Even With Falling Oil Prices, Debt Crisis Can Be Managed

The plunge in the price of oil has rocked economies in many developing countries already laden with international indebtedness and dependent on the sale of oil for income. Nowhere is this more true than in Mexico.

Before dire predictions of economic collapse become self-fulfilling prophecies, it is important to consider several factors that will help moderate the crisis and make it more manageable.

The drop in oil prices to levels below $20 a barrel will affect indebted nations in different ways. It is highly unlikely that the economies in these countries will collapse like a row of dominoes.

For instance Brazil, which carries more foreign debt than any other Third World country, will benefit from lower oil prices. Expected lower international interest rates will allow Brazil to service its current debt, as well as make future borrowing less expensive. Cuts in fuel prices will aid manufacturing and increase growth among Brazil’s trading partners, so its export picture will brighten too.

In Argentina the benefits and drawbacks of lower fuel prices will, for the most part, cancel each other.

Mexico, unfortunately, stands to lose the most because oil exports account for about 10% of its gross domestic product.

The crisis in the Mexican economy should not be minimized. One scenario we investigated showed that the expected 1.5% drop in the country’s gross domestic product in 1986 would balloon to 3.7% if prices stabilized at about $20 a barrel. Of course, lower oil prices would advance this decline. The increase in Mexico’s borrowing requirement would be reduced somewhat by expected drops in interest rates. Even with that bonus, however, new money needed would soar from the $4 billion already requested to $6 billion. This is not a new crisis. Many government and financial leaders have been coping with the problems of Third World debt for some time. In the meantime, one study has shown, the amount of net new external financing to 15 major debtors fell from $69.1 billion in 1981 to $9.7 billion in 1985. .

While no lasting answer has been found, recent new proposals give hope that even with the added weight of falling oil prices, the crisis can be managed.

Chief among these propositions is the global debt initiative proposed by Treasury Secretary James A. Baker III. While details of the plan remain to be worked out, it is already clear that any such plan must have an organizational focus. A coalition of private and public leaders must emerge and take the initiative--both in the formulation of a plan and in its implementation. Otherwise even the best-intentioned efforts will fail.

Baker’s plan has three parts. For their part, debtor nations would restructure their economies to eliminate inefficiencies and emphasize long-term growth, including the privatization of certain industries. Secondly, private banks would increase new lending to the indebted nations. Last, the multilateral lenders would step up their efforts to monitor debtor nations, boost lending and ease the process for disbursement of money.

Some very sound suggestions have been made to move the Baker plan ahead. Included are such ideas as reduced interest rate funding facilities, which would be sponsored by the International Monetary Fund; mandatory reinvestment of some portion of interest payments, and conversion of some debt held by private banks into long-term, reduced-rate debt instruments that would be issued by or discountable with central banks or multilateral institutions. None of these suggestions alone present any easy solution for either the borrowers or lenders, but they do provide methods over time to relieve the uncertainty, remove the crisis atmosphere and push the process along toward its ultimate solution.

That ultimate objective, and the key ingredient to a long-term solution, is to create an environment in those countries that encourages foreign investment. Opening up individual economies of the less developed countries so that foreign investors will feel secure is the key to sustained future economic progress, just as has been the case in the history of many industrialized countries.