Latin Nations May Be Facing Political Crisis as Economic Troubles Deepen

Imagine a Latin America ruled by leftist governments that are hostile to the United States: Debtor countries there default on loans to big U.S. banks. And some $40 billion in American exports are no longer welcome.

That bleak scenario is fiction so far, but many analysts believe that it may be closer to becoming reality than at any time in the past decade

After years of trying to cope with their massive foreign debts, Latin American countries are still being choked by hyperinflation and seemingly endless stagnation.

Worse yet, the region is embarking on a series of crucial elections, and the debt situation has increased the chances of gains by radical political parties. Both Argentina and Brazil are facing major challenges from leftist groups in presidential elections later this year, and Venezuela has just suffered a series of riots that left more than 300 people dead. Even Mexico is undergoing internal political strains.

“It’s clear that there’s a growing, burgeoning political crisis in Latin America,” says Peter Hakim, director of the Inter-American Dialogue, a Washington-based forum for U.S.-Latin American relations. “You’re seeing the moderate, pragmatic leaders who have been holding the reins for the past several years facing strong challenges from the Populist left. Things aren’t likely to get better very soon.”

To help ease the economic pressure in the region, Treasury Secretary Nicholas F. Brady has proposed a Third World debt-relief strategy that is designed to coax commercial banks into negotiating debt-reduction schemes with Latin countries. Senior U.S. officials have portrayed it as a major new step toward resolving Latin America’s debt problem.

The plan, still in outline form, will be the No. 1 item on the agenda this morning when finance ministers and central bankers of the major industrial nations--the United States, Japan, West Germany, Britain, France, Italy and Canada--meet for a periodic review of the world’s major economic problems. Governors of the 151-country World Bank and the International Monetary Fund will begin debating the proposal Monday.

‘Doesn’t Add Up’

So far, however, the plan seems to be raising more questions than it has resolved--chiefly, whether it would genuinely help Latin America or leave the region’s governments hanging dangerously out to dry.

Alan J. Stoga, a global debt expert at Henry Kissinger Associates in New York, calls the plan so inadequate that it would provide debtor countries with “serious incentives to move to financial anarchy.” It “simply doesn’t add up,” Stoga asserted.

What concerns critics most is the fear that debt reduction alone--as the Brady plan envisions--simply will not provide enough relief to enable the region both to meet its annual bills for debt service and to sustain economic growth.

Former Federal Reserve Board Chairman Paul A. Volcker points out that every dollar in debt reduction translates into only a 10-cent trim in annual interest payments. Slashing the debt burden of Mexico, which owes foreign banks about $62 billion, by one-third would yield barely more than $2 billion in reduced interest payments--less than half of what Mexico says it needs merely to meet its current bills.

Moreover, many investors in Latin America have been shipping their money to safer havens abroad. But Brady’s insistence that debtor countries reverse the outflow of capital before they can qualify for debt reduction would require them to adopt austerity programs far more stringent than those now demanded by the IMF as a condition for its loans. And that might be more than most Latin governments could deliver.

Demanding that debtor countries stem capital flight before qualifying for further help “is like saying, ‘Why don’t you fly without wings,’ ” says Rudiger Dornbusch, a Massachusetts Institute of Technology economist.

As a result, some critics fear that unless the Brady plan is modified, it could push Latin governments closer to defaulting on their foreign debt. That in turn could prompt them to close their markets to foreign investment and imports and to radicalize themselves politically.

Dornbusch brands the Brady proposal “a cover-up for a U.S. retreat” from management of the global debt problem. “And that means a debt moratorium for several years,” he asserts, “until the debtors and creditors have reached a common denominator again.”

Major Leadership Test

The controversy, which comes at a time of mounting political unrest in Latin America, demonstrates that the Third World debt situation has evolved from a financial and economic problem to a geopolitical one.

And at the same time, it is rapidly turning into a major test of U.S. leadership in the Western Hemisphere.

Only three years ago, when James A. Baker III, Brady’s predecessor as Treasury secretary, developed his strategy for dealing with Third World debt, other countries had little choice but to go along.

The Baker plan called on U.S. banks to step up their Third World lending in return for new efforts by the debtor countries to reform their economies. It produced mixed results, defusing the political unrest that had been building in Latin America but failing to prod U.S. banks into increasing their lending.

But now Japan is vying to be the linchpin of any new debt-reduction effort in hopes of garnering more political influence in Latin America, and it will probably put up a major portion of the money behind the plan. And the French are making no secret of their glee over the Japanese ploy. France has long been proposing grandiose schemes for Third World relief, only to be rebuffed by the United States.

Worst of all from the U.S. point of view, the debtor countries may prove disappointed by the Brady plan.

The Bush Administration’s public announcement in December that it was conducting a major review of the previous debt strategy raised expectations throughout Latin America. The Brady plan has failed to fulfill them, and even Mexico, which could well be the biggest immediate beneficiary of the plan, has been cautious in praising it.

William R. Cline, a debt specialist at the Institute for International Economics in Washington, warns that if the debtors believe the plan is inadequate, it “could undermine the Treasury’s political capital” and “lead to a more confrontational approach” by the Latin governments. Cline says the Treasury must press U.S. banks to step up their lending, not to walk away from the region.

Despite the disappointment, however, the Brady plan marks a turning point in the management of the 7-year-old Third World debt problem. In at least three major respects, it departs significantly from the Baker plan:

It declares that commercial banks must begin serious efforts to reduce the Third World’s debt by writing down some of their loans to the debtor countries--a step that the banks could not have taken very easily before they rebuilt their own reserves from their 1982 levels. Hakim, of the Inter-American Dialogue, said such a move would “end the notion that all people are sacrificing for is the commercial banks.”

It proposes using taxpayer-provided money--from the IMF and World Bank--to help finance new debt-reduction arrangements. Debtor countries could give banks new, higher-interest bonds in exchange for buying back a portion of their current loans at a discount, and the two international institutions would effectively guarantee the new bonds.

It calls for revamping bank regulations, tax laws and accounting rules in each of the major creditor countries to make it easier for banks to write down their questionable Third World loans without suffering substantially reduced earnings. The prospect of large losses has been a major factor in discouraging such bank discounting.

Lending Would Be Cut Back

Treasury officials insist that the plan will work. At a briefing last week, a senior Treasury strategist asserted that the proposals for reducing Latin countries’ debt-service burdens may prove far more effective in the marketplace than they have in economists’ models, particularly if they prompt banks to reduce the interest they charge debtor countries. “The leverages may be considerable,” the official said.

Critics counter that debt reduction alone cannot possibly meet Latin America’s needs. They argue that the way the Brady plan has been presented--as an alternative to bank lending rather than a supplement--virtually guarantees that commercial banks would cut back their lending. That, in turn, means that taxpayers in the industrial countries, through the IMF and World Bank, would have to finance most of the new money flows to Latin America.

More than that, critics fear that the Administration’s highly publicized review of the debt problem has already raised expectations so high in Latin American countries that governments there will have more difficulty than ever in imposing the wrenching measures that are needed to overhaul their inefficient economies.

In the view of most Americans, Latin governments still own too many of their key industries and corporations, which dampens industrial efficiency and saddles the governments with huge losses. The region’s trade and investment policies are viewed as antiquated, and most analysts agree that the Latin nations would not be able to grow even if they had no debt.

Reversing these inefficiencies usually means hardship for the public. Governments must slash spending for public services, curb borrowing by money-losing state-run enterprises and sell what corporations they can to private investors. They must also eliminate costly government subsidies on a wide range of goods and services, a process that usually results in sharp price increases for utilities, gasoline, steel and financial services.

Mexico has tried the hardest. Over the past several years, the Mexicans have slashed the governmental operating deficit by a staggering 10% of total economic output--the equivalent of a $500-billion spending cut in the United States. Inflation in Mexico is a relatively mild 19%.

But political opposition has prevented President Carlos Salinas de Gortari from devaluing the peso enough to keep the economy on track. Almost alone among the big debtors, Mexico has slowed the flight of capital--but at the cost of sky-high interest rates, which discourage economic growth.

Brazil has been through five major austerity programs, only to bow in the end to Populist demands for higher wage increases and other spending. Although Brazil’s trade surplus last year reached $19 billion, inflation hit 1,000% last year. Government spending is out of control, the economy still is heavily state controlled, and monetary policy is loose.

Riots in Venezuela

Argentina also has tried several times--and failed. The government has still not reined in spending sufficiently, and the country continues to discourage exports and keep economic control in the hands of the government. The railway system alone loses the equivalent of 1% of the country’s entire output each year.

Venezuela, despite its recent riots, is the Latin American country least burdened by foreign debt--and it has done the least to put its house in order. Last month’s riots were a reaction to “austerity” measures that other Latin countries carried out long ago--the price of gasoline, for example, was doubled to 25 cents a gallon.

For the United States, perhaps the most pressing question now is how quickly it can put a new debt-reduction plan into effect to help blunt the growing political unrest in Latin America. Treasury officials concede that it could be months before all the details of the Brady plan are worked out, after the new round of Latin American elections begins.

The Inter-American Dialogue’s Hakim suggests that the United States could buy some time by moving rapidly and visibly to aid a deserving debtor country, such as Mexico, as a signal to the region that some help is on the way. Indeed, there are signs that the Treasury may be planning just such a move.

“Six years of austerity has produced a belief in Latin America that further austerity won’t get results,” Hakim asserts. “What’s needed is to demonstrate, through Mexico, that these kinds of policies work.”

LATIN AMERICA’S DEBT PROBLEM

1988 figures are estimates.

Total foreign debt Interest payments as Consume (billions of dollars) percent of exports inflat Nation 1982 1988 1982 1988 1982 Argentina $44 $60 50% 41% 165% Bolivia 4 5 43 32 133 Brazil 86 116 53 28 98 Chile 18 19 45 17 10 Colombia 10 18 22 22 24 Ecuador 7 11 30 34 16 Mexico 91 102 44 27 59 Peru 11 18 24 39 64 Uruguay 4 6 20 24 19 Venezuela 34 33 22 24 8

r prices ion rate Nation 1988 Argentina 335% Bolivia 17 Brazil 520 Chile 14 Colombia 27 Ecuador 55 Mexico 114 Peru 650 Uruguay 61 Venezuela 28

Source: The Institute of International Finance

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