(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000707490001-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 8
• Document Creation Date: January 12, 2017
• Document Release Date: March 28, 2011
• Sequence Number: 1
• Publication Date: November 13, 1986
• Content Type: MEMO

Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
t"1 Lt-
IIIICIII ,CI1(C , c ,cfl ~
DATE
DATE
DOC NO 4L4 f'1 ~(~ X00 54
OIR 3
P & PD)
The Potential for a Latin American Debt Disaster
Summary
A major deterioration of the Latin American debt situation in the coming years is
plausible and could inflict serious harm on US interests at home and abroad, according
to three assessments undertaken by private-sector experts. Although all
three assessments point to strong grounds for optimism in an easing of the debt
problem during the balance of the 1980s, each draws attention to different critical points
of vulnerability in current debtor-creditor relations that could cause debt conditions to
unravel. Taken together, these analytically complementary expositions serve to
underscore the fragility of the debt situation in Latin America and the large stakes at risk
for the region and the US. Indeed, they note that several necessary conditions for a
renewed financial crisis are already in place, including difficult economic conditions such
as slow OECD growth and low commodity prices; the growing unpopularity of government
imposed austerity measures among the Latin American people and commitments by their
new civilian governments to increase living standards; and, foreign banks' resistance to
new lending for beleaguered debtors coupled with banking regulations that prohibit a
partial write down of bad loans. Finally, the assessments note that a renewed debt crisis
in which key debtor countries invoke payments moratoriums would have alarming
effects on the US banking system, the consolidation of democracy in Latin America, and
The Project
25X1
25X1
This memorandum was prepared by South America Division, Office of
African and Latin American Anayisis. Comments and queries
may be directed to Chief, South America
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
not unearth any startling worst-case possibilities
Although the experts did
their studies do cast fresh light on the potential for a Latin American debt disaster with some
interesting and perceptive new analytical twists. In particular, the three experts point to
several ways--not all of which are obvious--in which the Latin American debt bomb could be
exploded, with serious repercussions in both that region and the United States in all cases.
Detonation from International Economic Shocks
Using a quantitative methodology, assesses the
impact of a plausible worst-case triggered by international economic shocks on Latin
American growth and debt. For purposes of comparison, his baseline outlook for the medium
term calls for considerably higher Latin American growth than the dismal record of the past
five years and for continued manageability of the debt problem. The international economic
conditions underlying his base case assume 3 percent annual growth among the industrial
countries, approximately 4 percent average annual inflation in the industrial countries, a
nominal LIBOR lending rate of some 8 percent, and real oil prices hovering around $15 per
barrel in 1986 prices. Against this baseline forecast, he analyzes the potential adverse effects
of a plausible deterioration in the international environment.
The worst plausible case I postulates a "hard-landing" for
the overvalued US dollar and the international economy. A plummeting dollar
would prompt the US Federal Reserve to increase interest rates by three percentage points
and, consequently, precipitate a recession in the industrial countries that would reduce
average annual OECD growth to 1.4 percent during 1987-1990. Using estimates of
the elasticity of Latin American exports with respect to OECD growth and of increases in key
debtor country interest bills, the worst plausible case has a devastating impact
on Latin America's foreign exchange positions. If the Latin debtor countries absorb the
foreign exchange squeeze with commensurate cuts in imports, they would suffer serious
domestic growth repercussions. By calculating an elasticity of real output in Latin America
with respect to import availability, his worst plausible scenario would result in
a decline of annual GDP growth by about 3 percent for Brazil, Mexico and Argentina, with
one-third of the decline attributable to slower OECD growth and two-thirds to higher interest
Because a renewed cash flow crisis could heighten the appeal of radical debt actions,
also undertakes an evaluation of the effects of a debt moratorium, default, or
repudiation on key Latin debtor countries' finances and growth. His quantitative analysis of
the foreign exchange freed up by non-payment versus the foreign exchange lost through
retaliatory disruptions to trade and new borrowings indicates that Latin American debtors on
average would see their growth slow by one percentage point annually should they declare a
moratorium. Thus, Latin American economic growth already depressed by external shocks
would be set back still further by debtor moratorium responses. also finds
significant the implication that industrial countries can wreak more havoc on Latin economies
through their policy mismanagement than the debtor countries are likely to bring down on
themselves by declaring a moratorium.
25X1
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
Detonation From Inadequate Latin Economic Reform
In a second study,( (foresees
two worst-case outcomes for the region from a debt bomb explosion, each leading to
undesirable political as well as economic consequences for the United States. She cautions
that her assessment is not meant to be predictive but attempts to examine in a disciplined
way what could happen "if". At bottom of both scenarios is the potential for the new
democratic governments in Latin America to adopt misguided policies in efforts aimed at
quickly improving the economic lot of their peoples. She argues that economic development
is not only a shared goal of every Latin American country, but probably is the only dogma
that enjoys overriding and across-the-board support in the region. The new democracies
understand that they have to deliver economically or else face the prospect that they will be
ousted like their military predecessors. F_~
Her first scenario, dubbed the "high-level debt bomb detonation," closely resembles the
first) analysis, but the second scenario spotlights a distinctly different but equally
pertinent prospect. According to the high-level case, a debtor country finds it cannot meet
its payment obligations as a result of a collapse in oil prices or some other adverse external
event and, consequently, takes unilateral measures--such as a payments moratorium--that
earns political points domestically but inflicts serious harm on creditors. By contrast, in her
second scenario, a "low-level" detonation occurs in an international economic
environment--including moderate OECD growth--much as it exists now. Although debt
obligations are manageable, Latin governments squander their
opportunity to make important adjustments and reforms necessary to strengthen their
economies. Accordingly, they fail to implement orthodox stabilization policies, to cut fiscal
deficits, to get rid of state-owned enterprises, to increase and diversify exports, and to
liberalize foreign investment restrictions. As a result, Latin American debtors sink deeper into
an economic morass, their image in the eyes of world economic officials worsens, and so do
their abilities to climb out of their debt difficulties. Except for trade credits, international
creditors no longer would consider major lending to countries in the region.
Deteriorating financial and economic conditions in the region under both scenarios,
probably would lead to a reversal of the democratization process and the
rebirth of authoritarian governments. Although the exact process would vary from country to
country Latin American countries can tolerate for a while a period
of economic deterioration--as they already have), pressures by interest groups for jobs and
improved living standards would eventually build and create social unrest, opening the way
for more authoritarian governments that base their legitimacy on maintaining order and
decisive action. She notes that the countries now being visibly destabilized by the debt crisis
are Peru and Mexico and the countries that are vulnerable but not in immediate danger
include Brazil, Argentina, Ecuador, and Uruguay. Chile is vulnerable politically, but for reasons
Detonation Caused by Banks' Shareholder Suits
creditor actions also could trigger a worst-case Latin American debt scenario. This scenario
3
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
25X1
25X1
25X1
25X1
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
might arise in connection with a shareholder's suit over bank participation in a lending
package designed to provide additional funding to Latin debtors. He notes that some key
money-center banks in the United States are highly vulnerable to such developments because
of the heavy concentation of Latin debt inside their portfolios and because of US banking
regulations that require full write-down of non-performing loans in the event that interest
arrearages reach a certain level. In his view, Latin America's need for additional financial
resources will inevitably create tensions between these money-center banks, which are willing
to provide funds to keep their interest payments current and protect the value of their assets,
and regional banks, which may be under pressure from directors and shareholders to reduce
their exposure to the area.
In this worst-case scenario, the shareholders of a regional bank that was planning to
provide additional funding for a Latin American debtor sue the bank's directors for not
protecting bank capital. The case would go before a judge whose regional perspective was
sharper than his national perspective and who might uphold the suit. News of a successful
suit barring commitment of additional funds to the Latin American borrower would prompt a
suit or suits by blocks of shareholders in larger banks, enjoining their directors not to
participate in an additional lending package. The failure of American banks to contribute
would precipitate a collapse of the package since banks outside the United States would be
unwilling to agree to disproportionate increases in their commitments. Such a collapse would
then result in an accumulation of interest arrearages for the debtor because of its inability to
service its loans in a timely manner and, subsequently, lead to a decision by US regulators
that loans to that country are non-performing.
Furthermore, in a worst-case scenario, a crisis starting in
one Latin American debtor country might well spread to a number of others. The vision of
Mexico, for example, ceasing to service its debt would put tremendous pressure on
governments in Argentina, Brazil, and Chile, who are enduring the effects of large net
resource transfers abroad, to cease payments. were repudiations
of external payment obligations to include the five major Latin American
borrowers--Argentina, Brazil, Chile, Mexico, and Venezuela--the solvency of major
money-center banks would be threatened.
Implications for the United States
The worst-case events clearly would have
far reaching negative effects on US interests at home and in Latin America. Should several
Latin American debtors be forced to--or choose to--withhold debt servicing payments, many
US and foreign banks would have to write down substantial amounts of their Latin American
25X1
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
Latin American GDP Growth Under Alternative Scenarios
,
1987-1990
Worst Plausible Cases
Country
Baseline
Scenario
External
Shock
Debt
M
t
ora
orium
Combined
Argentina
3.5
0.4
2.5
-0.6
Brazil
6.0
3.1
5.0
2.1
Mexico
3.5
0.7
2.5
-0.3
Rest of
3.8
0.8
2.8
-0
2
Latin America
.
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
SUBJECT: The Potential for a Latin American Debt Disaster
1 - Doug Mulholland, TREASURY
1 - James W. Conrow, TREASURY
1 - Robert Cornell, TREASURY
1 - Thomas J. Berger, TREASURY
1 - Charles Schotta, TREASURY
1 - James A. Griffin, TREASURY
1 - Charles Dallara, TREASURY
1 - Ciro DeFalco, TREASURY
1 - Denis Lamb, STATE
1 - Jerome H. Kahan, STATE
1 - Ralph Lindstrom, STATE
1 - Paul D. Taylor, STATE
1 - Robert S. Gelbard, STATE
1 - James H. Michel, STATE
1 - Richard Holwill, STATE
1 - William G. Walker, STATE
1 - Luigi Einaudi, STATE
1 - A. Harold Eisner, STATE
1 - Richard Melton, STATE
1 - Kim Flower, STATE
1 - Perry Shankle, STATE
1 - Eugene L. Scassa, STATE
1 - J. Philip McLean, STATE
1 - Elkin Taylor, STATE
1 - Byron Jackson, COMMERCE
1 - Ann H. Hughes, COMMERCE
1 - Warren E. Farb, COMMERCE
1 - David Tarbell, DOD
1 - Col. David Montague, DOD
1 - Stephen P. Farrar, NSC
1 - Stephen I. Danzansky, NSC
1 - Jacqueline Tillman, NSC
1 - Raymond Burkhardt, NSC
INTERNAL:
1 - D/DCI-DDCI
1 - DDI
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
 Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3
SUBJECT: The Potential for a Latin American Debt Disaster
INTERNAL:
1 - O/DDI
1 - NIO/Econ
1 - NIO/LA
1 - PDB Staff
1 - C/PES
1 - DDI/CPAS/ILS
1 - D/ALA
1 - D/OGI
2 - ALA/PS
1 - ALA Research Director
5 - CPAS/IMC/CB
1 - C/ALA/SAD
1 - C/ALA/SAD/BR
ALA/SAD/BR~ I (12 Nov 86)
Sanitized Copy Approved for Release 2011/03/28: CIA-RDP86T01017R000707490001-3