MAJOR LDC DEBTORS: FINANCIAL IMPACT OF AN OIL PRICE DECLINE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85S00315R000300080002-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 13
• Document Creation Date: December 22, 2016
• Document Release Date: January 31, 2011
• Sequence Number: 2
• Publication Date: October 1, 1984
• Content Type: REPORT

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Directorate of
Intelligence
Major LDC Debtors:
Financial Impact of
an Oil Price Decline
GI 84-10198
October 1984
Copy 456
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Directorate of Secret
Intelligence
Major LDC Debtors:
Financial Impact of
an Oil Price Decline
This saner was nrenared
(Office of Global Issues.
Comments and queries are welcome and may be
directed to the Chief, Economics Division, OGI, on
Secret
GI 84-10198
October 1984
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Major LDC Debtors:
Financial Impact of
an Oil Price Decline[
Key Judgments Assuming that a small decline in world oil prices-say $2/bbl-emerges
Information available from the 29 October OPEC emergency meeting, we believe the financial
as of 25 October 1984 impact on most key LDC debtors will be moderate. Certainly a number of
was used in this report.
LDC debtors-notably Brazil, the Philippines, and South Korea-would
obtain significant savings on their oil import bills. In addition, we believe
most oil-exporting debtors would be able to manage the drop in foreign ex-
change earnings they would incur because they have adequate financial
resources. Even with a small price drop, however, Egypt and Nigeria would
be confronted with serious new financial strains because of their high
dependence on oil export earnings coupled with currently tenuous financial
positions. Finally, over the medium term all of the debtors would benefit
from somewhat faster OECD growth and easing of interest rates, which
probably would be prompted by a lower oil price.
If a major oil price drop were to occur, the implications for some other oil
exporters also would become serious. With a drop in oil prices to
approximately $20 a barrel, for example:
? Mexico would lose $5 billion in foreign exchange earnings. Such a drop
would result in a substantial increase in banker resistance to signing on to
the new multiyear rescheduling package and lead to a renewal of credit
difficulties for Mexico.
? Venezuela would see its exports drop by $4 billion. Even with its ample
reserves of $12 billion, we would expect Caracas to experience even
greater difficulty than currently in obtaining new money.
? Indonesia would lose $3 billion in export earnings. Although quick
implementation of austerity measures in the past has kept up Jakarta's
credit standing, this position could quickly erode following such a sharp
oil price decline.
Disruptions to the international financial system from sharply lower oil
prices also could come from other countries less dependent on oil earnings.
For example, Peru and Argentina already are in desperate financial straits.
A reduction in their export earnings, which would follow an oil price
decline, could push them closer to the brink of declaring a moratorium on
debt payments.
iii Secret
GI 84-10198
October 1984
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With respect to the oil-importing LDCs, a decline in oils, prices would not be
enough by itself to substantially ease their debt problems. Most of the
larger debtors-particularly in Latin America-are unable to attract any
new lending from foreign creditors outside of their debt restructuring
packages. Moreover, capital flight remains a problem as does a lack of
foreign direct investment. Still, to the extent that faster OECD growth and
an easing of interest rates result from a lower oil price, the combination
could lead to some easing of financial pressure.
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Key Judgments
Foreign Trade Impact
Interest Rate Impact
4
A Closer Look at the Oil-Exporting Debtors
4
Implications
6
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Major LDC Debtors:
Financial Impact of
an Oil Price Decline
Introduction
OPEC's benchmark oil price is again in jeopardy. In
early 1983, a British price cut, coupled with a precipi-
tous drop in Nigerian production, triggered a
$5.50/bbl reduction in Nigeria's official price. OPEC
responded by dropping its benchmark price from $34
to $29/bbl. In mid-October, first Norway and then
the United Kingdom reduced their official prices in
reaction to weak spot prices. To avert a buyer exodus,
Nigeria followed with a price drop of $2/bbl, under-
cutting Norwegian and British prices by 65 cents.
OPEC has called a meeting for 29 October to deter-
mine its response.
Table 1
Key Debtors:
Debt Service Ratios, 1983
Brazil 75 43
Chile 61 34
Ecuador 48 26
Egypt 33 15
Indonesia 19 11 25X1
A decline in oil prices of $2/bbl would have moderate
repercussions on most LDC debtors. If a major oil
drop were to occur, oil-exporting debtors would face
substantial reductions in their export earnings and
hence their ability to meet debt obligations. In any
case, oil-importing countries would realize savings on
their oil bill. Whatever the outcome, world oil price
shifts will introduce greater uncertainty into the
unfolding financial outlook for LDC debtors.
LDCs: Current Financial Situation
Even though some progress is being made, the LDCs
continue to be affected by severe debt problems. Total
LDC external debt continues to grow; we estimate it
will hit about $750 billion by yearend 1984. Growth
has slowed from previous years-both because of
lower LDC external financing requirements and the
reluctance of commercial banks to lend to financially
troubled countries-but debt service ratios remain
very high for some of the key debtors (table 1).
Moreover, the need for economic adjustment in debt-
troubled countries has pushed a record number of
LDCs to implement austerity programs under the
guidance of the IMF.
Overall capital flows continue to be a problem for
LDCs, particularly Latin America. Extensive capital
flight over the past several years-we estimate it may
have reached $100 billion during 1979-83-has
slowed but is still occurring. In addition, foreign
Debt Service/ Interest/
Exports a Exports b
21 10
Peru 65 30
Philippines 41 28
South Korea 20 12
Venezuela 31 18
a Ratio of total debt service (medium- and long-term principal
repayments plus interest payments of all maturities) to exports of
goods and services.
b Ratio of total interest payments to exports of goods and services.
direct investment remains stagnant, and prospects for
future growth are not good. These factors, combined
with the dropoff in bank lending, are raising serious
doubts among financial analysts about the ability of
Latin American countries to resume economic growth
and development any time soon.
Several positive actions, however, recently have
emerged. Creditor banks have granted multiyear debt
restructurings to Mexico and Venezuela, an indica-
tion that creditors are moving toward a longer term
approach to debt problems as opposed to annual
restructurings. According to many forecasters, the
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Western economic recovery, led by the United States,
should continue through 1985 and should boost LDC
exports as well. Moreover, interest rates have declined
slightly in the last month. Softer oil. prices are also
aiding the oil-importing LDCs.
PEC will try to support
the current $29 benchmark price. C)PEC's success in
maintaining the benchmark in the immediate period
will depend on whether Nigeria can be persuaded to
rescind its price reduction and whether OPEC mem-
bers can agree to and implement production cuts in
line with market requirements.
We believe OPEC will have a difficult time maintain-
ing the current benchmark price. First, there has been
a steep decline in non-Communist oil demand since
1979, spurred by price-induced conservation and sub-
stitution. Second, oil inventory reductions and in-
creased production from non-OPEC producers have
added to supply. Despite OPEC's attempt to reassert
control over prices through production ceilings, most
members have been unwilling to adhere strictly to
production and pricing guidelines. As a result of these
factors, spot oil prices have been soft and have
undermined official prices. OPEC's current enormous
production overhang of some 9 million b/d of surplus
available capacity will continue to encourage cheating
among members, maintaining downward pressure on
oil prices. Consequently, we view a drop in OPEC
prices of $2/bbl or so as quite possible
We believe there is a smaller chance that oil prices
over the next year could plummet, perhaps to about
$20/bbl. This could occur in at least a couple of ways:
OPEC collectively could reach the conclusion that
current oil prices are much too high from the view
of their best long-term interests. At current prices,
continued conservation and substitution adjust-
ments, as well as production increases in non-OPEC
countries, are keeping the market for OPEC oil flat.
A substantial price reduction would alter these
trends.'
' According to US Embassy reporting, a Nigerian official has
suggested that OPEC should "fight back" against the Norwegian,
British, and other high-cost producers by taking advantage of
OPEC's low production costs through allowing the current artifi-
The conflict of interests among OPEC members
could increase dramatically, resulting in a further
loss of production discipline. For example, the major
debtors in OPEC-Nigeria, Venezuela, and Indone-
sia-have a great incentive to overproduce. Collec-
tively they now have about 0.7 million b/d in
surplus capacity. Additional supplies on the market
would place more downward pressure on prices and
threaten OPEC's already tenuous March 1983 ac-
cord.
Foreign Trade Impact
The impact of any oil price decline on the major LDC
debtors will depend chiefly on their foreign trade
position in oil. In the short run, any oil price decline
will reduce the foreign exchange earnings of the oil-
exporting countries, while resulting in savings on the
oil bill of importing countries. LDC debtors, such as
Indonesia, Mexico, Nigeria., and Venezuela, would
find themselves with less foreign exchange to meet
their import spending and debt service obligations.
South Korea, the Philippines, and other debtors high-
ly dependent on oil imports would be able to increase
imports of nonoil goods and perhaps improve their
debt service record. The foreign trade impact would
not end here, however, as any oil price decline would
start up a global adjustment process that would
involve further trade shifts and require probably two
or more years to work out.
To quantify the impact of oil price declines on key
debtors, we have made the simplifying assumption
that export and import volumes stay constant at 1984
levels. We then calculated the dollar impact of two
scenarios, which should bound any price decline: a
price reduction of $2/bbl and a reduction of $9/bbl
(table 2).Z
The Losers. If prices decline only $2/bbl, we antici-
pate that of the major debtors only Egypt and Nigeria
would experience increased financial problems. With
this price fall, Egypt's oil earnings would fall by $160
million, representing almost 5 percent of total exports.
1 We are assuming across-the-board cuts in oil prices even though
prices for different types of oil may not change uniformly. Thus, for
because of their export product mix
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Table 2
Major LDC Debtors:
Impact of Alternative Oil Price Declines
Net Oil Exports a
1984
(thousand b/d)
Net Oil Trade Balance a
1984
(million US $)
Estimated Impact of Oil Price Declines on
Trade Balance
(million US $)
Of $2/bbl
Of $9/bbl
-5
-15
Brazil
-456
-4,790
330
1,500
Chile
-67
-700
50
220
Ecuador
145
1,300
-110
-480
Egypt
218
2,200
-160
-720
Indonesia
934
10,000
-680
-3,070
Mexico
1,550
15,275
-1,130
-5,090
Nigeria
1,120
12,800
-820
-3,680
Peru
50
525
- 40
-160
Philippines
-200
-2,100
150
660
South Korea
-550
-5,720
400
1,810
1,298
13,300
-950
-4,260
Nigeria's losses would be roughly $800 million, also 5
percent of total export earnings. Given a price fall of
$9/bbl, almost all of the oil-exporting debtors would
face serious problems. The revenue losses of Mexico
would be $5 billion, 20 percent of total exports, while
losses in Nigeria and Venezuela would amount to
about $4 billion each, representing 25 percent of their
total exports.
These countries and other oil-exporting countries
would have essentially four options for adjusting to
these revenue losses:
? Cut imports.
? Draw down foreign exchange reserves (including
foreign assets).
? Increase foreign borrowing.
? Delay foreign debt service payments (run
arrearages).
In most cases, countries would choose some combina-
tion of these policies depending on their credit stand-
ing, foreign exchange reserve level, and ability to
manage import cuts. Thus, such troubled debtors as
Mexico and Nigeria probably would have little suc-
cess in borrowing additional new funds unless special
help was provided. At the same time, according to
press reports, Mexico has foreign exchange reserves of
about $7 billion and Venezuela of $12.5 billion, which
could provide a cushion if desired. Alternatively, a
decision to maintain reserves would, as in the case of
simply low foreign exchange holdings, imply some 25X1
combination of import cutbacks and arrearages on
debt payments. Delaying debt payments could be the
preferred option, especially for countries like Nigeria
that already have made substantial reductions in
imports.
Debtors with excess oil-productive capacity would
have the additional option of increasing their oil
exports, although such a move would almost certainly
risk an unraveling of prices. Of the major LDC
debtors, Nigeria currently has about 500,000 b/d of
surplus productive capacity, and Venezuela and Indo-
nesia each have about 100,000 b/d.
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The Winners. Some of the major LDC debtors are
heavily dependent on oil imports and would realize
substantial savings if oil prices decline. Brazil and
South Korea would save $0.3-0.4 billion each under a
$2/bbl price decline, and about $1.5 billion each
under a $9/bbl price decline.
These countries and others that are net oil importers
would also face some policy decisions:
? In particular, there would be an excellent opportuni-
ty to raise government revenues relatively painlessly
by imposing a tax on each barrel of oil that matched
any price decline. Domestic oil prices would be
maintained, thus not disturbing investment projects
and energy consumption patterns that depend on a
roughly $30/bbl oil price. Governments especially
in need of funds, such as Brazil and the Philippines,
could find this tax policy attractive.
? Alternatively, some countries could choose simply to
pass on the full oil price reduction to their domestic
economies. The oil bill savings would allow greater
imports of other goods. At the same time, the oil
price decline would also encourage a greater volume
of oil imports, especially after an adjustment period
of several years.
Second-Order Effects. LDC debtors that sell substan-
tial amounts of goods to oil-exporting countries could
find markets in these countries diminishing following
an oil price decline. At the same time, however,
markets in the oil-importing countries, including most
of the OECD, would be expanding with the increased
purchasing power of consumers in those countries.
Thus, although initially exports to the oil producers
might drop faster than new exports to oil-importing
countries would increase, after a year or two these
effects would tend to cancel each other out
Because most of the OECD imports oil, any price
decline will tend to stimulate the OECD economies:
consumers' purchasing power would increase, produc-
ers' energy production costs would fall, and hence
demand for and production of nonenergy goods would
grow. Greater OECD growth would lead to greater
demand for imports, including from LDCs. Although
the diverse composition of LDC exports makes it
difficult to assess which countries would benefit most
from OECD growth, export-oriented countries, such
as South Korea and Brazil, would be in the best
position to gear up for increased export demand.
Interest Rate Impact
An oil price decline could have an effect on interest
rates. Over the longer term, interest rates reflect both
real supply and demand conditions for credit as well
as the anticipated rate of inflation. A falling oil price
would reduce the component of interest rates that
reflects future inflation. 'While increased real incomes
in the OECD could lead to greater savings and hence
a tendency for lower interest rates, such income
growth also would result in greater credit demand so
that these effects would tend to wash out. Further-
more, credit demand could grow faster than savings if
some of the oil-exporting, countries were able to
continue to increase their borrowing as they adjusted
to lower earnings.'
Overall, however, it seems likely that, if anything,
interest rates would tend to fall with an oil price
decline. Some analysts have predicted that a $2/bbl
oil price cut would lead to a 1-percentage-point drop
in interest rates. In this case, all of the major LDC
debtors would gain, particularly those with propor-
tionately large debts at floating interest rates, such as
Argentina, Brazil, Mexico, and Nigeria (table 3).
A Closer Look at the Oil-Exporting Debtors
The impact of lower oil prices would vary among key
oil-exporting debtors. Mexico would be hard hit by
lower oil revenues, largely because the country still
has little room to maneuver. Imports have been cut to
the bare minimum over the past three years, and
nonoil exports-although growing---would not be able
to pick up the slack generated by large oil revenue
losses. Mexico recently reached preliminary agree-
ment with its bank advisory committee on a debt
' We estimate that OPEC states together will borrow $8 billion
from banks and official creditors this year. Indonesia, Algeria, and
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Table 3
Major Debtors:
Impact of an Interest Rate Decline
Net Savings From a 1-
Percentage-Point Drop in
Interest Rates
(million US $) a
Indonesia also would be able to adjust to a small price
decline, although at some cost to its economic growth
prospects. Although Jakarta could not expect much
help from nonoil exports, the government could re-
duce spending on development projects as it did in
1983. This in turn would bring about a reduction in
imports of capital and intermediate goods, which
would offset the loss in oil revenue. Foreign exchange
reserves also would provide a cushion in the near
term. Even with a sharp drop in oil prices, Indonesia
would not have immediate debt repayment problems
because of the favorable structure of its repayment
schedule. Moreover, creditors probably would respond
Egypt 30 favorably to an Indonesian cutback in spending so
that the country's credit rating would not be severely
altered]
130
220
a These data are derived from the change in net debt (gross debt less
deposits) that is on floating interest rates.
restructuring, but the package must still be signed by
all creditor banks. A small drop in oil prices could be
absorbed by Mexico because some cushion has been
built into the restructuring package, but a large price
decline would pose serious problems. Many banks-
some of which are already reluctant to participate in
the restructuring-could find it even harder to justify
their participation. In the worst case, Mexico would
be unable to meet its interest payments, which would
put a large burden on major creditor banks.
Venezuela probably would be able to absorb a small
drop in oil prices because of its relatively better
financial position. Foreign exchange reserves remain
high, and the recent restructuring package with com-
mercial banks will reduce debt service requirements
over the next several years. The package probably will
be signed by the individual banks because of its
overall benefits for both creditors and debtor. Banks,
however, could be reluctant to participate in new
loans over the medium term should Venezuela not
take actions such as drawing down reserves to make
up for the loss in revenues from oil exports.
Egypt could be hard hit by falling oil prices because of
its precarious financial situation. Banks currently
view Egypt as a below-average credit risk, and a loss
of oil income-which accounts for more than 60
percent of exports and more than 20 percent of
exports of goods and services-could lead to debt
repayment difficulties. Cairo would press the United 25X1
States even harder for debt relief on Foreign Military
Sales credits and might have to seek rescheduling
from other private and official creditors. A significant
reduction in prices could also interrupt Egyptian oil
exploration efforts, hindering the future growth of oil
production. Moreover, deepening financial problems
in Persian Gulf countries could reduce the need for
Egyptian migrant labor
Nigeria currently is under serious financial strain.
Lagos has major debt servicing problems, with a large
buildup of arrearages on short-term debt and dwin- 25X1
dling foreign exchange reserves. If its recent oil price
cut is maintained, the annual loss in export earnings
would be some $800 million, according to our esti-
mate. Reduced oil revenues would put increased
pressure on Lagos to cut spending and reduce imports
and to reach agreement with the IMF on a standby
arrangement. The impasse with the Fund probably
will continue through yearend, however, because of
the government's unwillin ness to implement a deval-
uation.
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Ecuador probably would be able to absorb a small
drop in oil prices. Quito is close to reaching a new
standby arrangement with the IMF that will be
followed by bank negotiations on a debt restructuring
and new money. Ecuador's economic team has been
cooperative with the IMF and probably will take the
steps necessary to adjust to lower oil export revenues.
A large fall in oil prices, however, could make credi-
tors reluctant to provide new money; some banks
already are balking at increasing their exposure.
Implications
We believe lower oil prices would, on balance, con-
tribute appreciably to a more robust world economy,
especially after an adjustment period of several years.
OECD growth would be promoted and interest rates
probably would ease. However, some LDC debtors
that depend heavily on oil exports would be in a much
more precarious financial situation, particularly if an
oil price decline were substantial. Egypt and Nigeria
are especially vulnerable because of their lack of
maneuvering room; Egypt has few alternative exports,
and Nigeria has large arrearages and dwindling for-
eign exchange holdings.
The risks of a moratorium on debt service payments
by one of these countries thus would increase if oil
prices were to plummet. Initially these countries
probably would start to run more arrearages in their
debt payments and also attempt to negotiate much-
improved debt terms and new credit. However, private
creditors would be very reluctant to extend new loans
after a fall in oil prices. Only relatively small amounts
of new lending would be forthcoming as creditors
attempted to protect outstanding loans.
Disruptions to the international financial system from
lower oil prices also could stem from some other
countries that are less dependent on oil earnings. For
example, Peru and Argentina already are in desperate
financial straits. Even a small reduction in their
export earnings, which would follow an oil price
decline, could push them closer to a moratorium on all
debt payments.
With respect to the oil-importing LDCs, a decline in
oil prices would not be enough by itself to substantial-
ly ease their debt problems. Most of the larger
debtors-particularly in Latin America-are unable
to attract any new lending from foreign creditors
outside of their debt restructuring packages. More-
over, capital flight remains a problem as does a lack
of foreign direct investment. Still, to the extent that
faster OECD growth and a decline in interest rates
result from a lower oil price, the combination could
lead to some easing of financial pressure.
We expect creditors to look. at the oil-importing LDCs
more favorably in the event of lower oil prices, but
this could be overshadowed by lender concern for the
financial situation of the major oil-exporting debtors.
Mexico, in particular, would attract lender attention
because of the size of the country's debt and the
implications for the international financial system as
a whole. Thus, the overall positive impact on oil-
importing LDCs probably would be realized more
over the medium term than in the short term.
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