World Debt: Political Drama : As First ‘Solution’ Falters, U.S. Seeks to Try Again

The foreign debt drama, declared “all but over” just months ago in the headlines of some major newspapers, has once again taken center stage as debate intensifies over a new U.S. plan linking Reagan-style economic adjustment in the debtor nations to renewed lending from commercial banks and international agencies.

The short-lived lull in concern over the debt issue was not, as optimists claimed as recently as May, the end of the play. It was, rather, an interlude between acts of a trillion-dollar production that will run well into the 1990s.

The terms of the debate have changed, however. The debt crisis increasingly is seen as more than a payment dispute between big banks and their customers in the developing world. The Third World’s $960-billion debt to foreign banks and governments is now recognized as an explosive political issue dividing the world’s rich and poor nations.

“We are faced with a dramatic choice,” newly-elected Peruvian President Alan Garcia told the United Nations in September. “It is either debt or democracy.”

Garcia already had chosen. Declaring Peru’s domestic development his “most pressing priority,” he announced shortly after his election in July that he would limit payments on foreign debt to 10% of export income, repaying only one-third of what was owed. The country currently is behind by about $250 million on total external debt of $13.4 billion.

Throughout Latin America, annual debt service payments are consuming 40% of export income, limiting those nations’ ability to finance needed improvements, buy imports and develop a thriving private economy. According to the World Bank, developing countries’ debt payments will equal more than 55% of their export earnings in the next few years before returning to current painful levels in 1990.

Peru’s unilateral action, similar threats from Argentina and a deepening economic crisis in Mexico forced U.S. officials to reconsider their 3-year-old strategy for dealing with the international debt problem. The new plan, designed by Treasury Secretary James A. Baker III and Federal Reserve Board Chairman Paul A. Volcker, is a tacit admission that the jerry-built solution to the original debt crisis in 1982 has failed to provide long-term relief to either borrowers or lenders.

Three years of Third World austerity enforced by the International Monetary Fund had some success in righting acute trade imbalances and squeezing down government spending. Repayment terms of $200 billion in debt have been eased since the crisis days of 1982.

But the side effects were worse than expected. As missed interest payments were tacked onto the total bill, debt continued to grow. Falling prices for commodities and manufactured goods penalized the developing nations by paying them less for more of their natural wealth and industrial output. Living standards fell.

Increased exports from the Third World cost hundreds of thousands of jobs in the industrial world and sparked cries for protectionism. Inflation raged, averaging 180% this year for 10 major debtors. Rigid exchange rate and taxation policies accelerated capital flight from the developing world.

And, perhaps most threatening of all, the budget cutting, price increases and layoffs demanded by the IMF as the price of new funds touched off domestic unrest and inspired calls for repudiation of debt.

The Baker-Volcker plan, announced at the IMF annual meeting in Seoul, South Korea, last month, attempts to deal with these pressures in a three-pronged approach. First, the debtor nations must adopt market-oriented policies to reduce public-sector spending, encourage private investment and stem capital flight.

As those measures are implemented, the IMF and the World Bank will increase lending by 50% or $9 billion over the next three years to spur growth. And when the other elements are in place, commercial banks in the United States, Europe and Japan will be not-so-gently persuaded to cough up $20 billion in new money to assist in repaying old debt and rebuilding the debtors’ economies.

The plan focuses on 15 problem debtors, 10 in Latin America plus Ivory Coast, Morocco, Nigeria, the Philippines and Yugoslavia. Together, they owe $427.5 billion to banks, governments and multilateral development agencies. The U.S. bank portion of the debt is $94.2 billion, most of it concentrated in a dozen big banks based in New York, Chicago, San Francisco and Los Angeles, but also affecting scores of smaller regional institutions.

Admission of Problem

“It’s highly positive in the sense that it’s the first time the U.S. administration has said the problem is much deeper than was originally thought,” said Pedro-Pablo Kuczynski, co-chairman of First Boston International and Peru’s former minister of mines.

“The political aspect is now clear after three years of declining per-capita income, high unemployment, no spending on public works, capped off by the earthquake in Mexico. All of this has led to a sort of malaise some call ‘adjustment fatigue.’ These countries are tired of doing the right thing.”

And now the industrialized nations want to change the rules of the game. Recognizing that austerity has both stirred political disaffection and failed to provide developing countries with the earning power to repay their debts, bankers and development agencies have now declared the austerity period over and the growth period begun.

“A year ago, it was important to wring out the excesses and lower the borrowing appetites of these nations,” said Chase Manhattan Chairman Willard Butcher. “These countries have had their period of austerity. Now it’s time to get on the track of productive, non-wasteful growth. It’s in the United States’ self-interest.”

It’s also obviously in the interest of Chase Manhattan and the other big banks. Chase has loans amounting to 122% of its primary capital, which includes shareholders’ equity and loan-loss reserves to just six Latin borrowers.

Seen as Good News

At March 30, the nine biggest U.S. banks had loans equal to 214% of their capital outstanding in the Third World. In the weird arithmetic of foreign lending, that’s seen as good news. At the end of 1982, the figure was 288%.

While the threat of a collapse of the international banking system is dismissed as remote by most observers, the banks’ excesses in Third World lending have cost them millions in lost profits and seriously eroded the value of their shares. The reputations of scores of banks and bankers have been tarnished.

The banks have strengthened their capital position in part by declaring an unofficial moratorium on new loans to developing nations. U.S. bank lending to the Third World doubled between 1977 and 1982. Since then, new lending has virtually ceased. Debtor countries, which desperately need new capital, are actually paying more to their creditors than they are getting in loans.

The evaporation of bank lending was a factor that led Baker and Volcker to propose their new plan. Cynical bankers view it as the only factor.

“The money is just not coming and they want to get it flowing again. That’s the intent,” said an international lending officer at a major U.S. bank. “Our concern is that they’re asking us to throw good money after bad.”

Funds Were Squandered

Bankers complain that billions of their loans to the Third World were stolen, squandered on useless state-run projects, consumed by inflation and used politically to keep prices low and exchange rates high. They point to unfinished roads and industrial projects, the Argentine military misadventure in the Falklands and the massive flight of capital from several Latin countries.

Ironically, some of the flight capital ends up back in the big banks’ private banking departments where confidentiality rules prevent disclosure of the magnitude of foreign deposits. In Mexico, a thriving industry has sprung up for couriers who pick up small amounts of cash from ordinary laborers and office workers and ferry it across the border for deposit in Texas banks. As many as a million Mexicans hold more than $50 billion in assets in the United States, estimates Jorge Castaneda, Mexican political scientist and senior fellow at the Carnegie Endowment for International Peace in Washington.

A recent World Bank study of capital flight reveals that between 1979 and 1982--at a time when $147 billion in new loans was flowing into Argentina, Brazil, Mexico, Uruguay and Venezuela--$72 billion was funneled right back out to bank accounts and investments abroad. It’s little wonder the banks are frustrated.

Baker, in presenting the new plan, acknowledged the problem of capital flight and said his program will attack it by making investment in the debtor countries more attractive.

“Sustained growth in these countries will depend in large measure on their ability to generate greater domestic savings, to encourage the investment of those savings at home and to attract additional investment from abroad,” he told the Senate Foreign Relations Committee in October. “As a practical matter, it is unrealistic to call upon the support of voluntary lending from abroad when domestic funds are moving in the other direction.”

Smaller Government Role

To rekindle foreign and domestic investment, debtors will be asked to reduce the role of government in the economy, open markets to foreign equity capital, liberalize trade, reduce taxes and end controls on interest and exchange rates. In short, Reaganomics.

Critics respond that the plan expects too much too soon and ignores political realities in the developing world. Kuczynski notes that there is a long Latin American tradition of state monopolies in basic industries and job protection and food subsidies for the politically-powerful urban populations. He and others warn that imposition of supply-side methods by agents of the industrial world could produce as much unrest as austerity did.

“These are very difficult measures to implement politically in any of these countries,” Castaneda said. “To reduce the state-owned sector of the economy means laying off a substantial number of people who were featherbedding. And this in countries where the welfare net is practically non-existent.

“It becomes even more difficult if these reforms are identified with the United States. If the governments are perceived as too much in bed with the United States, then they become vulnerable on their political flank from the left.”

Another political issue arises between the U.S. government and its major allies and trading partners, whose public and private banks share heavily in Third World debt. Banks in Europe and Japan carry two-thirds of the total Third World bank debt, while U.S. institutions have only one-third. The Baker-Volcker plan envisions a $13-billion contribution from foreign banks and $7 billion from U.S. banks.

Have Less Incentive

European banks have less of an incentive to pump out new money, because they have heavily discounted the value of the loans under stiffer regulatory and accounting rules than have been imposed on U.S. banks.

Central banks in Europe and Japan will be asked to boost their contributions to the World Bank, but those talks haven’t yet begun. A number of observers question whether U.S. officials could persuade their counterparts abroad to go along with a plan based on supply-side economics that have been shown to be only partially successful in the United States.

Still another problem concerns the willingness of smaller U.S. banks to participate in the plan. As a rule, they have been more conservative in their Third World lending and quicker to write off the loans than the big multinationals. They don’t appear willing to ante up for another hand, leaving the bigger banks with a larger share of the burden.

“The whole process now is getting down to a question of self-interest, which is how it ought to be,” said Robert Higgins, chief of foreign lending at Fleet National Bank, based in Rhode Island. “Those who don’t see a need to participate won’t do it; those who have a need to protect what’s on the balance sheet will do it.”

Higgins placed Fleet in the first category. The bank’s total foreign loans are less than half of primary capital and it has aggressively written down loans in Mexico and Argentina. The big players are compelled to stay in the game in hopes of recouping some of their potential huge losses, Higgins said.

“Our exposures are modest. We don’t see any need to increase them.”

Keep Up Appearances

By contrast, the big U.S. banks have substantial interest in new lending if only to maintain the appearance that interest is being paid on Third World loans, what one banker called “the fiction of performing assets.”

Discussions currently under way between Treasury officials and bankers center on whether new loans will be guaranteed by development banks and, ultimately, the U.S. taxpayer. Congress is loathe to approve a bail-out for the banks, so the degree of the Treasury’s commitment to increase World Bank funding or ultimately guarantee commercial bank loans may be obscured.

“You can disguise and launder the money as much as you want, but that’s still basically what’s happening,” Castaneda said. “It’s money from the government through the Latin countries to the banks.”

The process has been sobering for U.S. bankers, who overindulged in Third World lending a decade ago as billions of Arab petro-dollars poured into their vaults. Bankers were praised by governments and themselves for stoking the engine of developing world growth.

Today, the mood is vastly different. Former Citicorp Chairman Walter Wriston, the most insistent prophet of Third World lending, continues to voice his optimistic opinions about the stability of the world banking system and the ability of developing nations to grow out of their debt problems.

But John Reed, named Wriston’s successor last year, sounds a different note. At the end of last year, Citicorp had $14.6 billion in loans outstanding to 31 developing nations that were rescheduling their debt under pressure.

“We don’t have any illusions that it is susceptible to a quick solution,” Reed said in September at his first press conference. “We’re taking it inch by inch.”