Foreign Relations of the United States, 1961–1963, Volume IX, Foreign Economic Policy

132. Memorandum From the Administrator of the Agency for International Development (Hamilton) to President Kennedy⁰

Washington, February 9, 1962.

SUBJECT

• Terms of AID Development Loans

This memorandum sets forth the background against which AID loan policy has evolved, gives our conclusion as to present AID policy and plans, outlines the advantages of such policy and the principal objections thereto, and states our proposals to deal with those objections.

Background. The Development Loan Fund was established in 1957 as a means of shifting U.S. economic assistance to the extent possible from a grant to a loan basis and of emphasizing assistance to promote economic development. At the beginning DLF loans were almost entirely repayable in local currency in order to avoid burdening the balance of payments of the less-developed countries which in turn would have adversely affected the operation of the IBRD and the Export-Import Bank. The IBRD and the Export-Import Bank had been in operation for many years and both were engaged in development financing on terms which have come to be regarded as “conventional,” and which are determined by their sources of lending funds, by the Articles of Agreement in the case of IBRD, and by U.S. legislation in the case of the Export-Import Bank. These terms provide for dollar payment, interest at 5-3/4 percent (presently) and maturity based generally on the estimated productivity of the project or generally in the range of 15-25 years. Again in 1959 consideration was given to making DLF loans repayable in dollars, although on more favorable terms than the IBRD and the Export-Import Bank. Eugene Black objected to substantial dollar repayment of DLF loans on the ground that loans on this basis would so consume loan repayment capacity of less developed countries as to make it impossible for them to gain access to private capital or to borrow further from IBRD, Export-Import Bank or from other Western country lenders. This view prevailed and DLF credits continued to be generally made repayable in local currencies with maturities comparable to those of IBRD; an interest rate of 3-1/2% was provided for economic overhead projects but other lending was generally at 5-3/4%. Such loans were substantially like grants from the point of view of impact on the balance of payments of developing countries because they were repayable largely in local currencies; unlike grants, however, they did impose the discipline of scheduled repayments on the internal finances of the borrowing countries.

The 1961 AID loan legislation required repayment in dollars because of the problems inherent in the accumulation of large amounts of local currencies derived not only from DLF loans but from other U.S. programs, such as the very large agricultural surplus sales under P.L. 480. Some currencies were being acquired in amounts far in excess of our prospective needs and of their usefulness in further programs in the countries concerned. Moreover, other countries became disturbed by the relatively large accumulation by the U.S. of their currencies. To reverse this trend, then, the AID legislation was established to provide dollar repayment on development lending. Since such lending was to be of greater significance in the future and since the ability of less-developed countries to service dollar indebtedness is generally minimal, it was proposed that loan service terms would be established to impose as light a burden as feasible on the present balance of payments of recipient countries and to permit repayments to be effected over a long term at times when the development efforts of such countries would show greater progress. It was therefore felt that it would be better to obtain a smaller annual service return in dollars than the larger returns in local currency previously in effect. Congress was fully advised and understood that such loans would be made on very liberal terms. For example, in your Foreign Aid Message, it was stated that “the single most important tool will be long-term development loans at no or low rates of interest.”

Conclusion. Our policy review has led us to conclude:

1. A loan term policy with flexibility for special cases, but based primarily on loans at 40-year maturity, 3/4 of 1% credit fee in lieu of interest and 10-year grace period, would best serve United States foreign policy objectives of fostering long-term economic development and stable governments in friendly less-developed countries. It would be our intention, as individual recipient countries improve their payments position, to shorten the maturities rather than raising interest rates or credit fees until such time as it is possible to shift to conventional terms completely.

2. The United States should reserve the right to renegotiate with respect to shortening the maturity of loans at the end of the 10-year grace period.

3. The problem arising out of the difference between liberal AID loan terms and harder terms of other Western country lenders is best dealt with by continuing to exert pressure on such countries to soften their terms.

Advantages of Aid Policy. The considerations that lead us to support such an AID loan policy, with very liberal terms, include the following:

1. As a group the underdeveloped countries face serious balance-of-payments difficulties which are likely to persist for many years. The percentage of their exports which must be used for the repayment of foreign debt, public and private, is large and growing. As our aid expenditures and those of other countries increase—as they must if we are to achieve our development objectives—the problem of financing repayment of debt will become increasingly serious. The attached charts, although not completely up to date, illustrate these trends.

2. AID loans must be on liberal terms if they are not to impair the operations of IBRD and the Export-Import Bank, and private investors. If AID terms are hardened the debt-service burden of less-developed countries will become further strained, and the borrowing countries will not be able to meet required payments to the various lending institutions or make other required external payments. AID can best carry on its work as a source of capital needed by countries which cannot obtain sufficient conventional financing and for activities for which conventional financing is not available. Substantial hardening of AID terms would make most questionable the extent to which IBRD and Export-Import Bank could participate in loans such as those to India and Pakistan in the recent consortia. Our objective of stimulating a greater degree of development depends upon providing capital additional to that which is available from conventional sources. If this cannot be accomplished on a dollar-repayable loan basis, the alternative would appear to be to return to grant aid or local currency repayment.

3. Development loans frequently finance basic economic infrastructure projects which typically do not generate exportable wealth sufficient to repay the loans for many years.

4. It is our judgment that the most effective way to induce other lending countries to ease the terms of their loans is not to harden our terms to correspond more closely to theirs, but rather to continue to emphasize the discrepancy between our terms and theirs. We have succeeded in persuading other countries (notably Germany) substantially to liberalize their lending terms. Retreat from our liberal policy would also hamper Eugene Black’s efforts to induce an increase in the country contributions to, and thus the loan capacity of, the International Development Association (IDA) which extends loans with 50-year maturities, a 3/4 of 1% credit fee in lieu of interest and 10-year grace periods. The present hard currency capitalization of IDA is about $760 million. The United States share is about 42%, the other industrialized countries putting in 54% and the less-developed countries 4% of the hard currency resources.

5. If AID loan terms approach those of IBRD or Export-Import Bank, Congressional opponents of the AID program will argue that AIDdevelopment loan authority constitutes a duplication of effort and can be eliminated, leaving IBRD and Export-Import Bank to carry our entire development financing load—a task they cannot perform.

6. Liberal AID loan terms, generally based on 40-year maturity and 3/4% fee, permit the United States: (a) to induce long-term development planning, including self-help; and (b) to provide loan terms consistent with the limits on the dollar repayment capacity of less-developed countries; and (c) to respond to other foreign policy considerations where appropriate.

7. Liberal AID terms tend to offset such detrimental effect on borrowing countries as might arise from our balance of payments policy of requiring American procurement with respect to commodities for which the United States price is substantially higher than the world price.

Objections to AID Policy. The two principal objections to a liberal loan policy for AID are:

1. Present loan agreements fail to make provision for hardening of loan terms if the borrowing country’s dollar repayment capacity unexpectedly improves, as in the case of Libya with its newly discovered oil reserves.

2. Liberal AID loans at least indirectly enable the borrower to repay loans made on harder terms by other Western countries. In this connection, however, it should be recognized that much of our lending is done by Export-Import Bank. This year Export-Import Bank may lend on its relatively hard terms as much as one billion dollars—almost equal to the total AID lending authorization. If Germany were to be persuaded to make half of its loans on relatively hard terms and half on soft terms comparable to those of AID, its total lending policies would be comparable to ours. It should be noted that in the case of France, about 85% of French economic aid totalling over $1 billion annually, mostly to the franc area, consists of outright grants.

Proposals to Deal with Objections.

1. We propose to deal with the first objection by requiring each borrowing country to agree that the United States reserves the right at the end of the grace period to renegotiate the maturity of the loan if conditions in the borrowing country, including its then existing and prospective dollar earning capacity, indicate that acceleration of repayment is feasible. Changes in the terms would require mutual consent. Furthermore, at any time that aid is no longer required because of dramatic changes in the recipient country, we would cease making liberal term loans.

2. We propose to deal with the second objection by continually pressing other countries further to liberalize their loan policies, so as to approximate as closely as possible the terms presently granted by the United States. To this end we are considering requesting a DAC Ministerial Meeting to be held in Paris in the spring at which we will again urge DAC countries to further soften loan terms. We would plan to follow up such a meeting with a second meeting in Washington in September at the time of the meeting of the Board of Directors of IBRD, at which we are hopeful more progress will be made in obtaining commitments by DAC countries to increase their development lending and still further to liberalize loan terms. Eugene Black has indicated his willingness to use his good offices to facilitate these ends in view.

Fowler Hamilton

0. Source: Washington National Records Center,RG 286, AID Administrator Files: FRC 65 A 481, Development Financing, FY 1962. Official Use Only. The source text, which was sent through the Secretary of State, bears the notation “DR per GWB” in the Secretary’s handwriting. Three charts and two tables of statistical material attached to the source text are not printed.