U.S. Shifting Policy on Global Debt : Aims to Ease Burden on Borrower Nations’ Middle Classes

The United States is quietly altering its strategy on global debt to help cope with serious domestic political pressures that have been mounting in Latin American countries in the past several months.

The changes fall well short of any shift to an outright forgiveness of some of the huge sums owed by debt-saddled nations, as some analysts believe is necessary. On the surface, the government will hew generally to its policy of dealing with debtor countries on a “case-by-case” basis, with full repayment expected. “There is no thought being given to making fundamental changes,” a senior Administration official says.

But U.S. strategists privately now believe that adjustments are necessary in a key element of the strategy that may be having damaging, unanticipated side effects.

Specifically, they fear that the policy of pressing larger debtor countries to keep devaluing their currencies to improve their balance of payments may be strangling the nations’ middle classes in inflation. This could set the stage for a potential political backlash that could erode the support that these nations’ leaders need to make painful, necessary changes to revamp their domestic economies.

Increase Lending

As a result, officials here are working privately to rewrite those economic prescriptions to ease the pressure on the Latin American countries’ middle class.

If Vice President George Bush wins the presidential election in November, the U.S. government also is expected to begin a new effort next year to prod U.S. banks to step up their loans to Latin American countries to give them more breathing room during their economic transitions. Banks have cut back sharply in recent years, despite promises in 1985 that they would increase their lending to debtor countries.

And Democratic nominee Michael S. Dukakis has indicated that if he wins, he would be receptive to more sweeping revisions in the debt strategy, possibly including a move toward massive debt reduction.

In the meantime, the new U.S. approach--the most significant revision since the U.S. plotted its global debt strategy three years ago--is quietly being introduced.

Earlier this week, it was reflected in the unprecedented $3.5-billion “bridge” loan that the U.S. offered Mexico and last month in a $1.25-billion package of World Bank loans worked out for Argentina.

The Treasury Department’s announcement on the Mexico loan indicated only that the move was designed as a show of confidence, to ward off a possible run on the peso amid the specter of a new fiscal crisis threatening the nation.

Mexico has been feeling a financial squeeze because of the recent decline in oil prices, which has sharply cut its export revenue. Washington’s offer to provide $3.5 billion in temporary loans signaled U.S. intentions to try to head off both those moves.

Discourage Import Buying

But the quick U.S. action also reflected concern over a longer-term problem--the possibility that a further devaluation of the peso might shatter the fragile economic compact Mexico leaders have struck with business, labor and agriculture to carry out the prescribed reforms to restructure the national economy.

Until recently, the United States and organizations such as the International Monetary Fund and World Bank have sought to right Latin nations’ balance of payments problems by prodding the country to devalue its currency, in hopes that the resulting temporary surge of inflation would discourage import-buying in the country. The strategy traditionally has worked in the case of large industrialized countries, such as Great Britain, and might have worked well in Latin American countries if their economies had been better able to bounce back.

As it has turned out, however, the impact of these harsh remedies has been spread unevenly in Latin America because the poor have been exempt from austerity measures while the rich, by keeping their assets in dollars, have escaped largely unscathed. As a result, the brunt of the burden has fallen on the middle class, which is crucial to the continuation of the existing governments.

In Mexico, for example, while newly elected President Carlos Salinas de Gortari won handily in poor rural regions, he did badly in Mexico City, which is critical to his base of support.

A similar situation has developed in Argentina, where President Raul Alfonsin is encountering fierce opposition to his national economic restructuring program because middle-class Argentines are feeling the squeeze. Alfonsin also is being opposed by a handful of wealthy industrialists, who would stand to lose from his income-redistribution plan.

U.S. officials hope the special “bridge” loans will allow the leading debtor nations to continue to enjoy the political stability needed to keep their economies afloat.

To be sure, relaxing the previous insistence that troubled debtor countries keep devaluing their currencies could cause some countries to slip in their fight to improve their balance of payments positions and become more deeply mired in debt. When a country’s currency is too high in value, imports become too attractive to consumers while its own exports become uncompetitive.

However, policy-makers hope to offset some of that effect by prodding the countries to make even greater efforts to streamline their domestic economies.

The U.S. effort at fine-tuning its debt strategy comes as the clamor for even more radical changes is building, both here and around the globe.

Contending that Third World nations must have more money free to boost their sagging economies, critics are calling for more radical relief that for the first time would enable debtor countries to reduce the actual size of their huge obligations and ease their burden of payments.

Earlier this month, Japan proposed a plan that would allow the debtor nations to convert their loans into long-term bonds and sell them to investors to get more breathing room. A plethora of alternative plans has also surfaced.

Although the United States angrily protested the Japanese approach, France and the management of the IMF have supported it. At least on the surface, momentum in that direction appears to be building.

“There’s something new on the table, although it’s still somewhat vague,” says Peter Hakim, director of the Inter-American Dialogue, a Washington-based group that keeps close tabs on the debt problem. “There’s an increasing consensus that these countries don’t have the resources to grow. And the money won’t come from the banks.”

Providing added urgency is that Brazil and Argentina, two of the biggest Third World debtors, are scheduled to hold elections next year, and both races feature leftist-populist challengers who are threatening to halt loan payments if they are elected.

Increased Willingness

With pressure mounting for a change, U.S. commercial banks so far have remained split on how to respond. John S. Reed, chairman of Citicorp, contends that the present debt strategy of helping keep nations’ current on their interest payments is working and needs no refining. “My own feeling is that the debt situation is going to resolve itself over the next several years,” Reed said in an interview recently. “I don’t see the American government’s role as being any different.”

Large American banks also have shown some increased willingness to reduce Latin countries’ debt burdens--by agreeing to discount some of their existing loans in exchange for new bonds, cash or equity investments--partly as a confidence-building move to head off any further decline in the banks’ own stock prices.

This year about $22 billion worth of Latin America’s $350 billion in foreign bank debt will be written down in value in this fashion--four times the total last year. And commercial banks--Reed’s has been the most conspicuous--have sharply increased the reserves they have set aside to cover bad Latin loans. They now have about 30% of the total covered--up sizably from previous years.

Last month, a commission of senior bankers headed by Anthony Solomon, former president of the New York Federal Reserve Bank, formally called for “negotiated debt reduction” to help ease the burdens of developing countries. The implication was that banks may now be willing actually to incur losses on a portion of the debt--in return other incentives.

The problem is, the bankers want more help from the United States and other industrial nations, either in tax breaks or in government aid to debtor countries and the United States is balking at that.

Populist Factions

At an IMF meeting earlier this month, U.S. Treasury Secretary Nicholas F. Brady warned that for governments to step in and assume more of the banks’ risk in the international loans would only “undermine” hopes that debtor countries’ finance ministers would be able to push through the needed economic reforms. Most are battling populist factions that oppose their restructuring programs. Other major industrial countries, such as Britain and West Germany, agree.

But debt analysts say no matter which candidate wins the next election in the United States, which traditionally has taken the lead in setting world debt policy, changes in strategy are likely.

The United States will have to prod banks to provide more new loans to Latin American governments. It will have to push to overhaul the IMF and World Bank to make them more responsive to the debtor nations’ political needs. And it will have to rally U.S. political support for existing Latin American democracies.

“The debate will continue, but my sense is that you’re going to have more of a resolution than a solution,” says Inter-American Dialogue’s Hakim. “They’re not going to eliminate the debt problem, but they will move in the direction of providing some greater relief.”

FOREIGN DEBT SCORE CARD

Total Debt Interest as % of exports: Nation (in billions) 1982 1987 Brazil $121 57 34 Mexico 107 31 29 Argentina 55 55 55 Venezuela 32 21 26 Chile 20 49 26

Source: Institute for International Economics, Economic Commission for Latin America