Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

149. Paper Prepared in the Department of the Treasury¹

Washington, undated

RESPONSE TO NSC “PROGRAM” TO DEAL WITH THE INTERNATIONAL DEBT PROBLEM

The following are paragraph-by-paragraph comments on the NSC “program” to deal with the international debt problem, hereinafter called the “program”:²

1. What are the “increasing number of indications” (since NSDD–96 was issued in June 1983)³ that the debt problem is “becoming a systemic structural financial crisis?”

The statement that “countries are going out of compliance with IMF programs” is incorrect. There are 45 IMF programs and only three countries technically out of compliance. Even if two or three more which are working to stay within compliance are included, it is safe to say that there are more countries with IMF programs, as well as a higher percentage of countries with programs that are in compliance, than in the past few years. For example, in December 1982 there were only 33 programs—12 less than today—while 6 of those programs were technically out of compliance, with a few others, as now, experiencing difficulties.

The statement that additional funds are being required within months of an additional rescue package is untrue. The only “packages” were for Mexico and Brazil. The Mexican program appears to be proceeding, if anything, better than expected and it was envisioned that Brazil would need another massive package at the time the last package (projects 1–4) was put together. Project 4, the interbank deposits, was known to be the most difficult one to achieve but there is nothing in the Brazilian situation to indicate that the problem is incrementally larger than what was expected. Likewise, it has always been known that the belt tightening economic adjustment process would create problems in the LDCs, but it was also recognized that there was no alternative to such adjustments.

The statement (less than six months after NSDD–96) that the present case-by-case approach will not suffice is unsubstantiated. We do not know what the effect of a major OECD recovery will be as it has not yet occurred. There is no analysis in the program of the impact on the world banking system if it were required at this moment to grant more drastic debt relief than that being undertaken. In addition, the program ignores that for the big debtor countries almost the entire debt is commercial bank debt and that what governments do with official debt will have little, if any, impact.

As to the points for systematic program of action, our reply would be as follows:

1. There are mechanisms in existence for the coordination of creditor government actions.

2. The IMF is at the center—setting out a basic adjustment program for the countries and trying to identify additional sources of financing if needed.

3. In addition, the G–5 finance ministers or their deputies are meeting approximately every other month and a group of special debt deputies of the G–5 has been set up to meet periodically and to deal with the problem by phone on a day-to-day basis.

4. The Paris Club has proven adequate for the rescheduling of official debt. There is no justification given for a multi-year rescheduling for official creditors. Rescheduling can be done with the expression of intention to reschedule in future years but the extent of rescheduling needed would depend on outside factors, such as adjustment or world growth. In addition, it is hard to see how official creditors can deal with their debt differently from the private creditors without it being justifiably claimed that the official creditors are bailing out the banks. Any multi-year action by official and private creditors will take pressure off the debtor countries to make the necessary adjustments so that when the debt does come due they will be unprepared to deal with it.

5. The same is true of interest rate adjustment or forgiveness, as one cannot expect the banks to turn into charitable institutions. It is true that they need to look at reducing the spreads over LIBOR and are in fact doing so, but at the same time they have to consider whether this will deter lending by the medium size banks.

Proposal 1C, forgiveness of the debt of the poorest countries, which may be a virtuous proposal, has nothing to do with the debt problem, as the debt of the poorest countries is almost entirely debt to official creditors.

Proposal 1D: There is coordination of provision of additional funds as was done for Brazil before the recent IMF meeting:⁴ First, through the debt deputies, then the G–5, and then the G–10. There is no indication that any of the governments are willing to provide funds to the large debtor countries, other than in the form of export credits, and even export credits are only reluctantly agreed to by several nations.

Again, with a net flow of funds to the Banks (under the Brazilian program, for example, more than $5 billion to the banks through the end of FY 1984), it is hard to see how the governments would come up with new money while the banks are receiving interest payments. The banks would be asked to stop receiving interest, but then it is hard to see how they would continue to provide financing for a country or why they would then refrain from trying to take legal action to get whatever legal repayments they could get.

Proposal 2 is very much what the multilateral development banks (MDBs) do. There is, however, a limitation on the absorptive capacity of countries for projects. Those that might have the greatest capacity, such as India and China, are not part of the debt problem and they still have the availability of commercial financing for their projects. It is difficult to see how the MDBs could justify doing a less economically justifiable project in a high debtor country just because it is a high debtor country.

As to Proposal 3, we have encouraged co-financing and syndications of bank financing and the MDBs are not being limited by restrictions but more by the fact that countries having to cut enormous budget deficits are having to cut back on some of the development projects.

As to Proposal 4, Eximbank does provide financing in almost all the LDCs. Ex-Im has stated that where there are valid requests for financing, Eximbank financing remains available. Where there is a valid IMF program, such as in Mexico, the U.S. Government, with Eximbank, is developing methods to advertise the availability of Ex-Im financing.

As to Proposal 5, it is unclear why these particular forms of U.S. Government subsidies should be promoted over any other subsidies to U.S. business. Again, however, if it looks as if there is a serious problem for countries who are making the effort to adjust with IMF programs, the suggestion could be examined, but experience so far shows where there is an IMF program, banks will finance and without one the financing would be throwing good money after bad.

As to Proposal 6, other creditor governments are even reluctant to provide export credits and they are certainly not prepared to increase their own deficits by providing the sorts of funding suggested. Basically, they see the situation as a problem for the countries that need to adjust for the private banks.

As to Proposal 7, all of 7 seems to run totally counter to U.S. philosophy and certainly to the Reagan Administration’s philosophy. We do not tell our banks what to do. When we start doing that, we will have to guarantee the results and essentially end up having the government run the banks. How private banks’ debt is rescheduled is a matter for the private banks, not the government, to determine. The kind of loans banks make is a decision for the banks. It is not for the government to insist on short-term trade credits. Medium and long-term loans might be more essential.

The amortization of front-end fees is dealt with in the IMF Bill. Question of front-end fees is largely an accounting question that matters to regulatory authorities but is of little interest to LDCs, who are mainly concerned with effective rate, not with whether it derives from contractual interest or from fees. A reduction of fee, however, would not necessarily mean reduction of overall interest.

As to Proposal 7D, the grace periods and the financial maturities are being extended and if at the end of the period more time is needed, a further extension can be agreed to at that time.

As to Proposal 7E, at a point where several of the packages, such as Brazil and Argentina, are completed, the bank may want to explore ways of developing a secondary market on international debt instruments. But no reason is given why we must immediately start doing so now.

As to Proposal 8, the regulators are working on establishing rules for loan loss reserves, but it must be remembered that while banks should be encouraged in general terms to strengthen capital positions, including through loan loss reserves, regulators need to avoid steps which would unduly impede flow of appropriate amounts of new lending.

As to Proposal 9, there is no particular magic as to the percent of debt service requirement. Much depends on each country’s ability to take further steps to adjust. It is hard to see how a method could be devised to reward those which over-borrowed and punish those countries which have acted more prudently.

Conclusion

We fail to see what has happened of a systemic nature in the four month period since June that merits vitiating the U.S. international debt strategy that NSC staff themselves helped formulate. The agreed strategy in general is operating as foreseen, with particularly favorable developments on the element dealing with economic growth. Specifically:

(1) Borrowing countries are taking domestic adjustment measures to stabilize their economies. This remains at the heart of any international program. With varying degrees of success, the process has started.

(2) A major effort is underway to increase IMF resources; that institution’s lending (and lending of other international organizations) is tailored to specific national circumstances.

(3) Emergency situations are being dealt with.

(4) Private lenders are continuing to lend. As expected, this is occurring at lower rates of increase, and reluctantly in many but not all cases. IMF programs are geared to increased bank lending. The situation, country-by-country, is much better appreciated than a year ago. The full magnitude of the problems are very serious and all participants appear aware of them. This can be an element of strength.

(5) An upturn in world growth is beginning to take hold, led by the United States. Commodity prices are turning up. If world growth does not resume, the debt problem could become systemic, but this is not yet the case.

Debtor countries are recognizing the need for adjustment and the futility of seeking radical solutions. Maturities are being lengthened on a case-by-case basis. While major sovereign borrowers are seeking debt restructuring appropriate to their needs, they are not seeking a debt repudiation or long-term moratorium; the Caracas Debt Conference illustrated their determination to “work out” problems individually and to reject global or systemic type solutions.⁵

The priority actions identified in NSDD–96—prompt approval of IMF resources, international agreement to avoid protectionism, and exploring other possible steps with creditor countries (to improve data, improve the bank regulatory and supervisory environment, and better manage individual debt problems)—are all underway. Progress will not be easy or fast, but the processes are activated.

An interagency group has prepared a study for SIG consideration on the Government Role in Trade Finance;⁶ subject to conditions, the Export-Import Bank has increased resources for Brazil and Mexico. The G–5 itself and through deputies and debt deputies is more actively coordinating on individual country debt problems; U.S. and other bank regulators are attending meetings of the private banks’ coordinating groups on individual debt reschedulings.

All the above points respond to NSDD–96. The bank regulatory agencies’ proposals in connection with the IMF legislation also mean that increased guidance and prudential concern will be a factor in future commercial lending without directly interfering with decisions of the market place.

NSDD–96 correctly foresaw that in pursuing the U.S. strategy, all elements of the Executive Branch should “recognize its medium-term nature and the fact that some turbulence, both in markets and in countries facing debt problems, must be anticipated in the near term.”

Many of the points included in the NSC memorandum are encompassed in the existing strategy and steps currently underway, but a non-selective “systemic program” to deal with an alleged “systemic structural crisis” goes beyond the NSDD findings and the actual facts of the current situation. It overlooks the progress and increase in confidence achieved since the Toronto IMF meeting in 1982 (when Mexico was the problem, and Brazil had not even surfaced).

The NSC program would tend to interpose the U.S. Government directly into the individual operations, decisions, and profits of U.S. commercial banks. Many of them are already undertaking actions similar to those proposed, but on a country-by-country basis, as circumstances warrant.

A rational appreciation of varying degrees of “turbulence” is necessary; the debt problem will be with us for some years to come. The strategy needs time to work. It may need some changing, but nothing indicates a need for that change now.

1. Source: Reagan Library, Roger Robinson Files, Chronological File, Robinson Chron 1983; NLR–487–10–4–23–1. Secret. The paper was forwarded under an unsigned October 14 covering memorandum from Robinson to Feldstein.
2. A copy of the program proposed by the NSC is in the Reagan Library, Norman Bailey Files, International Economics File, International Debt (09/17/1983–09/30/1983).
3. See Document 143.
4. Presumably a reference to the Annual Meeting of the Board of Governors of the World Bank Group and International Monetary Fund, which took place in Washington September 27–30. See Document 298.
5. A reference to the OAS Specialized Conference on External Financing, which took place September 5–9 in Caracas. Telegram 267204 to all OECD capitals and all American Republic diplomatic posts, September 20, reported on the conference. (Department of State, Central Foreign Policy File, Electronic Telegrams, D830542–0594)
6. See footnote 2, Document 152.