Bailout With Brady Plan: Third World Last Chance

The logjam on global debt is breaking up. After years when debt policy moved like a glacier, there has been an avalanche of activity in recent weeks. The International Monetary Fund and the World Bank have resolved longstanding differences on how to coordinate their policies on debt; and, with last week’s vote, the 153 members of the IMF have moved, sort of, to endorse the Brady plan. Using language rarely encountered at the rarefied levels of international economic policy, an IMF communique urged progress on global debt “as a matter of urgency.”

This plan is more than Treasury Secretary Nicholas F. Brady’s debut on the stage of international economics--it marks an important turning point in the long-running debt debacle. Shocked by the human, economic and--perhaps most of all--the political consequences of a capital flow from the world’s poor countries to the rich, now running on the order of $35 billion per year, the powers-that-be in the international monetary system have determined the time has come to reduce the debt by up to $70 billion over the next few years.

The indications are that the program will get off to a quick start--again, judged by the tortuously slow standards that prevail in international politics. Many debtor nations have been “good” lately: That is, they have accepted the advice of international financial agencies and the United States: to restructure their economies, to reduce domestic consumption and to gear their economies to produce more cheap goods for export--all the while paying at least the interest on their foreign debt in accordance with the agreed schedule.

After months and years of wrenching economic pain, these countries are growing weary--they have had plenty of stick and would like a little nibble of carrot. Since some of these nations--notably Mexico, Costa Rica and Venezuela--represent important foreign-policy challenges for the U.S. government and since another one, the Philippines, is of critical importance to both the United States and Japan, one can expect that funds will begin flowing in at least some of these directions fairly soon.

But the world is not out of the woods on the debt question. The approach to debt now being tried is an uneasy compromise--satisfying neither creditors nor debtors. The elimination of $70 billion from a total debt estimated at $1.3 trillion will reduce indebtedness by less than 6% over the next few years. This could well leave debtor countries with higher interest bills in 1992 than they faced before the recent run up of interest rates.

There is no shortage of ideas for reducing the debt of developing countries.

“Debt-for-equity swap,” in which developing countries sell shares in their assets to foreign creditors, has been around for several years. “Exit bonds” allow banks to escape pressures to participate in new lending at the cost of lower interest rates. Other bonds have allowed banks to swap their current loans--at a discount--for loans whose principal is guaranteed. With developing country debts selling on the markets at discounts of up to 90% from face value, some debtor countries have begun quietly buying up their own discounted IOUs for a fraction of the face amount.

All these approaches have drawbacks. Exit bonds work best for small banks and can only play a minor role in the overall problem. Debt-for-equity swaps increase inflationary pressures in debtor countries and can be politically unpopular. Buy-backs of discounted debts reward countries with bad credit records because the discounts on their debts are greater than on those of more responsible countries. Mexico’s ambitious program to reduce its debt through principal guarantee bonds did not interest creditor banks that wanted security for their interest as well.

The new approach to debt is actually a family of approaches aimed at reducing some of the drawbacks associated with existing debt reduction programs. The most innovative feature of the Brady plan may turn out to be its least popular feature in the congresses and parliaments of the advanced countries: Taxpayers of the developed countries are being lassoed into the bailout efforts. The interest guarantees sought by creditor banks will be provided, in part, by the IMF and the World Bank. Since the World Bank and the IMF are ultimately backed up by their member countries, U.S. taxpayers may end up shelling out funds if Third World countries default.

This prospect opens the door to endless complications. The potential liability is enormous; even limited loan guarantees could impair the credit rating of the IMF and the World Bank. With $100 billion and more committed to the thrift bailout, an indefinite commitment to bailing money center banks out of their international debt portfolios further reduces the possibility that the United States will balance its budget before the millennium.

Worse, Congress may well balk at schemes to repay the loans of foreign countries to money center banks while family farms continue to labor under high loads of debt, and while, instead of bailing out troubled thrifts, the U.S. government closes them down. Why should Citicorp or BankAmerica benefit from government giveaways while farmers and smaller banks are forced to the wall?

The question is likely to be posed with some urgency in Congress; the chances are that any bailout plan will be slow to win approval and that awkward strings will be attached. Is the United States going to spend money to bail out governments that violate human rights? That engage in unfair trading practices against American companies? Perhaps it will, but not without an ugly political battle.

Meanwhile, developing countries will be chomping at the bit to expand the size of the bailout program, to make it more generous and to anticipate future write-downs of debt. The banks will get nervous, and when banks get nervous they dig in their heels, refusing to do anything at all. Thus even as the total amount of outstanding debt begins to shrink, debtor countries could be faced with a new cash squeeze, precipitating a new crisis.

The Bush Administration is well aware of these problems. One reason that the U.S. government opposed debt relief proposals for so long was its belief that debt relief was a step into a quagmire, not out of one. Now the Administration has conceded that it has no alternative--but that doesn’t make the new course less risky.

Much, if not all, of the Third World debt cannot, perhaps should not, be repaid. On the other hand, the Western economies cannot survive the collapse of the banks who made these ill-judged loans in the first place. The Brady plan, and its quick acceptance on the international scene, brings us no closer to the resolution of the difficult economic and political questions connected with global debt. We are likely to see many more proposals, many more new departures, and many more turning points before the debt crisis goes away.