Developing Country Debts in the Mid–1980s: Facts, Theory and Policy

Summary The decline in interest rates in 1985–6 and the weakening of the US dollar have been favourable features of recent debt developments. The continuing pressure on commodity prices has taken a major toll on incomes of the debtors, however, with the interest rates in real terms remaining prohibitively high; while private capital market lending has continued to stagnate. Domestic investments have been slashed in most debt-affected countries, thus threatening the future capacity to produce. External debts have continued to increase in both money and real terms, despite large outward resource transfers, as interest payments have still been very large and a part of them had to be de facto capitalised, while the decline in debtor country export prices has raised the value of debts in real terms. For six major debtors — Argentina, Brazil, Chile, Mexico, Nigeria and the Republic of Korea — the increase in debt in real terms was 35 per cent from 1982 to 1985. A change in debt strategy is indicated. The past international debt policy has focused predominantly on the need for adjustment in debtor countries. Commercial banks have adjusted by postponing principal repayments (amortisation) of most debtors in difficulty, at a fee and mostly over the short term. Almost the whole burden of interest payments has fallen on the debtor countries, in an international environment marked by falling prices and growing obstacles to trade. In order to alleviate the debt burden and help resume economic growth, it is necessary to supplement ‘the case-by-case approach’ with across-the-board measures focused on the international framework: reduction in the international rate of interest, standstill on obstacles to trade and then their roll-back, and improvement in commodity prices. The experience has shown that domestic adjustment efforts, while essential for financial viability, can be frustrated unless accompanied by such concerted measures. The latter would not be necessary if market interest rates were to continue to fall towards 3–4 per cent per annum, commodity prices were to stabilise at a satisfactory level, and most obstacles to trade were alleviated by individual action of major importing countries. It is unlikely that such a combination of circumstances will occur in the foreseeable future. A concerted approach, even if it were agreed, would take time to develop. In the meantime, it is essential that quickly disbursing lending to debtor countries be resumed or that their interest payments be reduced, in order to avoid further deflationary pressures on them. The implementation of the ‘Baker Plan’, which involves lending to middle-income major debtor countries by commercial banks and development finance institutions, would make a contribution over the three years 1986–8. A substantial gap in resources would still remain, however; in addition, lending commitments have been very slow to develop. The Group of 24 has proposed that consideration be given to maintaining new credit flows together with a reduction of interest rates below the market on past debt. This proposal needs to be worked out in detail. With respect to low-income countries in Africa, the World Bank has estimated an uncovered financial gap of $US2.5 billion per year, which would have to be met on concessional terms, including highly concessional debt reorganisation in a number of countries. The quickest, most efficient, and probably the only way of providing the resources now missing, while preserving creditworthiness of debtor countries, would be through special issues for the benefit of the developing countries of Special Drawing Rights (SDRs) over the next two years. This time should be used for organising a concerted approach to the debt problem and to improvement of conditions in Africa. No significant inflationary effects of such SDR allocation should be feared, in view of the existing surplus capacity in major sectors of the world economy and present deflationary pressures in the international market for most products. While the IMF Interim Committee at its April 1986 meeting declined to agree to an SDR allocation, the SDR issue will be coming back at its next meeting.