DDI SEMINAR: ANALYSIS OF INTERNATIONAL FINANCIAL ISSUES 21-23 SEPTEMBER 1983

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97R00694R000200870001-3
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 285
• Document Creation Date: December 21, 2016
• Document Release Date: January 23, 2008
• Sequence Number: 1
• Publication Date: September 1, 1983
• Content Type: REPORT

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Directorate of
Intelligence
DDI Seminar:
Analysis of International Financial
Issues, 21-23 September 1983
Selected Readings
GI M 83-10226
September 1983
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Seminar on the Analysis of International Financial Issues
21-23 September 1983
Headquarters Auditorium
Wednesday, 21 September
08:45-10:15 - The International Financial Crisis:
Evolving US Policy
Speaker: Martin Feldstein
Chairman
Council of Economic Advisors
10:30-11:45 - US Concerns In International Finance:
The Problems and Policy Responses
Speaker: Roger Robinson
Director
International Economic Affairs
National Security Council
13:15-14:45 - International Financial Issues:
Congressional Perspectives and
Policy Responses
Speaker: Casimir Yost
Professional Staff Member
Senate Foreign Relations
Committee
14:45-16:00 - Trade - Monetary Linkages: North-South
Trade and LDC Financial Prospects
Speaker: Mike Liikala
Special Assistant to the
Undersecretary for International
Trade Administration
Department of Commerce
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International Banking
US Senate Banking Commitee, February 1983
State of Paul A. Volcher
The Banker, July 1983
US Banks: New capital rules
US Senate Committee on Foreign Relations, January 1983
Statement of William R. Cline
Latin American External Debt, 1982
The Rate of Return to External Borrowing
Euromoney, May 1983
Where the Banks Put Their Bad Debts
US Senate Banking Committee, February 1983
Risks in International Bank Lending
The Rescheduling of Country Debt:
Is a More Formalized Process Necessary?
Fortune, July 1983
The War Among Brazil's Bankers
Forbes, June 1983
South American debt -- now look at the assets
Euromoney, June 1983
The Loan Drought Hits Africa
Eurocredit
US Senate Banking committee, February 1983
Trends in Eurocurrency Credit
Participation 1972-1980
Euromoney, July 1983
From Brazil? Just a Minute, sir.
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Welcome Statement
Schedule
Selected Reading
Balance of Payments and Finance
Fortune, August 1983
The World's Missing Billions
Business Week, July 1983
The IMF's Dilemma On World
Debt Gets Worse
The Banker, June 1983
Where should the fund go from here?
US Senate Committee on Foreign Relations, February 1983
Statement of George P. Shultz
The Banker, July 1983
International debt crisis: the next phase
International debt crisis: the practical
lessons of restructuring
The Banker, June 1983
A new approach to international indebtedness
Euromoney, June 1983
Aid the Debtors
The World Bank Paradox
The Banker, July 1983
Indonesia tightens its belt
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Country Risk
Harvard Business Review, March-April 1983
You're the best judge of foreign risks
Euromoney, July 1983
How Big a Risk is Indonesia?
Japan's Bank Assess Asian Risk
The Money Lenders, 1982
Country Risk
Recent Developments
STAT
Businessweek, September 1983
Brazil could make or break a
Latin American "Debtor's Cartel"
Euromoney, May 1983
Can't Pay? Will Pay, But in Sultanas
Forbes, August 1983
Can Mexico pull through ?
Euromoney, July 1983
Is Mexico Making a Comeback ?
Euromoney, June 1983
Tracking The Big Projects
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Thursday, 22 September
08:45-10:15 - The International Financial Crisis:
Impact on Trading with the LDC's
STAT
10:30-11:45 - Eximbank and the International
Financial Crisis
Speaker: William Draper
President and Chairman
of the Board
Export-Import Bank of
the United States
13:15-16:00 - The International Financial Crisis:
Update on Commercial Bank Problems
and Prospects
STAT
Friday, 23 September
08:45-10:15 - The International Financial System:
Lingering Problems and Prospective
Scenarios
Speaker: Maurice Ernst
NIO-Economics
10:30-11:45 - The International Financial System:
Lingering Problems and Prospective
Scenarios
STAT
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THE WORLD ECONOMY/FINANCE/VIVIAN BROWNSTEIN
o Find the missing $100 billion. The rules are quite simple. At the end of every year economists
around the world figure up how much each country has paid out to foreigners for goods and ser-
vices, and as earnings on investments. They then compare this figure with how much the coun-
try received and calculate the country's current-account balance. One country's import being
another country's export, if you add up all the surpluses and deficits around the globe, you would
expect them to net out to a big zero. But here the plot thickens. They don't. When all the current
accounts for 1982 were added up, the total came to a mysterious $100-billion deficit.
The shortfall, known as the world current-
account discrepancy, is no joke. Its size casts
doubt on the current-account balance report-
ed by every country. Those current accounts
are the basis for many international econom-
ic forecasts and p.licies-who might need fi-
nancial aid, whose exports or imports ought
to be curbed, whose currency will be strong
and whose weak. For example, the dollar is
hanging high today despite a reported $11-
billion U.S. current-account deficit in 1982.
The effect of a deficit that size, economists
thought, would be to weaken the dollar.
S RECENTLY AS 1980, the jigsaw
puzzle of world accounts fitted to-
gether rather neatly. In a year when
they sold nine billion barrels of oil
for around $31 a barrel, OPEC countries
amassed a surplus of $114 billion on current
account, while the rest of the world reported
deep deficits totaling $144 billion. The result:
a world current-account discrepancy of a
mere $30 billion.
By comparison, the picture for 1982 looks
bizarre. The industrial nations were in better
shape, with smaller deficits on average. The
developing areas were still in trouble, how-
ever, and OPEC reported deficits too. As a
glance at the chart at right shows, there were
thus no surpluses to offset the minuses
hanging below the zero line. It's no trick to
figure out that something's wrong--the
whole world can't be in deficit.
The world current-account numbers rare-
ly balance out to zero, as the chart on the fac-
ing page indicates. Illegal imports don't usu-
ally find their way into the official accounts, OPEC's once huge trade surplus vanished lastycar..Vo othergroup of countries reporfed...
ME ACC?UNTS
1:1X( DOY 1'T
QALACU ICE
Surplus or deficit on
international
trade and payments
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one thing-no one expects a cocaine im- ground economy. U.S. residents who park
porter to stop off at his local customs office money offshore don't necessarily report
on the way from the airstrip. As long as the their earnings to official data collectors.
discrepancies were relatively small, though, The underground economy works both
few analysts got excited about them. ways, however, and some payments from
But $100 billion is significant, even by the the U.S. are probably missing too. An esti-
standards of global trade-well over $1.5 mated $30 billion to $35 billion of foreign
trillion last year. Economists, who are used capital poured into this country unreported
to second-guessing incomplete statistics, are last year. While capital flows are not included
in disarray on this one. They do agree that in the current accounts, income earned on
most of the 1982 di::crepancy can be attribut- the capital is. At least part of what's missing
ed to underrecordcd or hidden receipts for from U.S. current accounts is interest and
services and investment income. So in dividends paid to foreigners on capital
searching for the missing funds, analysts stashed here. At last year's interest rates,
start with the biggest service exporters, the this could amount to as much as $5 billion.
industrial countries, and especially the Papa How far the U.S. accounts are off the track
'
s chief
Bear of them all, the U.S. is hotly disputed. Morgan Guaranty
According to the reported statistics, the international economist, Rimmer de Vries, is
U.S. bought $294 billion in foreign merchan- convinced that about $20 billion should be
dise and services in 1982; paid foreigners added to U.S. current-account receipts. In-
$57 billion for rent on their U.S. real estate stead of a deficit last year, there would thus
holdings, profits on U.S. businesses they have been a surplus of about $10 billion. Not
owned, and income on other U.S. invest- likely, according to Bame at Commerce.
ments; and transferred $8 billion in dona- Though he's the first to admit that the
tions, government grants, and pensions to in- current-account numbers he has to work
dividuals living out of the country-a grand with have a lot of holes, he argues that there
total of $359 billion. Earnings from abroad is no reason to assume that they've suddenly
ame to $348 billion, according to the best gotten a lot worse. All the pluses and mi-
figures the government can come up with. nuses, Bame speculates, could reduce the
n T T e AM ;,4 i LS_ deficit by $5 billion to $10 billion at most.
T
h
1 , billi
hus t
at $
o
If the U.S. deficit is indeed overstates,
tough economic policy choices. Extra lar. Currency traders are seeing a lot more
a available when the demand for dollars than foreign exchange
_ d
ll _- T
o
ern
buys more abroad than it sells, forecasters had led them to expect. Last Jan-
S
U
.
.
and the value of the dollar should fall as for- uary, Wharton Econometric Forecasting As-
eigners become more reluctant to add to sociates, along with many others in the field,
their dollar holdings. So a severe deficit estimated that the dollar would drop by
might require the U.S. to hold interest rates about 8% in value relative to foreign curren-
h to attract foreign capital into dollars. cies between then and now. It has risen
hi
g
This creates a dilemma for many economists about 7%. Wharton says that foreigners' de-
who are advocating that Uncle Sam, in the sire to keep investments in the safest of safe
person of Fed Chairman Paul Volcker, keep havens, the U.S., has overwhelmed the extra
interest rates down to continue encouraging supply of dollars made available by the
economic recovery and to ease the burdens current-account deficit. But Wharton's ana-
of debtor countries. Lawrence A. Veit, lysts add that they wouldn't have forecast as
Brown Brothers Harriman & Co.'s noted ex- much of a decline if they had suspected, as
pert on international finance, complained re- they now do, that the deficit was badly over-
cently, "Perhaps the strangest aspect of the stated. In its latest forecast, Wharton again
discussions of the issues is the extent to expects that the dollar will drop, but not until
which the debate has been knowingly based next year. Whatever the U.S. deficit actually
on misinformation." is, Wharton assumes that it's getting larger.
Most observers think that the U.S. cur- If the U.S.'s portion of the world's discrep-
rent-account deficit is overstated. According ancy comes to $10 billion or even $20 billion,
`.o Jack Bame, the Commerce Department's there's a lot left to account for. Among other
l industrial countries France is considered a
ceipts should probably be ascribed to the
debtor countries. Mexicans, for example,
who hold an estimated $30 billion of private
assets abroad, don't bring home much of the
income on that capital, so it's not recorded in
Mexico's current account.
Attempts by individual countries and by in-
ternational organizations such as the OECD
to straighten out the statistical mess have
made little headway. The U.S., for one, has
been cutting back on money for collecting
data on international accounts. But worries
about the $100-billion mystery are mounting.
As the Bank for International Settlements
says in its ponderous prose, "... to the ex-
tent that policies are influenced by countries'
perceived current-account balances, overre-
cording of deficits or underrecording of sur-
pluses may result in policy stances being
more restrictive than they otherwise would
have been." When government policies af-
+ $25 billion
T ; B ! o
Tar'-1T Ai-;
V!crld currenl%_
c^,?nini
... a surplus that could balance the world's
account. The missing billions, once just a nui-
sance, now confound policymakers.
fecting a country's economy are too tight,
people and businesses hurt.
a
associate director of mternation econom-
ics, several billion dollars paid U.S. firms for likely candidate for a piece of the pie. ^ Most businessmen understand that the fig-
consulting and engineering services to oil- Frenchmen, unhappy with the Socialist gov- ures economists give them are freighted
exporting countries probably goes unreport- ernment, have probably contributed to the with a bit of uncertainty. When these figures
ed. For one thing, budget limitations prevent capital secretly flowing west, which makes are off by $100 billion, however, the discrep-
government surveys from reaching most of for unreported income that should be show- ancy calls for a degree of caution greater
u_ :.. rPrPintC even than that normally employed with the
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ULJ3SP~Ll fit
o
Q~
toy
25
o0,
$
nearly h s alf o n the its Third
up billion debt. interest
ern- razilian workers struck
ogovern- uts de dlopt stringent cmeasures that borrowers
V~D
I S ment-owned oil refinery
L. and muddled finances. World's total debt of $600 billion is con-
by At sam
.'_ Sao o Paulo in July, joining thou- their economies
cen
ationary
pay thetIMFdcan pushAthemeriregionca, and
in Latin sands of others walking out of near measures al oe help time,guarathe
Ford, General Motors, and other auto
ments ee protesting wage more importa tsomething e hundreds of bil- omiesTis fast becomh gna key internation-
plants. ordered unions Wmuc
cuts ordered by y President Joao
de Figueiredo to satisfy demands by the lions of dollars in private debt extended al policy question. The
more
eat International
my ht American otherwi and be written off, ciansL outhTof the Rio Grande feelothe
anon in Monetary Fund to
flaIn in exchange nt , for emergency loans. g
banking walk awayefrdanger that one or more Will
om their foreign debts alto-
In Argentina, workers rs threatened by ecwith onomy and the results greater
social x-
face
petted vote from the IMF eF are e
to o vo vote the populist Peronists into system. "Conditionality is essential be- ~ get her then rather than
relaxes on setting ponds
power in upcoming elections. A strong cause with a sovereign debtor, its
levera group within the Peronists pledges to no other way of making it pay," says tions, it loses
are moving town a aecfor re--22
declare a moratorium on Argentina's Federal Reserve Board Governor Henry form. billion Western-mostly takes it continues "You
with its policies, that will House officialayIf high-level
Americann-banks nks once the party
American-banks a
office. make it unable to pay." major debtor are unrealistic, then either
In Mexico, unemployment is soaring, The debt crisis is not limited to Latin the IMF eases off and loses credibility, or
it insists and the debtor stops paying."
crime is rising, and the exodus of illegal America. Yugoslavia and Nigeria, For debtor nations, the penalty for
immigrants to the U. S. is up sharply as among others, are in financial straits, would be harsh.
government measures to clamp down on and Poland's creditors, mostly European outright refusal to pay
the economy-again, demanded by the banks, are relending as trade credits Borrowers who declare a moratorium, {
r '" ti
Imo FIN n 77-127.
If it eases loan terms,
it loses credibility. But
pushing too hard could
fire up social turmoil
IMF-lead to lower growth and the de-
cline of the private sector.
The confrontation between social and
financial demands reflected in these cri-
ses came to a head in mid-July when the
Bank for International Settlements (BIS),
headquartered in Basel, demanded that
Brazil repay a $400 million short-term
credit. That heated up the pressure on
Brazil to comply with IMF demands for
tough economic austerity policies in re-
turn for $4.5 billion in emergency loans.
'NO OTHER WAY: Everywhere in Latin
America, the choice between social sta-
bility and economic restraint is becoming
a heated political issue. Caught in the
middle is the global lender and financial
cop, the 1M F' headed by Jacques de Laro-
siere. By insisting on "conditionality," or
severe restraints on domestic economies,
the IMF tries to ensure that the emergen-
cy loans it extends to troubled nations
.4 #rf
....~^S ,,,._ , wr lf:" l~ , V't13..e ? _ .~ . ~.. .; 3
AFTER WORKERS TOOK TO THE STREETS TO PROTEST UNEMPLOYMENT AND WAGE CUTS. BRAZIL
INTERNATIONAL MONEY MANAGEMENT
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unless it is accepted by creditors, "would
impose on themselves the worst reces-
sion they have ever seen," says a U. S.
banker. Such an action would reduce the
debtor country to little more than a bar-
ter economy and make its ships and air-
craft vulnerable to seizure by the banks.
Nowhere is this conundrum more
striking than in Brazil, which owes $90
billion. Unless it reaches a surprise
agreement with the IMF for more money
or cuts a deal with the U. S. government
for an emergency bridge loan by mid-
July, the country may have little choice
but to declare some kind of moratorium.
It could be for a brief 90 days, following
the example of Mexico last year, or it
could be a demand for relief of all debt
for five years or even longer. American
banks could live with a 90-day halt in
payments on principal if that led to an
orderly rescheduling of debts but not
with a long delay, which would force
them to take massive write-downs of
their assets.
The underlying fear, of course, is that
if the IMF miscalculates and triggers a
serious default, it could easily force the
Federal Reserve to rush in and rescue
the banks with massive injections of
funds that might reignite inflation in the
U. S. and unhinge the current economic
recovery.
Like Samson, the debtor nations have
grown so powerful by their accumula-
tion of IoUs that they can bring the en-
tire global financial temple down with
them. Even if that does not occur, tight-
ening up on all Third World debtor coun-
tries at once, as the IMF is doing, means
lower economic growth, fewer imports
from the U. S., and fewer jobs in Ameri-
can factories.
QUICK FIX. Just months ago, it appeared
that Brazil had worked out a complicat-
ed rescheduling of its debt with Western
bankers. Fed Chairman Paul A. Volcker
began stitching together rescue pack-
ages last August when it appeared that
Mexico was on the verge of defaulting
on its $80 billion debt.
The crisis resulted from the sharp
1981-82 global recession, which squeezed
Latin American export markets and
from the huge runup in American inter-
est rates, which hiked the region's al-
ready enormous debt repayments and
devastated commodity prices. By getting
the Bls and Washington to offer quick
funds, persuading the IMF to provide me-
dium-term money, and pressuring U. S.
banks to keep lending, Volcker was able
to prevent disaster.
The IMF's role in the bailout packages,
as always, was that of tough guy. All
the other moneylenders had premised
their loans on debtor governments' fol-
lowing stringent economic and financial
policies laid down by the fund.
For Brazil, it did not work. An agree-
ment was reached in February on a pro-
gram to prune state companies' capital
expenditures by 20%o in real terms, cut
subsidies for gasoline and wheat, and
start unlinking salaries and prices. Com-
mercial banks agreed to chip in a further
$4.4 billion if Brasilia went along with
the IMF.
And the BIS, a central bank for central
banks, committed $1.2 billion in short-
term loans to be doled out in four install-
ments. But Brazilian workers took to the
streets of Silo Paulo in April and again
in July, protesting against unemploy-
ment and the deindexing of wages-a
disaster to families in an economy where
inflation is expected to hit 180%o by year-
end. After that, Brazil began to stall on
implementing the IMF conditions.
In May the fund responded by stop-
ping payment of the second portion of
its loan. An IMF team looked at the coun-
try's books again and disagreed on just
how big Brazil's public-sector debt really
was and how fast to deindex wages and
inflation. With the IMF delay, commercial
bank money began drying up. The BIS
agreed to roll over its bridge loan twice,
but on July 11, BIS President Fritz
Leutwiler announced that the bank
would refuse a third time. "I still expect
to receive the money by July 15,"
Leutwiler said. Eduardo Wiesner, head
of the IMF's Brazilian mission, is in Bra-
silia for a last-minute attempt to work
out another deal.
SPLIT IN THE RANKS. NOW the question is
how tough the IMF can really get with
Brazil. If it "goes soft" and offers mon-
ey on easier terms, it will set a prece-
dent for other debtor nations around the
world. But if it does not modify its strin-
gent terms, will it risk setting off politi-
cal turmoil and possibly a declaration of
default? Ulisses Guimaries of the oppo-
sition Brazilian Democratic Movement
Party says that "by early August a par-
ty proposal for longer terms and lower
interest rates plus a grace period will be
presented in Congress."
The Reagan Administration has made
a major shift on the issue of conditional-
ity. When it first came into office, it
RTED STALLING ON r-rc ,*,r or cr~r-r v-n roc.rcwrr rrrrr cl-nwrnk.rrn ocrn- 1 .. ?...7 .......1..... L.-s than strict IMF
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terms for lending money, and it opposed
expanding the fund's financial re-
sources. Monetarists feared a renewed
inflationary surge if great quantities of
new money were created just to bolster
flagging debtors.
But in August, 1982, faced with the
imminent crisis in Mexico-a country
critical to U. S. security-the Adminis-
tration did an about-face. Secretary of
State George P. Shultz began working
quietly behind the scenes to help debtor
countries. "The combination of INIF man-
agement under de Larosiere, with help
from Tom Clausen [president of the
World Bank], Paul Volcker, and Don Re-
gan and their counterparts, plus the
banks around the world, has done a ter-
rific job," says Shultz.
Administration officials believe that
E S 5. LES TURIXE 1 I JT0 607S
r7lhe world debt crisis threatens to
put a serious crimp in the Penta-
gon's expanding role as arms
supplier to the Third World. Washing-
ton has been lending billions of dollars
to finance purchases of weapons by
countries on which the U. S. relies
heavily to wield' geopolitical influence
and military clout in world trouble
spots. But now, "the LDCs most depen-
dent on our loans are having a very
bad time with their indebtedness," says
a U. S. official involved in arms-sales
policy. Adds another official: "It is in-
creasingly likely that some countries
will not be able to meet their [arms
debt] payment schedules or will have
to cancel or defer weapons orders."
To help prevent such a development,
the U. S. has begun scaling down loans
and stepping up outright grants, in-
stead, to financially shaky arms cus-
tomers. "Our policy of favoring loans
over grants won't hold up much longer
with respect to several countries we
simply have to keep supplying," says a
U. S. official.
The list of nations on the precipice
makes U. S. military planners and for-
eign-policy makers shudder. Among 43
countries ordering $23.5 billion worth
of U. S. arms and military assistance
this fiscal year, fewer than a dozen are
in-or heading for-debt-repayment
straits. But they include Egypt, Tur-
key, Pakistan, Morocco, Somalia, Su-
dan, Tunisia, Zaire, and even Israel-
all viewed as crucial buffers against
military or political encroachment by
the Soviet Union or its surrogates.
COBALT SUPPLIER. Scheduled repay-
ments of interest and principal on
weapons loans to those debt-deluged
nations will add up to nearly $20 billion
from the start of the current fiscal
year through 1992. Israel accounts for
half of that total, or $9.8 billion, fol-
lowed by Egypt at $3.7 billion and Tur-
key at $2.5 billion.
Turkey already has been forced to
reschedule its repayments. And Zaire,
in hock to the U. S. for $170 million,
has declared a moratorium on repay-
ment. Under U. S. law, this action
makes Zaire-important for its cobalt
and its strategic location in Africa-
ineligible for further arms credits. In-
stead, the U. S. has switched to out-
right grants to Zaire, totaling $20 mil-
lion over the past two years.
Arms gifts to other countries have
also become more prevalent. Grants to
Tunisia and Morocco will total a com-
bined $60 million this fiscal year, while
Sudan will get $75 million and Somalia
$40 million. For Turkey, proposed arms
grants total $230 million for fiscal 1984.
And the Administration may have to
decide whether to give Pakistan $1.1
billion worth of F-16 fighter planes.
Saudi Arabia had planned to finance
the purchase, but it may back out of
the deal because of the slump in oil
revenues.
STOPGAP PAYMENTS. Israel and Egypt
are also benefiting more and more
from U. S. grants, thinly disguised as
"forgiven loans." Since 1974, the U. S.
has let Israel out of repaying $5.5 bil-
lion of loans, and it now is doing Egypt
the same favor. This year, Israel and
Egypt are receiving $750 million and
$400 million, respectively, from the
U. S. under no-payback terms.
Congress far prefers to authorize
loans instead of grants because it must
appropriate funds for the latter. The
loans are backed by the Defense
Dept.'s Guaranty Reserve Fund, which
contains about $800 million. If a U. S.
arms customer falls into arrears on a
loan, Defense dips into its fund to
make stopgap payments.
Now, with the world debt crisis
threatening to swamp some U. S. arms
customers and perhaps to spread, a se-
nior Pentagon official warns that "our
reserve fund could be depleted over-
night." Gloomily, he adds: "We are get-
ting very close to the margin."
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ABOUT A SIMPLE TESTING
PROCEDURE... ABOUT HOW
EARLY DETECTION
CAN SAVE LIVES...
,T WHY DIDN'T
WE TALK ABOUT
THIS BEFORE?
LET'S TALK. For a free booklet
on colon & rectum cancer,
contact your local ACS office.
l
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 icer Society
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 ------
is more hardline than is the -reasury Secretary Donald T. Regan
- ist influence
i
lli
f
l
n
a
ng
y
the U. S. recovery and slow
, terest rates will rescue Third World State Dept., which is concerned about w hould be doing a lot more to avert what
debtors by boosting demand for their political stability in Latin America, or they see as an explosive debt crisis.
'xports and lowering their interest the Fed, worried about the U. S. banking "You've got a Treasury Dept. that has a
osts. The White House now supports system. Beryl W. Sprinkel, Treasury Ur?- pretty conservative view on how to deal
expanding the IMF's resources, and Con- der Secretary for monetary affairs, in- with all of this," says a senior Adminis-
gress is expected to vote on hiking the sists that "it is very important that the tration diplomat. Adds another: "Sooner
U. S. share by $8.4 billion this summer. IMF sticks to strict conditionality." or later, Brazil will have to declare a
Yet divisions remain in the Administra- Other members of the Administration moratorium. The only question is wheth-
tion. The Treasury, still under monetar- feel the White House and especially er it will be long- or short-term."
EDE"
Fl 1125 K112VO(WAS
Ti or multinational corporations, the
k 7 financial abstractions of world debt
U translate into decimated markets,
blocked currencies, and a starvation diet
of raw materials and essential parts for
subsidiaries representing billions of dol-
lars' worth of investments in less devel-
oped countries. "We're just pumping in
cash to keep our subsidiaries alive,"
complains the harried treasurer of a ma-
jor U. S. multinational.
By continuing to supply faltering sub-
sidiaries in countries such as Brazil and
Mexico-despite their inability to pay for
If they don't keep
pumping in cash, their
Third World subsidiaries
could go under
imports-and by pushing those coun-
tries' products in world markets, the
multinationals are helping debtor na-
tions stave off defaults to creditors in
the U. S., Europe, and Japan. But most
LDCS give top priority to repaying banks
while stinting on hard currency for for-
eign corporate investors and suppliers.
COPING OR SELLING our. Says a U. S. offi-
cial: "We are the dominant supplier to
[Latin America], and we are bearing the
brunt of the adjustment. Here we are
endorsing IMF rescue packages that in
effect call for substantial cutbacks in
imports to achieve trade surpluses, and
that is coming out of our own hides."
Brazil's stunning 3 billion trade surplus
so far this year has been achieved large-
ly by slashing imports, while Mexico cut
imports, mostly from the U. S., by one-
third in the first four months from the
corresponding 1982 level.
To cope with the harsh new condi-
tions, multinationals are doing every-
thing from demanding cash on the bar-
relhead from some customers to
extending credit to others in order to sell
products and maintain market share. A
few, such as Sears Roebuck, Revlon,
Gerber, and Campbell Soup in Brazil,
have simply sold out. But others are
scrambling for financing in local curren-
cy and struggling to find locally made
substitutes for essential equipment and
components that used to be imported
and paid for with hard currency. Some
are resorting to barter and nearly all are
hustling exports to earn hard currency
for subsidiary operations. Some are even
stepping up their shareholdings in joint
ventures, particularly in Mexico, by con-
verting subsidiaries' debt to equity.
Paradoxically, most multinationals are
more sanguine than the bankers about
prospects for the debtor countries, par-
ticularly in Latin America, where North
American and European investors have
been building up productive assets for a
half-century or more. "I believe in Bra-
zil. They have a wealth of resources
equal to anywhere in the world, and
that's real money," says Robert P. Si-
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
mon, treasurer of Brascan Ltd. in Toron-
to. "In the final analysis, money is some-
thing you print. You don't print gold,
iron ore, and forests. Those are real.
And you don't print productive people."
Such faith is sorely needed to sustain
multinationals through their current
tribulations. In markets that once held
out the promise of booming expansion
and fat profits, multinational executives
relate tales of woe. To the chagrin of
Detroit's Big Three auto makers, car
sales in Mexico, where all have plants,
are off 33% this year, while truck sales
have fallen 50%. Volkswagenwerk Chair-
man Carl H. Hahn concedes: "In 1983 we
will be unable to break even in Mexico."
Despite layoffs and other cost-cutting
measures, Japan's Komatsu Ltd. reports
that its operations in Mexico-where it
has a 40% stake in a government-con-
trolled joint venture-will lose money
this year because of the construction
market's collapse, with bulldozer sales
to private contractors running two-thirds
behind last year's. In Brazil, Italy's Fiat
is fighting desperately to turn its joint
venture around after losing $40 million
nior partner, Fiat injected an additional
$300 million in 1982 and expects to drop
$100 million more before the year is out.
The depressing news reaches across
the product spectrum. "We expect Mexi-
can consumer spending to be down 3% in
real terms this year with some recovery
in sight next year and private invest-
ment to be off 25%," says John A. Ur-
quhart, executive vice-president and
head of the international sector at Gen-
eral Electric Co. in Fairfield, Conn. As a
result, refrigerator manufacturing is off
50% in Mexico-to balance inventories-
and the company has temporarily shut
down its clothes-washer and water-cool-
er production.
ARM-TWISTING. Compounding the sales
slump that has engulfed Latin nations
from Argentina to Mexico are severe
corporate financial problems. In subsid-
iaries' local markets, consumer credit is
in short supply, collections often require
ugly arm-twisting, price controls restrict
the ability of managers to keep prices
abreast of rampant inflation, and capital
equipment is so expensive that custom-
ers demand a long time to pay. Pay-
there in 1982. m no+~ o, ,.,;+>, ;+~ dsn ;n. i munte that "amen to rnma ;n Him rlnol-_ I lame T ;++n? T.,.i-+res Inc., for example,
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
work" now arrive six weeks late or
more, treasurers complain.
For parent companies, the story is
much the same. An executive at Frank-
furt chemical giant Hoechst reports:
"We're seeing more payment defaults
on deliveries, particularly in Brazil and
Venezuela, but we haven't gone out to
any customers to get back goods we
delivered." Rival BASF is less patient
with what it euphemistically calls "nega-
tive export sales"-goods delivered to
customers who cannot pay. "In a few
cases we have gone out to customers
and retrieved goods, hoping to find
someone else who could take them right
away," concedes a BASF executive.
Other corporations feel they cannot
afford to play so tough. "Multinationals
are lending money to customers to keep
markets and long-standing relationships,
especially if they're in up to their eye-
balls in receivables," says a U. S. bank-
er. "You have to make sure the guy you
have receivables from stays afloat."
This is particularly true for equipment
such as agricultural machinery sold on a
consignment basis, with the seller repaid
out of crop sales.
TODAY'S BIG STICK. For subsidiaries in
Latin America, many parent multination-
als face the Hobson's choice of letting
their offspring go out of business or
shelling out more cash for debt service
and for imports of needed materials and
equipment. In Mexico, for example, an
important subsidiary of Becton, Dickin-
son & Co. manufactures health care
products. "On intercompany accounts,
we are letting [the subsidiary] run up
arrears. We have also gotten coopera-
tion from some of our suppliers, who are
willing to wait for payments from Mexi-
co," says Willard D. Andrews, president
of the Latin American Div. of Becton
Dickinson, in Paramus, N. J. "We carry
a big stick because we buy a lot of sup-
plies around the world."
A major financial headache for multi-
nationals is complex currency-exchange
controls, coupled with massive devalua-
tions that make it nearly impossible for
companies to repatriate monetary as-
sets. Many corporations had become
lulled by the common Latin American
practice of maintaining an overvalued
exchange rate. While most multination-
als had adjusted to Brazil's periodic cru-
zeiro devaluations, Mexico's three
successive devaluations-dropping the
peso 82%o against the U. S. dollar since
mid-February, 1982-caught many short.
"We had always had a practice of fi-
nancing [Mexican] operations with dollar
debt because it was cheaper," regrets
the senior financial officer for a major
Midwestern manufacturing company.
Likewise, exchange restrictions com-
pound multinationals' financing prob-
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
'j .
suddenly discovered last summer that
the Mexican government had converted
about $1 million it had on deposit in
Mexican banks into pesos. The maneu-
ver amounted to "a little private-enter-
prise subsidy for the economy of Mexi-
co," says Fred M. Sullivan, Litton
assistant controller in Los Angeles.
'SPECTACULAR TERMS.' Stung by such
measures, nearly all multinationals now
try to borrow locally. But it is costly:
While Brazilian inflation is high at 130%,
the going rate on cruzeiro loans is a
staggering 205%. Such differentials,
says a Canadian executive, "give rise to
the most lovely opportunities. People
will pay through the nose for cruzeiros;
you get some spectacular terms."
The crisis for some multinationals has
developed into a bonanza, in fact, for
others whose treasuries are overflowing
with local currency. Italian tiremaker
Pirelli, for example, lends out its Brazil-
ian profits locally instead of repatriating
all the dividends it is entitled to. "A cru-
zeiro loan could kill you," says Andrea
Travelli, Pirelli's worldwide financial di-
rector in Milan.
To avoid costly borrowing, Tenneco
Inc. arranged for its subsidiary, Marlin
Drilling Co., to lend $10 million worth of
cruzeiros from its Brazilian operations
to the Brazilian subsidiary of J I Case
Co., Tenneco's construction equipment
manufacturer. "Luckily we had another
division in a profitable situation in Bra-
zil," says Robert T. Blakely, Tenneco's
chief financial officer in Houston.
Without hard currency for imports,
many multinationals are cutting produc-
tion. Nissan Motor Co., for one, imports
40% of the parts for the trucks and cars
it assembles in Mexico. "We cannot
make as many vehicles as we want,"
complains a Nissan executive. Thus,
many subsidiaries are scrambling for lo-
cally manufactured substitutes, even
though they are often inferior in quality.
"Indirect government pressure is creat-
ing substitute suppliers in Brazil, which
is exactly [Brazil's] game plan," says the
chief Latin expert for one U. S. compa-
ny. "The question is how much substitu-
tion is a structural change in trade pat-
terns," he adds. He wonders whether
the multinationals will ever regain their
lost markets-and whether the new local
suppliers will grow to become global
competitors.
PAYING BANKS FIRST. A few companies
have managed to pry hard currency out
of Latin central banks by threatening to
close plants and lay off workers. But
local authorities usually favor paying off
foreign bank creditors first. Because of
a need for massive infusions of fresh
capital and debt i reschedulings, debtor
nations are particularly dependent on
the commercial banking community. Af-
ter Mexico's near-default in August,
1982, "bankers were creating the impres-
sion that it was official U. S. and IMF
policy that banks be paid first," com-
plains a lawyer for a U. S. multinational.
Adds a U. S. government official: "The
companies say: 'When push came to
shove and we went in to get money we
needed for spare parts to keep our plant
running, the government told us it was
fresh out of money. Yet Chase got paid
off on a loan that was due."'
There is considerable resentment
among multinational corporate execu-
tives over the speed with which the
n
r
------------
~:~~-tr`"`'~`"a~-`-mot'-''' ~.~
VOLKSWAGEN EXPORTS BEETLES FROM
BRAZIL TO EARN MORE HARD CURRENCY
banks took care of themselves. "There's
a perception that there's a lot of weep-
ing while counting money in the back
room" at the banks, says one U. S. exec-
utive. Adds a Canadian, referring to the
increasing bank practice of insisting that
multinationals guarantee loans to sub-
sidiaries: "Banks like to have it both
ways: a parent-company guarantee on
one side and pricing that reflects a Bra-
zilian risk on the other."
Despite their huge stake in the out-
come of the debt crisis, U. S. multina-
tionals have been slow to organize a re-
sponse. Only now, under the auspices of
the New York-based Council of the
Americas, have they begun to collect in-
formation about the impact of the crisis
on multinational corporate finances.
"Bankers by practice know each other
well and organized more quickly," says
the lawyer for the multinational. "They
all participate in jumbo syndications and
have each other's phone numbers." He
adds: "The day after [Mexico's August
crisis], the chairman of Chase knew the
damage." By contrast, "in many cases it
took six to nine months for a multina-
tional's chairman to get an assessment
of the damage."
One way around the hard-currency
shortage and exchange controls, for
some multinationals, is to increase equi-
ty in their LDC subsidiaries. Last year,
instead of waiting an unknown length of
time for a $20 million payment from its
Mexican diesel-engine joint venture,
Cummins Engine Co. increased its share
to 40%, with the government's Diesel
Nacional retaining 60% ownership. De-
spite Mexican policy of encouraging or
forcing foreign investors to take on ma-
jority Mexican partners in most busi-
nesses in recent years, the administra-
tion of President Miguel de in Madrid
says it is willing to be more flexible in
permitting majority foreign control.
A goal of the Council of the Americas
is to push Washington to persuade Latin
nations that they would benefit by in-
creased foreign equity in their indus-
tries. And in a July 8 speech in Geneva,
International Monetary Fund Managing
Director Jacques de Larosiere noted:
"Given their large needs for external re-
sources, the developing countries would
be well advised to place greater empha-
sis on policies to attract foreign direct
investment as part of their development
strategy."
'STAY LOOSE' Multinationals are turning
in the meantime to other techniques for
coping with the crisis. One is to push
exports from LDCs as hard as they can,
knowing that the more they export, the
higher they will move on government
waiting lines for hard currency. Volks-
wagen exports Beetle cars from Brazil
and operates a cattle ranch there, ship-
ping frozen beef back to Germany. And
in Mexico, the company recently took
coffee in payment for local auto sales,
then sold the coffee in Germany. GE, on
the other hand, found LDC markets for
locomotives and hydraulic turbines so
depressed it switched to making boat
hulls at its Campinas pk.nt in Brazil.
Despite the problems, most multina-
tionals insist they are in Latin America
and other debt-ridden LDCs for the long
haul. "It requires a very dynamic ap-
proach," says John F. Beck, General Mo-
tors Corp. vice-president for North
American vehicle operations. "You can't
make a decision now and sleep with it
for the next two years." Beck's advice to
others doing business in Latin America:
"Stay loose." o
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 luable
:llents
es to
ration
ce the
ntact
15, Dr.
Iford.
Where should the Fund go
from here?
Alena Weis
New York
Various ideas are being canvassed for reforming the international financial system but
no consensus has yet emerged. Improvements, /MF managing director Jacques de
Larosiere argues, should be preceded by a period for 'maturation and gestation'
The severe international liquidity crisis has cast the
spotlight on the International Monetary Fund and the
slim, dapper and logical Frenchman, Jacques de
Larositre, who is the Fund's sixth managing director.
He began his second five-year term, with the unani-
mous support of the Fund's members, this month.
For the 53 year-old Mr de Larositre - the
quintessential French bureaucrat who spent four
years at the head of the French treasury, had been
chairman of the deputies of the Group of 10,
participated in the work of the Committee of 20 and
served as chef du cabinet of former French President
Valery Giscard d'Estaing when he was finance min-
ister - the spotlight is by no means unwelcome.
As Mr de Larositre put it recently, `increasingly
the eyes of the international financial community
have turned toward the Fund as the central element
in the search for a constructive solution to the current
international financing and indebtedness difficulties'.
Mr de Larositre, said C. Fred Bergsten, who heads
the Institute for International Economics, stepped
into the breach in a very decisive and effective way.
`He and Fed chairman Paul Volcker are the heroes of
the story'.
Another long-time American observer of the
Fund's operations observed that the managing
director `has done quite well in building a global
awareness of the Fund. He has done a great deal to
strengthen the separate image of the Fund from the
US and any other single country'. The perception
that the Fund is a tool of the US, which has always
played a leading role in the organisation, has proved a
major handicap in dealing with developing countries
in the past.
On the other hand, the US remains the strength of
the Fund, and Mr de Larositre, as an impeccable civil
servant, must see himself as the instrument of its
`most important minister'. The US administration
wanted him in the spotlight. Will he remain there
when the current debt crisis is resolved and how will
the role of the IMF evolve?
The French treasury official attracted the attention
and won the respect of the Americans when he and
the then US undersecretary of the treasury, Edwin H.
Yeo III, worked out a compromise between the
French and the American positions on the role of
gold, the exchange rate regime and surveillance that
was embodied in Article IV of the amended articles of
the Fund. He retains that respect still.
While his immediate predecessor H. Johannes
Witteveen, a former Dutch finance minister, had no
trouble with the Americans, Pierre-Paul Schweitzer,
who held the post for a decade before him, was barely
tolerated. Deeply pessimistic about his ability to stop
the collapse of the Bretton Woods system and stem
the disorder in monetary affairs that followed, Mr
Schweitzer angered the Americans by urging them to
devalue. He was told unceremoniously that he could
not expect a third term. His predecessor, Per
Jacobsson, an adviser to the Bank for International
Settlements, was a crusader for the free enterprise
system.
Main input
If Mr de Larositre's public positions would appear
to have swung from a more liberal approach during
the Carter years to a more conservative one currently,
he vehemently denies it. He says now that his first
action when he came to the Fund in 1978 was to insist
on the importance of adjustment. He made a very
strong plea to stop the sort of trust funds, oil facilities
and other unconditional recycling mechanisms that
had been developed in the wake of the first oil shock.
There was to be no more sales of gold to buy the
international community out of its problems, no more
oil facilities.
The abundance of money stemming from the sur-
pluses of the oil producing countries between 1978
and 1981 did, however, postpone adjustment by the
deficit countries. If the adjustment had been taken
INE 1983 THE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 41
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
earlier, he now believes, it would have been less
painful and more acceptable. Payments deficits would
not have soared to $100 billion for the non-oil
developing countries in 1981 and external debt would
not have mounted to $600 billion at the end of 1982,
a whopping 132% of their exports. The easy habits of
financing would not have caught on.
He is said to view the main input of the Fund in the
system as getting minds as well as countries to adjust.
He wants to dispel the notion that a debt conversion
scheme, similar to those under discussion in academic
and other circles, would pave the way for a return to
what he likes to call `the old, old game'. If member
countries have unanimously given him the oppor-
tunity for a second five-year term, they presumably
agree with having a managing director of that
persuasion. He, in any event, thinks so.
Another American close to the Fund says simply
that the managing director has taken a `sensible view
of the financing problem. He has, moreover, got the
support of the right people'. Mr Witteveen, this
observer comments, was well suited to the kind of
philosophical and analytical problems that engaged
the Fund during his tenure. Mr de Larositre may be
better suited to dealing with the practical problems
now facing him.
Surveillance
It is particularly significant that it would have been
on the US initiative that the managing director would
have been invited to participate in the meetings of the
inner group of industrial countries that now consult
on the implications of their economic policies on the
international system, an idea that emerged from the
Versailles summit.
The five countries, whose currencies make up the
SDR, the US, Germany, Japan, Britain and France,
have a major impact on the world economy. The five
are joined in their discussions by Canada and Italy,
the other two partners in the summit meetings. Better
compatibility and consistency of policy among the
major actors is viewed both at the Fund and within
the US government as an important element in the
recovery of the world economy and the establishment
of a better economic environment.
The concept of surveillance among a small group of
industrial countries has not had time to mature and
serious doubts have been expressed over the ability of
the international community to influence the policies
of the US, the most flamboyant player on the world
stage. It has been said also that there is an absence of a
mutually accepted economic framework, making it
difficult to consult on economic matters much less
seek some degree of economic collaboration.
Mr de LarosiPre's position is that it is essential that
the modest but gradual recovery now anticipated in
the industrial world be realised and sustained. The
central objective of economic policy, he said in a
recent speech at Neuchatel, Switzerland, is
achievement of sustainable growth. He continues to
Jacques de LarosiPre: no return to the old game
say that a durable recovery depends on the continuing
credibility of anti-inflation policies. He is particularly
concerned that budget deficits in the US be brought
down so that prospective deficits do not `cast their
shadow' in the form of high interest rates that would
hinder the process of recovery.
Mr Bergsten and others worry that Mr de Larosi2re
may be `sticking with deflation longer than is needed
and this could turn out to be very costly'. But the
managing director said at Neuchatel that there is no
satisfactory alternative to the general strategy of
bringing down inflation and tackling structural
rigidities and imbalances as the right course for a
lasting recovery.
He remains apparently unmoved by the calls for
coordinated economic stimulation even when they
come from his mentor, Valery Giscard d'Estaing.
The former French president told a meeting of the
Council on Foreign Relations that Europe should be
prepared to take up the gauntlet next year when the
economic stimulus in the US begins to weaken as it
surely will if real interest rates are not brought down
appreciably.
No short cut
Mr de Larosi@re asserts that it is still imperative to
continue the fight against inflation despite con-
siderable progress in that area because, if the message
now were changed, policy-makers would be doing an
enormous disservice to the chance for recovery and
growth. The flexibility of the world economies have
been so weakened by more than a decade of
uncontrolled inflation that it is an illusion to think
that a little bit more stimulation, a little more reform
and a little more liquidity will solve the world's
economic problems.
He is convinced that the chance for economic
recovery will be enhanced and the problems of the
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
indebted countries ameliorated if there is a more
constant set of economic policies in the world. But it
requires great skill to promote changes in the
economic policies of major industrial countries that
will conform to a model of multilateral consistency.
He is apparently ready to try his hand. He believes
that the IMF has been successful in setting the
general tone of anti-inflation efforts. He is also
convinced that IMF surveillance had discouraged
members from manipulating their exchange rates in
order to get competitive advantages.
However there is a general dissatisfaction with the
exchange rate regime and its inability to reflect
underlying economic conditions. Mr Bergsten
believes the Fund has been unable to push hard
enough to correct exchange rate imbalances largely
because of US indifference. In his New York speech,
Giscard d'Estaing was impatient with loose talk about
the need to return to more stable exchange rates. He
believes that the time has come for the major indus-
trial countries to decide whether they want to return
to fixed exchange rate parities. If they do agree to this
objective, they must decide whether to. pursue a
theoretical or empirical approach.
The latter approach, which Giscard d'Estaing
clearly favours, would involve 'the convergence of
mutually reinforcing actions'. These would include
the strengthening of the European Monetary System,
the strengthening of the European Currency Unit and
the establishment of target zones for the ECU, dollar
and yen with wide margins that would gradually be
reduced. This would involve some coordination of
monetary policies and mutually agreed intervention
in the foreign exchange markets. If the answer is
negative or mildly positive, Giscard d'Estaing
continued, there would still be a need for better
management of exchange rates. That necessitates
adequate intervention in which the Federal Reserve
participates.
r Approach to reform
Mr de Larositre senses that there is a desire in the
US administration as well to explore ways and means
to stabilise the monetary system. The time may have
come to overhaul the system but the managing dir-
ector is said to agree that there is a need for an
understanding and agreement on the basic objectives
to be pursued. The founders of the IMF understood
that they wanted to restore an open trading system
and that they needed an international organisation to
facilitate financing. The question that Mr de
Larosi@re will be facing in his next five years is the
nature of the system that is needed for the 1980s.
Reforms and improvements in the system, he
explains to associates, have to be preceded by a period
of maturation and gestation.
An academic conference held at the IMF in March
weighed the benefits and drawbacks of the floating
rate system. The general conclusion was that floating
rates have not worked well, having contributed to
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ally be
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floating
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excessive ' movements in real exchange rates, inef-
ficient adjustment and misallocation of resources. On
the other hand, the participants saw little prospect of
an early return to fixed exchange rates. Nor did they
see an enhanced role for the SDR in the system unless
the unit is made more attractive and usable in the
private market. This would involve the same kind of
government and institutional support that the
Euroj,eans are giving to the ECU. Nor did the
academics present view the IMF as an incipient world
central bank.
Warning against excessive ambition, Federal
Reserve chairman Paul Volcker told more than
10,000 foreign exchange traders at a dinner in April,
that `we can constructively do something to help
stabilise exchange rates within the general framework
of the floating system . . . nations should be in a
position to accept in the formulation and execution of
monetary policy and, in the fiscal-monetary mix, a
degree of discipline implicit in the desirability of
greater exchange rate stability'. In this context, he
concluded, intervention might have a modest sub-
sidiary role to play.
Irving Friedman, a consultant to First Boston with
extensive experience at the IMF and World Bank,
insists that there is a major need for a more precise
definition of where the Fund ought to be going and
what basic principles should guide it. The Fund must
have a clear mandate from its members on the areas
members would like to see considered and decided.
He believes that it is important that the members
decide whether currency stabilisation, for example,
should be the objective of a global body or of a
smaller group of industrial countries like the Group
of 5. There will be tension and ambiguity in this area
until this is resolved and it will make management of
the Fund very difficult, he says.
Contacts with banks
A decision must also be taken as to whether the
increasing contacts between the commercial banks
and the Fund, which has sprung from the debt crisis,
should be institutionalised in some way. Mr de
Larosii re's trip to New York to address the major
multinational banks at a rapidly convened meeting at
the New York Federal Reserve bank last November
was a milestone in this relationship. As he recalls it,
he did nothing more than explain the problems facing
Mexico and Argentina and that it would be impos-
sible to solve their liquidity problems without the
cooperation of the banks. He made clear that the
banks were perfectly free to make their own decisions
but he left the impression that the IMF adjustment
programmes would fail unless the banks put up
substantially more in new funds.
Current LMF projections suggest that the non-oil
developing countries will have a current account
deficit this year of $70 billion, down from $90 billion
in 1982. The Fund expects the banks to increase their
net contribution by 7-8% over the last year to about
$20 billion to help finance that deficit. Some $50
billion will come from grants, direct investments and
long-term official lending. The IMF will provide a
further $12 billion.
Mr de Larosiere said in Neuchatel that the
assumptions concerning commercial financing flows
were `both critical and uncertain'. He said further
that the projections for bank financing will depend on
a 'reassurance that sound adjustment policies are
underway in the borrowing countries. ... If
confidence in Fund-supported programmes were to
diminish because of a weakening of conditionality, an
abrupt curtailment of bank lending would seem to be
inevitable'.
Projected capital flows, he contends, would be
broadly consistent with an increase in the volume of
imports by these countries of 21h%. Mr de Larositre
is very sensitive to charges that the conditionality of
the Fund programmes may be too harsh and that it
may be detrimental to the world economy as a whole
to sharply curtail demand in the developing countries
which are major markets for the industrial world.
Conditionality works
The IMF has reviewed the overall performance of
developing countries that entered into upper tranche
stand-by arrangements in the period between 1971
and 1980 and found that they achieved significant
improvement in their balance of payments while
broadly maintaining their real economic growth. To
be sure, the past few years have seen a deterioration in
the world economic environment with growth rates
declining in industrial and developing countries alike.
But real growth rates may actually improve, even
during the first year of the Fund programme, for
most of the 23 countries that have recently approved
and the three that have proposed standby and
extended arrangements with the Fund.
Mr de Larosii re contends that the Fund's
adjustment programmes are designed to be `outward
oriented'. Of the most recent 26 programmes, 19
assume an increase in imports in the first programme
year as compared with the previous two years. Mr
Bergsten believes it is important for the Fund to
`calibrate' conditionality to take account of the world
economic situation. In reality, Mr de Larosi@re has
countered, Fund programmes have protected the
chances of recovery in the major developing
countries. Actions that do not make sense for
individual economies should not be taken simply for
the sake of international recovery.
The managing director continues to point out at
every opportunity that he cannot guarantee the
effectiveness of the Fund's adjustment programmes
or the quality of their implementation. Thus banks
must continue to lend at their own risk. He refused to
consider the provision of any sort of guarantee to the
banks nor does he have any interest in the numerous
schemes that are being proposed to consolidate the
debt of the developing countries. Even Giscard
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
d'Estaing raised the possibility that a market for bank
claims be established with some official support.
Some partial guarantees might be provided by a
multinational organisation, he said. Mr de Larositre,
on the other hand, is impatient with what he believes
to be easy answers, noting that a bad debt will not
disappear with the wave of a magic wand. It is
noteworthy that most bankers do not like these ideas,
either, because they generally involve the discounting
of their developing country assets.
Mr de Larosiere has said publicly that it may be
desirable for the Fund to issue explicit warnings
where external financing problems seem likely to
emerge. But the Fund remains cautious about
requests to increase the flow of confidential
information to the banks. Nor is the IMF noticeably
anxious to develop a closer relationship with the US
regulatory authorities.
The pressure, however, is building up. Anthony
Solomon, the president of the Federal Reserve Bank
of New York, told an audience in Geneva that bank
regulators in creditor countries should be able to
consult with the IMF so as to avoid an excessive
build-up of credit in the future. Some cooperative
approach, he believes, would avoid the competitive
inequities and convince borrowers that the authorities
are serious about moderating the amount of bank
lending in the future.
The American regulators made a series of proposals
to accompany the legislation for an $8-4 billion
expansion in the US contribution to increased IMF
quotas and the enlarged general arrangements to
borrow. These urged the Fund, in its consultations
with member governments on their economic poli-
cies, to intensify its examination of the trend and
volume of external indebtedness of private and public
borrowers in the member country. The regulators
want the Fund to report to the executive board on
such borrowing from the viewpoint of its con-
tribution to the economic stability of the borrower.
Of even more significance, however, is the request
that the IMF consider the extent or form that these
comments might be made available to the inter-
national banking community and the public. Further,
as part of any member's stabilisation programme, the
regulators want the Fund to place limits on public
sector external short and long-term borrowing and
publish information on the trend and volume of
international lending in the aggregate as it affects the
economic situation of lenders, borrowers and the
smooth functioning of the international financial
system.
For its part, the IMF has generally held the view
that there is a limit to the amount of information that
the Fund, on its own initiative, could make available
that bears on the economic and financial performance
of a member. The danger is that the Fund's rela-
tionships with the members would be harmed if the
IMF were to publish its reports and evaluations of
member countries economic policies and prospects.
Some bankers contend that the Fund protests too
much since any enterprising banker with good
contacts can learn of the Fund's assessments.
Early warning system?
Many bankers believe that the Fund should
develop its symbolic relationship with the private
market, evolve objective criteria for appropriate levels
of borrowing and act as an early warning system. Is
this possible? Irving Friedman thinks not. The IMFs
concerns, he explained, are of a macroeconomic
nature, ranging from balance of payments, inflation,
fiscal policy and the establishment of realistic
exchange rates. Bankers are interested in all these
things, but for them country risk is less of an
abstraction. They have their own exposures, balance
sheets and responsibilities to their shareholders to
consider. Therefore, they must be well informed
about the social and political environment in the
country in which they hope to lend. Those are
questions that the Fund cannot explicitly consider.
Can you conceive, Mr Friedman asks, of a situation
in which the Fund, having become aware of the heavy
short-term exposure of the Mexicans in early 1982,
were to have told the banks not to lend. Mr Friedman
cannot. That would have meant that the IMF was
prepared to take the responsibility for the level and
composition of international lending. It has neither
the authority given it by its members nor the
expertise to do so, he asserts. Said another observer,
you need it here, now So you
rns money for you
'
,
s success ea
When your company
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Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ANGLO FACTORING
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
n public
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`the borrowing countries would be very troubled if
the world banking community were to coalesce
around the Fund and the institution were to be able to
turn credit on and off like a faucet'.
While there is a growing recognition that closer
cooperation between the Fund and the banks might
help to keep credit flowing in the short term, people
are very sceptical as to how far this cooperation
should be allowed to go. The new Institute for
International Finance, established in Washington by
the major international banks, might provide one
channel for such cooperation. But it is not very clear
yet to most observers what the institute intends to do.
To this observer, the institute is still an `abstraction'.
Meanwhile, the staff of the Fund is severely
strained in attempting to put together plausible
adjustment programmes and to monitor the perfor-
mance of the borrowing countries. They find Mr de
Larosiere demanding and sometimes capricious.
They must often face hostility and deviousness in the
borrowing country.
Their calculations might be severely disrupted by a
further decline in oil prices, the failure of US interest
rates to decline or the dollar to fall from present
levels. But events that would harm one country would
benefit another. The Eastern European countries, for
example, would benefit if the dollar remains strong
because the bulk of their debts are in Swiss francs and
German marks.
Primary objective
Mr de Larosiere's primary objective, he tells those
around him, is to introduce more rationality into
economic decisions. He views the world dis-
passionately as a hard one, where resources are scarce
and often over-extended. The challenge is to sit down
with debtor countries, examine their future and the
resources available and decide what must be done to
return them to creditworthiness.
The path is a narrow one. On the one side are the
debtor countries that are increasing their sacrifices
and reducing their growth paths while, on the other,
are the banks which are often over-extended on a
number of key countries. But it is the considered
opinion of the staff and the managing director that the
type of adjustment that will be required to meet the
30% debt service burden envisaged for 1983 is poli-
tically and socially acceptable and does not ask for
impossible sacrifices. It is the nature of the situation
that some, especially in the developing countries;
would not agree.
The creditworthiness of the banks will also improve
if the programmes are successful, the IMF contends.
As Mr de Larosiere has been explaining to the banks,
it is better to have a restructured or rescheduled debt
on major borrowing countries with the prospect of
recovery, even if it is in the medium term, than for
the banks to slip away in a disorderly fashion and let
the situation deteriorate further.
Mr de Larosiere has been saying in recent months
that the current crisis is manageable if three basic
conditions exist. If the borrowing countries `stick to
their guns', if the bankers live up to their respon-
sibilities, and if the mix of policies in the major
countries allow for a durable recovery in the world
economy. It will be extremely difficult for the heavily
indebted countries to continue servicing their debts if
world trade does not pick up.
The Fund's responsibility in assuring that this will
happen is also three-fold. It must devise with the
borrowing countries stabilisation programmes that
are workable and convincing, it must develop an
understanding with the banks and it must continue its
surveillance of the major countries to assure that their
economic policies are correct for a sustained recovery.
Fund resources
It also goes without saying that the IMF must have
adequate funds to meet the unprecedented demands
on its resources. It was agreed at the Interim Com-
mittee meeting in Washington in February that the
Fund's quotas should be increased by 47.5% to SDR
90 billion or just short of $ 100 billion. There has also
been a pledge to increase the resources of the general
arrangements to borrow to SDR 17 billion or $ 19
billion and make these funds available to all members
of the IMF. This would roughly double the IMFs
available resources.
However, the legislation to approve the $8.4
billion US contribution could get bogged down into a
widescale debate on how banking regulations should
be amended to assure that debtors and their banks do
not become over-extended in the future. Despite Mr
de Larosiere's assurances that his intention is to `bail-
in' the banks, some in Congress persist in viewing the
IMF bill as some sort of `bail-out' for the banks.
The IMF will be short of funds this year, whether
or not the quotas are approved quickly. It has only $8
billion uncommitted and expects outlays in the $9
billion to $10 billion range. More funds will be
forthcoming from the Saudis but other sources of
financing may also be necessary.
The Group of 30 has argued that international
confidence would be enhanced if the IMF were to be
allowed to borrow from the private market. The
Japanese and Germans are very sceptical about a
market approach, much more so than the Americans.
There are those in the US who feel that such an
approach would drastically change the character of
the institution and they are not yet ready to see that
happen. That may mean that the Germans and the
Japanese will be approached for more funds. Since
such borrowing would also be at market rates, sources
within the IMF see little difference between that and
borrowing from the private market. In any event, the
major sources of funds will have to continue to be
subscriptions from the member countries. And, as
usual, increases in these subscriptions will continue
to be hostage to the US Congress' suspicion of foreign
aid.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
GLOBAL ECONOMIC OUTLOOIK
TUESDAY, FEBRUARY 15, 1983
UNITED STATES SENATE,
COMMITTEE ON FOREIGN RELATIONS
W ,
The committee met, pursuant to notice, at 10:30 ~a.m., n~ room
SD-419, Dirksen Senate Office Building, Hon. Charles H. Percy
(chairman of the committee) presiding.
Present: Senators Percy, Lugar, Mathias, Boschwitz, Pressler,
Pell, Biden, Sarbanes, and Dodd.
The CHAIRMAN. The committee apologizes to all of you. There
was a Cabinet session called by the President so that the Secretary
of State could report to the leadership of the Senate and members
of the Cabinet. We were delayed getting over here.
Secretary Shultz, we very warmly welcome you not only back to
the United States but for your first public appearance before this
committee in 1983. We are particularly pleased that you will be fo-
cusing your attention on the range of international economic issues
which affect the conduct of U.S. foreign policy today.
No one in this room need be reminded that you bring to these
issues a wealth of experience and expertise absolutely unique for a
Secretary of State, coming at a crucial time in American history
when international economic affairs are of greatest concern to all
countries throughout the world. It will be our good fortune to have
the benefit of your thinking in this area.
Senator Mathias conducted a series of hearings in January and
early February in the International Economic Policy Subcommittee
on the stresses and strains in the international financial system.
Today we continue the hearings at the full committee level. The
subcommittee received testimony from 15 witnesses including three
former Secretaries of the Treasury, the former Chairman of the
Council of Economic Advisers and the former Comptroller of the
Currency.
I wish to particularly commend Senator Mathias for the great
leadership and creativity that he and his staff have offered in fo-
cusing attention on the critically important economic factors which
so influence our Nation's security, and certainly, the timing of it
now, as the President this week sends forward his recommenda-
tions on IMF.
In these hearings we do not have to start the work, then, of de-
termining what the nature of the problem is, what the burden is
going to be. If the crushing debt incur red by these nations all come
together, will it lead to a world collapse of the economic system?
(369)
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
We now have 2 solid months of hearings anticipating this action
and recommendation by the President and action by the IMF.
The subcommittee hearings, together with the testimony we will
receive today from you, Mr. Secretary, and the testimony of Secre-
tary of the Treasury, Don Regan, who comes before this committee
next week, will form the basis for our consideration of authorizing
legislation for an additional U.S. contribution to the International
Monetary Fund.
We welcome your views, Secretary Shultz, on the need for addi-
tional resources for the IMF. In addition, this committee is charged
with authorizing the expenditure of U.S. dollars for foreign mili-
tary and economic assistance. We want to hear from you on how
such assistance is in the national interest of the United States.
We have, in short, a full plate of issues before us. I can assure
you that this committee will move with great dispatch in getting
these issues forward so we stay on schedule. We have already
scheduled a discussion with Howard Baker so we can move right
along on them, and we look forward to hearing from you today.
Senator Pell?
Senator PELL. Thank you, Mr. Chairman, and welcome. Today's
hearing before our committee on the state of the international
economy is, I think, symbolic of the importance which internation-
al economic issues have come to play in the formulation of our
policy.
It is particularly fitting that our Secretary of State, George
Shultz, himself a distinguished economist, should appear here
today to provide us with his assessment on the state of the world
economy and his recommendation for coping with the stresses of
the economic system brought on by the severe recession in the in-
dustrial West.
I am sure you are aware, Mr. Secretary, that a number of indi-
viduals have raised questions about the $8 billion-plus contribution
to the International Monetary Fund at a time when 12 million
Americans are jobless, and expenditures on domestic programs
have been cut to the bone.
I think it is necessary for the administration to articulate a
strong and credible case as to why it is in our interest to greatly
increase the resources of the IMF and provide funds for foreign as-
sistance programs in these difficult times.
When I was on the hustings these past weeks, this question came
up more often than anything else: Why should we send all this
money abroad when our people at home need employment, shelter,
food, and fuel? I think it would help us, the American people, if
you could give specific reasons why it is to the advantage of the
United States for these expenditures to be made. Why is it a good
investment for the taxpayer? Why is it a good idea that the aid re-
quest from the administration will go from $5 million to $6.3 bil-
lion; that the contribution to IMF will go from $16 billion to $24
billion.
I think these are tough questions, ones that I find are very diffi-
cult to answer to my constituents when they press me in my State
of Rhode Island, and I hope that today you could give us some spe-
cific reasons as to why it is to the advantage of the taxpayers of
the United States to move ahead with these expenditures.
1f
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
s anticipating this action
I action by the IMF.
ith the testimony we will
d the testimony of Secre-
Ies before this committee
sideration of authorizing
tion to the International
tz, on the need for addi-
his committee is charged
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hear from you on how
f the United States.
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reat dispatch in getting
dule. We have already.
r so we can move right
ing from you today.
, and welcome. Today's
to of the international
ince which internation-
the formulation of our
Mary of State, George
, should appear here
the state of the world
with the stresses of
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:hat a number of indi-
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time when 12 million
n domestic programs
'ation to articulate a
ur interest to greatly
funds for foreign as-
Cs , this question came
,uld we send all this
employment, shelter,
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ide. Why is it a good
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million to $6.3 bil-
m $16 billion to $24
I find are very diffi-
ress me in my State
Id give us some spe-
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371
Thank you, Mr. Chairman.
The CHAIRMAN. I wonder, Senator Mathias, having conducted
these subcommittee hearings, whether you would care to make a
comment.
Senator MATHIAS. Mr. Chairman, I would rather hear from the
Secretary, but I would take the opportunity to thank the extraordi-
nary roster of witnesses that we had come to this committee with
very deep preparation, who brought us an enormous amount of in-
formation so that we have a record, as you say. I think it will with-
stand challenge on this subject.
It is impossible to summarize all those hours of testimony in one
sentence, but the message they brought us very clearly is that we
live in an interdependent world economy in which unemployment
in the United States is very definitely tied to the lower levels of
trade with the developing world. The availability of capital is tied
to the whole question of the world debt and how we manage it. We
are going to have to proceed with great prudence and with a great
deal of determination to resolve these problems.
I think the answers to Senator Pell's questions lie in the kind of
program that the President alluded to in his state of the Union
message, so I am anxious to hear what Secretary Shultz has to say
on the subject.
The CHAIRMAN. We will try to adjourn close to 12 o'clock. The
Secretary has an appointment at 12:30, but because he dealt with
agriculture and just met briefly for a few minutes as he came into
the building with some agricultural leaders, if you have any open-
ing comment you would like to make, Senator Boschwitz and Sena-
tor Dodd, we would be happy to hear from you.
Senator BoscHWITZ. I am sorry I missed Senator Mathias' hear-
ings. I understand they were among the better hearings that have
been held in quite some time. And I share Senator Pell's concern.
I hope you will deal, Mr. Secretary, with the differences between
the budget authority and the outlays that, as I understand it, are
involved in contributions to the International Monetary Fund.
From the way I understand it these contributions would not in-
crease the deficit, though they would increase borrowing.
Are you going to cover that aspect of it?
Secretary SHULTZ. Yes, sir.
Senator BOSCHWITZ. Good. Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very much. Senator Dodd, do you
have any comments?
Senator Donn. Not at this time.
The CHAIRMAN. Secretary Shultz, we would be happy to hear
from you.
STATEMENT OF HON. GEORGE P. SHULTZ, SECRETARY OF STATE
Secretary SHULTZ. Mr. Chairman and distinguished members of
this committee, I am very pleased to have a chance to respond to
your invitation to testify on the international economic system and
the ramifications of it for the United States. So my
ject testimony re-
sponsive to your invitation and the questions is focused on this sub -
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
372
I would like to say at the outset, however, that you should not
infer from that that I think this is the only subject of interest in
foreign policy matters, and in particular, I 'would like to say that
the general program of security assistance and economic assistant
is of great importance to us in our foreign policy.
I am delighted to learn that you are going to push ahead rapid],
on your markup in this area, and I know that Under Secretary
Schneider is due to testify, I think, on Thursday. I simply want to
lend my support to what he will be telling you.
Restoring prosperity and stability in the world economy is one of
the fundamental goals of the President's foreign policy. Progress
toward that goal reinforces our other fundamental objectives-safe-
guarding peace and security and expanding the benefits of democ-
racy and freedom.
I am going to divide my remarks on the international economic
system into three sections. First, a discussion of the U.S. stake in
the international economy-where do we come in. Second, an ex-
amination of the antecedents of the current situation and the chal-
lenges that it presents; and finally, a description of some of the ac-
tions that the administration is taking and my thoughts about
them, to re-invigorate the world economy.
This country began as a trading nation. The legend of the
Yankee Trader has faded with time, but no matter how remote the
image, there are still plenty of Yankee traders among us, and I
think partly as a result, foreign trade is now more important than
ever to the vitality of our country.
In 1981, the United States represented about 25 percent of the
world gross national product. One out of five U.S. jobs depends in
some way on trade, and 40 percent of our cropland is devoted to
production for exports.
In the last decade, U.S. merchandise exports, as a percent of our
GNP, have doubled from 4 percent to over 8 percent. Much of this
increase is attributable to the growing interdependence of the
world's market economies in the 1970's.
Non-OPEC-leave the oil out of it-non-OPEC developing na-
tions, for example, accounted for roughly 20 percent of U.S. exports
in 1970. The same nations now account for nearly 30 percent of
U.S. exports, which happens to be more than either the European
community or Japan.
On the other side of the trade ledger, the non-OPEC developing
countries supply about 25 percent of the goods we import for use by
our factories and consumers. Since the counterpart to interdepend-
ence is dependence, it is not surprising that the Third World sup-
plies more than half the bauxite, tin, and cobalt used in American
industry, and virtually all the natural rubber, coffee, coca, and
hard fibers used by American consumers.
The North-South trade connection is important but it should not
be overstated. We should remember that Japan is our second larg-
est trading partner, and our neighbors, Canada and Mexico, are
first and third, respectively. Moreover, in the aggregate, the Euro-
pean Community is our single largest trading partner. Indeed, in
1982, U.S. trade with the EC totaled $46 billion as compared with
$32 billion with Canada.
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Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 you should not
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EC developing
Dort for use by
:) interdepend-
rd World sup-
1 in American
?ee, coca, and
it should not
r second larg-
I Mexico, are
ite, the Euro-
er. Indeed, in
impared with
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373
On the financial side, the United States has traditionally been a
large investor abroad, and conversely, has attracted a great deal of
foreign investment. In the 1950's and 1960's, returns to investment
were higher abroad than at home, and the United States was a
heavy net foreign investor.
The counterpart to this foreign investment was a persistent sur-
plus in our merchandise trade. By the 1970's, the demand for new
capital abroad had decreased, as had the U.S. supply of savings.
Thus, the United States ceased to be a net capital exporter and
usually incurred a deficit in merchandise trade.
This history is described in greater and more informative detail
in the "Economic Report of the President," so I will not develop it
further here. There is a very interesting chapter in the "Economic
Report on the United States and World Economy" that I think is
very well worth reading. There are a number of points in there
that they develop well.
The United States is also a significant factor in international fi-
nancial institutions, as you all referred to. Our support of the
World Bank and the International Development Association helps
mobilize capital for vital projects in the developing world. In addi-
tion, we are a major factor in the International Monetary Fund.
The IMF is an instrument of collective action and although we are
not a borrower, we still benefit when it supplements global liquid-
ity and provides members with temporary balance-of-payments fi-
nancing.
In sum, whether looked at from the trade side or the financial
side, the U.S. stake in the international economic system is signifi
cant-significant in terms of jobs, income, and opportunities. Spe-
cifically, we can infer from this brief overview that the United
States has a clear stake in the promotion of trade, in the vitality of
the international financial system, and in economic stability in de-
veloped and developing countries alike.
Beyond pure economics, however, we also have a stake that is
more political in character. The demonstration of the strength and
viability of market-oriented economies and the democratic form of
government with which they are associated. We should seize this
moment to prove the potential of the open market mentality that
inspired the Yankee traders.
In so doing, however, our own system will be put on trial. There-
fore, if we urge other countries to adopt market-oriented policies,
we should be sure to adhere to those policies ourselves.
The world is now coming through a period of painful decompres-
sion from the severe inflationary surge of the 1970's. That period
has left us with serious problems: High unemployment in the in-
dustrial countries, large public sector deficits that constrain recov-
ery, and the heavy debt burden of some developing nations that
now strains the international financial system. These problems had
their origin in the decade of the seventies. An analysis of that
period reveals that they may have a common solution-economic
expansion in the 1980's.
The level of developing countries' total debt, which now stands at
nearly $700 billion, increased more than sevenfold from 1972 to
1982. In the same 10-year period, debt to private lenders jumped
from 40 to 60 percent of outstanding LDC debt. The conclusion
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drawn from these facts by those who wish to fix blame is that
either the banks overlent during the 1970's or countries overbor-
rowed.
The truth is that many bad judgments were made. But it is also
true that after the oil price increases of 1973-74, lenders and bor-
rowers acted on a set of assumptions; buoyant export growth and
low interest rates, that though proven false, were thought reason-
able at the time. The recycling of petrodollars from the OPEC na-
tions to the nonoil LDCs was a highly profitable business for the
banks. And since the loans were in inflation-depressed dollars, the
LDCs assumed that today's loans would be repaid with cheaper
dollars tomorrow. In this environment, indebtedness mounted.
It would be wrong, however, to characterize the legacy of the oil
shock years as a debt problem. Rather, in its broadest aspect, it is
an income-earning problem.
True, LDCs borrowed a lot in the 1970's, but our domestic corpo-
rations borrowed a lot, also. The difference is the corporations
invest in productive capacity to generate income to repay their
debts. Some LDCs, however, tended to invest in consumption
rather than production, borrowing to finance internal income
transfers. This strategy, although of questionable wisdom, was tol-
erable as long as LDC export earnings grew fast enough to service
their debts.
That was, indeed, the case from 1975 to 1979 when LDC exports
grew 22 percent annually, roughly keeping pace with the 25 per-
cent annual growth of LDC debt.
In response to the second oil shock in 1978-79, however, the
major industrialized nations adopted more restrictive monetary
policies which slowed inflation, boosted interest rates and set in
motion a retrenchment from the economic excesses of the 1970's.
High interest rates and a strong dollar increased LDC debt serv-
ice costs. Simultaneously, LDC export earnings declined as the re-
cession reduced the demand for the slashed prices of LDC commod-
ities.
Indeed, nonoil commodity prices fell 28 percent between 1980 and
1982, increasing debt service ratios and eroding the terms of trade.
As Tanzania's President, Julius Nyerere, has put it to buy a heavy
truck in 1981, Tanzania had to produce 10 times as much tobacco
or 4 times as much cotton, or 3 times as much coffee as it took to
purchase the same truck just 5 years earlier.
The problem faced now by Tanzania and other high debt develop-
ing countries is not so much a debt problem as an income-earning
problem: Rising debt service costs consume an ever-increasing pro-
portion of declining export earnings. Many LDC's are now under
pressure to increase exports and curb imports. This comes at a
time when the industrialized countries face rising unemployment,
declining real income and deteriorating trade balances. As a result,
the international financial, trade and monetary systems are under
serious strain.
I recognize that is kind of a shorthand summary of much of your
hearings, Senator Mathias.
The only lasting solution to the income-earning problem of the
LDCs, as well as the serious problems of the industrial countries,
is sustained economic growth without renewed inflation. The key
to stimulating
the 1970's of th Today, for ex
ized West and
has been estir
in 1983 rather
countries woulc
West, a figure
service payment
The industri:i
an expansion c
States is on the
is just a persona
dent's fiscal yea
down, inflation
expansionary SE
States and other
are positioned to
The recent dr
course, an oil p
sudden unanticil
tions. An oil pric
tries, especially
ezuela.
But assume fo
tion-I underline
enough case so s
magnitude invoh
40-percent drop.
would, in the ag.,
2-year period:
Real growth ra
percent, and devc
the United State:
the 1983 oil-impo
billion, and that
count balance wo
of $17 billion. Si;
cutting their cur;
cant oil-price dec
proportional to th
Now, I say this
all of the handwri
of oil-price declir.
happen. And this
involved in the dii
Senator BoscHv
in your testimony'
Secretary SHUL'1
The salutary of
come about auton
nations, must wor
seized. In turn, th
four objectives. F
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blame is that
ntries overbor-
But it is also
nders and bor-
)rt growth and
hought reason-
the OPEC na-
isiness for the
!ed dollars, the
with cheaper
mounted.
gacy of the oil
Est aspect, it is
omestic corpo-
e corporations
to repay their
consumption
ternal income
sdom, was tol-
,ugh to service
i LDC exports
th the 25 per-
however, the
monetary
and set in
of the 1970's.
,DC debt serv-
ned as the re-
LDC commod-
veen 1980 and
arms of trade.
buy a heavy
much tobacco
as it took to
debt develop-
come-earning
icreasing pro-
?e now under
comes at a
iemployment,
;. As a result,
.-ns are under
much of your
oblem of the
al countries,
ion. The key
to stimulating that growth lies in the interdependence forged in
the 1970's of the world's economies.
Today, for example, the economic linkage between the industrial-
ized West and the developing world is tighter than ever. Indeed, it
has been estimated that if OECD GNP were to grow by 4 percent
in 1983 rather than the projected 1.8 percent, the nonoil developing
countries would earn an additional $15 billion on exports to the
West, a figure equal to 14 percent of their estimated 1983 debt
service payments.
The industrialized countries in my opinion are now poised to lead
an expansion of the world economy. In particular, the United
States is on the road to recovery. It appears to me personally-this
is just a personal opinion-that the growth projections in the Presi-
dent's fiscal year 1984 budget will be exceeded. Interest rates are
down, inflation is down, inventories are depleted. Basically, a very
expansionary set of policies are in place. In short, the United
States and other industrialized nations that have reduced inflation
are positioned to play a vital role in world economic expansion.
The recent drop in oil prices may also stimulate expansion. Of
course, an oil price decline is not unambiguously good, for any
sudden unanticipated change in the world economy causes disrup-
tions. An oil price decline may, for example, harm individual coun-
tries, especially net oil exporting LDCs such as Mexico and Ven-
ezuela.
But assume for the sake of illustration, as distinct from predic-
tion-I underline that-but I want an illustration, and I take a big
enough case so we can really kind of get an idea of the orders of
magnitude involved here: a decline, say, to $20 a barrel which is a
40-percent drop. It has been estimated that such a price decline
would, in the aggregate, have the following catalytic impact over a
2-year period:
Real growth rates in industrial countries would increase 1 to 11/2
percent, and developing country rates 2 to 21/2 percent. Inflation in
the United States and elsewhere would decline 11/2 to 21/2 percent;
the 1983 oil-import bill for industrial countries would drop by $90
billion, and that for LDCs by $9 billion. The OECD current ac-
count balance would swing from a deficit of $18 billion to a surplus
of $17 billion. Simultaneously, LDC exports would rise 3 percent,
cutting their current account deficit by $18 billion. A less signifi-
cant oil-price decline would have similar positive effects, roughly
proportional to the reduction from current prices.
Now, I say this not as a prediction but just to point up that with
all of the handwringing you sometimes hear of about the possibility
of oil-price declines, there is a very positive side if that should
happen. And this just gives some notion of the orders of magnitude
involved in the direction and the effect.
Senator BoscxwITZ. Are you going to make a prediction later on
in your testimony?
Secretary SHULTZ. No, sir; I have one, but I am not talking.
The salutary effects of the world economic expansion will not
come about automatically. The United States, together with other
nations, must work to insure that the opportunities for growth are
seized. In turn, this means that we must concentrate our efforts on
four objectives. First, insuring sufficient liquidity in the interna-
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376
tional financial system; second, preserving open markets; third, im-
proving the international monetary system; and, fourth, insuring
political stability in the developing world.
In working toward each of these objectives, which I shall address
in turn, cooperation will be essential. Cooperation between the
public and private sectors, between the developed and developing
worlds, between business and Government, and between the execu-
tive branch and the Congress.
The basic elements for successfully dealing with the liquidity
problems of the high debt developing countries are known and in
place. The so-called debt bomb can be defused through emergency,
short-term bridge financing, leading to adjustment programs imple-
mented in conjunction with the IMF and with the cooperation of
commercial banks.
Private banks, however, are now reducing their rate of new lend-
ing to the developing world. Net new bank lending was flat be-
tween the first half of 1981 and the first half of 1982. estimates for
the second half of 1982 show a precipitous drop in new lending,
which we have to say it is not surprising that that should happen
under the circumstances.
Such an abrupt contraction in new lending obviously would im-
peril the recovery of the debtor countries. Moreover, reduced lend-
ing in the face of increased debt-service costs would also retard our
own recovery by contracting LDC imports from the West. Indeed,
as Rimmer de Vries recently testified, a Morgan Guaranty Trust
Co. study estimates that if capital flows into the LDCs were cut by
$25 billion, OECD growth would drop at least a half a percentage
point. With OECD growth in 1983 expected to be only 1.8 percent,
half of a percentage point represents a significant cut in growth.
The Morgan Guaranty study is hypothetical. But import cuts are
already a reality. A dramatic case in point is Mexico whose 1982
imports from the United States dropped 36 percent from the 1981
level. Consequently, in the course of a single year, the U.S. balance
on merchandise trade with Mexico swung from a $3.7 billion sur-
plus to a $4.5 billion deficit.
The international economy is too vulnerable to this kind of con-
tradiction to permit a continued decline in lending to the Third
World. Private banks have a collective interest in extending suffi-
cient new money to permit the developing countries to service their
debts. Western governments, including our own, have a similar
stake in seeing that the LDCs have sufficient capital to pay for im-
ports of goods and services that will enhance LDC productivity and
contribute to world economic expansion.
The United States, I believe, stands ready to do its part in this
effort. Where appropriate, we will provide funds, as was the case
with Mexi,to, through bridge financing, CCC credits, Eximbank
loans or swap facilities.
This administration will also be seeking congressional support
for the expansion of IMF resources, coming directly to Senator
Pell's question. In just-concluded negotiations last Friday, member
countries agreed upon a quota increase of 47.5 percent. The U.S.
share of this increase will be approximately $5.8 billion. I might
note that the quota increase is not a U.S. budget item-this, I
think, is going to be responsive to your point, Senator Boschwitz-
for it
for n c l
J1or
nation
off old
are th.
with t
vate I(.
incre:rr
age wo
Anot
gener;,i
10 indc
upon sc
Howc
with th
the GA
is $2.6
quoted
that $8
Unlik
not be I
try wh(
whole.
'Our s
totals $t
approve
the poin
Ifull ys
Don Ret:
minister
outstand
here and
Let m,
lending
in LDC I
depend c
veloping
export g
Therefor,
serve the
The re
derstand;
gress wil
and other
hard-hit
These
and econ(
barriers r
currency
ports. Cor
ductive ,-
That do
nations' t
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narkets; third, im-
1, fourth, insuring
ich I shall address
lion between the
,d and developing
etween the execu-
?vith the liquidity
.ire known and in
rough emergency,
t programs imple-
.he cooperation of
rate of new lend-
ding was flat be-
982. Estimates for
in new lending,
.at should happen
viously would im-
ver, reduced lend-
Id also retard our
the West. Indeed,
? `:uaranty Trust
s were cut by
half a percentage
only 1.8 percent,
at cut in growth.
it import cuts are
exico whose 1982
at from the 1981
the U.S. balance
1 $3.7 billion sur-
this kind of con-
ing to the Third
i extending suffi-
~s to service their
, have a similar
tat to pay for im-
productivity and
3 its part in this
as was the case
edits, Eximbank
?essional support
ectly to Senator
Friday, member
ercent. The U.S.
billion. I might
,et item-this, I
ator Boschwitz-
377
for it represents an exchange of financial assets; cash in exchange
for a drawing right on the IMF.
More importantly, our quota represents an investment in inter-
national financial well-being. The purpose of the IMF is not to pay
off old debts, but to encourage sound policies. Indeed, indications
are that a borrowing country's creditworthiness tends to improve
with the successful implementation of an IMF program, and pri-
vate lending then generally increases rather than declines. A quota
increase is thus an inherent component of any program to encour-
age world economic growth.
Another component of such a program is the expansion of the
general agreements to borrow. A GAB was initially established by
10 industrialized nations as a backup line of credit to be drawn
upon solely by the 10 contributing countries.
However, late last month in Paris, the United States, together
with the other nations of the group of 10, agreed to almost triple
the GAB from $7 billion to $19 billion. Our share of this expansion
is $2.6 billion. I think, incidentally, the number that is being
quoted is the sum of the $5.8 and the $2.6 billion. That is where
that $8.4 billion figure comes from.
Unlike the traditional GAB, access to this expanded fund will
not be limited to the G-10 alone, but will be accessible to any coun-
try whose liquidity problems threaten the financial system as a
whole.
Our share of the IMF quota increase and the GAB expansion
totals $8.4 billion. This is the amount we will be asking Congress to
approve before the end of 1983. Anrl Secretary Regan, of course, is
the pointman in presenting that to you, but I want to say here that
I fully support what he is doing, and I think the combination of
Don Regan s efforts and Paul Volcker's efforts with other finance
ministers, and central bankers, and Jacques de La Roussiere, an
outstanding international civil servant, has been very important
here and effective.
Let me turn to the trading system. Even if the sustained bank
lending and increased IMF resources prevent a sharp contraction
in LDC liquidity, the success of our financial efforts will ultimately
depend on adjustments in the trade accounts of developed and de-
veloping countries alike. Import cuts can provide only so much;
export growth must lead the way in the recovery of the LDC's.
Therefore, we must resist protectionist pressures and seek to pre-
serve the system of open trade we helped to build.
The recession and high rates of unemployment in the West un-
derstandably have increased protectionist pressures. The 98th Con-
gress will probably confront local content legislation, agricultural
and other subsidies and a host of protectionist proposals directed at
hard-hit sectors such as steel and autos.
These protectionist moves threaten to impede our own recovery
and economic expansion generally. Quotas, tariffs, and other trade
barriers raise costs to us and deny borrowing countries the hard-
currency earnings needed to service their debts and buy our ex-
ports. Conversely, open trade speeds resources to their most pro-
ductive uses and creates more jobs than it destroys.
That does not mean, however, that we should acquiesce in other
nations' trade-distorting practices, expecially those imposed on sec-
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tors such as agriculture and services, in which we enjoy a compara-
tive advantage.
This is what we were discussing just before coming here, Mr.
Chairman.
Subsidized agricultural exports from the EC, for example, have
enabled European farmers to expand their share of third country
markets at the expense of U.S. farmers. In response, we recently
sold subsidized wheat flour to Egypt.
Temporary, trade-distorting measures such as the wheat flour
transaction can be justified on the ground that "when all the world
is mad, 'tis folly to be sane." But we should remember these are
insane things to be doing.
Temporary measures tend to become permanent; and retaliation
has an inherent tendency to escalate. Constructive negotiations-in
which we meet unreason with reason-present the only lasting so-
lution to protectionist problems such as export subsidies.
We have a situation emerging where, for example, through this
competitive subsidy program various countries in the world will be
producing butter, and as the butter gets sold in the world market
and winds up in the Soviet Union, through this insane system of
subsidies butter will be produced and sold to the Soviet housewife
at about one-quarter the price the American housewife pays for it.
Can anyone explain why that makes sense? I do not see it.
We will, therefore, work within the GATT to remove barriers to
the export of U.S. services and agricultural products, In addition,
we will work on a bilateral basis, as I did on my trip to Japan, to
roll back trade barriers. Difficult but important negotiations with
the EC on agricultural trade subsidies are now in process. Finally,
we will seek concrete ways of implementing the open trade pledges
made by the major industrialized countries at the Versailles
Summit and the GATT Ministerial.
Turning to the monetary system, trade is encouraged by stability
in exchange markets-something we have not had in recent years.
The instability of relative currency values over the last decade is
basically a reflection of turbulent economic conditions. But several
developments have created recent problems for the trading position
of U.S. producers.
Financial flows, for example, are having a powerful effect on ex-
change rate movements. This presents difficulties from the stand-
point of trade. During 1982 financial flows into the United States
led to the greatest appreciation of the dollar since the beginning of
floating rates in 1973. The strong dollar increased the price of U.S.
exports and decreased the cost competitiveness of U.S. industry.
Consequently, the U.S. trade deficit in 1983 is expected to widen.
Moreover, if large outyear budget deficits are not reduced, they
will consume U.S. national savings, which already accumulate at
the lowest annual rate in the industrial world. A shortage of sav-
ings would drive up both real interest rates and the dollar, thereby
further widening our trade deficit.
In other words, what is happening to us here is we suddenly find
ourselves in a kind of Switzerland position where big financial
flows are having an effect on the value of the dollar. The market is
behaving just right. I mean it is reflecting what is happening. How-
ever, when you look at trade, that strong dollar is making our
goods muc
real trade
An addi
system is
tween Mal
230 ven t(
Japan and
nese impoi
the ven ha
This poii
of Caterpil
to knock C
is not beca
not know I
mendous ii
The soli.
clear. Who
study by tl-
Finally,
ing relative
markets, a,
ficult-in
veloping cc
West and
curbing ec,
will be abo
tries have I
exports of
tempted by
LDC ausi
dangers U.;
culties thrc
States. Eco
hundreds o
difficulties
terest in M:
In short,
While LDC
place withi
cient finan
growth.
This anal
its implicat
dening the
LDC debt-
growth in t
the debt bu
become mar
The key t
creased exp,
dependent c
industrialize
everywhere-
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rich we enjoy a compara-
)efore coming here, Mr.
EC, for example, have
r share of third country
n response, we recently
uch as the wheat flour
hat "when all the world
lld remember these are
manent; and retaliation
ructive negotiations-in
sent the only lasting so-
ort subsidies.
example, through this
?ies in the world will be
,ld in the world market
1 this insane system of
to the Soviet housewife
n housewife pays for it.
I do not see it.
I' to remove barriers to
l products, In addition,
in my trip to Japan, to
it negotiations with
ww in process. Finally,
the open trade pledges
?ies at the Versailles
encouraged by stability
of had in recent years.
)ver the last decade is
conditions. But several
or the trading position
powerful effect on ex-
ulties from the stand-
nto the United States
since the beginning of
used the price of U.S.
less of U.S. industry.
is expected to widen.
are not reduced, they
Iready accumulate at
Id. A shortage of sav-
nd the dollar, thereby
?e is we suddenly find
where big financial
dollar. The market is
it is happening. How-
lollar is making our
379
goods much less competitive in third markets, thereby presenting a
real trade problem to us.
An additional problem we face in the international monetary
system is the great volatility in exchange rates. For example, be-
tween May and November of 1982, the yen depreciated from about
230 yen to the dollar to 276, raising the price of U.S. exports in
Japan and third country markets, and reducing the price of Japa-
nese imports in the United States. By the end of the year, however,
the yen had swung back to its previous level of 230.
This point was made very vividly to me by Lee Morgan, the head
of Caterpillar Tractor. And the effect of the big swing was basically
to knock Caterpillar out of a whole set of third-country markets. It
is not because something was wrong with management or they did
not know how to sell in third markets or whatever. It was the tre-
mendous impact on them of the swing in exchange rates.
The solution to such excessive exchange rate volatility is not
clear. What is clear, however, is that the problem warrants close
study by the major currency countries.
Finally, even if we succeed in increasing LDC liquidity, preserv-
ing relatively open trade and decreasing volatility in the exchange
markets, adjustment for many developing countries still will be dif-
ficult-in some cases, testing what the social fabric will bear. De-
veloping countries have had to accommodate the recession in the
West and their own financial problems by cutting imports and
curbing economic growth. Aggregate real LDC
will be about 1 to 1.5 percent-the lowest since 1950. African coup
tries have been especially hard hit because of their dependence on
exports of primary commodities. Increasingly desperate, they are
tempted by repressive strategies and radical panaceas.
LDC austerity can, if excessive, risk political instability that en-
dangers U.S. strategic interests. In this hemisphere, economic diffi-
culties threaten to increase illegal immigration into the United
States. Economic troubles were a factor in the recent expulsion of
hundreds of thousands of Ghanians from Nigeria. And economic
difficulties in the Sudan could, for example, threaten the U.S. in-
terest in Middle East stability.
In short, our own strategic interests dictate the following rule:
While LDC adjustment is necessary, such adjustment must take
place within the limits of the politically possible, and with suffi-
cient financial support to maintain stability and spark renewed
growth.
This analysis has, by necessity, been quite general. Yet I think
its implications are straightforward. The problems currently, bur-
dening the international economy-recession, high unemployment,
LDC debt-all have a common solution: economic expansion. If
growth in the world economy resumes and real interest rates fall,
the debt burden of even the most heavily indebted countries will
become manageable.
The key to recovery from the debt problems, however, lies in in-
creased exports from developing countries. That increase is in turn
dependent on an expansion of our own economy and those of other
industrialized countries. Economic expansion anywhere can help
everywhere-but not necessarily.
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380
For if we expand, while simultaneously erecting protectionist
barriers, neither the LDC's nor the industrialized countries will
benefit from that mutually reinforcing boost to recovery provided
by open trade. In shutting out goods from the rest of the world, we
will incur not only the usual costs of protection-higher prices to
consumers and jobs lost in the export sector-but retard our own
recovery and threaten the world economic system as well.
Our challenge, therefore, is to revitalize the international finan-
cial system; preserve and extend the benefits of open trade; im-
prove the monetary system; and insure political stability in the de-
veloping world. This administration is working hard to achieve
these four objectives, all of which contribute to leading orldn econthat is expanex--
pansion. Our own economy will P Y a
sion. As a result, we have an opportunity to demonstrate the con-
tinued viability of our market-oriented economy, and the democrat-
ic institutions it supports.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very much, Secretary Shultz.
Because of the number of Senators here this morning and the
time constraints we are working on, without objection we will go
on a 7-minute rule. farm Mr. Secretary, just before we came in here the met with of the
leaders, and they put the question to you problem
United States being a stable supplier and supported strongly ac-
tions taken by the administration in contract sanctity.
There was a position taken on those pipeline sanctions, which we
appreciate, a position of leadership that you and the President
took. Could you say something about long-term contracts with the
People's Republic of China, and longer than a 1-year
has been already committed with the Soviet Union? Are we work-
ing toward a longer term agreement so we can destroy this image
that we are not a reliable supplier? for any
Secretary SHULTZ. First I think it is very important we will do
trader to be viewed as reliable, so that when we say
something or I as a private businessman or farmer or whatever say
I will do something and I sign up to that, that the person I am
signing with can count on it. That is an essential ingredient
trade, so we have cthat make it necessary to breakea~ contract.
But t things happen as
BI think that we should view that as something that happens a last resort and under the most extreme circumstances. Other-
wise, we lost our position in the trading world.
As far as agricultural sales in China and the Soviet Union are
concerned, of course, those represent both large potential markets
for our farmers. Both from the standpoint of our farmers' role' in
our own markets and from the standpoint of the attitude of people
to whom we are selling, reliability is an important ingredient.
desir-
Other things reasonably equal, long-term
able because they tend to give information about what is happen-
ing to the marketplace and provide a level of assurance a to beota
suppliers and consumers about what can happen.
proposition I think they are desirable.
In order to move forward
that is congenial to t the expectations I think we need 'an implied by longter
P m
agreement
upgrade t!
is a great
with it. Iii
The Cii
in, the ii
in,,, the m
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tiation, ri
seen.
the agric,
member,
ability. i1
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lem that
exports.
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pediment
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first be d
could be
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market, c
closer pai
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do with
take the
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underval
ing is the
rencies a
and then
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land be 11
the char:
have bet
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into the
portant i
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market
the into
fact that
down is
chandist
heads pi
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the valu
Treasur:
along th
I wou
is a vei
dollar o
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
protectionist
)untries will
ery provided
he world, we
-:er prices to
and our own
tional finan-
n trade; im-
ty in the de-
l to achieve
economic ex-
that expan-
-ate the con-
he democrat-
iltz.
ling and the
a we will go
!t with farm
)blem of the
strongly ac-
ns, which we
President
with the
:tension that
,re we work-
y this image
ant for any
we will do
vhatever say
person I am
ngredient in
ies, unfortu-
i a contract.
t happens as
nces. Other-
t Union are
tial markets
ners' role in
.de of people
edient.
is are desir-
t is happen-
tnce to both
is a general
d an atr^os-
y long-term
agreements; so it is an important part of our diplomacy to try to
upgrade that atmosphere. Obviously it takes two to do that, and it
is a great big broad problem, and I hope we can make headway
with it. But it is a difficult situation to predict.
The CHAIRMAN. Will consideration be given to not only increas-
ing the limits at the bottom-6 million tons now-but also increas-
ing the maximums?
Secretary SHULTZ. All of these things would be part of any nego-
tiation, and just where one would come out would remain to be
seen. Right now there seems to be an atmosphere of surpluses in
the agricultural field. It isn't always that way, as we can all re-
member, and nature tends to have a way of imposing some vari-
ability. And so you have to be ready for both types of situations.
The CHAIRMAN. In your statement you touch briefly on a prob-
lem that the strong dollar creates for the competitiveness of U.S.
exports. We hear not only from farmers but manufacturers on this.
From your view or our view the overvalued dollar is a critical im-
pediment to increased exports.
From your own perspective as an ex-budget director should we
first be doing more to reduce the future budget deficits; what else
could be done? Second, do you think with resepct to the yen that
the yens value as against the dollar is entirely set by the free
market, or there are things that Japan could do to bring the yen in
closer parity to the dollar?
Secretary SHULTZ. Two different questions there, one having to
do with the monetary system and the other the budget. Let me
take the first and then the second.
I did not say that the dollar was overvalued or that the yen was
undervalued. The market has made an evaluation. What is happen-
ing is that we have tended historically to think of the dollar or cur-
rencies as reflecting sort of trade flows and relative inflation rates,
and then the values sort out to bring about some stability there.
A few countries have had a rather different problem, Switzer-
land being the outstanding one, because it has in a sense as much
the characteristics of a bank as it does of a country. Financial flows
have been very big there for a couple of reasons. Particularly in
the last couple of years there have been very big financial flows
into the United States, and they have tended to become very im-
portant in setting the value of the dollar.
The market has correctly reflected these flows, so in that sense
you cannot say it is overvalued or undervalued or anything. The
market has been reflecting these facts: That money has come to
the interest rates here and, I believe, seeking a safe haven. The
fact that money keeps coming even though interest rates are going
down is a measure of that fact. But it poses problems for our mer-
chandise trade, and that is something that we have to scratch our
heads pretty hard about.
There is no evidence that the Japanese have been maneuvering
the value of the yen; and that has been looked at very hard by the
Treasury, and they see no evidence for that whatever. It is more
along the lines of what I suggested.
I would point out also in the President's Economic Report there
is a very interesting chart that shows the cross rates with the
dollar of the yen, of the Deutsche mark, of some other currencies,
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382
but the yen and Deutsche mark are the two principal ones there.
The track is rather parallel, so you have a broad influence here.
On the budget side, I think the outyear deficits are the thing to
focus on. Personally, I think that the deficits in the current fiscal
year and 1984, while it would be desirable to compress them some-
what, are nevertheless ones we can live with. It is the outyear defi-
cits that are frightening to financial markets.
Just what they will turn out to be, of course, remains to be seen,
and I do not have total confidence in our ability to project exactly
what our economy will look like 5 years from now; but people have
done the best they can, and we see that there is a substantial defi-
cit. The President's contingent tax proposal I think is a good one
and a way of addressing that, and of course, the spending side
needs to be worked on continuously and hard.
The CHAIRMAN. Thank you, Mr. Secretary, and congratulations
to you on a much-needed and I think an outstanding trip to the
Far East.
Senator Pell.
Senator PELL. Thank you, Mr. Chairman.
In connection with the exclusive economic zone, under which you
know, we would have the exclusive right to all living and mineral
resources within a 200-mile area on a line from our shores, what
are the plans of the administration? Do you plan to move ahead
with a unilateral declaration on that, or would you be willing to
wait until we have had a hearing on the matter?
Secretary SHULTZ. You catch me unprepared, Senator Pell. I
have thought about the Law of the Sea Treaty a lot, and that is a
point that I have not registered on. I know that we feel that the
200-mile limit that is established in the Law of the Sea Treaty is
something that we would claim for ourselves and do claim for our-
selves. Certainly a hearing is fine, but I am not sure what the jux-
taposition of a formal declaration in a hearing is. I would have to
get back to you on that.
Senator PELL. Let me submit that in writing, if I may, sir.
Secretary SHULTZ. Certainly.
Senator PELL. I thought your statement was excellent. I found
that even though I am no economist myself, I understood it and its
thrust. But I speak to you as a representative of an administration
which is terrific in communication, headed up by a great communi-
cator, and in this regard I want you to imagine yourself not having
a group of friendly Senators here but having as I had a couple of
weeks ago, 500 very angry individuals without enough fuel, cold,
not enough food, some of them depending on soup kitchens, some of
them looking for lodging.
Many people are very upset at the foreign aid program and its
corollary, the IMF. When you add these figures up, they really are
tremendous. How would you in very simple terms explain to people
who have no college degrees, half of them no high school degrees,
what the advantages to the American poor and unemployed and
cold and hungry Americans are of the aid program?
Secretary SHULTZ. There is a lot of variety in the programs being
spoken of. There is the support for the IMF and the General Ar-
rangements to Borrow. There we essentially have asset trades in
the interest of n
from breaking dh
Senator PELL.
Secretary SHC;
The question is
pands, that can
people will be at
process of job cre
I think the evi ing system and f
pansion of trade
in history, not or
everyone has ber
risen. That is the
nation.
It is also true t
the developing cc
matic, we see wha
stake in keeping c
are a member of
healthy, not just c
Senator PELL.
question of jobs or
petitive ability th
Japanese are pro,
salaries, when you
employment and
wages from the sc,
to them that we
takes more than a
What I am real
ments that can be
ing, fair trading,
ment, as you know
Secretary SHULT
in the fact that 4(
Those exports havc
lands are dependec
tries that export h,
by imports, to be
some sense of pace
In the textile ca.,
that imports shoul(
market itself grow:
been a negotiation
At the same time
we have an indust
1970's than in mane
the problem. I thin
this very courageou
time I think we ha
produced off the U.;
the ones of 3 or 4 vc
the times, they are
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ncipal ones there.
Lid influence here.
s are the thing to
the current fiscal
npress them some-
s the outyear defi-
emains to be seen,
to project exactly
w; but people have
a substantial defi-
iink is a good one
the spending side
id congratulations
anding trip to the
under which you
living and mineral
i our shores, what
an to move ahead
'u be willing to
d, Senator Pell. I
i lot, and that is a
,t we feel that the
the Sea Treaty is
d do claim for our-
sure what the jux-
is. I would have to
'I may, sir.
excellent. I found
iderstood it and its
an administration
a great communi-
,ourself not having
I had a couple of
enough fuel, cold,
p kitchens, some of
d program and its
up, they really are
s explain to people
igh school degrees,
I unemployed and
m?
he programs being
d the General Ar-
Lve asset trades in
the interest of maintaining the health of the system and keeping it
from breaking down.
Senator PELL. To these people the system has broken down.
Secretary SHULTZ. Well, it has broken down but not irreparably.
The question is to keep things together so. that as our economy ex-
pands, that can take place with as much flourish as possible; and
people will be able to get their jobs back or get other jobs, so the
process of job creation can proceed.
I think the evidence for the importance of the international trad-
ing system and financial system to that is overwhelming. The ex-
pansion of trade has been accompanying one of the greatest booms
in history, not only for ourselves but for our trading partners. So
everyone has benefited from that. Their standards of living have
risen. That is the line along which I would try to make the expla-
nation.
It is also true that if our trading partners suffer too badly-and
the developing country examples I gave, such as Mexico, are dra-
matic, we see what that has done to us in many ways. So we have a
stake in keeping other people healthy, just as we have a stake if we
are a member of a community in keeping the whole community
healthy, not just ourselves alone.
Senator PELL. When it comes to explaining to our people the
question of jobs or the lack of jobs here and the difference in com-
petitive ability that we face-automobiles, for example, where the
Japanese are producing cars with fewer work people, where the
salaries, when you check into it, the benefits of permanent lifetime
employment and the side benefits are not that much different in
wages from the scale that we have here-it is very hard to explain
to them that we are losing our competitive edge. And I think it
takes more than a theoretical explanation.
What I am really groping for here are for some specific argu-
ments that can be used as to why the aid program and free trad-
ing, fair trading, is a good idea; because the protectionist senti-
ment, as you know, is building up very hot and heavy.
Secretary SHULTZ. I think you have to point, if you are a farmer,
in the fact that 40 percent of our cropland is devoted to exports.
Those exports have to go somewhere, and the people who till those
lands are depended on that trade. Similarly, there are many indus-
tries that export heavily. There are other industries being affected
by imports, to be sure, and some balance there is important and
some sense of pace as imports increase is important.
In the textile case, for example, there has been a determination
that imports should not increase faster than the rate at which the
market itself grows, at least for now. And the result of that has
been a negotiation to try to bring that into some kind of balance.
At the same time you mentioned the case of automobiles. There
we have an industry where wages rose much faster during the
1970's than in manufacturing generally, which accounts for part of
the problem. I think the auto union and industry has confronted
this very courageously in the last couple of years. But at the same
time. I think we have to take note of the fact that the cars being
produced off the U.S. assembly lines now are definitely superior to
the ones of 3 or 4 years ago, in my opinion. They are more suited to
the times, they are smaller, they are lighter. I think the quality
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has been improved greatly, so the U.S. consumer is getting some-
thing better.
One of the reasons is that our manufacturers saw that if they
are going to stay around, they have to compete, and they have to
make a product better; so we are getting benefits from that kind of
competition. We have to keep remembering that. And thinking
about the consumer, too.
Senator PELL. Thank you.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you.
Senator Lugar.
Senator LUGAR. Thank you, Mr. Chairman.
Mr. Secretary, in the debate that is shaping up on the IMF, sug-
gestions were made that restrictions ought to be placed on U.S.
banks with regard to amount of foreign lending or other guidelines
by our own banking system. It has also been suggested that there
ought to be some rediscount window or facility created in which
U.S. banks might discount some of the paper that they have
abroad, get out of the international lending business, take a loss
and write down uncollectible loans so that we are not jeopardized
continuously by this overhang of $500 or $600 billion.
What comments do you have on either the guideline issue-that
is, whether we ought to be having guidelines on our banks-and
whether the banks should either simply mark down these loans or
we should create a facility to handle some rediscount of its paper?
Secretary SHULTZ. Well, on the guidelines, probably that is a
good idea if the enactment is not too specific. When you start new
regulations, you generally wind up sorry 5 years later, because
there are all sorts of unanticipated results, if you give too little op-
portunity for those who are going to administer them to adjust
them to the circumstances.
Basically, however, I would have to say this is a subject on which
I would defer to the Treasury. They have thought about it a lot
more than I have had the opportunity to do.
As far as creating some sort of goveYnmental discount window
through which our private banks can unload their debt, I am very
dubious about that. I think that it is desirable for our banks to be
in the international lending business. It is a good business for
them, and they should take their part in financing the internation-
al economy.
I think it is a problem that there is a retreat going on now. We
need liquidity in the current situation. The answer to these debt
problems, as I tried to develop in my testimony, is to get the
system healthy and expanding; and while I do not want to be advo-
cating price increases, certainly there are many primary commod-
ities right now that are very depressed in their prices. So if we saw
some comeback in those prices and we saw world expansion coming
along, I think a lot of these debts would look different and could be
handled. I would rather see them worked out that way.
Senator LUGAR. Mr. Secretary, in your testimony you stressed
this thought: that as opposed to a debt repayment problem we
ought to be thinking in terms of income earnings for many coun-
tries that are growing. But is this not primarily a political problem
in the sense that even if IMF or other loans are made is not the
problem
their e,
ment
cent rn H
come ,.
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turn t},
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might `,
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that the
ernmen
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the idea
portant
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ditions
think t}
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commod
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prices.
So Ic
somethi
should I
whole, I
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planted
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ently is
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and pros
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from the
Senatc
The Cr
Senatc
Senatc
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
r is vetting some-
saw that if they
and they have to
from that kind of
nit. And thinkingg
p on the IMF, sug-
be placed on U.S.
or other guidelines
ggested that there
created in which
r that they have
siness, take a loss
ire not jeopardized
lion.
ideline issue-that
in our banks-and
own these loans or
count of its paper?
)robably that is a
7 you start new
later, because
i give too little op-
er them to adjust
a subject on which
ght about it a lot
I discount window
sir debt, I am very
or our banks to be
good business for
ig the internation-
going on now. We
,wer to these debt
any, is to get the
>t want to be advo-
primary commod-
,rices. So if we saw
expansion coming
erent and could be
t way.
nony you stressed
ment problem we
gs for many coun-
3 political problem
e made is not the
problem of growth within those countries essentially the nature of
their economic systems? In other words, what kind of encourage-
ment could we give to private enterprise in those countries whose
centralized economies have rather poorly used their assets and
come up with horrendous debts. Poland is a good example of this:
No amount of IMF lending or private lending would apparently
turn this around at this point.
Could you address yourself to the political dimensions of what we
might be able to do?
Secretary SHULTZ. One of the advantages of the IMF, I think, is
that the IMF is able to develop conditions for loans with the Gov-
ernment better than we ourselves or any other single government
can do-and certainly far better than private lenders can do. So
the idea of so-called conditionality with IMF loans I think is an im-
portant idea to preserve and enhance.
Now, then, you have to come to the question of what are the con-
ditions and how much sense do they make. Broadly speaking, I
think the IMF has tried to develop conditions that will help the
economy involved regain its momentum and its capacity to deal
with its debt. However, the IMF just cannot dictate things to
people, and different countries have their own ideas about what
they want to do with their tax system. Many have prices of basic
commodities that are controlled at a very low level-energy and
food being two big examples-and it is difficult to let up on those
prices.
So I do not think that a standard of perfection by our lights is
something that we can see imposed everywhere; but I think we
should like to see things moving in the right direction. And on the
whole, I think the IMF is trying to do that.
Senator LUGAR. Let me just add a comment to that. Senator Pell
certainly has had an experience similar to those of each one of us
at home during the recess. I would say on behalf of my constituents
in Indiana that we appreciate that 2 out of every a acres being
planted in our State will be exported, and we hope that someone
will have the money to pay for it.
Secretary SHULTZ. Well, that is what we are talking about here.
Senator LUGAR. One out of every eight manufacturing jobs pres-
ently is for export-goods and services, machinery, mechanisms,
parts and so forth. Without export we are dead in the water.
On the employment side-and I think this is the point we were
attempting to make-I would say simply that it is clear in my
State that we will have to have export financing facilities available
or we will have higher unemployment.
Secretary SHULTZ. I think export financing facilities is one point,
and providing some funds to the IMF is another point; but basical-
ly what we are trying to do, it seems to me, or should be trying to
do is different. We should be trying to help provide an expanding
and healthy world economy so it is that fundamental expansion
that is providing the market into which we are selling, as distinct
from the particular stimulative devices that are talked about.
Senator LUGAR. Thank you very much.
Ti'e CHAIRMAN. Thank you very much.
Senator Sarbanes.
Senator SARBANES. Thank you, Mr. Chairman.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Mr. Secretary, I am a little concerned about a possible implica-
tion of your statement. You are not asserting, I hope, that no loans
were made to countries now in difficulty at a time when careful
and prudent analysis of their situation would have argued against
making the loans.
I understand your point about the assumptions under which
people were proceeding in the mid-1970's with respect to export
growth and low-interest rates, which you outline in your state-
ment, but are you suggesting that all of a sudden one morning we
woke up to discover, to our great surprise, that we had a difficult
problem which no one could have seen coming if he had taken a
more careful look?
Secretary SHULTZ. No, sir. I think I say that many bad judgments
were made.
Senator SARBANES. If that is the case, should not the request for
an increase in the IMF quotas involve some process to assure that
we will not again find ourselves in the situation we now face, oth-
erwise, won't we be back for another increase in IMF quotas some-
time in the future because in having gone down this path without
some way to raise early warning flags?
Secretary SHULTZ. Well, of course, the market has provided a
kind of censure to people, and there have been a lot of bad loans
that people have had to record. Quota increases are now associated
dramatically with this problem, but of course historically as the
world economy expands and the need for world liquidity expands,
you would expect there to be a larger IMF facility. So it isn't all
simply related to this particular problem.
I do think the assumptions that turned out to be wrong were
very widely held. It is true that some people were saying watch
out, this is not going to go on this way and so on. And probably
most of us could find some statement that we made somewhere
that said that. So with hindsight and second-guessing, you can look
much wiser than a lot of loan officers look right now.
That does not mean they should be taken off the hook. That is
their job to make those judgments, and when they make bad ones,
they have to pay for it.
Senator SARBANES. They invariably will be taken off the hook,
will they not? The consequences that would normally flow from
such judgments will not be allowed to happen when the debtor is a
country and when the size of the debt is so large that if we fol-
lowed the normal course, we would give a major shock to the inter-
national financial system.
Is that not simply a given?
Secretary SHULTZ. I think what we are saying is something like
this: We have a choice. We can say that all you countries around
the world, including our own, and banks, including our own, made
some mistakes, so that you are going to have to live with those mis-
takes, and we are not going to do anything about it. Let the world
system go down the drain. We would rather have it go down the
drain and then pay for their mistakes than to try to help work the
situation around so that we do not go down the drain.
Senator SARBANES. That is right. You are not advocating the first
approach, I assume.
Secretary SHULTZ. I am advocating the exact opposite.
Senato
cause its
Secret.
Senato
should
down th
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vate bar
comment
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make the
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back es
desirable
ing to th
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
at a possible implica-
I hope, that no loans
a time when careful
I have argued against
notions under which
ith respect to export
)utline in your state-
dden one morning we
lat we had a difficult
ng if he had taken a
many bad judgments
Id not the request for
)rocess to assure that
ion we now face, oth-
in IMF quotas some-
wn this path without
irket has provided a
en a lot of bad loans
es are now associated
historically as the
liquidity expands,
acility. So it isn't all
at to be wrong were
e were saying watch
so on. And probably
we made somewhere
uessing, you can look
it now.
off the hook. That is
they make bad ones,
taken off the hook,
normally flow from
when the debtor is a
large that if we fol-
ir shock to the inter-
og is something like
Iou countries around
ding our own, made
I, live with those mis-
Out it. Let the world
leave it go down the
:ry to help work the
17
drain.
advocating the first
Senator SARBANES. No one does advocate the first approach, be-
cause its consequences are too heavy to bear.
Secretary SHULTZ. Right.
Senator SARBANES. In the course of trying to work this out,
should we not set up procedures to help assure that we will not go
down that path again?
For instance, what would be wrong with requiring that all pri-
vate loans to governments be submitted to the IMF for review and
comment-let us leave aside approval-so that we know what is
happening and have some sense of how much in private lending is
accumulating?
Secretary SHULTZ. Well, we have through bank regulation, in
this country anyway an ability to know what the banking system is
doing. We do not have a lack of that kind of information.
Senator SARBANES. Other countries do not require that, and they
make these loans. And in a great many instances, a good part of
the private debt is owed not to American bank's but to foreign
banks. But the international banking system is interrelated, as the
whole financial system is, as you point out.
Secretary SHULTZ. It is interrelated, and at the same time I, per-
sonally, would not be ready to put into the hands of a kind of world
central bank a regulatory authority over the flow of loans. I do not
think the evidence is strong at all, granted that some bad judg-
ments have been made, that on the whole, government judgments
are better than the sum total of private judgments. I think it is the
other way around.
Senator SARBANES. When you use the word "regulatory authori-
ty," how do. you define that?
Secretary SHULTZ. I suppose you are saying that you would-and
I am just taking your suggestion, which I thought it to be-any
time a private loan is made outside the country of the lending in-
stitution, that loan should be registered or somehow run through
the IMF for comment. Presumably you mean that that should be
true for U.S. private loans and also for those originating in other
countries.
Now, that sets the IMF up as a central functioning, virtually a
regulatory agency. It is not at all clear that other countries would
accept that. I do not know what our country's attitude toward that
would be. But I think it is something that I would personally be
rather reluctant about.
Senator SARBANES. What assurance can we give the people we
represent, as we are n-)w confronted with the question of expand-
ing the IMF quotas, that some safeguards have been put into place
to assure that this situation will not reoccur, that we will not be
back again seeking another increase in the IMF quotas because
once again a number of loans were made that everyone now agrees
should not have been made?
Secretary SHULTZ. We can hope there is some learning from ex-
perience. We can see that some people were caused to lose some
money. I think myself that the private banks have been drawing
back as a matter of fact from international lending faster than is
desirable and that if it goes on too far and too fast will be damag-
ing to the general interests of the private banks.
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But at any rate, it suggests that there has been caution imposed.
Senator Lugar has raised the question of some guidelines insofar as
our own banks are concerned. And no doubt, that will be consid-
ered and should be. But I do not see that anyone can give an assur-
ance that governments will never engage in the excesses that bring
about and encourage the sorts of problems that we have had.
If you come right down to it, where did this originate? Govern-
ment is responsible for the inflation. The Government of the
United States put on wage and price controls. I was there kicking
and screaming, but I was there. It was a catastrophe.
We kept the price of oil down. It was only when President
Reagan came in that finally the controls were taken off. And we
see how healthy that result is. So governments made mistakes all
through this process that have helped create an environment
where lots of other people made mistakes, too. I do not know that
we can lay down a guarantee that Government will never make a
mistake again.
Senator SARBANES. Mr. Chairman, my time is up. I just want to
make an observation. I think the administration ought to be giving
some constructive thought to coupling their request for an increase
in the IMF quotas with some procedures to provide assurances that
we will not go down this path again.
In saying that, I am not using the debater's device juxtaposing
extremes, either that we should assure that governments will
never make a mistake in the future as they have in the past, or
that the alternative is to suggest that the system should just be al-
lowed to collapse, et cetera, et cetera.
But it does seem to me that there is a range where we can work
toward some constructive proposals to link this request for an in-
crease in the IMF quotas to some process-whether it is a review
process, and how it involves other countries, are questions to be
worked out-that will provide assurances in the future that if we
start down the same path, there will be some early-warning flags
raised. Otherwise, we are just leaving it open for a repeat of the
current performance.
The CHAIRMAN. Thank you.
Senator Mathias.
Senator MATHIAS. Mr. Chairman, I would like to pursue the
theme that has been raised by Senator Sarbanes and Senator
Lugar of the private sector banks' involvement in this process, be-
cause I think that it is very close to the heart of the whole remedy.
Senator Sarbanes says that the banks will escape the conse-
quences of their poor judgment. During the course of the hearings
that issue was dealt with at some length, and one of the witnesses
said, we are not bailing out the banks, we are bailing them in. And
this, of course, is the fact.
The President's request and the IMF increase of quotas by 47.5
percent is not going to do this job. If that is it, in my judgment, we
have a failure on our hands. Another necessary ingredient is that
the commercial banks stay in and live with the consequences of
their prior judgments. And more than that, that the banks increase
their lending on an annual rate of something like 7 percent until
we get through this very shaky period. And it is going to require
this joint acti(
through a roc'
Secretary
you are absolt
Senator M.?..
The commerc!
some cases o,
of objective of
in. Are we a:
much? :Many
Secretary S
private banki
money, as yot
dividual bans
banks, which
going on very
Senator M;
gional banks.
Secretary S
and work aro
that take the
like to retrea
let out, then
kind of a run
So I think 1
it is not aski;
to measure u
particularly I
holding peopl
Senator M.
seem to be w
the time beir
well as their
tic view of
right.
Secretary
There are pl
But I do not
the problems
we do about t
Senator M:
Secretary
in the whole
have the con
economy wil:
world econon
Senator M.
back again f
the projectioi
may get thrc
But you wou
does continu
review of IM
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as been caution imposed.
ome guidelines insofar as
,ubt, that will be consid-
nyone can give an assur-
n the excesses that bring
that we have had.
this originate? Govern-
'he 'Government of the
rols. I was there kicking
tastrophe.
s only when President
were taken off. And we
cents made mistakes all
create an environment
too. I do not know that
went will never make a
me is up. I just want to
ation ought to be giving
request for an increase
provide assurances that
ter's device juxtaposing
that governments will
~y have in the past, or
'm should just be al-
ige where we can work
this request for an in-
-whether it is a review
3s, are questions to be
i the future that if we
ne early-warning flags
en for a repeat of the
Id like to pursue the
;arbanes and Senator
ant in this process, be-
t of the whole remedy.
'ill escape the conse-
2ourse of the hearings
i one of the witnesses
bailing them in. And
ease of quotas by 47.5
in my judgment, we
3ry ingredient is that
the consequences of
at the banks increase
r like 7 percent until
it is going to require
389
this joint action of the private sector and the public sector to get us
through a rocky time in the world's financial condition.
Secretary SHULTZ. I agree with that entirely, Senator. I think
you are absolutely right.
Senator MATHIAS. The question, of course, Mr. Secretary, is this.
The commercial banks in the United States consider themselves in
some cases overextended on foreign loans. Maybe in the judgment
of objective observers, they are overextended. But they have to stay
in. Are we asking too much of the banks, not too little but too
much? Many of the regional banks I think would like to get out.
Secretary SHULTZ. I think it is very much in the interest of the
private banking system as a whole to stay in and to provide new
money, as you suggested. When there is difficulty, of course, an in-
dividual bank may want to get out, and particularly regional
banks, which many feel they really do not understand what is
going on very well and have become part of the syndicate.
Senator MATHIAS. And that is a big group. There are 1,500 re-
gional banks.
Secretary SHULTZ. And they do not have the capacity to get out
and work around the world. They have to rely on the larger banks
that take the lead in the syndicate. So when there is trouble, they
like to retreat. But it is very hard to manage this, because if one is
let out, then everybody wants out and all of a sudden you have a
kind of a run on the bank, in effect.
So I think that it is important to hold these groups together, and
it is not asking too much. It is asking the private banking system
to measure up to its responsibilities and its interests. And so far,
particularly the big banks have been doing a pretty good job of
holding people together.
Senator MATHIAS. I concur with that. And the regional banks
seem to be willing to stay and seem to be willing to go forward for
the time being. I agree with you that it is in their self-interest as
well as their general interest to do. But you take a rather optimis-
tic view of where we are going economically, and I hope you are
right.
Secretary SHULTZ. I do not want to be a pollyanna about it.
There are plenty of problems, and I have tried to identify them.
But I do not think that we can just sit and wring our hands about
the problems. We have to say, well, there they are, now what can
we do about them?
Senator MATHIAS. You have to go forward.
Secretary SHULTZ. There are things to do about it, and no doubt,
in the whole picture the most important thing to do about it is to
have the conditions created in the United States whereby our own
economy will expand. That is the key. We are 25 percent of the
world economy.
Senator MATHIAS. The question was asked, will you have to come
back again for another quota increase? And I would think that if
the projections of growth are accurate, if they are realized, that we
may get through on this quota increase for the foreseeable future.
But you would not suggest, would you, that if the world economy
does continue to stagnate, that there may not have to be another
review of IMF capacities?
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Secretary SHULTZ. I would not say that, nor would I say that if
things work out well, there would never be another review of IMF
capacity, because that capacity has to reflect the general scope and
size of the world economy. So if 10 years from now or 5 years from
now things have worked out well, we will have a much bigger en-
terprise, in effect, to try to manage.
Senator MATHIAS. I think clearly the consensus agrees with you
that we have to have growth, No. 1. That is the essential ingredi-
ent. And if we have it, we have a fair chance of avoiding further
immediate difficulties.
One thing that you mention in your statement about which there
is not yet a consensus is the question of exchange rate stability.
Clearly, the poor relationship between the dollar and the yen, as
you have described it very vividly, is the root of many of our trade
problems with Japan. It has swung wildly in the recent past. When
our inflation rate should have been pushing it one way, it went the
other way.
Should we have some kind of international arrangement that at
least controls the far end of the swing, perhaps not the day-to-day
fluctuation, but the wild swinging of currency rates, something like
the European "snake," which I do not pretend to fully understand
but which seemed to work.
Secretary SHULTZ. Some very exotic terminology. Back in the
early 1970 s we had the tunnel and then we had the snake in the
tunnel and a lot of jargon like that. It was great.
Senator MATHIAS. But do we need something of that kind?
Secretary SHULTZ. Well, this is a question that is raised a lot, and
I would not lay down an answer. I think that it is important.
Senator MATHIAS. You have a lot of company in not being willing
to lay down an answer.
Secretary SHULTZ. I think it is important that the system be
flexible. The par value system of the 1960's basically .broke down
because there was no wav for the dollar to get itself adjusted to
what was happening. Other currencies all could play off against
the dollar, but the dollar was frozen. The floating system now
opens that up. The extremes of volatility I think have reflected the
fact that we have had a tremendous amount of turbulence connect-
ed in considerable part to the big swings in oil prices. And if the
situation becomes less turbulent, there will be more stability.
So in that sense, the exchange market is more a thermometer
registering the heat than it is a producer of the heat itself. Wheth-
er or not now there should be some effort to give the system some
additional constraints is a question that I am sure is being consid-
ered. And I would not want to leave it at that. I would think the
way to approach it is to think in.terms of just a few currencies
rather than the whole world currency system.
The currencies that are in the SDR basket are the main curren-
cies. And if the relationship among them or even among, say, the
dollar, the yen, the Deutsche mark, the French franc and the
pound were a little more stable, then everything else kind of re-
lates itself to that, and it may be that something can be done to
bring that about.
There has been a study of the effects of intervention that is
about completed. And I do not know what the results of that are.
Secretary P
tell you abo
that intervc<
that it is ahir
The CHA1r<
Senator iii
Senator Bi
Mr. Secret
fact that has
has gone on
the question;
equally as it
the cause. O1
have in doing
the request
Democratic-F
constituencie
floor of the L
And what
but I would
when Goverr
stockholder
taxpayer, the
But when
banks who ai
and I do not
with banks
"had" and t
people are "b
My first qr
for any of the
Secretary c
if one person
erybody gets
seeking to av,
Senator Bii
fruitful discus
not the bank:
being done a
The fact of
the banks ju!
that one coul
there is not n
thing, on the
know that we
us do, that w,
disaster.
Now, my
way-I think
is there any
tions upon th
the catastrop
ing about soil
Could you sa.,
~k
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would I say that if
)they review of IMF
e general scope and
low or 5 years from
a much bigger en-
;us agrees with you
ie essential ingredi-
of avoiding further
t about which there
ange rate stability.
ar and the yen, as
many of our trade
recent past. When
ne way, it went the
rrangement that at
not the day-to-day
rtes, something like
to fully understand
)logy. Back in the
.d the snake in the
f that kind?
raised a lot, and
mportant.
n not being willing
hat the system be
sically broke down
t itself adjusted to
d play off against
'ating system now
have reflected the
urbulence connect-
prices. And if the
_)re stability.
ire a thermometer
heat itself. Wheth-
e the system some
re is being consid-
I would think the
a few currencies
the main curren-
n among, say, the
ch franc and the
g else kind of re-
ig can be done to
.ervention that is
z~sults of that are.
Secretary Regan will be testifying, and he will be in a position to
tell you about those results. I would be surprised if the study shows
that intervention can really affect basic values. It does not figure
that it is able to do that.
The CHAIRSMAN. Thank you, Senator Mathias.
Senator Biden.
Senator BIDEN. Thank you very much.
Mr. Secretary, what we need is a mongoose in that tunnel. The
fact that has been mentioned time and again in the discussion that
has gone on here about imprudent bankers making decisions raises
the questions whether the Government makes decisions that are
equally as imprudent or maybe even more imprudent and who is
the cause. One of the problems that folks like us on the committee
have in doing what I think has to be done-and that is, acceding to
the request you are making-is a purely political one. Not in the
Democratic-Republican sense, but in terms of explaining it to our
constituencies and explaining it to some of our colleagues on the
floor of the U.S. Senate.
And what concerns people-I think I know the answer to this,
but I would like to hear you say it-what concerns people is that
when Government makes a mistake, they know they are sort of a
stockholder and they lose. But everybody loses in the country: The
taxpayer, the stockholder in a sense.
But when a private enterprise makes a mistake, particularly
banks who are not really well liked anyway-in my State, at least,
and I do not come from a State that is unaccustomed to dealing
with banks and corporate entities-they feel like they are being
"had" and that only a relatively few people, relatively wealthy
people are "being bailed out."
My first question is: Is it practical from an economic standpoint
for any of the banks to get out?
Secretary SHULTZ. Well, if it is just one bank, it is practical. But
if one person gets out, everybody else wants to get out, and if ev-
erybody gets out, then you bring about just the situation you are
seeking to avoid.
Senator BIDEN. The reason I ask that is I do not think it is a very
fruitful discussion for us in the Senate to be discussing, whether or
not the banks want to, are doing us a service by staying in or are
being done a service by staying in.
The fact of the matter is, we are all in this mess together, and
the banks just purely from their own economic standpoint know
that one could get out but that might cause a run so they know
there is not much they could do if the Government does not do any-
thing, on the one hand. On the other hand, we sit here and we
know that we have to do something, at least I think the majority of
us do, that we have to do something to prevent what is a potential
disaster.
Now, my question is: Is there anything, would there be any
way-I think I know the answer to this, but I just want to ask it-
is there any way that the U.S. Congress could so construct condi-
tions upon this additional money that would result in helping avoid
the catastrophe we are worried about; that is, doing its job, bring-
ing about some stability without any profit accruing to the banks?
Could you say, to be bizarre about it, we will come up with the ad-
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ditional money that we think we need but there will only be princi-
pal paid back by these countries to the banks; the banks have to
swallow their interest; they are not going to make any money?
I know that sounds ridiculous, but those are the kinds of ques-
tions I get asked by my constituents. As I said, I think I know the
answer, but I would like to hear you respond to that question. If
you were at a town meeting in Dagberg, Del., what is the answer to
that question? If it goes beyond 60 seconds, they do not listen.
Secretary SHULTZ. I think it is unwise to approach it as a puni-
tive matter. The way to approach it is to try to make the system
healthy, and then everybody can prosper.
Senator BIDEN. Well, I will be the devil's advocate. Let's say I do
not want those banks to prosper. I do not care if they are going to
prosper. They are going to take my tax dollars. Is thei e any way
we can prevent it from being a disaster but make them pay the
price for having made the bad judgment they made?
Secretary SHULTZ. Well, I think that when people approach our
financial system with minds made up that says no one should pros-
per in our financial system, you have a fundamental problem
there.
Senator BIDEN. No one should prosper for their mistakes.
Secretary SHULTZ. Well, they are not prospering from their mis-
takes. They are suffering from their mistakes. The question is how
drastically and how catastrophic do you want to make it?
Senator BIDEN. That is good enough answer. I will try that one
next time. [Laughter.]
Secretary SHULTZ. I think with a little thought, I could do better.
Senator BIDEN. I am going to ask you to maybe write a speech
for me to justify what I am about to do.
Let me say on a more serious note, all of your proposals relating
to the amount of money we are talking about here are premised
upon certain assumptions with regard to economic growth not only
in this country but around the world, that we are going to be
coming out of this recession, which is not only U.S. recession but a
worldwide recession.
Have you calculated how those numbers change if, in fact, we do
not have an economic growth for fiscal year 1984 that the Presi-
dent is predicting in terms of U.S. economy, which is, as you point-
ed out, 25 percent of the whole ball game, and the world economy
generally, or just take the big three, four, or five nations?
Secretary SHULTZ. I have not tried to run through the economet-
ric models of what happens to this, that, or the other. But obvious-
ly, if our economy fails to grow and the other industrial economies
fail to grow, that is very bad news, and that tends to make borrow-
ings and debts look worse. And you can say that that shows that
the judgment was bad to make the loan in the first place, but I do
not know that that is necessarily the case.
Senator BIDEN. I would not argue that, just for the record.
Secretary SHULTZ. It is just like saying if things go bad and some-
body has to foreclose on the debt for a farm, say, that the judgment
was bad to have made the loan in the first place. That is not neces-
sarily the case.
Senator BIDEN. The reason I asked the question is along the
same lines I thought Senator Mathias was pursuing, and that is
that I would thin:
our colleagues anti
making this infusi
be back at it again
say, this is what is
And my time is
in this committee
this time, apparent
I just do not thi
quarter of a billio
The CHAIRMAN.
Senator Boschwi
Senator Boscnw
We find, Mr. SE
myself, who are n
tions, have a grea
system, though I
banks from both rr
However, as Sci
understand that 1,
eign trade. But the
an explanation, w
type of situation '
dized so heavily tl
farmers.
I am careful in
larly wild-eyed, bi
some of the legish
the 98th Congress
agricultural and c
I have indeed i
that some of our
other fields, parti
subsidies or some
rather blatantly
that we will act si
They have not 1
eral salvos alrea(
world markets. Sc
flour to Egypt. In
had sold in the er
to the entire worl(
But my question
these countries h;
on doing the sam(
It has taken alms
to some of these c
legislation that
ridding the world
imposed upon it 1-
they impose again
Secretary Stied
from closing up i;
do to get them o
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" only be princi-
banks have to
any money?
he kinds of ques-
think I know the
that question. If
t is the answer to
o not listen.
each it as a puni-
make the system
ate. Let's say I do
they are going to
is there any way
tke them pay the
,ple approach our
t, one should pros-
amental problem
mistakes.
tg from their mis-
ie question is how
ake it?
will try that one
I could do better.
ae write a speech
proposals relating
,ere are premised
"rowth not only
?e going to be
;-). recession but a
if, in fact, we do
l that the Presi-
0 is, as you point-
e world economy
1ations?
1'gh the economet-
her. But obvious-
Rustrial economies
to make borrow-
that shows that
tit place, but I do
he record.
to bad and some-
pat the judgment
that I would think we should be realistic with the folks and with
our colleagues and with the country and be saying, look; we are not
making this infusion conditioned on the notion that we will never
be back at it again. I think we should be more honest about it and
say, this is what is needed now, we may need more.
And my time is up. One last question, like everybody always does
in this committee when their time is up. We are not going to do it
this time, apparently. OK, I will not ask it. [Laughter.]
I just do not think you should be increasing aid to Turkey by a
quarter of a billion dollars this time. But I will get back to that.
The CHAIRMAN. Thank you very much.
Senator Boschwitz.
Senator BOSCHWITZ. That was an afterthought, Senator Biden.
We find, Mr. Secretary, that Senator Biden, Senator Pell, and
myself, who are more imminently facing our constituents in elec-
tions, have a greater interest in not intellectualizing the banking
system, though I must say I have learned something about the
banks from both my colleagues from Maryland.
However, as Senator Lugar pointed out, our farmers certainly
understand that large portion of what they produce goes into for-
eign trade. But they do not have an explanation, or we do not have
an explanation, when our country gets involved in the bilateral
type of situation with Brazil, as we recently did, when they subsi-
dized so heavily their agricultural exports in competition with our
farmers.
I am careful in the legislation that I introduce. I am not particu-
larly wild-eyed, but I am one of the Senators who has introduced
some of the legislation you warn us about in your statement, that
the 98th Congress you said will probably confront legislation in the
agricultural and other subsidies, a host of protectionist proposals.
I have indeed introduced such legislation' because I do not feel
that some of our trading partners in the agricultural field or in
other fields, particularly Japan, are going to lower some of their
subsidies or some of their tariff barriers unless we confront them
rather blatantly and straightforwardly with the understanding
that we will act similarly.
They have not fired the first shot of a trade war; they fired sev-
eral salvos already. And we find ourselves being excluded from
world markets. So I was very approving with respect to the sale of
flour to Egypt. In that one sale we sold more wheat flour than we
had sold in the entire preceding year of the entire year before that
to the entire world.
But my question is, Mr. Secretary: Our negotiations with some of
these countries have not been very productive, and they just keep
on doing the same old things and referring the cases to the GATT.
It has taken almost a decade so far in trying to get the resolution
to some of these cases. Would you respond to the necessity of such
legislation that several of us have introduced for the purpose of
ridding the world trading place of some of the subsidies that are
imposed upon it by our so-called allies or some of the barriers that
they impose against our trade?
Secretary SHULTZ. I think it is very important to keep things
from closing up further and at the same time do everything we can
do to get them opened up more. We do have to shake people and
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394
say, wake up, world, if this continues and we really get into a com-
petitive protectionist subsidy game, it is bad for everybody.
And if the United States really gets into it, we can have a devas-
tating impact because we have a very deep pocket, when you get
right down to it. And if we start a big agricultural subsidy war and
that becomes the common way in which agricultural products are
marketed in the world, no doubt, we will be able to do our share.
But the nut of it all will not be good; we will in effect, be, giving
product away.
So I would say that the wheat flour sale that I referred to in my
testimony and that you mentioned was on the one hand designed,
of course, to sell some of our product but also to say to people that
we are serious about this problem and we think that the negotia-
tions to resolve these problems better be taken very seriously by
everybody or this whole thing can slip out of control.
Senator BoscHWITZ. Well, perhaps that is the answer then to leg-
islation-that our Government exerts its seriousness in that
manner. Perhaps this also includes that butter sale you spoke of
since we sell the butter at about the world market price. Since it
has sold at about half of the price that was taken to remove it by
the CCC, I am sure that the butter would not be sold at one q a r
ter of what the American consumer would pay for
unless they do subsidize it.
But the last time we sold a Communist nation some butter, they
objected because it is salted, and that is not particularly desirable.
Secretary SHULTZ. Not only did they want to cut price but they
want to have it to their specifications.
Senator BoscHWITZ. Well, there is not much you can do with
salted butter in the world market unless you melt it down.
I see you also mentioned services. I am aware that that is becom-
ing a very significant element in our exports. And also I am aware
that there were never really any considerations given to service ex-
ports, and as a result, rules or barriers have not previously arisen.
But those barriers are now arising. Service exports I think have a
very promising future for this country, and I would hope our Gov-
ernment would take a very firm viewpoint with respect to the erec-
tion of barriers in that regard as well as with respect to agricul-
ture.
Secretary SHULTZ. We have been taking the lead in trying to get
attention to that in the GATT, and there now is at least, a study
under way of that general area. Of course, services is a word that
covers a gigantic arra:' of things that are very unlike each other,
and in the end as this process proceeds I am sure there will have to
be a breakdown of that word and much finer categories introduced.
Senator BoscHWITZ. Mr. Secretary, I know that you are very
short on time, and it is 12:15 and there are still a couple of Sena-
tors who yet are to question you.
I agree with your statement about the positive effects of a de-
cline in oil prices to $20 a barrel-you give that as a for-instance, ce, I
think that if open market principles were to play a part, wil cer-
tainly would be at that price or lower. And I believe vtha t the will
reach those prices, and I do not have much sympathy
you are those
right. I hope your example correct.
countries I hope countries
I hope also thy
make the loans
while it makes
feel sorry for the
sorry for the guv
self on the court
Secretary SHt~
way.
Senator BOSC}
oil prices will do
covery.
The CHAIRMAN
Senator Dodd.
Senator Donn.
Mr. Secretary,
to be extremely N
have said here.
January and tra
most of our time
of international i
$190 billion betty
billion in worldw
Briefly, let me
agree, that our
going to make it
Mexico.
Mexico has soi
international oil
whelming major;
obligations, giver
and its depender
covery program,
cations in terms
place on our fron
But let me bri
pretty much this
nomic recovery
ance request tha
along with its su
My concern is
about economic
not just in term:
cal implications
It is something I
And yet, as I I
ing some $13.5 bi
vious year, the h
billion is in secui
Now, I am not
tary assistance I
goes to Israel a.
crease in milita:
ment assistance
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3.
'ally get into a com-
everybody.
e can have a devas-
cket, when you get
ral subsidy war and
iltural products are
ble to do our share.
in effect, be, giving
I referred to in my
one hand designed,
o say to people that
ik that the negotia-
n very seriously by
ntrol.
answer then to leg-
eriousness in that
r sale you spoke of
irket price. Since it
ken to remove it by
be sold at one-quar-
y for it in Russia-
n some butter, they
rticularly desirable.
,it price but they
h you can do with
alt it down.
that that is becom-
,nd also I am aware
given to service ex-
)t previously arisen.
)orts I think have a
;ould hope our Gov-
respect to the erec-
respect to agricul-
ead in trying to get
is at least, a study
vices is a word that
unlike each other,
-e there will have to
tegories introduced.
that you are very
11 a couple of Sena-
ive effects of a de-
. as a for-instance, I
)lay a part, oil cer-
believe that it will
ipathy with the oil-
-nade loans to those
nple is correct.
395
I hope also the increase in economic activity that will result will
make the loans of many of the banks now in jeopardy much better
while it makes others much worse. I feel sorry for the banks that
feel sorry for the oil-exporting countries. It is kind of like feeling
sorry for the guy who kills his mother and father and throws him-
self on the court for mercy as an orphan.
Secretary SHULTZ. I had not really thought of the analogy that
way.
Senator BOSCHWITZ. Well, I have. And I think that the decline in
oil prices will do a great deal in treating our general economic re-
covery.
The CHAIRMAN. Thank you, Senator Boschwitz.
Senator Dodd.
Senator Donn. Thank you very much, Mr. Chairman.
Mr. Secretary, let me quickly state that I found your statement
to be extremely worthwhile, and I agree with an awful lot that you
have said here. Senator Glenn and I took about 10 or 12 days in
January and traveled to Central and South America. We spent
most of our time in Mexico and Brazil, principally on the question
of international indebtedness. As you know, there is approximately
$190 billion between those two countries alone, of the some $700
billion in worldwide debt obligations.
Briefly, let me tell you, and I am sure Senator Glenn would
agree, that our assessment was that both Mexico and Brazil are
going to make it. Brazil is probably in a little better position than
Mexico.
Mexico has some serious problems, and the question of reduced
international oil prices, while it is very encouraging to the over-
whelming majority of nations in terms of their ability to meet their
obligations, given the existence of a 2,000-mile border with Mexico
and its dependency on oil sales -for a good part of its economic re-
covery program, this price reduction could have catastrophic impli-
cations in terms of immigration and the stress and strain it would
place on our frontier.
But let me bring up one other point here. We have concentrated
pretty much this morning on the question of the IMF and the eco-
nomic recovery program. I would like to turn to the foreign assist-
ance request that the administration has made for fiscal year 1984
along with its supplemental for 1983.
My concern is this. I could not agree more with your statements
about economic stability in the world and how important that is,
not just in terms of economic recovery but also because the politi-
cal implications associated with economic stability are so profound:
It is something I think you would agree with wholeheartedly.
And yet, as I look at the request that has come before us, total -
ing some $13.5 billion, an increase of almost $2 billion over the prc
vious year, the bulk of the program as $9.2 billion of the the $13.5
billion is in security and military assistance.
Now, I am not one who suggests that we ought to eliminate mili-
tary assistance programs. And I understand that a good part of it
goes to Israel and to Egypt. But when you see a 20.8-percent in-
crease in military aid and only a 3.3-percent increase in develop-
ment assistance for fiscal year 1984 is seems to me that our actions
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
in terms of providing funds for economic recovery are clearly
unsatisfactorv.
I would also point out to you that historically the coalition in
this body and in Congress generally that have supported foreign as-
sistance has been formed of those who generally agree with the de-
velopment assistance programs and have had some concerns about
military assistance. Increasing dramatically as we are the amount
of military assistance jeopardizes that coalition in Congress at a
time when we may need it most.
I wonder if you might address that general observation and the
concern that I have both with respect to the increase in military
assistance worldwide; and also the concern that I have that the co-
alition in Congress may evaporate if, in fact, this trend continues.
You have heard Senator Pell, Senator Boschwitz, Senator Biden,
and others as well talking about constituent concerns regarding
foreign aid generally. And when we see the increase in military as-
sistance, I think that concern becomes even more alarming.
Secretary SHULTZ. Our request is for $14.5 billion all together,
and represents an increase of 4.6 percent in current dollars from
our request least year. In other words, in real dollars, it is about a
wash. Now, the way it was broken down between security assist-
ance and economic assistance is not precisely the way it looks in
those categories. As we tabulated in the security assistance pro-
gram of $9.2 billion, $6.2 billion is strictly military aid, and the bal-
ance,.$3 billion,-is essentially economic growth-oriented money.
Senator Donn. Economic support funds, balance-of-payments
funds.
Secretary SHULTZ. In the economic assistance program, you have
a total of $5.3 billion, so if you add economic support funds and the
economic assistance together and compare it with the military, you
have a little over half in economic support and less than half, 4:3
percent of the total, is military aid.
Senator DODD. Isn't it a fact historically that the economic sup-
port funds and funds that they are given in grant assistance, are
generally used by nations to buy military equipment, which is
hardly what many of these countries need to be doing. If they hope
to achieve some economic stability, they ought to be investing those
dollars in economic development programs at home.
Secretary SHULTZ. I think in the countries involved, being able to
get themselves some stability is an essential ingredient for econom-
ic development, and if they are being attacked and ravaged by a
guerrilla movement that is being supplied by arms from the out-
side, and they do not have the capacity to contest that, and thereby
to try to create stability within their own country, they are not
going to get anywhere in economic development.
You cannot expect there to be development in the context of a
kind of military harassment.
Senator Donn. I am not suggesting to you that I am opposed to
all military assistance. It is merely when we were talking about
limited funds, growing domestic concern, the protectionist, isola-
tionist mentality that is very strident in the country, when the
major thrust of your remarks of this morning, ones which I agree
with, emphasize economic stability and the danger of some econom-
ic collapse, then it seems to me at this very hour our limited dol-
ought to b.
_ares :ire cc0rr
percE r
cr,~:i-ze in develkr
Now, it seems
in terms of wh,
trarv to the deci
Secretary Slit
the President's
needed for the
volved, and obvi
not have the ni
Mr. Schneider
which way and
But as a gene
balance betwee
package, and I
the way to get
sure you agree
nomic growth it
tions of the cowl
Senator DODD
the thrust of m,,
Secretary SHt
Senator DODD
time is up.Mr.(
The CHA1RMA;
Senator Press
Senator PRESS
Many of the
what has been
foreign policy. I
South Dakota,
meetings, and
spend less on fc
The foreign pol
you are well aw
But the point
the world of thi
Foreign Relatio:
are coming to t
ready answered
you can expand
business, the fa
feeling from sor
of it. In the 25 1
tarily raised in
But in any e,
commented. If
on to some of th
Secretary Slit
feels that these
up to us and tt
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
c recovery are clearly
)rically the coalition in
ve supported foreign as-
rally agree with the ?e-
id some concerns about
as we are the amount
lition in Congress at a
,al observation and the
he increase in military
that I have that the co-
.t, this trend continues.
;chwitz, Senator Biden,
?nt concerns regarding
increase in military as-
more alarming.
1.5 billion all together,
n current dollars from
,al dollars, it is about a
,etween security assist-
~ly the way it looks in
ecurity assistance pro-
ilitary aid, and the bal-
th-oriented money.
- balance-of-payments
nce program, you have
support funds and the
with the military, you
and less than-half, 43
:hat the economic sup-
i grant assistance, are
equipment, which is
be doing. If they hope
it to be investing those
home.
involved-, being able to
ingredient for econom-
ked and ravaged by a
)y arms from the out-
itest that, and thereby
country, they are not
,nt.
rat in the context of a
that I am opposed to
ie were talking about
ie protectionist, isola-
te country, when the
g, ones which I agree
anger of some econom-
hour our limited dol-
lars ought to be focused in the economic development area. If my
figures are correct, they show a 20.8-percent increase in military
aid, a 2.3-percent increase in Public Law 480, and 3.3-percent in-
crease in development assistance. That is how it breaks down.
Now, it seems to me if these percentages are correct, our actions
in terms of where those scare dollars are going seems to be con-
trary to the declared policy.
Secretary SHULTZ. Well,'
ell, the figures represent our judgment and
the President's judgment about the kind of help that is most
needed for the stability and economic growth of the countries in-
volved, and obviously there is a balance. As we have discussed, I do
not have the numbers classified the same way you do, but when
Mr. Schneider is here. Thursday, he will have it classified every
which way and can respond a little more directly to your questions.
But as a general proposition, we have sought to have the right
balance between military and economic matters in the overall
package, and I agree with you that having a healthy economy is
the way to get stability in these countries. At the same time, I am
sure you agree with me that it is hard to imagine that kind of eco-
nomic growth if you not have some stability in the military condi-
tions of the country.
Senator DODD. I was not speaking specifically of El Salvador. as
the thrust of my question.
Secretary SHULTZ. But you probably had it in mind.
Senator DoDD. I have another question on that one, but I see my
time is up. Mr. Chairman, I gather my time is up.
The CHAIRMAN. Thank you, Senator Dodd, very much.
Senator Pressler?
Senator PRESSLER. Thank you very much.
Manv of the areas have been covered, but I would just reiterate
what has been said so well here today regarding the two worlds of
foreign policy. I just returned a few hours ago from my State of
South Dakota, where I had 25 listening meetings or open door
meetings, and almost every one was volunteered. Someone said,
spend less on foreign aid. The big bankers are getting bailed out.
The foreign policy establishment is working against us. I am sure
you are well aware of that.
But the point is, we have to somehow have a marriage between
the world of the Foreign Relations Committee and the Council on
Foreign Relations and the conference in the State Department. We
are coming to a head on this budgetary matter, and you have al-
ready answered that or responded to it, but is there any way that
you can expand on your public statements to explain to the small
business, the farmer, the wage earner that there is a great deal of
feeling from some of the TV reports. I am sure you are well aware
of it. In the 25 which were held over the last 10 days, it was volun-
tarily raised in every meeting that that is the feeling.
But in any event, I pass that on to you, and you have already
commented. If you want to comment further, fine. If not, I will go
on to some of the other questions that I have.
Secretary SHULTZ. I think it is a very good point. The President
feels that these requests are appropriate and needed, but it is also
up to us and to all of us here to convince people in our country
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
398
that these programs are good for them. That is the ultimate test.
What is good for the United States?
We are saying that we are in a boat with a lot of other people,
and we will prosper or go down together, and these are things that
we think will be helpful in that regard. I agree with you, we have
to get out and sell this program, and I am going to try and do it.
Senator PRESSLER. In your recent trip to Japan-Japan is very
reliant on the Persian Gulf oil. I have been concerned about
burden sharing both in aid and defense. Does the concept of the
Japanese helping to defend the Persian Gulf ever come up in any
discussions you had with them?
Secretary SHULTZ. There has been a lot of discussion between
ourselves and the Japanese about their own effort in defense, and
the new prime minister, Mr. Nakasone, has taken a somewhat
more forthcoming leadership stance on that subject. We have to re-
member that Japan by its constitution, which we had a lot to do
with, has certain restrictions placed upon itself militarily.
Nevertheless, I think within that framework there are more
things that they can do, and I see evidence myself that they are
trying to do those things.
Senator PRESSLER. As I understand it, and this is not a question
on the banks, but it is related to aid, the administration's request
would reduce the forgiven military assistance program for Israel by
$200 million from last year, from $750 million to $550 million.
What are the reasons for this reduction?
Secretary SHuLTZ. Well, again, we have tried to put forward a
balanced program which looks at the needs of Israel and the needs
of other countries around the world, and within a framework of
what we think is doable, to divide that up accordingly. The overall
share of these total funds that goes to Israel is very substantial. I
do not have the proportion right in my head at this point, but at
any rate, the numbers are, in the judgment of the President, the
appropriate numbers.
Senator PRESSLER. The fiscal 1984 military aid request for El Sal-
vador is more than three times the amount contained in the fiscal
year 1983 continuing resolution, from $25 to $85 million, yet the
economic assistance request has been reduced by $20 million from
last year. Does this indicate that the administration is inclined
toward a military solution to the problems of El Salvador?
Secretary SHuLTZ. The solutions in El Salvador have to emerge
from a country that has political stability and is able to attain eco-
nomic growth. The military situation in El Salvador is such that
our judgment is that they need the military boost that those
number represent.
Senator PRESSLER. In that region, should we be prepared to take
special measures to assist Mexico should oil prices drop further?
Secretary SHuLTZ. Well, we have talked about the Mexican situa-
tion. I think we have to keep watching it. It is obvious that if oil
prices drop further, the countries that are the big exporters will be
the ones that will be affected adversely. I believe, as I said in my
testimony, that the world economy generally will be affected very
positively. We have to look at the Mexican situation, thinking of
not only their interests, but our interests, and certainly I think we
should
Mexico
Sena
from ti
are no
much
forts,
Seer
flow o
of ass(
They
how Ti
Arabi:
are in
have
exert
At t
about
foreig
able t
Sen
on th
made
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make
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have
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win!
hel'
mer
Sior
oug
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
with a lot of other people,
and these are things that
I agree with you, we have
ani going to try and do it.
p to Japan-Japan is very
we been concerned about
e. Does the concept of the
Gulf ever come up in any
lot of discussion between
own effort in defense, and
te, has taken a somewhat
.hat subject. We have to re-
which we had a lot to do
n itself militarily.
?amework there are more
lence myself that they are
and this is not a question
e administration's request
.ance program for Israel by
i million to $550 million.
tried to put forward a
of Israel and the needs
id within a framework of
p accordingly. The overall
srael is very substantial. I
head at this point, but at
nent of the President, the
ary aid request for El Sal-
int contained in the fiscal
?5 to $85 million, yet the
luced by $20 million from
idministration is inclined
s of El Salvador?
Salvador have to emerge
1 and is able to attain eco-
El Salvador is such that
ailitary boost that those
I
"d we be prepared to take
it prices drop further?
about the Mexican situa-
~t. It is obvious that if oil
the big exporters will be
[ believe, as I said in my
E:illy will be affected very
an situation, thinking of
and certainly I think we
should look at it very sympathetically in trying to be helpful to
Mexico.
Senator PRESSLER. Another country that is suffering somewhat
from the decline in oil prices is the Saudis, and I am told that they
are not fulfilling their previous financial pledges to Lebanon. How
much they expected to contribute to the Lebanese construction ef-
forts, and is this likely to be affected by the falling oil revenues?
Secretary SHULTZ. Well, obviously, they have had the greatest
flow of oil revenues. On the other hand, they have very large total
of assets that have piled up, so they are not broke by a long shot.
They have the ability to provide additional funds. The question of
how much for Lebanon comes forward from the Arab world, Saudi
Arabia in particular, no doubt will depend on how successful we
are in our efforts to get the foreign forces out of Lebanon and to
have emerge an independent Lebanon able to govern itself and
exert its sovereignty.
At this point, we are not there yet. So, people who are thinking
about putting money in there are waiting to see what happens. The
foreign forces are still there, as we all know, and there is consider-
able turmoil still in southern Lebanon.
Senator PRESSLER. Could the decline in oil prices have any effect
on the Saudis' ability to carry out some of the pledges they have
made during the sale of the AWACS?
Secretary SHULTZ. Well, the declining oil revenues have an
impact on them, obviously, but the assets they hold are so large
that they do not have any real problem with fulfilling any past
pledge, I am sure.
Senator PRESSLER. I see I have a red light. I will submit addition-
al questions for the record.
The CHAIRMAN. Thank you very much, Senator Pressler. We will
make a phone call, if you would like, that you are a little tardy to
your next appointment.
Mr. Secretary, before you leave, we have two very important
nominations I would like your judgment on. Tomorrow morning at
11 o'clock we will be available for opening statements for Senators
or comments on Director Adelman's nomination. We will have that
vote at 11:45. We received notification, an announcement from the
White House last year that our colleague, Ed Derwinski, would be
nominated to be counsel to the State Department. We understand
his papers will be arriving in the very near future, today some
time. Would you care to comment on both of those nominations?
Do both of those nominations have your full support?
Secretary SHULTZ. Absolutely. I have known both before they
were nominated, and thought very well of them. In each case, I
have had a fair amount of contact since they were nominated, and
I feel that both will do a first class job; in the case of Mr. Adelman,
that he will contribute significantly to the extremely important ef-
forts in the field of arms reduction, and in the case of Ed Der-
winski, an across the board kind of counselor role can be extremely
helpful to us, and it would not hurt us at all in the State Depart-
ment to have somebody there in addition to our excellent congres-
sional relations staff, but somebody in our top group who is thor-
oughly familiar with the workings of the Congress and knows what
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
listening to the grass roots is all about from his personal experi-
ence.
The CHAIRMAN. Well, I concur completely with you. I have
known Ed Derwinski for decades. I think he can be of invaluable
assistance to the Department at this particular time. And I will an-
nounce tomorrow the significant progress that Ambassador Adel-
man has made, including his last appearance, but also subsequent-
ly to that.
Thank you very much.
Secretary SHULTZ. Thank you, Mr. Chairman.
The CHAIRMAN. We will leave the record open for questions and
for the Secretary to reply to them.
[Additional questions and answers follow:]
STATE DEPARTMENT'S RESPONSES TO ADDITIONAL QUESTIONS SUBMITTED BY SENATOR
PRESSLER
Question 1. Secretary Shultz, what are your thoughts about the role of tourism in
our economy and our foreign relations?
Answer. Clearly the tourism and travel industry occupies a prominent position in
our economy. In 1982 it became the second largest retail industry in America in
terms of gross sales and employment. Travel in the United States now accounts for
more than $200 billion in domestic and foreign visitor spending, about 6 percent of
our gross national product. It generates substantial employment, accounting for 18
percent of all new jobs in 1981. The industry employs directly 4.6 million Americans
at every level of skill and an additional 2.3 million workers indirectly, generating
over $40 billion in wages and salaries annually.
Tourism can play an important role in enhancing our foreign relations. Increased
and less inhibited international travel of people from all nations for the purpose of
cultural exchange, recreation and trade leads to understanding, friendship and ulti-
mately to greater prospects for world peace. Tourism and travel to the United
States is a valuable method of fostering appreciation of the values of democracy,
freedom and human dignity.
Question 2. Would it be possible to designate at least one officer in each of our
foreign embassies to work for an increase in travel and tourism trade to the United
States? Some of the specific responsibilities of these officers would include the pro-
motion of travel to the United States, informing foreigners about all that the United
States has to offer, and facilitating and expediting foreigners' U.S. travel plans?
Answer. In accordance with the significant economic and foreign relations impact
of tourism and travel to the United States, our ambassadors and their staffs are and
will remain involved in tourism promotion and facilitation.
Scarce resources preclude assignment of individual officers at our posts abroad as
tourism attaches to devote full time to the tourism promotion effort. Commercial,
economic and consular officers now are jointly responsible for this function in addi-
tion to their other duties.
In the 66 largest markets for American goods and services, officers of the Foreign
Commercial Service (FCS) of the Department of Commerce have principal responsi-
bility for tourism promotion with support as required from consular and other mis-
sion sections. State Department economic/ commercial officers have the lead in pro-
moting increased travel to the United States in the remaining 73 countries. We will
be pleased to explore with the Commerce Department the feasibility of designating
a specific officer at each embassy or consulate as principal tourism promotion offi-
cer along with his or her other responsibilities.
In six key countries in which the U.S. Travel and Tourism Administration oper-
ates field offices, staffed by travel promotion officers with wide regional responsibil-
ities, our missions provide administrative support, while commercial, consular, ec,}
nomic and information officers work closely with their USTTA colleagues to coordi-
nate overall, program activities.
Question 3. If such designation was made, could we also implement a training pro-
gram to help these officers in the performance of their duty?
Answer. Whether or not specific officers are designated, it would be desirable for
the U.S. Travel and Tourism Administration to develop a training and operational
manual for the guidance of all officers involved in tourism promotion and facilita-
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tion. We will
priate Foreig
Question 4.
international
foreign trade
Answer. Ir
creased tour:
eliminate h,s.
tourist and
The St::;:.
time has
was part of
House in the
procedures :I
the Louisiun
The Unit,
Cooperation
define major
tual eliminat
Also, we si
USTR is cur
analysis of is
stacles inhibi
Question 1.
not to issue
ing all living
our exclusive
may have m:
the OES Bur
any particula
Answer. A:
mouslv recon
mile Exclusi'
We have c
reason to bel
note that aln
Economic Zor
I believe t:
critical time
sions in the
law and wit;
oceans usage
desire to ester
Question .
time as Cone
Answer. TI
gress and the
the results of
not to proclai
Question. I
Congress last
partment?
Answer. W
international
well as our
agreements
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
International debt crisis: the next
phase
Dr Wilfried Guth
Deutsche Bank, Frankfurt
Bank lending to developing countries is likely to be limited by the growth in each bank's
capita/base. Other contributions will have to come from the public sector, including the
IMF and the World Bank, and from private direct investment
We surely all agree that the grave international pay-
ments and financing problems, which began last
autumn with the Mexican debacle, have confronted
the world financial system with its greatest challenge
in the post-war period. There is also no disagreement
that this debt crisis, which is mainly concentrated on
a number of countries in Latin America and Eastern
Europe, is the cumulative effect of a prolonged reces-
sion, extremely high interest rates (nominal and real),
and growing protectionism in the industrialised
world.
In addition, certain countries have had specific,
`home-made' problems, such as the Falklands conflict
in Argentina, or the massive capital flight in Mexico,
whereas a country like Brazil became more or less a
victim of these adverse developments elsewhere,
which caused a sudden decline of international
lending to the third world. At the same time, it
should be noted that a number of problem countries
have not made sufficient efforts to adjust to deter-
iorating world economic conditions. Some of them
have taken greater recourse to short-term credits, thus
increasing further their vulnerability to fluctuations
in market confidence.
At this juncture a total of over 40 countries who
owe the greater part of their combined external debt
to commercial banks, have agreed to or applied for
debt reschedulings or have accumulated de facto sub-
stantial payment arrears. At mid-1982 the total
exposure of international banks in these problem
countries amounted, according to BIS statistics, to
about US$240 billion. This sum represented about
55% of all outstanding loans by banks to non-in-
dustrialised countries, or 15% of all international
bank credits recorded by the BIS (that is including
credits to industrialised countries).
These facts notwithstanding, we can say today,
with some satisfaction, although not with com-
placency, that any disruptive effects of these debt
problems on the entire financial system have been
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successfully prevented through the unprecedented co-
operative effort of the debtor countries, the Inter-
national Monetary Fund, governments and central
banks of creditor countries and commercial banks.
The rescue `packages' were put together with speed
and efficiency, thus preventing a breakdown of the,
debtor countries' economies.
Apart from the injection of badly needed funds, the
IMF has played a crucial and highly responsible role
in coordinating this concerted action to stabilise the
international financial system. And I should also like
to mention the extremely useful contribution of the
BIS, which on various occasions has provided bridg-
ing finance to countries negotiating adjustment and
medium-term financial support programmes with the
IMF and the banks.
Fresh money
The commercial banks' contribution towards re-
storing the financial viability of the debtor countries
consists in the rescheduling of the repayments on
outstanding credits and, in most cases, the provision
of fresh money through medium-term credits (in
addition to maintaining or restoring short-term trade
credit facilities and interbank lines). For the three
largest Latin American countries alone, the banks
have agreed to extend more than $10 billion in new
assistance, that is to increase their exposure by this
amount; in addition, bank loan repayments falling
due in 1983 will be rescheduled in the order of $35
billion.
This great cooperative financial effort of the various
creditors can, of course, only be help towards the self-
help of the debtors. Restoration of their financial
viability depends on the successful implementation of
the stabilisation programmes agreed upon with the
IMF. This is by no means an easy task and we should
not ignore the inherent risks. The rescheduling
countries have to undergo an often painful adjust-
ment process implying considerable strains on their
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DEBT CRISIS: NEXT PHASE
economies and, in some cases, their social and
political fabric.
Yet as there are many who like to play the role of
Cassandra, we should also take note of some en-
couraging developments. In the first quarter of 1983
there has been a pronounced further improvement in
the trade balances of the three largest Latin American
debtor countries, which together account for one-
third of the developing world's public and private
debt (of $700 billion). The marked decline in dollar
interest rates since mid-1982 (by about 6 percentage
points) has also helped to alleviate the debt service
burden of these countries (in the cases of Brazil and
Mexico each by around $700 million annually for
every one percentage point).
Nevertheless, there is general agreement that a
sufficient strengthening of the rescheduling coun-
tries' debt service capacity - perhaps one should
even say the very feasibility of the stabilisation
programmes - will depend decisively on a sustained
recovery of economic activity in the industrialised
world. In addition, it is essential that the
industrialised countries refrain from any further
restrictions on trade with developing countries and
that they embark on removing protectionist barriers
to third world exports. It is reassuring that in their
Williamsburg declaration the leaders of the major-
industrial nations stressed their commitment to these
aims but of course, as in other respects, it will be the
enactment of such high level intentions which counts
in the end.
Much as we all hope that the economic upswing
will proceed in line with the moderately optimistic
forecasts of international institutions like the IMF
and the OECD, we cannot expect that this will
speedily resolve the critical situation of some debtor
countries. We will, therefore, have to face - and to
master - several more difficult years before we can
hope to see the `light at the end of the tunnel'.
The question now therefore is how the successful
`first round' of cooperative rescue efforts can best be
continued and eventually transformed into longer-
term policies to stabilise the structural situation of
debtor countries. But first I would like to make a few
brief comments on some of the lessons to be drawn
from recent experience and on the implications of the
debt problem for the international banks.
Maturity extension
There are in particular two aspects which, to my
mind, give cause to further consideration. The first is
the question of the maturities to be included in debt
reschedulings. Most of the recent arrangements were
restricted to bank loan repayments falling due in
1983; in a few cases (such as Mexico and Chile)
maturities for 1984 were included. These payments
obligations have been rescheduled over a six to eight-
year period, a maturity extension which would seem
to be realistic in terms of the debtor countries' basic
situation. I am not so sure, on the other hand,
whether it would not have been wiser to include the
maturities of some further years in these reschedul-
ings. Dealing with the problem on a year-to-year basis
(as in the special case of Poland) does not seem to be
in the best interest of either the debtor countries or
the creditor banks for practical as well as psycho-
logical reasons.
Speaking very generally, I would like to add that it
makes little sense to tailor the `rescheduling costume'
too tightly, all the more so as the projection of the
debtor countries' cash flow cannot have the precision
of a mathematical equation. The arrangements should
also leave sufficient scope for flexible reaction to
unforeseen developments which are beyond the
debtor country's control; on the other hand, they
should not allow for any new inflationary deviations.
My second point relates to the impact of the debt
crisis on the interbank market, which the banks use to
balance their short-term assets and liabilities. Over
the past twelve months this highly sensitive world-
wide market has emerged as a critical element and
potential problem area in a two-fold sense.
Interbank market
Banks of some highly indebted developing coun-
tries last year raised increasing amounts of very short-
term money on this market through their foreign
branches, using this money for the funding of longer-
term loans to debtors at home; in the final analysis,
and in contrast to the underlying logic of this market,
bank-to-bank deposits were thus used to finance
balance of payments deficits. On the other hand,
creditor banks reacted to emerging payment dif-
ficulties of debtor countries or to debt problems in
neighbouring countries with substantial cuts in
interbank lines, thereby adding to the countries'
worsening foreign exchange situation.
The maintenance of interbank lines - and in the
case of Brazil the restoration of lines to the higher
levels of an earlier date (the by now famous Project
IV) - has been an essential ingredient in several of
the recent debt rescue `packages'. Although under the
given conditions there may have been no alternative,
this aspect of the rescheduling exercises has given rise
to unease among the banks and to criticism such as
`coerced interbank lending is a contradiction in terms'
or `abuses of the market are being institutionalised'.
And even in official central bank quarters the attitude
towards this ambiguous interbank problem seems to-
day to be divided.
The interbank market will, at any rate, remain
highly susceptible to fluctuations in confidence and to
any official intervention in the international banks'
liquidity management. This should be taken into
account by all parties involved, since this market
must be kept fully intact as an essential cornerstone of
our international financial system. By the same token,
banks and banking supervisors alike all over the world
ought to be fully aware of the potential dangers of
excessive short-term borrowing in this market.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
I think it is evident to everyone today that the
position of the commercial banks in the rescheduling
process is a very difficult one. A number of big
international banks have accumulated rather high
exposures in problem countries - high in relation to
their capital and reserves and in some cases to current
earnings - and the same presumably applies to some
of the regional and smaller banks which have in
recent years increasingly participated in international
lending.
'Punishment'
Of course, voices can now be heard to the effect that
the banks should not have entered the whole field of
balance of payments lending in the first place. But,
quite apart from the fact that the same people cannot
explain how the recycling of petrodollars could have
been achieved without the major contribution of the
commercial banks, this kind of critical reasoning on
past events is of no help when it comes to solving our
present problems. And it becomes even counter-pro-
ductive when politicians, in order to `punish' banks
for alleged past mistakes, feel tempted to block
necessary contributions from the public sector. I shall
refer to this question later on. But let it be said here
that `punishment' for imprudent banking, if there has
been any, invariably comes by itself; it need not be
imposed by anyone.
How then should the banks today act vis-d-vis the
problem countries? On the one hand, there can be no
question that beyond the stretching of maturities,
which is the core of rescheduling agreements, most of
these countries need fresh money to achieve a
moderate rate of growth; otherwise social peace might
be endangered. Nobody can say that the commercial
banks of industrial countries - with very few
exceptions - have not responded very constructively
to this undeniable necessity. I have given some
illustrative figures on this earlier.
Yet there is another side to the coin. It is equally
obvious that the commercial banks cannot ignore,
even for the best of reasons, prudential limits to their
country exposure. In many countries, supervisory
authorities have begun surveilling these country
exposures and the boards and credit committees of
the banks themselves (not to mention shareholders at
general meetings) are keeping a close watch on
country exposures. But even if these bodies were to
take a very lenient attitude bank management, which
carries the main responsibility, cannot allow certain
ratios to be surpassed. It is true such ratios should not
be defined too rigidly - and nobody can give exact
proof that one ratio or another is the right one - but
we would have a distinct feeling of insecurity if some
exposures became too great in relation both to total
lending and to capital and reserves.
Loan provisions
It can be argued that such insecurity can be
overcome if new lending to rescheduling countries
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DEBT CRISIS: NEXT PHASE
were accompanied by parallel increases in existing
loan loss provisions for these country risks. And this
is indeed what most banks have already done. We
should not overlook, however, that this represents a
somewhat unusual method of banking, the normal
and logical attitude being that exposures against
which loan loss provisions have to be made are not to
be increased, but rather decreased if possible.
What conclusions can be drawn from all this? I
would like to stress three points:
?. Adequate provisions for possible loan losses from
sovereign risk lending are an absolute necessity, no
matter what sums fiscal authorities might accept. By
the same token, finance ministers ought to be aware
that they are apt to put their own responsibility for
the soundness of the country's banking system in
question if they allow the attitude of fiscal authorities
in this matter to be determined by budgetary needs
rather than by an objective risk analysis.
I would like to add that I am not in favour of
uniform, fixed and inflexible percentages for such
provisions prescribed by supervisory authorities. I
clearly prefer a system in which banks have the
freedom to fix those percentages according to their
own judgment. All I venture to suggest is that the
minimum percentage to be set aside ought not to be
so small that it becomes meaningless in the moment
of need.
? While there will be strong reasons for banks not to
withhold their support for the debtor countries
during the critical years of rescheduling - to some -
extent out of solidarity with the world banking
community, but mainly to bring their debtors `out of
the woods' - additional inputs of fresh money, if at
all necessary, can only be moderate, given existing
exposures, capital ratios, and other factors. To my
mind, it makes no sense, therefore, when some
observers today want to determine what they call the
`necessary contribution of commercial banks' by
estimating the needs of the debtor countries for such
credits.
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Social welfare is a subject of serious
consideration in most modern societies. Man in
the twentieth century accepts his responsibility
to bequeath to the next generation a society
better than his own. Daiwa Bank is not unique in
accepting this responsibility, but Daiwa is unique
in making acceptance of this role in society an
integral part of their banking service.
Daiwa is the only Japanese city bank to
combine banking and trust business. Daiwa is
thus a fully integrated banking institution,
comprising banking, international financing, trust,
pension trust, and real estate business. This
integration is part of our effort to fulfil our social
responsibility consistent with society's needs in
a contemporary environment
a fully integrated banking service
Head Office: Osaka, Japan
New York Branch: 140 Broadway, New York. N.Y. 10005
Los Angeles Agency: 555 South Flower St., Suite 4040,
Los Angeles, Calif. 90071.
Branches: London, Frankfurt, Singapore and Hong Kong
Representative Offices: Sydney, Sao Paulo, Houston, Paris.
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Subsidiaries: Daiwa Bank Trust Company, 75 Rockefeller Plaza,
New York N.Y. 10019; Daiwa Bank (Capital Management)
Limited, London
Affiliates: P.T. Bank Perdania, Jakarta;
Daiwa Overseas Finance Limited, Hong Kong
Uncomfortable logic
Such assessments of needs ought to proceed in a
different manner. Starting from the Fund's estimate
of foreign exchange requirements of debtor countries,
in the framework of their stabilisation programmes, a
realistic figure for the commercial banks' possible
contribution should be deducted in order to arrive at
the `necessary contribution from the public sector'.
Governments and parliaments should not close their
eyes to this uncomfortable logic and take appropriate
steps to ensure greater public contributions in one
way or another. They ought to be aware that the
ultimate costs for them are likely to be higher if a
crisis is allowed to develop.
? Creditors and debtor countries alike must have
one overriding interest: to make sure that scarce
foreign exchange, that is the `fresh money' supplied
by the IMF and the commercial banks, is utilised in
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
the most productive manner so as to strengthen the
countries' repayment capacities. On the other hand,
commercial banks are hardly in a position to ensure
the proper use of those credits; they might even find
themselves in a dilemma if they were confronted with
financing requests from export firms in their own
countries for purposes which did not appear very
convincing in terms of structural balance of payments
improvements of the debtor countries. In fact, there
seems to be an urgent need for advising on and sur-
veilling the most efficient use of the new credits in
rescheduling countries. One would think that the
World Bank, with its great experience in project
selection and monitoring, is well suited to assume this
role in close cooperation with the IMF.
Most urgent tasks
After these general remarks on the problems of the
commercial banks I want to return to the basic ques-
tion of how the problems of highly-indebted third
world countries can be resolved in such a way that
they can become creditworthy again. It was certainly
clear from the beginning to everyone involved that
only in the most favourable - and unfortunately un-
likely - circumstances (rapid world economic re-
covery, dismantling of protectionism) would the `first
aid' packages for some of these countries be sufficient
to achieve this aim. But little thought, if any, was
given during this heavily strained period to the way in
which inevitable follow-up measures ought to be
conceived.
Today, however, we are confronted with clear evi-
dence that crisis management will have to continue in
a number of cases. How then should `the second
round' be tackled, for instance with respect to Brazil?
Estimates differ widely as to the extent of the
additional foreign exchange requirement likely to
arise for 1983. But, whether it is $2 billion or $3 bil-
lion, we should say right away that the commercial
banks cannot be counted upon to fill this gap by
themselves. While it may be necessary for all banks
engaged in Brazil, including those which are still
lagging behind on the old programmes (Projects III
and IV), to act in solidarity and provide a certain
percentage of `fresh money' for the second time, such
new credits must be matched by additional
contributions from public sources.
Naturally, our eyes are primarily directed towards
the IMF in this context. As the Fund has already
committed the maximum amount available for Brazil
under the present enlarged access policy, that is 450%
of its quota, it is argued that the only way in which
the IMF could help in the given situation is by
accelerating disbursements. This may well be
advisable, but it will in all likelihood not be sufficient
nor will it satisfy the banks as a `matching formula'.
The same would be true for another stopgap measure,
namely a roll-over of the bridging loan from the BIS.
Accelerated disbursements under an existing loan
agreement or the extension of bridging loans only
make sense if, to extend the metaphor, there is firm
ground at the other end of the bridge or, to put it in
terms of the actual case, if Brazil's external cash flow
is expected to improve sufficiently or if the country
can be eligible for market loans after such operations.
Unfortunately this state of affairs is not yet in sight
and cannot be safely assumed, unless the world
economy sees a very vigorous upturn.
In order to ensure an appropriate contribution of
official funds towards debtor countries' additional
borrowing needs, the speedy enactment of the
proposed increase in IMF quotas and enlarged
General Arrangements to Borrow is essential. Besides
providing the IMF with adequate resources the quota
increase should also be reflected in the Fund's
lending policy. At the very least one half of the quota
increase ought to be made available to problem
countries on the same basis as under the present Fund
guidelines for members' enlarged access which
specify maximum assistance of 450% over a three-
year period, as already mentioned.
Wrong setting
As we know, the more restrictive attitude of some
governments or parliaments towards increased IMF
lending is largely based on fears of inflation. This is
certainly legitimate and in principle by no means
unfounded. Yet in my opinion the rescheduling
countries facing negative growth rates and social
tensions are today the wrong setting for the
curtailment of international liquidity. Furthermore, it
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DEBT CRISIS: NEXT PHASE
is the very essence of the stabilisation programmes probably be rather reluctant to grant loans for general
_ ,ation voidance of budget or balance of payments purposes and (will
rPm
_- the
especially the financing of capital goods exports.
a In this context, the World Bank's introduction of
new co-financing schemes for high-priority projects
in developing countries, designed to provide greater
risk protection for the banks while at the same time
accommodating those countries' need for longer-term
maturities, is to be welcomed. One possible idea
worth considering is to extend co-financing to the
broader programme loans of the World Bank. Co-
financing should also be intensified by the regional
development banks, such as IADB and ADB, which
are also becoming increasingly active in this field.
? One of the most important lessons of this crisis
period is the confirmation of the crucial importance
of the two Bretton Woods institutions, the Fund and
the Bank. Rather than pondering over the need for
new institutions, governments and parliaments ought
to do everything to keep these well-established and
highly efficient institutions intact, and to assure the
adequacy of their capital base; endless negotiations
for every capital increase would appear rather
anachronistic after the events of 1982-83.
? This is by no means to say that the share of public
lending ought to remain at the high level indispens-
able during the present period. On the contrary, there
is no other policy aim of such fundamental
importance than to attract a large flow of private
funds in all possible forms to the newly in-
dustrialising countries of the third world.
Direct investment
Promotion of private direct and equity investment,
whose importance in the overall transfer of resources
to the developing countries has decreased over the
past decades, represents an ideal way for these
countries to expand their growth potential without
increasing their debt burden. Foreign private in-
vestment could make a significant contribution in
helping to develop new primary product sources, and
by transferring technology and marketing skills.
In many countries such a change in development
financing strategies would imply a revision of the
hitherto often restrictive and even hostile attitude of
governments towards foreign risk capital. Another
member of the World Bank family, the International
Finance Corporation, could be called upon to assist
these countries in improving
productive investment, particularly by medium-sized
and smaller firms from industrial countries.
The guiding principle must be no more public
funds than absolutely necessary. This is all the more
important as scarce budgetary contributions of the
industrial countries will continue to be urgently
poorest
needed for supporting growth in the developing countries.
Dr Guth is joint spokesman of the Board of Managing Directors
of Deutsche Bank.
a
wor
This has nothing to do with 'early warning', a term
currently often misused; it is rather to be seen as a
joint effort to avoid a situation where market lending
comes to an abrupt end.
? There is little doubt that after the deep shock
which the debt crisis has caused, the role of private
banks in the financing of developing countries will
take on a somewhat different character in the re-
mainder of the 1980s. Banks will, in my opinion, be
concerned in future that the expansion of their
international lending will, as a rule, not proceed faster
than the growth of their capital base. They will
the IMF to keep m
In search of other contributions from the public
side to ease the balance of payments situation of
rescheduling countries one is inclined to think of the
debt incurred on guaranteed export credits of the
industrial countries, for which no rescheduling has
been arranged so far. Although the amounts involved
might not be very substantial, it would in my view
represent a fair 'burden sharing' if the debtor
countries in question were to call on the official
creditors of the Paris Club to agree to a rescheduling.
Needless to say, parallel to such operations, the
creditor governments' extension of new export credit
insurance must go on - just as the commercial banks
have been prepared to provide fresh money in
addition to rescheduling the maturities of non-
guaranteed loans.
Another. way - indeed a very natural one - of
increasing official contributions is, of course, to
intensify World Bank and regional development
banks' lending to problem countries. In fact, the
World Bank and the InterAmerican Development
Bank have already responded to this challenge and
have greatly increased their commitments to Brazil
and Chile.
Financing future growth
As I indicated at the outset, the immediate task of
continued crisis management must not detract from
the more far-reaching basic problem of how to ensure
the necessary financing of future growth and develop-
ment of third world countries under the world econ-
omic conditions of the 1980s. On this broad subject
I would like to make only a few concluding
observations:
? The great progress in international cooperation of
public and private creditors, which has been achieved
during this difficult period, ought to be maintained.
The main purpose of such cooperation should then be
crisis prevention. To achieve this aim, the Fund will
have an important role to play within the framework
of its surveillance function, which it must exercise
strictly wherever necessary. But ways and means
should also be explored to assure that the commercial
banks in their lending to the various countries do not
t 'cross purposes' to the Fund's intentions.
k
carne.l out -
+1 Lion under better control.
30
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
International debt crisis: the practical
lessons of restructuring
M. S. Mendelsohn
London
In the past year, some 25 developing countries have been renegotiating the terms of
about $ 100 billion of external debt to the markets. Borrowers, banks and the authorities
have all learned in this 'crucible of recent experience'
The past year's concentration of sovereign debt
restructuring has taught a few new lessons, driven
home again some half-forgotten truths, but has also
revived some popular misconceptions. Since Mexico
abruptly interrupted full service of its external debt
last August, some 25 developing countries have
followed or returned to the bargaining table to
renegotiate the terms of about $100 billion of external
debt owed to the international banking system and
other private creditors, or about 20 times the amount
of cross-border debt to the markets renegotiated in
any previous year. About three-quarters of that total
is being renegotiated by five borrowing countries
alone - Mexico, Brazil, Argentina, Venezuela and
Poland.
This is a new phenomenon, representing the
realisation of a fear long felt. Of about 80 debt relief
agreements signed in the 25 years up to 1982, nearly
70 covered debt owed by the governments of
developing countries to the governments and the
officially-supported export credit agencies of the
leading industrial countries. Relief agreements with
the banking system were isolated events until the
mid-1970s and only nine countries restructured such
debt even in the six years up to 1982. With the excep-
tions of Turkey, which renegotiated $3 billion of
market debt in 1979, and Poland, which renegotiated
$4.8 billion in 1982, most such market relief agree-
ments were with smaller African and central
American countries and the sums were relatively
small for the creditor banks though not, of course, for
the countries concerned.
So far, it is the macro-economic lessons and impli-
cations that have received most attention, but a study
published this month by the Group of Thirty
concentrates, instead, on the practical experience of
cross-border debt renegotiation gained over the years
and `in the crucible of recent experience'*.
The economic aspects need therefore be rehearsed
here only briefly. Much comment on the present
`debt crisis' of developing countries has suggested, or
at least implied, that borrowing on the part of
economically developing countries is a recent
phenomenon, that it is intrinsically unsound, that the
banks lent recklessly during the 1970s and that the
borrowing countries squandered the proceeds. It is
impossible not to detect in all this a thinly disguised
strand of xenophobia and, indeed, racialism, tinged
with a certain schadenfreude that matters have
apparently gone so very wrong.
That attitude was summarised in a question put
recently by an intelligent television interviewer in the
United States who asked her panel, `why did our
banks lend all this money of ours to foreign countries
and how will the countries ever pay back their debts?'
The same question is being asked by legislators,
especially in the US Congress, echoing Calvin
Coolidge's celebrated observation, `well, they hired
the money, didn't they?'
Classical process
The recycling of oil surpluses during the 1970s was
novel only for the enlarged part played by the
banking system in the classical development process,
by which poorer countries augment domestic savings
with imported capital to finance their economic
advance until they join the ranks of capital exporting
countries, a transition which the United States made
only at the turn of the present century and countries
like Switzerland and Sweden later than that. Indeed,
the same process takes place within sovereign states,
where unrecorded imbalances of payments between
regions are adjusted by flows of short-term banking
funds, longer-term capital, the built-in redistribution
of the tax system and, in the last resort, all else failing,
by migrations from poorer to richer regions.
So far from squandering the capital they borrowed
'Commercial banks and the restructuring of cross-border debt,
Group of Thirty, New York, July 1983.
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during the 1970s, the advanced developing countries
responsible for most market borrowing used the
money wisely and productively. Taken as a group,
they achieved an impressive record of export-led
growth by concentrating much of their investment in
ways that increased their net foreign exchange
earning capacity, as pointed out by the World Bank
recently in `an unfashionably positive view of the
external indebtedness of developing countries".
Yet the successful use made by advanced
developing countries of borrowed capital during the
1970s has caused almost as much dismay as the recent
suspension of full debt service by some of them,
including the biggest borrowers. The resentment
created in the older industrial countries and especially
in their declining industries by the growth of compe-
tition for world export markets by the newer indus-
trialised countries and the advanced LDCs explains at
least in part the covert pleasure now felt in their
plight and that of their bankers.
For the most part, the foreign debt taken on at
minimal or negative real interest rates in the 1970s
seemed manageable to the countries and their
creditors and actually was in the circumstances in
which the debt was contracted. There were certainly
inefficiencies at the all-important margin, but the
main cause for the difficulties of sovereign and other
borrowers has been the global disinflation of the past
three years with its undue emphasis on monetary
restraint, which steeply increased the real cost of
borrowed money while severely restricting the ability
of domestic and sovereign borrowers to earn enough
for the maintenance of full debt service.
Paris club
The plight of sovereign borrowers is only one
symptom and not the most important of the economic
difficulties from which the world is just beginning an
uncertain recovery and, even on the most hopeful
outlook, many sovereign borrowers will be returning
to the bargaining table with their bankers this year,
next year and quite possibly for several years. The
first shock of sovereign market debt restructuring has
been absorbed more smoothly than many dared hope
in the panic of the late summer and autumn of last
year, but the difficulties are by no means over. What,
then, has been learned from earlier and more recent
practical experience?
Some lessons have undoubtedly been absorbed
from the Paris club in which developing countries
have been renegotiating since 1956 the terms of
public sector debt owed to the 17 members of the
DAC, or Development Assistance Committee of the
OECD. The `club' has been notably shy about
publicising its workings or even existence from the
very first, for fear that this might encourage more
relief applications, and it hesitated until 1974 before
appointing a small secretariat at the French treasury
where it meets. Yet a set of procedures has evolved by
trial and precedent over the years.
With few exceptions, creditor governments have
tried to confine relief to the stretching out of principal
repayments falling due within a `current period' of up
to 21h years. These are commonly allowed to be
stretched out over 8-10 years, of which the first half is
usually conceded as a grace period during which no
principal is repaid, although interest payments must
be kept up at a `moratorium' or market rate which is
usually, but not always, above the rate at which the
loans were contracted.
Equal treatment
Over the years, Paris club agreements have tended
to incorporate provisions intended to provide equal
treatment for all creditors. These require debtor
governments to renegotiate debt to non-DAC govern-
ments and also to private creditors, mostly banks, on
terms no more favourable to the creditors than those
DEBT RENEGOTIATIONS WITH COMMERCIAL BANKS
1982-83
$ billion
d i
i
n
ate
Amounts being renegot
Public
sector
Private
sector
Total liabilities
to inter-
national banks
debt
debt
Gross Net
Mexico
19.5
15.0
59-0 48-5
Brazil
4-7
...
56-0 51-8
Argentina
5-5
6.0(Estl
22-2 16.4
Venezuela
16.3
n.a.
.22-7 9.7
Peru
2-0
0.3
5-2 3-3
Chile
3.4
...
10.5 8.0
Uruguay
0.8
n.a.
1.2 0
Ecuador
1.2
1.3
4-1 3.3
Jugoslavia
3-4
n.a.
9-3 7.3
Romania
0-6
n.a.
4.0 . 3-7
Poland
7.0
n.a.
13-4 12-4
Cuba, Costa
Rica,
Nicaragua,
Honduras
2-1
n.a.
2.5 2-1
66-5
22.6
210.0 166.5
Estimated by authoritative supervisory sources. Source for
end-1982 liabilities to banking system: Bank for International
Settlements.
n.a.: not available or applicable.
... Some private sector debt included in public sector total.
(Est) : estimated.
agreed with the Paris club governments. In practice,
however, the debtors are required to show only that
they have sought to restructure such other debt, not
that they have actually succeeded in doing so, and the
requirements to restructure debt to all creditors are
not, therefore, always mett.
The difficulty faced by the Paris club and, indeed,
*World Debt Tables 1982-83, February 1983.
tAn exception in all cases is the World Bank, whose loans are
always serviced in full because of its inflexible policy of treating
any interruption of service as a default, which would bring the
borrower into default to all creditors under cross-default clauses.
That threat has never yet had to be carried out.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
have
cipal
:)f up
o be
alf is
h no
must
ch is
1 the
nded
equal
=btor
vern-
s, on
:hose
'r-
,ahks
Net
s8-r
51
16.4
9.7
3.3
80
0
3.3
73
3.7
12.4
2_1
66-5
:e for
tonal
:tice,
that
not
i the
s are
ns ;,
.atmg
ig the
aUSCS.
all creditors, is to discover the fine point between
conditions which are too lax to induce a sufficient
adjustment by the borrower or too harsh to be met.
The result in either case is a fresh round of negotia-
tions, as shown by the number of `recidivists' who
have returned to the Paris bargaining table three, four
and even five times, in many cases in successive years.
However, a common sense approach to that
difficulty has evolved over time and, like all
evolutionary solutions, seems for that very reason to
be the best of the alternatives available for reconciling
the legitimate differences of interest between those
involved.
It consists of a `goodwill clause' under which
creditor governments undertake to consider favour-
ably fresh relief applications in succeeding years,
provided that debtor countries can show that they are
continuing to meet the performance targets agreed
with the International Monetary Fund for the adjust-
ment of their balances of payments. This is, indeed,
the criterion by which the Fund itself disburses
conditional assistance to member countries.
Precedent
That may be the most important practical lesson
learned from the experience of intra-government debt
renegotiation and it has crept into the renegotiation of
cross-border debt owed to the commercial banking
system although it has not been and is unlikely to
become a formally acknowledged practice for fear of
DEBT CRISIS: LESSONS
setting a precedent. Nor is it without some dangers,
unless the creditor banks show their determination to
see actual performance rather than mere promises.
At least one small developing country has
repeatedly renegotiated its external debt to the
banking system for several years past without meeting
any of its performance targets and its debts are so
small for the creditor banks that they would gladly
write them off, excepting for the dangerous precedent
which that would create. Indeed, they are troubled by
the precedent already created, which amounts to
default by attrition (as distinct from outright default,
which most bankers still think unlikely).
Corporate debt
Some practical experience of corporate debt
renegotiation in the United States has likewise been
applied to the renegotiation of cross-border debt owed
to the international banking system. In the US, it is
more usual for companies to have several bankers and
corporate debt is common syndicated in the domestic
market. As in other countries, the restructuring of
corporate debt is a routine experience but, because
US banks have more experience than many others of
restructuring syndicated corporate debt, they are
perceived by many other bankers as being especially
good also at renegotiating syndicated international
debt, their alleged `bullying tactics' evoking, on the
whole, more admiration than resentment among
European bankers.
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DEBT CRISIS: LESSONS
t
Euromoney July 1983 53
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
sovereign debt is supported by former
Chase vice Chairman, William Ogden, now
chairman of the interim board of the
Institute of International Finance. "I don't
believe in these radical solutions," he
asserted. "They deal with problems which
don't yet exist, namely LDC insolvency.
They would not maintain sufficient flows of
funds to LDCs." Assume permanent insol-
vency and you certainly don't get an
adequate flow, he maintained. And he
added: "It's naive to lump together all the
problem countries with their very different
economies into a single global problem."
That is also the view of de Larosiere:
"There can be no generalized solutions to
the debt problems," he said in May at Boca
Raton, Florida. What are needed are
"forceful and well crafted adjustment
programmes geared to the individual
circumstances and problems of each debtor
country and supported in each case by
judicious and coordinated financing
arrangements."
Heimann, too, was sceptical of the need
for far-reaching reform: "To bail out the
banking system is neither necessary nor
moral. We already have the central banks in
place to deal with any liquidity or solvency
problems the banks might encounter."
Wilfried Guth, chairman of the
managing board of Deutsche Bank, believes
that the existing financial institutions can
tackle debt problems. In a speech in Stock-
holm, he said: "Banks should not ask for
or be given a bail-out or a lifeboat. I agree
with the public opinion that we must
ourselves carry the consequences of earlier
lending policies ... these [sweeping
reforms] are contingency plans which
would be taken out of the drawer only if the
situation were to deteriorate dramatically."
Advocates of this ad hoc system stress
that the banks have an orderly approach to
reschedulings and are not muddling
through. Laurence Brainard, senior vice
president and chief international economist
at Bankers Trust said: "An understanding
has developed among the banks on the
methods of approaching reschedulings. No-
where is it codified, but there are under-
stood priorities. For example, trade debts
should be kept out of reschedulings, so that
countries can continue to have access to
trade finance. And we've learnt; on Poland
we made the mistake of ignoring the short-
term lines, so everyone tried to pull out on
them. So, subsequently we've tried to
ensure the short-term lines are kept open."
Proponents of radical change accept that
the piecemeal approach has worked so far,
but doubt if it can satisfy the funding needs
How the Ditchley initiative is becoming reality
"We've found a beautiful location, just institute's dual purpose: "The data collec-
opposite the US Treasury Department. lion is for the banks, the missions will be
From one side we can took right down on
the White House," said Bill Ogden, chair-
man of the interim board of the Institute
of International Finance (HIF). In April
the institute picked a permanent HQ, in
downtown Washington DC, and sent out
about a thousand application forms,
inviting banks to join the institute.
Recently, the interim directors chose
Andre de Lattre, a former deputy governor
of the Banque de France, to be the insti-
tute's first managing director. Conceived
at Ditchley Park, in the UK, last August,
the institute should begin operations by
the end of this year.
The IIF will gather country informa-
tion, to be used by second-tier banks,
which don't have their own large research
departments. This should allow smaller
banks to evaluate credit risks better, so
that they may become less reluctant about
cross-border lending.
It will also engage in an on-going
dialogue with borrowing countries, on a
voluntary basis. The HF will discuss
borrowers' economic plans, assumptions
and borrowing needs. The discussions will
include missions to the borrowing
countries, though the IIF is not keen on
that word because of its IMF connota-
tions of browbeating.
L One interim director described the
for the borrowers."
One difficulty for the IIF is that many
bankers, even some of those associated
with it, are unclear about what it will do.
While it is now generally understood that
the IIF will not act as an equivalent of the
Paris club for bank reschedulings, some
bankers believe it will have access to IMF
information which it could relay indirectly
to the banks.
That is not the case. One IMF official
said: "We cannot pass on to the institute
information given to us on a confidential
basis, unless the countries concerned
agree. So I don't think Ditchley will make
a great deal of difference."
The most common criticism levelled at
the IIF by commercial bankers is that
it won't make much difference now,
because the small banks it is aiming at
have already- left the sovereign loan
market. One senior vice president of a US
bank said: "It's missed the gun by five
years. It's a good idea five years too late."
But criticism is unfair; the I1F's
founders are aware that it will not solve
contemporary problems of sovereign
lending. "The institute is not really
designed to deal with today's problems,
like Mexico and Brazil," said Ogden.
"We'll only be able to test how successful
the institute has been in five to 10 years
SOVEREIGN LENDING
of borrowers like Mexico and Brazil over
the next few years. Mexico is paying about
$12 billion a year in interest, and will have
to find $20 billion to repay principal due at
the end of next year. According to IMF
calculations, Brazil's annual repayments of
principal will reach $16 billion by 1987,
together with about $10 billion a year
interest. Even some of the most conserva-
tive bankers recognize that the big debtors
are going to keep coming back for resched-
ulings, each time demanding more fresh
money so that they can meet interest
payments.
Would the system be able to survive this?
A British bank economist stressed the diffi-
culty of persuading commercial banks to
increase their exposure to the rescheduling
countries: "We've gone along with arm
twisting this far. But at each rescheduling of
reschedulings, the central banks will have to
twist harder, and more banks will drop out
of the net. It's not likely to work more than
once or twice."
The Bretton Woods institutions have
already begun to increase their contribution
to Third World deficit financing. In
January, the World Bank launched a
scheme for cofinancing under which the
bank will encourage more commercial bank
project-lending by guaranteeing or partici- -
from now. Its major task is to prevent
these sorts of crises from happening
again. If countries choose to approach us
for consultations, they will be able to
adjust voluntarily on their own, before
they are forced to go to the Fund."
Although some have reservations, most
leading international banks support the
establishment of the institute. Deutsche
Bank was the only leading bank which
turned down the invitation to be one of
the 35 founding members.
Ogden hopes the despatch of country
information to member banks will dissuade
them from the extreme swings which, in
the past, have sometimes resulted in all
the banks rushing into a country, only to
suddenly rush out again. Said Ogden: "As
I see the institute's role, it shouldn't put
up red lights or green lights, but rather it
should put up yellow precautionary lights
and point to the speed limits."
Ogden is particularly pleased that the
initiative behind Ditchley has been private
sector. "The private sector has come up
with a better mechanism for tackling these
problems. No one told us we had to do
this. It's a good argument to use against
the regulators who don't trust us."
Ogden has made it clear that he does
not wish to be the institute's first
managing director - but he wouldn't
mind being the first non-executive
Euromoney July 1983 55
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SOVEREIGN LENDING
Laurence Brainard: Trade debts should be kept out of reschedulings.
pating in normal syndicated credits. In
February, World Bank President Tom
Clausen announced a special action
programme of accelerated disbursements
on project lending, and more structural
adjustment loans.
The IMF has achieved a quota rise of
47.5%, and an increase in the general
arrangement to borrow from SDR 6 billion
to SDR 17 billion. But these new funds for
the IMF are unlikely to be approved by the
various national assemblies until at least the
end of the year. According to a study
published in March by the Group of 30, the
IMF had only $9 billion of spare resources
to lend. Considering the likely demands on
IMF funds, the Group of 30 estimated that
the IMF would need to borrow an extra $9
billion on world capital markets before the
end of the year.
The IMF and the World Bank will take a
bigger share of LDC financing this year,
but, even if the IMF starts to borrow in the
loan market, they will lack the resources to
supplant the banks, if the banks will not
provide the 7% increase in exposure
requested by de Larosiere.
Supporters of sweeping solutions
maintain that increasing the resources of
the IMF and the World Bank will not
preserve stability in the world financial
vstem, nor keep an adequate flow of
-apital to LDCs.
The most radical idea is to stretch out the
maturities on existing LDC loans by con-
verting them into long-term bonds.
Variations on this idea have been canvassed
by Peter Kenen, Professor of Economics at
Princeton; Felix Rohatyn, a partner of
Young, chairman of Morgan Grenfell.
They believe a stretch-out would act as a
bulwark against the threat of default, and
would reduce the need for new bank loans
to LDCs, by diminishing debt service
burdens and easing current account
deficits.
Kenen and Rohatyn suggest that govern-
ments of developed countries should set up
a new agency. (Kenen suggests the name
International Debt Discount Corporation.)
This would buy LDC loans from the banks,
at a , discount of, say, 90%, and issue in
return guaranteed long-term bonds in its
own name. The agency would reschedule its
loans to problem borrowers on a long-term,
low interest, and final basis.
According to Rohatyn: "The reality of
the situation is that a significant part of the
approximately $700 billion now lent to the
Third World and the eastern bloc will come
back, if ever, only over a long period."
Geoffrey Bell, a director of Schroder
International, expressed a general criticism
of the Kenen/Rohatyn model: "These
schemes don't address themselves to the
real issue, which is how to get new money to
these countries, rather than dealing with
existing debts." (Bell has himself proposed
an international lending facility, linked to
the IMF: banks would place funds in the
facility, which the IMF would lend along-
side its own loans).
Rohatyn and Kenen assume new lending
to LDCs on a normal commercial basis. But
Mackworth-Young's idea tackles Bell's
criticism. LDCs would fund their deficits by
issuing bonds, carrying an international
guarantee.
from now on must be incurred outside the
international banking system," said
Mackworth-Young. "It's right for banks to
finance trade and projects, but you
shouldn't ask a bank to lend if it's not clear
how and when it'll be paid back, and if it
has no control over the financial manage-
ment of the borrower."
Mackworth-Young wants this principle
to be applied retrospectively. Balance-of-
payments assets should be stripped off the
banks and put into the capital markets with
a guarantee. "The LDC bonds need to be
guaranteed, so that if there is a default the
whole developed world bears the weight,
and not just the banks, because if banks
lose their capital it's a catastrophe."
Mackworth-Young said he did not want
to boost bank profits, but to strip assets
from them, to free them for new lending to
LDCs of the right sort. "I know of projects
in some countries, for example a good
copper mine project, where the banks won't
finance it because they are full up on
country limits. That's a shame; it's the sort
of lending banks should do."
At the moment these stretch-out schemes
are politically unacceptable to the govern-
ments of the developed countries. The US
Congress would not vote money to bail out
the banks.
The practical difficulties of setting up
such a scheme would be enormous: for
example, how should the cost be borne by
the various participants? Which debts
should be included and which should not?
So far the schemes have won little
support from commercial bankers. George
J. Clark, executive vice president in charge
of international lending strategy at Citibank
said: "Not only do lenders not want to
discount loans at 90 cents to the dollar, but
the borrowers don't want it either. If, say,
Chilean paper circulates at a discount,
that's a severe impediment on Chile's
ability to borrow anew. Nearly all these
ideas are written by people outside the
rescheduling process, like academics and
politicians."
Clark believed the ad hoc system could
maintain an adequate flow of funds to
LDCs. He maintained that the biggest
threat to this flow was not the borrowers,
but the legislators and regulators, who may
impose country limits that are too
restrictive.
Yves Laulan, chief economist of Soci6t6
G6n6rale, is concerned about the impact of
plans like Rohatyn's on confidence in the
financial system. "They could be very
dangerous and counterproductive," he
said. "Instead of forestalling a crisis of
confidence, they could actually create
one." He thought the other major draw-
backs about the plans was that "they
address only the problem of outstanding
debt, not what happens in the future."
Laulan himself has a plan, with what he
calls upstream and downstream procedures.
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SOVEREIGN LENDING
on annual country-by-country reviews
between commercial banks, the IMF and
the World Bank, to provide better data on
Third World debt.
The latter proposes a degree of risk
sharing in lending to the Third World by
commercial banks and the World Bank,
possibly through greater use of cross-
default clauses to co-financings, and by risk
sharing between the banks and the IMF,
possibly by opening a new window.
Through this facility, Laulan believes
international banks could, under certain
conditions, enjoy an indirect guarantee
from the fund. If the fund were unwilling to
go that far, be thinks the banks themselves
might be able to organize multi-bank
guarantees.
His proposals raise legal and confiden-
tiality problems, but they have the merit of
working within the existing framework of
relationships between the multilateral
institutions and commercial banks.
The idea proposed by Peter Leslie, senior
general manager of Barclays Bank Inter-
national, tackles the criticism that bankers
should not be bailed out. He suggests that
commercial banks should discount problem
loans with central banks, to clear them off
their balance sheets. Central banks would
buy the loans on condition that, for each
loan discounted, the commercial bank
should make a new loan to a more healthy
borrower in the Third World, perhaps in
the form of export credits. The commercial
banks would still be liable for the risk on
the loans they discounted; the discounted
loans would appear as contingent liabilities
on their balance sheets.
The discounting facility is meant to boost
banks' liquidity. "I don't think some new
scheme, such as the discounting facility, is
necessary to avoid disaster, or maintain
confidence in the financial system," said
Leslie. "But we will need some new initia-
tive to maintain an adequate flow of funds
to LDCs."
Leslie said that the place of immobilized
debt on the balance sheet is insufficiently
appreciated. "Even if a bank such as our-
selves has, say, less than 3% of its assets out
to problem borrowers, those assets will
make up a much bigger proportion of our
Eurocurrency book. The funding of bad
loans can become quite significant, as you
will have less cashflow coming in as repay-
ments of principal from problem borrowers.
So if you don't want your Eurocurrency
book to grow, you may not be able to do
any new lending for several years, especially
as you may have undrawn loan commit-
ments being drawn down in the future."
Manfred Meier-Preschany, who is a
member of the managing board of
Dresdner Bank, has put forward a similar
proposal: the World Bank, rather than
central banks, should take problem debts
off the banks' balance sheets, while the
banks retain the risk. The debts should be
converted into long-term loans or bonds.
Felix Rohatyn: A debt discount corporation
should be set up to buy LDC loans.
Meier-Preschany, like Leslie, wants to
encourage new bank lending to LDCs.
Other bankers dispute whether the banks
have a liquidity problem. Said Dr Kurt
Richolt, deputy manager on the board of
managing directors of Commerzbank:
"Lack of liquidity on the part of the lenders
is certainly not the reason for the slackened
flow of credit funds to LDCs."
A British bank executive agreed: "We've
had no problems funding ourselves in the
interbank market. We could probably raise
another 25% in deposits if we saw the com-
mercial outlets. It's for other reasons that
we prefer a lower growth of assets." He
said that the discounting facility involved
more risk. "We've too much risk. Any
scheme which assumes we'll voluntarily
increase our risk is being unrealistic."
Clark of Citibank agreed that funding
rescheduled loans did not create liquidity
problems: "Rescheduling principal isn't a
very big problem - you're just maintain-
ing your exposure, instead of making new
loans to refinance the maturing ones."
There are no signs that central banks are
willing to offer discounting facilities; the
discounting facility, like the stretch-out
models, has so far attracted very little
support from commercial bankers. The one
radical solution to win some support is the
state guaranteeing of new LDC lending. Its
advocates include Harry Taylor, president
of Manufacturers Hanover Corporation,
Hans Baer, chairman of the management
committee of Bank Julius Baer, and a
number of senior UK clearing bankers.
They wish to overcome the problem of
supporting LDC current account deficits.
Baer explained: "New sovereign lending
should be guaranteed by institutions or
governments. Without this carrot it will be
difficult to achieve the $20 billion We
Larosiere has asked for]. In the interests of
making LDC economies grow, some risk
should be taken off private shoulders."
Baer believes that the potential losses which
governments might suffer from guarantee-
ing new loans would be preferable to the
increased amounts of unemployment bene-
fits they would have to pay if LDCs were
forced to cut back imports from developed
countries.
"The problem is not so much to get one
or other scheme adopted, but rather to get
banks to agree there is a problem, which is
greater than a liquidity crisis, " said Baer.
"Many American bankers won't talk about
the problem, and just hope it will go
away."
Taylor agreed that the banks needed a
larger carrot. In a recent speech, he said:
"Can those banks which have stayed put
accept an even larger burden on top of the
involuntary new loans we are now required
to make? I think not ... One possibility
would be a new application of the guarantee
mechanism."
A senior executive with a London clear-
ing bank asserted bluntly: "We won't
increase our risk to problem borrowers
without guarantees. Governments have
been cowardly since 1974. They encouraged
the banks to take on difficult problems like
recycling. It's the public sector's problem."
He added that his bank would say nothing
in public on guarantees, because there
would be a clamour about the bank wanting
a bail out, which was not the case.
"I don't particularly want a guarantee
scheme, but I'd prefer it to the Bank of
England calling us in again and telling us to
increase our exposure to Mexico by another
8%."
Those who dislike radical change could
regard guarantees as an extension of export
credit guarantee schemes to balance-of-
payments loans. The guarantee would be
less than 100%, to make bankers keep their
wits about them.
Compared with the stretch-out ideas, it
would be very cheap for western govern-
ments: they would only have to underwrite
new loans to problem borrowers, rather
than all past lending.
But that is also the plan's disadvantage
for those who think it insufficiently radical.
It offers LDCs no relief on the burden of
debt they have already accumulated, or on
the heavy cost of servicing it.
As with the stretch-out models, there
would be political opposition to the use of
public funds to help bankers. But a
guarantee scheme, like the discounting
facility, could be implemented unilaterally
by one or several countries, without all
developed countries having to follow.
The debt nightmare may have to become
far more disturbing before the majority of
bankers are prepared to consider seriously
any radical plan for changing the relation-
ships between commercial banks, official
bodies and sovereign governments. The
existing system will probably hang on for
the moment. But for how long? "The ad
hoc system may not work the second time
around," Mackworth-Young cautioned.
"We may not be so skilful or so fortunate
next time."
Euromoney
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
A new approach to international
indebtedness
Yves Laulan
Paris
Servicing existing debt is not the main problem: it is maintaining the flow of capital
finance to developing nations. To help banks play their part in that, the IMFand the
World Bank could undertake two additional functions
The problem of international indebtedness will not
disappear by magic. A first major crisis was narrowly
avoided last autumn, but the problem is still there. By
this coming September, Mexico, Brazil, Argentina
and other countries will be experiencing further
financial difficulties and possibly face default.
The problem has both short-term and long-term
aspects. In the short term, it is important for the
various sources of international financing, namely the
banks and official financial institutions, to come up
with the means required to avoid a liquidity crisis.
The long-term problem is different, since it entails
finding a way to prevent the depletion of financing
sources from threatening the fundamental economic
health and stability of the third world. A drop in
average income a head, however necessary to restore
order in the economy, is acceptable for only a limited
period of time. Over a five or ten-year span, such a
drop might have a strong destabilising influence.
That is precisely what might happen should banks
- through caution in the face of an economic crisis -
sharply reduce their financial flows to the third world
(not by 10 to 15% but by 50% or even more). It
appears inevitable that small and middle-sized banks,
especially in the United States where they account for
15% of the total exposure US banks have in the third
world, will withdraw from the market. The tighten-
ing of international lending control procedures which
is currently occurring in the major banks can be
expected to lead automatically to a drop in the volume
of loans to the third world.
The practice of debt rescheduling is clearly
growing. It is natural for borrowing nations to
reschedule since there is no immediate punishment
involved. Under the twin pressures of the IMF and
governments, banks have readily gone along with this
practice, especially because they claim to be getting a
profit of 2% or more from it. But, just as the banks
precipitated the crisis last year by shortening the
maturity of their loans (in 1982 50% were short-term
loans), one may well wonder whether they are not
going to precipitate a new crisis by increasing the cost
of refinancing these loans.
The borrowers too are taking a tougher line. One
may well wonder whether a `cartel' of borrowers in
difficulty may emerge, ready to threaten default,
similar to the `cartel' of oil-producing countries.
A worldwide recovery, with higher commodity ex-
port prices and lower interest rates, will certainly
moderate the harshness of the crisis. But it would be a
serious mistake to suppose that it will cause it to
disappear. Even with recovery, debt servicing/exports
ratios will remain unfavourable (between 70% and
100% for Latin America and other deeply indebted
countries) in the next few years. A laissez-faire or free-
market approach alone cannot be expected to solve
this problem. It is necessary to come up with a more
strategic and convincing remedy.
Shared burden
Another kind of solution which at times is put
forward consists of saying that `the banks should pay'
out of their reserves or their own funds - an
approach which is reminiscent of the famous adage of
the 1920s that `Germany will pay' and history has
shown us the consequences of that approach. The
banks are scarcely capable of paying. The total equity
of the major banks (capital plus reserves) amounts to
about 5% of their total outstanding assets (some $200
billion), and is about equivalent to the amount of the
doubtful claims on the third world. The mere match-
ing up the two figures should suffice to demonstrate
how questionable any solution would be which
consists of asking the banks alone to bear this burden.
It should be realised that banks are essentially
financial intermediaries. In the final analysis, the
burden will have to be shared between lending and
borrowing countries, with a proportional breakdown
THE BANKE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 25
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INTERNATIONAL DEBT
to be determined by an initial arbitration. A second
arbitration will be required among the creditor
nations, who will be forced to make consumers carry
part of the burden through inflation and/or interest
rates and/or make tax-payers do their part through
taxation. Expressed in these terms, the problem
consists merely of providing a smooth, untraumatic
transition towards a more healthy state of affairs.
It is also worth dispatching the widely-held belief
that the debtors should pay back their debts. A
country never pays back its debts, except over a very
long period (for example, the US in the nineteenth
century). The problem for the third world is simply
to provide for regular and balanced growth of debt (in
accordance with the world's inflation rate and their
real growth rate) so as to be able to service their debt
regularly. No more and no less is involved. It is a
matter of confidence as well as of. good financial
management and proper utilisation of the funds
borrowed.
Last but not least, it is worth bearing in mind that
the nature of the problem varies from one country to
another. Some people have argued that the current
crisis is above all a matter of `liquidity problems'.
That is the well-known assertion of Walter Wriston,
chairman of Citibank. Others, on the contrary, have
claimed it is essentially a crisis of `insolvency'. The
truth is that it is a bit of both, in a mix that varies with
the country concerned. The Citibank position is hard
to accept; part of the funds have been wasted. Never-
theless, for Mexico, the crisis seems to indeed involve
`liquidity' and much less `insolvency'. Exactly the
reverse situation applies however to the Sudan. More-
over, at present, everything is a matter of `liquidity'
whereas in the long run, especially in a time of
inflation, any problem of insolvency can be resolved.
Debt discounting ...
Rather than get caught up in a theological quarrel,
one is better off recognising that it is difficult to
conceive of solutions that can be applied broadly to
every case. On the contrary, solutions must be prag-
matic and flexible. They must vary from case to case
and must be tailored as closely as possible to the par-
ticular conditions of the creditors, the banks, and the
debtor nations of the third world.
On the basis of these introductory remarks, it is
possible to examine the solutions which are currently
being put forward, particularly in the United States,
to provide a remedy for the crisis*. We will purposely
avoid dealing with the bills currently before the US
Congress which are designed to control banking
activities and which are only indirectly relevant to our
topic.
The common feature of these plans is the removal
*Among others, such plans have been proposed by Norman
Bailey of the National Security Council, Professor Peter Kenen,
Congressman Clarence Schumer, Senator Bill Bradley, and by
Felix Rohatyn of Lazards.
of bad debts from the balance sheets of the lending
banks so as to stabilise their position and provide
them indirectly with new liquidity. The idea is
that these debts would be bought back at a price
less than their nominal value (a discount of 10% to
15% for instance) either by some newly created
agency, for example some international debt retire-
ment fund, or by the IMF (or the central banks
according to some versions), or even by investment
mechanisms on some secondary market (to be set up
for the purpose).
The authors of these plans believe they have two
virtues. They make it possible to restore a certain
truthfulness to balance sheets and they also improve
bank liquidity at the cost of limited accounting losses.
Moreover, consolidating these debts over a very long
time period (up to 30 years) and with a very low
interest rate would reduce the borrowers' debt
servicing costs.
. not the answer
However good their intentions, these plans have
serious flaws. They are dangerous in the short run
inasmuch as they would be likely to precipitate the
very crisis they aim to avert. They are counter-
productive inasmuch as the long-term side effects,
even assuming an immediate crisis is avoided, would
make the cure worse than the disease. Implementing
them would be very likely to damage the reputation of
the lending institutions, whose real or supposed
management errors would thereby be revealed in
broad daylight, and at the same time ruin the credit of
the debtors, whose solvency troubles would be cruelly
brought to the fore. If such plans were applied, they
would undoubtedly help to make the loans granted to
the third world in the 1970s go down in history
alongside the notorious `Russian loans'.
Expressed more systematically, the main objections
to these plans may be summarised as follows:
? It is doubtful under present circumstances that
institutions or individuals operating on a secondary
market would be inclined to buy bad debts with just a
10% discount. A discount of 50% or more would
seem more likely. That would be enough to cast a
shadow over the reputation of the debtor nations and
cause the creditor banks to withdraw permanently
from this kind of operation.
? As for the possibility of having the IMF or some
other financial institution buy these debts with a
reasonable `discount', the objections are of another
kind. First, one can well imagine the difficulties
involved in defining which bad debts are eligible.
Even if this delicate issue were resolved, an
opportunity of this kind would bring about a vast
shift in debt positions, first on the part of small US
banks and then by the larger banks under pressure
from their shareholders. Indeed, they would be sorely
tempted to unload much of their third world port-
folios in the rediscount institution.
Since countries with debt rescheduling problems
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
INTERNATIONAL DEBT
account for about half of the medium-term and long-
term debts declared by the banks (that is about $320
billion), one can readily imagine how much money
the IMF would need to handle this influx of debts.
The IMF is currently lending no more than $ 10 to
12 billion a year and Congress has already been
baulking at the prospect of increasing the IMF quotas
in 1983. Needless to say, the practical obstacles such
plans would encounter would be considerable.
New approach
The real problem is not so much to deal with the
outstanding debt as to give priority to new debt. The
current problem of indebtedness can be solved
satisfactorily over time if it is possible to find
reasonable conditions under which banks will be
willing in future to help third world nations borrow
money. In other words, handling the future problem
would make it possible to provide a solution to all the
problems.
Banks have always had to carry bad debts on their
books. The most striking recent example was the
experience with real estate loans in the mid-1970s
which weighed heavily on the accounts of US banks.
The problem today of course is much bigger. Never-
theless, the prospects for an economic recovery allow
one to think that banks, by wise long-term provisions,
may gradually manage to rehabilitate their own
balance sheets.
For such a process to occur, it will be necessary to
re-establish confidence at two levels.
First, a way must be found to make sure that in
future the best possible use is made of the funds made
available to borrowing countries. The current crisis is
to a large extent due to poor resource allocation. Far
more credit was granted than was reasonable over and
beyond the normal absorptive capacity of the borrow-
ing nations. Mexico figures as a classic example, with
a foreign indebtedness rate that rose to more than
30%. A lot could also be said about the utilisation of
these resources in some countries (some African
countries built fancy edifices or even schools). One
need not be a specialist to realise that, however
justifiable such programmes may be, they do not call
for commercial-type financing. Yet that is what was
attempted all too often. There must be an end to such
practices and a return to more realistic and rigorous
modes of financing.
Secondly, bankers must be able to recover their
confidence in reasonable operations in the third world
so that they do not give in to a panic reaction or mere
distrust as far as this kind of operation is concerned.
On the basis of this sort of reasoning, it is possible
to envisage `upstream' and `downstream' solutions for
bank loans. The purpose of both would be to re-
organise the relationship between the leading inter-
national banks, the IMF and the World Bank.
Upstream. Banks should promise to provide
systematic information about their intentions to grant
loans to any borrowing nation, to be sent to the IMF
for general loans and to the World Bank for project
financing. There would thus be a systematic form of
consultation and analysis before the loans were made.
That would put an end to `telex lending' which has
contributed considerably to increasing indebtedness.
Banks cannot carry out such prior studies because
they lack the technical facilities to do so. But the IMF
and the World Bank have well-staffed technical
departments capable of providing this service. That
will not be easy to achieve. The Fund and World
Bank people like to keep secrets and they are wary of
banks. They will not open up their files willingly but,
over time, their distrust may be overcome.
Downstream. In return for this prior examination,
the commercial banks might be given a guarantee of
some sort. Their main concern nowadays is to get
their money back. They do not always succeed in
doing so. The present spate of rescheduling
arrangements, even if the result does not immediately
show up as losses on bank balance sheets, entails a
serious future threat for the banks' operating accounts
and they are aware of that. So their chief concern
today is security rather than a return on investment.
That is why the intervention of the Fund and the
World Bank could prove valuable. Banks must have
more confidence if they are to continue to engage in
an adequate amount of lending. They must be sure
that, under certain conditions, part of the risks
involved will be borne by some international in-
surance system, comprised of a network of inter-
national institutions.
Implementation
While the principles behind such measures may be
clear, there are awesome problems involved in
putting them into practice. The implementation
process must therefore be examined carefully.
Upstream. -Clearly there would be no point in
asking the 15,000 banks which are directly or
indirectly involved in international financing
operations to go knocking on the door of the IMF or
the World Bank every time they grant a loan to some
developing country. But it is worth noting that the
Fund is already consulted when rescheduling
arrangements are made. That amounts to a precedent
which may perhaps prove valuable. An annual
country-by-country review system of sorts could be
set up under the auspices of the Fund, which could
provide a forum for exchanging information of two
kinds.
First, this annual review would make it possible to
learn more about present conditions in any given
debtor country and their likely future evolution, on
the basis of the loans under consideration. It would
then be possible to find out if a country's rate of debt
increase is in keeping or not with its capital
absorptive capacity. Opinions vary about absorptive
capacity. Nevertheless certain guidelines could be
used which take into account both the country's real
growth rate and the worldwide inflation rate. Any
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
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Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
debt growth greater than the sum of these two
percentage figures could be deemed excessive and
hence potentially dangerous.
Determining the volume of a nation's debt would in
itself be an advance on the previous state of affairs, as
has been evident when rescheduling occurred.
Beyond that, however, it is worth considering
whether investigations should not go further, to the
point of making an assessment of the various factors
(the budget, investment programmes, the balance of
payments situation, export prospects, and so on)
likely to influence a country's overall solvency. It
would be important for the analysis to deal with
world economic trends as well since certain
parameters, such as the price of oil, raw materials and
so forth, can have an important bearing on a country's
future prospect.
In addition to these annual reviews, it would be
necessary to have constant discussion of technical and
financial matters among specialists, especially with
officials from the World Bank when it comes to
examining the financing of certain projects. Such
discussions have already begun to take place
concerning co-financing.
Downstream. Establishing a degree of risk-sharing
between international banks and international
institutions is perhaps a more delicate problem to
resolve. It appears dangerous and useless to set up
new structures, as the Rohatyn plan proposes to do. It
also seems venturesome to seek to initiate new
procedures, especially for the IMF. Having the Fund
buy up certain kinds of debts, as has been suggested,
would require an amendment to its by-laws. Given
the current state of thinking, it is doubtful whether
such a change could readily be achieved. Yet a third
pitfall to be avoided would be to make a large-scale
appeal for government financing. This approach
would run up against the opposition of the US
Congress and perhaps that of other governments as
well. It would therefore seem preferable to operate
within the existing or already known procedures,
while adjusting them as need be.
Cross-default
For the World Bank one could, for instance,
consider using a cross-default clause under
appropriate conditions. This clause would entail
linking loans granted by the World Bank to those
agreed by banking establishments. Once again, it
should be pointed out that this is only a limited
innovation. The extension of cross-default to co-
financing, as the banks have requested, has so far not
been agreed under conditions that the banks find
acceptable. If the World Bank agreed to allow a cross-
default clause to apply to loans issued by international
banks for some financing projects, the result would be
the very risk-sharing scheme which is sought.
For the IMF, the problem is similar. It appears
quite unreasonable to put the IMF into a direct
relationship with banks. That is entirely outside the
scope of its legal jurisdiction. Nevertheless,
interesting possibilities could well be explored within
the framework of existing procedures. As an example,
the IMF in recent years has set up various 'windows'
to meet the needs of member states - for example,
the compensatory financing facilities. One might
consider opening another 'window' for member states
which would allow them to draw on the resources of
the Fund, in accordance with procedures and under
circumstances which should be very carefully deter-
mined, to meet difficult deadlines for payments to
banks that have respected the prior consultation
procedures discussed above*.
International banks would thus benefit, under
specific conditions, from a kind of indirect guarantee
from the Fund, thereby providing a means of re-
storing confidence. It should be noted in passing that
the help which the Fund currently provides for debt
rescheduling is in many respects based on the same
principle, albeit under exceptional circumstances.
This proposal would merely make systematic use of
an existing exceptional procedure.
Objectives
These proposals naturally encounter a number of
criticisms which should be examined.
The first objection is that they would meet
reservations on the part of banks for whom 'upstream'
consultation procedure would be tantamount to
sacrificing part of their 'sovereignty' and independ-
ence. One answer to this is that a loss of independence
is already a fact of life, especially when it comes to
massive debt rescheduling. The governments of
debtor and creditor countries and international
institutions are quite often led to force the bankers'
hands.
A second objection involves the debtor countries
themselves which might refuse to go along with such
consultations or might prove reluctant to supply the
data required to make the right diagnosis. This objec-
tion does not stand up under analysis. This time
when Mexico was capable of choosing between loans
offered by different banks which often took the stance
of petitioners is now past. The situation today is the
reverse: it is the scarcity rather than the
overabundance of credit that is feared. Debtor
countries are thus likely to be concerned to protect
their reputation for solvency under the best
conditions.
A third objection may come from the Fund and the
World Bank, since they might not wish to have to
share their knowledge with international banks. Their
concern for confidentiality must obviously be re-
spected, but one is entitled to wonder whether it is
still meaningful today.
After all, confidentiality failed to prevent the
excessive increase in international debt levels which
led to the present crisis. One may well wonder
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INTERNATIONAL DEBT
whether confidentiality is not the very opposite of the
concern which should now be uppermost in people's
minds. It is the broadest possible circulation of
information about the
ears desirable in order to avoid
countries which appears
repeating the errors of the past.
One should not overlook the fact that one major
difficulty stems from the habits and traditions of the
which until now
staff
of international l to be discreet about publishing have been required certain information. In addition to the institutional or
political obstacles, there are psychological barriers
that are just as formidable. Certain behaviour
patterns will undoubtedly have to be altered to meet
the new circumstances.
Another objection concerns the impossibility of
increasing the resources of the IMF and the World
Bank to allow for risk-sharing in the form of direct or
indirect guarantees. Three points can be made in this
regard.
? The first is that, although the US Congress may
currently be very hostile to any increase in the
sources of these agencies, attitudes may change in
the future-
s The solution put forward would in the final
yalysis be infinitely less wasteful of resources than
fly of the other plans mentioned above, especially
those that call for the IMF or some other institution
to buy banks' bad debts.
? The purpose of prior consultation would be to
reduce or even eliminate the volume of claims. If
good loans are granted under proper conditions, the
use of guarantee funds would be only marginal.
Advice not finance
A massive increase in IMF or World Bank re-
sources does not seem to be desirable or necessary. It
would be indeed be unfortunate if these agencies
became so gigantic that they experienced troubles in
maintaining their internal balance or operating
correctly. In any case the IMF and the World Bank
should develop their advisory function as much or
more than their financial role. It is as advisers as
much as lenders that they make make a useful
contribution to international economic recovery.
Over the last 30 years both the Fund and the Bank,
by virtue of remarkably qualified staffs, have
managed to acquire an unequalled store of knowledge
about developing countries, the techniques of
financing, and the preparation of economic and
financial diagnoses. Yet this store of knowledge is not
utilised generously for the benefit of the international
community. The time has perhaps come to draw
upon it much more fully now that a radical change in
the ways and means of international financing seems
to be required.
Under such conditions, one should consider
whether such procedures could not be established
within the framework of existing resources, without
there being any need, at least in the short run, to
increase the resources of the Fund or the Bank. This
would moreover make it possible to give a categorical
reply to the standard objection that 'the Fund must
not bail out the banks'.
As for the specific problem of the guarantee that the
IMF might provide, the relevant objections may be
put as follows:
? There is no need to change anything whatsoever
since economic recovery, if it is sharp and long-
lasting, will take care of the problem by increasing
raw material prices and reducing interest rates.
? If the banks obtain any kind of guarantee, they
will lose interest in making adjustments because they
will no longer feel required to do so.
? Similarly, guarantees may discourage debtor
countries from making efforts and their public may
think it unnecessary to accept the sacrifices that an
adjustment policy would demand of them.
? No one single remedy can apply everywhere
inasmuch as the situation varies a great deal from one
country to another. The Sudan is not Mexico.
Effectiveness
Some of these criticisms have already been
answered, especially the first and last. Some
additional remarks may be made, however.
As for the differences between debtor countries, the
guarantees would obviously also vary so as to fit each
particular case. A guarantee can be provided only to
deal with an unforeseen liquidity problem and not to
handle probable insolvency.
A similar reply may be given to the argument that
banks would cease to be motivated. Any guarantee
would be subject to making the extra effort to engage
in prior consultation. On the other hand, there may
indeed be a problem concerning the adjustment
efforts required from debtor countries. Very serious
difficulties will certainly crop up when implementing
the stabilisation plans which the indebtedness of these
countries will require, whatever solution is decided
upon.
The new feature will be that not only the Fund but
also the banks will make their help subject to
respecting certain conditions. People should not
delude themselves; they should realise that, whatever
happens, the banks will in future not be in a position
to shell out funds as easily as in the past. That is
precisely the key to correcting successfully the
current situation.
Finally, a worldwide recovery is not necessarily
sure to occur. Even a strong and long-lasting
recovery, although it would ease the problem of old
debt, would not make it possible to handle the
problem of new debt. It is essential that future
financing be offered under conditions which allow for
an increase in its economic effectiveness. Only this
effort at rationalisation will allow international
financing to be provided more satisfactorily than in
the past and will prevent the recurrence of problems
which marked the beginning of the 1980s.
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America's once-troubled savings and
loans associations are set to become an
important force in international capital
markets. From this month they have been
allowed to invest in seasoned Eurobonds.
New issue managers expect the S&Ls to
favour top quality FRN issues because of
the match with their hugely successful
money market and Super NOW accounts.
Since the beginning of this year almost $150
billion has flooded into the S&Ls - $112
billion through- money market accounts
alone.
One result of the thrifts' new freedom
will be to strengthen the position of major
US investment banks in the Euromarket.
They have the regional networks and distri-
butive experience to capitalize on this new
source of funds. Salomon Brothers demon-
strated this two months ago with its
privately-placed floating-rate issue for BF
Goodrich. That was priced over Libor but
placed in the US, mainly with S&Ls. The
company repeated the formula with an
equally successful issue for the Kingdom of
Denmark: 29 thrifts came into that deal.
The boost to US investment banks won't
come amiss. Last year they profited as
issuers streamed from the States to the
Eurobond market. In 1982, two thirds of
the issuers of all listed Eurobonds were
based in the States. This year that has
changed. So far, US issuers have accounted
for barely a third of all new Eurobonds.
And that trend looks set to continue.
The influential Morgan Guaranty Survey
predicts that US corporations' need for
external finance will remain weak this year.
Morgan's economists cite "the dramatic
rise in corporate profits [they are looking
for an increase of over 30% this year]
inventory liquidations and weak investment
demand" as reasons for "the decidedly
modest need for external financing". They
also point out that corporations have taken
advantage of the booming stock markets to
restructure their balance sheets and replace
debt with equity.
So far the yawning US budget deficit
seems not to have deterred those institu-
tions that want to issue debt. But that
doesn't mean crowding out won't happen.
David Maxwell, chairman of America's
second largest borrower after the Treasury,
the Federal National Mortgage Association,
hinted that the possibility of being crowded
out toward the end of next year had
prompted Fannie Mae's efforts to start
ARE D" TE E D 9 1 WEI
There were as many lay-offs in the US
because of declining sales to Mexico in 1983
as there have been in three years of depres-
sion in the American automobile industry.
That's according to Jeffrey Garten of
Lehman Brothers Kuhn Loeb at the
International Monetary Conference in
Brussels last month.
The point being developed was this: can
the world economic recovery be fostered
while exports from the industrialized
countries are being limited by the austerity
programmes imposed as a result of the
sovereign debt crisis? Can the Third World,
in Particular Latin America, export its way
out of crisis when its natural markets are
themselves in crisis? Brazil, for example,
before the crisis emerged, had fixed on four
key markets for its exports: Argentina,
Chile, Mexico and Nigeria. All four are
now deep in their own troubles.
Even if the economic recovery does
bloom fully and sweep the world back into
prosperity, it will be 1984 or later before the
effects filter through to the poor nations.
Can ad hoc arrangements hold the fort until
then? The IMF quota increase cannot come
into effect until the end of 1984, and that
Approved
increase is already inadequate for the level
of support needed for the problem
countries.
Some of the rescue packages are already
foundering. More money will be needed
soon for those, like Mexico, who so far
have showed determination to haul them-
selves back to recovery.
All this means that more cash will be
needed to shore up the LDCs than will be
available this year or next year. It's
estimated that some $15 to 20 billion of new
commercial bank funds are required by
LDCs in 1983. True, that's only 7% more
than the 1982 exposure, but it's probably
out of reach, as the smaller banks pull out
of sovereign lending and the interbank
market shrinks.
So where's the cash to come from? Not
the Bank for International Settlements, for
sure. Central bank governors at the IMC in
Brussels displayed a common wariness of
further bridging finance for countries
crippled by debt.
The problem, as Fed Chairman Paul
Volcker rightly identified it in the same
forum, is "getting longer term credits in
here from other sources".
EDITORIAL
borrowing in the Eurobond market.
But the unshackling of the thrifts is also
likely to have wider and more important
effects. This year has seen an unprece-
dented boom in floating rate note and
floating rate CD issues in the United States.
Most have been priced over Treasury Bill
rates, again to appeal to the S&Ls and
regional banks' money market accounts.
This makes them substantially cheaper to
the issuers than Libor-based funds - a
vital point, when most of the issuers have
been banks.
Regional banks have launched floating
rate CD issues in the US at rates well under
Libor. And last month Swiss Bank Corpor-
ation became the first European bank to
issue a floating rate CD in the US. The
spread it paid was a mere 55 basis points
over the three-month Treasury Bill rate. At
the time of issue, that was 31 basis points
under Libor.
The increasing investment power of the
S&Ls and the regional banks - because of
the success of the money market accounts -
will draw more banks to the United States
for their funds. It will also erode the
hegemony of Libor in bank funding. More
and more, the base will be the T-Bill rate.
In the present environment those longer
term credits can come from only one kind
of agency, an aid agency. That implies that
industrial governments should be prepared
to be far more generous in the coming
decade than in the last two, not for any
altruistic reasons but out of naked self-
interest. The United Nations' target of
0.7% of GNP in official development
assistance has only been met by one or two
of the smaller industrial nations. It's time
that record was improved, both on a
bilateral basis and through multilateral
bodies like the IMF and World Bank.
The alternative is to let the commercial
banks sort out the mess as best they can
with the indebted nations. That way, the
taxpayers in the west may eventually face a
higher bill - one that can't be measured in
terms of dollars or pounds.
Commercial banks should not expect to
be rescued from the consequences of their
own lending folly, if indeed that is what
they have indulged in. But they are entitled
to point out that their lending to Latin
America bolstered exports and jobs in their
home countries.
Euromoney
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support to Nigeria's Moslem
rule will continue. After the
,ncv to sacrifice the nation to
r present shadow of an army
ed up by the political elite,
ker who said: `All your con-
.in oil was not exploited until
rule. Now the government
s opportunities so great that
to lose them through lack of
is the parliamentarians, who
brated their return by voting
id allowances'.21
curbs is that of the army.
ljo Danjuma both talked
warning them not to misbe-
iew early in 1979 Obasanjo
tire that the military did not
Brigadier Shehu Yar' Adua,
s, went farther. He said in an
ollege that the military, being
excluded from the political
ested that the country should
,d civilians; such an arrange-
. and other aspirations of the
s proposal. But Nigeria's his-
s in the next stage some kind
can expect. Meanwhile it is
on with the rest of the Third
n-style democracy.
8 The World Bank paradox
In the preceding chapters an attempt has been made to demonstrate
that cultural constraints in the Third World block significant socio-
economic change. Limitations of demand, as in India, constitute a
further, secondary obstacle; and it follows from the social rela-
tionships that have been described that the relatively few Indian
workers who may be caught up in any industrial expansion are
unlikely to be paid much more than the present pittances - an
officially estimated average of Rs 3,139 (#174) per year for factory
workers in 1973. If widespread, socially beneficial development is
to take place, it must be from the village upwards, not from urban
centres, in all Third World countries - except small islands in
which foreign capital and Western influence are concentrated. As
a fundamental policy this principle is neglected, because it offers
little or no profit to either the elite of the poor countries or the
economies of the industrialized. It would certainly not benefit the
West to the extent apparently imagined by Edward Heath when
he said in a BBC interview that the richer countries could make
the equipment to help the others; for in the only useful development
that is possible - and it is doubtful whether even this will occur
- the tools needed are negligible.
Few people who talk about Third World development under-
stand what it entails. The Brandt Commission's report is an ex-
ample.' Slogans such as `mutual interests' and `partnership'
between North and South are accompanied by no more than a
vague, token reference to the problems raised in this book.' The
commission sees a new approach to international finance and re-
form of the monetary system as playing a major part in helping
both the Third World and the West. Its recommendations are what
one would expect from a body consisting of Western politicians,
with little experience outside Europe, and shrewd representatives
of the wealthy Third World elite. What the commission's rec-
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ommendations amount to is a transfer of wealth from the indus-
trialized to the non-industrialized countries, to the ultimate benefit
of all. But, even if we ignore the all-important cultural impedi-
ments, it may be seen that the proposal is not practicable. The
amount of capital transferred could never be sufficient to provide
jobs to match the expectations aroused. And if it were enough, the
shortage of skilled workers and of teachers to train them would
make it impossible for the funds to be assimilated constructively.
As it is, large amounts of Western aid remain unused. The
commission's main proposals would not alleviate poverty, but
would accelerate the disturbance of Third World structures, which
are unable to withstand the shocks of an aggressive, alien culture.
To see development problems as they are it will be useful to look
at an example of what is happening in the villages, where most of
the Third World people live. Such an opportunity is afforded by
an illuminating experiment which was made in the 1970s among
the Hausas of Northern Nigeria. A report on the project by the
Dutch sociologist, Bert Huizinga,3 contrasts two conflicting ap-
proaches to rural development, one of which aims at helping the
poor to help themselves, while the other, in practice, abandons
them as a lost cause and concentrates on increasing the output of
the few who are already relatively prosperous; common to both is
the recognition of formidable cultural impediments. Not least, the
report reveals sterile World Bank thinking.
The experiment, called the Guided Change Project (GCP), was
carried out in the Zaria Emirate, Kaduna State, by the Department
of Agricultural Economics and Rural Sociology of the Institute of
Agricultural Research (IAR), Zaria. The GCP aimed to find the
best possible use of development funds, both to raise production
generally and to benefit the very small farmers, who form the
majority. It had been apparent for years that successful experiments
with IAR crops were not being repeated significantly in the villages.
Because of this the team sought ways of fitting certain Western
techniques into village life, leaving the social structure intact, for
the time being. The target was the village, not the privileged or
exceptional individual. This required an entirely new approach to
fieldwork.
The policy that the team rejected is known as Research, Devel-
opment and Diffusion (RDD). This presumes a need determined
by the planner. The developer, not the receiver, takes the initiative
in designing a pro
doing the physica
know virtually no
about achieving it
ted to laziness, s'
aspiration; those
more able than th
Huizinga and hi
that the failure c
disinterestedness
frozen by the soc
that, as Polly Hill
tively rich farmer;
poorer4 - a poini
Third World pros]
economic aims of
performance woul
level that was dict
From the outset
that have been ide
lems, although for
teenth century fai
practices. Access t
remains limited to
descendants of a v
British weakened t
taxes and forbidd:
tration, torture an
rise to the Hausa
of patronage, soc
belief, characterist
the supernatural,
The less fortunate
mighty, to whom
- luck of occult on
off to monopolize
or 20 per cent carr
inputs.' Large nun
richer, under a sys
kind. But the const
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
r of wealth from the indus-
tries, to the ultimate benefit
-important cultural impedi-
.)sal is not practicable. The
ever be sufficient to provide
1. And if it were enough, the
achers to train them would
e assimilated constructively.
i aid remain unused. The
not alleviate poverty, but
iird World structures, which
an aggressive, alien culture.
y are it will be useful to look
t the Villages, where most of
op. tunity is afforded by
s made in the 1970s among
eport on the project by the
)ntrasts two conflicting ap-
f which aims at helping the
'ther, in practice, abandons
on increasing the output of
sperous; common to both is
impediments. Not least, the
king.
Change Project (GCP), was
na State, by the Department
Sociology of the Institute of
['he GCP aimed to find the
is, both to raise production
all farmers, who form the
s that successful experiments
.1 significantly in the villages.
s of fitting certain Western
e social structure intact, for
illage, not the privileged or
in entirely new approaLh to
known as Research, Devel-
resur^~s a need determined
rec. r, takes the initiative
The World Bank paradox
in designing a programme and promoting its adoption. Apart from
doing the physical work, the farmer is passive and is presumed to
know virtually nothing about what he needs or how he should set
about achieving it. Failure of the programme to take root is attribu-
ted to laziness, stupidity and such psychological factors as low
aspiration; those who profit from it are considered to be simply
more able than the rest.
Huizinga and his colleagues belong to that school which believes
that the failure of the majority to participate results less from
disinterestedness or innate incompetence than from their being
frozen by the social structure. At the same time they recognized
that, as Polly Hill found, the economic aspirations of many rela-
tively rich farmers are vastly different from those of many of the
poorer' - a point of great importance in any attempt to assess
Third World prospects. They realized that they could not meet the
economic aims of all farmers and that the measure of the project's
performance would be the extent of participation `at the benefit
level that was dictated by the strategy that the project followed'.'
From the outset the team took note of certain cultural factors
that have been identified by anthropologists. The Hausas are Mos-
lems, although forcible conversion in the Fulani jihad of the nine-
teenth century failed to eliminate all their animistic beliefs and
practices. Access to the highest ranks of traditional state authority
remains limited to those of noble birth; by the same principle the
descendants of a village chief may never become commoners. The
British weakened the traditional pattern by abolishing occupational
taxes and forbidding slavery and punishment by mutilation, cas-
tration, torture and death. But the attitudes and values that gave
rise to the Hausa structure persist, notably in an elaborate system
of patronage, socially decisive subservience to authority and a
belief, characteristic of West Africa, that man is powerless before
the supernatural, which constantly intervenes in human affairs.
The less fortunate attribute their lot either to the will of the Al-
mighty, to whom they frequently refer, or to their lack of arziki
- luck of occult origin. The tradition of deference enables the better
off to monopolize loans from credit organizations; and the top 10
or 20 per cent carry off 60 to 70 per cent of the scarce agricultural
inputs." Large numbers of the poorer are obliged to work for the
richer, under a system known as Palle, to repay loans received in
kind. But the consequences of debt can be worse than this seasonal
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The World Bank paradox
bondage; in the Katsina Emirate Polly Hill found that just before
a harvest in 1967, 64 per cent of sample households were suffering
either `somewhat' or `severely' from hunger; they had sold their
grain stocks to pay debts and were obliged to buy subsequently at
higher prices.' Yet amid all this poverty such is the respect for
status that farmyard manure swept up in the smaller compounds
is regularly transferred to the larger.
Looking at the general social picture in Hausaland Huizinga sees
`the development of an historically grown and culturally main-
tained status-stratified society into a [economic] class-stratified
one',' So far the process is taking place largely outside agriculture,
in which traditional techniques and social patterns have undergone
little change. But the combination of trading, credit arrangements
and use of patronage constitutes `an extremely efficient instrument'
that enables a minority to advance economically in both village
and district communities. Huizinga adds: `The danger thus exists
that the agricultural modernization process itself merely reinforces
the existing tendencies towards class formation and thus accelerates
the unmistakeable trend towards proletarianization of the peasant
population.'
One would need to take an extremely Darwinian view of life to
be happy about such a prospect. For, as has been made clear in
other chapters, there is no prospect at all that this shattering of an
old structure would be part of a larger development that would
bring the benefits of an industrialized society. The outcome would
be that a very poor majority would be almost totally dependent on
a relatively rich minority - a situation similar to that which has
evolved in India (see chapter 5).
The GCP sought to establish a development policy that would
improve the lives of the majority, rather than worsen them, while
at the same time providing the highest overall return on the funds
invested. It was necessary, therefore, to overcome the constraints
of the social structure. Adopting the line of C. J. Zwart, the team
aimed at `bypassing the impeding aspects of the socio-cultural
system ... without on the other hand causing an abrupt disorgan-
ization of the system'.9 Beyond that it appears to have been hoped
that eventually such projects would themselves lead to social re-
construction by removing the underlying production constraints.
In the meantime it was considered sufficient to neutralize the effects
of the present hierarchic.
of peasant families.
The IAR's Departme
Sociology designed the
economy for nearly sevc
experiment in small fa:
words are important, si
rigid plan, but was co
techniques, to ascertain
the logic of traditional
twelve villages of Giw;
7,638, during 1974-8.
team, led by Europeans
work. It consulted the.
credit arrangements, di;
ga says that their advi,
attitudes were indispei
perform various admin
some of the meetings I
nominated men of their
present. In such circu
which in any case had
of the question. Here
consulting the commui
the team imposed cei
should personally colle
graphs to prevent botl
came to pay for mater:
opinion at this stage o
in the project area do
thrive.i10
These consultations
such as the origins, ag
wives per farmer, ed
belongings were spre
distribution of inputs
plexity of the initial I
right temperament tr
techniques, would pe
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 id that just before
olds were suffering
ev had sold their
iy subsequently at
is the respect for
nailer compounds
and Huizinga sees
I culturally main-
.icj class-stratified
utside agriculture,
s have undergone
edit arrangements
ficient instrument'
lly in both village
day thus exists
E met iy reinforces
nd thus accelerates
ion of the peasant
Tian view of life to
een made clear in
is shattering of an
pment that would
he outcome would
tally dependent on
to that which has
policy that would
'orsen them, while
eturn on the funds
me the constraints
J. Zwart, the team
the socio-cultural
n abrupt disorgan-
o have been hoped
lead to social re-
uction constraints.
utralize the effects
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The World Bank paradox
of the present hierarchical structure in order to involve the majority
of peasant families.
The IAR's Department of Agricultural Economics and Rural
Sociology designed the GCP after having studied village socio-
economy for nearly seven years. The project was described as `an
experiment in small farmer development administration'. These
words are important, since they emphasize that the team had no
rigid plan, but was concerned, while teaching farmers Western
techniques, to ascertain their felt needs and to learn more about
the logic of traditional methods. The project was carried out in
twelve villages of Giwa, with a total male adult population of
7,638, during 1974-8. To gain the confidence of the villagers, the
team, led by Europeans, tried to involve them in all aspects of the
work. It consulted them from the outset on the formulation of
credit arrangements, distribution of inputs, and extension; Huizin-
ga says that their advice and opinions and a knowledge of their
attitudes were indispensable. When committees were set up to
perform various administrative tasks, tradition made itself felt: at
some of the meetings held to elect members, village heads simply
nominated men of their choice, apparently with the approval of all
present. In such circumstances the setting up of co-operatives,
which in any case had already failed throughout Nigeria, was out
of the question. Here the team felt obliged to intrude. Instead of
consulting the community, which usually meant the village head,
the team imposed ceilings on inputs, insisted that each farmer
should personally collect his allocation and issued passport photo-
graphs to prevent both abuse and denial of receipt when the time
came to pay for material issued. As Huizinga kindly put it: `In our
opinion at this stage of its socio-economic development village life
in the project area does not allow for the cooperative spirit to
thrive.'10
These consultations and the establishment of important variables
such as the origins, ages and relationships of villagers, numbers of
wives per farmer, education, size of landholdings and personal
belongings were spread over about two years. The subsequent
distribution of inputs covered two years of cropping. The com-
plexity of the initial task alone, with its demand for men of the
right temperament trained in the necessary statistical and other
techniques, would perhaps sober those who appear to think that
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The World Bank paradox
the effective transfer of wealth from North to South requires little
more than a bank operation.
The basic Hausa social unit is the extended family, which lives
in a compound consisting of huts surrounded by a fence made of
guinea-corn stalks or a mud wall, to shield N, omen from the eyes
of unrelated males. It is socially prestigious for a man to have more
than one wife. In a sample of villages 95 per cent of compounds
had fewer than ten male adults; the largest single category was
those with only one, but one compound had twenty-seven. Some
compounds are partitioned to separate nuclear families. Irrespec-
tive of these subdivisions, a group may be distinguished by the fact
that its members work together and eat from the same pot; the
mean number of persons, including women and children, in 248
sampled pots, as sociologists call them, was 6.9 (median 6.0); the
lowest was 1 and the highest 23. The compounds are grouped into
wards and the wards into villages.
Since a tarred road cut through the project area, giving some
villages access to markets, the inhabitants would have been more
prosperous and less resistant to innovation than those more iso-
lated. In a sample of four villages the average cultivated area per
compound was 2.99 hectares (median 2.17). Twenty-two per cent
of adult males, however, cultivated 36 per cent of the total area."
In the eight villages where baseline studies were made 95 per cent
of households (pots) possessed (at least) one hurricane lamp, 63
per cent an iron bed, 73 per cent a cotton mattress, 42 per cent a
wireless, 42 per cent a wristwatch and 60 per cent a bicycle. Many
farmers did other work, such as building, smithing, carpentry,
trading of a kind and Koranic studies, which some considered to
be an occupation and some not. In most households at least some
of the food crops were sold and women earned extra income,
mostly by preparing and selling food and by spinning, weaving
and embroidery. Some men were obliged to work to pay Palle
debts, but going out to earn wages was disliked because it reduced
status. These activities returned a mean annual income of 89 naira
(probably worth about #30 in real purchasing terms) per person
or 151 naira (probably about #50) per adult, with a household
consisting of an average of 6.9 persons (or 4.1 adults). But the
average is misleading, since 10 per cent of households received 27
per cent of total income.'2
The aim of those several years of dedicated research, of which
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only a sketch h
scheme, regardl
among the glos
wanted to find c
be obtained by
bags of fertilize
millet, Guinea
those in Hausal,
team offered a
reasons, on suc
plained the use
interference wit
farmer solve the
After the pre
into three groin
inputs, those in
were to be pros
membership fig
improve prodw
joined the sche
extension-credit
tralized social f
variables such a
ownership of p
influence on w'
other hand hid
language, writti
of the cash sch4
The unexpec
provided strikir
ploratory, rath,
confining it to
they applied it
consequent inci
make good rea
would have bet
sively. But Hui
use of fertilizer
siderably highe
ing methods a
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The World Bank paradox
South requires little
family, which lives
by a fence made of
omen from the eyes
a man to have more
cent of compounds
single category was
twenty-seven. Some
it families. Irrespec-
nguished by the fact
i the same pot; the
.nd children, in 248
.9 (median 6.0); the
ids are grouped into
t area, giving some
uld have been more
an those more iso-
cultivated area per
wenty-two per cent
t of the total area."
re made 95 per cent
hurricane lamp, 63
ttress, 42 per cent a
:ent a bicycle. Many
mithing, carpentry,
some considered to
eholds at least some
rued extra income,
r spinning, weaving
work to pay falle
1 because it reduced
income of 89 naira
g terms) per person
with a household
4.1 adults). But the
iseholds received 27
research, of which
only a sketch has been given, was not to launch some grandiose
scheme, regardless of the social consequences, such as is found
among the glossy brochures of the World Bank. What the team
wanted to find out was the most socially beneficial result that could
be obtained by providing each farmer with no more than a few
bags of fertilizer and packages of pesticides and seed - mostly
millet, Guinea corn and groundnuts. The farmers, like most of
those in Hausaland, were using the African hoe to till the soil. The
team offered advice, which was sometimes rejected for sound
reasons, on such matters as distances between ridges, and it ex-
plained the use of the packages; but in general it did not press any
interference with traditional methods. The aim was to help the
farmer solve the problems that he encountered.
After the preliminary studies, the twelve villages were divided
into three groups of four - those in which farmers paid cash for
inputs, those in which they bought them on credit and those that
were to be provided with inputs, credit and extension advice. The
membership figures show both the need for credit and a desire to
improve production. In the cash villages 36 per cent of farmers
joined the scheme, in the credit villages 54 per cent and in the
extension-credit villages 74 per cent. The GCP seems to have neu-
tralized social factors in villages in which credit was available, for
variables such as the number of fields owned, labour expenses paid,
ownership of personal items, and education had an insignificant
influence on whether or not farmers joined the scheme. On the
other hand higher economic level and literacy in the Hausa
language, written in Arabic script, were significant in membership
of the cash scheme.
The unexpected way in which the farmers used the fertilizer
provided strikingly useful information and justified the GCP's ex-
ploratory, rather than merely technocratic, approach. Instead of
confining it to the package crops, as the project team proposed,
they applied it to pepper, tomatoes, rice, cowpeas and yams. The
consequent increases in farmers' incomes were not high enough to
make good reading in the usual kind of developer's report and
would have been much higher if the fertilizer had been used inten-
sively. But Huizinga and his colleagues found that less intensive
use of fertilizer was more economical; returns per bag were con-
siderably higher. The explanation of this result is that Hausa farm-
ing methods are so rudimentary that a low or medium use of
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The World Bank paradox
physical inputs, especially fertilizer, achieves a higher production
per unit of inputs than more intensive application; above about
100 kg of fertilizer per hectare, marginal increases decline.13
While the GCP provides the first hope of genuine rural advance
to be offered in Nigeria, it is difficult to imagine that the consider-
able number of teams required for widespread development on
similar lines would ever be trained. The project designers realized
that their main task was to convince the government that a change
in its development policy, in so far as it has one, would pay. But
apart from the tendency of the urban Elite to support its rural
counterpart's attitudes to the lower strata, it is inconceivable, in
view of what has been written in chapter 4, that a desire to help
the poor, or even to raise production, would be strong enough to
overcome civil service lethargy. And without enthusiasm and in-
spiration from the top, the scheme would not work. It is possible
that managers could be trained under an arrangement like that
being carried out by the UNDP in Bangkok. But even if this hap-
pened, most of the graduates would soon be in the power of district
and village leaders. Probably of equal importance, but still an open
question, is that Hausa subservience to authority may have a deep
psychological origin.
As it is, the team's conclusion that small farmers, adequately
guided, could as a whole produce more food than the larger,
inevitably received a cold response from the state government,
which is under the influence of the World Bank. Since 1974 the
bank has been sponsoring the Funtua Agricultural Development
Project (FADP), which adjoins the area in which the GCP was
carried out. In a letter to the GCP dated 15 May 1978 the FADP
Planning Unit said:14
I think your paper underestimates the influence of vested
interests and the local hierarchy. A project on the scale of
FADP would not take off at all unless we had their support.
This in turn means working through the system rather than
outside it. I am not sure whether your GCP approach would
work on a FADP scale; purely because those in power would
resent their loss of patronage. It is not our job to start social
revolutions.
Elsewhere the letter said:15
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
We doubt
Without sr
groups ten
approach f
thereby be]
concentrate
organizatic
reasonably
This is a cynic
`trickle down
which is wha
get richer whi
estimating the
it. And if cre
World Bank i
projects that
bay, mention
knew that th
necessary pro
The letter i
like paradox
for its yield-i
lament, on tl
nearer. The
even if the
their per c
maintainer
absolute it
differences
groups.
The doublin?
of disaster ii
hundred, or
The bank I
poverty', 800
will be reduc
figures are n(
Even then, tl
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
The World Bank paradox
,roduction
ove about
ine.13
al advance
e consider-
)pment on
rs realized
it a change
.d pay. But
rt its rural
:eivable, in
;ire to help
enough to
sm ---I in-
is Z. Bible
it like that
if this hap-
r of district
till an open
',ave a deep
adequately
the larger,
overnment,
?e 1974 the
evelopment
GCP was
3 the FADP
'ested
ale of
support.
her than
ch would
ver would
:art social
We doubt the long-term effectiveness of group extension.
Without suitable glue - like the offer of credit for fertilizer -
groups tend to split up. Instead we prefer the `trickle down'
approach from farmer to farmer, accepting that some will
thereby benefit later than the others. As a consequence, we
concentrate on our notorious `progressive' farmers. For
organizational and administrative reasons we must choose a
reasonably small section at first.
This is a cynical communication. It is common knowledge that the
`trickle down' rarely takes place and that the RDD approach,
which is what the FADP is pursuing, enables a small minority to
get richer while the majority, at best, remain poor. Far from under-
estimating the force of patronage, the GCP succeeded in bypassing
it. And if credit is all that is needed to hold groups together, the
World Bank might well supply it, instead of lending huge sums for
projects that are often socially destructive, like the one near Bom-
bay, mentioned in chapter 6. As Huizinga says, the FADP men
knew that their model was not working, but failed to draw the
necessary professional conclusions.16
The letter is a useful document; for it helps to explain the Zeno-
like paradox of the bank's thirty-five years of proclaiming success
for its yield-raising projects, on the one hand, and its incessant
lament, on the other, that the end of Third World misery is no
nearer. The bank's 1979 report said:'7
even if the developing countries were to manage to double
their per capita growth rate, while the industrialized world but
maintained its, it would take almost a century to close the
absolute income gap between them, so great are the
differences in the capital and technological base of the two
groups.
The doubling of Third World growth is inconceivable; and short
of disaster in the West, the inequality will continue not for a
hundred, or a few hundred, years, but indefinitely.
The bank believes that the number of people living in `absolute
poverty', 800,000,000 in 1978, excluding those in People's China,
will be reduced to 600,000,000 by the end of the century. If these
figures are not a confession of failure, they are a description of it.
Even then, the bank's projections are sometimes as overdrawn as
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
The World Bank paradox
would be expected from a money-lending organization, staffed by
ambitious and prosperous men, which is constantly trying to ex-
tend its scope and influence. According to Professor H. W. Arndt,
who in general favours the bank's approach, one of its most im-
portant forecasts - for Indonesia - `strains credulity'.18 The bank
presented its projection at a special meeting of Western countries
called in May 1975 to buttress the country's finances after the
notorious state oil company, Pertamina, had gone bankrupt to the
tune of US $10,500 million - a sum greater than the total 1976-
7 national budget and two-thirds of the Gross Domestic Product.
The company's financial collapse resulted from the chronic corrup-
tion and incompetence of its directors, whose numerous, futile
enterprises included an extravagant and uneconomic steel plant,
bought from hard-selling Germans in what was described as `the
biggest order of all time'. The bank sought and obtained increased
aid to rescue Indonesia's ruling junta, which the United States saw
as a bastion of its dwindling influence in South-East Asia. This
may have been justified strategically, but it had little to do with
the bank's ostensible task of `helping to raise living standards in
developing countries'.
Political interests, however, do not always, or even most often,
predominate directly in bank policy. Generally the sine qua non is
that the granting of aid, as it is called, must be consistent with
Western economic needs, which are usually seen in the short term,
although the overall concept purports to be long-term. Huge con-
struction contracts provide profits and jobs for the West. That
much is certain; what is left unexamined is the social and economic
effects on the people among whom they are planted. Somehow it
is hoped that `the economic nucleus we are establishing will fan
out through the rest of society' - words used by a World Bank
man, who was asked in Jakarta what the bank was really trying to
do. But for cultural reasons of various kinds the nucleus does not
fan out. A few get richer while traditional society is destroyed or
damaged, without anything creative being put in its place.
The World Bank's activities rest on the fallacy that Western
systems can be grown in or imposed upon any culture. This is a
common error; but it is a little less obtusely perpetrated in Europe
than in the United States, some of whose diplomats and their
families were so overwhelmed by unexpected attitudes in the Third
World that in 1978 the State Department engaged a psychiatrist,
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Dr Elm
cultural
astounc
Educati
divertcc
explain
Lndone:
general
ernerS t
consegi
ma, Vi,
was on
author
1960s
that str
The
to B
try t
lend
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not
rnak
In its I
shift i
farmer
factory
`small'
each m
credit
bank's
has ali
and is
Econo
those
cant nr
of def;
credit.
nothin
Zaria
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
The World Bank paradox
by
ex-
ldt,
im-
ank
ties
the
the
76-
uct.
.up-
itile
ant,
,the
ised
say
rhis
with
.s in
ten,
)n is
with
rm,
con-
rhat
)mic
1w it
fan
lank
ig to
not
d or
;tern
is a
rope
their
-bird
trist,
Dr Elmore Rigamer, to treat them for what was described as acute
cultural shock. An American working for UNESCO in Jakarta
astounded his European colleagues by writing to the Ministry of
Education, requesting it to arrange for a mosque amplifier to be
diverted, because the early morning prayers woke him up; this, he
explained, left him unfit to perform his task of helping to educate
Indonesians. Trifling though it is, this anecdote emphasizes the
general insensitivity towards alien cultures, which blinds West-
erners to the inapplicability of their development plans. The serious
consequences of this defect brought criticism from Dr A. S. Chae-
ma, Vice-Chancellor of the Punjab Agricultural University, who
was on the staff of the World Bank for fourteen years. He told the
author in Ludhiana that the surge of Punjab agriculture in the
1960s (see chapter 9), with which he was associated, had shown
that small-scale methods were best for India. Dr Chaema said:
The World Bank do not see this. They do not try to apply it
to Bihar, Eastern Uttar Pradesh, Maharashtra and so on. They
try to impose a capital-intensive model. They are interested in
lending; they create a borrower mentality. Everybody thinks
money is cheap. This leads to inefficiency and waste. But I do
not mind aid in technology and in equipment we do not
make.
In its 1978 report the bank said that it had achieved a `significant
shift in the orientation of Bank lending towards the small
farmer'.19But the statement was insufficiently detailed to be satis-
factory for other than public relations purposes. In Guatemala
`small' appears to include the top three per cent of landowners,
each with 112 acres or more, who are to receive one-half of the
credit granted under a joint FAO/World Bank programme.20The
bank's attitude to the social consequences of its financial operations
has already been described. In general the bank remains a bank
and is obliged to minimize risk. In one of its reports, quoted in the
Economic and Political Weekly, the bank said:21 `Lending only to
those with investment opportunities sufficient to produce a signifi-
cant marketable surplus is perhaps the best way to reduce the level
of default.' In other words, it is wise to select the less needy for
credit. Such a policy is essential to the bank's solvency, but it has
nothing to do with helping the world's poor. The bank's man in
Zaria was simply echoing its general policy when he wrote that it
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
The World Bank paradox
was important to respect the `local hierarchy'. A bank paper says:
`In many countries, avoiding opposition from powerful and influ-
ential sections of the rural community is essential if the Bank's
programme is not to be subverted from within.'22
Dr Chaema's disillusionment with Western concepts of Third
World development was shared by Dr A. S. Kahlon, Dean of the
Faculty of Basic Science and Humanities at the Punjab Agricultural
University. He said (to the author):
I was influenced by Western ideas at Kansas University. It
takes a long time after being exposed to Western models to
see things differently. The basic error is that the cultural
matrix is completely neglected. The difference is not marginal.
In my earlier work, as an econometrician, I wrote of capital-
intensive models. Most of our teaching in the university was
nothing more than those models.... Somehow at no stage of
my training was I told that those models were developed in
Western conditions, particularly those in the United States,
and had very little application to the economic and social
conditions of developing countries. Nobody said: `It may not
work in your country'. Perhaps I should have questioned the
professors; this shows failure on my part. Perhaps we didn't
have much time for thinking, with so many courses. I
developed rigour there, then had to apply it here. But it was a
dozen years before I realized that the models did not apply.
Whichever way it is tackled, socially beneficial rural development
in the Third World presents formidable problems. Even cash crops
can be agriculturally counterproductive, and monetization can pro-
duce social disruption. Writing of the Ivory Coast, Alland says:
The Abron, however, are now perched on the edge of violent,
perhaps catastrophic change. Since the introduction of cash
crops forty years ago, they have decreased their fallow to ten
years on the savanna and seven years in the forest. It is
already too short for adequate regeneration of the land....
The money economy has affected the Abron in other ways as
well. Most significant has been the breakdown of the lineage
system and the development of private property. There is
evidence that this has increased social tensions and the
frequency of witchcraft.
Western develops
destroy.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
I hierarchy'. A bank paper says:
)sition from powerful and influ-
iunity is essential if the Bank's
from within.'22
vith Western concepts of Third
y Dr A. S. Kahlon, Dean of the
inities at the Punjab Agricultural
eas at Kansas University. It
:posed to Western models to
error is that the cultural
The difference is not marginal.
Dmetrician, I wrote of capital-
:eac ; in the university was
Is.... Somehow at no stage of
se models were developed in
y those in the United States,
to the economic and social
ries. Nobody said: `It may not
I should have questioned the
n my part. Perhaps we didn't
iith so many courses. I
d to apply it here. But it was a
at the models did not apply.
My beneficial rural development
cable problems. Even cash crops
ctive, and monetization can pro-
the Ivory Coast, Alland says:23
perched on the edge of violent,
nce the introduction of cash
c decreased their fallow to ten
i years in the forest. It is
regeneration of the land....
ed the Abron in other ways as
the breakdown of the lineage
private property. There is
sor -' tensions and the
The World Bank paradox
Western development policies not only fail to develop; they can
destroy.
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Indonesia tightens its belt
Richard Cowper
Jakarta
Hit by lower oil demand, Indonesia has been forced to undertake a series of stringency
measures. Economic growth will be much slower than in the recent past, threatening to
push the country back into the ranks of /ow income earners
In recent months Indonesia has had to introduce a
series of crisis measures. On 30 March the govern-
ment was forced to devalue the rupiah by 27.5% after
more than US$1 billion in capital fled the country in
the space of less than four weeks. In the middle of
May the government announced that it was postpon-
ing four of its most cherished and costly investment
projects worth just over US$5 billion in a bid to ease
the growing pressure on the nation's balance of
payments.
The key problem is that Indonesia's economy has
become overdependent on earnings from petroleum.
Last year oil and natural gas accounted for almost
85% of the country's US$20 billion gross export
earnings and 65% of the government's budgetary
revenues. When the oil price was set on a seemingly
endless upwards spiral Indonesia was the boom
economy of south east Asia - a goldmine for foreign
bankers, contractors and traders. But in 1982 the
country was badly hit by slumping demand for its oil
and non-oil commodities, and earlier this year a sharp
decline in the international price of crude dealt the
economy what is now agreed was a stunning blow.
With record international reserves in the central
bank the government was able to muddle through in
1982 without a sharp change in its expansionary
course. But the pressures built up steadily. Last year
oil production slumped by almost 17% to 488 million
barrels and exports of crude and condensate fell by a
similar proportion to 319 million barrels. The result
was that in 1982 Indonesia recorded its biggest ever
balance of payments deficit and a sizeable shortfall in
government budgetary revenues.
Economic growth slumped by more than half to a
17-year low of around 3.5%. The deficit on the
current account of the balance of payments in the
1982/3 fiscal year ending in March increased almost
threefold to an estimated US$7 billion. In the last 12
months or so total foreign exchange reserves are
believed to have fallen by about 40% to less than
three months of non-oil imports.
Early in the year, as bankers began to express grow-
ing concern over Indonesia's ability to finance future
balance of payments deficits, the government's first
reaction was to try to borrow its way out of the
problem. In January Indonesia appointed Morgan
Guaranty Trust of New York to arrange a US$1
billion syndicated loan (Asia's second largest
commercial credit) and in February asked Dai-Ichi
Kangyo bank of Japan to lead manage a syndicated
loan worth the yen equivalent of US$325 million.
This was well over the US$1.2 billion or so raised by
the Indonesian Government last year, and was part of
a strategy to double straight commercial borrowing to
over US$ 2 billion in 1983.
Second thoughts
Bankers felt that such an increase in borrowing was
just about within acceptable limits. Indonesia's
foreign public and private debt - now estimated at
around US$23 billion - makes the country the third
largest borrower in Asia after South Korea and India
and according to Dr J. E. Ismael, managing director
of Indonesia's central bank, the sixth or seventh
largest developing country borrower in the world.
But despite its high ranking Indonesia had a number
of things in its favour.
BALANCE OF PAYMENTS
US $ billion
Exports (fob)
total
oil $ LNG
Imports (fob)
total
Current
account
balance
1978-79
11.4
7-4
8.4
-1-16
1979-80
17.5
11.3
9-8
+2-20
1980-81
21.8
16.2
13.2
+2-13
1981-82
23.1
18.9
18.2
-2-50
1982-83 est.
19.9
16-5
20-5
-6-80
Source: Indonesian monetary authorities and IMF.
TH Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Disbursed and outstanding
public debt
8.0
10.0
11-7
13.1
13-2
15-0
15.7
19.0
Debt service2
0-5
0.8
1-3
2.1
2.1
1-8
2-0
2-5
Commercial and concessional
3.3
3.1
1-T
3.3
4.3
3.8
4-1
4-2
borrowing3
0-5
1-2
2.4
2-6
4.1
6.5
6-2
4-1
Official reserves4
Debt service as % of
net exports
10-3
11.4
15-9
3 On a signed commitment basis. Much of this will not be drawn down in the year of signing. For example Indonesia's disbursed
and undisbursed debt at end-1981 was $26.8 billion, of which only $15.7 billion or 59% had actually been drawn down.
4 Includes gold, use of IMF resources and loans from foreign commercial banks of less than one year maturity.
Source: World Bank, IMF, and Indonesian authorities.
1 Unofficial estimates 2 Amortisation plus interest.
The country is considered politically stable, has
little short-term or private overseas debt and its
borrowings are still widely regarded as relatively
light. Indonesia's debt service ratio, measured as a
proportion of exports taking oil and gas on a net basis,
is now running at around 24%, less than a fifth of that
being run by countries in Latin America which are
being forced to reschedule. Unlike many Latin
American countries Indonesia has little private
overseas debt. Estimates range from US$5 billion to
US$3 billion. A doubling of straight commercial
borrowing to over US$2 billion in 1983 was, bankers
felt, an achievable target though at considerably
higher rates than were achieved in 1982. Should
Indonesia require more than this, however, many felt
that it would meet with some considerable resistance
following world-wide nervousness amongst bankers
after the Latin American debt crisis and a general
flight to quality.
Foreign exchange problems
As a further cut in the oil price seemed more and
more likely bankers became increasingly concerned as
to whether even a doubling of commercial borrowing
would be enough to finance the deficit. `Indonesia is
facing serious foreign exchange problems. The cur-
rent account deficit in 1982, 1983 and 1984 will be in
the US$6 to US$8 billion range, even assuming a
modest recovery in the US economy in the second
half of 1983 . . . further measures will have to be
taken', said the senior economist of one leading
foreign bank in February.
Unpalatable measures
The banker was right. With official reserves down
to just over US$4 billion at the end of December
Indonesia clearly could not afford a repeat per-
formance in 1983, and when Opec was forced to
accept a sharp cut in the international price of oil in
March Jakarta was compelled to undertake a series of
unpalatable . measures to head off what everyone
agrees was a looming economic crisis. The govern-
ment hurriedly began to make contingency plans for a
sharp cut-back in its budgetary spending, and fol-
lowing the appointment of a new cabinet in March,
devalued the rupiah from 702.5 rupiahs to the US
fou Oan BE-Inic va*%n Us For Help
Being one of the country's most experienced banks, we have
branches in every Taiwan population centre and nearly 2,000
correspondents in the major cities of the world. No matter
what your banking requirements-commercial or financial,
national or international-we always stand ready to help. We
are your helpful banking partner.
BANK OF TAIWAN
P.O. Box 305, Taipei, 100, Taiwan,
Republic of China. Tel: [phone]
TPIpx- TP11201. TP1 1202. TP1 1637
Cable: TAIWANBANK. TAIPEI
Chairman: S. C. Liu President: C. D. Wang
THEE Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
growth
1978
9,483
6.9
1979
9,990
5.4
1980
10.954
9.6
1981
11,810
3.5
1982 unofficial estimate
12,220
3.5
1983 unofficial forecast
12,460
2.0
dollar to 970 rupiahs.
Many felt the devaluation was long overdue. The
rupiah had been significantly overvalued for some
time, tied as it was so closely to an appreciating US
dollar. In the event the government was given little
choice. Following the Opec price cut the currency
came under intense pressure as the balance of
payments outlook worsened and domestic and foreign
business confidence in the economy nosedived.
Predictions of a devaluation had been rife for months
but in late March capital flight turned into a veritable
stampede with at least US$1 billion leaving the
country under Indonesia's free foreign exchange
system in a period of less than four weeks.
IMF facilities
At the same time the Indonesian government
continued to consider actively the possibility of
making formal request to the International Monetary
Fund for loans of up to US$600 million. In January
fashioned standards are
complemented by a totally
professional organisation.
For business meetings,
social visits, client enter-
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the city or in the beauty
of rural England. A call to
our office will bring you
your chosen vehicle, on
time, and in immaculate
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TEAMED FOR STYLE
AND COMFORT -
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
the IMF had agreed to lend Indonesia 69 million
SDRs from the country's contribution to the IMF
buffer stocks for tin and rubber, though it is as yet
unclear whether this has been drawn down. The
government is now debating whether to ask the IMF
formally for further loans under the organisation's
compensating financing facility (CFF) as well as
drawing a first tranche of 25% of the 720 million
SDR deposit it has with the IMF.
Jakarta has provided the IMF with export figures
for the Fund to make a decision as to whether
Indonesia's financing problems qualify it for a
US$389 million drawdown under the CFF facility. In
addition Indonesia is now looking hard at the
possibility of taking a first tranche facility of
US$194.4 million - 25% of its total IMF SDR
deposit. Many believe that Jakarta may avail itself of
these facilities some time later this year.
Investment postponed
The latest, and perhaps the most dramatic policy
measure to be announced by the government, came
on 6 May when Professor Ali Wardhana, the
country's economics co-ordinating minister, told the
nation that four of the country's largest investment
projects were to be postponed and a host of smaller
projects put under close scrutiny. Despite the fine
words of 'rephasing' it was a heavy blow to the
goyernment's ambitious plans to build up a large
petrochemicals industry. Effectively put on ice were a
DI SARDEGNA
Public law bank and Associated Sections
- AGRICOLTURAL CREDIT SECTION
- MORTGAGE CREDIT SECTION
- PUBLIC WORKS CREDIT SECTION
ANNUAL REPORT: Summary 1982
(million Iles)
Total deposits 11) 4,079,317 (+ 30,72961
- Liabilities with customers 3,266,997 1+ 27,10%)
- Cre
dit balances with
cust
omers
Net pr
ofit for the year 12,724 (+ 71,07%)
Funds
and reserves 361,640 (+47,89%)
- Monetary adjustment
reserves (Law n. 72 of
March 19, 19531
Branches in Sardinia 63
Other peripheral offices in Sardinia 299
Main branches outside Sardinia: Roma 2, Livorno 1, Milano 1,
Genova 1.
Ill Including mortgage, other bonds in circulation, funds of credit
institutions and other funds.
(2) Including loans to customers. balances with credit institutions,
debentures and other minor items.
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
OIL OUTPUT AND SALES
Million barrels
Production Exports Domestic
(crude) consumption
1978
597
462
112
1979
580
411
124
1980
577
379
139
1981
585
383
153
1982 (preliminary)
488
319
150
1983 (unofficial forecast)
450
280
150
Exports are of crude and condensate, and do not include some
45 million barrels a year of products. Domestic consumption is
for products only.
Source: Ministry of Mines and Energy, and industry sources.
US$1.5 billion aromatics chemical plant at Plaju in
south Sumatra, a US$1.6 billion olefins petro-
chemicals complex in northern Sumatra, a US$1.35
billion oil refinery at Musi in south Sumatra, and a
US$600 million alumina plant which was due to
provide the feedstock to a recently completed US$2
billion aluminium complex at Asahan, also in
Sumatra.
No alternative
Contracts for all these plants had already been
awarded and their postponement clearly shows that
the government has been prepared to take the tough
measures necessary to deal with the changed
economic outlook. The project delays have been
widely welcomed by both foreign and local econ-
omists who believe that a number of important gains
will result. These include: a much reduced import
bill which will help cut the balance of payments
deficit; an essential shift away from capital-intensive
low employment investment at a time when many of
the nation's 155 million population is experiencing
severe economic hardship; and lastly an important
reduction in budgetary outlays at a time of much
reduced government revenues.
Jakarta's new financial stringency seems set to
depress further the state of the Indonesian economy at
a time when growth is already low, but few believe
that a responsible government had any real alterna-
tive. In the next couple of years both foreign and
domestic investment is likely to slow and the in-
evitable decline in government spending, which in
the past has had such an important effect on the
overall level of economic growth, will also have a
GOVERNMENT FINANCE
Billion rupiahs
Fiscal years to 31 March
1979
1980
1981
Revenue
4,339
7,016
10,405
Expenditure
4,461
7,175
11,504
Deficit
-122
-159
-1,099
Financed by:
Domestic borrowing
...
2
40
Foreign borrowing
111
302
1,023
Cash balance
11
-145
36
Source: IMF
HEAD OFFICE III FOREIGN DEPARTMENT
53 HUAI NINE STREET. TAIPEI. TAINAN.
A leading bank of Republic
of China handling all banking
transactions, nationally and
internationally.
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
debilitating effect. Such measures however will
ensure that Indonesia does not run into the awesome
problems faced by such spendthrift oil economies as
Mexico.
In 1981 Indonesia managed to pull itself up into the
ranks of the middle income countries as classified by
the World Bank. But some now fear that the decline in
the oil price could push Asia's largest oil exporter and
Opec's most populous nation back into the ranks of
the low income countries.
Few economists believe that growth will be more
than 2% in 1983 - a sharp contrast to the average of
around 7.5% recorded over the last decade. With
2 million new jobs to find each year and 3 million
new mouths to feed this is bound to bring increased
hardship for the 60 million or so Indonesians still
living below the poverty line in this the world's fifth
most populous nation. It will also mean smaller
pickings for foreign bankers, contractors and traders
many of whom over the last few years made enormous
profits in a country which seemed to come up with a
never-ending supply of multi-million dollar projects.
Amidst all the gloom, however, there is perhaps one
glimmer of light. The government has now been
forcibly made to realise that it has to plan the
development of a much less lopsided (oil-dependent)
economy and reduce its unrealistic ambitions of
setting up a massive capital-intensive industrial base
which left many of the nation's poor peasant farmers
and urban unemployed out in the cold.
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;unction wth any loan,
tiny of a number of
in our case the
si'crs and security
lily of earnings.
scoots an earnings
t stance will be
f'ees in those cases
rated.
by the end of 1982.
,bt. Four-fifths
.utions. Is this
91 markets will be
ure?
31 bank lending is
y to be a slowdown
niess there is an
overall amount of
only moderately.
slowly, the share
INTER .IIO'',_+IJ I)ED'I'
THURSDAY. FEBRUARY 17, 198:,
U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND
URBAN AFFAIRS, SUBCOMMIII"I'EE ON INTERNATIONAL FI-
NANCE AND MONETARY POLICY,
Washington, D.C.
The committee met, at 9:30 a.m. in room 538, Dirksen Senate
Office Building, Senator John Heinz (chairman of the subcommit-
tee) presiding.
Present: Senators Heinz, Gorton, Mattingly, Hecht, Proxmire,
Riegle, Dodd, Sasser, and Lautenberg.
OPENING STATEMENT OF SENATOR HEINZ
Senator HEINZ. Today the subcommittee will hold the third of its
oversight hearings on the international financial situation and the
participation of the United States in the International Monetary
Fund. So far we have heard from the administration, bankers, and
bank critics. Today we will receive testimony from the bank regula-
tors. Our witnesses are distinguished, and it is an honor to have
them here today.
The role of the Nation's bank regulators in the current crisis is
direct and significant. Indeed, many critics have argued that the
U.S. bank debt problems would not have gotten to their present
dangerous stage had our bank -regulators not been asleep at the
switch. The primary mission of our bank regulators is the safety
and soundness of our banking system. Yet, we have been told of
bank after bank whose entire capital is exposed in one or two or
three countries, shaking international borrowers. To say the least,
therefore, this has hardly been bank regulation's finest hour.
This committee has received information that countries that are
now in deep financial trouble have been using the agencies and
branches of their banks to draw billions of dollars out of our Feder-
al funds market to finance their own foreign exchange imbalances.
In clear violation of the purpose of this market, the Federal funds
market as it is called, those foreign agencies withdrew as much as
$10 billion, while both U.S. regulators and banks were either igno-
rant of these transactions or failed to respond to the risks that they
posed.
On Tuesday, Mr. Martin Mayer testified and described this epi-
sode as "a disgraceful spectacle of the big New York banks and,
indeed, the Federal Reserve, leaning on our regional banks to con-
tinue the dangerous practice of selling Federal funds to foreign
purchasers who were using them for purposE>a quite illicit by the
generally accepted terms and conditions of this market."
(237)
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This regulatory failure, if the record is accurate as described
not unique. What we have is an international financial cn~'
brought on by a failure to stop at the prudential limits, et?~.
though the purpose of regulation is to determine just what th
prudential limits are. Mexico did not get into as much financial
ficulty with its first 10 or ?50 billion of debt as it did with its i
810 or 820 billion of debt. Likewise, it is hard to believe that t? aJ:
is anything that could be celled an effective country limit if
we discover, as we did on Tuesday, that our largest bank in
United States has 100 percent of its capital exposed in just o^~
country, Brazil.
Having noted this, h_'wever, I must add that if our regulator.
aren't clear on the fact that the mission that we have charter
them to achieve is that of safety and soundness of our bankin
system, then clearly Congress is going to have to take some addi-
tional steps to make what we thought was apparently clear more
clear. And several of my colleagues and I do plan to introduce leg.
islation. Indeed, we have introduced legislation, in addition to an-
legislation that will come before us for the IMF increase, to direct
bank regulators toward these kinds of problems. Yesterday Senator
Proxmire and I did introduce a bill that targets what we believe to
be three of those needs.
Let me comment briefly on that legislation. First of all, the bill
would empower the Federal Reserve to establish firm guidelines on
country lending limits. The legislation does not attempt to arbitrar.
ily assign those limits itself. It would allow the Fed to do that. That
is in keeping with advice we received from Secretary Regan earlier
this week where he agreed that it is appropriate for Congress to
require the Fed to establish loan limits but warned against Con-
gress doing it.
Second, the bill would mandate that the Federal Reserve require
banks to establish special loan loss reserves to be charged against
bank capital whenever the Board determines that the aggregate
amount of external debt incurred by the public and private borrow-
ers in a country is at a level where there is a substantial likelihood
that such debt cannot reasonably be expected to be repaid. Again,
that would be left to the Federal Reserve Board's judgment as to
when such a point is reached and what the amount of those re-
serves shou'd be.
Finally, the bill calls upon the Federal Reserve to promulgate
regulations to require that fees resulting from loan reschedulings
should be amortized over the life of the loan rather than taken and
recognized as one-shot earnings. This provision would insure that
earnings statements more accurately reflect the quality of both the
bank earnings and assets and would minimize the incentive for
bank syndicators to continually be under pressure to make one
syndication after another in order to make profits look better and
better.
These provisions, I believe, will make it clear to our bank regula-
tory agencies, including the Fed, what congressional intentions are,
while still giving them the flexibility to implement these directives
according to their special knowledge and experience. I would like
to emphasize that I and Senator Proxmire and the other members
of this committee are open to suggestions for better ways to deal
th these issues. But my prin
,,solving our current crisis, we
"I
icz not repeated.
Let me yield at this point
~,.
to I w lerstand has in
,nd Senator Proxmire has
?re that committee will
this
op( -ate if we don't get
turn on the microphones.
GPENING STA
senator PROX`.IIRE. Yes, I f
ake a pitch for more spendi;.
Mr. Chairman, I want to
morning of our hearing sched
concerning the foreign lendin
me that regulatory changes III
to be approved. For that reas
troducing the International
have introduced.
Let me cite just a few facts
adequacy of our present regul
First, the nine largest U.:
their capital to the non-oil de
Second, these same nine b
their capital to just three
Brazil, according to the Fed
eating the figure is 130 perce
At least one large U.S. ban
tal loaned to Mexico alone.
Even though danger signa
obtuse, U.S. banks Increases
'
first half of 1982 by 83.4 bil
increase of 21 percent.
Over the last 4 years, our
oil LDC's at an annual rate
banks increased by only 9 I ,
Mr. Chairman, as we go t
get the answer to a very si
tors? How is it possible for
posed on foreign loans with
As far as I can tell, the rci
lem. They advised, they mo
in fact, they did everythint
that is to regulate.
One reason for this ab\ -
the division of authority
agencies. When authority i
and energy of the regulate
When authority is divided
for the total foreign debt p
one agency can be held acs
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rrcord is accurate as described, is
an international fin uncial crisis
p at the prudential limits, even
is to determine just what those
not get into as much financial dif-
Iion of debt as it did with its last
-e, it is hard to believe that there
in effective country limit if when
.iv, that our largest bank in the
f its capital exposed in just one
must add that if our regulators
mission that we have chartered
and soundness of our banking
;oing to have to take some addi-
~u ;ht was apparently clear more
?s and I do plan to introduce leg-
ed legislation, in addition to any
s for the IMF increase, to direct
s of problems. Yesterday Senator
I that targets what we believe to
gislation. First of all, the bill
?e to establish firm guidelines on
ion does not attempt to arbitrar-
Id allow the Fed to do that. That
Ld from Secretary Regan earlier
is appropriate for Congress to
imits but warned against Con-
hat the Federal Reserve require
reserves to be chared against
determines that the' aggregate
the public and private borrov~-
there is a substantial likelihccd
e expected to be repaid. Again.
Zeserve Board's judgment as to
what the amount of those re-
ederal Reserve to promulgate
ilting from loan reschedulings
he loan rather than taken and
is provision would insure that
reflect the quality of both the
ld minimize the incentive for
under pressure to make one
make profits look better and
ke it clear to our bank regula-
t congressional intentions are.
to implement these directives
and experience. I would like
,mire and the other members
is for better ways to deal
with these issues. But my principal concern is that, in addition to
resolving our current crisis, we must do our utmost to insure that
it is not repeated.
Let me yield at this point to my colleague, Senator Prox,;re.
who I understand has an opening statement. And then I under-
stand Senator Proxmire has to go to the Rules Comin i'tee to make
sure that this committee will be operating at the first of March. It
won't operate if we don't get any money from the Rules Committee
to turn on the microphones.
OPENING STATEMENT OF SENATOR PROXMIRE
Senator PROXMIRE. Yes, I feel pretty h
ocriti
l
I'
yp
ca
.
m going to
make a pitch for more spending.
Mr. Chairman, I want to congratulate you for devoting a full
morning of our hearing schedule to hear from the bank regulators
concerning the foreign lending issue. I think you will agree with
me that regulatory changes are needed if the IMF quota increase is
to be approved. For that reason, I was glad to join with you in in-
troducing the International Bank Lending Reform Act that we
have introduced.
Let me cite just a few facts that raise serious questions about the
adequacy of our present regulatory system.
First, the nine largest U.S. banks have loaned 222 percent of
their capital to the non-oil developing countries as of mid-1982.
Second, these same nine banks have loaned over 112 percent of
their capital to just three cou
t
i
A
n
r
es-
rgentina, Mexico, and
Brazil, according to the Fed figures. I have seen other reports indi-
catin
th
fi
i
1
e
gure
s
30 percent.
g
At least one large U.S. bank reportedly has 78 percent of its capi
tal loaned to Mexico alone.
Even though danger signals were apparent to all but the wilful'v
obtuse, U.S. banks increased their exposure in Mexico during the
first half of 1982 by $3.8 billion. This represents an annual rate of
increase of 21 percent.
Over the last 4 years
our bank
i
,
s
ncreased their loans in the non-
i oil LDC's at an annual rate of 21 percent, while the capital of these
banks increased by only 9 percent a year.
M
r. Chairman, as we go through these hearings, I th;nk we must
get the answer to a very simple question: Where were our regula
tors? How is it possible for our banks to have become so overex-
Posed on foreign loans without the regulators blowing the whistle?
As far as I can tell, the regulators were not unaware of the prob-
lem. They advised, they monitored, they cajoled, they encouraged-
in fact, they did everything except what they are paid to do, and
that is to regulate.
One reason for this abysmal failure of our regulatory system is
the division of authority among
a three separate and independent
gencies. When authority is divided three ways. much of the time
and energy of the regulators is spent bickering among themselves.
When authority is divided three ways, no agency feels responsible
for the total foreign debt position of U.S. banks. And in the end, no
One agency can be held accountable by the Congress.
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One of the key features of the Heinz-Proxmire legislation is that
it assigns authority over international lending to a single vagency that has the greatest expertise' in international I,,
nance-the Federal Reserve Board. I am convinc,d that we wil'
never get the job done unless we assign responsibility to ors
agency, give it a clear mandate to regulate foreign lending, a
hold it strictly accountable.
Mr. Chairman, I look forward to hearing the testimony from
today's witnesses and to developing a continuing discussion of the
legislation we have put forward. I will be back shortly.
Senator HEINZ. Senator Lautenberg.
Senator LAUTENBERG. I have no opening statement.
Senator HEINZ. Senator Dodd.
Senator DODD. Nothing.
Senator HEINZ. Chairman Volcker, this is the second time the
committee within about 24 hours has had a chance to welcome you.
Welcome back.
STATEMENT OF PAUL A. VOLCKER, CHAIRMAN, FEDERAL
RESERVE SYSTEM
Mr. VOLCKER. Thank you. I wonder if it's worth reading even the
relatively short statement I have after you have had the testimony
that you have had.
Let me just pick out a few points. I outline, in the first few pages
of my statement, the general approach toward this problem of pres-
sures in the international financial system. I have gone over that
before, and I'm sure others have, with this committee or with other
committees.
I submitted to the committee earlier the statement that I deliv-
ered before the House Banking and Currency Committee which dis-
cussed at length some tentative ideas in connection with the super-
visory area. I did not plan to review that in my preliminary state-
ment today because you have that material.
But let me just say, in connection with this problem that has
arisen, that I think much of the lending of banks over this past
decade has reflected a constructive response by the financial
system to the need to ease adjustments associated with the world
oil crisis. International lending will continue to have to play an im-
portant role in a developing world economy.
Of course, there can be excesses, and some of the lending pro-
ceeded on assumptions that, in retrospect, seem invalid. None of us
enjoys perfect foresight, and it remains central to our financial and
economic system that the individual lenders reach their own credit
judgments.
But it is the responsibility of government to establish and main-
tain ground rules and procedures that, without stifling the market,
provide assurance that the stability of the system as a whole can
be protected against the dangers of excessive concentration of risk,
and that the element of risk is appropriately weighed. While our
present supervisory approaches are aimed at that objective, the
rapid development of international lending and today s problems
do point to the need for careful review of present policies. Possible
modified or new approaches-touched upon in my earlier state-
anent-are under intensive re
I expect to be able to repor
weeks.
Al, the ame time, the
citcn~':y an abrupt
lord fact is few borrowers,
5,1hstantial debts accumulatt-
-,rocess would be doomed to i s
nake the adjustments to ear
ccess. What may seem lob,
bank in demanding paymci
strain on the system as a
within it, could only be damn
As I noted earlier, the par
ing the international debt pry
ments and the private lendir
nizations-have been acting
points of pressures to the fir
center of this effort, and it
ship.
The remainder of my state
ing with the IMF need fo
course, is a matter that I he
early date. I do not think th
ers, financial, political, and t
escape the responsibility of
particular effort, if we want
terest that it succeed. It is it
here this morning-
I might say, too, Mr. Chai
tance of safety and soundne
tors, and I very much welcor
fully accept that. It is not
areas. At the same time, it
system work. There has be
air. I think Congress has be
looks at problems of this sc
suppose, before they begin.
developed in full-blown fora
Let me just say in that cc
actions last year in other
were not very happy about,
considerations. I can think
legal lending limits for Am
that you think is relevant
area of export trading coin
trading companies, but we
soundness considerations w
as banks got into that area
ly, did not reflect our Coll,
future in that area.
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Proxmire legislation is that
(ending to a single a.-ency-
cpertise in internati-rnal fi-
am convinced that we will
issign responsibility to one
';;uLite foreign lending, and
iearing the testimony from
continuing discussion of the
)e back shortly.
int., statement.
this is the second time the
id a chance to welcome you.
CIRIRMAN, FEDERAL
i:M1
it's worth reading even the
have had the testimony
aline, in the first few pages
oward this problem of pres-
!ern. I have gone over that
its committee or with other
the statement that I deliv-
ericy Committee which dis-
connection with the super-
A in my preliminary state-
inl.
ith this problem that has
ig of banks over this past
esponse by the financial
associated with the world
nue to have to play an im-
ny.
some of the lending pro-
seem invalid. None of us
,ntral to our financial and
ers reach their own credit
'rit to establish and nmain-
thout stifling the mar net,
le system as a whole can
give concentration of risk.
ately weighed. While our
ed at that objective,. the
rng and today s problems
present policies. Possible
in my earlier state-
ment-are under intensive review: by the super-is, ;ry a-eu.cies, and
I expect to be able to report conclusions to you in a matter of
weeks.
THE DANGER OF OVERREACTION
At the same time, the danger of overreaction-of encouraging in-
advertently an abrupt retreat from lending-is equally real. The
hard fact is few borrowers, at home or abroad, can suddenly repay
substantial debts accumulated over years. An attempt to force the
process would be doomed to failure, because borrowers need time to
make the adjustments to earn the funds or to restore their market
access. What may seem logical and appropriate to an individual
bank in demanding payment, if generalized, would place such
strain on the system as a whole that it, and the individual banks
within it, could only be damaged.
As I noted earlier, the parties immediately at interest in resolv-
ing the international debt problem-lenders and borrowers, govern-
ments and the private lending institutions, and international orga-
nizations-have been acting cooperatively to deal with the major
points of pressures to the financial system. The IMF stands in the
center of this effort, and it has responded with force and leader-
ship.
The remainder of my statement discusses the importance of deal-
ing with the IMF need for additional resources. And that, of
course, is a matter that I hope this committee will act upon at an
early date. I do not think that the United States-we are the lead-
ers, financial, political, and economic, of the rest of the world-can
escape the responsibility of leadership and participation in this
particular effort, if we want it to succeed, and it is in our own in-
terest that it succeed. It is in that context that I am delighted to be
here this morning.
I might say, too, Mr. Chairman, you have emphasized the impor-
tance of safety and soundness and the responsibility of the regula-
tors, and I very much welcome your statement in that connection. I
fully accept that. It is not only relevant in this area but in other
areas. At the same time, it has to be balanced against letting the
system work. There has been a certain deregulation wind in the
air. I think Congress has been involved in that as well. When one
looks at problems of this sort, the time to worry about them is, I
suppose, before they begin. It is a little late when the problem has
developed in full-blown form.
Let me just say in that connection, the Congress itself took some
actions last year in other areas that we in the Federal Reserve
were not very happy about, in terms of future safety and soundness
considerations. I can think of a very considerable expansion of the
legal lending limits for American banks. That seems to be an area
that you' think is relevant in the international area. And in the
area of export trading companies, we were not opposed to export
trading companies, but we wanted to make sure that safety and
soundness considerations were clear in the minds of the Conti ess
as banks got into that area. The legislation that was passed, frank-
ly, did not reflect our concerns as to what might develop in the
future in that area.
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I suspect you will be faced with legislation this year sponsored i?
part by the banks which are looking for additional powers. I this;
some of those will be well justified. I don't know precisely
they are going to ask for, but I would suggest you look at th,V
areas with some care in connection with your obvious coneJJ
about the future implications for the safety and soundness of
banking c-.,stem. I think you might want to look at the reverse, tr.
to nonbanking institutions, nonregulated institutions, that in
sense are getting into the banking business through the back da,4
and going around the regulatory structure.
I think this is an area that we have to work on, and I share tl
concerns that you expressed at the start, not just in this area
in other areas.
Senator HEINZ. Mr. Chairman, the process you have just d,
scribed from the export trading company legislation which was en.
acted in September or October-I think the President signed it in
early October of last year-the increase of the lending limit wa.
also something that carne in very late last year--
Mr. VOLCKFR. That is correct.
Senator HEINZ [continuing]. Clearly antedated the kinds of prob.
lems we are talking about with the international banks.
Mr. VOLCKLR. Yes.
Senator HEINZ. When we had Secretary Regan before us on
Monday, he was asked a very direct question, exactly the one you
raised: With deregulation in the wind, did some of this deregula?
tion spill over in any way into international bank lending? And he
said no, absolutely not. The main spirit of deregulation, he pointed
out, had been aimed at deregulating the retail depositors' kinds of
concerns, and he indicated very clearly that in terms of interna-
tional bank lending there had been no signals sent and no legisla-
tion sent down or acted upon, other than those two you mentioned
at the very end of last year, that in his judgment had any influence
on this. Would you agree or disagree with that?
Mr. VOLCKER. If I understand you correctly, the regulators, to the,
best of my knowledge, have not requested any legislation hereto-
fore on this international lending area. We have, obviously, among
us, been working on this problem and, indeed, we have been rather
intensively involved in recent years, reflecting some of the con-
cerns that you suggested. Someone can look back and say-I look
back myself and say-"Were we forceful enough? Were we aggres-
sive enough?"
That is obviously a legitimate question in retrospect. I don't
think it's correct to say we had no concern. We have spoken about
it in public as well as in private in connection with banks. We have
not asked for additional legislative authority, that is quite clear.
What we have under review is whether we need additional legisla-
tive authority or not; whether we can use our other regulatory su-
pervisory instruments is a matter which is under consideration
right at the moment.
Senator HEINZ. Well, clearly, you are taking seriously the ques-
tion of whether our system has resulted de facto in some kind of
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failure of bank regulatic
some kind of failure, wi'tl
red or the FDIC--
`.ir. VOLCKh:R. No, no,
Se;;ator HCINZ icontr.
ive- the general ua .
can = ome about in ~~ne
know how to regulate
regulators, or the rr gul:1
Of the two, which '.Quid
lem?
Mr. VOLCKER. YOU s.i'
Sense we are not in the
in the business of instrc:a
Senator HEINZ. Instru
Mr. VOLCKFR. All rig
First of all, you say that
erything is relative in t'
part of the world in wh
to play in the world ecc
the United States, and
United States. One is t,
suppose, and how to stri
eral philosophy that in
belong to the banks. Bu
exercise of discretion.
I think we can learn
of this experience, and
future; that is our coma
Senator HEINZ. Wha'
liked to have had bette,
in any way, you don't a
tion, you don't admit tl-
problems. From our po,
derstand that given the
other regulators with,
conclusion would to us t
Mr. VOLCKER. We arc
Since I have already in
other points.
Senator HEINZ. I the
statement.
Mr. VOLCKER. I have.
Senator HEINZ. Let's
view, there are four. I
statement. But let's sta
To expand a little bit
who on Tuesday testifib
of the Federal funds n
banks. Funds borrowed
as "445 billion on one
Mayer, in 1981-82, br:
used their access to th
change deficits, and soi
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
:'at:un this year sponsored in
or additional powers. I think
i dent know precisely .~
to finonce a continuing 'w
Mr. VOLCKER. I hatetl't
focus is probably yvron is
They were short-ti rill t:c
Senator HEINZ. Verb' Mr. VOI,CKER. But I nl
although I'm sure they
American banks are. ;,...
posits.
Senator HEINZ. This till:
those very short funds.
Mr. VOLCKER. I am sups
But the problem is the sa
it or overnight Federal fu
Senator HEINZ. Surely
ternational lending systel
ments things that are ver
Mr. VOLCKER. All bank;
is the diversification on
having appropriate liquid
I can sit here, and asl;
quidity? Was there adequ
operations in the United
risky countries you know
this thing is you ve got to
Senator HEINZ. I afire
down this practice, becat
in fact, $10 billion was o
overnight deposits--
Mr. VOLCKER. That is I-
Senator HEINZ. Mr. Ch
plain to you my concern
cans or the Brazilians tli
gentinians, I guess, act u
sorry, we are just not
think that that might h:
ticular market?
Mr. VOLCKER. Yes.
Senator HEINZ. All rig
Now, your second poi
this. This is an intern:i
only players in the gam
it doesn't seem to me th
in dangerous practice.
Mr. VOLCKER. Well---
Senator HEINZ. I'm j1
stand where I'm coming
Finally, it seems to nl
propriate authority to
you-and this is my qu
something about this?
:.Ir. VOLCKER. We nl:i'
may, and that is certain
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
h 'Mexican-Brazilia-..
hat practice seem
iv'. and clearly this i
is it's not suppos,,
countries, and n;
t ricted solely to &
ct Federal funds in
n Federal funds as a
I(,d. But I think Mr.
I would refer to as
e interbank lending
s interbank deposits.
eneral have expand-
Ts, that banks from
in that expansion-
he situation now, as
inches and agencies
ey had a large pro-
entries. I think that
' ferring to.
stions about the
s; that is certainly
` to be looking at. I
ory authority over
)ervised directly by
e supervision, and
onal Banking Act.
the other Federal
)wn up rather rap-
)reign banks to op-
-f this that needs a
general banking
ice whether those
Los Angeles, Chi-
Cayman Islands.
waking broadly-
ins to their oper-
k that there is in
at in the interna-
got to get cooper-
untries, and that
a sound or un-
)reign exchange.
rns, use the ulti-
mate in short-term borrowing, overnight deposits and transactions,
to finance a continuing long-term problem.
Mr. VOLCK :a. I haven't got a statistical analysis, but I think y
our
focus is probably wrong if you're talking about overnight deposits.
They were short-term deposits, no doubt about that.
Senator Hxu z. Very short.
Mr. VOLCKER. But I'm not so sure they were so much overnight,
although I'm sure they are in the Federal funds market like the
American banks are. Basically they were financing with bank de-
posits.
Senator HEINZ. This question is directed principally at the use of
those very short funds.
Mr. VOLCKER. I am suggesting that that focus is probably wrong.
But the problem is the same, whether it's a short-term bank depos-
it or overnight Federal funds.
Senator HEINZ. Surely you don't agree that it's good for the in-
ternational lending system to finance with v
h
ery s
ort term instru
ments things that are very long-term ones.
Mr. VOLCKER. All banks, I'm afraid, do that. I think the problem
is the diversification on the other side of the balance sheet and
having appropriate liquidity.
I can sit here, and ask in retrospect: Was there appropriate li-
quidity? Was there adequate diversification on these foreign banks'
operations in the United States? When they get in trouble or are
risky countries you know you have a problem. But the nature of
this thing is you ve got to worry before they get to be risky.
Senator HEINZ. I agree with you, but I think we have to nail
down this practice, because I believe it's a very dangerous one. If,
in fact, $10 billion was on loan to just two countries in the way of
overnight deposits--
Mr. VOLCKER. That is not true.
Senator HEINZ. Mr. Chairman, just a minute. Let me try and ex-
plain to you my concern so you can react to it. And if, as the Mexi-
cans or the Brazilians threatened to do on one occasion-or the Ar-
gentinians, I guess, actually did do it for a few days; they said, "I'm
sorry, we are just not going to pay anything back"-would you
think that that might have a somewhat chilling effect on this par-
ticular market?
Mr. VOLCKER. Yes.
Senator HEINZ. All right. That's the point.
Nov, your second point was, "Well, other people will be doing
this. This is an international financial situation. We are not the`
only players in the game. Our banks have to be competitive." But
it doesn't seem to me that being competitive is a license to engage
in dangerous practice.
Mr. VOLCKER. Well--
Senator HEINZ. I'm just making my observations so you under-
stand where I'm coming from.
Finally, it seems to me you have said you don't think this is ap-
propriate authority to do something about this, and I'm asking
you-and this is my question-do you want some authority to do
something about this?
Mr. VOLCKER. We may. I am not certain that we need it, but we
may, and that is certainly one of the areas I want to look at.
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we now have a cooperative venture among the three regulator,
bank agencies. Arthur Burns, who was a long-time critic of
three-agency regulatory structure, said the system causes compe.:
tion in laxity.
REGULATORS NOT FORCEFUL ENOUGH WITH BANKS
It's clear from your own statement and the GAO report that tl;,
regulators may not have been forceful enough over the years wit4.
the banks in foreign lending concentration.
What is your reaction to our proposal to provide guidelines or,
country risk lending in the Federal Reserve exclusively so that yot.
don't have this division of authority?
Mr. VOLCKER. I think on the face of it putting the authority it
one agency has advantages, whatever agency that may be. Looked
at from that point of view, it's very straightforward. I think the
only question that arises is whether you feel that that is consistent
with the more general approach toward banking regulation and
whether it could be fit into the existing division of authority. 1
think you could do it either way.
Looking at this problem in isolation, I think there are advan.
tages in the approach of centralizing. But the question doesn't stop
there; it's whether you want to accept or reject the more general
banking supervisory structure, because I think we can work it--
Senator PROXMIRE. Well, we have made exceptions to the divi-
sion-the bank holding companies, for example, are concentrated
in the Federal Reserve Board.
Mr. VOLCKER. That is correct. There were exceptions made
before.
Senator PROXMIRE. That has worked very well. I don't think any-
body now argues that ought to be divided between the three agen-
cies. I haven't heard too much of that. I suppose there is some of it.
Mr. Chairman, loans to the lesser developed countries run into
the hundreds of billions of dollars. Most of the economies of these
countries are in poor shape. How realistic is it to think that a pro-
gram such as the IMF has, with $40 billion of additional capital, is
going to allow those debts to be repaid? Isn't it more realistic to
face the fact that some of those loans will have to be written off as
a loss to the banks and others?
Mr. VOLCKER. No, I don't think -so, for the major borrowers we
are talking about. The IMF programs and approaches and re-
sources in and of themselves, are not going to lead to those debts
being paid off; that is not the purpose of the IMF resources and the
IMF lending. What will enable those loans to be moderated, if not
paid off, by and large, is to have the debtors growing into a strong
creditworthy position; they don't have to pay off all their debts.
You want to have a climate in which those countries are so evi-
dently creditworthy that they can finance themselves in the
market, not one in which they will get themselves in difficulties in
the future. You want to return to a more normal market climate
with a debt burden that they can readily service. That gets you
into questions, over time, of the growth of the world economy, on
the one side, and their own policies on th,: other side.
Senator PROXMIRE. I
don't get some kind of
cave to at least write
Mfr. VOLCKER. If you
tl,,'n you imply an ('no,enator PROXMIRE.
c rates raises the
pint. The impact is
l97Os remain un-
'h past experience
ate implicit in the
hout - 4% for the
if deflator and fu-
\verage real rates
ms. And there is
tied, it will yield
)ns in infrastruc-
ve investment-
Dital in Brazilian
d rates that are
The debt in the
of course, make
:ralized concern
Brazilian debt.
old requirement
d paid in foreign
t-term elasticity
s. The larger the
ominal interest
iris and the en-
e 13 is the share of
tan value added is
latter approximate
rate is I F-,. What
capital share, and
7. Latin ,-American External Debt 153
In sum, long-term positive returns on borrowed resources do not guar-
antee the foreign exchange when needed in the short term. The time pro-
files of benefits and costs are likely to diverge, requiring continued financ-
ing until returns are realized over a longer horizon. If additional external
loans are not available, short-term obligations may not be met, or only at
the expense of other imports and consequently of economic growth. Ex-
ports are unlikely to satisfy immediate foreign-exchange needs even with
rapid growth. But they are also an essential element to avoiding a debt
trap. The short-term liquidity problem has its counterpart in a medium-
term transformation problem: the capacity to divert increased productive
capacity to export. Debt can only be repaid, or its rate of growth slowed,
through a growing merchandise surplus.
An adequate supply of new loans and liberal access to markets are not
assured in the present difficult international economic environment. In
addition, nominal rates of interest :a 1980 and 1981 are at peak levels and
show little sign of consistent decline. They are likely to lag behind reduc-
tions in inflation. Oil-poor countries have the gloomy prospect of de-
teriorating terms of trade as future oil prices outstrip export prices. To-
gether these factors could cause a real debt problem: the costs of the new
loans in the 1980s necessary to meet the short-term liquidity requirements
of the debt of the 1970s could very well begin to outstrip real returns. A
fundamental limitation of a model of debt finance is that it requires a con-
tinuing supply of credit on favorable terms for its advantages to be real-
ized. Debt in the 1970s could turn out to be more expensive than it
seemed.
We expand upon this theme in the next section, examining in quantita-
tive terms the near- and medium-term foreign-exchange requirements of
Latin American debtor countries, with special emphasis on the case of
Brazil.
IV. PROJECTIONS OF LATIN AMERICAN FINANCING NEEDS
The dynamic of the debt is best understood quantitatively by embed-
ding its required continuing service within a structure that also projects
the merchandise balance. The simplest model for so doing is one that re-
lates import requirements to product growth. Despite its abstraction from
real-economy complexity, such an approach-because of its orientation
to the future-is more informative than reliance upon static debt service
ratios or similar measures. It also is more accurate than regression-
derived estimates of current account deficits that ignore the mounting role
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BANKING/ACCOUNTING
WHERE WE BANKS PUY THEME BA
n
Accounting methods vary; on net income, but distort inter-country the ratio of recoveries or write-banks to
comparisons of interest margins and loan charge-offs should be much greater than
so do legal requirements. losses. The US system lowers interest for a bank using the specific provision
By Roger Taillon income but does not affect the loan loss method. How are problem loans treated in
provision or charge-off figure; the German other countries? In Great Britain banks set
The financial statements of banks are system increases loan loss provisions, and up two types of provision for loan losses,
affected by differences between countries in perhaps ultimately charge-offs, while specific and general. The treatment is
the accounting treatment of problem, or leaving interest income at a higher level similar to that of banks in a number of
non-performing, loans. A non-performing until the loan is charged off. The Italian other European countries, except that the
loan is any loan on which interest or method leaves interest income, loan loss British clearing banks provide a higher level
principal is not (or is not expected to be) provisions and charge-offs all unaffected. of disclosure.
paid in full and on time. This includes loans If the non-accrual method is used, a There has been some discussion about the
on which there has been outright default, further decision must be made as to what to appropriateness of the general provision -
whether declared by the bank or not; loans do with interest actually received on loans some people see this as a reserve, which is
on which amoratorium has been declared; on a non-accrual status. Some banks take not allowed under British accounting
loans which have been rescheduled; and the cash interest received as interest income. standards. But the view that it is not a
loans which have been converted into stock Others use cash received to reduce the reserve seems to have prevailed and all
because of the borrower's difficulties. principal amount of the loan (for book major banks continue to make them or
Loans which remain current are regarded as Purposes, not for the borrower's benefit) have resumed doing so.
non-performing if there is substantial doubt either for all non-accrual loans or for those For specific sovereign risk, British banks
about the ability of the borrower to where it considers collateral insufficient. are now allowed to make tax deductible
continue to pay -if, for example, the For rescheduled and renegotiated loans, provisions and some are doing so.
borrower has defaulted on other loans. virtually all banks recognize interest in Germany two kinds of tax-deductible
This broad definition leaves room for according to the new terms either on a cash loan loss provisions are made-. general pro-
subjective judgement on whether a parti- or an accrual basis. Although these loans visions based on a formula established by
molar loan is non-performing. For example, might be written down or provided for if tax authorities and the Bundesbank, and
is a loan non-performing if it is only 30 days loss of principal is expected, they are not specific provisions. Non-tax deductible
overdue and the bank expects the borrower normally adjusted to bring the effective general provisions, considered by most
to catch upon the payments? Is rescheduling yield up to a realistic risk-adjusted rate. The banks to be a type of loan loss provision,
a normal extension of maturity, or the same is true with foreclosed assets and can be made above the formula amount at
result of the borrower's difficulties? Do the shares received in exchange for debt. The each bank's discretion. The balance sheet
terms of the rescheduled loan fully reflect practice of writing down assets to provide a amount to provisions is not disclosed, and
the risk of lending to the borrower? If more realistic yield was tried in a few the income statement amount can be
payments are current and the loan is well isolated instances by US banks in the combined with provisions for reductions in
secured, but the borrower has defaulted on mid-1970s, but never became widespread, value of securities holdings and reduced by
unsecured loans, will the borrower remain though it seems to make economic sense. realized securities gains, according to the
current on this particular loan? For losses of principal, banks in most principle of compensation. The specific
Some banks recognize loans as non- countries establish provisions, which may provisions are the banks' estimates, made
performing according to strict numerical be specific or general, according to the laws on conservative lines, of probable losses on
standards. Many US banks consider any of the country. Loan losses may be charged problem loans. Provisions have been made
loan over 90 days overdue non-performing, to these provisions, or directly to earnings. for risk on certain country credits. Unpaid
and put it in a non-accrual status. Other The method used in. most European interest is provided for and ultimately
banks have a totally subjective process, and countries is to establish general provisions charged against the specific provision.
still others use numerical standards as a to the extent tax laws allow, and specific In France, banks can make tax-
guide, though the final decision is provisions based on estimated losses on deductible specific provisions against short-
subjective. For some types of loans, such as loans regarded as problems. Loans are term loans, and have a choice between a
rescheduled loans, the criteria must almost normally charged off against the specific, 0.5074 formula provision and specific
always be subjective. not the general, provisions when the final provisions against medium and long-term
Once a loan is recognized as non- amount of a loss has been determined loans. In recent years, most major banks
performing, interest that already has been, (usually when bankruptcy or reorganization have chosen the specific provision, as it has
or is to be accrued, must be dealt with. proceedings have been completed). One of been larger. Although the three largest
Previously accrued but unpaid interest can the advantages of this system is flexibility. French commercial banks have been state-
be reversed out of interest income and the A provision appears to be a less drastic owned since 1946, and all major ones now
accrual of interest stopped. This is the measure than a write-off, so many banks are, banks have made their own decisions
method in the United States. US banks will make generous provisions relatively about provisions, subject to a periodic tax
continue to accrue interest on loans to early after a borrower's problems have been audit. They have been making substantial
Mexico, but some have placed certain discovered, particularly if they can gain tax provisions against country risk for years.
Because of Securities and Exchange
private loans to Mexico on non-accrual. advantages by so doing.
German (and some other) banks accrue The less common method, which is used Commission (SEC) regulations, US bank
interest, but make specific loan loss in the US, is to make partial charge-offs of holding companies provide the fullest
provisions of an equal amount. In Italy, loans where there is a significant risk of loss disclosure of problem loans. Bank holding
separate provision is set up for unpaid of principal. The loans are reviewed companies disclose the totals of loans on
interest. periodically. An additional charge-off may non-accrual, other loans over 90 days
All three methods have the same impact be made, or, if the borrower's condition is overdue, renegotiated loans and foreclosed
b k f the is Most banks use the 90-day standard
o rise
t
The author is vice president, international
ratings, at Standard and Poor's.
.
e- ac
improving, there may be a wn
loan. If a bank is conservatively applying to place the loans on non-accrual, although
this method of accounting for loan losses, this is not required. Adequacy of loan loss'
Euromoney May 1983 161
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BANKING/ACCOUNTING
provisions, or reserves as they are called in
the US, is determined by the bank and its
auditors. The reserves are generally larger
for book purposes.
The tax-allowed reserves have decreased
as a percentage of loans since a 1969 tax law
change, and in 1983 dropped to 0.6% of
loans. The reserves are, technically,
general. The SEC requires an allocation of
the reserve to different categories of loans,
but this is not the same as true specific
provisions, and any portion of the reserve is
available for losses on any loan.
When banks recognize a probable loss on
a loan, they are supposed to charge off all,
or a portion of, the loan. Although bankers
sometimes speak of "reserving" for a
particular loan, this is no more than an
internal allocation of the general reserve,
and is usually done only on an interim
basis. US bank holding companies are
required to disclose major exposures to
problem sovereign credits, but few have
included these in their non-performing loan
total, or charged off any portion of the
loans. The reason why banks have differed
about private sector companies is that some
of these companies - in Mexico, for
example - have been prevented from
paying interest on loans by government
bans on foreign exchange.
Canadian banks will make specific loan
loss provisions when they think it is appro-
priate, but they will also charge off loans
directly. The total of the net increase in the
specific provision and the direct charge-offs
each year is considered to be a bank's loan
loss experience. Loan losses are charged to
income based on a five-year moving average
of loan loss experience divided by loans,
which is then applied to the year's average
loans. The difference between a year's loan
loss experience and the amount charged to
income based on the five-year moving
average formula is taken from, or added to,
a reserve for contingencies. The reserve for
contingencies is nourished by an allocation
from net income. Because loan loss
experience has been rising in recent years,
the charge to income has tended to be signi-
ficantly less than actual loss at most banks.
Canadian banks cease to accrue interest
when its payment is in doubt.
In Japan, as in the US, the loan loss
provision allowable for tax purposes has
been decreasing as a percentage of loans.
Technically banks are not required to
decrease the balance sheet amount of these
provisions from previous levels, but some
have done so, apparently with official
encouragement. Non tax-deductible
provisions are also allowed, but, to date,
the provisions for book purposes have not
been very different from the provisions for
tax purposes. Most of the provisions are
general, and Japanese banks are required
immediately to charge off all loans
classified as loss by the regulators and the
estimated loss on those classified as
doubtful. These charge-offs are made
directly from the income statement, as an
expense item, and not out of the provision.
Specific provisions can be made, but only
where the loss cannot be closely estimated,
and the loan should be written off, in whole
or in part, soon thereafter. Specific
provisions are not differentiated from
general provisions in the income statement,
except that, because of the decrease in
provisions allowable for tax purposes, very
few banks have made any general provi-
sions in recent years. When a loan on which
a specific provision has been made is
written off it is written off against the
specific provision rather than directly
through the income statement.
The Ministry of Finance recently decided
to require a third type of provision, for
sovereign risk, which in effect will be some-
where between general and specific. At
present it is not tax-deductible. It is to be
established as 1 to S% of loans to countries
experiencing repayment difficulties, with
the individual banks formally responsible
for working out the percentage.
Individual banks will decide which
countries are in difficulties, but they have
to use criteria established by the Ministry of
Finance.
S020
COMMERZBANK FINANCE COMPANY B.V.
U.S.$ 100,000,000
11% Notes due 1991
COMMERZBANK
Commerzbank Aktiengesellschaft
Goldman Sachs International Corp.
Kuwait Investment Company (S.A.K.)
Banquelndosuez
Credit Lyonnais
Daiwa Europe Limited
LTCB International Limited
Manufacturers Hanover Limited
Merrill Lynch International & Co.
S.G. Warburg & Co. Ltd.
Morgan Guaranty Ltd
Morgan Stanley International
Orion Royal Bank Limited
Salomon Brothers International
Swiss Bank Corporation International
Limited
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187
Risks in International Bank Lending
1. COUNTRY RISK
The large increase in international bank lending since 1973-74 has
been accompanied by significant changes in the nature as well as the
relative magnitudes of such activity from the standpoints of both borrowers
and lenders. One of the distinguishing characteristics of many international
loans during this period has been their purpose - the funding of current
account deficits. Countries have resorted to overseas borrowing on an
unprecedented scale to cushion the impact of adverse changes in their
external circumstances - notably spiraling energy costs - and to finance
industrialization and economic development programs. The result, for a
number of borrowers, particularly some LDCs, has been a rapid increase in
debt burdens, aggravated by high interest rates. For example, the ratio of
debt service to export earnings for ten major LDC exporters of manufac-
tured goods is estimated to have jumped from 13 per cent to 21 per cent
between 1974 and 19811. The outstanding debt owed to banks by four
groups of major borrowers - smaller European countries, OPEC, Eastern
Europe and non-oil LDCs totalled nearly $400 billion at the end of 1980.2
Moreover, whereas balance-of-payments financing needs were form-
erly viewed as short-term, cyclical, liquidity problems, current payments
imbalances are often structural in nature. As a result, many borrowing
countries now face periods of basic structural readjustments. Thus, greater
demands are being placed on domestic management, capabilities of bor-
rowing countries to devise and implement the necessary economic ad-
justment programs.
While borrowers' debt burdens have grown, so have the relative mag-
nitudes of banks' international loans in loan portfolios. Recent U.S. data
' IMF: World Economic Outlook, June 1981, p. 135.
BIS Annual Report. 1981, p. 105.
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highlight the growing importance of LDC borrowers: the aggregate expo-
sure of the nine largest U.S. banks to LDCs has increased from 1 times
total capital in 1977 to more than double capital in 1980, and by the end of
1980 there were 80 instances of U.S. banks with exposure to single LDCs
greater than 30 percent of capital funds. More generally, foreign assets and
liabilities now account for a large proportion of total assets and liabilities of
the banking systems of many OECD countires: for the OECD as a whole,
the ratio nearly doubled during the 1970s, from 12 per cent to about 22 per
cent.
Risks and Concerns
The extension of credit across national borders in non-local currencies
complicates the traditional assessment of a borrowers ability to repay
because "country risk" is a factor. Under the rubric of "country risk," most
analysts distinguish "transfer risk" from "political risk".` "Transfer risk" is
the danger that a country may impose restrictions on remittances of capital,
dividends or interest payments to foreign investors as part of its economic
policy. In addition, repayment may be endangered by political develop-
ments, like civil or local wars.
Recently, concern about country risk has increased. There is a general
belief that, at the same time as more and more banks are involved in
international lending and the relative magnitude of the international por-
tions of loan portfolios has been growing, the actual risk inherent in such
activity has grown. At the same time, there is skepticism about the efficacy
of approaches that banks have taken to country risk assessment
The concerns suggest two lines of inquiry.
1) Have the risks of international lending increased? If so, how?
2) How are banks managing those risks? What is the supervisor's role?
' A few definitions of terms may be useful to the reader.
Country risk is taken to refer to the possibility that sovereign borrowers of a particular
country may be unable or unwilling, and other borrowers unable, to fulfill their foreign
obligations for reasons beyond the usual risks which arise in relation to all lending.
Country risk assessment, following on from the above, refers to the methods used (by
lending banks in particular) to evaluate the risk of an interruption in the servicing or
repayment of obligations by borrowers of a particular country.
Country exposure is taken to refer to an individual bank's or banking group's exposure
in its total claims on borrowers in individual foreign countries. Measures of exposure to a
particular country may take account of guarantees or other factors that could shift risk to a
different country from that of the borrower.
Country indebtedness is taken to refer, in an international context, to the sum total of
external borrowing by a particular country from all sources.
Sovereign risk arises from the special risk associated with a sovereign loan, which is a
loan to, or guaranteed by, a government (and some government-guaranteed bodies). The
special significance of such lending lies in the risk that it might prove impossible to secure
redress through legal action i.e. the borrower might claim immunity from process or might
not abide by a judgment
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The second area, that of risl
of subsidiary questions:
? What techniques of i
? Is country risk asses
? Are some banks bet
Gauging the Overall Risks
The most frequently us,
the loan loss record whict
particular categories of lent
tional banks engaged in inte
loss statistics for the large:
measure, the record appear
far lower for international tt
record has been improving.
loan losses as a percent of
record 039 per cent in 197E
losses relative to total Iosse:
cent in 1977 to 153 percent
the less direct costs of rescl
those indirect costs in man
quality have not been high
The views expressed in
riskiness of international bar
dents expected a 'substant
lending over the next five yei
'no significant change' or a 'r
ings Involving large sums o
seen as the most serious tt-.
How Banks Assess Countr
Existing systems for a
complexity from bank to ba
that nearly all banks have inc
analysis (it also confirmed th
country risk assessments b)
spondent banks).' However
the economic and the politi
? "How Bankers See the World Fir
Appendix I summarizes nine syste
Canadian, and European banks.
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
gate expo-
s 1 Vi times
r the end of
Ingle LDCs
assets and
liabilities of
as a whole,
,out 22 per
currencies
.y to repay
risk," most
sfer risk" is
s of capital,
economic
al. develop-
is - neral
in _d in
Tonal por-
ent in such
the efficacy
ent
w?
isor's role?
of a particular
I their foreign
lending.
hods used (by
- servicing or
pup's exposure
exposure to a
i shift risk to a
)an, which is a
I bodies). The
,ible to secure
~cess or might
The second area, that of risk management practices, in turn raises a series
of subsidiary questions:
? What techniques of risk management and/or reduction are employed?
? Is country risk assessment effective? What are its flaws?
? Are some banks better positioned than others to assess country risk?
Gauging the Overall Risks
The most frequently used indicator of the risk of bank lending activity is
the loan loss record which can be used to assess risks in relation to
particular categories of lending. Across-the-board data for major interna-
tional banks engaged in international lending are not available, but the loan
loss statistics for the largest U.S. banks may be representative. By this
measure, the record appears to be reassuring since loan losses have been
far lower for international than for domestic activities. Moreover, the loss
record has been improving. For the ten largest U.S. banks, international net
loan losses as a percent of average international loans dropped from a
record 039 per cent in 1976 to 0.10 per cent in 1980. International net loan
losses relative to total losses have also dropped, from a peak of 293 per
cent in 1977 to 153 per cent in 1980. However, such statistics do not reflect
the less direct costs of reschedulings to banks. Although most banks say
those indirect costs in management time, liquidity, income and portfolio
quality have not been high to date, many believe those costs may grow.
The views expressed in the accompanying banking survey' on future
riskiness of international bank lending were mixed: 40 per cent of respon-
dents expected a 'substantial increase' in the riskiness of international
lending over the next five years to the end of 1986, but a majority expected
.no significant change' or a'modest increase'. A large number of reschedul-
ings involving large sums or a default by a major country borrower were
seen as the most serious threats to the system.
How Banks Assess Country Risk and Manage Exposures
Existing systems for assessing country risk vary in approach and
complexity from bank to bank. The study group's bank survey confirmed
that nearly all banks have increased the resources dedic::ted to country risk
analysis (it also confirmed that smaller banks rely more than larger ones on
country risk assessments by others, such as syndicate leaders and corre-
spondent banks)' However, there are acknowledged problems with both
the economic and the political sides of country risk assessment systems.
' "How Bankers See the World Financial Market", Group of Thirty, May 1982.
' Appendix I summarizes nine systems which have been used or are in use at some major U.S.,
Canadian, and European banks.
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The more serious problems on the economic side stem from the deficien-
cies of the data. True, the quality of data has improved somewhat in recent
years, and additional efforts at improvement are currently under way. (For
example the IMF and BIS have recently been discussing efforts to expand
and improve banking information.) Nevertheless, there remain some signif-
icant deficiencies in both the quality and availability of the data."
Lags in data reporting can be quite serious, sometimes rendering the
available statistics virtually useless. There is much evidence that many
banks simply did not know the magnitude of the debts of either Turkey or
Poland, before the crises in those countries erupted
Even assuming reliable and current economic data, however, there are
still differences of opinion regarding how well banks use and interpret the
data. There are past instances, for example, of banks' enthusiasm for
lending being based on a country's natural resource endowments without a
concomitant realistic appraisal of the country's ability to manage its natural
resources. Currently, most country risk analysis systems utilize a number of
economic indicators to develop measures that serve as indicators of coun-
try risk While the ratio of debt service to exports is widely acknowledged as
an important measure, opinions differ as to the significance of a number of
other measures often used to predict the ability to service debt
Recently, banks have placed increased emphasis on assessing politi-
cal and social factors in borrowing countries. A number of banks have hired
political experts and incorporated political considerations in their analysis in
new ways, including attempts to develop lists of socio-political "early warn-
ing indicators." However, such judgments are no doubt even more prob-
lematical than economic analysis. Despite new attempts to take political
factors into account, such analysis has often failed to detect important
trends, such as political developments which, for example, in the case of
Poland, may have contributed to the need to reschedule.
In the end, of course, even very sophisticated country risk assessments
may be overridden by other considerations. Final action may run the range
from voluntary decisions, based for example on perceptions of marketing
opportunities, to those that are less than fully voluntary. Examples in the
latter category would include situations where the bank is afraid of jeopar-
dizing a large existing exposure if it withholds new loans or instances of
strong external pressure from the bank's home government arising from
foreign policy motivations: one quarter of banks responding to our survey
believed that lending had been significantly affected by such pressures.
Also, since a bank's competitive status depends importantly on the regard
? Country debt service data, for instance, do not capture all annual amortization requirements;
military debt, which is often large, is usually excluded from official statistics; and statistics on
short-term debt (up to one year) are frequently deficient
of others in the system, some
cooperating with other lender
out of a sense of responsibil
international lending market
Competitive pressures i
sessments and engage in imf
of country lending, competitit
that new money will continue
even though signs of econ(
instance, in the cases of Peru
beginning to feel more cautiot
able to sustain the inflow of fu
excessive debt.
Debates about the effica,
systems notwithstanding, ba
undue risk concentrations In
means by which banks reduc
particular lender. These inclu
with multilateral institutions, i
agencies, or securing home g
port banks or agencies.
Most importantly, banks t)
ing loan portfolio diversificatio,
tional risk exposure. Nearly all
tries, sometimes as a proporti
total assets. To arrive at limits,
elaborate country risk analyses
Most banks can follow strategic
monitor quite closely their cot:
Supervisory Practices
Supervisory practices also
risk In general, the principal roll
individual bank carry out the t<
responsibility and to satisfy thef
evaluates country risk and mon
not entirely clear how and to
authorities currently fulfill this ro
bank's country risk systems doe!
Also, supervisors follow more ci
dons of risk in their banking systt
ing statistical reports on country
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
he deficien-
tat in recent
er way. (For
s to expand
.ome signif-
ta?
ndering the
that many
r Turkey or
?r, there are
iterpret the
usiasm for
is without a
its natural
number of
rs of coun-
viedged as
rii, '-er of
t.
sing politi-
have hired
analysis in
.arty wam-
;ore prob-
.e political
important
ie case of
essments
the range
narketing
des in the
of jeopar-
tances of
;ing from
ur survey
ressures.
ie regard
juirements;
statistics on
of others in the system, some banks may feel pressured by the desirabilityof
cooperating with other lenders. Finally, some banks may act, at least in part,
out of a sense of responsibility to help maintain the longer-run stability of
international lending markets.
Competitive pressures may lead banks to override country risk as-
sessments and engage in imprudent lending. Particularly in the early stages
of country lending, competitive behavior tends to dominate. This can mean
that new money will continue to pour into a country once it is in vogue,"
even though signs of economic difficulty may already be evident. For
instance, in the cases of Peru, Turkey and Poland, even when banks were
beginning to feel more cautious about further lending, those countries were
able to sustain the inflow of funds. In such ways, a country can accumulate
excessive debt
Debates about the efficacy and actual use of country risk assessment
systems notwithstanding, banks can and do protect themselves from
undue risk concentrations in a number of ways. For example, there are
means by which banks reduce or spread the risks of involvement with a
particular lender. These include syndication of large loans, co-financing
with multilateral institutions, insuring loans with either private or public
agencies, or securing home government guarantees through national ex-
port banks or agencies.
Most importantly, banks typically follow policies and practices promot-
ing loan portfolio diversification as the main method of managing interna-
tional risk exposure. Nearly all banks set lending limits to individual coun-
tries, sometimes as a proportion of capital and reserves or of external or
total assets. To arrive at limits, subjective judgments (whether derived from
elaborate country risk analyses or not) are translated into objective ceilings.
Most banks can follow strategies that allow them to allocate, measure, and
monitor quite closely their country risk exposures.
Supervisory Practices
Supervisory practices also play a part in the management of country
risk In general, the principal role of the supervisory authorities is to help the
individual bank carry out the task of country risk assessment on its own
responsibility and to satisfy themselves about the ways in which the bank
evaluates country risk and monitors its own exposure to each country. It is
not entirely clear how and to what degree various national regulatory
authorities currently fulfill this role. However, bank supervisory evaluation of
bank's country risk systems does appear to be becoming more widespread.
Also, supervisors follow more closely than formerly trends and concentra-
tions of risk in their banking systems, and/or at individual banks, by collect-
ing statistical reports on country exposure. In the U.S., because of the nature
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and history of bank supervision, supervisory authorities make an indepen-
dent judgment regarding the risk in lending to particular countries.
The practice is not much in evidence elsewhere; but many countries
apply requirements designed to prevent undue risk concentrations. (A
description of supervisory systems in a number of G-10 countries is at
present being prepared by Richard Dale of the Brookings Institution, to be
published later this year as part of the overall work of The Group of Thirty.
Meanwhile, a brief overview of relevant national regulatory arrangements is
supplied in Appendix D).
Conclusions
There have been no major disasters for the international banking
system arising from the growth in international lending activities. However,
our survey confirms that most bankers believe that risks have increased and
will increase more rapidly in the future. Evaluating the degree to which this
may be true is of course no simple matter. For instance, there are factors
which appear to mitigate the relative burden of debt for some borrowers.
These include growing GDPs, higher levels of reserves, and above all
improvements in economic policy-making in most debtor countries en-
hancing their own ability to adjust to changes in external circumstances. Yet
the rapid growth and relatively high level of international indebtedness has
certainly increased borrowers' vulnerability to exogenous events which
could impair their ability to service debt At the same time, the growth in the
ratio of international to domestic assets in bank portfolios suggests that the
system's vulnerability to 'shocks' may also have increased.
The concerns generated by aggregate figures on debtor condition and
country exposure are often exaggerated. A variety of official support func-
tions are already in place. To the extent that ultimate country lending risks
are borne by government or multilateral institutions which lend directly,
co-finance with banks, subsidize, insure or guarantee bank loans, the actual
risk of commercial banks is at least partly underwritten.
More significantly, borrowers represent a range of risks, and banks
manage their exposures with the intention of avoiding undue concentra-
tions of risk. Especially in the last several years, banks and their supervisors
have devoted considerable effort to improving management of interna-
tional loan portfolios. The question remains as to whether these efforts are
fully adequate at a time when the system has probably become more
vulnerable to shocks - and perhaps more likely to experience them.
Weighing these partly conflicting considerations, the study group believes
the following observations are relevant:
1) Banks' decision-making sometimes appears to take place against
a background of insufficient factual information. This is partly because
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there remain serious In,
assessments are based.
are particularly deficient
quality, timeliness and a,
lenders.
2) To this end, me
plored. Many members
centralization of data anal
decisions, however, shot
3) Risk assessment
There is evidence that c
banking market has some
borrowers, leading subse
4) The study group
be concerned with review,
it is not yet possible to re
such reviews. It is also th
principle, supervisors shot
assessments to the banks
U.S. supervisors, who are r
judgments).
2. RESCHEDULI
The number and ma,
creased considerably in th'
official debt rescheduling:
involving 13 countries have
have been a party in reneg
Peru, Nicaragua, Sudan, Ja
way with Rumania, Costa R
in these reschedulings hav
$421 million for Sudan an(
Nicaragua and $3 billion for
repayments of capital due
aggregate debt owed to bar
different order of magnitu,
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
there remain serious inadequacies in the data upon which country risk
assessments are based. International debt data for short-term borrowing
are particularly deficient Further efforts should be made to improve the
quality, timeliness and availability of the basic economic data available to
lenders.
2) To this end, means for centralizing data collection could be ex-
plored. Many members of the study group believe that some degree of
centralization of data analysis would be also be appropriate. Judgments and
decisions, however, should be left to individual banks.
3) Risk assessments may be influenced by other considerations.
There is evidence that competition for business within the international
banking market has sometimes resulted in excessive debt accumulation by
borrowers, leading subsequently to debt servicing problems.
4) The study group believes that bank supervisory authorities should
be concerned with reviewing country risk management systems. However,
it is not yet possible to reach firm conclusions about the effectiveness of
such reviews. It is also the opinion of the study group that, as a general
principle, supervisors should leave the task of actually making country risk
assessments to the banks (while recognizing the special circumstances of
U.S. supervisors, who are required by law and practice to make loan quality
judgments).
2. RESCHEDUUNG
The number and magnitudes of country debt rescheduling have in-
creased considerably in the last six years. Since 1956, there have been 53
official debt reschedulings involving 20 countries. Twenty-two of these
involving 13 countries have occurred since 1975. In the recent past, banks
have been a party in renegotiations with seven countries - Turkey, Zaire,
Peru, Nicaragua, Sudan, Jamaica, Poland. Discussions are currently under
way with Rumania, Costa Rica, Senegal and Liberia. The amounts involved
in these reschedulings have varied greatly: $518 million for Peru in 1978,
$421 million for Sudan and $13 billion for Zaire in 1979, $580 million for
Nicaragua and $3 billion for Turkey in 1980. Rescheduling of Poland's debt
repayments of capital due in 1981 alone involved $22. billion. (Poland's
aggregate debt owed to banks outside Comecon, at about $17 billion, is a
different order of magnitude from that of any other country previously
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involved in rescheduling).' Most of the banks' exposure to loans subject to
rescheduling so far, however, have been relatively small in relation to their
capital or earnings.
Concerns
The possibility of a substantially larger rescheduling, or a series of
them, involving large numbers of banks, has created concern whether
processes presently used will be adequate for the debt rescheduling of the
1980s. First, the rescheduling process is not codified and involves large
numbers of participants - official creditors, banks and other private len-
ders, multilateral institutions, the borrower, and sometimes, investment
bankers who are advisors to the borrowers. Second, increasingly serious
consequences may arise from the conflict between creditors' responses
and debtors' needs.
Again, the result of the G-30 survey are pertinent to these issues. Asked
whether existing ad hoc arrangements would be adequate to deal with
more frequent reschedulings involving larger amounts than in the past, 17
per cent said no, 54 per cent were uncertain, and 29 per cent said yes (i.e.,
were content with existing arrangements).
The concerns point to two sets of questions:
1) What are the arrangements usually adopted for rescheduling, their
strengths, weaknesses, and risks?
2) What have the terms of rescheduling been? What have the consequences
been for lenders and borrowers?
The Rescheduling Process
The rescheduling of official debt is handled by the Paris Club, an ad
hoc group of western official creditors which, since 1956, has met infor-
mally when needed under the chairmanship of the French Treasury. Al-
though there are no formal rules, the Paris Club has over the years adopted
a set of unwritten procedures. The common practice is that the request for a
meeting is initiated by the debtor country, generally the creditors have
agreed to convene only after payments arrears have already occurred; and
an agreement is concluded after the borrower has agreed to an IMF
stabilization program. Since the only debt eligible for consideration is
government obligations, the practice has been to include as participants at
the meetings only the borrower and the principal OECD government
Under an agreement signed in April, 1982, repayments of the $2.2 billion in capital that fell
due in 1981 is to start in December 1985 and end in December 1988, with the interest rate for
the sum rescheduled set at 1.75 per cent over LIBOR.
creditors. Observers may inclu
World Bank, the OECD and UN
the amount eligible for reschec
official debt over a 2-3 year pei
Because of the changing
banks have increasingly becor
Hence troubled country borrow
Club or private banks or both.
There is no standard me(
creditors; each case has require
The numbers of bank creditors
nationalities have been large an(
in the case of Nicaragua, over 2C
A small number of lead banks,
steering committee that actually
of the group may be selected t
jointly.
Bank reschedulings have b
ments have taken from 6 month
numerous loan syndications hav
collection of basic data on outst
ber of times the negotiations ha'
Club rescheduling discussions
added to delay.
Even though banks begin
pears imminent, there is still a tt
banks to pull in different directio
agreement on coherent strategy
scheduling by extending a balan
was undercut when some other
term credit lines to Peru. Divisior
to be along national lines. The d
including relative levels of exI
pressures from home governs
and/or capital requirements.
In most reschedulings the
imposing needed economic ad
since 1966 the Paris Club has ri
the borrower has agreed to an I
sometimes made their resched
tance of IMF conditions. In the
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)ans subject to
elation to their
or a series of
ncern whether
heduling of the
involves large
tier private len-
es, investment
asingly serious
:ors' responses
e issues. Asked
to to deal with
t in the past, 17
nt said yes (i.e.,
iris Club, an ad
, has met infor-
:h Treasury. Al-
e years adopted
the request for a
creditors have
y occurred; and
eed to an IMF
:onsideration is
s participants at
:D government
on in capital that fell
th the interest rate for
creditors. Observers may include other government creditors, the IMF,
World Bank, the OECD and UNCTAD. The unwritten rules extend also to
the amount eligible for rescheduling (about 80 per cent of consolidated
official debt over a 2-3 year period) and the repayment terms.
Because of the changing composition of developing country debt,
banks have increasingly become involved in the rescheduling process.
Hence troubled country borrowers may have to seek relief from the Paris
Club or private banks or both.
There is no standard mechanism for rescheduling debt to private
creditors; each case has required than an entirely new process be stated.
The numbers of bank creditors involved in recent reschedulings and their
nationalities have been large and growing -115 banks from 12 countries
In the case of Nicaragua, over 200 creditors for Turkey, and 500 for Poland.
A small number of lead banks, usually a dozen of fewer, have formed a
steering committee that actually participates in discussions. The members
of the group may be selected by the borrower or the major creditors or
jointly.
Bank reschedulings have been costly and time-consuming. Arrange-
ments have taken from 6 months to 4 years to complete. Participants in the
numerous loan syndications have had to be contacted; sometimes primary
collection of basic data on outstanding loans has been necessary. A num-
ber of times the negotiations have had to be coordinated with parallel Paris
Club rescheduling discussions. Procedural quarrels have sometimes
added to delay.
Even though banks begin to "close ranks" once a rescheduling ap-
pears imminent, there is still a tendency for individual banks or groups of
banks to pull in different directions. Thus it has been difficult at times to get
agreement on coherent strategy. A 1976 bankers' attempt to obviate re-
scheduling by extending a balance-of-payments loan to Peru, for example,
was undercut when some other banks simultaneously reduced their short-
term credit lines to Peru. Divisions among banks during a time of crisis tend
to be along national lines. The divergence may have any number of roots,
including relative levels of exposure to a particular country, political
pressures from home governments, or different accounting practices
and/or capital requirements.
In most reschedulings the IMF plays a critical part in devising and
imposing needed economic adjustment programs. As mentioned earlier,
since 1966 the Paris Club has refused to proceed with reschedulings until
the borrower has agreed to an IMF adjustment program. Banks, too, have
sometimes made their rescheduling contingent on the borrower's accep-
tance of IMF conditions. In the case of Peru, banks discovered that they
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alone did not have the sanctions to impose conditions for economic
adjustment
Poland's application to rejoin the IMF aroused expectations that such a
move would facilitate the rescheduling of Poland's 1982 debt repayment
The IMF can play a useful role as a catalyst exerting pressure on both
sides to move towards a settlement Indeed, in the Nicaragua rescheduling,
where the IMF was not itself involved, other multilateral institutions such as
the InterAmerican Development Bank, World Bank, and Central American
Bank for Economic Integration played a somewhat analogous role.
Rescheduling Terms
With few exceptions, rescheduling whether by Paris Club or private
creditors has consisted of a lengthening of maturities of principal repay-
ments at market rates of interest Banks have been particularly insistent on
maintaining commercial terms and (except in the case of Nicaragua) have
thus far upheld the principle that interest payments may not be resched-
uled. Although borrowers have negotiated for lower spreads and fees, they
have tended to accept lenders' determinations of grace periods and final
maturities. For Paris Club debt the average maturity has lengthened only
from 8 to 10 years since 1975. Bankers have rescheduled on similar terms
with average terms of 7 to 10 years with up to 3 years grace at rates of LIBOR
plus 13144 to 2 per cent
Creditors have so far emerged relatively undamanged from reschedul-
ing. Paris Club creditors have undertaken no concessional debt restructur-
ings since 1971. In a present value comparison of official loans before and
after the debt rescheduling over the period 1956-1980, Chandra Hardy
estimated the loss to creditors at only about $2 billion or 0.5 percent of the
total debt outstanding and noted that "since 1975, there has been no loss to
the (Paris Club) creditors."' Although it is not possible to duplicate these
calculations for bank debt, estimates indicate that private creditors have
probably not suffered a financial loss on a present value basis either. From
the borrowers' perspective, however, the terms have been quite onerous,
failing to reflect their likely cash flows and essential adjustment plans. Short
maturities and creditors' insistence on rescheduling only one year's debt at
a time have increased the likelihood of subsequent liquidity problems and
the necessity for a subsequent rescheduling.
- Most members of the study group believe that the present ad hoc
? Chandra Hardy "Rescheduling Developing-Country Debts. 1956-80; Lessons and Recom-
mendations" Overseas Development Council Working Paper. No. 1.
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mechanism may be insuffic
that future reschedulings a
complex, increasing the risi
partly by creating intole4
t. ollectively to be better org,
effectively.
There also appears to I
rescheduling terms are st
opinions about optimum
negotiators. In some case.,
reasonably satisfactory - t
cited. However, in some ca:
argued that the terms have
term view by the banks on
focusing solely on the triter
creditors may either have
economic and political re
sometimes has been to s(
problems later - an event
banks nor the borrower.
There are precedents f
bank relationships with corl
that the balance-of-paymen
from long-term structural
reschedulings will be to rea(
medium-term interest of b
realistically are able to resur
an ideal the study group is r
achieving an optimum arra
subject to different national
sion. "Equal" treatment fo
could mean unequal treatr
interested parties should
debt-servicing difficulties. T
play the leading role in gaini
in a stabilization program. I-
strong case for considerinc
the banking industry to hel
lenders, discuss issues rel
expertise in this area that
lenders (see chapter 7).
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
tations that such a
debt repayment
I pressure on both
qua rescheduling,
stitutions such as
Central American
flogous role.
is Club or private
A principal repay-
:ularly insistent on
f Nicaragua) have
y not be resched-
ads and fees, they
p, Its and final
k chened only
i on similar terms
at rates of LIBOR
d from reschedul-
jl debt restructur-
loans before and
1, Chandra Hardy
0.5 percent of the
as been no loss to
o duplicate these
to creditors have
'asis either. From
'n quite onerous,
rent plans. Short
one years debt at
ity problems and
present ad hoc
Lessons and Recom-
mechanism may be insufficient for the needs of the 1980s. They emphasize
that future reschedulings are likely to be larger, more numerous and more
complex, increasing the risks that the present system will prove inadequate,
partly by creating intolerable delays. Most, then, see a need for banks
collectively to be better organized to handle their role in rescheduling more
effectively.
There also appears to be a need for re-thinking the principles on which
rescheduling terms are struck It is nearly always true, of course, that
opinions about optimum terms for debt repayment will differ among
negotiators. In some cases, the outcome appears thus far to have been
reasonably satisfactory - the experience of Turkey and Jamaica may be
cited. However, in some cases of sovereign debt reschedulings it has been
argued that the terms have been based on an excessively narrow or short
term view by the banks on their own best interest On this argument, by
focusing solely on the criterion of reaching an agreement on market terms,
creditors may either have failed to recognize or turned a blind eye to
economic and political realities confronting the borrowers. The result
sometimes has been to set in place conditions likely to result in more
problems later - an eventuality that is in the best interest of neither the
banks nor the borrower.
There are precedents for less rigid approaches to debt restructuring in
bank relationships with corporate borrowers. Given increasing recognition
that the balance-of-payments problems of many borrowing countries stem
from long-term structural development needs, the challenge for future
reschedulings will be to reach terms that strike a better balance between the
medium-term interest of banks and the timescale over which borrowers
realistically are able to resume full debt service. While putting this forward as
an ideal the study group is nevertheless aware of the practical difficulties of
achieving an optimum arrangement Banks in international syndicates are
subject to different national taxes and national regulatory laws and supervi-
sion. "Equal" treatment for a borrower in an international rescheduling
could mean unequal treatment for lenders. The essential point is that all
interested parties should get together at an early stage in a country's
debt-servicing difficulties. The study group feels that the IMF should usually
play the leading role in gaining acceptance by all parties to the key elements
in a stabilization program. However, in the group's judgment, there is also a
strong case for considering the establishment of a representative body for
the banking industry to help improve the flow of information available to
lenders, discuss issues related to debt servicing difficulties and develop
expertise in this area that would be of assistance to both borrowers and
lenders (see chapter 7).
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3. INTERNATIONAL. INTERBANK MARKET
The international interbank market links banks to one another much
as domestic money markets link banks within national markets. The market
owes its existence to the need of banks to be able to bid for funds of a
particular maturity to fund a loan of a similar maturity and their need to lay
off unwanted deposits with other banks. Funds are thus shifted within the
international banking system - and between the international market and
domestic markets - as banks take deposits from and/or place deposits
with one another. The market serves an important intermediary function
between savers and borrowers on a global basis. By reallocating funds in
the same currency among banks, it also permits participants to generate
and/or manage liquidity.
Initially limited to transactions among major multinational banks, the
market has grown from a few hundred banks in the mid-1970s to well about
1,000 banks from more than 50 countries by 1981.
According to BIS estimates, the size of the market grew from about
$182 billion in 1975 to $522 billion in June, 1981. The world's largest banks
play a predominant role in the international interbank market The banks to
which they lend typically relend a certain proportion as well. Most banks
participate actively on both sides of the market Reliance on interbank
funding tends to be higher for smaller banks and newcomers in the interna-
tional market, banks without a U.S. dollar base, and consortium banks. The
market constitutes an indispensable source of funds for many banks'
international activity, a recent study suggests that interbank deposits ac-
count for between two thirds and three-quarters of total external and
Eurocurrency deposits.'
Two features deserve special mention - the practice of redepositing
and the classification of banks according to perceived riskiness ("tiering").
It is not uncommon for funds from nonbank depositors to pass through a
chain of interbank transactions before finding an ultimate borrower outside
the banking system. Active trading on both sides of the market may
accomplish one or more of the following purposes: (1) keeping the bank's
name in the market; (2) enhancing the size of bank by increasing total
footings; (3) establishing reciprocal relationships that will assure access to
liquidity, or access at a reasonable price, in event of a squeeze (banks that
only take funds are said to fare especially poorly when markets are tight); (4)
gathering current market intelligence about both changing conditions of
supply and demand in the market and the market's sense of the needs and
'J.G. Ellis, "Eurobanks and the Interbank Market" Bank of England Quarterly Bulletin.
September 1981.
conditions of individual participai
banks re-deposit more than 40 pe
the largest banks) of interbank de
The perceived risks of placir
been reflected in pricing tiers and/
differences in rate between therr
uncertainty. The Herstatt collapse
ing in the foreign exchange marke
instance of pricing tiers; some bai
However, the pattern of interbank
months.
In current practice, differentiati
may be more significant than the
study group's survey confirms, ban
and overall limits for the funds the
These are usually not disclosed, cot
limits set by credit officers as para
There are two levels of risk
individual banks based on their par
ity and risk for the system as a who
sides of the market, they are confrc
Second, and more importantly, thet
of the interbank linkages even sow
problem caused elsewhere in the s~
the case of the UK fringe banking cr
suffered.
The above-mentioned survey
majority of banks feel that interban
because of a change in the com
proportion of interbank borrowing
banks). And bankers rated "unava
potential threat to individual banks,
a major country debtor."
The concerns that have been
can be summarized as follows:
? Now have banks and bank SL
the market?
? Has risk in international bar
interbank market? Do the inl
bute to its instability or stabii
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
MARKET
> one another much
narkets. The market
bid for funds of a
rnd their need to lay
is shifted within the
rational market and
i/or place deposits
ermediary function
'allocating funds in
:ipants to generate
rational banks, the
1970s to well about
t grew from about
r! rgest banks
rkc.. The banks to
well. Most banks
nce on interbank
ters in the intema-
)rtium banks. The
for many banks'
sank deposits ac-
)tal external and
e of redepositing
ciness ("tiering").
pass through a
Borrower outside
he market may
:ping the bank's
increasing total
rssure access to
?eze (banks that
ets are tight); (4)
g conditions of
-f the needs and
conditions of individual participants. The bank survey shows that most
banks re-deposit more than 40 per cent (nearly 60 per cent in the case of
the largest banks) of interbank deposits.
The perceived risks of placing deposits with particular banks have
been reflected in pricing tiers and/or credit limits. The number of tiers and
differences in rate between them tend to increase in times of market
uncertainty. The Herstatt collapse of 1974, though originating in overtrad-
ing in the foreign exchange market, appears to have provoked an extreme
instance of pricing tiers; some banks paid as much as 2% above LIBOR.
However, the pattern of interbank rates returned to normal within a few
months.
In current practice, differentiation among banks in terms of credit lines
may be more significant than the minimal tiering in deposit rates. As the
study group's survey confirms, banks in the market typically establish daily
and overall limits for the funds they will place with (loan to) other banks.
These are usually not disclosed, committed lines but are internally imposed
limits set by credit officers as parameters for bank traders.
Risks and Concerns
There are two levels of risk associated with the market - risk for
individual banks based on their particular characteristics and market activ-
ity and risk for the system as a whole. First, since banks participate on both
sides of the market, they are confronted with both credit and funding risks.
Second, and more importantly, there is an underlying concern that because
of the interbank linkages even sound banks might not be immune from a
problem caused elsewhere in the system because of the knock-on effect. In
the case of the UK fringe banking crisis of 1974, even perfectly sound banks
suffered.
The above-mentioned survey by the Group of Thirty showed that a
majority of banks feel that interbank activity may be becoming more risky
because of a change in the composition of the market (an increasing
proportion of interbank borrowing being done by second and third tier
banks). And bankers rated "unavailability of interbank funds" as great a
potential threat to individual banks, though not to the system, as "default by
a major country debtor."
The concerns that have been articulated in the press and elsewhere
can be summarized as follows:
? How have banks and bank supervisors responded to the funding risks in
the market? g
? Has risk in international banking increased because of growth in the
interbank market? Do the inherent characteristics of the market contri-
bute to its instability or stability?
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Banking Practices
In the past, banks were "often prepared to lend on an interbank basis
with relatively little financial analysis or personal knowledge of the borrow-
ing bank ... on the implicit assumption that a participant in the market
possessed sufficient capital resources, support from stockholders (or par-
ent bank) or a potential call on central bank assistance to be able to meet its
obligations."10 In 'the aftermath of the international banking crisis of 1974,
banks began to review this assumption, tightening and improving their
credit analysis practices, utilizing stricter limits and controls, and developing
more direct personal contacts.
Many banks now treat deposit placement lines in the same way as
credit lines, basing overall limits and individual transaction limits on as-
sessments of creditworthiness, including consideration of country risk (99
per cent of respondents to the G-30 survey said that country risk played a
significant role in determining interbank placement and credits).
Four factors may influence decisions. First, financial statements may
be analyzed. Some banks do a careful analysis of even the largest banks,
supplemented by visits by bank staff. Banks without the resources to collect
and compile financial information themselves can purchase balance sheet
and income statement data along with some standard ratios from several
outside sources.
There are problems, however, in interpreting annual reports because
accounting conventions and disclosure practices vary widely. For this and
other reasons, banks themselves as well as some of the new credit informa-
tion services, place a great deal of emphasis on a second set of factors.
These are the ownership of a bank (and the nature of its relationship to its
parent institution, if there is one) and the bank's national support systems
- the quality and degree of bank supervision and consideration of lender of
last resort facilities; 69 per cent of respondents to the G-30 questionnaire
said that they evaluated the willingness of the other bank's government or
central bank to come to its aid in adversity. Third, banks watch for unpro-
fessional money market dealings and evidence of overtrading. (This, too
has its limits since skillful liability management can hide problems, al-
though for only a short time). Finally, banks, to varying degrees, strive for a
qualitative assessment of management.
However, not all banks exercise the same degree of care. Some banks
omit or do only a cursory analysis of the very largest banks; some apply
general rules of thumb, e.g., considering the largest banks in the world or in
any country to be unquestionably creditworthy; and others appear to rely
heavily on the judgment of their correspondents. The G-30 survey provides
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some evidence to support f
that all the banks with whicl
be backed up by their ce
countries.
Although many banks
commitment fees for these
assured, and may indeed dr
Many banks therefore take c
overall relationships with of
important Banks employ v,
to gauge as well as possible
and in different currencies a
may be developed to recipe
deliberately cultivated as w,
Supervisory Practices
As with banking practi(
supervision of banks with n
Beyond qualitative supervisi
liquidity requirements or gu
placing outside bounds 01
liabilities. (See Appendix D;
survey reported that their t
their bank's international int
Support Mechanisms and
The market as a whole
shocks, as was demonstrate
freeze. This may be partly t
tional interbank market tend
response to a shock, becat
system. As a result, there i!
adjusted rate differentials) a
dente.
However, it is always it
mistrust In the case of serf
rests critically on a rapid r
depend also on the assure
market's ultimate depenc
heightened by the nature o
discretionary, some degree
crisis. To the extent that this
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
on an interbank basis
wledge of the borrow-
ticipant in the market
stockholders (or par-
to be able to meet its
inking crisis of 1974,
and improving their
,trols, and developing
in the same way as
action limits on as-
n of country risk (99
ountry risk played a
nd credits).
'a' statements may
the largest banks,
resources to collect
hase balance sheet
ratios from several
al Irts because
'idc.,, For this and
ew credit informa-
)nd set of factors.
relationship to its
support systems
ration of lender of
30 questionnaire
s government or
watch for unpro-
ading. (This, too
le problems, al-
Irees, strive for a
re. Some banks
ks; some apply
the world or in
appear to rely
survey provides
some evidence to support the contention that some banks act on the faith
that all the banks with which they place deposits are well regulated and will
be backed up by their central banks, even outside the Group of Ten
countries.
Although many banks assure the availability of standby lines (paying
commitment fees for these when necessary), interbank lines are not always
assured, and may indeed dry up for any individual bank when most needed.
Many banks therefore take great care to maintain and test lines and cultivate
overall relationships with other banks. Diversification of sources is clearly
important Banks employ various techniques to monitor their lines and try
to gauge as well as possible how much they can tap from different sources
and in different currencies and maturities. Additional business relationships
may be developed to reciprocate for lines, and personal contacts may be
deliberately cultivated as well.
Supervisory Practices
As with banking practices, it is difficult to make generalizations about
supervision of banks with respect to their activity in the interbank market
Beyond qualitative supervision of bank practices, the capital adequacy and
liquidity requirements or guidelines of bank supervisors would play a role in
placing outside bounds on the aggregate level of a bank's interbank
liabilities. (See Appendix D). About one third of banks responding to our
survey reported that their home supervisory authority does not monitor
their bank's international interbank lending and deposit placement activity.
Support Mechanisms and System Stability
The market as a whole has so far been resilient in the face of external
shocks, as was demonstrated by the moderate reaction to the Iranian asset
freeze. This may be partly because the breadth and depth of the interna-
tional interbank market tend to limit the damage when funds are switched in
response to a shock, because that causes no net loss of liquidity to the
system. As a result, there is a greater chance for a reflow of funds (with
adjusted rate differentials) as long as there is no generalized loss of confi-
dence.
However, it is always important to prevent the spread of contagious
mistrust In the case of serious shock, smooth functioning of the market
rests critically on a rapid restoration of confidence and may therefore,
depend also on the assurance of adequate support mechanisms. The
market's ultimate dependence on official support mechanisms is
heightened by the nature of market relationshps. Siiice deposit lines are
discretionary, some degree of credit rationing appears likely in a general
crisis. To the extent that this occurs, banks faced with a sudden unavailabil-
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16-632 0 - 83 - 14
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ity of funds and unable to obtain new funds by raising rates would be at least
temporarily reliant on official support
There are various forms official support may take - including lender
of last resort and other, ad hoc arrangements. For the interbank market, the
somewhat paradoxical role of these mechanisms in their dormant state, i.e.,
short of actually being called into action, is to maintain a degree of am-
biguity as to when and under what circumstances an individual bank will be
given support while at the same time sustaining confidence that shocks to
the system will be controlled and neutralized. The ambiguity serves on the
one hand to induce discipline on the part of market participants while at the
same time fostering confidence sufficient to ensure that shocks will not
trigger panic. Hundreds of new participants have entered the interbank
market in recent years, many of them relatively small. The quality of
supervision of a number of such banks from outside the major countries
and uncertainty about access they might have to lender of last resort
facilities in time of crisis leaves cause for concern.
Conclusions
The interbank market has functioned remarkably well; its considerable
breadth, liquidity, and efficiency enable the international banking system to
accomplish its enormous recycling task smoothly. The major change in the
market is the proliferation in participants that has introduced second- and
third-tier banks and banks from a number of non-GIO countries to the
system. This bears on both the risks facing individual banks and the system
risk and is the main reason why banks themselves feel that the riskiness of
the market has increased.
It appears from the survey results that banking practices have changed
in response, although the extent to which this is true is difficult to gauge. The
treatment of bank deposit facilities as credit lines is a positive development;
it is just as important for banks to perform careful credit analysis when
lending to other banks as when lending to non-bank borrowers. Similarly,
effective monitoring and management of funding risks are highly desirable.
For large, well known banks, taking interbank deposits may not pre-
sent funding risks significantly different from other types of interest-
sensitive, short-term liquid liabilities. However, smaller banks, newcomers,
and banks without an established funding base are more vulnerable than
the major multinational banks to increased tiering of rates or unavailability
of funds in the event of a loss of confidence. The possibility of a re-
emergence of steeper tiering or withdrawal of standby lines under adverse
market conditions, which would naturally have a particularly marked effect
on banks that are large 'net takers' of interbank funds, should add an
element of self-discipline for all participants. Because of such consid-
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erations, and the lack o
ascertaining the ultimat,
inter-bank market bank F
less than it appears to b
It would seem approp
market to exercise spec
proach to interbank func
increase in activity in Eun
overall deposit-taking at
funding obtained througl
because it does not can
relationships which man,
It is worth emphasise
risk than any other type o
that supervisory authoriti
continued stability of sucl
to, or place deposits with.
of the quality of manage
concerned, the economic
resides and a judgment c
willingness and ability to i?
support in an emergency
4. MATURITY TI
While the practice of n
its at one maturity and lend
mediation, perceived cha
have prompted renewed
borrowers' market has at t
the liability side, typical 0
been reinforced by rising
other depositors as well to
Competition in loan
lengthening of lending ma
putting pressure for extra
same time, a shift in the U
management of monetary
accompanied by great vola
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ke - including lender
interbank market, the
heir dormant state, i.e.,
-lain a degree of am-
individual bank will be
fidence that shocks to
nbiguity serves on the
articipants while at the
e that shocks will not
entered the interbank
small. The quality of
e the major countries
lender of last resort
y well; its considerable
nal banking system to
ie major change in the
roduced second- and
GIO countries to the
banks and the system
el that the riskiness of
actices have changed
difficult to gauge. The
positive development;
credit analysis when
borrowers. Similarly,
s are highly desirable.
eposits may not pre-
er types of interest-
,r banks, newcomers,
pore vulnerable than
rates or unavailability
possibility of a re-
y lines under adverse
cularly marked effect
Inds, should add an
ise of such consid-
erations, and the lack of 'transparency of the market - the difficulty in
ascertaining the ultimate sources and uses of funds - reliance on the
inter-bank market bank placements as a source of effective liquidity may be
less than it appears to be.
It would seem appropriate for smaller banks and new entrants to the
market to exercise special care and take a relatively more cautious ap-
proach to interbank funding, but it is not clear that all of them do so. The
increase in activity in Euro-market brokers may reflect a relative increase in
overall deposit-taking and placing by less well established banks, and
funding obtained through brokers may be less reliable in times of difficulty
because it does not carry with it the backing of business and personal
relationships which many banks have cultivated.
It is worth emphasising that a bank is not necessarily a better or worse
risk than any other type of borrower even though it is increasingly the case
that supervisory authorities in each country pay special attention to the
continued stability of such institutions. Decisions to extend credit facilities
to, or place deposits with, a bank must therefore be made on an assessment
of the quality of management and fundamental strength of the bank
concerned, the economic and political condition of the country in which it
resides and a judgment of the quality of supervision in that country. The
willingness and ability to its central bank to provide "lender-of last resort"
support in an emergency should not be taken for granted.
4. MATURITY TRANSFORMATION
While the practice of maturity transformation, namely receiving depos-
its at one maturity and lending at another, is an integral part of financial inter
mediation, perceived changes in Euromarket conditions and practices
have prompted renewed attention to the subject. On the asset side, a
borrowers' market has at times produced a lengthening of maturities. On
the liability side, typical OPEC preferences for short-term deposits have
been reinforced by rising short-term interest rates which have induced
other depositors as well to seek shorter terms.
Competition in loan markets has at times resulted not only in a
lengthening of lending maturities, but also a shrinkage of loan margins,
putting pressure for extra income on other bank activities. At about the
same time, a shift in the U.S. approach to monetary policy, emphasizing
management of monetary aggregates vs. short-term interest rates, was
accompanied by great volatility of U.S. rates 4and hence Euromarket rates,
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
making portfolio management more difficult In 1980 and early 1981,
substantial losses on mismatched Positions were reported by a number of
major multinational banks. Others, however, profited from the new volatility
of interest rates. This greater volatility increases both the risks and possible
rewards of mismatching.
It is important to try to distinguish the two components of risk in
maturity mismatching - interest rate risk and funding (liquidity) risk-and
to understand how Euromarket practices affect each. The interest rate risk
component is to a great extent alleviated (but not eliminated) by floating
rates and the rollover technique which pass interest rate risk on to the
borrower. The effect in a period of rising interest rates is to increase credit
risk. The extent to which a bank covers itself against interest rate risk
depends for the most part on how closely it matches liability maturities to
the rollover maturities in its assets. If a loan that is repriced every six months
is funded with 30-day money, the bank's exposure to potentially adverse
changes in market rates of interest is not fully covered. In addition, smaller,
less well-known banks would continue to be vulnerable to increased tiering
of rates even if liabilities were completely matched to asset rollover dates.
The rollover mechanism does not, however, neutralize funding risk -
that is, the possibility that a bank may be unable to tap resources to meet its
continuing obligations. For the market as a whole, supply and demand are
kept in balance by interest rates; however, the market response for particu-
lar banks in different circumstances can vary considerably. Banks with
established names can reasonably expect to tap even a large amount of
funds, when needed, and at relatively advantageous rates. For smaller, less
well known banks, particularly relative newcomers or ones without a con-
nection to the U.S. dollar market, the funding risk may be a real one.
Bank Practices
In the 1970's many banks began to re-examine procedures for asset
and liability management with an eye to greater global coordination. Most
banks monitor their liquidity positions with some care. As in the case of
foreign exchange positions, top management sets general policy for matur-
ity mismatches and puts limits on discretionary decisions by lower manag-
ers, based on assumptions about movements in rates. The range of practi-
cal approaches to fund management runs from centralized global control
to decentralized, local (profit center) control. Neither way is clearly superior,
there are advantages and disadvantages to both. Banks' actual practices
vary. About 40 per cent of banks participating in the G-30 survey indicated
that they had reduced limits in reaction to greater risks posed by the current
volatility of interest rates.
Supervisory Practices
Bank supervisors,
ment that may arise fro
parison of the approach
difficult by the variety of
wide institutional differe
participating in the survr
their mismatched posit,
Because of the inz
Banking Supervision an
Mr. Peter Cooke has b,
uniform reporting syster
maturity mismatching,
ness.
A number of superv
their banks to fund a pro
with long-term foreign ci
currency business, bank;
who is itself the issuer of
Conclusions
Available maturity s
conclusions about wheth,
by bank supervisors to irr
thus a positive developme
is important that the cover
worldwide business.
Yet even if no worser
place most bankers and.
volatility has tended to inc
This increased risk requir
course, losses themselves
greater discipline in bank
sponsible for their own m
concerned to ensure that
5. DISTRESSED
The growth of the inrn
potential range of problerr
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
)80 and early 1981,
xrted by a number of
rom the new volatility
he risks and possible
mponents of risk in
(liquidity) risk-and
The interest rate risk
minated) by floating
rate risk on to the
is to increase credit
ist interest rate risk
!lability maturities to
ed every six months
potentially adverse
In addition, smaller,
to'-'reased tiering
s, allover dates.
alize funding risk -
esources to meet its
ply and demand are
?sponse for particu-
lerably. Banks with
a large amount of
s. For smaller, less
ones without a con-
y be a real one.
rocedures for asset
coordination. Most
?. As in the case of
ral policy for matur-
es by lower manag-
-he range of practi-
lized global control
is clearly superior,
s' actual practices
10 survey indicated
ased by the cuffent
Supervisory Practices
Bank supervisors are aware of special problems in liquidity manage-
ment that may arise from banks' international operations. But direct com-
parison of the approaches adopted by different supervisors is rendered very
difficult by the variety of techniques used to measure "transformation" and
wide institutional differences. It may be noted, that about one third of banks
participating in the survey said that supervisors' performance in monitoring
their mismatched positions was "poor' or "fair".
Because of the inadequacy of existing statistics, the Committee on
Banking Supervision and Regulatory Practices under the chairmanship of
Mr. Peter Cooke has been working to try to encourage and develop a
uniform reporting system to be used by the BIS to collect data on banks'
maturity mismatching, particularly with regard to their international busi-
ness.
A number of supervisors (e.g., France, Japan) have increasingly urged
their banks to fund a proportion of their long-term foreign currency assets
with long-term foreign currency liabilities, partly at least because in foreign
currency business, banks have no automatic lender of last resort to turn to
who is itself the issuer of the currency in question.
Conclusions
Available maturity structure data make it impossible to reach any
conclusions about whether the degree of mismatch has worsened. Efforts
by bank supervisors to improve the collection of statistics of this kind are
thus a positive development and for these statistics to be fully meaningful it
is important that the coverage of data should embrace international banks'
worldwide business.
Yet even if no worsening of trends on a consolidated basis has taken
place most bankers and study group members believe that interest-rate
volatility has tended to increase riskiness of traditional mismatch practices.
This increased risk requires banks to be more cautious. Furthermore, of
course, losses themselves will tend to have the healthy effect of inducing
greater discipline in bank practices. Whilst banks' managements are re-
sponsible for their own mismatching practices, supervisors must also be
concerned to ensure that these are prudently established and operated.
5. DISTRESSED BANKS
The growth of the international banking system has increased the
potential range of problems created by bank failure. The problems of a
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
single bank, unless contained, could have an impact through the interna.
tional interbank market; banks and banking systems are always vulnerable
to confidence crises. Moreover, the transnational structure of the interna-
tional banking system and the potential global spread of contagion have
enormously complicated the management and resolution of bank failures
and distressed bank situations.
Three different cases of bank failures in the last decade illustrate some
of the international ramifications such occurrences may have, not only the
unfolding distress of the bank itself, but also the nature, extent, and timing of
crisis resolution by national banking authorities.
? In June 1974, the Bankhaus I.D. Herstatt, which had incurred large foreign
exchange losses, was abruptly closed by the German Federal Supervisory
Authority for Credit Matters. The collapse of the bank shocked the mar-
kets, which had not previously demanded risk premia for interbank trans-
actions. After the Herstatt crisis, rate tiering appeared, and many sound
banks had difficulty getting access to funds simply on the ground of being
small
In addition, by closing Herstatt at the end of the banking day in
Cologne but just after the beginning of the banking day in New York where
scores of Herstatt's foreign exchange contracts were in the midst of
settlement, the German authorities inadvertently interrupted the interna-
tional payments mechanism. Herstatt's principal New York clearing bank,
Chase Manhattan, froze the account Debit orders were not honored;
credits coming in were not returned. A race for Herstatt's New York assets
by its creditors from around the world ensued.
? At about the same time as Herstatt's problems were becoming more
visible in the spring of 1974, U.S. banking authorities were in the midst of a
protracted attempt to prevent the collapse of Franklin National Bank then
the 20th largest bank in the United States. A decision by the Federal
Reserve Bank of New York to provide emergency liquidity assistance in
substantial amounts had as one of its two main objectives prevention of
"the severe deterioration of confidence, at home and abroad, that would
have resulted from an early failure of the bank" (Federal Reserve Bank of
New York, Annual Report, 1974.)
The same concern for international market stability, which was
shared by other central banks as well, also prompted the Federal Reserve
to acquire Franklin's foreign exchange book when the market, fearing the
bank would fail to perform on contracts, began to refuse to sell foreign
exchange to Franklin.
Because Franklin had a large London branch, management of the
problem required the Bank of England's cooperation at two junctures.
First, during the months of liquidity assistance, the steadily increasing
need for collateral for Franklin's borrowings from the Federal Reserve
required the use of assets at the London branch. Second. the ultimate
solution, a purchase and assumption transaction, required that the Bank
of England help to secure the necessary approvals under English law for
transfer of Franklin's London assets to the FDIC which acted as receiver
prior to the sale to European-American Bank
? In the spring of 1980? Argentina's Central Bank ordered the liquidation of
Banco Intercambio Regional (BIR), the country's second largest private
bank The exposure of foreign banks was about $80 million. Foreign
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currency deposits
plan. Moreover, Arg,
to accept responsit
York State Banking
be able to pay off c
The liquidation
nian banks. The Arg
$2 billion to avoid
meantime, the cow
reserves had begun
worry about the adc
prolonged banking
Concerns about distn
international financial mart
of interdependence amor
doubts about the ability of (
and contain future crises
A majority of bankers
agreement with the prop(
would be vulnerable to a c
significant bank or group
suggested that they considt
two-thirds said, however, tt
of lender of last resort fact
Two distinct lines of c
? Do individual natior
judgment) and willi
? Given the complex
system, is there suffi
responsible for whit
Crisis Management Mech
The organization of
different national legislatic
other countries, rescue re'
that respond to illiquidity z
tion, of course, is not easy
sometimes required to mi
central bank has responsit
insolvency, though this is t
latter countries there are (
Crisis management rr
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
erna-
:rable
:erna-
have
Silures
some
rly the
ping of
oreign
rvisory
e mar-
t trans-
sound
f being
day in
c where
lids' of
n .
9
mored;
(assets
3 more
dst of a
k, then
Federal
ance in
ntion of
,t would
Bank of
ch was
Reserve
.ring the
foreign
t of the
nctures.
.reasing
Reserve
ultimate
he Bank
- law for
receiver
cation of
.t private
Foreign
currency deposits were not covered by Argentina's deposit insurance
plan. Moreover. Argentinian authorities, claiming lack of authority, refused
to accept responsibility for claims on BIR's New York branch. The New
York State Banking Department took possession of the branch, hoping to
be able to pay off depositors and creditors by selling branch assets.
The liquidation of BIR triggered a run on deposits at other Argenti-
nian banks. The Argentine Central Bank was forced to inject an estimated
$2 billion to avoid a collapse of the private banking system. In the
meantime, the country's $10 billion accumulation of foreign exchange
reserves had begun to drain away, leading some concerned observers to
worry about the adequacy of Argentina's resources to meet a potentially
prolonged banking crisis.
Concerns
Concerns about distressed banks and their impact on the stability of
international financial markets spring from perceptions of the large degree
of interdependence among banks from all over the world and market
doubts about the ability of existing lender-of-last-resort facilities to manage
and contain future crises of potentially global proportions.
A majority of bankers participating in the G-30 survey expressed their
agreement with the proposition that "the international banking system
would be vulnerable to a chain collapse in the event of a crisis affecting a
significant bank or group of banks", although supplementary comments
suggested that they considered this eventuality to be improbable. More than
two-thirds said, however, that there was "a need for clearer understanding
of lender of last resort facilities."
Two distinct lines of questions are raised by such firm comments:
? Do individual national authorities have the capacity (powers, resources,
judgment) and willingness to act to avert an international crisis?
? Given the complex transnational structure of the international banking
system, is there sufficient clarity of responsibility, i.e., which central bank is
responsible for which banking institution?
Crisis Management Mechanisms
The organization of nations' crisis management systems reflects
different national legislation and policies. In the United States and a few
other countries, rescue responsibilities are divided among the institutions
that respond to illiquidity and those that deal with insolvency. The distinc-
tion, of course, is not easy to draw, and interaction of the two functions is
sometimes required to meet emerging problems. In some countries, the
central bank has responsibility for handling crises both of illiquidity and of
insolvency, though this is by no means true of all. However, in some of the
latter countries there are other institutions for dealing with insolvency.
Crisis management mechanisms may take a number of forms, includ-
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ing lender of last resort facilities, deposit insurance and ad hoc arrange-
ments. Regardless of the original source or nature of an individual bank's
problems, what triggers a crisis of confidence for the whole banking system
is a liquidity crisis. In order to stave off or contain such a crisis, authorities
must be able to provide needed liquidity quickly to avoid a panic run on
deposits. Hence debates about dealing with distressed banks in an interna-
tional context have tended to concentrate on lender of last resort facilities.
In the classic view, a lender of last resort is an institution which has the
responsibility to provide the residual liquidity needs of the financial system
rather than to specific institutions. These may arise in day-to-day activity or
in emergency situations. In the latter case, the lender of last resort may
prevent and neutralize the impact of financial shocks by lending to institu-
tions during periods of crisis and by acknowledging its duty to lend in the
future. In fact, the presence of a lender of last resort alone may be sufficient
to sustain public confidence.
At the same time, the efficacy of lender of last resort and other kinds of
support arrangements requires that they should not be viewed as providing
an unconditional guarantee. Such a guarantee would have the perverse
effect of encouraging some banks to take undue risks in the belief that if
they got into trouble rescue by national authorities was assured.
The development of lender of last resort facilities and other types of
crisis management mechanisms is closely related to the degree of maturity
of a country's banking system. Such facilities are usually not questioned for
the G-10 and other industrialized countries. However, as already noted, the
increasing participation in the international system of banks from develop-
ing countries has given rise to some unease, in large part because the
quality and commitment of their national support arrangements are not
clear.
The transnational structure of the international banking system poses
additional questions of access to lender of last resort facilities for several
types of banking institutions. These include foreign subsidiaries and par-
ticipations and sometimes even foreign branches which, in a crisis, may be
unable to obtain access to their parents' lender of last resort. Increasing
numbers of multinational consortium banks add their own element of
uncertainty.
The Response of Banks After Herstatt
Since 1974, the behavior of banks in the interbank market has re-
flected varying perceptions of the support that may be made available to a
distressed bank. Some banks treat possible unwillingness or inability of a
central bank to support its national banks as part of country risk and may
extend or withdraw credit lines as their analysis of circumstances dictates
(See answer to Questi
attempts to determine %
large and/or govemmc
believed to be in distre
rests on the belief that t
then continue to lend it
avoid crisis while other.
tinue to extend credit n
take advantage of relatih
from having proved the
The Response of Major
With the events of
potential need for concc
was considered at a me(
1974. The statement tl
public concerns should
available but, in order to
stances under which sup
specified. Specifically, th
announced that, after cor
Euromarkets, "they reco<
advance detailed rules
liquidity." But they were
and will be used if and
Conclusions
The study group belie
feature of a lender of last r
and conditions under whic
distress would have the c
pline. At the same time, the
need for clearer understan
6. COMPETITIO
CAPITAL
In explaining the nary
greatest weight to supply ai
by lenders seeking to enter
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id hoc arrange-
ndividual bank's
banking system
risis, authorities
a panic run on
ks in an interna-
resort facilities.
)n which has the
financial system
o-day activity or
last resort may
nding to institu-
ty to lend in the
iay be sufficient
d other kinds of
'ed as providing
re perverse
h. lief that if
sured.
I other types of
3ree of maturity
questioned for
eady noted, the
from develop-
rt because the
!ments are not
3 system poses
ties for several
iaries and par-
r crisis, may be
ort Increasing
vn element of
narket has re-
available to a
)r inability of a
1 risk and may
inces dictates
(See answer to Question 50 in bank survey). Such analysis may include
attempts to determine whether rescue efforts might be forthcoming only for
large and/or government-owned banks. Once a bank is actually known or
believed to be in distress, continued extension of credit from other banks
rests on the belief that the authorities will provide support Some banks will
then continue to lend in an effort to maintain confidence in the system and
avoid crisis while others withdraw deposits or lines; some banks that con-
tinue to extend credit may be additionally motivated by the opportunity to
take advantage of relatively high rates and the hope of benefiting, over time,
from having proved themselves "friends in need".
The Response of Major Central Banks
With the events of 1973 and 1974 as a catalyst, recognition of the
potential need for concerted action in the event of international problems
was considered at a meeting of the world's major central banks in Basle in
1974. The statement they issued reflected the classical model, that is,
public concerns should be put to rest with assurance that support is
available but, in order to keep the markets disciplined, the exact circum-
stances under which support would be forthcoming should not be formally
specified. Specifically, the Governors of the G- 10 and Swiss central banks
announced that, after considering the problem of lender of last resort in the
Euromarkets, "they recognized that it would not be practical to lay down in
advance detailed rules and procedures for the provision of temporary
liquidity." But they were "satisfied that means are available for that purpose
and will be used if and when necessary."
Conclusions
The study group believes that some degree of ambiguity is a necessary
feature of a lender of last resort facility. Any move to spell out specific terms
and conditions under which assistance would be made available to banks in
distress would have the detrimental effect of undermining market disci-
pline. At the same time, the strong views of commercial banks that there is a
need for clearer understanding of lender-of-last-resort facilities were noted.
6. COMPETITION, PROFITABILITY AND
CAPITAL
In explaining the narrow spreads on international loans bankers give
greatest weight to supply and demand conditions and to aggressive pricing
by lenders seeking to enter new markets or expand market share. The entry
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of new banks into the Euromarket and expansion of international activities
by previously established institutions have obviously maintained intensely
competitive conditions. For example, data on syndicated loans collected by
the World Bank suggest that there may be as many as 10 times the number
of lending institutions in the syndicated loan market today as there were in
1972. Of those that the World Bank identified by name (institutions in the
first nine or ten manager positions), one-third of 1980's syndicated loan
managers are headquartered outside Europe or North America, compared
to only one-eight in 1973: See Appendix C.
Concerns
Perceptions of increasing risk in international lending are frequently
accompanied by concern that, with spreads on loans squeezed by intense
competition, returns are not commensurate with risk. Moreover, there is
concern that the narrow margins lead to lower profits, thus impairing banks'
ability to maintain adequate capital ratios.
The remainder of this section will explore the following questions:
? What is the relationship between quoted spreads and bank profitability?
? How have banks responded to narrower margins?
? Does competitive pressure come particularly from some banks with
competitive advantages?
? What has the supervisory response been?
The Effect of Spreads on Profitability
Quoted spreads are a guide to establishing borrower costs, not
measuring profit margins, if only because banks' average costs of funds are
usually below UBOR, front-end fees on loan agreements provide further
compensation and there is the unquantifiable benefit of other business kept
or gained.
In general, large banks enjoy wider gross lending margins because of
their lower average cost of bought-in funds. They and banks that take lead
roles are more likely to gain more also from fees and related business.
Participants that do not have such advantages - or have them to a lesser
extent - have some offsetting benefit, however, since they do not incur as
much indirect (non-funding) costs as the lead banks.
The question of what level of spreads is "acceptable," i.e., likely to
generate an adequate net return, is a very difficult question for any individual
bank. Analysis of the profitability of international lending, and international
operations generally, poses problems which include allocating indirect
costs. It has been reported that many bankers have been dissatisfied with
their own internal data and profit-center analyses. The difficulty of account-
ing for the true economic cost of rescheduled loans, discussed earlier,
further complicates the issues.
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Follow-up interviews :
"guesstimates" on profite
true gross return at about
estimated their breakeven
elements of front-end fee
The record shows 0
erosion of loan spreads.
maintain market presence
the line at a given "accept,
of its loan portfolio.
Sources of Pressure on I
Some banks have co
tory regime within which t
relatively low margins an(
because there is less emF
banks or savings banks
differences in reserve requ
have an impact on comp(
be manipulated to promc
However, not all corn
tory advantages. For exam
more aggressive pricing
times. Also, more recent ei
aggressively to gain mark(
the more established ins
cutting price to increase n
various groups of banks I
Such competitive pr(
The bank survey identifiec
distorting competition, in
were thought by a majori:
competition.
Supervisory Capital Regt.
The continuing declii
recovery, and perception:
special attention to capita
from the major industriz
"The Outlook for Intematic na
these guesstimates were highh
to monitor efficiently their m
allocate overheads. etc.. mad,
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ies
ely
by
Der
!in
the
an
-ed
ttly
ise
is
ks'
riot
are
her
e pt
of
:ad
ss.
ser
to
ual
nal
ect
'ith
nt-
ier,
Follow-up interviews to a previous Group of Thirty survey yielded some
-'guesstimates" on profitability from non-U.S. banks. Most estimated their
true gross return at about 025 per cent above quoted spreads. Also, most
estimated their breakeven point at about - per cent over UBOR plus some
elements of front-end fees."
The record shows that individual lenders are not able to stop the
erosion of loan spreads. Since banks feel in many cases compelled to
maintain market presence, the principal results of a bank's attempt to hold
the fine at a given "acceptable" spread may be a deterioration in the quality
of its loan portfolio.
Sources of Pressure on Margins
Some banks have competitive advantages that arise from the regula-
tory regime within which they operate. Highly leveraged banks can lend at
relatively low margins and still earn a reasonable return on equity. Also,
because there is less emphasis on profitability, some government-owned
banks or savings banks may have a similar pricing advantage. Finally
differences in reserve requirements and other regulatory measures can also
have an impact on competitive abilities of banks, especially if they were to
be manipulated to promote or discourage international activities.
However, not all competitive pressure comes from banks with regula-
tory advantages. For example, sluggish domestic loan demand may lead to
more aggressive pricing by banks from different countries at different
times. Also, more recent entrants may at any given time be competing more
aggressively to gain market share or carve out a special niche. Finally, even
the more established institutions may adopt a competitive strategy of
cutting price to increase market share. Waves of intense competition from
various groups of banks tend to maintain the pressure on margins.
Such competitive pressures in the market are expected to continue.
The bank survey identified varying capital requirements as the main factor
distorting competition, in the view of bankers. Differences in regulation
were thought by a majority to be "somewhat" important factors affecting
competition.
Supervisory Capital Requirements
The continuing decline in spreads, since 1976, in spite of some recent
recovery, and perceptions of increased risks in the market, has prompted
special attention to capital adequacy on the part of banking supervisors
from the major industrialized countries. Germany and Switzerland, for
" 'The Outlook for International Bank Lending", G-30, August 1981. It should be noted that
these guesstimates were highly qualified since many respondents indicated they are not able
to monitor efficiently their marginal cost of dollars, and most admitted that inability to
allocate overheads, etc., made costing unreliable.
-7 7 _777i
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
example, have recently widened the scope of their capital requirements in
order to encourage their banks to increase provision for the risks they incur
in their international activities. A brief outline of capital adequacy require-
ments is given in Appendix D.
To the extent that capital requirements are effective, they should
ultimately constrain expansion of lending when returns are inadequate.
Reportedly, some Swiss and German banks have reduced their interna-
tional lending activity in reaction to new or proposed requirements, and
some banks in London claim to have been constrained by Bank of England
capital adequacy guidelines, although it is not clear whether this has had
any direct impact on their international business. A previous Group of Thirty
survey revealed that respondents' banks believe capital adequacy will be
one of the more important constraints on future international lending,
although not necessarily a very significant one.
The BIS, in its April 1980 communique, listed capital adequacy as one
of the three elements of international banking soundness to which the
central bank governors attach "cardinal importance", and endorsed the
efforts of the Cooke Committee in this area. It seems likely pressure by
national authorities to sustain adequate levels of capital will continue, and
will be beneficial for the protection of the earning capacity of the interna-
tional banking system as a whole. This may be accompanied by some
move towards convergence of different countries' capital adequacy
standards, although this is likely to be a fairly long-term prospect
Conclusions
It is the opinion of the study group that supervisors should not attempt
any direct action to increase loan margins. There may in any event be
practical limits to the efforts of individual supervisors, because of possible
disadvantages to their banks from prudential requirements that are signifi-
cantly more stringent than their competitors'. For that reason, cooperative
efforts among supervisory authorities are a very positive development The
bank survey revealed support for the view that requirements should be
harmonized - with a preference (perhaps not surprisingly) for achieving
this by reducing rather than raising regulatory requirements.
7. FURTHER SUGGESTIONS FOR REDUCING
RISKS IN BANKING
The purpose of this concluding section is to explore two suggestions
for reducing risk - through a requirement for banks to make provision for
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rescheduled loans ar
dealing with resche
indebtedness. These
preceding sections
Provision For Resc'
A recently topi
should be obliged tc
uled. The question i
the making of some
time of reschedulin
indicates the existei
presumably resolve,
doubt that the lendii
not been borne ou
provision for oppo
opinion of the stu(
common, it would
against reschedule,
some general prov
exceptional, superv
Those who arc
1. There is littl
and resche
and differin
concept of
vidual regu
safety and s
more lenie
2. A second
solved by b
loans to c
obviously r
to the sam
3. A third arg
creditors' i
fulfill their
has been
On the positive Si(
1. The resch
lems. Sucl
the resche
reality of d
in reschec
2. Provisions
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
I requirements in
e risks they incur
1equacy require-
ve. they should
are inadequate.
td their interna-
luirements, and
lank of England
ier this has had
Group of Thirty
3equacy will be
itional lending,
1equacy as one
s to which the
I endorsed the
.ly pressure by
continue, and
o interna-
nied by some
ital adequacy
ospect
ild not attempt
any event be
ise of possible
hat are signifi-
?i, cooperative
lopment. The
its should be
for achieving
)(ICING
suggestions
provision for
rescheduled loans and, secondly, byway of improving the arrangements for
dealing with rescheduling and the flow of information on international
indebtedness. These are in addition to the recommendations made in the
preceding sections of this report.
Provision For Rescheduled Loans
A recently topical subject has been the question of whether banks
should be obliged to make provisions against loans that are to be resched-
uled. The question is whether regulators ought to move towards requiring
the making of some provision against a portion of rescheduled loans at the
time of rescheduling. To put it another way, rescheduling - de facto -
indicates the existence of a loan quality problem. Even if this problem is
presumably resolved through an agreed rescheduling, there is no reason to
doubt that the lending institutions' judgment at time of loan origination had
not been borne out. Consequently, provision against possible loss or a
provision for opportunity-loss seems prudent and reasonable. It is the
opinion of the study group that, as reschedulings may become more
common, it would be in, the interest of banks to make some provision
against rescheduled debts either specifically or through the existence of
some general provision of adequate size and, unless circumstances are
exceptional, supervisors should encourage action on these lines.
Those who argue against this point of view note the following:
1. There is little international uniformity in the treatment of non-performing
and rescheduled loans. Obviously, the inequity posed by differing rules
and differing standards can be used as an argument to frustrate the basic
concept of provisions for rescheduled sovereign loans. However, indi-
vidual regulators could proceed along lines they deem to be best for the
safety and soundness of their banking system even if other regulators are
more lenient
2. A second argument is that the requirement for rescheduling can be
solved by bank refinancing. Rescheduling might be avoided by increasing
loans to cover interest and/or principal payments. This technique is
obviously nothing more than putting off the day of reckoning; it amounts
to the same thing as a rescheduling and lacks conviction.
3. A third argument in opposition to provisioning has been that it weakens
creditors' negotiating position and might tempt debtor nations not to
fulfill their obligations, although there is little evidence to suggest that this
has been a feature in rescheduling activities to date.
On the positive side, the argument for provisioning is that
1. The rescheduling is, in and of itself, an indication of loan-quality prob-
lems. Such quality problems should be recognized and some portion of
the rescheduled loan should be reserved both as an indication of the
reality of the loan quality problem and also because of the costs involved
in rescheduling, not the least of which is the opportunity cost
2. Provisioning reinstills into sovereign lending one element of discipline
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which may have diminished substantially over the past decade as losses
in international lending have been contained due to rescheduling ac-
tivities.
Clearly, the problems concerning provisions for losses and reschedul-
ing activities are substantial. On the other hand, a more rigorous approach
could help improve discipline within the international banking system. In
addition, it would discipline the sovereign borrowers and strengthen forces
making for better balance of payment adjustments. In sum, the study group
believes that it is appropriate for all supervisory and regulatory authorities to
encourage banks to take action in this area, although it is recognized that it
is unlikely that this will be possible at least initially in any uniform way.
Inadequacies of Existing Arrangements
The study group feels that the existing arrangements among banks to
deal with country debt reschedulings are unsatisfactory, being almost
entirely of an ad hoc nature. In particular, the period leading up to renegotia-
tion has been extended, to the detriment of all parties, by the need for
lending banks to be persuaded to join together, pool information and
appoint negotiators (recent experience has shown that it can take a long
time before the major banks even know what other banks are involved).
Also, the study group notes that the assembly process in respect of gather-
ing information on cross-border claims of commercial banks is incomplete
and needs to be improved.
A good example was that of Turkey where the first estimates of lending
proved to be far lower than the total which emerged when banks and other
creditors revealed their individual lending figures. The same happened in
the case of Poland. The study group feels that it would be in the best
interests of both debtor countries and creditor banks if it were possible to
have a central unit in which statistics on international lending were kept
complete, up-to-date and confidential. This might be undertaken by the
BIS, building on their existing work, or conceivably by a new organization
established by the banks themselves.
Clearly, the combination of a prolonged recession, falling commodity
prices and historically high levels of real interest rates in most major
countries and especially in the United States could lead to further strains
appearing in the banking system, especially if a number of reschedulings
were to take place either simultaneously or within a short space of time. It
might well be that the banks would react to an increase in perceived risk by
cutting back international lending. If the same phenomenon applied to the
inter-bank market, an individual bank could find it difficult to renew deposits
in the inter-bank market, thus setting off a contraction in liquidity. While
these risks exist whether arrangements for rescheduling of country debts
are efficient or inefficit
unnecessarily increasec
activated mechanism fc
lens. By contrast, it w
creditors, once a coun
convened and the govt
unison to a common p
The same point aF
and the International M
even informal) system e
as a group and officer
regularly to discuss mute
that the IMF and the Wo
initiate discussions with
being accused by memt
is felt strongly that this
establish means of bette
to establish a method o
lending, namely the corn
and government credito
each other and with borr
to react quickly in case
A Consultative Group ft
The study group felt
dealing with a debt resc
country could resolve its
to a precipitous withdr
severe domestic econoi
such prompt action co
consideration to initiative
international financial cc
One area in which
ously in this report, is in ti
on the liabilities of coun
Data on intemation.
Bank and the Bank for
which could supplemer
additional information frc
increasing the 'transpar,
information on the expos
sovereign borrowers, lei
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 it decade as losses
rescheduling ac-
s and reschedul-
lorous approach
nking system. In
trengthen forces
. the study group
ory authorities to
ecognized that it
uniform way.
among banks to
1, being almost
up to renegotia-
by the need for
nfo---ation and
ca, ce a long
s are involved).
spect of gather-
,s is incomplete
nates of lending
ranks and other
ie happened in
be in the best
sere possible to
ding were kept
fertaken by the
,w organization
ng commodity
in most major
further strains
reschedulings
pace of time. It
.rceived risk by
i applied to the
renew deposits
liquidity. While
country debts
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are efficient or inefficient, the study group feels that the level of risk is
unnecessarily increased because there is no generally accepted and readily
activated mechanism for dealing with a potential escalation of such prob-
lems. By contrast, it was noted that in the case of official government
creditors, once a country finds itself in difficulty, the Paris Club can be
convened and the government creditors are able to react quickly and in
unison to a common problem.
The same point applies to relationships between commercial banks
and the International Monetary Fund and the World Bank. No formal (or
even informal) system exists whereby representatives of commercial banks
as a group and officers of the International Monetary Fund can meet
regularly to discuss mutual problems. Naturally, the study group recognizes
that the IMF and the World Bank would find it difficult, if not impossible, to
initiate discussions with commercial banks on country problems for fear of
being accused by member countries of favoring such creditors. However, it
is felt strongly that this legitimate concern does not obviate the need to
establish means of better communication. The overriding consideration is
to establish a method or forum whereby the major actors in international
lending, namely the commercial banks, the multilateral official institutions,
and government creditors could find a way of working more closely with
each other and with borrowers both to improve the flow of information and
to react quickly in case of need.
A Consultative Group for International Banking?
The study group felt that the more rapid the action of the main actors in
dealing with a debt rescheduling need, the more likely would it be that a
country could resolve its problems in a timely manner without being subject
to a precipitous withdrawal of credit and hence possibly unnecessarily
severe domestic economic adjustments. Among various ways in which
such prompt action could be encouraged the study group gave close
consideration to initiatives that might be taken by the private sector of the
international financial community.
One area in which further improvement is required, as noted previ-
ously in this report, is in the collection and timely dissemination of statistics
on the liabilities of countries to the banking system and capital markets.
Data on international bank lending is already gathered by the World
Bank and the Bank for International Settlements, but a banking bureau
which could supplement information from such sources by obtaining
additional information from borrowers or lenders could play a useful role in
increasing the 'transparency' of the market (for example, by gathering
information on the exposure of banks from different countries to particular
sovereign borrowers, lending by banks outside the Group of Ten and
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Switzerland, the positions of official and other non-bank creditors, and
movements in short-term credit flows).
Beyond such initiatives to improve information could come the estab-
lishment of some forum (an "International Banking Consultative Group"?)
in which leading international bankers would be able to discuss issues of
mutual concern. It might also be able to liaise on behalf of bankers with
official international and government agencies, providing these bodies with
an additional forum for discussing problems concerning international capi-
tal flows and market regulation. Equally important, it would be available as
an additional channel through which borrowers would be able to convey
their views more effectively to the international banking community at large.
This role as a "channel of communication" might over time be found
particularly useful in connection with international debt servicing problems.
The body could not itself represent banks in rescheduling negotiations, but
could in certain circumstances occupy a liaison role between bankers and
borrowers, and between different banking interests in a problem loan
situation. The possibility of conflicts of interest must be acknowledged,
given that the group would be composed of bankers who are themselves
active in the international field, but the group would be in a good position to
look beyond such interests and focus on factors of longer-run importance.
Past experience has shown that debtors as well as creditors have much
to gain from improvements in the machinery for dealing with debt prob-
lems. It would be for the "consultative group" to demonstrate through its
actions that its role is a constructive one, and not narrowly sectoral in
outlook It could provide the means for bringing involved banks together
quickly once a rescheduling request had been received, and in due course
could be expected to develop expertise that would be of great assistance to
negotiators of both parties. A "consultative group" could not, of course,
have legal powers to enforce decisions, but would derive its authority from
the standing of its members, the expertise of its secretariat, and from the
moral support given to its work by the international banking industry. It
would certainly be important to discuss the objectives of the new body as
widely as possible, to demonstrate the positive role it is intended to play, and
to take full account of the views of sovereign borrowers.
New patterns of international financial flows will be called for in carry-
ing through the volume of international lending needed in the 1980's.
These may include expanded use of co-financing, parallel lending and
similar techniques. Progress in these directions, which has so far been
disappointing, might well be facilitated if there was in existence an
authoritative body amongst commercial bankers with which the interna-
tional agencies could co-ordinate their thinking and establish acceptable
ground rules for co-operation and joint development
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The study group full
difficulties in setting up suc
members should be form
banking communities or sc
consideration. On the one
markets have developed or
of interest along national lir
best to avoid members bein
(There is also the possibilit'
this should not be exaggera
would provide a more for
perhaps strengthen its moi
More generally, these
problem if in the first instan(
on an informal basis. It wou!
helping to avoid the probler
enjoy greater freedom to si
sions indicate that a wide me
industry and among interes
sentative international body
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
-ould come the estab-
Zonsultative Group"?)
e to discuss issues of
>ehalf of bankers with
ding these bodies with
ing international capi-
would be available as
uld be able to convey
g community at large.
ht over time be found
bt servicing problems.
uli- -iegotiations, but
b. _en bankers and
s in a problem loan
ist be acknowledged,
s who are themselves
e in a good position to
onger-run importance.
s creditors have much
!aling with debt prob-
monstrate through its
t narrowly sectoral in
+olved banks together
,ed, and in due course
of great assistance to
could not, of course,
!rive its authority from
retariat, and from the
t banking industry. It
s of the new body as
s intended to play, and
wers.
be called for in carry-
eeded in the 1980's.
parallel lending and
hich has so far been
was in existence an
ith which the intema-
I e lish acceptable
it.
The study group fully recognized that there are likely to be many
difficulties in setting up such a group. For example, the question of whether
members should be formally representative of their respective national
banking communities or selected in another manner would require careful
consideration. On the one hand, in view of the fact the Euro-currency
markets have developed on a transnational basis and that sectionalization
of interest along national lines could be counter-productive, it may well be
best to avoid members being nominated by national banking communities.
(There is also the possibility of anti-trust conflict to be considered, though
this should not be exaggerated). On the other hand, national representation
would provide a more formal element of structure to the Council and
perhaps strengthen its moral authority.
More generally, these areas of difficulty might be found less of a
problem if in the first instance an experimental body were to be established
on an informal basis. It would then grow when experience was gained, thus
helping to avoid the problem of unrealistic expectations, and by this means
enjoy greater freedom to set a style for future operations. Private discus-
sions indicate that a wide measure of support exists, both inside the banking
industry and among interested outside parties, for the concept of a repre-
sentative international body of the kind discussed in this paper.
I
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
The Rescheduling of Country Debt: Is a More
Formalized Process Necessary?
With the growing importance of commercial bank lending in interna-
tional financial flows in the 1970s, it was inevitable that country debt service
crises would take on a new flavor. The debt reschedulings that resulted from
such crises were not new or unprecedented, of course. Reschedulings of
official debt had become fairly commonplace ever since Argentina had
asked its government creditors to reschedule in 1956; ten countries en-
gaged in 31 separate reschedulings over the two decades 1956-75. Such
multilateral exercises had, in fact, become fairly routine through the proce-
dures of the Paris Club, an informal group of major Western creditor
governments chaired by the French Treasury.' And, while the rescheduling
of debt owed to private creditors was less frequent, it was by no means
unheard oF, several countries - including Argentina, Brazil, and Chile -
had rescheduled their private debt in the 1960s and early 1970s.
What distinguished the reschedulings of the later 1970s, then, was not
so much their novelty as their scope. Instead of the relative handful of banks,
often from a single country that once had been involved in negotiations,
there were now 100, 200, or more. (Poland is currently attempting to
reschedule debts owed to some 500 separate institutions.) And where a few
million dollars were once at issue, the stake had grown to the hundreds of
millions, or, in some cases, billions of dollars.
This increase in the scale of the reschedulings suggests a correspond-
ing increase in their complexity - a complexity manifested both in the
substance of the talks as well as the mechanics of a process involving so
many participants. And it calls into question whether the ad hoc approach
that has previously been taken toward the organization of these negotia-
Richard Huff is Financial Analyst in the Strategic Analysis Division of the Office of the
Comptroller of the Currency in Washington.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
tions will continue to be effective in the reschedulings of the '80s. That
approach, to be sure, has thus far been adequate to the demands placed
upon it No rescheduling talks have failed simply because of organizational
difficulties in starting a new rescheduling process from scratch each time
that banks and debtor governments decide to enter into negotiations. And
the flexibility afforded by the absence of a more formalized process has
perhaps aided in the resolution of difficult substantive issues.But "ad-
hocery" has had its costs - notably the confusion and delay in resolving
difficult organizational and procedural questions before substantive discus-
sions can begin. And if reschedulings become more numerous and fre-
quent in the years ahead - as many observers predict - it is well worth
considering whether the process for conducting them ought to be more
formalized and institutionalized.
This paper will examine that question. We will begin with a review of the
rescheduling experience of the past half-dozen years, focusing in particular
on whatever recurring problems and difficulties have arisen. The paper will
then consider the coordination of commercial debt rescheduling with the
renegotiation of official debt and the appropriate role of the International
Monetary Fund. It will conclude with a brief discussion of possible im-
provements in the present rescheduling process.
The Rescheduling Process
Getting to the table. A recent IMF staff study2 examined the cases of six
IMF members that rescheduled their obligations to commercial banks
between 1976 and 1980. It noted that the rescheduling process was gener-
ally a long and difficult one, taking from two to five years from the time a
debt service problem first emerged until an agreement was actually signed.
Generally, negotiations did not begin until one or two years after such
signals as the emergence of arrears or the reluctance of banks to roll over
maturing credits might have suggested that a rescheduling would be
necessary, once begun, the talks themselves took anywhere from 18
months to four years to complete.
One of the difficulties the parties to these negotiations faced surely was
the lack of a well established means of resolving their differences. "While
the modalities for the restructuring of official debt were fairly well estab-
lished," comments the IMF study, "the restructuring of debt owed to
commercial banks involved, to a large extent, the breaking of new ground."
Previous commercial debt reschedulings had concentrated on the restruc-
turing of short-term trade credits, but now the focus was on medium-term
syndicated Eurocredits, which brought a host of complications. The hun-
dreds of banks of many different nationalities involved in the various loan
syndications had to be contacted. Basic data on how much was owed to
whom had to be col
(One country, whict
to sending out a que
owed.) And in four
tions had to be cool
who insisted that pr.
terms."
Ultimately, thoL
the six cases were SL
reached and signed
adhere to the terms
The actual hard bar
dozen or so lead ba:
nation (often assist(
other. Also playing k,
active participants, i
World Bank. The n
chosen from the leac
lent money to the c
largest individual ex
were chosen on the
each of the major ci
Interbank tensi(
sen, they faced the ~'~ i _i1 / 711_itl ilf f t (i .,t11( 'i11,+1 _r~%11111... - .. ~ ..
i'1r } (ul ?nu~
lY.f,:.l_. ti7:.1r- i 111in11Plj :11 1 u( ii 1 n9
fiii1lit ^ W 111
is3. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
viduals. This permits the corporation to
increase the dividends on its new shares
and so attract new equity. After some
investment is made by the corporation,
the exemption might be extended to the
old shares, too. If your President did that,
I'm sure he'd recuperate the private sec-
tor of your economy in short order."
Argentina's Roberto Alemann would
be equally stem on U.S. fiscal policy.
"If I were your Secretary of the Trea-
sury, I would reduce the deficit," he
says. "I see in the U.S. a very substan-
tial money-supply expansion through
fiscal deficits. I don't see any correction
of it. What Mr. Reagan really did was
reduce income and increase expendi-
tures. And therefore the deficit has never been as high
as it is now in the U.S. And it's the Fed that's
financing it. You'll have to adopt indexation if you
keep it up. Cut back fiscal deficits, and you might
have a small reduction in the standard of living for a
while, but then there would be a significant increase.
The dollar would be the strongest currency in the
world. You'd have long-term money to invest. But
instead you will go down the other road. You pump
money into the economy. You get higher prices. Then
you index, and you think you have corrected. But you
have not."-G.S.
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
SYNDICATED CREDITS
V" MMAJ%mm m m I T S C A
A Ew wjU T Wd
01 DI "'no
deal was no exception and in the end only covers East Africa. "It's fifty-fifty whether
Even the good African risks $123 million was raised. or not they reschedule this year."
may reschedule as bankers Bankers were also alarmed by the debt Zimbabwe should still be able to boiro,
hold off, service ratio of 34%, and the news that oil for projects, at the short end of the
reserves were less than expected. But the medium-term market. It is not expected to
By Charles Grant market's reluctance was not justified by any seek many commercial loans: most of this
sudden turnabout in the Ivorian economy, year's current account deficit, which is not
As they talked in Nairobi in the second which remained under the aegis of an IMF likely to be less than last year's 5500
week of May, African bankers and finance programme. million, should be covered by an IMF loan
ministers attending the African Develop- According to the 1983 Ivorian budget, of $384 million agreed in March, together
ment Bank meeting faced a major problem: the country will seek commercial bank with western aid.
the drying up of Euromarket lending to loans of $183 million this year. A few banks Among the handful of countries which
Africa. For many African countries, Euro- are still prepared to lend on an export- could borrow balance of payments loans
currency loans had become an important related project basis. They point to the -without difficulty, Gabon and Botswana
means of funding current account deficits. efficiently managed and diversified cash are unlikely to do so because of their
The source is dwindling. Syndicated crop sector, and to the likelihood of oil extremely conservative economic manage.
loans to African borrowers totalled $5 exports starting later this year. ment, while Libya is unlikely to do so
billion in 1982, a drop of $2 billion from the "France wouldn't let Ivory Coast re- because of its radical politics. Libya does
year before. Euromarket borrowing schedule, it's the jewel of French West not want to become enmeshed in the
declined more drastically in the first quarter Africa," said an optimistic banker. "It can capitalist system, so is unlikely to repeat its
of 1983, with the signing of only 17 loans continue to borrow from the French Euromarket sortie of December 1981,
worth $609 million. Treasury, via the Banque Centrale des Etats unless oil output drops drastically.
At a time when the syndicated loan de 1'Afrique de l'Ouest." Only Tunisia, Algeria and Cameroon
market has been contracting worldwide, But other bankers are less confident that have sought or look likely to seek balance
Eurobankers have needed little prompting French indulgence is unlimited. Some of payments credits this year. Fresh from
to close their doors on African borrowers, banks will not lend any more to Ivory the success of its $125 million loan signed in
many of which rank among the world's Coast. Inflows of new Eurocurrency funds February, which achieved an astonishing
least solvent countries. Eleven of them have have fallen to a trickle this year. If more 50% selldown below lead manager level,
recently rescheduled foreign debt or are in banks hold back new lending, a Tunisia is expected to borrow again. Falling
the process of doing so: Central African rescheduling could be precipitated. oil output has widened the current account
Republic, Liberia, Madagascar, Malawi, Morocco is another country which some deficit, not all of which can be financed by
Sierra Leone, Senegal, Sudan, Togo, bankers have tipped for rescheduling in Arab aid. Tunisia should be able to hold the
Uganda, Zaire and Zambia. 1983. Morgan Guaranty predicts that 65% very fire spread of '/2% which it paid in
Three of Africa's biggest borrowers are of this year's export earnings will be used to February, thanks to the scarcity value of its
possible candidates for rescheduling this service Morocco's $10.3 billion of foreign paper. Much in Tunisia appeals to bankers:
year: Nigeria, Morocco and Ivory Coast, debt. Conservative Arab countries are political stability, up-to-date statistics, and
which together owe $35 billion. Other expected to chip in over $1 billion of aid, diversified sources of foreign exchange,
candidates include Kenya, Tanzania, but that may not suffice to cover the including tourism, and exports of olives and
Mozambique and Ghana. (For analysis of current account deficit. citrus fruit, as well as oil.
the Nigerian economy, see "Nigeria on the Morocco will continue to seek Euro- Algeria, like Tunisia, has been spurred to
brink", Euromoney, April 1983.) market funds for the development of its borrow by falling demand for oil. The $500
Bankers polled by Euromoney believe phosphates industry. It has 75% of the million eight-year credit launched in April
that only six African countries can still world's known phosphate reserves. Some met a warm reception in the market.
borrow by a traditional syndicated balance leading French banks told Euromoney that American, Japanese and French banks
of payments loan: Algeria, Cameroon, they had struck Morocco off the list of joined the five Arab coordinating banks at
Tunisia, Botswana, Gabon and Libya. And countries they were prepared to lend to, but lead manager level and the amount was
three of these favoured countries, other French banks believed the kingdom increased to $600 million.
Botswana, Gabon and Libya, are unlikely could still raise project-linked funds, > The loan's success was despite a split
to borrow in 1983. provided Arab banks supported the loan. spread of only ''A to 3 Ve, Algeria's
However, several other African countries "Despite the grim economic situtation," alarming debt service ratio-of 35%, and its
can still tap the Euromarket for project said a French banker, "the European and total foreign debt of $16 billion. The
finance on a club basis, as long as the American banks which are already heavily explanation? Algeria has abstained from
circumstances are favourable for foreign committed will provide the credits Morocco balance of payments borrowing for four
banks. If part of the loan is export credit needs, because of its immense strategic years, its foreign debt has fallen, and it has
guaranteed, or if the project contractor is importance; it has offered bases to the US started to diversify its exports away from
an important customer of the lending bank, Rapid Deployment Force." crude oil towards LNG and refined
etroleum products.
a and
o Ken
f
p
y
years ag
foreign banks are more likely to join a Only a couple o
project loan. Zimbabwe ranked among the brightest Cameroon, like Algeria, has borrowed
No African country's creditworthiness credit risks in Africa. Now the ratings of little since 1979. But this March it returned
has fallen more spectacularly in the last year both have entered a steep slide, in part to the market, with a $350 million loan, led
than that of Ivory Coast. Up till last because of political instability. Zimbabwe is by Bankers Trust and Credit Lyonnais, for
August, it borrowed regularly and easily on becoming a one-party state, while in Kenya the development of the Lokele oilfield.
the syndicated loan market. On August 16 political opposition has been crushed Cameroon's enormous gas reserves of 100
Bankers Trust won a mandate to raise $150 following last August's attempted coup. billion cubic metres are still undeveloped.
million. Two days later, Mexico announced "Kenya's gone downhill since Kenyatta but if President Paul Biya decides to launch
that it would reschedule, and all sovereign died; mismanagement and corruption have an LNG industry, considerable external
lending received a '"^^' r.,~cr flnuriehe 1 " said a British banker who finance will be required. C
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
SEI
1,0
GAS
12(
Gill
BIS
tot
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
row
the
i to
this
not
000
loan
ther
?hich
cans
Nana
their
'tage-
0 so
does
the
at its
981,
croon
lance
from
ed in
shi^q
ht,rg
count
ed by
Id the
id in
of its
hikers:
and
ange,
fired to
$500
April
+arket.
banks
bks at
t was
split
eria's
and its
The
from
. four
it has
from
?efned
wed
led
led
Of 100
launch
tern3
W THE DOT STAC!S UP
_?D a~~'.sir da`at?~ ah?~a~JS?sc`?oP?cc?~~?.?~~?~i~4?~~?~C~'ers~3?~J~~~?a1.?~1?~4~1b?~?c`~c-~tt~id~`~V?i!~
6810
1.066
GAMBI
126
GUINEA
BISSAU
106$
Debt service ratio
x % %
Togo 65- Madagascar 15 - Niger 9
Guinea Bissau 60- Mali 15 Sudan 9
Uganda 45- Mozambique 15- Angola 8
Guinea 41 Sierra Leone 15 Burundi 8
Morocco 40 Tunisia 15 Upper Volta S.
Algeria 35 Tanzania 14 Gambia 7
Ivory Coast 31 Congo 13 Somalia 6
Egypt 30 Gabon 12.5 Zimbabwe 6
Zaire 29 Liberia 12.5 Nigeria 4.5
Malawi 25 Cameroon 12 Libya 4-
Zambia 24 Ethiopia 11 Lesotho 3.5
Kenya 17 Benin 10 Swaziland 3.5
Chad 16 Mauritius 9-5 Botswana 1.5
Mauritania 16 C.A.R. 9 Rwanda 1-5
Senegal 15.5- Ghana 9 Seychelles 0.5
The percentage of a country's earnings from the export of goods and services
used to pay interest and maturities on medium-term foreign debt in 1981.
Sources World Bank debt tables. UNCTAO, NatWest, except where ? indicates
a Ewomoney estimate
?Edirnm for 1982. except where (a) indicates IMF figures for 1981, Of where
1 IMF figure
IN imk&tn eg,malg for for 1977 at W IMF figure for 1981 19of (c) 79 or MO IMF figure for 1978
?
SEYCHELLES
34
Countries rescheduling medium-
term debt is 1982 or 1983
D Countries generally considered
able to borrow medium-term funds
on the syndicated loan market
t u medium term disbursed debt, owed to official and penile creditors, at
December 31, 1981. Figures based on World debt tables except where $
is indicated. which denotes a Eworrroney estimate,
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'omoncy June 1983 63
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Trends in Eurocurrency Credit Participation
1972-1980
The burgeoning Eurocurrency credit market exceeded $70 billion in
publicized volume in 1980, compared to $9 billion in 1972. Today, the bulk
of publicized Eurocurrency lending is done by bank syndicates rather than
individual institutions. Although the financial press annually allocates syn-
dicated Euroloan volume among managing institutions, identifying the
world's top Eurolenders, no one has documented the steady influx of new
loan participants into the Eurocurrency credit market or comprehensively
considered the changing nationality of participants over time. Using World
Bank data, Office of the Comptroller of the Currency staff were able to
examine these non-volume indicators of the increasing breadth of the
publicized Eurocurrency credit market'
Analysis of the World Bank data shows that a relatively constant
average of 66 independent financial institutions became first-time entrants
into the Eurocurrency credit market each year between 1973 and 1980. By
1980, nearly 400 independent financial institutions were active in the mar-
ket In the earlier years, the new entrants were largely European and North
American banks and international consortium banks. More recently, Latin
American, Middle Eastern and Asian institutions have entered the market in
greater numbers. Further findings from the World Bank data reinforce the
well-documented expansion of Middle Eastern financial institutions into
Eurocurrency lending. For example, in terms of number of participating
institutions, Middle Eastern institutions have increased their presence in the
market from less than one percent in 1972 to an eight percent share of the
total in 1980. However, in every year, European and U.S. institutions ac-
Diane Page and Walter D. Rogers are Financial Analysts of the Strategic Analysis Division of the
Office of the Comptroller of the Currency. C. Stewart Goddin, Judith A. Walter and Steven J.
Weiss made valuable comments on earlier drafts of this paper. Vivian L Oyola did the
necessary computer programming. The views expressed in this paper are the authors and do
not necessarily represent the views of the Office of the Comptroller of the Currency.
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 count for the bulk of total participating institutions as well as total loan
participations.
Analysis in this paper is restricted to publicized Eurocurrency credits. it
examines financial institutions which were Eurocurrency loan participants
between 1972 and 1980, considering their nationality, entry Into the
Eurocurrency market, and number of yearly loan participations.
Eurocurrency credits are loans and credit lines denominated in a
currency other than that of the country in which the lending institution is
located. Eurocurrency credits first appeared in the 1960s. At that time, they
were almost exclusively fixed-rate loans to corporate borrowers underwrit-
ten by specialized investment banks, notably the British merchant banks,
which later sold participations to other banks. The Eurocurrency credit
market began to take on its present characteristics in the early 1970s. Loans
became floating rate instruments. Nations began to finance balance of
trade deficits through Eurocurrency borrowings. And the world's large
international commercial banks began managing large Eurocurrency cred-
its through syndications. Syndication of credits reduced risk for the under-
writers and brought together the large resources necessary to finance
sovereign debt. With successive oil price increases in 1973 and 1974, the
oil-producing nations developed trade surpluses while non-oil-producing
less-developed countries faced growing deficits. The Eurocurrency credit
market began to serve a vital function as a recycling mechanism, moving
surplus capital from the oil-producers to the non oil-producing nations.
Publicized Eurocurrency credits reached a volume of $70.4 billion in 1980,
according to World Bank data. Publicized credits, which are medium- to
long-term and usually syndicated, represent only a portion of international
borrowing. It has been estimated that one-half of Eurocurrency bank lend-
ing is short term, unpublicized lending used for private trade and interna-
tional business financing.' International and foreign bond issues are an-
other vehicle for international borrowing, and accounted for $41.8 billion in
1980.'
Description of the Data
Data collected by the World Bank cover publicized borrowing in inter-
national capital markets in the form of Eurocurrency credits between 1972
and 1981.' Notice of Eurocurrency credits appears in a published an-
nouncement known as a tombstone. The tombstone generally contains the
name of the borrower, the amount of the credit, and the names of the
financial institutions which participate in the loan. Often, but not always,
Eurocurrency credits are led by a single large institution. Smaller volume
credits are less likely
more co-lead manat
prospective borrower
group.
The lead manag
making a commitme
tion. On the tombsto
the participation they
1972 8.8
1973 20.8
1974 28.5
1975 20.6
1976 28.7
1977 34.2
1978 73.7
1979 702
1980 70.4
first, followed by ma
successively smaller
alphabetical order. th
an equal participatio
order within manage
Computerized V
participants per indivi
on the tombstone. I
participants are identi
participants is indicat
tified, there is no way
pated in all loans in e,
number of named an
and likewise to deterr
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117-
,ncy credits. It
n participants
ntry Into the
ons.
minated in a
institution is
lat time, they
is underwrit-
chant banks,
rrency credit
970s. Loans
balance of
vorld's large
lrrency cred-
rr f" under-
nance
id 1974, the
l-producing
rency credit
sm, moving
ng nations.
ion in 1980,
nedium- to
ternational
banklend-
nd intema-
ies are an-
.8 billion in
ng In inter-
veen 1972
lished an-
mtains the
ies of the
of always,
er volume
credits are less likely to have a lead manager, while some loans have two or
more co-lead managers. The lead manager receives a mandate from the
prospective borrower to raise funds and seeks to put together a managing
group.
The lead manager typically underwrites the entire amount of the credit,
making a commitment to provide the funds before arranging the syndica-
tion. On the tombstone, institutions are usually listed in order of the size of
the participation they take in the loan. As a rule, the lead manager is listed
Table I
first, followed by managers, co-managers, and participants, which take
successively smaller portions of the loan. When institutions are listed in
alphabetical order, this generally indicates that each participant has taken
an equal participation. Sometimes institutions are listed in alphabetical
order within manager, co-manager and participant sub-groups.
Computerized World Bank data identify by name a maximum of ten
participants per individual Eurocurrency credit in order of their appearance
on the tombstone. When a loan has more than ten participants, nine
participants are identified by name and the number of additional, unnamed
participants is indicated. Since these additional participants are not iden-
tified, there is no way to ascertain how many individual institutions partici-
pated in all loans in each year. However, it is possible to aggregate the total
number of named and unnamed participations- for all loans in each year,
and likewise to determine how many loans had unnamed (more than ten)
Year
Loan Volume
(S billions)
Total
# Loans
Total #
Participations
zUn am dth
Participants
%By U named
Participants
1972
8.8
258
415
1
1
1973
20.8
402
725
1
1
1974
28.5
474
1027
1
1
1975
20.6
418
1482
5
6
1976
28.7
430
1827
8
9
1977
342
489
2360
10
10
1978
73.7
786
3781
15
20
1979
70.2
813
4329
16
22
1980
70.4
797
4913
18
24
Source: World Bank data.
A small percentage of participants are listed as "syndicates" and thus actually represent more
than one institution.
Eurocurrency Credit Aggregates
1972-1980
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242
participants. As shown in Table I, an increasingly significant proportion of
total loan participations, 24 percent by 1980, have been taken over time by
participants not identified by name in the World Bank data. The number of
loans with unnamed' participants increases to 18 percent of total loans by
1980. The reader should bear in mind that, in most of the following
discussions of participant nationality, new entry and loan participations,
only named participants, those who took the first nine or ten listed positions
on each loan, are considered. It was not possible to identify the unnamed
participants or to draw any conclusions about their entry trends or national-
ity patterns.
In the following analysis, information has been provided on those
institutions appearing as first listed participant for each loan in the World
Bank data, i.e., institutions listed first on the loan tombstones. Although this
information provides some indication of the nationality distribution of lead'
managers, it should be interpreted with caution. As explained above, lead
managers usually appear first on the publicized loan notices. However,
since some credits have no lead manager, some credits have a number of
co-lead managers, and some tombstones list all participants alphabetically,
first participant position in the World Bank data is not a perfect proxy for
lead manager. (World Bank staff estimate that about 20 percent of the
Eurocurrency credit tombstones list participants alphabetically.)
Nationality of the named participants is not included in World Bank
data and was determined using a variety of almanacs, yearbooks and other
reference sources. Institutions were grouped by nationality of ownership
rather than country of charter, Euroloan activity of branch offices or sub-
sidiary companies has been credited to the head office or parent institution.
For example, Deutsche Bank AG, Deutsche Bank AG (London), and
Deutsche Bank Cie. Fin. Luxembourg were all considered part of a single
German financial institution when determining the number of German
Euroloan participants, German entry into the market, and the number of
German loan participations.
Between 1972 and 1980, the number of publicized Eurocurrency
credits tripled from 258 to 797 and their combined volume increased from
$8.8 to $70.4 billion, according to World Bank data (see Table 1).5 The
following analysis is based on a direct comparison between Eurocurrency
credit activity in 1972 and 1980, since changes between 1972 and 1980
reflect trends which characterize the intervening years. However, the figures
are also affected by specific factors such as the slowdown in U.S. Eurolend-
ing dating from 1979 and government restrictions on foreign lending of
Japanese banks in 1980. (See Appendix tables.)
Number of lenders
The number of nan
institutions, nearly tripled
shows a geographic brei
(Consortium banks were I
categories when their ow
European or all Middle E
geographic categories In
over time. The predomin,
of the total in both years
Middle Eastern institution
total share in 1972 and 8
institutions, on the other h
share of Asian institution
New enby
Between 1973 and
ticipated in any previous
Eurocurrency credit ma
constant, averaging 66 p
Nationality of Paren
Publiciz
(First throuc
Hn
Source: World Bank data
Consortium banks which did
by European and Middle Ea!
t Africa. Oceania and a very sir
not be identified by nationali
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
portion of
er time by
camber of
I loans by
following
cipations,
positions
unnamed,
national-
on those
he World
ough this
m of lead'
eve, lead
However,
umber of
betically,
pro-, for
nt he
rld Bank
end other
.vnership
> or sub-
stitution.
)n), and
a single
German
mber of
urrency
ed from
I).' The
urrency
d 1980
figures
rolend-
ding of
Number of lenders
The number of named loan participants, consolidated into parent
Institutions, nearly tripled from 133 to 386 between 1972 and 1980. Figure 1
shows a geographic breakdown of these institutions in 1972 and 1980
(Consortium banks were placed in the Asian, European and Middle Eastern
categories when their owning institutions were identified as all Asian, all
European or all Middle Eastern.) The absolute number of managers in all
geographic categories increased, but relative shares of the total changed
over time. The predominance of European institutions, well over one third
of the total in both years, is evident, as is the growing importance of the
Middle Eastern institutions, which represented less than one percent of the
total share in 1972 and 8 percent in 1980. The share of U.S. and Canadian
institutions, on the other hand, dropped by ten percent of the total, while the
share of Asian institutions dropped by five percent of the total.
New entry
Between 1973 and 1980, 526 parent institutions which had not par-
ticipated in any previous year for which data are available entered the
Eurocurrency credit market The number of new entrants is relatively
constant, averaging 66 per year (Figure ii).
Figure I
Nationality of Parent Financial Institutions Participating in the
Publicized Eurocurrency Credit Market
1972 & 1980
(First through Tenth Listed Participants Only)
Source: World Bank data
' Consortium banks which did not fit in any regional category, such as UBAF, which is owned
by European and Middle Eastern institutions.
t Africa, Oceania and a very small percentage (less than 1 percent) of institutions which could
not be identified by nationality.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
First-Time and
Eui
# Institutions
400 r-
300
U First Time Par
Financial Institutions
Participating In the Euroloan Market
1972-1980
(First through Tenth Listed Participants Onty)
Austria
0
0
4
4
4
11
5
7
14
Belgium
4
3
3
5
4
3
3
4
4
Luxembourg
3
3
3
4
5
7
11
7
7
Fed. Rep. of Germany
5
7
10
13
13
17
17
22
21
France
9
15
14
16
15
17
17
22
19
it*
3
5
6
5
8
9
18
12
15
Netherlands
0
1
3
4
5
5
5
6
5
Spain/Portugal
2
5
9
13
14
13
11
19
22
Switzerland
2
2
4
4
9
9
8
9
11
United Kingdom
18
24
20
18
19
18
18
19
18
Other. W. Europe
1
9
9
18
12
14
14
16
17
r- r-urope
1
2
3
3
2
1
1
2
5
Total
48
76
88
107
110
124
128
145
.158
Canada
3
4
7
9
7
9
9
10
9
USA
31
40
41
46
46
43
49
50
54
34
44
48
55
53
52
58
60
63
Mexico/Central/S. Amer.
6
3
5
6
5
8
8
12
23
Caribbean
3
2
5
3
4
3
2
4
3
Middle East
1
2
3
6
11
17
25
23
25
Africa
1
0
1
1
1
2
1
2
3
Japan
17
21
17
7
13
18
24
24
24
Other Asia
5
2
4
5
4
9
11
16
19
22
23
21
12
17
27
35
40
43
Oceania
2
0
1
2
1
1
3
5
8
Consortia
12
22
30
36
48
49
60
51
51
of which European
1
4
4
5
6
7
7
8
9
Arab
0
0
1
2
3
5
9
6
6
Asian
0
1
1
1
1
0
0
1
0
Other
11
17
24
28
38
37
44
36
36
4
6
5
7
6
5
7
5
9
133
178
207
235
256
288
327
347
386
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I 5
7
14
! 3
4
4
11
7
7
r 17
22
21
17
22
19
18
12
15
5
6
5
! 11
19
22
8
9
11
! 18
19
18
1 14
16
17
1
2
5
t 128
145
158
9
10
9
49
50
54
58
60
63
t
12
23
4
3
25
23
25
1
2
3
24
24
24
11
16
19
35
40
43
3
5
8
60
51
51
7
8
9
9
6
6
0
1
0
44
36
36
7
5
9
327
347
386
Figure H
First-Time and Previous Participants in the Publicized
Eurocurrency Credit Market*
1972-1980
M First Time Participants
M
? Refers to first-time entry since 1972; data not available for previous years.
63
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Financial Institutions Entering the Euroloan
Market for the First Time'
1973-1980
(First through Tenth Listed Participants Only)
Austria
0
4
1
1
5
1
0
5
Belgium
0
0
1
1
0
0
1
0
Luxembourg
0
0
2
3
3
3
0
2
Fed. Rep. of Germany
2
5
4
1
4
1
4
2
France
7
2
4
2
3
0
6
1
Raly
2
1
1
2
5
5
2
1
Netherlands
1
2
1
2
2
1
0
0
Spain/Portugal
3
4
5
2
1
1
6
7
Switzerland
1
2
0
5
3
1
3
2
United Kingdom
9
2
1
1
0
1
0
1
Other, W. Europe
8
3
9
3
1
0
0
1
E. Europe
1
1
1
0
0
0
0
3
34
26
30
23
27
14
22
25
Canada
USA
13
9
10
7
5
7
6
10
14
12
13
8
6
7
7
10
Mexico/Central/S. Amer.
2
2
0
0
3
3
3
10
Caribbean
0
2
0
0
2
0
3
1
Middle East
2
3
2
6
9
11
.7
3
Africa
0
0
0
1
1
0
2
1
Japan
4
1
0
1
2
4
1
1
Other Asia
2
1
2
1
6
4
5
10
6
2
2
2
8
8
6
11
Oceania
0
0
1
0
0
1
4
2
Consortia
13
14
13
14
7
15
6
5
of which European
3
0
1
2
1
0
1
0
Arab
0
1
2
1
1
4
0
1
Asian
1
1
1
0
0
0
0
0
Other
9
12
9
11
5
11
5
4
Unidentified
4
4
3
2
3
4
4
5
GRAND TOTAL
75
65
64
56
66
63
64
73
? Refers to first-time entry since 1972; data for previous years not available.
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Nationality of Paren
Eurocurrei
t
Yew
E W.
N. Am
1973
37
14
1974
26
12
1975
31
13
1976
25
8
1977
28
6
1978
14
7
1979
23
7
1980
25
10
TOTE.
29
77
Sours Lr .aik data
' Relc = ? .r a entry sir
7arie r s`~ows the
Ame-r3r: arG Other C
owns 4 -rz fit neart
rate ? ie. :-=y. This is
the rres 17---national)
enter '--e E_rocurren
ests: c tarly as a m
and Ivzda Estem ins
time.,-iiar -ass would
Japr_e r_.emment
Jape--se e =j and pi:
flucr.ze .tier Asian i
Lion. V1-.:eE_ropean it
in k=_ a 'seer numt
regi_=Ydc s the gr
Nurrl- T sn partic
Imit e y loan pa
Eta__-c :redit me
nur-- i ir.cipatior
fron-4 ? z 13 betwr
tiott s+ -&-ad particil
pert?.orized i
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78
79
80
1
0
5
0
1
0
3
0
2
1
4
2
0
6
1
5
2
1
1
0
0
1
6
7
1
3
2
1
0
1
0
0
1
0
0
3
7
14
22
25
I '
0
1
0
7
6
10
i
7
10
3
3
3
10
2
0
3
1
11
7
3
1
0
2
1
2
4
1
1
6
4
5
10
8
8
6
11
0
1
4
2
7
15
6
5
1
0
1
0
1
4
0
1
0
0
0
0
5
11
5
4
3
4
4
5
6
63
64
73
Table 11
Nationality of Parent Financial Institutions Entering the Publicized
Eurocurrency Credit Market for the First Time'
1973-1980
Nationality
Other
Oth
year
Eur.
N. Amer. Latin Amer.
Asian
M. East
er
Consortium
1973
37
14
2
2
7
9
4
1974
26
12
4
4
3
12
4
1975
31
13
0
4
3
9
4
1976
25
8
0
7
2
11
3
1977
28
6
5
10
8
5
4
1978
14
7
3
15
8
11
5
1979
23
7
6
7
6
5
10
1980
25
10
11
4
11
4
8
TOTAL
209
77
31
53
48
66
42
Source: World Bank data
? Refers to first-time entry since 1972; data not available for previous years.
Table II shows the nationalities of the new entrants. European, North
American and Other Consortium institutions (consortium banks whose
entered the Eurocurrency credit market first Also, consortium banks were
established early as a means of access to the market Latin American. Asian
and Middle Eastern institutions exhibit increasing rates of new entry over
time. (Asian rates would be more pronounced if not for the effect of periodic
Japanese government restrictions on foreign lending, which caused
Japanese entry and participation in the syndicated Euroloan market to
fluctuate. Other Asian nations demonstrate steadily increasing participa-
tion.) While European institutions continue to dominate the new entry table
in terms of sheer numbers, the increasing entry of institutions from other
regions indicates the growing breadth of the Eurocurrency credit market
Plumber of Loan participations
Total yearly loan participations by all institutions provide a measure of
Eurocurrency credit market size distinct from dollar volume measures. The
number of participations by both named and unnamed participants grew
from 415 to 4,913 between 1972 and 1980, a twelvefold increase. Participa-
tions by named participants, which grew from 412 to 3,723 in that time
period, are categorized by nationality in Figure Ill. In terms of loan participa-
i owners did not fit nearty into a regional category) demonstrate a declining
rate of new entry. This is not surprising since institutions from countries with
the most internationally active and highly developed banking systems
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tions, European institutions increased their share from just over one third to
almost half the yearly total. Again Middle Eastern growth is notable, from a
less than one percent to a six percent share. Both the North American and
Asian shares declined, by ten percent and five percent of the total respec-
tively.
Figure ID
Publicized Eurocurrency Credit Market Participations
by Nationality of Participant
1972 & 1980
(First through Tenth Listed Participations Only)
Austria
Belgium
Luxembourg
Fed. Rep. of German
France
Italy
Netherlands
Spain/Portugal
Switzerland
United Kingdom
Other, W. Europe
E. Europe
Canada
USA
Source: World Bank data
' Consortium banks which did not fit in any regional category, such as UBAF, which is owned
by European and Middle Eastern institutions.
t Africa, Oceania and a very small percentage (less than 1 percent) of institutions which could
not be identified by nationality.
First listed participants
World Bank's first listed participants can be used as a proxy, albeit an
imperfect one, for Eurocurrency credit lead managers. It is evident that
changes in national shares of total first listed participants are consistent with
other share changes described in previous sections. Figure N illustrates
that European institutions account for almost half of total first participants
positions in 1972 and 1980. North American institutions moved from
holding first participant position in almost a third of all Eurocurrency credits
to a 22 percent share in the same time period. Asian institutions maintained
a stable first participant share of approximately ten percent, while Middle
Eastern institutions, which appeared in no first participant positions in
1972, had a seven percent share in 1980.
Mexico/Central/S. Ame
Caribbean
Middle East
Africa
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Japan
Other Asia
Oceania
Consortia
of which European
Arab
Asian
Other
Unidentified
GRAND TOTE
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
fist over one third to
h is notable, from a
orth American and
of the total respec-
s a proxy, albeit an
a. It is evident that
are consistent with
figure IV illustrates
al first participants
ions moved from
rocurrency credits
tutions maintained
cent, while Middle
ipant positions in
Euroloan Participations by Nationality of Participant
1972-1980
(Fist through Tenth Listed Participants Only)
Austria
Belgium
Luxembourg
Fed Rep. of Germany
France
Italy
Netherlands
Spain/Portugal
Switzerland
United Kingdom
Other, W. Europe
E Europe
72 73 74 75 76 77
0 0 5 16 7 42
12 6 17 28 12 35
8 9 15 11 27 31
11 15 59 115 108 219
27 67 125 100 92 103
9 25 22 7 11 15
0 2 8 27 28 45
5 7 29 32 36 41
2 4 9 20 32 47
65 106 113 127 156 207
2 15 16 35 48 47
3 4 7 11 6 1
144 260
42
5 529 563 833
78
79
80
15
31
41
49
106
110
51
70
45
254
300
254
162
223
395
39
55
98
81
78
67
38
77
100
63
74
76
280
357
416
46
71
81
2
6
17
1080 1448 1700
10 24 44 117 121 153 261 284 301
136 239 346 503 653 658 749 613 657
146 263 390 620 774 811 1010 897 958
10 3 8 29 19 22 29 60 95
9 10 12 3 5 3 2 4 9
1 5 4 19 19 48 106 80 113
1 0 1 1 3 2 2 2 5
51 99 37 14 32 97 355 466 258
6 4 7 14 11 24 36 42 80
57 103 44 28 43 121 391 508 338
2 0 2 3 1 1 5 5 25
36 70 128 161 233 284 373 386 467
4 9 25 14 19 37 45 55 72
0 0 1 4 8 12 50 54 92
0 1 1 1 1 0 0 2 0
32 60 101 142 205 235 278 275 303
6 6 9 15 9 6 9 9 13
412 720 1023 1408 1669 2131 3007 3399 3723
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Figure IV
Total Publicized Eurocurrency Credits by Nationality
of First-lasted Participants
1972 & 1980
+lustria
Belgium
Luxembourg
Fed Rep. of Germany
France
halt'
Netherlands
Spain
Switzerland
United Kingdom
Other, W. Europe
E. Europe
Source: World Bank data
Consortium banks which did not fit in any regional category, such as UBAF, which is owned
by European and Middle Eastern institutions.
t Africa. Oceania and a very small percentage (less than 1 percent) of institutions which could
not be identified by nationality.
'? Totals do not match loan totals in Table I due to omissions in World Bank data.
Canada
USA
Mexico/Central/S. Amer.
Canlbean
Middle East
Africa
Japan
Other Asia
Oceania
Consortia
of which European
Arab
Asian
Other
Unidentified
GRAND TOTAL'
First-listed participant in Worl,
Totals do not equal Eurocurret
World Bank data.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Number of Euroloans by Nationality of First-Listed Participant'
1972-1980
Austria
Belgium
Luxembourg
Fed. Rep. of Germany
France
Italy
Netherlands
Spain
Switzerland
United Kingdom
Other, W. Europe
E. Europe
0 0 3 3 1 3 3 2 6
6 2 3 7 1 7 7 13 19
4 4 3 3 7 10 7 14 8
4 7 20 19 23 39 67 55 40
19 34 58 32 23 19 35 45 70
2 7 7 1 2 4 15 8 9
0 1 2 6 8 6 17 8 12
1 1 2 5 6 10 8 21 27
1 1 4 4 2 1 10 21 22
45 83 73 50 46 50 73 100 90
0 2 3 7 11 18 18 19 19
3 0 0 3 0 0 0 0 0
ich is owned
which could
later.
Canada 6 12 7 14 10 14 35 55 45
USA 87 145 179 181 190 194 286 242 231
Total 93 157 186 195 200 208 321 297 276
Mexico/Central/S. Amer. 1 0 3 6 4 2 12 11 15
Caribbean 7 10 6 1 2 2 1 1 1
Middle East 0 3 3 1 2 6 34 17 28
Japan 11 33 12 2 5 12 45 66 24
Other Asia 1 2 3 8 5 4 4 2 11
Total 12 35 15 10 10 16 49 68 35
Oceania 1 0 1 1 0 0 2 2 5
Consortia 26 31 59 51 79 84 96 105. 114
of which European 1 1 3 3 8 11 11 15 21
Arab 0 0 1 2 4 1 16 10 14
Asian 0 0 0 1 1 0 0 0 0
Other 25 30 55 45 66 72 69 80 79
Unidentified 5 1 4 5 0 4 0 3 2
GRAND TOTAL' 230 379 455 410 427 489 776 810 798
First-listed participant in World Bank data usually refers to the lead manager.
' Totals do not equal Eurocurrency loan totals found in Table I in the text due to omissions in
World Bank data.
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Conclusion
World Bank data, although identifying only ten participants per Euro-
loan, can be used to provide some information on the pace of new entry into
the Eurocurrency credit market and patterns of changing nationality
among lending institutions. Conclusions drawn from the data become less
certain in later years, because of the significant increase in the number of
unidentified participants listed beyond position ten in individual loans.
The picture resulting from a study of the data is one of a growing and
broadening syndicated Eurocurrency credit market between 1972 and
1980. The growth in number and volume of loans has been accompanied
by a growth in the number of institutions participating in those loans.
Growth in total number of loan participations has outstripped the growth
rate in number of loans; this is another indicator of increased market
breadth. A steady average of 66 new institutions has entered the market
yearly.
Institutions headquartered in Europe and North America, active in the
Euroloan market in earlier years by virtue of their well developed interna-
tional banking presence, still accounted for the bulk of yearly participations,
lending institutions and first listed participants (a proxy for lead manager) in
1980. However, new lender institutions from these countries are entering
the publicized Eurocurrency credit market at a declining rate. In recent
years, increasing numbers of new entrants are from Latin America, Asia and
the Middle East. Institutions from the Middle East as a whole have increased
their share of yearly loan participations, loan leadership and representation
among lending institutions notably, from less than one percent of the total
in 1972 to six to eight percent in 1980. This increased share has been
balanced in part by the declining share of North American institutions.
Endnotes
World Bank data are limited, identifying a maximum of ten participant institutions per
individual loan. This limitation becomes more important over time. See Table I for the
number of loans with unidentified (greater than ten) participants on a yearly basis.
Laurie Goodman, The Pricing of Syndicated Eurocurrency Credits,- Federal Reserve Bank
of New York Quarterly Bulletin. Summer 1980, p 40.
' Morgan Guaranty Trust Company, World Financial Markets.
' The World Bank stopped collecting this type of data as of the second quarter of 1981, since it
is now available from several other sources such as Caploan and the Euromoney syndication
service.
Volume of publicized Eurocurrency credits is available from many other sources including
Morgan Guaranty Trust Company, the OECD and Caploan. Reported numbers differ due to
differences in timing, coverage, etc. Compare, for example, the World Bank figures with those
found in Morgan Guaranty's World Fuancial Markets: $6.9 billion in 1972 and $76.8 billion
in 1980.
? Tables from which these charts are derived may be found in the following these notes.
Overvie
National authoritie
bank safety and souni
system as a whole. Thf
into preventive regula
schemes which offer p
and support provided I:
ing liquidity difficulties
Preventive Regulation
Among measures
banks are those conce
acy, permissible busine
tion of loans and coun
In virtually all natioi
entry stage. Before the
requirements which tyf
minimum amount of
formalized, varying fror
USS10m (United Kingc
branches of foreign ba
endowment capital, alt
quirement while Canac
form. Several countries
market entry may be re
view to curbing excess
In addition to a rr
Richard Dale is currently a
at the Brookings Institution
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
R041 a M QMMe199 J1? Q JIM ac'R'" . $ 0 G3
The interbank deposit markets
are the Euromarket's most
sensitive barometer. Here's how
the climate's changed.
By Tim Anderson
"We realize we have had to prove our
credibility," said George Gunson, general
manager of Euro-Latinamerican Bank.
"To reassure the market, we never ask to
roll over an interbank deposit. That way the
bank can prove it has the funds to repay
them."
In National Westminster Bank's Thread-
needle Street offices, interbank deposit
dealers do not take calls from Brazilian
banks. If one of the direct lines lights up on
a dealer's desk, he politely refers the caller
to the Latin American division. There is no
automatic trading, as there used to be.
Neither would have happened a year ago.
These changes are the everyday realities of
the reshaping of the Eurodollar interbank
market, which took place after the shocks
which hit banking last year, and has con-
tinued with Brazil's attempts to maintain its
interbank lines.
The flight to quality, most vividly seen
during the autumn of 1982 in the Euro-
dollar certificate of deposit market
(Euromoney October 1982), when the yield
on CDs rose to 300 basis points over T-bills,
had an impact on the interbank market
which many believe is permanent.
US banks are offered more deposits than
ever - so many that they may even be
turning them down, thereby reducing the
pool of funds available to other banks. For
non-US banks, the market is now frag-
mented. Greater caution, higher spreads,
stricter bank and country limits, have
reduced liquidity. The interbank market
remains the main source of short-term
funds for most international banks and its
size depends, more than ever before, on the
funds funnelled through the big US banks.
Calm has returned to the Eurodollar CD
market, and it remains an important source
of funds for a select club of eight US banks.
Euro-Latinamerican and other banks
connected with Latin America have
suffered the brunt of the changes because
the shocks from the region have been the
most severe. But no bank is unaffected. The
shocks which undermined confidence in
banks were worldwide; from Banco
Ambrosiano in Luxembourg and Italy to
Penn Square and Lombard-Wall in the US.
And there is hardly a bank in the world
without exposure to Mexico, Brazil or
Argentina.
As the lubricant of the international
banking system, the interbank market is
essential. Now there is grit in it. In 1973 the
size of the market was just $150 billion. By
the end of 1982 it had reached $1,000
billion, 12 times larger than the syndicated
loan market. But in the last quarter of 1982
it grew by only $20 billion, as compared
with the $63.5 billion increase in the same
quarter in 1981.
While the interbank market was
expanding dramatically every year, it
gained a confidence which pushed aside the
memory of the Herstatt crisis in 1974. Now
banks are more selective over which banks
they deal with. Limits are tighter and more
strictly imposed.
Gunson of Euro-Latinamerican said:
"There is a general decrease in liquidity. As
a result there are very few banks which
quote prices continually. We have learned
who our friends are." Euro-Latinamerican
has had to ask its shareholder banks to
increase their interbank tines to it, to
compensate for the cuts made by other
banks.
It is important for a bank's market credi-
bility to be seen as a provider as well as a
taker. Consortium banks generally use their
tines from their shareholders, which they
obtain at the finest rates, to lend in the
market. They fund their books from what
they can raise on the interbank market.
Part of the decrease in liquidity comes
from the fall in the Opec surplus. Last year
Opec members were large net takers of
funds, withdrawing $18.3 billion in
deposits, whereas in the past they were
enormous net contributors. The switch has
hit liquidity and confidence.
But what hits liquidity more is the
increased selectivity in the market. While
the biggest US banks are offered more
dollar deposits than ever, other banks,
including consortia, have to scratch around
the market for funds.
Carl Malmaeus, general manager of
Toronto-Dominion Bank, said: "In prac-
tice banks deal with those banks with which
they do other business. Interbank has to be
risk-free because the return is so low."
As there is now a risk, banks want a good
return, and they are insisting on the profit-
ability of all interbank lending. Combined
with strictly imposed balance sheet re-
straints, this has further reduced liquidity.
In the 1970s, spreads of 25 basis points
were justified by the low risk and the high
volume. With a new view of risk, volume
does not appear so attractive.
Mike Rice, head of Citibank's inter-
national money markets division, said:
"Profit, not growth, is the emphasis now.
It is not attractive to turn money round at
small spreads as before."
This pattern of higher profits, from deals
with more cautiously selected banks, re-
stricts the flow of funds.
For the big US banks, "the problem is
not funding", according to Rice. He added:
"People are so risk-averse that banks like
Citibank are offered more deposits than
ever. But we do not like taking money at a
quarter under Libor to lend at Libor."
The US banks, which supplied so much
of the market liquidity in the 1970s, are now
constrained by return on total assets ratios.
Some US banks deny that these ratios
have caused them to refuse deposits. In the
secretive interbank market it is difficult to
discern what is happening. But, according
to the head of one US bank's treasury D
Euromoney July 1983 63
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THE INTERBANK MARKET
section, the ratios are biting. "Increasingly
you see banks trying to raise their fee
income from bond, CD, and forex trading.
If they can increase the income side of the
ratio, they can then take on more assets. It
is one of the giveaway signs." Last year US
banks supplied 45% of the net increase in
funds - $38.3 billion out of $85 billion,
according to the Bank of International
Settlements. In 1981 they supplied only
29% of the net increase, but the amount
was greater - $47.7 billion in 1981, or
$9.4 billion more than in 1982. Direct
deposits have become more important, as
US corporations have recognized the higher
yields available in the Euromarket. US
banks have also encouraged rich individuals
to deposit with their London subsidiaries
for the same reason. These are more stable
sources of funds and are cheaper than the
wholesale market.
On the wholesale Euromarket the cheap-
est funds available are Eurodollar CDs. It is
a US-dominated market. Over 60% of the
CDs outstanding in March this year were
issued by US banks, according to Bank of
England figures. Most of these were issued
by eight US banks at as much as 75 basis
points under interbank rates, the lowest
available in the market. And the CDs of
these banks make up 70 to 80% of those
actively traded in the secondary market.
The marketmakers are US investment
banks and the buyers US investors - cor-
porations, pension funds, money market
funds, states and municipalities.
These CDs are issued by a select club
called the run, which enables those on it to
issue CDs at the lowest rates. Once a bank
is a member of this informal and unregu-
lated club, its CDs are always issued and
traded at the best rate. The club's CDs
carry the same risk and investors buy them
on a no-names basis. The run used to
include nine banks, but Continental Illinois
removed itself in July 1982 after its involve-
ment with Penn Square was made public.
For the banks on the run the liquidity of
their issues is as important as the volume.
This was undermined at the height of the
debt crisis last year. Investors, who see CDs
as one of the most liquid ways to invest
money, began to fear for the acceptability
of CDs. As these investors, and the traders
of on-the-run CDs, are mainly from the
US, the lack of confidence in some US
banks was a reflection of the feeling inside
the US. That confidence seems now to have
been largely restored, and, with it, the
liquidity of the market.
The largest US banks also virtually
monopolize the next cheapest source of
'unds, deposits by US regional banks. Early
afternoon, London time, when the regional
US banks enter the market, is often the
busiest part of the day.
This part of the interbank market is as
secretive as the rest. But it is clear that
regional banks are becoming more selective
now prefer the large regional banks from
their own areas to the money centre banks.
One broker said: "The regionals are more
careful, but the market is calm."
Outside the Euromarket, US banks and a
select number of European banks, which
have the best rating from Standard and
Poors and Moodys, obtain their funds by
issuing bankers' acceptances and commer-
cial paper in New York. Both are, at least in
theory, trade related. They are a cheap
source of funds, but an insignificant slice of
the market. The Securities and Exchange
Commission sets a limit on the amount of
commercial paper a bank is permitted to
have outstanding. NatWest's limit, for
example, is $1.5 billion. The average life is
50 to 70 days, with a maximum of 270.
For most international banks the shape
of the Eurodollar interbank market is all.
important. French banks make great use of
floating rate notes and Japanese banks
favour floating rate CDs, because of
Ministry of Finance requirements. But it is
the interbank market which provides both
with immediate access to funds.
One US bank treasurer suggested that the
full consequences of the changes in the
market had not yet been seen. "If the
pattern continues, the top US banks will
break away from the rest of the market and
automatically obtain rates well under inter-
bank."
At the other end of the market, Brazil is
already paying 1 % to 'ri 016 over interbank.
Perhaps the change in the shape of the
interbank market has only just begun.
^ -
The Rates Banks Bid for Funds
Eurodollar interbank market,
six-month deposits
subsidiaries
Canadians
Small
Europeans
Large
Europeans
(not French
and German)
41
Certificates
of deposit
French
Large
Germans
Load..
interbank
offered rate
London
later bank
bid rate
This diagram is a guide to the shape of the interbank market. When the market is illiquid, even US
regional banks could be forced to pay the offered rate. When it is highly liquid, French banks obtain
the bid side of the market. Each transaction is an individual agreement between the bank offering the
funds and the one taking them. This diagram shows the underlying positions of the groups of banks in
the market.
US majors. These are rarely takers in interbank. If they require wholesale funds they prefer issuing
certificates of deposit because they are a cheaper source of funds.
Large Europeans. Of these, the big German banks command the best rates, often at the bid rate of
the market.
French. These tend to move the market rate because of the size of their trades.
US regionals. new hardly ever bid for funds. If they do, it is through brokers and they get the best
rates.
Japanese. The trust companies pay the highest rates. For big trades even the best names pay the top
rates, near the offered rate.
Canadians. Much the same as the big Japanese banks. They pay near the offered rate for size.
Brazilian. These rarely raise funds through brokers. They have to rely on their direct relationships
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You're the
best judge of
foreign risks
A guide to the best techniques
for managing your
international exposure
without having to rely
on outside experts
Pravin Banker
When the world returned from the almost In today's world, it is safe to say that
unbelievable economic stability that nothing is sacrosanct. The France of d'Estaing, Pompi-
characterized the 1950s and early 1960s to dou, and de Gaulle can quickly become the France of
the more normal instability of the 1970s, Mitterrand. Even the once hallowed doctrine of sover-
many international companies and the eign risk, under which commercial banks lent to coun-
managers who ran them were hit hard. tries like Poland at rates equal to the prime plus
They had grown their businesses in a hot- one-half of 1% because it was considered unthinkable
house environment and all of a sudden saw that a communist regime, with its inbuilt power of
their well-cultivated gardens flattened
with monsoon-like ferocity perpetual control, could ever default, is now in disre-
pute. As a consequence, nothing is more important to
This turn of events brought into vogue the maintaining the profitability of international compa-
idea that executives should make risk nies than the successful management of exposure to
management part of their international political, economic, and financial risk.
strategy. Despite the prominence of expo- Taking risks is, of course, a part of any
sure management, many companies still business. Because of the larger number of unknown
lack sophisticated strategies for coping factors, however, international business has always
with the unpredictable environments they entailed greater risk than domestic enterprise. But
face in international markets. In this arti- many companies have only recently come to realize
cle, a financial expert gives readers the that the degree of risk to which they are exposed is
benefit of his years of international experi- wi
ence. His practical guide to exposure tech- gowing lust as fast as the complexity of doing daily
niques shows where many that are
considered sacred fall down and where Despite years of experience, most have
more innovative methods might do a developed no precise guidelines for managing their
better job. exposure to this risk. Many companies simply rely on
techniques they have always used. They don't factor in
Mr. Banker is an international treasury much of their own experience. Often they assume that
consultant, responsible for exposure man- outside organizations can provide secret formulas or
agement and international finance for cookbook solutions. Managers turn too often, for
IBM's overseas branches and subsidiaries. example, to standardized risk ratings for quick solu-
Employed by IBM for 17 years in numerous tions to the problem of matching countries with
positions in engineering, sales, and finance,
he has recently been promoted from his investment or operating plans, but these ratings do not
position as manager, treasury operations, of include the sophisticated detail necessary for success.
the Americas-Far East subsidiary of IBM's All countries have some element of risk as well as
World Trade Corporation to his current some potential to produce profits. The difference is in
position at the IBM corporate headquarters the degree of risk.
i in Armonk, New York. Outside organizations and indices can
at best provide basic information, but the manager
Photographs courtesy of E.P. /ones and must know how to use it in light of his or her own
Ivan Massar. experience. Remember that the track record of con-
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Harvard Business Review March-April 1983
suiting and rating organizations is not good. The best
illustration I have comes from my recent experience
-h the Mexican devaluation. At the beginning of
12, I polled 11 experts for their opinions. Most of
them believed the Portillo-Kolbeck assurances that the
peso would be devalued by merely 18%. Only one cor-
rectly predicted the actual extent of the devaluation
(50%, on February 17,1982).
To determine the degree of risk a com-
pany can stand and yet sustain its profitability, a man-
ager must understand the risk factors of the countries
in which the company operates and develop tech-
niques to handle each one. For its part, the company
must create a focal point clearly charged with the
responsibility of protecting its worldwide investment
and profitability. The world is full of narrow windows
of opportunity requiring quick entry; it does not suffer
plodding bureaucracy. Responsibility must stay in-
house. The involvement of senior line executives is
critical, for without it, even the most brilliant plan can
fail in execution.
The following discussion, drawn from
my experience with international business, serves as a
guide to the various techniques needed to successfully
implement a strategy to soften political, economic, and
financial risks.
Handling political &
economic risks
Because they are not as precise, the
techniques developed to deal with political and eco-
nomic risks are more difficult to apply than those deal-
ing with financial risks. Managers should use them
sparingly and only after identifying the potential for
misapplication.
Concession ; greements. Prior to mak-
ing new commitments or adding to existing ones,
companies (particularly in extractive industries) often
reach agreements with host governments either
through written legislation or through verbal under-
standing. Such concession agreements define the rules
under which multinationals can do business in local
environments. Usually they include the concessions
the government grants in the form of royalties, market
share, tax incentives, tariff protection, and pricing
flexibility. Historically, multinationals investing in
less developed countries (LDCs) have favored such
Rreements. But history has also shown that the devel-
ed countries, with their tradition of orderly govern-
mental change, are more likely to honor them. In
LDCs, the risk of their emasculation or outright repu-
diation is high.
Insurance. Most industrialized coun-
tries offer political risk insurance for MNCs' invest-
ment in certain countries. The U.S. Overseas Private
Insurance Corporation, for example, offers coverage
against expropriation, war, revolution, insurrection,
and blocked currency. This coverage is narrow, however,
and useful only in extreme cases like the expropriation
of assets by North Vietnam after the fall of Saigon.
A more sophisticated kind of insurance
used in an LDC is the currency swap agreement. With
a central bank (often through a commercial bank inter-
mediary) a company signs a contract whereby, for a fee,
the central bank guarantees the future convertibility of
a foreign currency investment at a fixed exchange rate.
Swap contracts usually apply to foreign loans. Instead
of making direct capital investment, multinationals
therefore often offer subsidiaries "parent company"
loans denominated in foreign currencies, which are
then covered by swaps.
Funneling the parent company loan
through a commercial bank intermediary (via a partici-
pation agreement) enhances protection and flexibility.
One note of caution: if the country issues too many
swap agreements, it may not be possible for the central
bank to honor them on maturity. This is the dilemma
confronting Argentina, which has more than $5 billion
in such agreements maturing within six months.
Organization & structure. MNCs are
complex organizations that may make machine parts
in Brazil, assemble them as engines in Germany, install
the engines in bodies in Italy, and ship completed cars
to the United States for sale. The manufacture of a sin-
gle finished product may depend on three manufactur-
ing plants located in three countries, and sales may
depend on a fourth.
Companies have fostered this strategy
of "dependency" to neutralize the political risks of
operating in one country. But economic risks grow
with such dependency-a company agreeing to export
a certain product volume in a concession agreement
can get in trouble if demand in the country of sale falls
and an alternative market is not available. The country
in which a part is produced may be unreceptive to cut-
backs due to falling demand. Instead, the multinational
must often maintain full production and yet honor the
country's export commitments.
A recent innovation, called an export
enhancement program, attempts to address this pi ob-
lem. Host countries will allow the international
companies to export less than the amount specified in
their export contract if they will make up the shortfall
by exporting other companies' products. MNCs have
responded by exporting coffee from Honduras, crude
oil and petroleum derivatives from Iran, machine tools
from Brazil, and cacao from Ecuador.
A multinational does not have to
scatter its product manufacture to neutralize risk.
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Foreign risks 159
Developing its worldwide marketing and distribution
capability and control of transport facilities is just as
effective. Because they cross borders, they are fairly
safe from government action.
During the political turmoil between
Zambia and the then white-minority-controlled Rho-
desia, an uneasy economic alliance continued because
Zambia depended on the Rhodesian railroad to trans-
port its principal commodity (copper) to the sea and
European markets. The sacrosanct railroad enjoyed
long tranquility during the guerrilla wars.
Proprietary protection. Patent and trade-
mark protection is the most common proprietary tech-
nique used in exposure management. Another method,
commonly used by pharmaceutical companies, is to
locate research and development facilities in the home
country. Today many countries oppose both tech-
niques. Mexico, for example, forces companies to use
trademarks that are geared to its culture and sold to
local interests. India has introduced price controls on
drugs and mandated the dilution of equity in foreign
subsidiaries through its restrictive Foreign Equity Reg-
ulation Act. Canada, Australia, Brazil, and Mexico all
require companies to transfer technology if they wish
to keep their access to these countries' markets.
In light of these trends, companies that
are dependent on proprietary protection should con-
sider developing other kinds of protection.
Phaseout. During the Allende years in
Chile, the self-liquidation, or planned divestiture, of a
potentially risky investment became popular. As an
objective, however, it is very difficult to guarantee.
Companies have chosen two. ways to accomplish it.
The preferred approach is to structure the investment
with a minimum of capital and a maximum of loans.
Loans should come first from local government
sources (incentive loans), second from international
bodies, third from banks (preferably local), and last
from parent companies. The loans should be short-
term rollovers to limit investment risks. True, the
loans constitute leverage, but they transfer some of the
risk to the shoulders of organizations that are influen-
tial enough to ensure companies' continued economic
".)fit'-I .)) _?~:(.1 -i
Hedging:
Make currency swap arrangements, and negotiate
forward cover.
2
Remittances:
Use leads and lags.
3
Capital structure:
Remit surplus or convert to a parent company loan or a
bank participation agreement.
4
Pricing:
Use anticipatory pricing at the retail level; charge a
manufacturing transfer pricing premium.
s
Uabilitles:
Minimize strong currencies and maximize weak ones
by prepaying strong currency liabilities, converting them
to weak currency loans, and demanding confirmed
letters of credit for strong currency imports.
6
Assets:
Maximize strong currencies and minimize weak ones by
floating external (strong currency) bonds and by making
parallel market currency purchases and cross-currency,
cross-company loans as welt as local exchange-
indexed intercompany loans, preferably with bank
guarantees.
7
Accounts receivable:
Tighten collection procedures to transfer exchange risk
to local finance companies by factoring local currency
receivables.
8
Contracts:
Bill in strong currencies (most commonly dollars); use
a price escalation clause to take care of large devalua-
tions, an index clause for accounts receivable, and
a force maieure clause for protection against large
devaluations.
9
Blocked currencies:
Two methods. One, choose a blocked funds country as a
site for an international convention or seminar and use
local funds for expenses, including air tickets. Two, set
up a barter arrangement whereby marketable goods are
exported in lieu of a dividend, royalty, licensing fee, or
other service; an offshore agent will handle the details
and convert the goods to cash dollars for a fee.
Approved For
well-being.
Companies can extend this technique
by tapping local marketing outlets for advances or
loans that can eventually be converted to local equity
ownership. I remember a scene during the anti-
American riots in Istanbul more than a decade ago
when troops were posted in front of the Istanbul
Hilton, where management had hung out a large sign
clearly stating "Turkish ownership." Conrad Hilton
had always stressed local ownership and invested not
one nickel in his hotels abroad. His profits came
through lucrative management and service contracts.
Another phaseout approach is to sell a
maiority investment to local shareholders-for the
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Harvard Business Review Marh-April 1983
future. The uncertainty of price and local investor
'vailability make this approach more difficult to take,
MNCs discovered in Malaysia when they were
forced to sell equity to "Bumiputra" (indigenous inves-
tors). A company takes a chance when it agrees to
negotiate a price in advance; governments have been
known to renege. Even the much-vaunted shah of Iran
revoked a contract to supply oil to India at a fixed price
when the price of oil skyrocketed.
Risk premium in profitability. As part of
the evaluation of a potential investment in a country,
managers often calculate how much more the invest-
ment must return on capital in comparison with a sim-
ilar investment in its home country. The difference is
called the risk premium.
Take, for example, an investment in a
country with a low level of political risk at 1% (on a
scale where Switzerland's risk is zero and Iran's or
Zaire's 100%) but with an economic risk of a periodic
(say, five-year) boom-and-bust cycle that translates into
one exceptionally bad year out of five as well as a 40%
risk of devaluation.
First, we calculate the return on
invested capital (ROIC) that a top multinational nor-
mally requires: ROIC = interest + business risk =
18% + 12% = 30%. Then we use this ROIC to see
what the ROIC for that country is: country ROIC =
ompany ROIC + political risk x economic risk x
devaluation risk = (30% + 1%) 1.2 x 1.4 = 52%. To
be equal to an opportunity for that multinational in its
home country, the investment in this country would
have to command a 52% ROIC before taxes.
This kind of premium is, of course,
hefty and difficult to realize in a competitive environ-
ment. Moreover, its calculation is based on the most
subjective of assessments. Sophisticated companies
therefore often factor political and economic risks into
the profitability of their operations and relegate the
responsibility for devaluation or financial risk to a cur-
rency exposure management team. Their objective is
to neutralize currency loss and maintain profitability
in constant currency.
Can you be ready for everything?
Beyond these techniques, corporate
strategy dictates that most companies be in business in
host countries for the long run and live within the
political and economic rules they set. During periods
of prosperity, companies build up protected reserves.
Nhen adversity strikes, they reassess, reorient, restruc-
ture, and even retrench, but they don't immediately
divest. It is possible tp weather most storms.
Companies should of course be alert to
the possibility that the adverse condition is permanent
and requires action. A simple illustration is Costa
Rica. Stable for decades with the only democratic gov-
ernment in Central America, the economy of Costa
Rica suddenly became turbulent in 1980. Its govern-
ment unpegged the currency from its official mooring
of 8.6 colones to the dollar in September 1980; the
colon reached a level of 14 by year-end. Throughout
1981, the president and the legislature remained dead-
locked on plans to redress the deteriorating economic
situation.
Costa Rica's supreme court interceded
in mid-1981 with a decision that the floating rate,
which by that time was up to 40 colones to the dollar,
was illegal. Ignoring the court decision, customs con-
tinued to impose duties calculated at the free rate,
while the central bank offered dollars only at the free
rate. The government reneged on its 1980 vow to settle
dollar liabilities incurred prior to the colon float at the
official rate. It offered government bonds to cover divi-
dend remittances. High dollar interest rates and fear of
Nicaraguan encroachment triggered flight of capital
from the country-in short, economic conditions
became chaotic.
The situation turned into a nightmare.
Imports were payable at the free rate, but companies
could collect dollar billings only at the official rate.
Companies had to limit price increases because of con-
tractual obligations or because customers simply
would not pay. The outlook for government payables,
receivables, and even tariffs was riddled with uncer-
tainty. The only alternative to ceasing business
entirely was surgery.
Many international companies would
say that the speed with which events unraveled in
Costa Rica prevented them from being forewarned and
thus, forearmed. But I have found that an alert com-
pany can be ready for abrupt changes and have in hand
a number of ways to deal with crisis. Because financial
risk is the most common operational risk encountered,
the company that arms itself with sophisticated tech-
niques to counter financial risk can protect its long-
term profitability.
The complexity of
financial risk
It has become fashionable to play down
the importance of finance to the success of interna-
tional companies, but this attitude is as shortsighted as
that which gave finance undue importance in the first
place. Unlike political and economic risk, which hits
companies haphazardly, financial risk presents almost
daily difficulties.
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In a financial market like the United
States, the availability of capital is large, the flexibility
of vehicles through which companies can find that
capital is considerable, the costs competitive, and long-
term stability almost ensured in the hands of a respon-
sible institution. When a company leaves this country,
however, the picture changes dramatically. While it is
not possible within the context of this article to exam-
ine all the variations in each environment, you can
learn a lot from looking at one typical problem and the
techniques used to solve it.
The Peruvian headache
At the beginning of 1980, the environ-
ment in Peru changed-for the better, it seemed. A long
period of socialist military rule gave way to an elected
civilian government. Anxious to encourage foreign
investment, implement the International Monetary
Fund's recommendations, and secure the IMF pay-
ments credit facility, the government refinanced its
external debt and modified the onerous provisions of
Decision 24 of the Andean Common Market
(ANCOM).
The trade balance had turned positive,
and estimates of the potential surplus ran as high as
$1.4 billion-quite a remarkable change from the flirta-
tion in 1978 with bankruptcy.
The total financing requirement of one
U.S. multinational's Peruvian subsidiary was around
$12 million, about $ 5 million of which was long term.
The local financing environment the subsidiary
faced had:
^ Limited local currency available for pri-
mary customers. Five local banks could provide $6
million at an interest rate of 4% per month, but it was
available for a maximum term of six months with one
six-month rollover guarantee. ANCOM's rules forbade
multinationals to borrow long term.
^ The prospect of a minidevaluation of
30% annually, bringing the effective costs of local
loans to about 23% annually (interest at maturity).
^ Local dollar loans with no limit but a
maximum of 180 days and an interest rate of New York
prime plus 4%.
^ Offshore loans at the London interbank
rate (LIBOR) plus 1/2% but with a 25% mandatory
deposit required without interest. The central bank
granted exceptions for capital equipment loans whose
Foreign risks 161
After some debate, the company
decided to maximize its local loans to obtain dollar
loans. While the 23% net cost (including devaluation)
was 7% higher than the 16% offshore loan cost, the
company decided that this premium counted as insur-
ance against a larger-than-forecasted devaluation. The
subsidiary would not take out local dollar loans
because of their expense and would use them only as a
contingency buffer. Finally, the subsidiary turned to
offshore dollar loans of $5 million but wanted to avoid
making the expensive mandatory deposit.
To do this, the subsidiary had to
approach the Peruvian Central Bank (through a local
bank) to determine the conditions under which it
would grant an exception to the mandatory deposit
requirement. The central bank stipulated that the loan
term had to be three years and that the company had to
pay a preferential interest rate no higher than what the
country commanded in its international borrowing.
(This rate was subsequently defined as LIBOR.)
Research turned up three alternatives -
a commercial bank loan at LIBOR that would absorb
the 10% withholding tax and the differential compen-
sation paid to the bank by the parent company; a direct
parent company loan at LIBOR with the parent com-
pany borrowing in the United States or Europe; and a
bank participation loan at LIBOR with a 1/8% bank fee
to be paid by the parent. The bank participation loan
was attractive because it gave the parent anonymity at
a nominal 1/8% cost and was more likely to gain the
approval of the central bank as an external bank loan at
LIBOR. It was also added insurance if the country's
conditions ever changed for the worse since such a
loan would be unlikely to be part of a debt mora-
torium.
Moreover, both the direct parent com-
pany and the bank participation loans offered U.S. tax
advantages. By providing foreign-sourced income, they
allowed the parent to use up any excess foreign tax
credit. For example, $5 million at 16% loaned to the
subsidiary and borrowed at 13.5% by the parent would
have an annual net benefit before taxes of $125,000 or
$67,000 after taxes. For this company an annual for-
eign source income of $800,000 gave a potential after-
tax benefit of $324,000.
The currency blues
terms exceeded three years. MNCs must consider two kinds of fac-
^ Financing tax payments for 90 days at tors in managing their currency exposure -reporting
the nominal interest rate of 12%. Because the subsidi- and operational. The reporting requirement is gov-
ary had a $2 million tax bill to pay in March, this was erred by the U.S. Financial Accounting Standards
an obvious "- Board IFASBI Statement 8_ Under this standard, a com-
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Harvard Business Review March-April 1983
pany must translate its balance sheet at the current
exchange rate and charge to the profit and loss state-
ment any net gain or loss resulting from asset-liability
ranslation. Fixed assets are carried at historical ex-
change rates and excluded from the translation pro-
cess. For reporting purposes, therefore, the key focal
point is net exposed assets. From an operational view-
point, however, the focus is the transaction itself,
regardless of either time factors or other assets and
liabilities.
Most international companies restrict
their concern about managing currency exposure to
satisfying the FASB's reporting requirements. Their
strategy is meant to manage the balance sheet (opera-
tional hedging) to a zero net exposed asset position.
Neither a revaluation nor a devaluation would cause
any sudden exchange impact on the balance sheet.
Other companies focus on daily transactions and
hedge the impact of foreign exchange through currency
swap arrangements or the purchase of forward cover
(financial hedging).
With the assumption that these two
considerations run at cross-purposes, companies have
debated which kind of strategy is most important.
Opponents of FASB 8 contend that the reporting
requirement penalizes current-year profitability by
treating unrealized gains or losses as if they were real
and thereby distorts the profit and loss statement.
:xecutives are driven to make "reporting" decisions
rather than sound "financial" decisions in multicur-
rency environments.
The debate led to FASB 52, which differs
in two ways from FASB 8. It provides some flexibility
by introducing the concept of "functional currency"
Company management may now decide whether the
currency in which major decisions are made is the
local currency or the dollar. FASB 52 also permits the
establishment of a special account on the balance
sheet through which translation gains and losses can
be directly charged against the surplus without first
being reflected in the P&L statement. Companies that
choose the local currency as their functional currency
can follow this route. They must, however, translate all
assets (including fixed) and liabilities. For companies
whose functional currency is the dollar, the provisions
of FASB 8 still apply.
One important consideration should
not be overlooked. The relief FASB 52 provides per-
tains only to balance sheet gains or losses. The larger
impact of revenue translation on profits remains. In
fact, an increasing number of consultants have advised
their corporate clients to hedge net aftertax earnings
through a combination of operational and financial
echniques. The recent increased exchange rate volatil-
ity and the rapidly declining accuracy of exchange rate
forecasts are probably, responsible for the increasing
inclination of companies to listen.
Putting out operational fires
International managers have developed
a number of solutions for currency problems. Most of
these techniques are familiar (for a complete rundown
see the ruled insert). Stemming from the kind of com-
plex trading transactions and intercompany transfer
mechanisms companies have developed to get around
roadblocks like those put up by the Peruvian govern-
ment in the example, these techniques have many pit-
falls managers should avoid. Because they have been
developed in a haphazard, mostly ad hoc fashion, .
they need to be monitored carefully and controlled
rigorously.
Local currency loans and hedging tech-
niques, for example, generally carry premium costs in
weak currencies. Many companies operate entirely
with this kind of local loan and include the premium
with the product or service. For those that cannot and
must use strong currency loans-either because of cost
or local banking restrictions-managers must reli-
giously follow the probability and timing of currency
changes..
Strong currency loans carry additional
difficulties. Many countries with exchange controls
designate minimum periods for foreign loans. While
such controls appear to constrain a manager's freedom
of movement in minimizing strong currency liabilities
when the company has excess cash, they do not neces-
sarily do so. The central bank is the point of control in
a country and, as the Peruvian example illustrates, hav-
ing a dialogue with the central bank on important
points is often possible. In my experience, the key peo-
ple in these institutions have been intelligent, knowl-
edgeable, and pragmatic.
In one instance, we persuaded the cen-
tral bank to permit a dollar loan "repass." This method
allowed term loans of five to seven years to be repaid in
two or three years, without a change in the country's
balance of payments. With the assistance of Chase
Manhattan Bank, we located a large Brazilian company
with financing needs. With the permission of the cen-
tral bank, the subsidiary paid the Brazilian company
the cruzeiro equivalent of $30 million. The creditor
bank changed the original loan agreement and replaced
the name of the MNC subsidiary debtor with that of
the Brazilian company. All other terms and conditions
remained unchanged. The central bank transferred the
future right to obtain foreign exchange to the Brazilian
company, which in turn, compensated Chase Manhat-
tan and the creditor bank for services, change in cred-
itworthiness, and change in interest rates with a front-
end lump sum payment in cruzeiros. The loan was
"repassed" without currency having to cross borders or
affect the balance of payments.
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third party is a commercial bank but quite happy to
pany should quote the export price of a manufactured delay or refuse payment to a supplier.
To minimize currency impact, a com-
product in the currency of manufacture. One impor-
tant exception: if the import content of the exported
product is large and the import currency stronger than
the export currency, the company may wish to reverse
the currency of export billing. For example, a French
plant importing from the Netherlands and exporting to
Germany may wish to bill in deutsche marks.
Many export houses also hedge their
sales through forward cover for six to nine months and
factor the hedge premium into the export price.
Parallel market is a "semilegal"
exchange market in a country with exchange control
operating outside the venue of a central bank. In many
of the smaller countries, such as Bolivia, Paraguay, and
the Dominican Republic, it is the multinational's only
source of foreign exchange. In others, such as Brazil and
the Philippines, it is an alternate source for certain
purposes.
Most managers are familiar with the
technique of making intercompany loans at preferen-
tial interest rates with guarantees of the exchange rate.
But companies should be open to variations on this
theme. Two companies, for instance, had excess cash in
El Salvador. Because of restrictions, they were unable
to remit this cash in the form of dividends to the
parent company. Both Company A and Company B,
however, had subsidiaries in Guatemala. Company
A loaned $2 million excess cash to Company B's
subsidiary in Guatemala, while Company B loaned
$2 million to Company A's Guatemalan subsidiary.
The funds were then remitted to the United States
from Guatemala.
If a devaluation occurs, the exchange
losses suffered by the El Salvadoran subsidiaries of A
and B are offset on consolidated books by correspond-
Anticipating currency
changes
The amount of a currency change is
important, but its timing is critical. Deducing that a
country must change the value of its currency on the
international market is easy; economists forecast
devaluation as a matter of course. Their formula is very
simple. Over time, a country must adjust its currency
to take into account the difference between its own
inflation rate and the trade-weighted average rate of its
trading partners. The term over time holds the key.
Because each country responds according to different
criteria, it could mean one, two, five, or ten years, or
perhaps never. Brazil adjusts regularly; Argentina sub-
stantially every five years; Venezuela hardly ever.
France, under the Gaullists, absorbed inflation rate
differentials and quite comfortably maintained a
stable franc.
Predictions of amount are rarely ful-
filled. The extent of the two-year decline in several key
currencies vis-a-vis the U.S. dollar was beyond the
imagination of economists. The Argentine peso
declined 2,500%, the Mexican peso 600%, and the
French franc and the Spanish peseta more than 50%.
Companies should look at five factors to
try to understand the difference in each country's
approach to currency change. They are instrumental
in determining both its potential and its size:
Balance of trade. Economists focus on
the difference in inflation rates because they assume
that a disparity in labor rates creates an imbalance in
the trade position over time; a prudent country will
change its currency to adjust. There are two weaknesses
in this assumption, however. First, very few countries
are prudent. Second, a country's trade balance may
depend on a high-yield product such as oil or gold; the
labor rate is irrelevent. This is Venezuela's secret.
in many weak currency countries for the international A country's reserve position. The Inter-
airlines, oil companies, and aircraft companies, most national Monetary Fund requires that member nations
other companies must bill in local currency. These report each month on their reserves of gold, special
companies must offset the impact of currency on prof- drawing rights, fund reserve positions, and foreign
itability by anticipating price increases. In countries exchanges. International Financial Statistics, the
where the rate bf currency adjustment is severe, monthly publication of the IMF gives clues to the
companies can run into severe collection problems health of a currency based on the trend in a country's
with dollar billings. One method that can help is reserves. Delayed reporting is an even better clue.
financing through a third party like a commercial Argentina was four to five months behind in early
bank. Debtor ' . . _ - t__.,_ _..L,._ A_ ,no, -4 T"----- - .,,, ,.t, -"- -,)nths. Rather
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ing gains in Guatemala. In this case, while regulations
restricted dividend remittances to 10% of registered
foreign investment in El Salvador, no such restrictions
applied to loans. In order to ensure the approval of the
central bank, however, the companies decided to lend
to each other's subsidiaries. They chose the subsid-
iaries located in Guatemala because its government
had good relations with the El Salvadoran junta and
had impo-;ed no restrictions on dividend remittances.
While dollar billing provides protection
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Harvard Business Review
Percentage of Gross national product
Increase
or decrease Cost of living
tcumulauve increase, auJuaicv
devaluation)
Exchange rate at year end
pesos per dollar
Foreign Imports
exchange
in billions of Exports
Import
cover months
for goods and
services
Argentina's cost of living
index (Arg. COL)
United States' cost of
living index (U.S. COL)
1975
1976
1977
1973
1979
1980
176
175
160
101
0
14
35
108
199
331
510
61
$ 3.6
351
- 275
-S-2-.8
117
598
$ 3.8
68
1,004
$ 3.5
61
1,619
$ 6.0
23
1,993
$ 9.4
3.0
3.9
5.6
6.4
7.8
8.0
(0.6)
1.1
1.8
2.9
1.8
(1.4)
(0.7)
(0.5)
(0.5)
(1.1)
(2.2)
(3.4)
(1.3)
0.6
1.3
1.8
(0.4)
(4.8)
100 543 1,500
Arg.
( COL ) -1.0 x 100
Gap {expressed as a percentage) =100 U.S.C CO OL x EXCH
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
than risk releasing damaging information to the public
domain, these countries withheld data.
Note that the countries' reserve posi-
tions, as stated by the IMF, may not all be liquid, since
they include such things as receivables from other
countries. Thus, a reported $2 billion reserve may
actually contain a zero cash foreign currency position.
External debt. The larger the external
debt, the bigger the drain on the current account and
the greater the country's vulnerability to interest rate
changes and debt rollover. Peru's massive devaluations
in 1978 were due to its inability to roll over maturing
debt; the banking syndicates were unwilling to allow
rollovers without IMF participation. The composition
of the external debt is also important. If a significant
percentage is short term, then the risk is high. As it
entered 1981, Argentina had an external debt of about
$27 billion, of which reportedly more than 50% was
coming due in 1981.
Interest rates. Differences in interest
rates influence the movement of short-term money.
Even in countries with tight exchange controls, the
attractiveness of high yields, particularly in strong cur-
rencies such as the dollar, influences money to cross
borders-surreptitiously, if not legally.
Politics. In most countries, politics is
the most imps nrtant of these five factors. In japan
domestic politics argue for weakening the yen; in
France for defending the franc. In Venezuela a politi-
cally vulnerable president would rather deplete his
country's oil fund than follow his central bank's advice
and devalue the currency. Often, as in Argentina, Mex-
ico, and Ecuador, politicians allow their currencies to
sink only when reserves are finally exhausted.
Politics also plays a key role in inves-
tors' confidence. The election of Mitterrand in France
could have been anticipated. In fact, many French
companies hedged against this possibility. Given the
image of the 1950s that most French citizens conjured
up, the subsequent run on the reserves and the decline
of the franc was certain. Even at seven or more francs
to the dollar, this decline may not have yet run its
course.
Foreign risks 165
the peseta. Stimulation of exports even at the risk of a
"beggar thy neighbor" policy was part of their electoral
platforms and known well in advance.
Devaluation expectations are high for
Venezuela and Brazil. In Venezuela the catalyst for
change could be the near depletion of the oil fund or
the presidential election, whichever comes first. In Bra-
zil it could be the cumulative reluctance of foreign
banks to participate in loan syndications and the need
for a forced IMF rule.
I correctly anticipated the 1981 currency
change in Argentina. On the political front, I knew that
the next president, General Viola, would take office on
March 31,1981 and bring with him a new economy
minister. It was uncertain what the minister's posture
would be. Looking at the country's vital economic sta-
tistics (see the Exhibit), I saw that the country had
already had minidevaluations of the currency amount-
ing to 3% each month. The statistics for 1980 bore
striking similiarities to those for 1975. Both included
negative balances of trade, declining reserves, and large
current account deficits.
I calculated the inflation rate differen-
tial (the gap calculation) according to the formula in
the ruled insert and monitored an increasing gap
between the two countries. In fact, the cumulative gap
was extremely wide and led me to conclude that the
probability of a maxidevaluation was very high. It
would be timed to anticipate the inauguration of the
new president. As it turned out, my estimate of the
timing was perfect. The first maxidevaluation of 10%
took place in February, followed soon after by a 30%
devaluation in April and a panic run on the peso.
Carrying greater risks but with them
the potential for big rewards, the world of tomorrow
promises to be far more volatile than that of yesterday.
The world outside these United States is not a mono-
lith. Each country is different and the spectrum wide,
ranging from the traditional safe haven of a Switzer-
land to the turbulence of an Argentina.
To be successful, it is important to
understand each environment and the risks involved.
A thorough understanding of them, coupled with your
knowledge of your own business, could help you
develop an exposure management strategy that would
mitigate risk, protect your investment, and maximize
the rewards.
I have discussed many techniques that
can serve as a basis for the development of a strategy.
Once you have begun it, you will discover that many
more techniques are developed and rediscovered each
day. The process is a continual one, the horizon
limitless. 8
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Keep a sharp watch for the "catalyst"
for timing currency changes. In France, the catalyst
was the election of Mitterrand. In Mexico, it was the
oil glut and the disastrous residual impact of the mid-
1981 confrontation with the oil buyers. In Argentina, it
was the pending nomination as economy minister of
Lorenzo Sigaut, who had very different ideas about
devaluation than his predecessor, Alfredo Martinez de
Hoz The elerrinn of socialists in Sweden and Spain
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ASIAN BANKING/INDONESIA
is
mmirEsm m1w, dop
Even its tough policies can't
cope with a $7 billion deficit.
That's why Indonesia will be
back to the markets soon.
By Donal Curtin
"Indonesia is not another Mexico," said
the first foreign banker. "They have a very
good economic team who have done a good
job, and as long as there are no recession
problems in the major economies Indonesia
will pull through. They have been cutting
back development programmes, they de-
valued the currency, and they have a
borrowing capability that people are not
generally aware of."
"If nothing had happened this country
would have been in trouble," said the second
foreign banker. "The fall in the oil price hit
them badly, and they could have made the
classic mistake of trying to continue spending
rather than face the alternative. But they were
real gutsy. They devalued, they rephased
projects - precisely what they had to do.
They have their troubles; who hasn't? But "We think the current account will be
they are doing the right things." not much different from the $6.2 billion
"The world economy is down, world deficit projected in the budget," said a
trade is down, and there are winners and government economist. "Oil income has
losers because of that," said the third gone down since that projection was made,
foreign banker. "Indonesia is not a loser." but the policy adjustments bring the deficit
Jakarta has a small foreign banking com- back to that level."
munity, and these remarks are typical of the The World Bank's annual report on
mood of guarded optimism among them. Indonesia, which was presented to the
When Indonesia devalued the rupiah by government at the end of May, makes
27.5% against the dollar on March 30, and similar predictions. It expects a current
followed up with what the Indonesians call account deficit of $6.5 billion in fiscal 1983,
a "rephasing", or indefinite delay, of falling to $4 billion in fiscal 1984 and to
major development projects, most $3 billion in fiscal 1985.
observers reckoned that enough had been The government's tough decisions on
done to tackle the country's widening devaluation, slower development, a
balance of payments deficit. continuing freeze on public sector pay,
At the beginning of the year, on highly lower subsidies - domestic fuel prices were
optimistic assumptions, the Indonesian raised sharply in January - and a tight
budget for fiscal 1983 (the year from April credit ceiling of 15% have disposed in-
1983) predicted a current account shortfall vestors to look kindly at Indonesia's
of $6.2 billion. In fact, on more realistic prospects. In addition, the Indonesian
views the gap was heading for between $8 government keeps a balanced budget and
and $10 billion. The gap for fiscal 1982 was has a large volume of undisbursed debt
$6.8 billion. available to meet its external funding needs.
"These days, after the policy steps, an As developing countries go, Indonesia
optimistic forecast of the balance of pay- presents an image of decisive, efficient
ments deficit would be between $5 and government.
$5.5 billion, and a more realistic estimate But have the numbers significantly
would be between $6 and $6.5 billion," changed?
according to an economist with a foreign According to the World Bank, even
embassy in Jakarta. "From what visiting though the current account deficit will fall
bankers tell me, a deficit around $6 billion steadily over the next three years, Indonesia
its total foreign public debt will go up by
$10 billion to over $30 billion, and the debt
service ratio will rise from 22% now to 26014
in fiscal 1985. That forecast is based on
fairly charitable views of probable Indo-
nesian exports. If oil production rises to
over 1.6 million barrels a day (the current
Opec limit is 1.3 million); if liquefied
natural gas exports double in three years; if
non-oil exports grow by 9% a year in dollar
terms (they fell by 10% in fiscal 1982) and if
oil is $32 a barrel by 1985, all will be well.
Indonesia's current account deficit might
be a lot worse than the World Bank and the
government expect.
Oil is all-important. At present Indonesia
produces 1.3 million barrels a day; accord-
ing to sources in Jakarta it has been able to
find buyers at $29.50 a barrel for the
900,000 barrels it exports. If demand picks
up, and Opec production ceilings are
raised, as the World Bank expects, Indo-
nesia stands to earn over $2.5 billion a year
in additional revenue (assuming 250,000
barrels of the extra 300,000 a day are
exported at today's price). That is an
optimistic guess. Oil prices are still falling -
Japan, Indonesia's biggest oil market, has
recently negotiated price discounts with
Iran - and if the next Opec price meeting
were to lower the benchmark price to $25 a
barrel, Indonesia would lose some $L 3 billion
a year.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
A statue in Jakarta commemorates freedom
from the Dutch. Now Indonesia struggles
to free the bonds of its payments crisis.
prices and production quotas, Indonesia
foregoes $2 to $2.5 billion a year, and the
current account deficit stays where it is.
According to some preliminary guesswork
in Jakarta the current account deficit is
running at around $7 billion annually.
Taking a more pessimistic view still, if oil
prices were to fall by $4 to $5 a barrel, the
current account deficit would rise by about
$1 to $1.5 billion.
However, there is room for higher LNG
exports to offset any decline in the price of
crude oil. Japan, which takes all of Indo-
nesia's annual LNG output of 7.5 million
tons, has contracted to take a further
3.2 million tons a year from East Kali-
mantan, starting in September this year,
and a further 3.3 million tons a year from
North Sumatra from January 1984. Korea
is likely to take 2 million tons a year,
according to an agreement signed in May.
Together, new LNG contracts will double
net LNG export income, which has been
estimated at $1.5 billion in fiscal 1982.
If the worst comes to the worst, and
Indonesian oil sells for $25 a barrel, higher
LNG revenues will maintain the net export
income of the oil and gas sector at around
$6 billion a year, but will not provide
enough extra income to start closing the
current account deficit.
Will the March devaluation have any
significant effect on Indonesia's non-oil
exports? Again, there is room to doubt the
optimistic figures now circulating in
Jakarta.
In 1982, Indonesia's non-oil exports
came to around $3.9 bil lion (the latest
incomplete figures show a total of $3.81
billion). This was down by over 9% from
the $4.3 billion of 1981, and well below the
peak income of S6 billion in 1980. The
world recession hit Indonesia hard, since
virtually all the country's non-oil exports
are industrial raw materials, with prices
determined by world market conditions.
Lower world trade has meant lower export
volume, and generally lower export prices,
for almost all non-oil exports.
The country's biggest non-oil earner,
timber, was affected by a government
decision to restrict exports of raw logs and
to encourage the export of worked timber,
such as plywood. Log exports fell, but ply-
wood exports did not rise. Timber earnings
were $1.9 billion in 1979 and 1980. They fell
to $1.1 billion in 1981 and to $900 million in
1982.
There are some signs that non-oil exports
will do better in 1983 and 1984. Demand
from the industrialized countries should be
higher, and prices at least no worse. For
Indonesia's second largest non-oil earner,
rubber, prices are actually back to 1981
levels. For the time being, however, Indo-
nesia faces a buyers' market for its non-oil
goods, and foreign buyers appear to have
been able to negotiate dollar price cuts for
some commodities, exploiting the devalua-
tion of the rupiah.
"Our non-oil exports are still declining,"
said an economist with one of the large
state-owned banks, "although I think for
1983 as a whole export revenue will be
about the same as in 1982."
Non-oil imports will certainly be restrained
by the March devaluation, which raised the
rupiah price of imports by 38%, and by
government measures to restrict non-
essential imports such as fruit. But the
government is keen not to cut back too far.
The one statistic every government official
likes to quote is the 2 million new jobs that
must be created each year to absorb the
growth in Indonesia's labour force.
Thus real growth must be 3% a year if
the growth is concentrated on labour
intensive sectors, or, more realistically,
nearer 5% a year. For fiscal 1982, govern-
ment economists reckon that growth was
around 3%, and for the current fiscal year
they predict a slightly lower 2 to 3%. That
makes it difficult to squeeze imports hard.
Consumption goods comprise only a small
fraction of total imports, with capital goods
and raw materials forming some 85% of
non-oil imports. Imports are closely linked
to doti,estic economic growth, and the
country will be doing well if imports are cut
back to $14 billion from the $15 billion of
ASIAN 'BANKING/INDONESIA
fiscal 1982.
Putting together net oil and gas income
of $6 billion, non-oil exports of S4 billion,
imports of $14 billion and a services deficit
of $2,750 million (only slightly up on 1982)
gives an estimate for Indonesia's current
account deficit of $6,750 million - un-
changed from the fiscal 1982 level, and,
unless there is a strong world economy
coupled with firmer oil prices, unlikely to
budge much from that level over the next
two to three years.
Can Indonesia finance it? Not out of
reserves. "If you had told me a year ago
that the foreign exchange reserves were
going to be less than $5 billion, I would
have been very surprised," one embassy
analyst put it. Bank Indonesia's reserves are
now little more than $3 billion - equiva-
lent to about two and a half months'
imports, and not easily reduced further
without straining the country's liquidity.
The state banks hold a further S3 to
$3.5 billion in foreign exchange, and,
according to one central bank source, it is
hoped that restrictions on lending to lower
priority sectors will induce the state banks
to swap some of their foreign currency into
rupiah. If that happens, the central bank
might be able to spend up to another
$1 billion to meet this year's current
account shortfall.
Running down the reserves can meet only
part of the $6,750 million gap (and, in any
event, is a one-shot weapon). Most of the
funds will come from Indonesia's treasure
chest of undisbursed foreign debt, which,
according to the World Bank's resident
staff in Jakarta, amounts to $12 billion. Of
that, some $7 billion is on concessional
terms from the 13 member countries of the
Inter-Governmental Group on Indonesia,
and the remaining $5 billion is a mixture of
buyer and supplier credit and funds on
international market terms.
The World Bank's staff calculates that
$4.2 billion of the undisbursed foreign
credit lines will be drawn down by Indo-
nesia during fiscal 1983, with the World
Bank itself the largest single source.
Projects supported by the Bank will receive
between $600 and $800 million during the
year. Another important component of the
$4.2 billion is the outstanding amount
available under the terms of Indonesia's
March jumbo borrowing of $1 billion.
A current account deficit of $6,750 million,
capital inflows of $4.2 billion and a
$500 million drawdown of foreign reserves
would still leave Indonesia with $2 billion to
find - a figure higher than most bankers
in Jakarta expect. Representatives of the
major banks know that Indonesia will have
to borrow again later this year. The general
feeling is that there will be another jumbo
of between $700 million and $1 billion,
although some bankers would prefer to see
a gradual series of smaller borrowings.
"A big borrowing is inevitable," said one
banker, "and I think Bank Indonesia will'
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ASIAN BANKING/INDONESIA
be leaning hard on its friends, although it
will have to pay more - maybe 40 basis
points over US prime, compared with the
20 points on the March jumbo."
Indonesia is likely to approach the
markets for more than the bankers expect -
probably for $1.5 billion, possibly for $2
billion. That is not an indictment of the
Indonesian administration. Bankers give it
credit for its successive steps to tackle the
deficit, especially the devaluation, which
was a classic success. The rupiah strength-
ened in the market immediately afterwards,
and short-term capital outflows returned,
sending short-term rupiah rates down from
nearly 30% to under 2091i.
Indonesia's need to borrow is structural.
It was disguised fora time by the oil price
rise in 1979, but the country has the arche-
typal developing economy - dependent on
a narrow range of natural resources with
volatile prices, lacking manufactured
exports (except a few textiles and electrical
appliances) and needing to import many of
its raw .materials and most of its capital
equipment. In bad years, Indonesia even
has to import the staple food, rice.
Its natural pattern of development is to
run current account deficits, financed by
development aid and, as development pro-
ceeds, by funds on commercial terms. At
the end of 1981, 64% of Indonesia's debt
was aid of one kind or another. Trade
credits made up 10%. Market borrowings
made up the remaining 26%, but that pro-
portion is going to rise.
13 The world recession
hit Indonesia hard, since
virtually all the country's
non-oil exportsareindustrial
raw materials, with prices
determined by world
market conditions
Indonesia is not another Mexico or
another Venezuela. It is not even another
Nigeria. Bankers trying to assess Indonesia
may be wise not to look on it as an oil
economy. Its appetite for capital is greater
than its export revenue from oil or gas, and a
$6 billion a year oil income, although some
reassurance to lenders, tends to get eaten up
by the import demands of an S85 billion
economy. The 1983 payments crisis is not so
much a crisis as the normal pattern from now
on. The best pointer to Indonesia's future
may well be what happened after the 1979 oil
price rise. Within 18 months, Indonesia was
Rachman of Wardley-Summa: Ideal links.
restrictions on branch banks, leasing should
make a lot of money for the newcomers. It
is not hard to get in - the minimum paid-
up capital requirement is Rupiah (Rp) 3 bil-
lion ($3 million), though it is likely that the
minimum will shortly be raised to Rp4.5 bil-
lion ($4.5 million). There must be an
Indonesian partner, an agreement that
majority control will pass to Indonesian
interests within 10 years, and arrangements
for training Indonesians in the leasing
business.
The rewards look promising. The
amount of business a leasing company can
do is governed by a gearing ratio of 33 times
capital. With a typical spread on lease con-
tracts of 3%, it should not be hard to make
a good return on equity.
So far, not much leasing business has
been done. Leasing companies are not yet
required to report their results, so the size
and distribution of the leasing business is
unclear. According to estimates prepared
by the Indonesia Leasing Association, lease
contracts worth Rp27 billion (then worth
S42 million) were written in fiscal 1980.
That went up to Rp73 billion ($110 million)
in fiscal 1981 and to around Rp95 billion
($135 million) in fiscal 1982. The three
biggest companies - Orient Bina Usaha
Leasing, an affiliate of Japan's biggest
leasing company; Wardley-Summa Leas-
ing, an affiliate of the merchant banking
arm of Hongkong and Shanghai; and First
Indo-American Leasing, an affiliate of
Bank of America - have something like
$65 million, or roughly half, of the market
between them. That is partly because they
have had a head start.
But if the market is small and concen-
trated now, it is likely to grow and widen in
the future.
"Indonesia is one of the last frontiers, at
least in Asia," said Amir Abdul Rachman,
assistant director with Wardley-Summa,
pointing out that much of the country's
private capital investment is financed by
rolled-over short-term loans. "There is a lot
of mismatching," he said, explaining the
backinthered. Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001 3 more reliable, longer--
TE
A4YRASYC
IXJ~r
9`* LA$]
Indonesia's domestic banking
system has been closed to
foreigners for years. Now
there's a way in through the
back door: leasing companies.
By Donal Curtin
New leasing companies are starting up in
Indonesia faster than fast-food franchises.
For several years there were only five, all set
up between the middle of 1975 and early
1976. In late 1981, however, three firms
were set up, and in 1982, nine more. So far
this year another five companies have been
given operating licences, with a further
eight at the halfway stage of provisional
licences. And there is a long backlog of
applications for licences at the Ministry of
Finance.
Why the sudden attraction? Belatedly,
overseas banks, finance houses and leasing
companies have discovered leasing as the
back door into the profitable but inacces-
sible world of Indonesian banking. In the
late 1960s, the authorities closed off
domestic branch banking; only 10 foreign
banks and a joint venture involving Japan-
ese banks had established operations before
the door was locked.
In the early 1970s access became even
more difficult, when foreigners were also
cut off from the non-bank financial institu-
tion sector. Foreign banks that did not take
a shareholding in one of the nine finance
houses or in either of the development
finance companies were left out of the
boom in Indonesian banking in the late
1970s and early 1980s.
Leasing companies are giving banks that
missed the bus a new vehicle for their ambi-
tions. "Foreign banks are really setting up
what - in the US - would be called in-
dustrial banks," said the chief executive of
one of the new companies.
Even for banks with existing branch
operations in Indonesia, a leasing company
is useful. It enables the bank to skirt some
of the tight restrictions on foreign banks,
especially the prohibition on lending to
companies outside Jakarta. Recently,
Indonesian officials have taken a tougher
line on defining a Jakarta company. A
leasing office is also an extra outlet for the
branch banks, which are restricted to one
main and one sub-branch.
Apart from the advantages of getting
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ASIAN BANKING/COUNTRY RISK
iLrs s ssss ~, SIAN Lusx
Japanese investors prefer
Europe to their neighbours.
But they like Singapore,
Malaysia and Thailand.
By Donal Curtin
"Quite frankly," said the syndication
manager of a leading Japanese trust bank,
"Japanese investors - the trust banks and
the life insurance companies - don't like
to have a portfolio in Asia, except in
Malaysia and Singapore.
"Some of the city banks are sophisticated
enough not to mind a portfolio in Indonesia
or Thailand, but the major institutional
investors don't like it. That is the problem
for Asian borrowers."
Sentiment has changed significantly in
the Tokyo market. The change is not easy
to detect from the terms that borrowing
countries obtain in Tokyo, because admini-
strative guidelines compress the differentials
in spreads that would otherwise discriminate
between strong and weak borrowers. But
from what syndication managers say, Asian
borrowers have fallen out of favour.
Some years ago the South-East Asian
newly industrialized countries, such as
Singapore and Korea, seemed to offer
highly attractive lending opportunities. In a
word beset by recession and default, they
offered high growth, strong exports, firm
government and tractable debt. Some of
them - particularly Singapore, Malaysia
and, possibly Thailand - still look good to
Japanese lenders.
But the Philippines, Indonesia and Korea
are now distinctly unpopular. Taiwan is
also out, but for a different reason. Since
the normalization of Japan's diplomatic
relations with the People's Republic of
China in 1972, Japanese banks have not
lent to Taiwan.
At the bottom of every Japanese inves-
tor's Asian list is the Philippines. Trade
financing, buyers' and suppliers' credits,
are still being arranged, but many bankers
in Tokyo would avoid sovereign lending.
"There are two sorts of risk in lending to
the Philippines," said one executive with a
city bank. "One is the general sort of
country risk, the country's external
position, its foreign exchange reserves and
so on. And the other is what I call the
Marcos risk."
Above the Philippines, but still regarded
with disfavour, are Indonesia and South
Korea. "These are countries with very
ambitious development plans, and big
increases in foreign borrowing, which are
now a handicap," said one city banker.
Both countries are in the market for yen
syndicated loans - Indonesia for #24
billion ($102 million) through the Industrial
Bank of Japan (IBJ) and Sanwa Bank; and
Korea through Korea Electric Power
(KEPCO), looking for if 10 billion ($42
million) through Nippon Credit Bank and
Sumitomo Bank, and through its Exim-
bank, which is raising *10 billion ($42
million) through Yasuda Trust.
Bankers were generally reluctant to parti-
cipate in these borrowings. "For many of
us, we are at our country limits for
Indonesia, which has its problems with the
oil price," said one banker. Others pointed
to the large volume of trade-related loans
raised for Indonesian borrowers in Tokyo.
"If Indonesia's borrowing is finished
smoothly, it will be because of the position
of IBJ in this market, not because of Indo-
nesia," said another banker.
Tokyo lenders are worried by South
Korea's high level of existing debt. "Korea
is improving very much in various
respects,'." said a syndication manager with
a regional bank, "but its total overseas
borrowing is so high - the third or fourth
largest in the world. Even if its economy
improves a lot, and inflation seems to be
going down and growth improving,
financial institutions will still be worried
about its total borrowing."
The surprise country in the country risk
ratings in Tokyo is Thailand, which has
risen in estimation as its neighbours have
declined. "Thailand has been keeping a low
profile for some time, and now it has a
smaller level of external indebtedness than
most Asian countries."
"Thailand is one of our best customers,"
agreed a syndication manager with one of
the long term credit banks. It is getting
better recognition in the market because of
the relatively low number of its borrowings
in the past."
Thailand's image in the Tokyo market
has improved to the point that it can
command the going market rate on yen
credits, 30 basis points over Japanese long-
term prime. Thailand has only one credit in
the Tokyo market, a #5 billion (S21
million) cofmancing with the Asian
Development Bank. "It's a bit too small to
say anything about Thailand as a country
risk," said one of the lead managers, "but
it certainly seems to be quite popular."
At the head of the country popularity
stakes is Malaysia. "There is no doubt
about their essential creditworthiness," said
the chief manager of a city bank's syndica-
tion department. .The balance of
payments has deteriorated slightly recently,
but it has basic strength from development
of its natural resources, and Malaysia's
management is good. Their civil service
system is the best outside Singapore."
Only one country would surpass Malaysia
if it came to the Tokyo market - Singa-
pore. "It's best," said a long-term banker,
"but unfortunately we have had little
opportunity to lend to Singapore as a
sovereign credit."
Other bankers echoed this complaint -
proving once more that the way to get the
best terms is not to borrow at all. ^
FORTHCOMING EUROMONEY CONFERENCES 1983
August 8-9 JOHANNESBURG International Finance for South African
Companies: Source and Techniques
September 14-.15 HONG KONG
September 20 LONDON
Default 83: The Problem Loan and the
Bankrupt Borrower
Interest Rates and Currency Swaps
For full details contact: Susan Turner, Conference Administration Manager, Euromoney Publications Ltd,
Nestor House, Playhouse Yard, LONDON EC4V 5EX Telephone: [phone] Telex: 8814985/6 EURMON G
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
. They had
ithing they
m Iran at a
ompany in
n per cent.
he Iranians
lably bitter
t.
he Iranian
:e Banking
lined their
I not be a
orative ac-
her OPEC
)e and the
European
take over
not having
lect that, if
;s of the
,ju don't
.l intrigue,'
d certainly
ernational
r one mo-
bank and
ociated his
seen as a
Chapter Eighteen
COUNTRY RISK
If I owe a million dollars, then I am lost. But if I owe fifty billions, the
bankers are lost.
Celso Ming (Brazilian Economist), 1980
THE revolution in Iran had taken nearly everyone by surprise, and it
brought a new urgency to an old question: how do you measure the
political risks in a foreign country? With some prompting from govern-
ments and central banks, bankers began trying to assess more seriously
the hazards of their operations. They turned not only to economists, but
to diplomats, political scientists and intelligence experts to advise them
in the fashionable new science called `country risk'.
The problem was as old as banking, but the American banks had
become more concerned since the late sixties when the influence of their
own government over developing countries was visibly waning. `It really
began in 1967,' according to one political scientist, Stephen Blank of
Multinational Strategies Inc., `when Occidental Petroleum did their
deal with the Libyan government which undermined the power of the
big oil companies. In the next six years it became clear that American
companies had lost the capacity to tell countries what to do: they had to
begin studying what countries would do to them. By 1973, with the new
power of OPEC, the transition was over.' The unpredicted success of
OPEC had certainly undermined much of the confidence in the projec-
tions of economists. When the futurologist Herman Kahn had written
his book The Year 2000 in 1967 the words oil, energy and Saudi
Arabia did not appear in the index, and after the price-increases which
changed the balance of the world many economists still insisted that the
price must come down. As the bankers lent more money to unstable
countries like Zaire or Indonesia, they began to feel the need for
political as well as economic assessments; and the collapse of the Shah
revealed all the shortcomings of their information.
There was something inherently comic about this attempt to measure
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
the immeasurable, to award credit-ratings to countries as if they were
hire-purchase customers. The spectacle of bankers, with all their zeal for
precision and objectivity, giving marks to nations for good behaviour
could never be altogether convincing. What could they learn from their
hotel suites of the gossip in the bazaars, the mutterings of revolution in
the back alleys? How could these immaculate men wander inconspicu-
ously in the souks of the Middle East or drink in the shebeens of
Johannesburg? How could they calculate whether Bangladesh or Sri
Lanka was the more ripe for revolution? They might think that they
were establishing rational systems and yardsticks to measure the world;
but they were always deeply influenced, directly or indirectly, by the
assumptions of their foreign ministries and governments. They were still
following some kind of flag.
While each bank made its own assessment of country risk, the market
revealed its own consensus in terms of the length and profit-margins of
the loans (the `maturity' and the `spread'). The magazine Euromoney
compiles its own `league table' of country risk, based on its statistical
analysis of syndicated loans, grading sixty-six borrowing countries in
order, and awarding them stars from seven to one. In 1979 the list began
with three seven-star countries, France, China and Britain, and ended
with six one-star countries (Gabon, Ethiopia, Guyana, Madagascar,
Niger and Pakistan). It had some remarkable juxtapositions: the six-star
countries included five communist countries - Russia, Czechoslovakia,
Hungary, Bulgaria and East Germany - alongside western countries
like Italy and Canada and newly-industrialised countries like Korea or
Columbia. In the roll-call of three-star countries, White South Africa
was sandwiched between black nations like Malawi, Cameroons and
Tanzania. The market revealed no colour bar, no ideological bias.I
'I think I can say I was the inventor of the whole subject called country
risk analysis,' said Irving Friedman, with characteristic modesty; and it
was true that Citibank, after Friedman joined it in 1974, set up a more
formalised and self-conscious study of risks than other banks, as we
saw in Chapter 10. As Citibank began lending more to the third world,
Wriston built up a team to assess credit risks, led by Friedman and the
vice-chairman, Al Costanzo, and he insisted that they had independent
powers to defy any pressure to lend.
Other American banks took their own steps to strengthen their politi-
cal analysis. `We're much more sophisticated on the economics side than
on the politics,' admitted the senior international economist at
Morgan's, Rimmer de Vries:' and in 1980 Morgan's tried to establish
Institutional Investor produces a rival grading: see Chapter 1.
Euromoney, July 1980.
their own
with their
have to be
'once a COL
pay.'
The 13;tn
system .ift`
Banking n
tive capaci
factors was
American
classificatic,
offices. It N
Heller expl
just one sin
the form (ft
The first
capacity ins
countries.
cator' base(
managers,
sistency'. T
cator', whic
for social u
`on-site knc
Francisco. '
can't see th,
tions (it see
indicator lib
excellent ec
unrest. But
all the benel
The Chap
officers to I
already set t
Kissinger, r
into doubtfi
economists,
clean-shaves
service to cf
' Robert Helle
Conference on
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
countries as if they were
r' , with all their zeal for
.icon; for good behaviour
,uld they learn from th::ir
uticrings of revolution in
men wander inconspicu-
rink in the shebeens of
ether Bangladesh or Sri
_y night think that they
ks to measure the world;
.:tly or indirectly, by the
trnrnents. They were still
country risk, the market
;th and profit-margins of
ie magazine Euromoney
based on its statistical
borrowing countries in
ne. In 1979 the list began
and Britain, and ended
Guyana, Madagascar,
positions: the six-star
Russia, Czechoslovakia,
gside western countries
countries like Korea or
ies, White South Africa
lalawi, Cameroons and
io ideological bias.'
-le subject called country
cteristic modesty; and it
it in 1974, set up a more
Zan other banks, as we
nore to the third world,
ed by Friedman and the
it they had independent
strengthen their politi-
the economics side than
national economist at
rgan's tried to establish
their own careful rating of countries, so that they could compare them
with their ratings of American companies in the same system. 'But we
have to be very security-minded,' one man in Morgan's explained to me;
once a country discovers that it's got a low credit rating, there's hell to
pay.'
The Bank of America was determined to set up a specially thorough
system after the mistakes of Iran. As Richard Puz, the head of the World
Banking Division, expressed it to me in California: `In Iran our predic-
tive capacity was weak: at that time the visibility of non-quantifiable
factors was secondary to hard numbers. We didn't realise how rapidly
American support would disappear.' The Bank of America devised a
classification to make full use of its worldwide staff and decentralised
offices. It was unlikely, as their chief international economist Robert
Heller explained, `that all relevant information can be compressed into
just one single number';' so they gave countries a three-point rating, in
the form (for instance) of 82AC.
The first number, ranging from 1 to 100, expresses the `debt service
capacity index' based on an international data bank covering eighty
countries. The first letter represents the `judgmental economic indi-
cator' based on questionnaires sent out to the bank's country or regional
managers, which are then checked at headquarters `for global con-
sistency'. The second letter expresses the `judgmental political indi-
cator', which focuses on three areas - governmental control, potential
for social unrest, and external factors, assembled from replies from
`on-site knowledgeable officers' and revised by senior managers in San
Francisco. `The country manager,' as Puz explains, `can get so close he
can't see the wood for the trees.' But the difficulty with such classifica-
tions (it seems to me) is that they can't see the trees for the wood. An
indicator like 82AC might describe a country like South Africa, with
excellent economic statistics and prospects but high potential for social
unrest. But once the AC goes down to AE, the E can quickly cancel out
all the benefits of the A.
The Chase characteristically turned to ex-diplomats and ex-CIA
officers to provide its political intelligence. David Rockefeller had
already set up an International Advisory Group, which included Henry
Kissinger, meeting four times a year; as the Chase moved deeper
into doubtful countries, they took on more political scientists and
economists, with beards and moustaches which stood out among the
clean-shaven orthodox bankers. They even prepared a special new
service to clients called `Chase World Outlook', full of computerised
' Robert Heller: `Bank of America's New Country Evaluation System.' Euromoney
Conference on Country Risk Assessment, New York, October 30, 1980.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
THE MONEY LENDERS
calcul ; tions about country risks; but it was Soon clear that they could not
say candidly what they thought about (for instance) Saudi Arabia,
whose deposits were crucial to the bank; after spending three-quarters
of a million dollars they abandoned the project. Rockefeller's personal
influence still prevailed. In 1980 he set up a three-man 'Country Risk
Management Group', with their own patrician approval, headed by the
former head of the western hemisphere division, Francis Mason, and
including Archie Roosevelt, a former CIA officer, and Ridgway Knight,
the ex-ambassador who had often accompanied Rockefeller on his
journeys.
`If you sat in on a meeting of the country risk committee,' said the
Chase's chief economist, Robert Slighton, who also once worked for the
CIA, `I think you'd be impressed by how much they knew, but appalled
by the difficulty of transferring that knowledge into policies for loans.
We can't afford to go into a country when it looks good, and pull out
when it looks bad.... In retrospect, we overloaned in the seventies:
there's a much more hostile environment projected for the eighties.'
`Operational banking' (Slighton continued) `consists in a constant
war, a continuous adversary process between credit officers and loan
officers - it takes place at every level, and it can be very bloody. In
assessing the country risk, the most critical questions are, first, the
likelihood that the political consensus will be intact; second, can
economic policies respond to a sudden shock? A country that doesn't
redistribute its wealth is a bad risk; if a loan helps a country to redistri-
bute, that's desirable. In. general, we'd rather lend to a country that's
had its revolution.,I
Why did the banks, with all their different systems and attitudes, still
reach the same conclusions about so many countries, even when they
were all wrong? Why did they still behave like starlings or lemmings? In
the nineteenth century banks would take their own risks in lending to
unreliable countries, as Barings backed the United States. But they
were now much more reluctant to get out of line with each other:
'There's no opportunity so good,' as one Chase man explained, `that we
want a hundred per cent of it.'
`Facts make their own decisions,' Wriston told me at Citibank when I
complained about this uniformity. 'If you all look at the same facts it
would not be unusual to come up with the same answer.... In those
days Mr. Rothschild made his fortune by getting carrier pigeons to tell
him who won the battle of Waterloo. Now today, when the President
frowns in the Rose Garden, it is in the rate of the dollar in thirty seconds.
The information explosion puts the facts at everyone's command.' But
' Interview with author, March 12, 1980.
others are more wor
theory ,' Wilson Sch,
institution feels the
Indians looked to tl
their economists. hu
they can't predict
together. And they
both special inforn
opinion - like the c;,
The Iranian revolt,
banks not only hcca,
revealed the full iml
terests. It was much h
so little ability to inflt
the vulnerability of tl
can tell you that as a I
Mexican authorities,'
against Chase Manhat
making certain that t
European banks get th
The American hanl
were turning less to th
World Bank and the I
laxing their discretion
of the seven veils,' one 1
more.'
European bankers li
calculations of country
and hunches. 'They lik(
tive,'said a British bank,
atmosphere in Washing
like waving a wand.' ?hways and car plants had
been built on the assumption of unlimited cheap oil; and the four-fold
increase wrecked the balance of payments and boosted inflation. A new
President, General Geisel, sent ?Delfim into exile to be ambassador in
Paris, but continued with expansionist policies, pushing ahead with new
steelworks, shipyards and nuclear power stations, while inflation went
over forty per cent. Most bankers found Brazil now much less attractive,
but Wriston at Citibank saw the opportunity both to profit from the high
returns and to cement the bank's relationship with Brazil. By 1977 Brazil
seemed to be on the road to recovery, and other bankers including
the Japanese again began piling in, bringing the margins down again.
Citibank had been shown to be a good friend of Brazil, and the Brazi-
lians appreciated it: 'We feel much safer with Citibank,' explained one
government economist, `because we know they've got so much at stake.'
By 1979 Delfim was back as economic overlord under the new Presi-
dent Figueiredo. He was again bent on high growth, but the new oil crisis
and strikes in Sao Paulo brought new dangers. Inflation was back to over
eighty per cent, with growth of only six per cent. Delfim promised that
Brazil would become less dependent on oil by financing a vast project to
produce alcohol from sugar, on which Brazilians could run their cars:
and when the bankers met at their annual meeting of the IMF in
Belgrade in 1979 he persuaded them to raise a jumbo loan of 1.2 billion
dollars for the new alcohol programme, backed by the Brazilian govern-
ment itself. It was a historic loan, led by Morgan's and three other
American banks, with a margin of less than one per cent above the
standard rate of interest, running for twelve years. It was a triumph for
Delfim who had personally persuaded many leading bankers against
much of their current advice about country risk. But many big banks,
including Bankers' Trust in America and the German Big Three, stayed
out of it; and the Japanese banks, who had been warned to cut back their
foreign loans, only contributed 125 million dollars.
Brazil was still on a tight-rope and in February 1980 Delfim toured
America and Europe to try to raise confidence; in New York he
breakfasted with Wriston, and saw McNamara who had flown up from
Washington. But most bankers were still sceptical and insisted on high
margins or spreads: `I didn't expect to be greeted by a bunch of adding
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
machines,' r)
precious rese
IMF which '.'
always show c
new America
next it was t
Brazilians wL
suggesting th
benefit.
Brazil rein
governments,
power? Or x(
would make i
international
`it could well
huge profits f
others, or he(
down? And
government,
The bankers I
traditional `si,
nightmare sin
frontier of .th.
supported by
crisis to the nc
early seventic
remittances fr
the country w
imports furthc
The potent I
solidarity of i\
to lend move}
where the De'
American an
margins. By
terest rates t;
banks, with C
rushed in to t.-
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
J the gross inequal-
nara at the World
=commercial banks;
government, and
s - argued against
y looked bleaker.
'rid car plants had
and the four-fold
d inflation. A new
be ambassador in
ig ahead with new
file inflation went
ich less attractive,
'ofiit from the high
zil. By 1977Brazil
'ankers including
gins down again.
il, and the Brazi-
explained one
o much at stake.'
the new Presi-
.e new oil crisis.
was back to over
m promised that
a vast project to
J run their cars:
of the IMF in
an of 1.2 billion
~razilian govern-
ind three other
cent above the
is a triumph for
)ankers against
many big banks,
g Three, stayed
o cut back their
Delfim toured
New York he
flown up from
isisted on high
inch of adding
machines,' Delfim complained.' He was now having to dip into Brazil's
precious reserves; and he dreaded that he might have to borrow from the
IMF which would cut back on Brazil's bid for economic freedom. Brazil
always showed two different faces to the world: one moment it was the
new America, competing over-confidently with the rich nations; the
next it was the most vulnerable of all developing countries. By 1950
Brazilians were again talking of being part of the third world, and
suggesting that the world institutions should be restructured for their
benefit.
Brazil remained an expensive question mark for both bankers and
governments. Would it at last stand on its own feet as a major industrial
power? Or would the economic crisis bring about a political crisis which
would make it unable to pay off its debts? `If there is a real threat to the
international banking system,' one veteran London banker observed,
`it could well begin in the slums of Sao Paulo.' Had Wriston made his
huge profits from Brazil because he understood the country better than
others, or because he knew that his government could not let Brazil go
down? And who was really taking the risk - the bank, the American
government, or the International Monetary Fund?
TURKEY IN TROUBLE
The bankers faced a more highly charged political scene in Turkey, the
traditional `sick man of Europe', which like Iran had been a bankers'
nightmare since the mid-nineteenth century, and which stood on the
frontier of the western alliance with the Soviets. In the post-war years,
supported by massive aid, Turkey had staggered from one economic
crisis to the next, teetering between democracy and military rule. In the
early seventies the economy made some recovery with help from
remittances from Turkish workers in Germany, but the oil crisis soon hit
the country with double severity: the workers were sent home while oil
imports further wrecked the balance of payments.
The potential bankruptcy of Turkey now looked like threatening the
solidarity of NATO. The Bonn government pressed the German banks
to lend money to this traditional sphere of German influence and trade,
where the Deutsche Bank had spread itself a hundred years earlier; and
American and other European banks were attracted by the high
margins. By 1976 the Turkish government was guaranteeing high in-
terest rates through convertible lira deposits and the big American
banks, with Citibank and the Bank of America in the forefront soon
rushed in to take advantage of the quick profits.
' Institutional Investor, August 1980.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
THE MONEY LENDERS
By January 1978, when a new Prime Minister Bulent Ecevit was
elected, the banks were losing their enthusiasm for Turkey as rapidly as
they had acquired it. There was mounting violence between extreme left
and right, the bureaucr-cy was corrupt, and the economy showed no
sign of recovering. The government had borrowed three billion dol'ars
in short-term loans which had to be renewed, but after one massive
rescheduling the banks were reluctant to roll it over, and they were soon
cutting off credits, leaving Turkey with little time to adjust. The Turks
turned to the International Monetary Fund, which raised two massive
loans - the second of which, for 1.6 billion dollars, was the biggest in its
history, amounting to 625 per cent of Turkey's quota. The Fund hoped
that their 'seal of approval' for Turkey's austere programme would
reassure banks; but as the Fund moved in, so the bankers began moving
out, stealthily withdrawing more of their interest and part of their
capital; in 1979 they made net withdrawals of 340 million dollars.' The
Bank of America, which had rapidly retreated, became a dirty word in
Turkey and changed its name for its remaining operations.
The mandarins at the Fund in Washington were bitterly critical: 'The
banks overlent when the going was good, and now they show no re-
sponsibility,' one of them complained to me, for once losing his cool:
'The IMF cannot act as the banks' debt-collector - we didn't go in to let
them get out.' The Turks now had a total foreign debt of sixteen billion
dollars, and half of their exports (including their foreign workers' remit-
tances) went to repaying the debt; while the bankers were resisting the
pressures from the IMF to reschedule their loans. Turkey - now once
again under a military government - remained a crucial member of
NATO: but the bankers, having made their quick profits, were glad to
leave it to western governments and the IMF to cope with as best they
could.
THE POLISH PREDICAMENT
Of all the frontiers between banking and politics, the most critical but
unmapped were in Eastern Europe, where the bankers moved out of the
protective system of the IMF and into the heart of the communist
system. Since the Eastern Europeans had rejected Marshall Aid in the
post-war years they had formed their own self-enclosed economic
system of `Comecon', and their central banks had been closely in-
terlinked with Moscow. The Soviets underpinned and supervised their
lending more strictly than the IMF, with all the rigour of orthodox
bankers, with no misgivings about usury, and with large supplies of gold
' Financial Times, Novernber 13, 1980.
to fort
with
to hors
in Fa
had b
in 1911
ubiglui
with
Amcri
in M o,
were t
regarc
really
Rock,
Rock(.
ing cli
risk,' 1
goverl
Fro
the cc
reassu
Sovici
like th
of the
intere
necti.
ton. I
Willy
influc
Kissir
distar
while
cousit
impri
polici
rcaso
Bai
' Sec (
also F.
Petri
Signet
' !dart
Sect
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
ter Bulent Ecevit was
or Turkey as rapidly as
e between extreme left
economy ?sho< ed no
_d three billion dollar,
but after one massiv-:
er, and they were soon
to adjust. The Turks
ch raised two massive
s, was the biggest in its
iota. The Fund hoped
re programme would
)ankers began moving
est and part of their
million dollars.' The
ecame?a dirty word in
erations.
bitterly critical: `The
ow they show no re-
once losing his cool:
we didn't go in to let
iebt of sixteen billion
;n workers' remit-
ets were resisting the
Turkey - now once
t crucial member of
profits, were glad to
)pe with as best they
the most critical but
ers moved out of the
t of the communist
Marshall Aid in the
enclosed economic
Ad been closely in-
ind supervised their
rigour of orthodox
trge supplies of gold
to fortify the reserves. As the Eastern Europeans began to trade more
with the West and to buy more western technology and food, they began
to borrow to finance their trade. The first western bank to open a branch
in Eastern Europe was the Credit Lyonnais, the French bank which
had been the chief lender to Tsarist Russia in the 1890s, and which Lenin
in 1916 had regarded as one of the key imperialist banks'. By 1964 the
ubiquitous David Rockefeller was visiting Moscow, talking at length
with Khrushchev, and soon afterwards the Chase became the first
American bank to open a representative office, at 1 Karl Marx Square,
in Moscow. The relationships between the communists and Rockefeller
were the subject of continual amusement and irony. The communists
regarded him as a king of capitalism, wielding far greater powers than he
really enjoyed: `Nobody knows how to revere, blandish and exalt a
Rockefeller,' said George Gilder, `half so well as the Marxists.'z
Rockefeller on his side saw the communists as more reliable and endur-
ing clients than many capitalist democracies: `In terms of straight credit
risk,' he explained, `the presumption is that there is greater continuity of
government in certain socialist states than in non-socialist states."
From the late sixties the western banks began lending increasingly to
the countries of Eastern Europe, including.the Soviet Union itself,
reassured by the so-called `umbrella theory' which assumed that the
Soviet Union would give its economic support to any country in trouble,
like the IMF and the central banks in the West. With the great expansion
of the Eurodollar market in the early seventies the banks became more
interested in lending to Eastern Europe, independently of trading con-
nections, encouraged by the political atmosphere in Bonn and Washing-
ton. In West Germany the Ostpolitik, or opening to the East which
Willy Brandt had initiated, encouraged the banks to extend their area of
influence into the communist countries. In the United States Henry
Kissinger and others maintained that western lending could help to
distance the Eastern European satellites from their Soviet masters,
while the Polish-Americans pressed for more liberal loans for their
cousins. There was a general belief in the West that any economic
improvement would have a liberalising effect on Eastern European
policies; and many Marxists were suspicious of western lending for that
reason.4
Bankers were inclined to see the whole of Comecon as coming into the
See Charles Levinson: VodkaCola: New York, Gordon & Cremonesi, 1978, p. 28. See
also Feis, p. 216 ff.
2 Peter Collier and David Horowitz: The Rockefellers (paperback edition), New York,
Signet, 1977, p. 427.
Martin Mayer: The Bankers (paperback edition), p. 483.
See M. S. Mendelsohn: Money on the Move, p. 104.
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THE MONEY LENDERS
same category of risk, assuming that one country would be helped by all
the others; and they lent with almost equal confidence to Hungary,
Czechoslovakia and the Soviet Union itself - as the credit ratings (see
page 254) suggested. The bankers widely assumed, in the words of
Institutional Investor, that `Moscow would not allow any Comecon
member to default or even reschedule, for economic, political, strategic
and image reasons.
..'.'
Poland was always a special case. It had the richest resources of
minerals of any of the six countries of Eastern Europe, including coal,
sulphur, copper, zinc, silver and lignite. But it also had more headstrong
leaders, more determined workers, and inefficient industries. Poland's
industrial backwardness had long been the despair of bankers: back in
the twenties the young Jean Monnet (later the father of the Common
Market) had helped to arrange a loan to Poland and had found Polish
industry `only just emerging from medieval conditions'.2 Now the
Marxist ideologues had brought their own mismanagement both into
Polish industry and agriculture. Poland had, in the words of one distin-
guished economist, `a combination of wildly over-ambitious, gravely
flawed, voluntarist economic policies; incompetent planning and man-
agement; and an especially unstable body politic ...'3
When Gierek took over as Prime Minister in 1970, after food riots
which had led to the fall of Gomulka, he looked to the western banks to
help revive the economy. The Brandt government in West Germany
pressed the banks to provide loans, and the American banks, as well as
government agencies, followed with loans - many of them into very
dubious industrial projects. The First Chicago Bank, in the midst of a
Polish-American stronghold, was specially active in Warsaw, and set up
its own office there. The western loans certainly helped to improve the
standard of living, and Gierek presided over a boom which was very
visible in the form of more cars, TV sets and consumer goods. But the
industrial managers failed to achieve much improvement in industrial
production, and behind the outward boom there was economic confu-
sion, about which the bankers were allowed to know very little. The
bankers still felt secure under the Soviet umbrella; but, by the same
rules, they could do nothing to interfere with national sovereignty.
By 1976 Poland looked much less attractive to bankers: there was a
crisis in agriculture, and Gierek put up food prices which precipitated a
new workers' revolt. Some American banks now felt that they had lent
' See Institutional Investor, July 1976. Also Richard Portes: `East Europe's Debt to the
West, Foreign Affairs, July 1977.
Jean Monnet: Memoirs, London, Collins, 1978, p. 103.
Richard Portes: The Polish Crisis', Western Economic Policy Options, London, Royal
Institute of International Affairs, February 1981, p. 8.
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quite enou
Poland 'wc
American
were becot
the debt, s
accurnulat~
clearly left
the Chase
Europe, 11
informati0
Poland rai
western b:
Polish gov
spected of
By the
another ha
to Warsaw
formed, at
1980, with
unionists r
The wes
who abom
of the Polio
Polish goo
cans presst
wielding a
had been t
the IMF c
country \
wage-clain
disciplinar
bankers n
confidence
and they
supportint
Why shot.
`pay for th
socialism"
House T3.,
p. 721.
' Foreign .-I
See Nora 13
November
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
)uld be helped by all
idence to Hungary,
e credit ratings (see
-d, in the words of
flow any Comecon
political, strategic
ichest resources of
)pe, including coal,
3d more headstrong
ndustries. Poland's
of bankers: back in
er of the Common
d had found Polish
litions'.2 Now the
agement both into
/ords of one distin-
ambitious, gravely
Manning and man-
after food riots
..estern banks to
in West Germany
1 banks, as well as
)f them into very
, in the midst of a
'arsaw, and set up
-d to improve the
n which was very
er goods. But the
nent in industrial
economic confu-
v very little. The
gut, by the same
sovereignty.
leers: there was a
ch precipitated a
hat they had lent
.urope's Debt to the
ons, London, Royal
quite enough; Alvin Rice, of the Bank of America, testified in 1977 that
Poland 'would have a difficult time increasing term indebtedness to any
American bank that I know of'.' And some international economists
were becoming seriously worried. `We cannot simply continue to ignore
the debt, supposing that it will go away as quickly and rapidly as it has
accumulated,' wrote Professor Richard Portes in July 1977: 'We have
clearly left it to the bankers for too long already.'2 Yet in the same year
the.Chase Manhattan was leading a 600-million-dollar loan to Eastern
Europe, including Poland, to finance a new gas pipeline with little
information about how the money would be used.3 In the following year
Poland raised a new syndicated loan worth half a billion dollars. The
western bankers, after all, were short of reliable borrowers; and the
Polish government negotiator Jan Woloszyn was one of the most re-
spected of all international bankers.
By the beginning of 1980 the Poles were negotiating to borrow
another half a billion dollars and in April they invited western bankers
to Warsaw to discuss terms, promising that Polish industry was being re-
formed, and that the banks could monitor it. Then came the crisis of July
1980, with unprecedented strikes, the power struggle between labour
unionists and the government, and the capitulation to higher wages.
The western attitudes were full of paradoxes. American conservatives
who abominated labour unions were now boundless in their admiration
of the Polish strikers. American labour unionists were refusing to import
Polish goods in support of their Polish comrades, while Polish Am?ri-
cans pressed for more credits. The workers in this communist state were
wielding a power enjoyed by few other workers in the world. If Poland
had been under the IMF umbrella (as Romania and Yugoslavia were),
the IMF could have been required to be thoroughly stern towards a
country with such a huge debt which was now giving in to inflationary
wage-claims. But it was Moscow, not the IMF, that was the ultimate
disciplinarian in Poland; and the western governments were urging the
bankers not to pull back but to make further loans. The bankers'
confidence in Eastern European discipline was thoroughly undermined,
and they could not be at all sure which side their loans were really
supporting. Was it the communist government or the dissident strikers?
`Why should the US or others in the West,' asked the Washington Post,
`pay for the privilege of making Poland safe again for Soviet-style state
socialism?' 4
' House Banking Committee: International Banking Operations, Washington, 1977,
p. 721.
2 Foreign Affairs, July 1977.
See Nora Beloff'The Comecon Bumble-Bee', The Banker, London, May 1978.
' November 23, 1980.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
Poland was now altogether a very doubtful proposition. Yet just as
the Polish government was issuing a statement condemning the strikes in
Lublin, bankers were meeting in the London offices of the Bank of
America to approve the new loan. By August a consortium, including
eleven American banks and the Moscow Narodny Bank, had signed the
agreement. The loan had been reduced to 325 million dollars, at a higher
interest rate and with strict terms of supervision; the bankers were
insisting that the money must be prudently spent, and had at last
extr;:_ted more economic information from Warsaw. But no one could
be \- rv confident about where it would end up. In the meantime a
German consortium led by the Dresdner Bank had raised a new jumbo
loan in which other German banks felt compelled to join: 'We weren't
forced to,' as one smaller participant told me, but we knew that if we
didn't we would be left out of other good things in the future.' The Bonn
government encouraged the loan, but could not guarantee it: it only
undertook to use all its influence to create political stability in Poland.
The total Polish debt was now alarming - twenty-four billion dollars,
of which more than half was owed to commercial banks - led by the
Germans, and followed by the British and Americans. The cost of
repayments in 1981 was reckoned to be more than the total value of
Polish exports. The commercial banks were now feeling much more
aware of their insecurity in Poland, at a time when other big debtor
countries like Brazil were also looking more doubtful. For no one could
be confident of who would guarantee its debts, and enforce its financial
discipline. Many bankers assumed that Poland would have to look
towards the Soviets for much of their future borrowing; but they could
no longer be sure that it was still under the Soviet umbrella, and the
West was offering no more than a parasol. Several bankers privately
admitted that they would feel much safer if the Russian tanks rolled into
Poland.
As for the Poles, they had little to show in exchange for their moun-
tain of debt. The succession of loans had fed their economic expecta-
tions and temporarily pushed up their standard of living; but they had
done little to improve the basic economy, and had left the Poles
apparently still more dependent on their Soviet money-masters. As for
the theory that western loans would help to wean the Poles away from
their communist loyalties, it had the most ironic consequence of all: for
the Polish strikers had taken the idea of freedom altogether too literally,
and the West was now as anxious as Moscow to damp them down.
The western bankers, having made handsome profits out of indis-
criminate loans, now looked to their governments to help them out.
They had held long and tense discussions in the Paris Club - the tradi-
tional casualty station of international banking - under the chairman-
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ship of the
the reschei
impossible
bankers. T
the bleak t,
realism. at
worries as
political to
between tl
By the e
of the Po
twenty-thr
repayment
telex that t
western b:
Lloyds an(
the Bank
undertake
situation
Montagno
in this w;
European
speedy agi
try to rev
mindful of
for a more
forefront.
The bank
economy.
and at the
over the i
the coma,
Turkey
countries
without c
in both Si
more wo
world ins
lending l
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
,)position. Yet just as
deriinin- the strikes in
ftices of the Bank of
:onsortium, including
Bank, had signed the
On dollars, at a higher
n; the bankers were
_nt, and had at last
iw. But no one could
In the meantime a
I raised a new jumbo
to join: We weren't
t we knew that if we
to future.' The Bonn
;uarantee it: it only
stability in Poland.
-four billion dollars,
banks - led by the
ricans. The cost of
the total value of
-cling much more
,n other big debtor
d. For no one could
::nforce its financial
ould have to look
ink; but they could
umbrella, and the
bankers privately
in tanks rolled into
tie fo: their moun-
:conomic expecta-
ving; but they had
ad left the Poles
:y masters. As for
Poles away from
!quence of all: for
,ther too literally,
them down.
)fits out of indis-
) help them out.
Club - the tradi-
cr the chairman-
ship of the French Treasury, while the Poles had to come to terms with
the rescheduling - or as they preferred to call it, restructuring - of their
impossible debt. It was now clearly too dangerous to be left to the
bankers. The ultimate country risk lay with the governments who faced
the bleak task of trying to bring Polish finances back on the road towards
realism, and Washington, London and Bonn shared the same financial
worries as Moscow. While the Polish crisis had created a dangerous
political tension between the superpowers, it induced a common interest
between their central bankers.
By the end of March 1981 the crunch had come. The representatives
of the Polish Central Bank met in London with representatives of
twenty-three western banks, and explained that they could not make the
repayments on debts that were due. A week later Warsaw confirmed by
telex that they could not repay loans amounting to a billion dollars. The
western bankers appointed a task force of twenty banks - including
Lloyds and Barclays from Britain, the Dresdner from Germany and
the Bank of America and Citibank from the United States - to
undertake the painful process of rescheduling, while the political
situation was constantly deteriorating: `Never before,' wrote Peter
Montagnon in the Financial Times, `has a country on the financial brink
in this way also been under threat of invasion from abroad.' The
European banks, more heavily exposed than the Americans, wanted a
speedy agreement to ensure that no single bank called a default and to
try to revive the shattered Polish economy. The Americans, more
mindful of lawsuits, wanted to freeze all loan agreements to give time
for a more equitable agreement; and the Chase, which had been in the
forefront, insisted that its loans to copper mines be treated separately.
The bankers tried to insist on more information about the Polish
economy, while the Soviets accused them of `economic blackmail';
and at the time of writing (July 1981) the threat of invasion still hung
over the negotiations. The unhappy love affair between bankers and
the communists was emphatically over.
Turkey and Poland were both part of the same story. In both
countries the bankers' herds had first fallen over themselves to lend
without circumspection and then all retreated together. Their interest
in both senses had been essentially short-term. Now, as they became
more worried about their country risk, they looked again towards the
world institutions - which had been left on the sidelines in the great
lending boom.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
RISK MANAGEMENT
It's as vital for manufacturing
companies as for banks.
But there are differences in
approach. By Bharat Bhalla
Foreign risk assessment is a term
normally used to mean political risk assess-
ment. It is a way of selecting countries of
reasonable political stability and acceptable
risk for investment. In its fuller sense,
foreign risk assessment should enable
management to devise and develop strate-
gies for avoiding, accepting, transferring,
and adapting risks present in the total
foreign investment cycle, from planning
and initiation to divestment. In this sense,
assessment becomes management: a strate-
gic response to an uncertain environment
affecting international investments.
Foreign risk involves defining, monitor-
ing, and controlling risks. To be effective,
foreign risk assessment must be linked with
the specific business of each company,
because the relevance and intensity of risk
varies between industries and between pro-
ducts. Specific risks and sources of risk
relevant to a specific business must be
identified. Once this is done, monitoring
and controlling risks becomes easier. Risks
are products of change in regulations,
policies, practices, institutions and decision
makers.
Following the initiative of commercial
banks in the US, multi-national manu-
facturing companies are developing in-
Bharat Bhalle is director of foreign risk
management at The Continental Group, Inc.
house expertise for foreign risk assessment.
This effort is limited to major companies.
Most manufacturing companies use input
from outside agencies or commercial banks.
This arrangement overlooks the uniqueness
of individual industries and products.
Banks deal in a homogenous product -
money, a necessity for all nations. But
manufacturing companies deal in hetero-
genous products which are discretionary
items for host countries. Banks lend liquid
assets likely to be retrievable at any time.
Manufacturing companies make permanent
investments, mostly in fixed assets, which
cannot be retrieved quickly without loss of
value or ownership. As lenders, banks are
primarily concerned with the creditworthi-
ness or the debt-servicing ability of a
borrowing country, which is not necessarily
affected by the instability of its govern-
ment, and is rarely damaged permanently.
A manufacturing company is equally
interested in creditworthiness, but is much
more interested in assessing socio-political-
economic factors which could threaten the
safety and profit-making ability of its
physical assets. For banks, these factors are
incidental to a country's balance-of-
payment situation. Foreign risk manage-
ment is much more comprehensive and
complicated for a manufacturing company
than for a commercial bank.
Foreign risk is defined as a change
causing uncertainty about the business
environment of a country. Economic un-
certainties are changes in the environment
that adversely affect the operational ability
of assets. Political uncertainty embodies a
threat to the safety of financial, human,
and physical assets and emanates from
changes in government or policies. Mon t
policy ,changes are made in response to .
socio-economic needs, so, for a manu-
facturing company, foreign risk has both
economic and political dimensions.
According to its source, foreign risk can
be classified as general or specific. General
being
risks originate outside the country assessed and vitiate its overall business
environment. Their impact affects all
foreign investors, in varying degrees.
General risks include:
? War: regional or global.
? Economic shocks: from oil cartels,
droughts, protectionism.
? Financial instability: LDC debt, oil
dollar recycling.
? Corporate citizenship: UN and OECD
sponsored guidelines.
Specific risks are changes within the
sovereign state, unique to that country and
resulting from policy changes made by its
government.
There are three tiers of specific risks: 1
country risk, industry risk, and project risk.
Country risk refers to the uncertainty
caused by economic, political and social
instability of a country and its ambivalent
attitude towards foreign investment. It
affects the initial foreign investment entry
decision and the physical safety and owner-
ship of assets subsequently.
Industry risk is caused by a change in the
host government policy towards foreign
investment in a particular industry, which is
considered vital to national economic inter-
ests. Changes are expressed through official
economic and budgetary statements and
through institutions created to review,
monitor and evaluate foreign investments.
aI
sul
pa
do
ma
rer
7
is tc
cert
invc
stra
H
folk
iden
into
four
cons
? Fi
?C
? In
? Ft
71
at dc
ing,
risk
inves
declil
INVESTMENT RISK EXPOSURE
Political instability
Analysis Military is willing to restore civilian rule
after 10 years New constitution is being drafted
and parliamentary elections are scheduled.
Impact on proposed investment Transition to
civilian rule likely to be frustrated by social
disorder and military may be forced to retain
some control.
Expropriation Terrorism
Analysis Did expropriate most foreign invest- Analysis Hiring of expatriates is limited to 10% of
ments and nationalized basic industries. However, a company's total employment Normally,
Government is anxious to allow foreign partici- expatriates cannot be employed for more than
pation with local private and state enterprises. three years.
Impact on proposed investment Remote Impact on proposed investment No threat to
possibility of expropriation of joint ventures with expatriates' lives, but prudent to manage through
minority oarticination lnval nersnnnel
Co-
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A060n U
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Project risks affect foreign investments in
a particular project through a 100% owned
subsidiary or a joint venture with a local
partner. These risks relate to five opera-
tional aspects of a foreign investment:
marketability, operability, profitability,
remittability and the integrity of assets.
process is relevant for both new and existing
investments.
FIRM is used in the planning stage of an
international investment decision, to avoid
unnecessary risk by selecting countries
which are relatively stable and offer a
market potential.
Banks lend liquid assets. Manufacturing
companies make permanent investments
which cannot be retrieved quickly. 19
The purpose of foreign risk management
is to identify the nature and sources of un-
certainties surrounding a particular foreign
investment and to develop appropriate
strategies.
How can this goal be achieved? The
following system has proved effective in
identifying uncertainty and transforming it
into manageable risk. This is achieved by a
four-phase continuous iterative process
consisting of:
? Foreign investment risk matrix (FIRM)
? Country risk profile (CRISP)
? Investment risk analysis (IRAN)
? Foreign investment risk audit (FIRA)
These states are interdependent and aim
at developing feasible strategies for accept-
ing, transferring, adapting and avoiding
risk inherent in four phases of foreign
investment: entry, growth, maturity and
decline. This foreign risk management
In 1976, 114 market-oriented countries
were evaluated for risk connected with the
packaging industry. Each was rated on a
risk matrix for short and long-term political
and economic risks. Political risk was rated
on an alphabetical, and economic risk on a
numerical scale:
Political risk:
A Stability
B Moderate instability
C Volatile instability
D Substantial instability
Economic risk:
1 Acceptable risk
2 Moderate risk
3 Major risk
4 Unacceptable risk
Political risk was assessed in terms of the
stability of the government, judged by the
Co-determination
Analysis Workers allowed 10% profit sharing up to
a maximum of 50% of equity. Law still applicable
with certain exceptions. Workers' equity
participation excepted in fishing and forestry.
Impact on proposed investment Limits profit
potential and management authority of enterprise.
Price controls
Analysis Food products are strictly controlled.
Industrial goods producers are required to inform
the Government only 24 hours in advance of price
increases. Normally, cost coverage allowable.
Impact on proposed investment Limited ability
to support profits through increasing prices.
RISK MANAGEMENT
IS
quality of its administration and the fre-
quency and character of its change; and the
legitimacy of the government, evident in
public attitude towards and support for its
leaders and political institutions.
Economic risk, reflecting the market
potential of a country, was measured by:
? Demographic structure: Size, growth and
density of population; growth and quality
of labour force; and urbanization.
? Infrastructures: Adequacy of financial,
human (administrative, managerial and
skilled) and physical (communication and
transportation) facilities.
? Economic structure: Sectoral contribu-
tion to gross national/domestic product
and its changing character; extent of
industrialization; and resource balance.
? Demand structure: Size, growth and
density of per capita income, and regionat
market potential.
? Economic growth: Level, rate, and
quality of growth reflected in gross
national/domestic product; the importance
and changing composition of foreign trade.
The level, growth, and density (distribu-
tion evenness) of per capita income is the
most critical variable in assessing economic
and socio-political risks. of various
countries. Per capita income reflects the
character, quality and level of economic
growth of a country, and also the quality of
its economic policy makers and managers.
There is a correlation between socio-
political instability and uneven income
distribution. As the per capita income
(PCI) increases beyond a certain level,
political risk starts declining, and economic
risk begins to emerge and become domin-
ant.
Depressed economy
Analysis IMF imposed an austerity programme.
slowing down economic growth. Five year real
GNP growth unlikely to exceed 2 to 3%. Debt
service liability estimated S5 billion in 1985.
Impact on proposed investment Austere
environment will constrain consumer market
growth.
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RISK MANAGEMENT
The per capita income of each of the 114
market-oriented economies was calculated
by dividing the gross domestic product of a
country by its population for each year.
This series was calculated for 10 years (1965
through 1975) expressed in 1975 US dollars.
The analysis of level, growth, and density
of per capita income for these countries
yielded specific results:
Countries with a per capita income of up
to $1,000 suffer from great inequality of
distribution (5 to 10% of the population
enjoying 25 to 50% of the national
income). This was more pronounced in
countries with a per capita income of up to
$600 and in countries whose economies
depend for growth on one, or few, staple
products or resources. Economic inequality
and social disparity becomes much more
emphasized as these economies start
growing and diversifying. These economies
continuously threaten the survival of the
government and political institutions of
their countries. The government's response
is repression, or inconsistent economic
policies that appeal to popular nationalism.
These countries offer the maximum
economic and socio-political risks.
Countries with a per capita income from
$1,000 to $3,000, derived from a diversified
economic base, show increasing balance in
income distribution. The economic and
socio-political risk of these countries is
manageable.
Countries with a per capita income of
$3,000 and higher, from a diversified base
and evenly distributed, generally enjoy a
stable political system. But as the income
level increases, economic risks increase.
Economic constraints are expressed
through policies aimed at protecting local
interests; the social overtones of such
policies often burden industry with
increasing social costs and even allow
Inflation
Analysis Currently 70% but likely to slow down
to 30% by 1984. Real wages are sustained
through indexation adjusted frequently, more
than once a year.
Impact on proposed investment Cost impacted
due to indexation, rising benefits, and subsidies.
Country risk profile
Internal: Political structure and institutions
Power centres
Ideological foundation
Cultural foundation
Bureaucracy
External: Axis with superpowers (US and USSR)
Regional economic and defence alliances
Relations with neighbours
Population density
Demographic balance
Level of education
Family structure
Ethnic composition
Religious cohesiveness
Labour and labour unions
Income distribution
Economic goals (attainable or ambitious)
Economic policy and management
Economic and structural growth
Economic infrastructure
Resource availability
Energy independence
Role of foreign investment
labour participation in the management
and profits of the enterprise.
Within this overall distribution, countries
experience growing economic and political
turbulence during the transitional phase
from one income level to another.
Of the original 114 market-oriented
economies, 26 countries with a population
of less than 5 million and per capita income
of less than $500 were dropped, as they
lacked the market potential for packaging
products. Fourteen countries with a popula-
tion of less than 5 million and a per capita
Devaluation
Analysis Exports being supported through mini-
devaluation. 40% devaluation in 1979 and 25% in
the next two to three years.
Impact on proposed investment Translation
losses in the first three to four years.
income of over $1,000 did not offer a
market by themselves, but were considered
as part of a regional market.
Chart 1 shows the location of 88 count-
ries on the risk matrix, their population
range, income level, and the compounded
annual growth rate in their per capita
income from 1965 to 1975. (The allocation
of countries on the risk matrix is somewhat
arbitrary and is being further refined.)
The risk matrix does not assign any
specific priority for selection of countries
by the product companies. However, it-
Exchange controls
Analysis No exchange controls but limited
availability of foreign exchange due to large debt
burden. Foreign investment covered under
Decision 24 of the Andean Pact
Impact on proposed investment Annual profit
repatriation limited to 20% of capital.
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RISK MANAGEMENT
helped product companies to select initially
countries in which to concentrate diversifi-
cation efforts during the plan period.
The results of FIRM were reasonably
accurate and reliable. In view of subsequent
events, there were not many surprises.
Once a country is selected and an invest-
ment effort is initiated by a product com-
pany, foreign risk management concen-
trates on risk acceptance strategy. This is at
the heart of foreign risk management, and
is managed through the country risk profile
(CRISP).
CRISP develops an understanding of the
total business environment of a country.
The main emphasis is on identifying sources
of external and internal tensions and their
potential threat to the socio-political and
economic structure of the country; and on
identifying risks relevant to the entry and
operation of the planned investment.
CRISP is comprehensive but concise. It
provides an analytical description of a
country's business environment in its
historical and future perspectives within the
framework of the table on' page 69.
Economic projections are made over a
10-year period based on a country's present
state of development, realistic economic
policies and goals, and external financial
and resource dependence.
Information developed at this stage is
crucial. It enables a company to make a
'Go' or 'No Go' decision. It provides
economic and other assumptions necessary
to develop an investment project. It speci-
fies risks to the proposed investment and
indicates feasible strategies, including
capital and ownership structures, and out-
lines the basis for obtaining the host
government's approval of the proposed
investment. Information is available for
monitoring investment after it becomes
operative.
Once a decision is made to proceed and
an investment proposal is confirmed by a
product company, the investment risk
analysis (IRAN) is carried out to verify that
the indicated return on investment is
realistic and consistent with the economic
assumptions included in the CRISP report;
and that the investment structure (capital,
ownership, management, etc.) is designed
to insulate the proposed investment from
anticipated risks.
The exposure analysis is rigidly focused
on risks already identified as ones to which
a specific investment will be exposed in a
particular country. The results of this
analysis are summarized on pages 66, 67
and 69.
The final phase of foreign risk manage-
ment is foreign investment risk audit,
FIRA, aimed at adapting and avoiding
unnecessary risks. FIRA has three specific
objectives:
? FIRA is a continuing process and is
helpful in foreseeing changes in the local
environment which affect existing invest-
ments. It takes the surprise element out of
the situation and enables management t
take preemptive action. Although i o
it impossible to anticipate or predict all
changes, even a partial success helps to
minimize the impact of an event The
monitoring of the host country envt,
ment is limited to changes already identifies
through CRISP as critical for the
company's investments.
? FIRA facilitates the monitoring of
changes in the local market which may
warrant no further investment, or an
eventual withdrawal. This assessment is
used in developing an exit strategy without
jeopardizing re-entry prospects.
? FIRA assists the development of
economic information, and monitoring and
evaluation of critical issues which form the
basis of strategic planning. These issues
include: world and regional political stability
energy outlook, international financial
stability, economic interdependence or
protectionism, and co-determination. These
are reviewed and analyzed for a 10-year
period, consistent with the company's
strategic plan duration.
FIRA may be difficult and time con-
suming. However, it becomes manageable
if, at an early stage of investment
development (CRISP), areas of concern
critical to one's business are identified. This
allows operational and strategic signifi-
cance of critical factors to be evaluated.
Foreign risk management is a strategic -
Foreign Investment Risk Matrix (Firm)
Acceptable
Japan
Australia. Saudi Arabia
Hong Kong
Israel
Cyprus New Zealand
Kuwait
France. Germany( Fed Rep),UK
Austria, Belgium, Netherlands,
Portugal
,
.
.
Singapore
United States
Denmark, Norway. Sweden,
Libya
1T`
Switzerland
Iceland. Ireland
Finland
Luxembourg
Canada
,
,
Costa Rica. Jamaica. Trinidad & Tobagoi
Uruguay
Pop 53-215m
Pop 5-23m
Pop. 5-6m
Pop Less than 5m
PCI $4000-$7500 (2-0-7-0%/yr)
PCI 55000- $8500 (2.7- 4-1 %/yr)
PCI $1600-$2000(52%/yr)
PCI Over $1000(1-9%/yr)
South Africa
Malaysia
Mexico
Algeria. Ivory Coast. Tunisia
Ecuador
Pop 9-56m
Pop 26-60m
Pop 6-16m
Pop 139-633m
PCI $2000-$3700(2.5-6.0%/yr)
PCI $1300-$1500(2-4%/yr)
PCI $600-$1000(2.7-5.5%/yr)
PCI $140 $25011.6-4.6%/yri
Pop 13-113m
South Korea
Morocco
Colombia. Peru
Pop 7-45m
Philippines. Sri Lanka. Thailand
Cameroon, Kenya. Zimbabwe
Pop 7-45m
Pakistan
Angola. Ghana, Madagascar
Mozambique. Senegal, Sudan.
Tanzania Uganda, Zambia
Haiti
Pop 5-73m
PCI $1200-$2500)0-6.5%/yr)
PCI $500-$1000(1.4-8.0%/yr)
PCI $225-$500(1-E%/yr )
PCI $175-$500(-5.0-2.0%/yr)
Iran Iraq. Syria Turkey
Bolivia. Central America (El Salvador
Afghanistan
Bangladesh Burma
Chile
Pop 8-41m
Pop 38-68m
.
Guat nnala, Honduras. Nicaragua),
Dominican Republic. Paraguay
Pop 2-6m
.
.
Nepal
Ethiopia. Malt. Zaire
Pop 6-70m
PCI $800-S2000(-0-4-7-5% /V0
PCI $350-$800(264-47%/yr)
PCI $375-$750(0.7-4.8%/yr)
PCI L_ssthan $150(Negative)
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RISK MANAGEMENT
tool, and the method used for it is
analytical. While political risk analysis is
basically qualitative, economic risks are
weighed heavily in quantitative terms. The
end product is the outcome of informed
judgement. The quality of this judgement is
affected by one's experience in interna-
tional business development activities.
The basic premise underlying foreign risk
management is that, without understanding
a particular country, it is extremely difficult
to identify precise sources of risk to a
specific foreign investment. This requires
knowledge of that country's political
system, structure, institutions; power
centres and their interaction; quality of
economic management; social, ethnic, and
religious cohesiveness; and regional and
global position.
There is no short cut to historical
perspective. It requires patience and
perseverance in investigating published
literature and eye-witness reports. The
comprehension of a country helps the
assessment of one's business potential
there, and the identification of specific risks
to the investment.
The historical perspective should always
be supplemented by a visit to the country. A
visit should be used to verify available
economic data and to gather additional
information helpful in making a realistic
forecast of overall economic growth and of
variables like labour costs, inflation and
exchange rate, affecting the feasibility of
the proposed investment; to establish the
quality and size of infrastructure facilities
necessary to support projected market
growth; to assess the magnitude of income
disparity and the rate at which this gap can
be narrowed down; and to understand the
quality of the current administration, its
ability to manage the economy effectively in
the future, and its ability to survive under
pressure.
The knowledge gained during a country
visit is helpful in judging its overall
investment potential and the specific risks
to the proposed investment. This judge-
ment can be biased if the visit is confined to
contacts mainly with the official agencies.
Certainly, they must be visited and heard to
get the official view. But a conscious effort
must be made to learn the dissenting or
adversary view from various sources -
leaders of the opposition parties, labour
leaders, small or medium-sized business-
men, academicians, and journalists.
This method has proved effective in
predicting events and their approximate
timing, and helpful in managing risk
exposure. The fates of dictatorial regimes in
Nicaragua, Iran, and South Korea were
predicted six to 12 months before they
became historical facts.
Changes in economic policies and events
affecting investments in various countries
were also predicted with reasonable
accuracy.
Foreign risk management is essential for
all manufacturing companies already
engaged, or planning to engage, in inter.
national diversification through foreign
direct investment. Growing uncertainty is
caused by changing political relationships
amongst 167 sovereign nations, their in-
dependent and frequently changing eco.
nomic policies supporting local or national
interests, and the demand for establishing a
new world economic order, in which
resource-rich countries are guaranteed a
true economic rent for their resources from
consuming nations.
This economic and political turbulence
calls for a rigorous environmental assess.
ment by multi-national companies to
transform uncertainty into a definable,
predictable, insurable, and manageable
risk. Foreign risk management does this. As
a strategic tool, it pays for itself.
It helps companies avoid bad and un-
profitable investments. It minimizes the
risk exposure of committed investments,
helps to avoid further risk exposure and
develops the sense of confidence necessary
for international diversification. ^
Has acquired
The Churchill and Montcalm Hotels, London
The undersigned has arranged and
provided the finance for the acquisition
The National Bank of Kuwait SAK
London Branch
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01-3
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Next 6 Page(s) In Document Denied
STAT
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J
EDITED BY SOL W. SANDERS
9 a C 0 U I D uO51LJcK ~ o~ 3&(
cnraora h T?' CA(L'['
he specter of a "debtors' cartel"-a combine of countries
that would call for a debt moratorium-is hovering over
a meeting of the Organization of American States in
Caracas on Sept. 5-9. Originally proposed by Venezuela, and
opposed only by the U. S., the meeting will discuss "a Latin
American response to the international economic crisis." U. S.
bankers hope the meeting will serve only as a sounding board
for debtor countries' complaints.
So far heavily mortgaged countries have resisted a unilater-
al repudiation of debts, because such a move would reduce
them to cash-and-carry trade with the rest of the world. Bank-
ers also count on divergent interests among the debtors to
thwart any agreement. Mexico, for example, has swallowed
the strong austerity medicine prescribed by the International
Monetary Fund (IMF) and improved its credit position (page 49).
Thus it is unlikely to go along with Venezuela, the most vocal
advocate of a still-nebulous "global debt negotiation."
Brazil, the most critical Latin country, has opposed a mora-
torium, using belt-tightening to maintain access to new money
by meeting payments on its $90 billion debt. But it is already
more than $2 billion in arrears. And support is growing inside
Brazil-and outside-for the argument that its economy can-
not continue to carry its present debt load. If that view were
to overwhelm the essentially conservative Brazilian bureaucra-
cy, the world banking structure would face a crisis.
A FRESH START. "Brazil is a developing country with serious
internal imbalances and an external impasse, both of which
require implementation of realistic economic policies," says an
August newsletter of Banco de Boston, the Brazilian branch of
First National Bank of Boston. "A good start would be ... am-
ple renegotiation of the foreign debt, which is understood to
be stretching out maturities with necessary rate adjustment."
Without that, the report says, austerity will exacerbate Bra-
zil's tw o-vear-old recession (BW-Apr. 8).
A number of smaller foreign banks believe the latest IMF
renegotiation was just another quick fix that, like an earlier
one in February, will fall apart when Brazil cannot or will not
implement its draconian measures. Their solution is a major
restructuring of the Brazilian debt-at significant cost to U. S.
banks, Brazil's biggest creditors. In May the IMF and foreign
banks stopped paying out about $1 billion in new financing,
because Brazil was not meeting commitments to reduce the
public-sector deficit. Since then, however, Brazil has increased
taxes, lowered consumer subsidies, reduced government in-
A SHANTYTOWN IN THE STATE OF BAHIA: FOOD CONSUMPTION IS
DROPPING. AND 40% OF BRAZIL'S WORKERS ARE UNDEREMPLOYED
vestments, set caps on interest rates and rents, and stiffened
price controls. Bankers are most heartened by a curb on salary
increases, limiting them to 80% of the inflation index, although
the measure still requires congressional approval
But some argue that these tourniquets are causing gan-
grene. Economists predict the gross national product will drop
by as much as 4% this year, after last year's estimated 1%
increase. Banco de Boston says that 40% of Brazil's 47 million
workers are underemployed, and, despite an annual 2.5% popu-
lation increase, food consumption declined for the third year.
The impressive trade surplus of $3 billion through June was
based on a 23% import cut. Industries are stagnating from
lack of imports, and local banks are refusing to lend at artifi-
cially low rates. Inflation is now at 142%; July's 13.3% was the
highest monthly rise in history.
The clamor is rising, with some businessmen advocating
debt repudiation. Brasilia's technocrats have resisted, not only
because they believe continued access to new credits is essen-
tial but also because they feel that, as the largest debtor,
Brazil has enormous leverage on world capital markets. This
attitude is enhanced by Brazil's traditional aloofness from
Latin American cabals. But the heady atmosphere of rhetoric
and desperation in Caracas could generate new pressures. o
~11"23 A u l] (J L.a r 31TJ7 t--) L:3 b \J ~ L~
(~~ J 1`~L E1 L
hina's leaders have switched from harsh repression to
more benevolent rule in Tibet, hoping to demonstrate the
benefits of autonomy within a reunited China-an ar-
rangement they are also offering on even more liberal terms
to Hong Kong and Taiwan. But a little freedom extended to
the Tibetans is proving, from Beijing's point of view, a danger-
ous thing. Tibet offers little evidence that Beijing's program
has eased bitter resentments against Chinese domination.
In 1951, Tibetans yielded to Chinese Communist pressures
for more control over their country-beyond the traditional
Chinese "suzerainty"-in return for pledges not to tamper
with Tibet's Buddhist faith or impose a socialist economy.
Although those promises were much less generous than those
now being offered Hong Kong and Taiwan, the Chinese re-
neged after an abortive 1959 uprising and began sacking mon-
asteries and communizing the land. In 1950, after a fact-
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COUNTERTRADE
CMI'? PAST? WflLL Pi4Yj B&97 IAA SULTA1AS
Barter need not bring you
unwanted diesel engines.
By Rupert Birley
Barter is also known as compensation,
buy-back, counter-purchase, switch, recip-
rocal trading, pay-back, bilateral trading
and parallel -transactions. The Indonesian
Department of Trade calls it: "The imple-
mentation of linking government pro-
curements from imports with Indonesian
export products, excluding petroleum and
natural gas."
To the Rumanians it's "parallel
business"; to the Russians "compensation".
Barter deals between east and west are
now extremely rare, since western manu-
facturers dislike being landed with a
lifetime supply of Yugoslav hams. But
between eastern European countries and
developing countries, and among
developing countries, barter goes on.
Payments are effected in soft, non-
transferable currencies, known as clearing
dollars or clearing roubles. Imbalances
often arise, because one partner cannot
absorb goods equal in clearing units to
those he has sold to the other. In the 1950s
and 1960s, the heyday of these agreements,
there developed a sophisticated trade in
clearing surpluses known as switch (because
it involved the switching of goods from a
communist country to the open market).
For example, an imbalance might build
up in the Polish/Greek clearing agreement
(which is defunct since Greece joined the
EEC) because Poland had not bought from
Greece as much as it had sold. A switch
trader would buy the rights to 250,000
clearing dollars from the Poles for $225,000
(a discount of 10%). The clearing dollars
would then be sold for $235,000 (a 6% dis-
count) to a European sultana merchant who
used them, through the Greek Foreign
Trade Bank, to purchase Greek sultanas at
a discount to what he would pay in hard
currency. This multilateral use of bilateral
agreements would reduce the imbalance
between Poland and Greece - and
generate trade which otherwise might not
have taken place.
Barter, countertrade or CT used to be an
exotic feature of trade with eastern Europe.
Experts in it had names ending in "owsky"
and "nyi", and could usually be found in
Vienna. Nowadays, information about CT
is more widespread. Banks are hiring CT
experts as fast as they can find them.
The international trading houses such as
Philipp Brothers, the Man Group, Marc
Rich and Cargill should be ideal vehicles for
transactions of this sort. They are secretive
requires discretion. Rumours abound of CT
deals involving the trading of New Zealand
lamb for Iranian oil, and Thai rice for
Brazilian maize, but nobody is prepared to
be precise about who put these deals
together.
There are signs, however, that these
trading houses are now coming out into the
open. Andre, Lausanne, is one trading
group which has for many years successfully
run a CT department in conjunction with
its mainstream trading activities.
Others, such as the Man Group, are also
beginning to adopt a more systematic
approach to CT. Tradax, Cargill's
subsidiary in Geneva, is now head-hunting
CT experts.
Barter trade has increased. But how
important is it in terms of world trade? The
US Department of Trade predicts that it
will account for 10 to 20% of world trade in
the 1980s. Reliable statistics are, however,
non-existent. Western exporters are
reluctant to divulge details about deals
which have been condemned by western
governments, by the IMF and GATT as
distorting multi-lateral trade, and by
Europe's trade unions as encouraging the
dumping of goods on western markets with
consequent losses of jobs. The Osteuropa
Institut Munchen recently studied estimates
of the share of CT in total east-west trade,
which ranged from under 10% to 77%.
CT has now expanded far beyond
Comecon countries. The Indonesian
government in 1982 made 100% CTs in
non-oil and gas commodities obligatory for
all government-awarded contracts. The
penalty for non-compliance is 50% of
contract value. According to sources in
about what they do, as their business Indonesia, contracts signed on this basis
already amount to $250 million.
Other ASEAN countries are following
suit - much to Japan's dismay - while
oil producing countries, such as Venezuela,
Iran and possibly Nigeria, are offering
otherwise unsaleable oil in lieu of payment
for capital imports. Mexico and Brazil are
now refusing to discuss imports even of raw
materials unless some form of CT is
considered.
CT, however, is not restricted to LDCs or
countries with unmanageable foreign trade
debts. As any aerospace executive will tell
you, willingness and the ability to handle
CT is often decisive in winning contracts in
western Europe. In 1980, the Austrian
Government decided to buy Mirage jets
because the French accepted a measure of
CT; Rolls Royce's sales to Finland entailed>
j S tht idWo%9ica ( cdklh
,t'hat' 14,f g.s it fo /Qflla.l. ---
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
the marketing of various Finnish consumer
items such as TV sets; Messerschmitt
Balkow Blohm are now negotiating sales to
Italy and Belgium, both of which will entail
a large percentage of CT.
During his state visit to Indonesia in
January, Canada's Prime Minister, Pierre
Trudeau, argued that contracts worth $160
million, won by Canadian firms for the $1.3
billion Bukit Asam Mining Development
project in South Sumatra; should be
exempt from CT.
The Indonesian government, however,
stuck to its guns, even threatening to
retender contracts already awarded to
Canadian firms. In late February the
Canadian government notified Jakarta of
its full acceptance of the CT policy.
As governments have reconciled them-
selves to what many consider a necessary
evil, the advisory services they offer have
improved. Before Trudeau visited Indo-
nesia, the Canadian government had
completed a fact-finding mission in Europe
on all aspects of CF. The US Department
of Commerce and the UK Department of
Trade and Industry provide explanatory
booklets.
Perhaps the best service is provided in
France, where in 1977, following prompting
by Raymond Barre, then Prime Minister,
ACECO (Association pour la Compensa-
tion des Echanges Commerciaux) was set
up by France's five leading banks and the
Paris Chamber of Commerce and Industry.
Funded by subscriptions from member
companies, it gathers and distributes
detailed information about developments in
CT all over the world.
A similar service offered by the Evidenz-
bt ro, which was set up by the Austrian
Federal Chamber of Commerce, the
Ministry of Trade and Industry and
Association of Industrialists.
US and UK banks have been, with few
exceptions, latecomers. Citicorp and
European American Bank have recently set
up their own CT departments.
Three European banks, Kleinwort
Benson, Credit Lyonnais and Creditanstalt
Bankverein, have gone into the CT business
in a big way.
The Creditanstalt Bankverein, Austria's
leading bank, has for many years owned
AWT (Allgemeine Finanz-und-Waren-
Treuhand), a trading subsidiary. AWT has
had considerable success in negotiating and
discharging CT contracts on behalf of the
Creditanstalt's clients. Business in eastern
Europe has dried up; it is now concentrat-
ing more on its d forfait business. The
Creditanstalt also has an 11014 stake in
Hungary's Central European International
Bank, the first western-financed bank to
operate in Comecon.
Credit Lyonnais has set up its own CT
department, and participates - in
partnership with France's other banks -
in ACECO and in COOPINTER (Societe
de Cooperation Internationale), whose
speciality is CT in Rumania. Credit
Lyonnais joined forces with the US-based
Lissauer Group to form Greficomex in
1980.
In addition to the Merban Corporation,
which has had considerable experience with
CT, Lissauer also owns Associated Metals
and Minerals, New York, Leopold Lazarus,
London, Metall & Rohstoff, Zug, and
Oxyde, Amsterdam, all of which supple-
COUNTERTRADE
ment the financial expertise of Credit
Lyonnais with solid trading back-up. This
marriage of bank and trading group has
been a success, because purchases in CT are
handled within the group and are not
farmed out to third parties (as is often the
case with other CT subsidiaries of banks).
The Centro Internationale Handelsbank
(Centrobank) in Vienna was originally the
brainchild of Kleinwort Benson. Founded
in 1974 by a consortium of banks led by
Kleinwort Benson (and including the Bank
Handlowy, the Polish Foreign Trade
Bank), Centrobank was conceived as a
merchant bank in the historical sense of the
word, with its banking and trading activities
equally balanced. Centrobank has a reputa-
tion for innovation. Under the joint
management of Gerhard Vogt, a former
grain dealer who syndicated sales of
Austrian grain to Poland, and Kazimierz
Glazewski (who was appointed president of
Bank Handlowy in February this year) it
has pioneered many new techniques in
countertrading, such as the use of evidence
accounts. It is now setting up an office in
Jakarta to handle Indonesian CT.
CT is often a vital element in a trade
financing package for the Third World.
Here the banks are useful. As sources of
commercial knowledge and credit informa-
tion, they complement the role of the
traders. But problems arise when the banks
try to go it alone through subsidiaries which
lack focus and whose employees end up as
jacks of all trades and masters of none.
Because they can rarely act as principals to
the CT deals under their supervision, they
often play the role of the honest broker,
with a consequent reduction in profit. D
COUNTERTRADE VARIES FROM AIRPORT CONSTRUCTION TO COKE
Countertrade or CT includes: of Foreign Trade for the construction of a and Winston cigarettes to Hungary on this
A INDUSTRIAL COMPENSATION
i) Buy-back agreements
These are agreements not worth less
than $20 million lasting from five to 25
years, that involve the delivery of
industrial plant, with 100076 repayment in
the resultant manufactured products.
Examples: Occidental . Petroleum's
agreement, signed in 1974, to supply the
USSR with two ammonia plants, with
repayment over a ten-year period in
ammonia; Davy Power Gas and ICI's
1977 agreement to supply the USSR with
two methanol plants, with repayment in
methanol.
ii) Co-operation agreements
These do not entail CT in resultant
products.
Examples; PepsiCola's 1972 agreement
with Nixon's help to sell the USSR Pepsi
concentrate in exchange for vodka; and
the agreement in 1977 between Cementa-
tion International and the Polish Ministry
complex at Warsaw airport. This involved
the employment of Polish construction
crews on CI's contracts with Third World
nations, plus the purchase by CI of Polish
construction material.
iii) Joint venture agreements
These involve western equity participa-
tion with the partner.
Example: Honeywell's joint venture
with Yugoslavia for the manufacture of
computers.
.B COMMERCIAL COMPENSATION
This covers the smaller transactions,
between $10,000 and 1 million, lasting
from six months to three years, with two
separate contracts (one for the sale; the
other for counter-purchases in non-
related products).
i) Pre-compensation
The western supplier purchases before
he sells. Whatever he purchases qualifies
as a credit to be offset against subsequent
deliveries.
Example: R. J. Reynolds sells Camel
basis.
ii) Parallel transactions
The counter-trade is carried out after
delivery by the western firm.
Example: The sale of machinery worth
$250,000 to the Rumanians. The seller has
to purchase Rumanian machinery
products equivalent in value to 50010 of the
sales contract within a specified period
(usually 12 to 18 months). Failure to do so
is subject to a penalty, anything from 5 to
100010 of sales contract value.
iii) Framework agreements (goodwill or
gentlemen's agreements)
These are what every exporter hopes
for. Whereas non-fulfilment of (i) results
in no sale, and of (ii) a penalty,
framework agreements rely on goodwill.
Example: Rolls Royce supplies
components without which Rumania's
domestic airline would grind to a halt.
The best endeavours clause in the sales
contract merely refers to "Rumanian
products".
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COUNTERTRADE
Although many banks offer a CT service to
their clients, it is very rarely a profitable
exercise. Centrobank is, perhaps, the excep-
tion.
"Most banks are not structured to handle
these deals," said John Burge, general
manager of Fendrake (a Kleinwort
subsidiary involved in trade and trade
finance) who is also Kicinwort's liaison man
with Centrobank. "This is a trading
business with trading risks. On the other
hand, the banks do lend credibility to an
esoteric style of business."
The boom in buy-back deals in the late
1960s and early 1970s led to the setting up
of trading units specialising in CT by large
manufacturing and engineering groups.
With characteristic over-saturation, the big
Japanese corporations such as Mitsubishi,
Marubeni and Nissho-Iwai set up
permanent offices in all the Comecon
capitals, which they have maintained ever
since, long' after their European rivals
decided that theirs did not justify the cost.
The corporations' own CT subsidiaries
have had experiences similar to those of the
banks. The Germans, French, Austrians
and Italians have had the most success.
Industriehandel, Daimler-Benz's equiva-
lent, has had success, not only in using CT
as a means of maintaining sales to cash-
strapped markets, but also in turning it into
a profitable business exercise. Such is its
expertise that it has been known to take
over and discharge CT obligations on
behalf of other companies.
The UK and US groups have recently
been making up for lost time. British
Aerospace, Hawker-Siddeley and Rolls
Royce are already CT veterans, while GKN,
Courtaulds and Massey Ferguson have
expanded their trading departments.
Rockwell International Trading Com-
pany has in the last two years educated
Rockwell's various divisions in CT, and has
already identified several areas where
counter-purchases can be streamlined into
the group's existing purchases.
Tins of Ham & Ham & Ham
One European ? telecommunications
group was saddled with a CT contract in
Poland. They established that the CT
contract permitted purchases of copper
wire, which was required in large quantities
for their own manufacture of telephones.
The Polish copper wire, however, required
certain modifications. Research revealed
that the cost of installing the machinery to
modify the wire in the Polish factories more
d
administratively by the Third World
countries insisting on it. Indonesia, the only
country outside eastern Europe to
introduce official CT regulations, has until
now relied heavily on the expertise of
specialized organisations such as
Centrobank. Everyone is praying that they
will not follow the eastern European
example too closely (and particularly not
the Yugoslav example, which is utterly
chaotic). There was a scare in 1980 when
rumours began to circulate that the Chinese
were consulting the Yugoslavs on CT.
Unofficially, the experts exist. Interagra
is run by Jean-Baptiste Doumeng, the
French Communist who grew rich by
"exploiting flaws in the capitalist system".
It is known for its sales of EEC surplus
butter and meat to the USSR, and, it has
just completed a barter deal with Vietnam,
the newest recruit to Comecon. Companies
associated with Italy's and France's
Communist parties have built up profitable
sidelines in the field of Cr. Many
subsidiaries of eastern European trade
organizations in the west have realized that
linking their existing sales to CT obligations
is an easy way of earning commission. This
is fine for western suppliers, but negates the
already dubious benefits of CT for those
who imposed the system in the first place.
In the 1960s and 1970s, CT in eastern
Europe always involved counter-deliveries
of shoddy, finished products which could
not be marketed through normal channels.
Raw materials, such as coal, sulphur or
sugar, were never eligible for purchase
within the framework of these contracts.
Today the reverse is true with CT in
Third World countries. Global recession
and slumping commodity prices have
forced these countries to offload their
commodity surpluses by means of reciprocal
trading arrangements: oil from Venezuela
and Iran; cotton from Mexico and the
Sudan; rice from Thailand, Pakistan and
Burma; timber and rubber from Indonesia
... the list gets longer every day.
than justified the vast savrngs ma e n , ? &, , ,
discharging their CT obligations internally. might be expected to possess a few skilled
CT specialists themselves. The answer is
officially "no", but unofficially "yes".
efficiency, provides standardized CT con-
tracts, and offers extensive guidance on
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Vietnam is on the other side of the world. Even El Salvador seems
remote. But if turmoil comes to Mexico, there is no way the U.S.
can avoid being dragged in. Here's why the current Mexican
crisis, -so threatening to the U.S., goes deeper than the usual
complaints about oil prices, foreign debt and corruption.
By r:o'man Gall
igin-A a la riad- rid: the
L,resiaent as priest and !miafs.
'Muchas gracias, Senor Presidente, mudxrs
gracias. " The president of the republic was
seated in a crowded tent pitched on the small cattle
fairground of the municipio of Tlaquiltenango in the dry
hills of the Valle de Vazquez in the state of Morelos. Near
here, seven decades ago, the guerrillas of Emiliano Zapata
dodged federal troops during the bloodiest phase of the
Mexican Revolution. Now the descendants of these guer-
rillas were patiently waiting their turn to present their
requests and make their complaints to the highest author-
ity. Each of them would get just 30 seconds to present his
or her case.
The speeches are brief because the meeting has been
very carefully arranged. "Senor Presidente: Valle de Vazquez
covers 12,000 acres, of which roughly 11,000 are dry hills
and only 1,000 can be farmed when it rains. We are 2,000
inhabitants. With the money you have given us, about U.S.
$63,000, we have invested in fences and pastures and
water troughs and a corral, benefiting our families. Lastly,
we peasants of Valle de Vazquez ask you urgently to
provide us with an irrigation system to better use our land.
For all this, we thank you."
Notwithstanding: the republican and revolutionary trap-
pings of his office, the president of Mexico is a priest and a
king. He travels often among the dusty villages of his
realm, as do few of the world's heads of state, in a continu-
ing ritual to renew the security and legitimacy of the rule
of the Partido Revolucionario Institutional (PRI), which has
governed Mexico for the past half century.
The presidential pageant is accompanied by flags,
flowers, mariac"hi bands, speeches, recitals of the con-
quests of the Revolution and vows of support for the
president of the republic, who brings gifts for his peo-
ple. The pageant triumphantly passes through a blur of
baked Indian faces on baked village streets, half hidden
by banners and posters bearing portraits of Zapata, the
Indian with glistening eyes who rose from the mass of
peasants whose communal lands had been stolen. Za-
pata refused to be bribed and had to be killed. In death
as in life, however, then and now, he haunts the essen-
tially conservative leaders of the Revolution, who have
been unable to cure many of the sufferings that led
him to rebel. All the more reason for the president to
listen, and try to help. The populace must not think of
the government as being remote and unresponsive.
'Senor Presidente: The lands of Morelos are turning to
dust," announces Manuel Peralta Subdiaz over the loud-
speaker in Tehuixtla, the next stop for the presidential
motorcade. "We are the state that most needs conversion
of dry farmland for irrigation. But the participation of the
officials in charge of the irrigation programs has been
FORBES, AUGUST 15, 1983
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
mean and devious. Please help us..Muclxrs gracias."
Big problems and small ones, the president is expected
to solve them all. The priestly and kingly functions of the
Mexican president come from the Aztecs, whose emperor
declared himself to be a god. The incessant presidential
touring began in the reign of General Lazaro Cardenas
(1934-40). This hulking, taciturn son of a small-town pool-
room proprietor became the towering figure of the Mexi-
can Revolution after he nationalized the foreign oil com-
panies in 1938. It was Cardenas who established the ritual
that, 45 years later, Miguel de la Madrid is now observing.
In those days the provincial revolts and counterrevolts
still had not ended, and a presidential presence in the
interior was a political imperative.
President de la Madrid does it somewhat differently,
however, from most of his predecessors. Instead of giving a
speech in each village, the newly inaugurated (December
1982) president listens with great care to the speeches of
others in the ritual acted out before him. Behind his
silence may lie the brutal fact that the president of Mexico
now has little to promise and less to give. Nevertheless,
small requests are made and often granted. Symbolism
counts for much.
In Tehuixtla the merchants of the municipal market
asked the president for a desk and chair, filing cabinet,
typewriter, 30 folding chairs and a roof for their stalls. In
another request, Hipolito Garcia Albarran told the presi-
dent: "Man does not live by bread alone. He needs enter-
tainment. For this reason we have formed a brass band that
we wish to expand with two trombones, four trumpets,
three saxophones, a drum and a pair of cymbals."
The requests were granted. The President has renewed
his ties, and his party's ties, to the people.
crisis since the armed phase of the Mexican Revolution
and the Great Depression of the 1930s. But today we ar a
bigger and more complex country. In 1930, after the ci. I
war ended, we only had 16.5 million people. Today we are
75 million Mexicans. The size of our economy is much
greater, and so are the dimensions of our crisis. For the first
time in this century we are going through 100% inflation
and economic stagnation at the same time.
Nevertheless, I don't think you can compare Mexico
with other countries where economic problems have led
into social and political crisis. Although Mexico still is
backward in several aspects of its economy and its soci-
ety, it has been continually modernizing ever since the
Revolution.
We have a stable political system, very stable when you
compare it with the rest of Latin America and political
systems elsewhere in the world. Moreover, Mexico is
endowed with large and diversified natural resources. We
are the world's fourth-ranking country in oil and gas
reserves. We have abundant mineral resources, most of
them still to be discovered. We have abundant farming and
cattle land whose productivity gives us a wide margin for
improvement. Mexico already has reached 14th place in the
world in fisheries production, and we are only beginning.
For thousands of years, the presence or lack of water 1x-Ls been
a matter of life or death in Mexico. Recently Mez-ico has been
lacking water.
De laMadrid: I agree that water is one of the great problems
of Mexico. Our hydraulic resources are very unevenly
distributed. They are concentrated in the tropical south-
east, where the problem is flooding, swamps and runoff of
valuable water to the sea. On the other hand, the central
plateau and the north, where three-fourths of the popula-
tion is concentrated, can be considered desert country by
standards of rainfall.
Over the past half century, one of Mexico's great
achievements has been the building of gigantic hydraulic
works-dams, irrigation canals and deep-draft wells-that
have brought increasing amounts of land under cultiva-
tion. Nevertheless, water remains scarce. Large areas of
farming and cattle land depend on rainfall, and, as you
have said, there is great scarcity of water in the cities just
as the cost of extracting, transporting and distributing
gravity of this crisis. water is increasing.
De Ia .tl, Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 exico. We must learn
iguel de la Madrid: We shall
overcome our difficulties.
L The following are excerpts from an inter-
view with Miguel de la Madrid, president of
Mexico, conducted in Spanish by FORBES Contributing
Editor Norman Gall:
The US. ;and .tlei-ico are increasingly interdependent and so
people in the US. are worried about aletico. Our people discuss
the passibility tat .ti lento may become another Central America
or another Iran. You yourself lxtte referred Horny times to the
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
how to use it better. In the future we must build more small
dams and irrigation canals to maximize development of our
water resources. The result will be a new culture of water
that will create greater awareness in Mexicans of problems
of scarcity by raising the price of water.
Water is far from being the only necessity subsidized by the
Mexican government.
De la Madrid. One of our economic strategies is revision of
our policy of subsidies, which have grown to be an impor-
tant part of the budget and have put us under heavy
pressure.
Growing deficits, caused by artificially low prices of
public goods and services, to a great degree explain the
inflation we are now suffering. Adjusting these prices will
imply some sacrifices and some important changes of
co or the rest of the world. We are achieving this by
increasing government income-raising sales taxes and
prices of public sector goods and services-and by cutting
public spending. This is an enormous sacrifice, painfully
affecting living standards and expectations. But I am con-
vinced that there is no other choice.
In Mexico our deficit comes from a low tax burden, not
because rates are low but because of inadequacies in ad-
ministration of the revenue system. There still is much
tax evasion.
Mexico City has become the second most populous metropoli-
tan area in the world. Isn't it cheaper and more viable to resettle
people in other places?
De laMadrid: The cost of the city's expansion is extremely
high and it represents an injustice to the rest of the
republic. Subsidies have made the city more attractive and
have stimulated migration even more. In our new Devel-
opment Plan for 1983-88, one basic goal is decentralization
of national life. Within our system of freedom-of work
and movement-we cannot impose coercive measures to
block people from coming to Mexico City or to expel
them. But we can take measures to encourage them to
move to new poles of attraction that are being developed in
other regions.
Many millions of Mexicans do not produce or earn enough
to live. This is wiry subsidies were started They seem to paper over
a basic imbalance between population and resources.
De la Madrid. We are convinced that we should reduce our
rate of population growth. In the 1960s the population was
growing by 3.5% yearly. Today the rate is going down, and
we intend to reduce it to 1% by the end of the century.
Over the past decade the government has been supporting
family planning, and this will continue.
It is true that many of our people live at the subsistence
level. But many others have achieved standards of living
that we could not have dreamed of a few decades ago. We
also must take into account the improved capacity pro-
vided by technological innovation, in Mexico and through-
out the world. Thus, with better use of our own natural
resources and with improved technology, we can continue
aspiring toward dignified standards of living for all our
people, even when this means changing many patterns of
past behavior.
habit. But it will bring us closer to economic rationality.
At the same time, we must realize that Mexico was a
much weaker country four or five decades ago than it is
now. We have modernized and absorbed new population
that has grown at the world's highest rates. Our school
population is now 24 million, more than the whole Mexi-
can population in 1940. We have taken great strides in
education, health and housing in a country that, before the
Revolution, was primitive, lacking institutional stability
and internal communications. Mexico today has reason-
ably good communications. Although the tasks ahead of
us are great, I feel that our potential is sufficient to over-
come these temporary problems.
In the 1950s and 1960s Mexico became known internation-
ally for its pr udent management of its public f nances. How did
these finances get into so much trouble?
De la Madrid: Our public sector deficit reached 18% of the
domestic product last year, which is one of the main
causes of our present inflation. Our program of economic
reorganization for 1983 aims to bring this d "icit down to
8.5%. This is a gigantic effort, without precc:ient in Mexi-
Some critics say the basic problem in Mexican economic
policy is the domination of the public sector over the private
sector.
De laMadrid: Mexico wishes to continue living in a mixed
economy and will take measures to ensure that the public
and private sectors coexist. We are introducing more real-
ism into pricing policies to ensure sufficient profitability
for private business to work and invest. We are promoting
a reasonable equilibrium between the public and private
sectors by helping companies with their financial difficul-
ties, by recognizing the realities of prices and by stimulat-
ing private activity through fiscal, credit and tariff poli-
cies. Over the next few months, once we pass the worst
phase of our economic crisis, I expect the private sector to
resume its role as a force for economic growth. As for
prices, we cannot free them all at the same time because
this would accelerate inflation. But I must remind you that
in December, the first month of my government, we freed
half of our price controls.
Many thanks, Mr. President.
De laMadrid: Your questions penetrated our reality. They
are my questions as well. I ask myself them every day.
FORBES, AUGUST 15, 1983
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
e
o
mean, stnppe its r
investment and putting it into the stomachs and pockets Mostly they come to Mexico City, cradled in the central
of the people. It has its virtues, but it also has its delayed valley of the country. This valley was once largely covered
price. ' Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 th the basin's fertile
"From the highways you can see
groups of peasants in the open fields
kneeling around statues of the Vir-
gin, desperately praying for rain. It
did not rain last year, nor this year
either. If it does not rain by mid-
June the crops are lost.... "
eography is destiny.
In interviews with reporters from the U.S.,
Mexican Treasury Secretary Jesus Silva Her-
zog has repeatedly said: "I don't think Mexi-
co is capable of living with a stagnant economy beyond
1984." He said it again in an interview with FoRBES in his
spacious offices in Mexico City's colonial-era National
Palace. He was giving a clear message to Mexico's credi-
tors. It was: If you squeeze us too hard or too long, you will
end up losing everything.
Yet Mexico continues to struggle bravely to put its
financial house in order-imposing tough sacrifices on
business and consumer alike. To its credit, it is doing
so with a will that the U.S. Congress has failed to
display in curbing fiscal extravagance in this country.
So why does the principal architect of this austerity,
the urbane Silva Herzog, harp constantly on the limits
to this austerity? Because he is aware of the political
realities of his situation.
It is easy enough to say that wasteful government spend-
ing, egregious policy errors and shameful corruption are at
the root of Mexico's current near-insolvency. All this is
true, but it is not the whole story, nor does it get to the root
of the situation.
Where did Mexico go astray after 40 years of economic
growth that was one of the wonders of the world? Why did
its public sector deficit zoom from 3% of gross domestic
product in 1970 to 18% in 1982, while inflation went from
5% to 100%? Inflation, swelling deficits and overcon-
sumption are global problems today, but an event specifi-
cally Mexican also contributed to the end of stable growth.
This was the student demonstrations in several cities that
preceded the 1968 Olympics. These uprisings led to the
death of an estimated 200 people when the army and
security forces attacked demonstrators in Mexico City's
Plaza of the Three Cultures.
The demonstrations shook the ruling politicians and
brought shivers of terror to a people aware of the potential
for violence that always lurks just beneath the Mexican
surface. Novelists and poets have long recognized that
there is an almost mystical tendency to violence penned
up in Mexico-and sometimes it bursts out.
The politicians responded by yielding more and more to
"populist'' demands. And what does "populism" really
ric ? It means taking money from
d ,-Sc ; h
t
Mexicans now call the docena tragica (the tragic dozen
years) under the presidencies of Luis Echeverria (1970-76)
and Jose Lopez Portillo (1976-82). This is not to say that
the ordinary Mexican was rolling in affluence during those
years. He certainly wasn't. But with resources scarce and
population soaring, the nation could ill afford populist
demagoguery. Sacrificing investment for consumption is
dangerous for any economy, but especially bad for Mexico.
Why? In a word: Water.
When writing about Mexico, most journalists concen-
trate on the surface events-the price of oil, corruption,
industrial inefficiency, the crushing burden of internation-
al debt, the flight of funds abroad. They rarely mention
water. And yet water is in the most profound sense Mexi-
co's greatest need. The nation has plenty of land, but it is
desperately short of water. It is for the most part an and
land, lacking rivers and lakes. Short of water, it cannot
wring from its soil sufficient food for its swelling popula-
tion-75 million now, soon to be 100 million.
Under Mexican irrigation conditions, it requires 3,000
tons of water to produce 11/2 tons of corn-enough to feed
eight people for a year. The cost and difficulty of getting
this much water severely limits Mexico's ability to raise
food. This year Mexico will have to import half the grain it
needs, thus losing precious foreign currency that could
otherwise help service its debt, supply its industry and
import badly needed capital goods. It's a vicious cycle.
Lack of water drains away capital that otherwise might
help solve the water problem.
History records that, along with an international finan-
cial crisis, internal drought was one of the factors that
brought down the long dictatorship of Porfirio Diaz (1876-
1911) and brought on the bloody Mexican Revolution that
began in 1910. But now drought has become a permanent
curse, not only because of Mexico's natural aridity but also
because the population has grown so much faster than
water resources.
Listen to Governor Tulio Hernandez Gomez of the tiny
state of Tlaxcala, near Mexico City. "The absence of water
changes people's moods. From the highways you can see
groups of peasants in the open fields kneeling around
statues of the Virgin, desperately praying for rain. It did not
rain last year, nor this year either. If it does not rain by
mid-June, the crops are lost because corn planted after that
is killed by the autumn frosts before it ripens. Peasants
either plant corn or move to the cities."
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volcanic soils, made highly productive by large-scale irri-
gation and drainage works, supported one of the world's
largest urban centers by the 7th century A.D.-Teotihua-
can, the ancient ancestor of Mexico City, with a popula-
tion of 125,000.
But now there are 16 million people, not 125,000, and
each year Mexico City adds 900,000 people, more than its
entire population in 1920. "This city is an absurdity," says
Elias Sahab Haddad, executive director of the Valley of
Mexico Water Commission. "We know this. But it is a
fact, a reality." On the average, the inhabitants of this
overcrowded absurdity sleep six to a room-and a lot more
than that among the two-fifths of the population living in
squatter settlements. Even on a subsistence basis, they
require vast amounts of water. In the Valley of Mexico the
excessive extraction of water from underground beds has
led to a steady sinking of the land on which the city is
built, by some 30 feet during this century, forcing aban-
donment of important buildings such as the Basilica of the
Virgin of Guadalupe, the national religious shrine. As for
the ancient lakes, they are long vanished.
Mexico's creditors and friendly nations would do well to
remember all this when Mexico appeals for debt exten-
sions and for fresh loans. The problems facing any Mexi-
can government are almost overwhelming.
One of the most highly regarded people in Presi-
dent Miguel de la Madrid's cabinet is Silva Her-
zog. A potential presidential successor, in 1988,
Silva Herzog coolly analyzed the situation for FORBES
and explained how the government faces grave risks in
striving to bring consumption down to a level the econo-
my can afford: "There is no consciousness or understand-
ing among the [Mexican] people that the government
needs income to meet basic social needs. They tell each
other that their tax money goes straight into the pockets
of corrupt politicians.
"With oil and with the heavy foreign borrowing that the
oil made possible, the government could avoid living with-
in its means. The government could paper this over and
still hand out more and more because lots of foreign
money was coming into Mexico over the past six years:
$50 billion in bank loans and $50 billion for oil exports.
"But now the easy money is spent, and we are deeply in
debt. We have become somewhat unpopular by decreeing
big increases in taxes and in prices of gasoline and electric-
ity, which have been kept artificially low by state corpora-
tions for many years, and more steep increases are coming.
"We intend to meet our commitment to the Internation-
al Monetary Fund to cut our public sector deficit from 18%
to 8.5% of GDP this year. This is an ambitious and
extremely painful undertaking. Last year the Mexican
economy shrank by 0.2%. This year it will continue con-
tracting by between 2% and 4% of GDP, and in 1984 there
probably will be no growth at all."
But until Mexico regains its capacity to invest, it has
little hope of dealing effectively with its hydraulic prob-
lem. This will require billions of dollars. Gigantic schemes
are being implemented to pump water uphill into the
Mexico City metropolitan area from coastal or intermoun-
tain valleys lying between 3,000 and 6,000 feet below the
metropolis, over distances and on a scale never before
attempted anywhere, in order to more than double the
city's water supply by the year 2000. The first stage of this
effort, the Cutzamala System, already is partially com-
plete and, when finished, will pump 19 tons of water per
second uphill to an additional height of 4,100 feet. But by
the time it is fin'ished, Mexico will need yet more water
and more water.
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"He is talking about the possibility of
bloodshed, of possible revolution, of
the potential influx of millions of
Mexican refugees into the U.S. Mexi-
cans know only too well that when
things go wrong in their country
they can go very far wrong indeed."
Technologically it is feasible to build such projects, but
financially it is a crushing burden for a society that needs
so many other things, too, and has so little capital avail-
able. The capital and operating costs of these efforts are
very hard to measure in money because the Mexican peso
is so unstable now in terms of the world's major curren-
cies. The energy costs probably are more meaningful. If gas
or heavy fuel oil were used to pump 19 tons of water per
second over these heights and distances, at prevailing
efficiencies of oil conversion and pumping, then 4.3 mil-
lion barrels of oil would be absorbed yearly at a cost, in
terms of forgone exports, of $125 million at the current
OPEC benchmark price of $29 per barrel. For the nearly 55
tons per second of new water flow now planned, the energy
cost for pumping alone would be $362 million per year.
"We cannot pay for the pumping of water to Mexico
City," says Andres Moreno Fernandez, head of the city's
water system. "Instead, we must stop the growth of the
city." And not only Mexico City suffers. Some 16 million
urban Mexicans live in squatter colonies where many
depend for water, not on pipes or wells, but on a weekly
visit by a water truck-and the truck doesn't always come.
But still people pour into the cities, seeking food, water
and a chance at earning a few pesos.
The failure to manage water resources has helped to
destroy many civilizations. It may sound melodra-
matic to people in the U.S., who take water for
granted, but many Mexicans are asking each other wheth-
er the PRI regime, which has ruled Mexico for more than
half a century, is now reaching that stage of hydraulic
disaster. Water and food are closely related. Mexico's poli-
ticians and technocrats have been very active on the food
supply side. Over the past half-century they have more
than doubled the area of irrigated land for farming. Howev-
er, because of fast population growth, the irrigated acreage
per capita is less than half what it was 50 years ago.
Moreover, all the easy dam-building and irrigation projects
have been done, while the population keeps growing. In
other words, both in the city and the countryside, Mexico
has entangled itself in the hydraulic trap while following
the commendable and sensible goal of trying to keep
Mexican bellies full.
Food and water were not the only priorities in the post-
1968 surge of spending on subsidies to consumption. These
were years of giant giveaways. To facilitate them, the
government systematically enlarged its role in the econo-
my. When they can't enlarge the bureaucracy anymore,
politicians can do the next best thing for patronage by
absorbing private business into the bureaucracy. In these
years the number of state corporations grew tenfold, from
84 in 1971 to 845 in 1976 alone, while subsidies and transfer
payments rose from 3% of GDP in 1970 to 15% in 1982.
"Until recently each big-spending presidential administra-
tion was succeeded by one of austerity that cleaned up the
mess," a leading physician explained. "Since 1970 we have
had two big-spending governments in a row."
"Besides direct spending, there were vast price subsidies
to keep the price of necessities in check. Our policies of
excessive subsidies gave us the problems we have today,"
says Planning and Budget Secretary Carlos Salinas de Gor-
tari a small wiry, 35-year-old political economist with a
Harvard doctorate. These subsidies embrace a bewildering
variety of goods and services-from corn and sugar and
gasoline to water and electricity and rail and bus transpor-
tation. There are even public coin telephones costing less
than one-seventh of a U.S. penny per call ($0.00 13). Ramon
Aguirre Velazquez, the presidentially appointed mayor
(regente) of Mexico City, told FORBES that "these subsidies
are part of a redistribution of national wealth to achieve
social justice." At the cost, alas, of badly needed private
and public capital investments and, ultimately, of national
solvency.
Such subsidies, improvident though they were, helped
keep the political peace after the violence of 1968. So when
Mexico's Treasury Secretary warns that there are time
limits to his government's ability to impose austerity, he
is not only complaining about the political inconvenience
involved. He is talking about the possibility of bloodshed,
of possible revolution, of the potential influx of millions of
Mexican refugees into the U.S. Mexicans know only too
well that when things go wrong in their country they can
go very far wrong indeed.
They are only too aware of the events that overwhelmed
the long dictatorship of Porfirio Diaz and led to a civil war
that dragged on for nearly two decades and killed or
starved over 2 million Mexicans. It was a civil war in
which U.S. citizens died. At one point, in 1914, U.S. troops
occupied the port of Veracruz. Later the fighting spilled
over into the U.S. Southwest when Pancho Villa's guerrilla
forces raided New Mexico and General "Black Jack" Per-
shing led U.S. soldiers across the border in retaliation.
11 this was long ago, but there are parallels between'
then and now that are close enough to worry
thoughtful people on both sides of the border.
Too much, of course, can be made of historical parallels.
Miguel de la Madrid is no Porfirio Diaz, and for decades
Mexico has had one of the world's highest rates of econom-
ic growth. The development of its oil resources provides a
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"It is a flight from reality to expect
countries like Mexico and Brazil to
divert up to 5% oftheir annual nation-
al incomes and a much larger share of
their foreign exchange earnings to
paying interest on foreign debts."_
huge new source of wealth. Since its revolution, whose vents the collection of a great mass of water.... Saline
violence lingered on until the 1930s, Mexico has enjoyed a substances cover the surface of the soil. Through this
political stability matched in the hemisphere only by the abundance of salt, the table land of Mexico bears a great
U.S. and Canada. It is Mexico's good fortune that-in spite resemblance to many places in Tibet and the saline
of the well-known larcenous tendencies among its politi- steppes of central Asia."
cians-it has a trained, talented leadership, equal in some Humboldt was writing about a Mexico with 5.8 million
respects to any in the world. The ruling party, the PRI, is to inhabitants-sparsely populated like Tibet and central
the Mexican Revolution what the Vatican is to St. Peter. Asia. But this same and land today must support 75
The party rules in a direct succession from the middle- million people. This is not to say that Mexico cannot
class leadership of the old revolution. The leadership is support a large population, but it cannot do so without
continually renewing itself with young men and women. huge capital expenditures for hydraulic works, for agricul-
President de la Madrid himself is only 48 years old. ture, for job- and capital-creating industry. Whence is the
Several cabinet ministers and state governors are much capital to come, while at the same time keeping the
younger, while party chieftains often are in their early 30s. populace minimally content? That is the grim geographic
and financial reality.
B But while there are some things to be grateful for in The foreign lenders who sent $81 billion to Mexico with
present-day Mexico, anyone who thinks the crisis virtually no strings attached still delude themselves. It is
has passed is deluding himself. President de la Ma- obvious that Mexico and other developing countries do
drid, just nine months into his six-year term of office, not have, and never had, the cash-generating capacity to
must move fast to restore solvency before the necessary repay the foreign loans they have piled up over the past
austerity becomes intolerable. His task is made trebly decade. The money is gone. The interest burdens alone
difficult by the ruling party's slackened grip on the reins of have become too big to manage. It is a flight from reality to
power. After liberalizing the election law over the past expect countries like Mexico and Brazil to divert up to 5%
decade-partly in response to protests after the 1968 mas- of their annual national incomes and a much larger share
sacre-the long-ruling PRI has been suffering both losses of their foreign exchange earnings to paying interest on
and unaccustomed close calls in state and local elections. their foreign debts continually over the next decade or
One obscure town in Oaxaca state has actually come two. Payments on this scale would wipe out their chances
under Communist rule, with backing from Salvadoran to earn an economic surplus that must be invested in
peasants camped there. just last month the PRI lost con- meeting urgent national needs.
Chih h
trol of capitals in two key northern states- uaua
and Durango-as well as Ciudad Juarez, a border city of exico is trying to meet its obligations and impose
almost 1 million people. In these same northern states- a degree of discipline on government spending,
where, not incidentally, the Mexican Revolution erupt- . but we in the U.S., should listen carefully to
ed-the PRI faces a strong challenge from the conserva- Treasury Secretary Silva Herzog when he says: "I don't
tive, Catholic-oriented Partido de Acci6n National (PAN). think Mexico is capable of living with a stagnant economy
Conservative PAN maybe, but its growing strength limits beyond 1984. This would carry an additional risk of social
the president's freedom of action. and political instability."
Dealing from a declining position of power, with this Abstract words, those: "social and political instability."
legacy of other presidents' mistakes and with the ancient What do they mean? They mean that decades of peace and
problem of water, is a crushing job. Whether sitting under progress in Mexico could end in bloodshed and disorder,
a tent hearing peasants' complaints or sitting in his air- with incalculable consequences for the U.S. In the long
conditioned offices dealing with big problems of econom- run, helping Mexico to handle her horrendous problems is
ics and politics, President de la Madrid is acutely aware much more useful to the U.S. than collecting bank loans to
that hell hath no fury like a populace suddenly deprived of the last peso. And how can the U.S. help? By supplying
the largesse it has grown accustomed to. food, technology and capital to our neighbor on favorable
For nations, geography is destiny, and Mexico's geogra- terms. This wouldn't be charity. It would be simple com-
phy is particularly grim. Writing nearly 180 years ago, the mon sense. Of the Mexican-U.S. relationship, John Gavin,
German nary-?'" a 1a..-,rn pr vnn Hiimholdt reported: Ronald Reagan's ambassador to Mexico, recently declared:
"n the w}__Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 once." That says
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COVER STORY
It stunned the world when its
economy crashed 11 months
ago. But now Mexico's
economic team offers new hope
that a gradual comeback may
have begun. By Alan Robinson
S ome bankers will remember August 20
1982 to the end of their days: they
have a chilling recollection of the
moment they heard the news that Mexico
had announced it could no longer service
repayments of principal.
The months that followed brought one
rescheduling announcement after another,
including one that is at least as significant as
that of Mexico - Brazil. The perception
grew, and remains to this day at many
banks, that Mexico, which probably
triggered the Brazilian rescheduling, could
be written off for the indefinite future.
That perception may still be correct. But
in Mexico itself foreign bankers are more
hopeful, though their hopes may be based
on faith as much as facts. "Mexico can
come through this," said a British banker
in Mexico City last month. "They have
another 18 months on the tightrope, but
they seem to have developed a good sense
of balance."
Most local bankers believe that the
government of President Miguel de la
Madrid has the right policies to contain
the crisis. "The IMF says Mexico is on
schedule in meeting the aims set out in the
letter of intent," said a US banker. "That's
good enough for me." A second US banker
was even more hopeful. "They seem to be
doing most things right," he said. "If
nothing unforeseen hits them they could be
back on the road to economic growth by the
end of 1984."
The unforeseen, however, worries many
bankers. "I want to believe, but I don't
believe, that OPEC will hold firm on [oil]
prices," a Swiss banker said. "I also want
to believe that if it doesn't hold firm the
damage will be minimal, but I'm not sure
about that. Any considerable drop in
petroleum prices would be very damaging
to Mexico. All calculations would have to
be redone. I think the economic cabinet
must be making frequent pilgrimages to the
Shrine of Guadalupe [Mexico's national
shrine]. I'm praying a little myself."
Some bankers put their trust in President
Reagan's strong sense of Mexico's strategic
importance to the US. "Take the worst
scenario we have got," said a foreign
banker. "That would include oil prices
falling to $18 or 20 a barrel, food produc-
tion hit by the current drought, interest
rates going up, the government failing to
control inflation, massive unemployment,
hunger marches and anything else negative
you can think of.
"I'm sure the US would do everything in
its power to keep Mexico stable," he said.
"And it can do a great deal. It isn't in the
interest of the US or of banks to let Mexico
go down to default. We cannot afford the
economic and political consequences. Not
that I think it's coming to that. It hasn't
gone that far. Mexico could pull itself out
of this hole, with a little help."
Mexico had no economic growth in 1982,
expects GDP to shrink between 2 and 5%
this year, and will, at best, have marginal
growth in 1984, according to the current
consensus. "That is what worries me
most," said a German banker. "True, the
government has kept the lid on so far, but
how long can it keep on controlling the
pressures from labour for higher wages? -
"When I think about the next two years
my hair stands on end. The social risks of
the IMF programme are enormous. On
paper, the first quarter results are promis-
ing: the Mexican authorities have been
diligent and the IMF is happy. But I can't
say that I'm happy. I'm worried. The
Mexican Government is taking a calculated
risk. I only hope it can contain the growing
discontent."
The Government's main financial aim is
to keep the public sector deficit to pesos 1.5
billion (S10 million) or 8.5% of GDP,
against 18% last year. In the first quarter,
the public sector deficit was 23% lower
than for the same period last year.
"That's fine, just fine," one banker said.
"We like to see a decent frugality. They are
right on target, I would say. Now let's see
what they can do about inflation."
The National Consumer Price Index went
up by 22.5% in the first three months of the
year, with the monthly rate declining from
10.9% in January to 4.8% in March. But
for a shopping basket of only basic items
the average monthly increase was 13.1%.
Finance Minister Jesus Silva Herzog has
forecast an annual inflation rate of 70%
this calendar year, against 98% for the last
0
calendar year. "I feel that inflation will
reach at least 80% in 1983," a French
economic analyst said. "It could be more,
of course. The anti-inflation policy is
working more slowly than is required.
Although the government has raised the
prices of its own goods and services, and
will continue to do so, in an attempt to
reach healthy price levels and thus slow
inflation considerably, I don't think we
shall see a great reduction in inflation this
year."
The private sector quickly jumped on the
bandwagon of rising prices and the govern-
ment freed many prices from controls.
Even controls on products in the shopping
basket of the index were slackened. The
response from organized labour, which is
one of the pillars of the ruling Institutional
Revolutionary Party (PRI), was sharper
than ever before. But the PRI's system of
control was not changed and a wage
demand of 50% was halved by the labour
leaders. Even this had not been granted by
early June.
"To sum up," said the French econo-
mist, "they are on course with the deficit
and way off course with inflation."
Preliminary estimates show a trade
surplus of $3.4 billion for the first quarter
of 1983, compared with a $708 million
deficit for the first three quarters of 1982.
Imports were cut to the bone, down 70.8014,
with capital goods imports down 81.3%,
consumer goods 71.5%, and raw materials
64%. Exports were $4.8 billion, up 11.1 %
over the first quarter of 1982, with oil sales
contributing 82.3% of the total. The share
of non-oil exports were down 28.2% on the
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COVER STORY
first quarter of 1982.
Border transactions and tourism
provided a surplus of $379 million. Mexi-
cans have been spending less abroad, but
visitors in Mexico have also been spending
less. "The results on the trade account are
excellent," said a British banker. "The
Mexicans have shown themselves capable of
great discipline and sacrifice." But a
German banker was less enthusiastic.
"Good results on paper, again," he said.
"Results achieved by cutting imports and
eliminating economic growth. But these
results also jeopardize jobs."
then I would think the single rate would be
subject to slippage," a Mexican Govern-
ment economist said. "In that way we hope
to keep the peso competitive and avoid the
necessity for another brusque devaluation."
A US banker commented: "Devaluation
is out of the question for now. Last
December they overdid their big devalua-
tion in order to buy time - to get stability
for the rest of this year. These rumours are
uninformed, but none the less dangerous
for that. I'm told that Mexican pesos are
being taken out and exchanged for dollars,
but I don't think the traffic is significant
whole thing just keeps rolling along for as
long as is necessary. That's life in the world
of finance, my friend."
Most foreign bankers in Mexico believe
that the nation has options other than
foreign borrowing. "You would be
surprised," said a German banker, "if you
knew how many very big international
corporations are sniffing around for invest-
ment opportunities. Given Mexico's
potential and the current exchange rate,
investment is much cheaper and likely to
become more productive. In spite of my
own reservations, I would agree that now is
Last month Mexico shuddered with
devaluation rumours once again. "It
doesn't make sense," said the Briton. "The
peso is undervalued by any system of
measurement. What we are seeing is a kind
of re-occurring psychosis."
The special parity for dollar-denominated
deposits was abolished on March 15,
leaving a dual parity for the peso: a free
market rate which has been stuck at 149.40
buy and 147.90 sell since last December,
and a controlled rate with a daily slippage
of 13 centavos and an average value of
106.20 pesos to the dollar during March.
"The Government intends to continue
the slippage until the free and controlled
rates are united, near the end of the year,
The Mexican challenge
Mexico met the first quarter economic
target set by the IMF, but there's a long
and rocky path ahead. Total external debt
is some $85 billion. At end-1982, $59
billion was public debt. And more than
half the total matures before the end of
1985.
Being negotiated now is the reschedul-
ing of $19.7 billion of public sector debt
maturing by end-1984 and $15 billion of
private debt. Deadline: August 15 (that
may be extended).
The public sector rescheduling proposal
is for an eight-year maturity with four
years' grace at either I % % over Libor or
11/4076 over US prime. The private sector
debt proposals are outlined in the inter-
view. Remember that Mexico's debt
burden is still being increased.
yet."
Most bankers agree that devaluation is
unlikely in the near future. Mexico's
foreign debt is close to $85 billion. "About
90% of the debt is in dollars, so you can
imagine the effect of another plunge for the
peso," an American banker said.
"Sure, the debt burden remains despite
rescheduling," he said. "If the worst
happens we just have to find a way of
pushing the problem further away. To the
end of the century, if necessary, or further.
As long as there is an outside chance that
Mexico can pay we must give it that chance.
That's my view. In the long term Mexico
has everything going for it. And of course
we keep collecting interest and fees and the
Commercial banks advanced $5 billion of
new money in March while the IMF
granted a $3.9 billion extended fund
facility. Repayment of the commercial
loan begins in 1986. Disbursement of this
loan and the IMF funds depend on
Halfway to a cure ...
the time to invest here if you are going to
invest at all."
"Invest?" a US banker said. "Sure I
would invest in Mexico. There has never
been a better time for it."
"On balance I would recommend invest-
ment . in Mexico now," said a British
banker. "I know there is some interest in
Britain and I'm sure the Americans are on
to it. Of course, there are risks, some might
say considerable risks, but that is what the
game is about, isn't it?"
"I would be extremely cautious about
recommending investment at this time,"
said a Swiss banker. But he added: "I
understand there is a great deal of
interest." 10.
Mexico meeting the targets set by the
Fund. Keep your fingers crossed.
... with tough medicine
IMF targets for Mexico
%GDP
Public sector debt by maturity date (S billion)
1982
16.5
1983
8
5
Before
After
1984
.
5.5
rescheduling
rescheduling
1985
3.5
1983
9.4
1.5
1984
5.4
1.3
1985
9.7
9.7
1988
5.1
5.1
1982
6.5
1987
7.5
12.3
1983
4.25
1988
4.7
9.5
1989
3.5
8.3
Inflation
%
1990
1.1
5.9
1982
90-100
after 1990
4.3
4.7
1983
55
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COVER STORY
The Mexican Government, meanwhile,
nas been saying repeatedly that its foreign
investment regulations are "flexible
enough" to allow majority foreign owner-
ship in new projects, "if they are in
Mexico's interests".
In the long run, everyone agrees Mexico's
economic recovery is possible only after
economic recovery in the US and the other
industrialized nations. "The signs seem to
be good for a US recovery," the Swiss
banker said. "But it won't be quick and the
benefits will take time to filter through to
Mexico. I see no escape from austerity in
the short run."
"I wish I was as sure as the Americans
seem to be about their economic upturn,"
the German banker said. "If it does come,
and if it lasts, Mexico will obviously
benefit. At the moment Mexico wants to
export very badly, but there are no markets
for non-oil products."
According to the Mexican Government
economist, "we need to export our way out
of the mess and so we need an economic
revival among the industrial nations, especi-
ally the US, which is our biggest trading
partner."
The new mood of cautious hope con-
trasts strongly with the gloom-and-doom
messages being put out by some of the same
inkers only six months ago.
"In my opinion, bank representatives
don't stay long enough in one place to
understand it," said the German banker.
"We over-react; our head offices over-
react; we frequently don't have the proper
information and most of us lack a feel for
the country we work in. Now there is some
optimism about Mexico. I can only hope it
is well-founded. A few months ago nobody
had a good word to say. The judgements
you hear today are coming from the same
people. We can be very changeable, I'm
afraid."
Even if Mexico's public sector debt
problem can be solved over time, there is
still much concern over the treatment of the
private sector debt. Until now (see inter-
view) little has been published to show how
Mexico will handle that.
If bankers see Mexico in a more hopeful
light, a major cloud on the world's financial
horizon would disappear. It's still too early
to judge, but so far this year Mexico has
moved in the right direction. ^
1 (71
LiInvest? Sure I would
invest in Mexico. There
has never been a
better time for it
F PE
Along with Finance Minister Jesus Silva
Herzog, it Is Miguel Mancera Aguayo,
governor of Mexico's central bank, who is
most often cited as an architect of any
recovery in Mexico.
Mancera has a formidable technical
reputation at home. He is one of the
strongest members of President Miguel de
la Madrid's financial team and Is a close
friend of the President. His colleagues,
admittedly with a vested Interest, say he's
brilliant.
Mancera is also a very private man. Aside
from obligatory public appearances, he
avoids publicity.
As an economist he is fundamentally
opposed to exchange controls. In the
waning months of the Lopez Portillo
government, In the thick of an economic
and financial crisis, he sensed the way the
wind was blowing and produced a pamphlet
telling Mexicans why exchange controls
would not work for their country. It was a
brave, last-ditch attempt to stem forces that
were moving the Government toward a
course that Mancera saw as disastrous.
It cannot have been an easy decision for a
man who likes his privacy. He and his
pamphlet were attacked by the partisans of
exchange controls. In the ensuing battle he
seemed increasingly alone. Three months
later, President Jose Lopez Portillo nation-
alized the private banks, imposed a full
range of exchange controls, and demanded
Mancera's resignation. Carlos Tello, the
architect of the new controls system, took
over at the central bank.
During the last three months of the
Lopez Portillo administration, Mancera's
arguments took on a prophetic look.
Almost everything he had said would
happen as a result of exchange controls
happened. When President Miguel de la
Madrid took office on December 1 1982
one of his first actions was to bring back
Mancera to the central bank with the task
of gradually and carefully dismantling the
controls his Government had Inherited.
It was a considerable personal triumph
for Mancera, but he never succumbed to
the temptation to say: "I told you so." He
will discuss neither his departure nor his
return. He simply went back to his desk and
got on with the job.
Mancera was born in Mexico (Sty on
December 18 1932, studied economics at
the Instituto Tecnologico de Mexico and
took a master's degree at Yale University
before going on to the Bank of England for
a special course of financial studies. He has
been a professor of economic theory at
several Mexican institutions and at the
Latin American Monetary Studies Centre.
In 1957, he went into government work
with the Presidency Commission on Public
Investment. The following year he joined
Banco de Mexico, where he held various
posts, culminating in his appointment as
director general. The generally-agreed
prognosis is that he will stay there for the
duration of the de Is Madrid administra-
tion.
Mancera refused to answer questions of a
personal or political nature, declined to
discuss economic theory - his own or
anyone else's - and studiously avoided
judgements on the IMF's strict adjustment
programme for Mexico.
46 Euromoney july is Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
COVER STORY
Miguel Mancera Aguayo, Mexico's
central bank governor:
"Moderate optimism."
The drop in oil prices has cut Mexico's
export earnings. How serious is that?
It was an unfortunate development for
us, since, given our export platform, it
meant a loss of $1.4 to 1.5 billion in 1983.
But, this loss will be compensated by the
drop in market interest rates. The financial
programme for 1983 was constructed in late
1982 on the basis of an effective average
interest rate of 14'/4%. At present we have
an effective average interest rate of about
12.2%. Since current public and private
external debt is estimated at over $80 billion,
this will be reflected in a substantial
decrease in interest payments, and will yield
some $1.4 to 1.5 billion in foreign exchange
savings.
So, as you see, in the short run the
decrease in international interest rates will
offset the reduction in oil prices. In the
medium run, it is likely that lower energy
prices will help to strengthen the economic
recovery, which is under way in the in-
dustrial world. Mexican non-oil exports,
both commodities and manufactures, will
benefit from that recovery.
Will you need more credits this year?
I do not believe we will require additional
credits beyond those programmed. There
are several reasons for this. First, and most
important, we now expect a much stronger
balance of payments position than origin-
ally envisaged. Preliminary figures show a
current account surplus for the first quarter
of over $1.5 million, which contrasts
markedly with the $3.4 billion deficit for
the same period of 1982. This surplus is
basically due to a strong positive trade
balance of over $3.5 billion. Secondly,
public expenditure is under tight control
and the fiscal deficit is on target, eliminat-
ing the need for external finance over and
above that envisaged in the programme.
Thus, short of unforeseen difficulties
such as a collapse of the oil markets, we do
not expect to return to the external credit
market in 1983.
How would you describe the progress
made in meeting the terms of the IMF
agreement?
A few days ago, the Executive Board of
the IMF made an evaluation of the com-
pliance with the adjustment programme
currently under way. They certified that
Mexico has satisfactorily fulfilled all the
requirements of the programme.
The directors praised the determination
and forcefulness with which the Mexican
authorities have moved to implement the
economic adjustment programme sup-
ported by the extended arrangement with
the fund. The size of the imbalances, both
external and internal, that had been
building up during recent years made a
severe cutback in domestic demand un-
avoidable. Fund directors recognized that
the Mexican authorities had responded with
the necessary resolve and that the adjust-
ment programme was being carried out
without hesitation.
They noted that the results of the first
few months of the year were encouraging
and indicated that the programme was on
track, though perhaps with higher inflation
and lower growth than had been forecast.
We are, therefore, able to draw $325 million
of additional resources from the IMF and
$1.1 billion from commercial banks within
the next few weeks.
While the first balance of payments
results indicate that the external sector is
adjusting rapidly, other results of the
programme will take longer to become
apparent. But we are sure the programme is
appropriate to curb inflation, correct
imbalances and lay the foundations for sus-
tained growth in output and employment.
Banco de Mexico has come up with a
strategy to enable private companies to deal
with their foreign debts. Can you explain it?
The tight liquidity situation which we are
undergoing has led us to devise several
mechanisms to deal with the private debt.
The first deals with interest past due to
foreign banks, which could not be paid in
the period August 1982 to January 1983,
due to our precarious international reserve
position. We entered into an agreement
with creditor banks by which Mexican
debtors will deposit in the Bank of Mexico
the peso equivalent to the foreign exchange
required to meet payments at the controlled
rate.
The Bank of Mexico opens a dollar
account in the name of the foreign creditor,
which earns a market interest rate, a pro-
cedure by which foreign banks avoid having
to list these loans as non-performing assets. p.
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
COVER STORY
These sums are being transferred abroad as
foreign exchange becomes available. Over
$90 million, or 15% of the total deposits,
have already been transferred and another
5% is to be paid within a few days.
The second mechanism, which is similar
to the first, was established to deal with
suppliers' credits. This allows the Mexican
importers to pay pesos to the Bank of
Mexico for an amount equivalent to their
debts to foreign suppliers at the controlled
rate of exchange, and to obtain in return a
dollar denominated certificate of deposit
which earns a Libor interest rate payable
semi-annually.
The dollar certificate of deposit issued in
favour of the Mexican importer may be
assigned or pledged in favour of the foreign
supplier, allowing him to obtain other
financing or to retain it as a security for
payment. These CDs bear no maturity date
and the regulations issued on February 28
state that the terms of payment of these
debts will be defined by next August 1983.
The reason for this delay in defining the
terms of payment for these debts is simple:
the Ministry of Trade is in the process of
registering these suppliers' debts, the total
amount of which is still unknown to us.
The third mechanism is for special for-
ward cover procedures for the repayment of
obligations outstanding at December 29
1982 by the Mexican private sector with
financial institutions, payable outside
Mexico.
This mechanism offers four procedures
for settlement, based on coverage of the
forward contract (principal only or
principal plus interest) and on financing by
private borrowers (from their own or
borrowed resources). In all cases a prior
agreement to restructure maturities by the
foreign creditor is required.
The forward cover scheme will be
handled by the Fideicomiso para la
Cobertura del Riesgo Cambiario (Fund for
Exchange Risk Coverage), FICORCA,
which assumes only the obligation to deliver
the foreign exchange to the domestic
borrower on the basis of a repayment
schedule agreed between the local borrower
and the foreign creditor.
Does any of this imply a subsidy for
private sector debtors?
The FICORCA schemes are entirely
voluntary, do not imply any subsidy and do
not imply the absorption of commercial
risks. FICORCA only assumes the
exchange risk and, through the required
restructuring, provides firms having -
liquidity problems with the necessary
breathing space to overcome them.
To qualify for the various forward cover
alternatives, the maturity of the
outstanding loan or the refinancing loan
should exceed six years, with three years of
grace, when only the principal is subject to
coverage, and eight years, with four years
of grace, when both principal and interest
payments are covered.
The lead
k in
Adh
ban
domestic
}loi'wegian
bond
issues.
SPAREBANKEN
AKERSHUS
Fvrex and Treasury Section
Tel.? Oslo 3185 28-30. Telex: 16463 sparx.
Capital Market Section
Tek? Oslo 3190 50. Telex: 19968 spark n.
Tordenskiolds gt. 8-10, Oslo 1, Norway. Tel: [phone].
Euromoney July 1983 49
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
COVER STORY
You mentioned various alternatives.
What are they?
There are four possibilities under the
FICORCA scheme. The first offers im-
mediate delivery by the Mexican debtor of
the peso equivalent of the total value of the
obligation abroad, converted at special
rates that are more appreciated than the
controlled market rate, depending on the
maturity of the loan. The delivery of pesos
guarantees access to foreign exchange to
cover the amortization due from the
Mexican borrower over a period of six or
more years, with at least three years of
grace. The rates applicable for transactions
effected to June 5 1983 are these:
The rate for the debtor
Final Grace Exchange-
maturity period rate
(in years) (in years) (pesos per $1)
8 4 77
7 3 83
6 3 87
The second arrangement is like the first,
except that FICORCA will provide financ-
ing in pesos to local firms without sufficient
liquidity to enable them to make the
necessary delivery of pesos as in the first
case. In this case, interest payments abroad
are not covered and the local debtor must
continue to pay these at the prevailing
exchange rate for the peso in the controlled
market on the date on which the payments
are remitted.
With the third arrangement there is
immediate delivery of local currency
equivalent to the total outstanding foreign
obligation at the controlled market rate.
But the forward cover includes principal
and interest on the external liability.
The fourth arrangement is like the third,
except that FICORCA provides domestic
financing for the local currency payment by
the domestic borrower, as in the second
arrangement. In all instances, the forward
cover does not transfer the foreign liabilities
to FICORCA and the domestic borrower
remains responsible vis-d-vis the foreign
creditor.
Let me also mention that officially
guaranteed private sector supplier credits
present a special problem with which we are
trying to deal. Our policy has been that, in
every scheme, we consult with our creditors
and establish mechanisms that are generally
accepted. This was the case with our bank
restructuring, for public and private
sectors. It was virtually impossible with
suppliers' credits, because there were
thousands of creditors. Moreover, we are
still determining the amounts.
To deal with these credits, which are
private for us but, because of the guarantees,
are public for our creditors, we have pro-
posed the following arrangements. The
Mexican Government and the export credit
or export guarantee institutions would
jointly determine the amount of officially
guaranteed commercial debt owed by Mexi-
can private sector borrowers or importers to
either financial institutions or suppliers in
each country, derived from commitments
made on or before December 20 1982.
A financial institution of the creditor
country would extend a line of credit for the
full amount outstanding to an official
institution in Mexico, which would enable it
to pay in full all outstanding guaranteed
debts matured, or that will mature, from
commitments enter ed before December 20
1982 by the Mexican private sector.
These lines of credit would be made
available at market rates. These credit lines
could be medium term, with an adequate
grace period, and would be consistent with
the terms of restructuring and with the
availability of new money for the public
sector. A minimum of six years, with three
years of grace, is suggested, equal to SS bil-
lion of new money.
If a Mexican private company could not
deliver the pesos to the Mexican public
sector institution that had assumed the
guaranteed debt from the foreign creditors,
that debt would be covered by the original
export guarantee agency of the relevant
country. We have already adopted such a
scheme with the Banco Exterior de Espana,
Istituto Centrale per it Credito
a Medio Termine
Mediocredito Centrale
U .S.$ 4090005000
Medium-Term Eurodollar Loan
Arranged by:
Morgan Grenfell & Co. Limited
Managed and provided by,
Arab Banking Corporation (ABC) Bahrain Middle East Bank (BMB)
Bankers Trust Company Dai-Ichi Kangyo Bank Nederland N.V.
The Gulf Bank K.S.C. Italian International Bank Limited
Lavoro Bank International Morgan Grenfell & Co. Limited
Agent
Morgan Grenfell & Co. Limited
whi(
Thi<
prol
of
rest,
owr
V
to d
esse
Ir
at $
S91
way
met
crec
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$1
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re
50 Euromoney July Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
COVER STORY
These sums are being transferred abroad as
foreign exchange becomes available. Over
S90 million, or 15% of the total deposits,
have already been transferred and another
5% is to be paid within a few days.
The second mechanism, which is similar
to the first, was established to deal with
suppliers' credits. This allows the Mexican
importers to pay pesos to the Bank of
Mexico for an amount equivalent to their
debts to foreign suppliers at the controlled
rate of exchange, and to obtain in return a
dollar denominated certificate of deposit
which earns a Libor interest rate payable
semi-annually.
The dollar certificate of deposit issued in
favour of the Mexican importer may be
assigned or pledged in favour of the foreign
supplier, allowing him to obtain other
financing or to retain it as a security for
payment. These CDs bear no maturity date
and the regulations issued on February 28
state that the terms of payment of these
debts will be defined by next August 1983.
The reason for this delay in defining the
terms of payment for these debts is simple:
the Ministry of Trade is in the process of
registering these suppliers' debts, the total
amount of which is still unknown to us.
The third mechanism is for special for-
ward cover procedures for the repayment of
obligations outstanding at December 29
1982 by the Mexican private sector with
financial institutions, payable outside
Mexico.
This mechanism offers four procedures
for settlement, based on coverage of the
forward contract (principal only or
principal plus interest) and on financing by
private borrowers (from their own or
borrowed resources). In all cases a prior
agreement to restructure maturities by the
foreign creditor is required.
The forward cover scheme will be
handled by the Fideicomiso para la
Cobertura del Riesgo Cambiario (Fund for
Exchange Risk Coverage), FICORCA,
which assumes only the obligation to deliver
the foreign exchange to the domestic
borrower on the basis of a repayment
schedule agreed between the local borrower
and the foreign creditor.
Does any of this imply it subsidy for
private sector debtors?
The FICORCA schemes are entirely
voluntary, do not imply any subsidy and do
not imply the absorption of commercial
risks. FICORCA only assumes the
exchange risk and, through the required
restructuring, provides firms having -
liquidity problems with the necessary
breathing space to overcome them.
To qualify for the various forward cover
alternatives, the maturity of the
outstanding loan or the refinancing loan
should exceed six years, with three years of
grace, when only the principal is subject to
coverage, and eight years, with four years
of grace, when both principal and interest
Payments are covered.
SPAREBANKEN OSLO AKERSHUS
The lead
ba ihlk
domestic
I~o~~vegi~~
bond
issues.
SPAREBANKEN
AKERSHUS
Fonx and Treasury Section
Tel? Oslo 3185 28-30. Telex: 16463 sparx.
Capital Market Section
Tel? Oslo 3190 50. Telex: 19968 spark n.
Tordenskiolds gt. 8-10, Oslo 1, Norway. Tel: [phone].
Euromoney July 1983 49
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 Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3
R COffSH'Y P
Should a bank keep
every dealer within limits?
By Robert Winder
Two slightly different ways of monitor-
ing worldwide exposure have been deve-
loped by the network operators Geisco of
the US and I. P. Sharp of Canada.
Both systems are based on a microcom-
puter on the dealer's desk, into which all
deals must be entered. Once the dealer has
keyed in the facts about the deal, the com-
puter will check all the limits which that
deal may threaten - country, currency,
counterparty or a dozen other limits. If the
deal is good, it may be entered; if not, it
may still be entered, but the computer will
record the breaking of the limit and issue
reports on the deal.
The worldwide processing networks give
the head office of a bank immediate access
to information about the activities of all its
branches. Said I. P. Sharp's Leo Bettes:
"We're talking about the nervous system of
a bank, the integration of its various opera-
tions." Bettes estimated that 300 banks
needed such a system.
At Geisco, Peter Greenhill explained: "If
a bank has branches in New York, London
and Singapore, it's quite possible that the
Singapore branch may have dealt up to its
limit in a currency, and be turning down
deals, when there is unused limit in the
other two centres. The other two centres
may not even be dealing at that time. It's a
waste of a bank's resources at a time when
they're looking to cut risks."
Deutsche Bank has cut its overall limit by
around 20% since taking the Geisco system
in 1980.
Most banks, however, have already
invested a great deal in developing their
own control systems in-house. And many
bankers expressed reservations about the
idea of global limits. One told Euromoney:
"Limits are set locally because it's impor-
tant to know the markets. It's hard for a
New Yorker to set the limit for the Japanese
discount market, and much better to have
people in Tokyo who can do it."
Another drawback of such systems is the
pressure they put on dealers. Some dealing
room managers insisted that-dealers should
not be distracted by systems which query
every deal. But Greenhill rejected this. "It's
not really an extra screen and keyboard,"
he said. "It's a replacement for the bank's
own in-house files, which the dealers
update anyway. If you use Global Limits
properly you can run your entire dealing
room operation on it. It helps dealers
because the information's live, they can ask
it questions. And of course, once a deal is
BANKING TECHNOLOGY
made, all the limits are automatically
adjusted."
He added: "It's insurance. Every bank is
thinking about ways to control risk, and
consolidating information from all the
branches is an essential part of their
thinking."
I. P. Sharp's system allows two dealers to
deal with the same client simultaneously,
but the Geisco system prevents this.
Greenhill argued: "We want to avoid a
situation where the same limit is being
broken by two dealers at the same time. It's
the same as the reason why dealers should
enter the deals themselves. If they hand
over to clerks there'd inevitably be a lag, in
which time limits could be broken by
accident."
Essentially both systems operate on the
basis that they give the banks a framework
in which they can insert their own defini-
tions of limits, and the size of those limits.
They can then use the systems' real time,
capability for dealer support, and their'
reporting . facilities for management
information. It is possible to limit deals
maturing on a single day to avoid bunched
payment schedules, as well as limiting them
on a currency or counterparty basis.
In the Geisco system, them is a moral
twist. To prevent two deals being done
simultaneously, dealers must not hesitate
too long once they have begun to deal. If
they do, a message comes up on the screen.
It reads: "You have been idle too long."
CKKIG THE BIG POJL1S
EBC's new computer system
helps reduce project finance
risk. By Robert Winder
generalized modelling systems in the extent
and detail of its applications. The system is
modular, so the functions can be used
individually as well as collectively. It con-
tains modules for scheduling productivity,
pricing and costing, taxation and sensitivity
analysis, as well as the facilities for all the
standard economic parameters. The sensi-
tivity analysis module assesses the inter-
action between different variables,
permitting the user to identify the effect of
each adjustment to the whole project. The
system is multiple currency, and contains
pre-programmed routines for the US and
the major European tax structures.
But Andreas Crede, head of the Ebcore
project at European Banking Company,
said that Ebcore has creative uses: "In
situations where you have a marginal
development it's hard to structure a loan
and remain confident. With Ebcore you can
be much more precise about the
computers are better suited to modelling
specific projects. "Country risk is very
difficult to quantify accurately, in
economic terms," he said, "and often,
strategic or psychological reasons for
lending override the data, as in the case of
Mexico. The advantage for computers in
project financing is that it is coherent; a
project has a natural logic and life of its
own. Scientific analysis in these cases has
much more value and importance, and you
can be much more confident with the
results."
Crede is aware that even Ebcore remains
a tool, dependent on the assumptions it is
given. "It's actually quite a hard task-
master," he pointed out. "But it's usefully
hard. It forces you to be very careful about
what you give it, and since it works by
asking you questions, it makes you consider
things you might prefer to neglect."
The development of Ebcore is a sign that
When William Blackwell became head of
European Banking Company's project
group in 1977, his first requirement was a
computer modelling system, to help him
control the immense risks involved in
financing natural resource projects.
Most banks use all purpose modelling
systems like Visicalc or Micromodeller to
track the effects of variables on a project's
profitability. The biggest banks, though,
have developed their own, more adaptable
systems. Citibank's International Com-
mand is used by over 60 companies for con-
solidation of accounts, and for construc-
tion of models for future performance. The
bank is now working on refining the
system.
Blackwell was determined to evolve a
package precisely tailored to the demands
of natural resource projects. It took three
years of work with Core Laboratories of
--
etroleum
ise in the
d
p
expert
who ha
vulnerability of a project to adverse banks are becoming increasingly concerned
conditions." with the control of risk. As Crede said: "In
For many years bank economists have project finance the bank takes all of the
used computers to construct models for downside risk and none of the potential for
country risk, projecting the balance of pay- gain, as an equity investor would. In a
1Phrnr& is
industry, before the system was ready. general contusions aoouc rncu crcuu- ouup-y ....?
It is called Ebcore. and it differs from worthiness. But Crede argued that this kind of finance.
June 1983 0
Approved For Release 2008/01/23: CIA-RDP97R00694R000200870001-3 8uromoney 95