic Scenario
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Key
LDCs: Vu
Table 5
lnerability R
atios*
1980-82
1985
Argentina
0.50
1.34
Brazil
0.95
6
40
Chile
0.65
.
5.77
Colombia
0.65
1.41
Ecuador
0.48
1.56
Egypt
0.69
1.88
India
0.32
0.86
Indonesia
0.60
1.76
Ivory Coast
0.65
3
18
Malaysia
0.37
.
1
24
Mexico
0.70
.
7
44
Morocco
0.66
.
1.35
Nigeria
0.35
3
02
Peru
1.01
.
1.37
Philippines
0.53
8.08
South Korea
0.67
0.84
Thailand
0.88
0.54
Venezuela
1.37
2.10
* Ratio
of interest payments to net new external borrowing.
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TEXT BOX 3
The LDC Debt Vulnerability Ratio
There are many indicators used in attempting to determine the relative
debt burden of a country. The most common ones are the debt
service-to-exports ratio, total debt-to-exports ratio, and total
debt-to-GNP ratio. A different and unique measure
is the vulnerability ratio. The indicator is used
to provide a quick reference point to a country's temptation to defnijlt
Using IMF data, the vulnerability ratio has been above 1.0 since 1983
for LDCs as a group, and this trend is projected to continue. The
aggregate for Latin American countries has been the driving force behind
the LDC average, with vulnerability ratios of as high as 5.0-6.0 over the
same period. It should be noted, however, that despite the high ratios,
only Peru has formally limited debt payments. Presumably, individual
countries have d' ent thresholds as to when to cease payments on their
debts. F 7
incentive is greater to suspend or limit debt payments.
The vulnerability ratio is computed by dividing total interest payments
by net new external borrowing. The key is whether the ratio exceeds 1.0.
o If the ratio is below 1.0, there is a positive or normal
transfer of funds to the debtor country. This implies that
the incentive is for the debtor to service its debt in order
keep the flow of funds coming.
o If the ratio exceeds 1.0, there is a negative transfer of funds
out of the debtor country, meaning that the debtor will be forced
to consider the option of not paying. At higher ratios, the
oFU1
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A more optimistic scenario suggests that creditors and debtors will be
able to build on a number of positive steps already undertaken. After a
sobering couple of years, the players will seek to maintain overall
progress, a key challenge given the severe liquidity problems that
periodically plague key debtors like Mexico and Brazil. Debtors and
creditors will continue to show flexibility in resolving these periodic
crises, which have resulted in improved terms -- such as lower interest
rates and longer tenors -- on existing debt. This flexibility, in
conjunction with new initiatives by the private sectors and the debtor
governments themselves, could lead to some, albeit slow, progress in
resolving the issue.
The debt situation also will improve if creditors and debtors will
continue to seek ways of reducing the debt levels instead of merely adding
to the already high total debt. Following Chile's example, other major
debtors, such as Mexico, Brazil, and the Philippines will take advantage of
debt-for-equity swaps, although this will only affect a small portion of
their total debt. Meanwhile, a growing number of banks will look more
seriously at granting concessions on existing debt to LDCs instead of
extending new money. The recent Mexican negotiations brought some of these
ideas to the table, including interest capitalization, tying of repayments
to commodity prices or economic growth, and interest forgiveness.
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observers expect interest rates to rise.
For the optimistic scenario to fully materialize, however, we believe
world economic trends would have to improve. Above all, OECD growth would
have to accelerate above the pace we expect. Only in 1984 when OECD growth
exceeded 4 percent did LDC debt problems actually recede. This scenario
also would require continued low nominal and real interest rates and
limited changes in oil prices. The latter seems possible but most
(TABLE 6)
dependence on commodity prices.
There may be some future benefits to LDCs emanating from the current
world economic situation. Low commodity prices, including oil, have forced
many countries to more closely examine ways of diversifying their exports.
Other debtors, however, will have to follow Brazil's example and diversify
to a point where commodities and manufactured goods are in better balance.
Debtors that have the longest way to go are oil-exporters -- such as
Mexico, Venezuela, and Nigeria -- and major commodity producers such as the
Ivory Coast, Peru, and Chile; progress on export diversification in these
countries will have to improve dramatically in order to reduce their
A New Risk
In addition to what we see as insufficiently favorable economic trends,
our concern about the outlook for the debt situation is heightened by our
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Table 6
The Optimistic Scenario: A "Solution Set" of Events
Necessary Trends
World Economic Conditions * Stable interest rates at or below
current levels
* Moderate and steady increases in
non-oil commodity prices
* Stable oil prices
Industrial Countries * Elimination of barriers and
restrictions on imports
* Coordination of exchange rate and
monetary policies
* Increased flow of funds to LDCs through
either increased lending or greater
guarantees of private lending
Developing Countries * Serious A
Commercial Banks
an sustained commitment to
adjustment policies.
* Removal of barriers to foreign
investment
* Maintenance of realistic exchange rates
* Strengthening of the private sectors
by reduction of governments' role in
the economy
* Greater export diversification
* Maintain or increase existing short-
term trade credit lines
* Return to medium-term lending for
specific projects
* Reduce the volume of existing loans
that have little or no chance of
being repaid
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belief that debtor attitudes and negotiation stances are hardening. Aside
from Brasilia's unilateral moratorium-on servicing its $65 billion in
medium and long term commercial debt:
0 Ecuador, previously a model debtor with a good payments record
and good relationships with creditor banks and governments,
suddenly began allowing interest arrearages to build.
o Chile has also taken an unusually tough negotiating stance,
threatening a payments moratorium unless creditors acceded to
their demands for additional concessions. At present, Chile seems
to have obtained a number of its demands from its creditors.
o Argentina and the Domincan Republic are actively considering
suspension in debt servicing identical to that put in place by
While debtor demands are not new -- they always have asked for more
than they have eventually been willing to settle for in negotiations with
their creditors -- we detect a markedly increased toughness and arrogance
in their present stances. In our judgment, these harder, more forcefully
stated positions are not just negotiation ploys; rather, they represent a
growing general perception among debtors that it is time for developed
country governments and banks to bear more of the burden of the debt. We
believe debtors are becoming especially unwilling to let reserves be
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depleted again to the rock-bottom levels of 1982-83 -- Brazil, in our view,
is already at its minimum acceptable level'of $1.5 billion -- or to place
their people under a new round of further austerity.
(TABLE 7)
Even if the current problems with Brazil are resolved, we do not see
debtor's negotiating toughness ebbing. Indeed, each additional bailout of
a key debtor by creditor banks and governments will be viewed by debtors --
not just the one affected but all others as well -- as affirmation of their
attitudes. In turn, we believe the debtors will perceive that they can
continue to postpone their day of reckoning with the blessing of their
creditors. In such a case, we see debtor attitudes hardening further in
the future, making it more difficult to reach agreements. on debt.
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Table 7
Key Debtors: Foreign Exchange Reserves
(Billion US $, End of Period)
1980
1981
1982 1983
1984
1985
1986
Argentina
6.1
2.6
2.4 1.2
1.2
3.1
2.6
Brazil
5.0
5.9
3.6 4.4
11.5
10.6
5.0
Chile
3.0
3.1
1.7 2.0
2.3
2.4
2.0
Egypt
1.0
0.7
0.7 0.7
0.7
0.8
0.9
Indonesia
5.0
4.5
2.6 3.6
4.7
4.8
4.5
Mexico
4.2
5.0
1.8 4.9
8.1
5.8
6.3
Nigeria
9.6
3.1
1.6 1.0
1.5
1.7.
1.0
Peru
2.0
1.2
1.3 1.4
1.6
1.8
0.9
Philippines
2.8
2.1
0.9 0.7
0.6
0.6
1.7
Venezuela
5.6
7.1
5.4 6.4
7.7
8.9
5.0
25X1
Declassified in Part - Sanitized Copy Approved for Release 2012/02/22 : CIA-RDP90TO0114R000404400003-4