MEXICAN-IMF AGREEMENT: THE RISKS OF SPILLOVER

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97R00694R000600440001-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 19
• Document Creation Date: December 22, 2016
• Document Release Date: March 24, 2011
• Sequence Number: 1
• Publication Date: October 1, 1986
• Content Type: REPORT

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Directorate of Seer-et
Intelligence
The Risks of Spillover
Mexican-IMF Agreement:
Seeret
GI 86-10068
October 1986
Copy 3 19
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Directorate of Secret
Intelligence
The Risks of Spillover
Mexican-IMF Agreement:
This paper was prepared by
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Office of Global Issues.
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Comments and queries are welcome and may be
directed to the Chief, Economics Division, OGIn
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I
Secret
GI 86-10068
October 1986
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Mexican-IMF Agreement:
The Risks of Spillover
Key Judgments On 22 July 1986, Mexico and the International Monetary Fund announced
Information available a ground-breaking agreement to deal with Mexico's debt problems. The
as of 12 September 1986 agreement assumes more than $12 billion in new funding, allows for
was used in this report.
annual real GDP growth of at least 3 percent through 1987, and shields
Mexico from the effects of further oil-price declines. This accord appears
to have diffused a volatile situatio
Nevertheless, the precedents established in
the accord could create new risks for the management of the LDC debt
situation.
In our view, the major risks will be those stemming from the spillover effect
of this Mexican agreement on other debtors and negotiations:
? The debt negotiating environment will almost certainly become more
drawn-out and strained as debtors stall in their negotiations and demand
similar treatment and as commercial creditors become increasingly
reluctant to go along with such arrangements. We already see signs of
this in Argentina, Venezuela, and the Philippines.
? Other debtor governments will come under increased pressure from their
domestic constituency to get "as good a deal as Mexico." To the extent
they are unable to do so, the Mexican agreement may paradoxically
increase the strains on other debtors that continue to pay their debts
without resorting to concession-gaining strategies.
? There will be an increased concentration of exposure to debtor LDCs by
the largest international banks as more regional banks swap or write off
their existing LDC debt and refuse to participate in future financing
packages. These increases in involuntary lending will place the larger
creditors in greater jeopardy.
Other LDC debtors believe their economic and political situations are
similar to Mexico's and that they deserve equal treatment. In requesting
relief they will cite a variety of reasons. In Latin America, some debtors-
notably Argentina and Brazil-will cite prior economic reform efforts. The
adverse effects of falling commodity prices will be used as justification by
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GI 86-10068
October 1986
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Argentina and Venezuela in particular. All will argue the need for faster
economic growth to justify debt conscessions. In addition, Egypt and the
Philippines may cite their special relationships with the United States.
Despite the risks it has created, the agreement has shown a new flexibility
on the part of the Fund-in the Mexico case, allowing larger budget
deficits and tying further assistance to growth-that may encourage other
recalcitrant debtors to stay within the case-by-case debt strategy and not
go it alone as Peru has done. Nevertheless, should key debtors fail to
receive what they consider to be equal treatment to that given Mexico, it is
possible that they may adopt unilateral measures to limit their debt service
payments.
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Increased Complexity
8
Deterioration of Debt Negotiations
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Debtor Networking
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Creditor Response
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Major concessions of the Mexican-IMF letter of
intent include:
? The amount of new financing. The agreement as-
sumes more than $12 billion in new money between
now and the end of 1987, with half coming from
commercial banks, according to financial press
reporting. Mexico's preliminary financing package
comprises the following:
5,000 7,200 12,200
2,500 3,500 6,000
World Bank 900 1,000 1,900
IMF 700 900 1,600
Inter-American Development Bank 200 200 400
International export credits 500 1,000 1,500
US farm credits 200 600 800
? Tying additional loans to commodity prices. A
contingency fund has been created under the letter
of intent to insulate Mexico from the further effects
of declining oil prices. New money would be made
available automatically if oil prices fall below $9
per barrel for more than 90 days during the first
nine months of the accord. Mexico will receive less
financing if oil prices rise above $14 per barrel.
? An orientation toward growth. The accord in effect
replaces IMF's traditional policy of supporting
austerity reforms with a new flexible approach that
promotes efforts to foster longer term growth. The
Fund agreed to let Mexico tailor an economic
recovery program that allows real GDP growth of
at least 3 percent starting in 1987. To assist
Mexico, the letter of intent established a $500
million reserve to bolster domestic investment if
the economy fails to recover by the first quarter of
1987.
? The longer term creditor commitment. Mexico can
seek medium-term lending commitments from cred-
itor banks beyond the 18 months covered by the
IMF-supported program. In addition, the letter of
intent reportedly allows Mexico to renew the IMF
package automatically for another year at the end
of the program.
Although most of the official funding has been ap-
proved for the package, Mexico's commercial credi-
tors have yet to agree to provide the $6 billion
specified in the accord.
The IMF agreement fails to force Mexico to adopt a
stringent austerity program, but Mexico City is
promising to make a renewed effort to accelerate
economic restructuring.
Mexico's strategy is to reduce government operating
costs, encourage new capital inflows, and stimulate
trade. Mexico reportedly will try to cut its budget
deficit projected to top 16 percent of GDP in 1986-
primarily by increasing government revenues. Mexico
has also promised to sell or close about 300 nonstra-
tegic parastatals, although no formal timetable has
been established. In addition, monetary policy will
remain tight with interest rates higher than inflation
in an attempt to reverse capital flight. Mexico will
also encourage the entry of foreign investors, particu-
larly those in export-oriented industries that provide
modern technology, and meet GATT regulations as
part of an expanded policy of opening its trade doors.
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Mexican-IMF Agreement:
The Risks of Spillover
Mexico has been the center of attention in the debt
arena since the beginning of 1986. After suffering a
decline in export revenues and international reserves,
an economic slowdown in 1985, and with little pros-
pect for improvement in 1986, Mexican debt negotia-
tors again turned to their international creditors for
relief. After lengthy and often difficult talks, Mexico
and the International Monetary Fund (IMF) signed
on 22 July 1986 a letter of intent that offers the de la
Madrid administration a less painful solution to its
chronic economic problems.
We expect that other LDC debtors may use the
Mexican-IMF agreement as a model for their future
negotiations with creditors. Many of these debtors
may put strong pressure on the IMF and commercial
banks for similar concessions because they also face
acute financial difficulties or believe that they deserve
special consideration because of their strong economic
adjustment efforts. In addition, some debtors-espe-
cially those countries that are more financially hard
pressed or belligerent-could model alternative pay-
ment schemes after concessions granted in the Mexi-
can agreement and take unilateral action to reduce
debt payments instead of negotiating with creditors.
Mexico is not alone in being hard hit by export
revenue losses resulting from stagnant or falling com-
modity prices and lower import demand in developed
countries. Falling export earnings and rising debt
service burdens are forcing many other LDCs to
continue economic reforms and austerity-related
cutbacks in spending-especially for investment-to
maintain financial solvency and foreign exchange
reserves. In turn, these developments are placing
additional checks on growth and development among
the key debtors. These adverse financial conditions
are likely to continue over the next 18 months and
may lead to increased demands from several other
Arguments for Relief
In our view, major LDC debtors will be likely to use
at least one of the following arguments to support
their demand for debt concessions:
? Bleak trade outlook. Export revenues in key debt-
ors have fallen sharply over the past two years
because of low commodity prices, a 50 percent drop
in oil prices, and slack import demand in developed
countries. Slowing real GDP growth in OECD
member states and continued oversupply conditions
make a sustained commodity price recovery unlike-
ly, especially for agricultural products. In addition,
many debtors frustrated by five years of economic
austerity-are now more concerned with economic
recovery than with debt service payments, and are
determined to boost imports and real GDP growth.
This combination of lower export revenues and the
need for higher imports is setting the stage for
growing financial gaps in many debtor countries.
? Prior economic reforms. A few key debtors, such as
Brazil, have undertaken significant economic re-
form measures, including exchange rate devalua-
tions and anti-inflation programs. They could de-
mand lenient debt treatment as a reward for these
efforts, given their adverse impact on real GDP
growth and unemployment. They may also contrast
their own efforts with Mexico's lack of progress
toward economic adjustment.
? A special relationship with major creditors. Mexico
is of special concern to the United States, given the
closeness of economic and political ties between
Mexico City and Washington and Mexico's prox-
imity to the United States. But the United States
has developed special relationships, based on eco-
nomic, political, and military factors, with other
countries such as Egypt and the Philippines. In
addition, European and Japanese creditors have
maintained close ties to debtors in their regions. We
feel that some of these countries will vociferously
argue that Mexico used its special relationship with
the United States as leverage to obtain concessions
and that they are entitled to similar relief from
creditors for the same reason.
debtors for Mexican-type concessions.
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Figure 1
Key LDC Debtors: The Road to Financial Problems, 1975-86
And Slowing OECD Real
GNP Growth ...
Have Sharply Cut
Export Earnings ...
Raising Debt Payments ... And the Debt Service
Ratio ...
Forcing Import Cutbacks ... And Reducing Average
Annual Real GNP Growth
a Data for 1986 is for the first half.
b Estimated.
We believe several Latin American countries are
candidates for spillover. These debtors will base argu-
ments for debt relief on current financial hardships,
the need for renewed economic growth, and structural
adjustment achievements. Moreover, some political
leaders have a "populist" outlook and are likely to
demand lenient debt-repayment terms to alleviate
what they perceive as painful economic burdens on
their constituents. These countries have closely fol-
lowed the Mexican talks and are already positioning
themselves to demand similar concessions.
Larger Countries
Argentina. Argentina's year-old austerity program,
the Austral Plan, sharply lowered the inflation rate,
reduced the government budget deficit as a share of
GDP, and set the stage for short-term industrial
improvement. Even though the plan is beginning to
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unravel, Argentine officials will be quick to point out
their progress on reform and argue that such efforts
should be rewarded with debt concessions.
On the payments side, falling prices and flooding in
agricultural areas last fall could reduce 1986 export
earnings by as much as $1 billion. Buenos Aires has
already cited the US decision to subsidize agricultural
sales to the Soviet Union as wreaking further havoc
with its foreign payments position. In addition, boost-
ing real GDP growth is an announced government
priority, and renewed import growth is a prerequisite
to higher real-income levels. To realize these goals, we
believe that Argentina will seek $2-3 billion in new
money over the next 18 months or concessions on
interest payments to meet financial needs.
The Mexican debt agreement with the IMF already is
playing a role in Argentina's negotiating strategy.
Buenos Aires delayed negotiations with the IMF and
commercial banks until the details of the Mexican
arrangement became clear. Press reports indicate that
Argentina is seeking to link debt repayment terms to
resume this year after a slight decline in 1985. Real
GDP growth also remains strong. Lower oil prices and
greater domestic production will reduce petroleum
imports, allowing for higher imports of raw materials
and other industrial inputs. Finally, an agreement to
restructure debt repayments for 1985 and 1986 has
been concluded, and press reports indicate that nego-
tiations toward a more comprehensive multiyear re-
structuring could begin before the end of 1986.
Chile. Chile's financial situation is nearly as bad as
Mexico's. Export earnings have stagnated since
1981-after a near tripling between 1975 and 1980-
as lower prices (especially for copper) offset higher
export volume. A worsening balance-of-payments sit-
uation and sharp increases in the level of foreign debt
forced draconian import cuts. As a result, real GDP
fell 14 percent in 1982 and has yet to recover
completely to 1981 levels. Chile's debt situation is
now so burdensome that principal payments must be
rescheduled, and interest payments take up 40 percent
of export earnings.
agricultural export prices.
Brazil. With a $102 billion foreign debt, massive debt
service payments, and a high debt service ratio, Brazil
also is a candidate for spillover, despite its strong
current account position and substantial foreign ex-
change reserves. The Sarney administration has re-
peatedly argued that foreign creditors should give
Brazil the easiest financing conditions in Latin Amer-
ica because of that country's superior economic ad-
justment achievements. Brasilia can cite elimination
of a current account deficit that was $16 billion in
1982, tax reform, and budget consolidation. More
recently, the Cruzado Plan-Brazil's six-month-old
austerity program-has slashed the rate of inflation,
reduced interest rates, and set in motion market-
oriented reforms that could strengthen Brazil's econo-
my. However, government spending has not been
curbed, savings have declined sharply, and new busi-
ness investment continues to be sluggish-signs that
inflationary expectations may not have been broken.
Brazil's case for major concessions is not as strong as
that of other Latin American debtors. Bolstered in
part by higher coffee prices, export growth is likely to
At the same time, Chile's economic management
team has carried out domestic reforms, including
liberalization of trade and capital markets, exchange-
rate devaluation, and efforts to stimulate private
saving while maintaining fair treatment of foreign
investment. These measures have been supported by
strict adherence to IMF-supported austerity pro-
grams, supplemented by new loans and rescheduling
agreements. These actions have allowed Chile to
make interest payments and achieve some resurgence
in economic growth over the past two years.
Given its precarious financial situation and its eco-
nomic reforms, Santiago probably feels it has a strong
case for debt relief. Negotiations are scheduled to
begin before the end of 1986, and US Embassy
reports indicate that Chile will seek rescheduling
of payments due through 1989 or 1990, and more
than $400 million in new funding during the period
1987-88. Given competent economic management in
the face of adverse external factors, a perfect interest
payment record, and full compliance with IMF and
World Bank adjustment programs, we believe that
Chile can lay a strong case for debt relief. The human
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rights issue, however, remains sensitive and could
delay approval of new loans or other debt concessions,
especially from official creditors.
Venezuela. Venezuela is likely to argue for debt relief
on grounds of a poor financial situation, the need to
revive a stalled economy, and bank reluctance to
provide new funds. Falling oil prices will cost Venezu-
ela $5-6 billion in export revenue in 1986, and we
forecast a 2-percent decline in real GDP. As a result,
Venezuela almost certainly will request a postpone-
ment of $3.4 billion in principal payments due during
Ecuador. The sharp drop in oil prices will slash
Ecuador's export revenues by $500-600 million in
1986 and increase the current account deficit to $750
million, In re-
sponse, Quito has negotiated increased financial assis-
tance-such as a $200 million syndicated loan-and
on 11 August announced new economic adjustment
measures, including exchange-rate reform and dereg-
ulation of interest rates on savings and loan accounts
at private banks. Given Ecuador's proven record of
making economic reforms and its poor financial out-
look, we believe Quito has a strong argument for
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1987-89.
banks will be extremely reluctant to provide new
funds, insisting that Venezuela first draw on its $13
billion in foreign exchange reserves.
Venezuelan leaders have been carefully monitoring
the Mexican debt negotiations
Moreover, Cara-
cas's unilateral and short-lived decision to pay
private-sector debt with long-term, low-interest rate
bonds angered creditors, and could complicate future
debt negotiations. In our opinion, however, a resched-
uling of public- and private-sector debt, coupled with
the use of foreign exchange reserves, will be necessary
to cover the loss of export revenue in the near term.
Smaller Countries
Colombia. In our opinion Colombia probably will not
press for concessions or rescheduling over the next 18
months. We forecast a sharp increase in export earn-
ings in 1986 as a result of higher coffee prices
it is unlikely Colombia
will need to draw on all external funding that has
been made available. A strenuous, IMF-monitored
economic stabilization program has led to economic
recovery; we forecast 4-percent real GDP growth this
year, following increases averaging 2 percent per year
between 1982 and 1985. Moreover, compared with
other Latin American debtors, Colombian economic
performance during the past four years has been
excellent
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further debt concessions.
Peru. Peru's financial outlook has been clouded by a
number of adverse factors, including persistently low
commodity prices. While progress has been made
toward curbing triple-digit inflation and boosting
economic growth, these benefits are likely to be short
lived. As- a result, we believe that a case for debt
concessions can be made. However, given Peru's
hardline confrontational attitude toward debt repay-
ment, the resultant de facto debt relief, and a near-
complete lack of creditor confidence, Lima almost
certainly will not obtain major debt concessions from
commercial banks or the IMF unless it substantially
moderates its debt repayment position.
insurgent threats.
Core Four Central American Countries. Costa Rica,
El Salvador, Guatemala, and Honduras-the Core
Four Central American countries-may be candi-
dates for spillover because of an increased debt bur-
den and continuing economic stagnation. We expect
total debt service to weigh heavily on these small
economies, remaining near 40 percent of goods and
services exports in 1986-after more than doubling
between 1980 and 1985. In addition, we forecast only
a slight increase in real GDP in 1986, which fell 5
percent between 1980 and 1985. Despite an expected
improvement in the trade picture in 1986 because of
higher coffee prices and lower petroleum imports, we
expect most of these debtors to seek payment conces-
sions and new financing to compensate for five years
of eroding export earnings, the continued fall in per
capita income, and the need to combat domestic
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Jamaica. In the Caribbean, Jamaica is in need of
some special financial arrangement because of baux-
ite revenue losses and real GDP declines. Prime
Minister Seaga, citing the need for growth after years
of austerity, abandoned IMF guidelines in May.
Because Jamaica's debt negotiations with the IMF
and other creditors are currently at a difficult stage
and the country is $70 million in arrears to the Fund,
Kingston almost certainly will not obtain major con-
cessions or new financing in the near term. Seaga,
however, may feel that his good relations with the
United States and the potential for former Prime
Minister Michael Manley to be reelected if the
economy does not improve may enhance his chances
Manila probably believes
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for concessions.
In general, the potential for spillover is not as great in
Asia as in Latin America. Most of the Asian countries
have considerably stronger financial positions. More-
over, Asian debtors generally are less belligerent
toward creditors and are more amenable to imple-
menting measures to permit full servicing of debt
obligations.
The Philippines
The Philippines is a marked exception, however.
There the financial and economic situation deteriorat-
ed in 1983, and the economy remained in recession
through 1985. Since 1984, Philippine export earnings
have been depressed by a sharp 40-percent drop in
commodity prices, imports have been slashed, and real
GDP has fallen more than 2 percent. Since President
Aquino assumed power in February 1986, however,
economic adjustment measures have been put into
effect-tax measures have been passed, trade liberal-
ization is under way, and reform of financial institu-
tions has begun. We believe, however, that Manila
will need to demonstrate that leftists do not dominate
policymaking, that the Communist insurgency can be
arrested, and that the new government can implement
economic programs to restore the confidence of credi-
tors and investors.
that the severe political and economic problems faced
by the new government put the Philippines in line for
favorable treatment. Manila will cite the need-
especially to Washington-to make resources avail-
able both to fight the insurgents and to make life
better in the rural areas-a key source of insurgent
support. With renewed economic growth a top govern-
ment priority, Manila's approach is to seek the sup-
port of its foreign donors and creditors for a growth-
oriented economic strategy that includes a multiyear 25X1
debt rescheduling and tolerates a high government
budget deficit.
Indonesia and Malaysia
Although they are in much stronger positions than the
Latin American debtors, Indonesia and Malaysia also
suffered economic and financial reverses during 1985
and 1986. Lower oil prices and, for Malaysia, a sharp
decline in commodity prices have reduced export
earnings for the two countries by $4-6 billion each
since 1984, and resulting import cutbacks have re-
duced the rate of real GDP growth. In addition, the
decline of the US dollar has sharply raised debt
servicing costs for both countries on the portion of
foreign debt that is nondollar denominated.
We believe that, unless oil and commodity prices
rebound sharply, these countries will need substantial
amounts of new funding-$2 billion per year for
Malaysia and $5 billion per year for Indonesia-to
boost real GDP growth and absorb labor force in-
creases. If these funds are not forthcoming, debt
concessions modeled in part on those in the Mexican
agreement could be requested.
Thailand
Thailand's economic outlook has brightened, follow-
ing an economic slowdown in 1985. Exports have risen
19 percent in dollar terms over the first half of 1986,
and lower oil prices have slashed Thailand's oil import
bill. In addition, while the cost of servicing yen-
denominated debt has risen-as a result of the depre-
ciation of the US dollar-Bangkok is refinancing its
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Figure 2
LDC Debtors: Trade and Financial Indicators
Mozambique
Madagascar
Burma
Somalia
Egypt
Morocco
Chile
Algeria
Bolivia
Sierra Leone
Brazil
Mexico
Yemen Arab
Republic
Nigeria
Colombia
Uruguay
Argentina
Philippines
Costa Rica
Ecuador
Kenya
Tunisia
Papua New
Guinea
Pakistan
Jamaica
Venezuela
Malaysia
dollar-denominated debt, and
=overall debt servicing costs could be lower for
1986 than in 1985. We believe that, unless oil prices
rise sharply, the chances for a Mexican-type debt
agreement are remote.
Nigeria
Mozambique
Venezuela
Jamaica
Somalia
Sierra Leone
Mexico
Bolivia
Burma
Uruguay
Egypt
Kenya
Yemen Arab
Republic
Madagascar
Malaysia
Tunisia
Ecuador
Philippines
Chile
Morocco
Argentina
Papua New
Guinea
Pakistan
Colombia
Costa Rica
Brazil
Algeria
H
Egypt
Although there are several countries in these regions
that are candidates for spillover, Egypt is the one of
greatest concern. Export revenues have been devastat-
ed by lower oil prices and a sharp dropoff in worker
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Figure 2 (continued)
remains unpalatable to Cairo because the strict finan-
cial and economic guidelines of a fund-supported
program would almost certainly provoke political and
social unrest.
Mozambique
Chile
Madagascar
Bolivia
Brazil
Somalia
Mexico
Argentina
Burma
Morocco
Philippines
Ecuador
Costa Rica
Uruguay
Egypt
Colombia
Sierra Leone
Yemen Arab
Republic
Venezuela
Nigeria
Jamaica
Kenya
Tunisia
Algeria
n New
Gwnea
Pakistan
Malaysia
Nevertheless, Nigeria does not seem willing to press
the issue of debt relief. Lagos is aware that past
3105799 3086 actions, such as the accumulation of large debt ar-
rearages, have left creditors with a dim view of
further lending. In addition, Nigeria does not demand
remittances, and we believe that, even with modest the attention from creditors that the Latin American
import cutbacks, Cairo will require substantial new countries receive. Creditors appear split on offering
funding to meet financial needs. Although US Em- new financing to Lagos, with most US banks viewing
bassy reports indicate that the Egyptians have recent- Nigeria as a poor credit risk, while European banks
ly met with IMF officials, a formal IMF agreement are still willing to make new loans because of their
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Cairo will probably also point to a newly formulated
program of economic reform as justification for debt
relief. US Embassy reports indicate that the program
is far reaching and comprehensive, but specific weak-
nesses remain in the areas of the budget deficit, credit
expansion, and exchange-rate reform. Egypt has
proved more adept at proposing reforms than at
implementing them, which has created a credibility
gap with commercial banks, creditor governments,
and the IMF, and has delayed agreement on a new
standby accord.
Finally, Cairo will continue to cite its special relation-
ship with Washington as an argument for debt con-
cessions. Egypt and the United States share concerns
on several major military and political issues, and
Cairo almost certainly assumes that the strong US
commitment to supporting a moderate regime in
Cairo will provide the leverage needed to win in-
creased funding and debt rescheduling.
Nigeria
Elsewhere, Nigeria could argue that its financial
situation is worse than Mexico's and that major debt
relief is needed. Falling oil prices will slash export
earnings as much as $5 billion in 1986, and, despite
initial moves such as a two-tiered exchange-rate
system, political considerations will make meaningful
austerity measures difficult. In addition, efforts to
obtain an IMF agreement have been stalled by strong
anti-IMF feeling within the government.
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historical relationship with Africa
These differences could make agree-
ment on a package of debt concessions more difficult.
Morocco and Tunisia
Morocco and Tunisia could be candidates for spill-
over, given their bleak financial condition, strategic
location at the entrance to the Mediterranean, and
shared concern with the United States over regional
political matters. Export earnings have fallen because
of declining demand for phosphate, and foreign ex-
change reserves for both countries are nearly exhaust-
ed. Cautious steps toward economic reform are now
being taken to secure increased funding, but progress
has been limited by fear that these measures will lead
to a repeat of the bloody riots that followed the
attempted imposition of austerity in 1984.
Sub-Saharan Africa
A number of small countries in Sub-Saharan Afri-
ca-including Cameroon, Ghana, Ivory Coast, and
Senegal-have implemented economic reform pro-
grams to rescue their battered economies, ensure
continued external funding, and create a more favor-
able long-term environment for economic growth.
These measures, however, have not been without
opposition, and have potentially serious political and
social implications because already poor countries are
being called on for further sacrifice. As a result, these
debtors may press for lenient debt treatment as a
reward for their economic reform efforts.
could demand terms linked to oil prices. Press reports
confirm that Buenos Aires is already making such an
argument. Similarly, some key debtors seem more
inclined to link debt payments to GDP. For example,
Brazilian Finance Minister Funaro stated in off-the-
cuff remarks to the press on 28 July 1986 that Brazil
needs to limit its debt service to 2.5 percent of GDP to
support economic growth. Funaro and members of
President Sarney's staff subsequently explained that
reducing payments was a goal Brasilia wanted to
negotiate with creditors and did not imply an inten-
tion to take unilateral action.
A major risk of the Mexican package is a deteriora-
tion in the conduct of debt negotiations. The Mexican
package makes it politically more difficult for other
debtors to continue paying without extracting conces-
sions from creditors while continuing to keep tight
reins on their respective economies. Therefore, we
believe that debt-troubled countries will be less will-
ing to operate under the old strategy where continued
financing was contingent on an IMF-supported pro-
gram. If a debtor fails to receive what it considers
adequate financing or payment terms, or cannot find
other orderly ways to reduce debt payments or at least
link them to export performance, there is a greater
possibility that the debtor would unilaterally act to
curtail payments. While we believe the possibility of a
debtors' cartel remains remote, there nevertheless is
now a greater chance that LDC debtors may act
jointly if they are not satisfied with creditors' respons-
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Creditor-debtor relations are likely to become more
complicated in the wake of the Mexican package.
Mexico is the first debtor to have commodity export
prices explicitly linked to the terms of a new IMF
agreement, thus setting the stage for other key debt-
ors with narrow export bases to demand similar terms.
For example, debtors such as Argentina and Malaysia
could argue for linkage to a basket of commodity
export prices, and Indonesia, Nigeria, and Venezuela
es to their plight.
We expect the question of spillover will grow in
importance as the future debt negotiations of major
LDCs progress. Debtors are likely to increase contacts
among themselves in an effort to receive comparable
treatment from creditors-stepping up bilateral con-
tacts, keeping each other informed of current negoti-
ating strategies, and exchanging documentation.
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Although debtor demands for relief will probably be
modeled after the Mexican financial package, alter-
native schemes have been proposed-and some have
been implemented. It is possible that these proposals
could surface again as debtor countries search for
ways to ease their financial problems. Such past
actions have included:
? Tying payments to export revenues. President
Garcia announced on 28 July 1986 that Peru would
restrict principal and interest payments on public
debt to 10 percent of export revenues for another
year, and that payments would be contingent upon
creditor inflows meeting or exceeding Peru's pay-
ment levels. At the same time, Lima stated that new
interest rate charges or refinancing terms must
meet the 10 percent payment limit. Similarly,
Nigeria announced on 31 December 1985 that it
would limit debt payments to 30 percent of export
revenues, covering roughly half the projected obli-
gations due in 1986.
? Issuing bonds to service debt. Venezuela passed a
new law on 7 July 1986 that provided for repay-
ment of a portion of $7 billion in private-sector debt
in the form of 15 year, dollar-denominated govern-
ment bonds carrying a 5 -percent interest rate. Un-
der this system, Venezuelan firms would buy bonds
from the newly created exchange compensation
fund in domestic currency and then turn the bonds
over to foreign creditors as payment for outstanding
debt. Criticism from creditors forced Caracas to
Troubled debtors may use this network to time an-
nouncements of alternative payment schemes to maxi-
mize their effect.
Only when Mexico deci a to negotiate rat er
than take unilateral action did Venezuela become
abolish the legislation in mid-August, and Venezu-
ela will instead alter the prior private-debt scheme
through executive decrees to change the exchange
agreements, according to the US Embassy.
? Domestic currency deposit schemes. Mexican fi-
nance officials
drafted a plan where interest
payments due to foreign creditors would instead be
deposited in an escrow account at the Central Bank,
according to press reports. These funds were to bear
interest at the normal interbank rate set in London,
but could not be transferred abroad as dollars until
Mexico's foreign reserves increased substantially.
Although the need to implement this plan has
lessened with the signing of the IMF letter of intent,
its presentation to creditors showed the severity of
Mexico's threat to lower debt payments and sig-
naled the end of its previously moderate approach
to debt negotiations.
Creditors have generally responded harshly to unilat-
eral attempts at reducing debt payments. Commercial
creditors view such payment schemes as setting dan-
gerous precedents and as obstacles to financial nego-
tiations. When such unilateral actions are taken,
banks first retaliate against an LDC-as they did
with Peru, Nigeria, and Venezuela-by cutting back
short-term trade financing. But they may also take
more drastic steps; for example, banks threatened
legal action against Venezuelan firms when the bond
system was first announced.
more willing to negotiate a mutually acceptable solu-
tion instead of maintaining its hardline position.
becomes the standard.
There also is a danger that creditors, especially
commercial banks, will become more opposed to
negotiating with debtors if the Mexican-IMF accord
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IWe believe that com-
mercial banks will remain hesitant to extend new
longer term loans to most LDCs unless pressured to
do so in conjunction with an IMF-supported program.
In addition, creditors would be likely to face a
substantial need for new funds if every major debtor is
to receive a large Mexican-scale agreement. Also
troubling is the fact that involuntary bank lending
over the next few years will become more concentrat-
ed among the world's larger banks-increasing their
risks and exposure-as US regional and smaller
foreign banks largely opt out of large new money
packages. Although most large money center banks
are now in better financial shape after building up
loan-loss reserves, lending to LDCs that are poor
credit risks, as well as the possibility of unilateral
payment stoppages or negotiated payment reductions,
places these creditors-especially some large interna-
tional banks-in greater jeopardy.
Offsetting these increased risks is the fact that be-
cause the Fund will be perceived as having had a more
flexible approach during negotiations-by allowing
larger budget deficits and by tying further assistance
to growth and oil prices-some recalcitrant debtors
may be encouraged to stay within the case-by-case
debt strategy and not follow Peru's example and go it
alone. Nonetheless, should other key debtors fail to
receive what they consider to be equal treatment, or at
least softer payment terms, the spillover risks may
become real, and it is possible that some debtors will
even adopt unilateral measures to limit debt service
payments.
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