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

156. Action Memorandum From the Chairman of the Policy Planning Council (Bosworth) to Secretary of State Shultz¹

Washington, March 2, 1984

SUBJECT

• The Next Round of Debt Problems

This memo 1) analyzes the effectiveness of the USG policy on LDC debt and 2) seeks your approval to develop specific options for enhancing medium-term official flows—mainly for a group of second-tier countries such as Peru, the Philippines, Nigeria and Morocco. These countries are not as serious a threat to the world financial system as Mexico and Brazil, but their fragile societies are more likely to crack under the pressure of sustained adjustment, threatening our foreign policy interests.

Potential Problems in the Debt Strategy—1984–1986

The USG debt strategy approved last April has so far provided an adequate framework for dealing with the problem.² The two major Latin American debtors which were considered a threat to the world financial system—Mexico and Brazil—have begun to stabilize their economies; Argentina and Venezuela have had successful elections; and the crisis atmosphere which prevailed in early 1983 has abated.

Despite the relative calm, we believe some key elements of our five-pronged approach are falling short of expectations. Specifically, we are concerned about slippages in both actual and potential performance in the following areas covered in the policy:

— Lending by commercial banks to many LDCs is barely adequate. Morgan Guaranty estimates gross new lending (bank credits and bonds) to the LDCs for all 1983 at $35 billion, down 24 percent from $47 billion in 1982. OECD estimates indicate a similar trend with net lending falling from $35 to $22 billion between 1982 and 1983. These estimates are broadly consistent with the $20–$25 billion in annual net flows of new money many observers believe is necessary over the medium term. Nonetheless, we seem to be at the low end of the viable range and much of the 1983 lending was “extracted” from the banks by the IMF and creditor governments for the benefit of the major Latin American debtors.

Despite the fall, it appears that almost all the LDCs involved in IMF programs were able to find sufficient resources to close their IMF-estimated financial gaps in the balance of payments sense. It is clear, however, that in many cases the lack of available financing often made the gap smaller than desirable and forced additional import compression with its subsequent effect on economic growth. Projected trade-weighted average GDP growth for the seven largest Latin American countries is –3.9 percent in 1983 following a .9 percent fall in 1982. The prospects for 1984 are not much better.

— The industrial countries are facing increasing difficulty in providing levels of official finance to support the adjustment process. For the U.S. this represents a combination of Congressional resistance and the Administration’s reluctance to increase significantly the levels of IDA financing and guarantee authority for the CCC and EXIM. For example, our CCC allocation is small, and there is only $77 million in reserves to plug any emerging debt problem or to fulfill the expectations of such politically important countries as Portugal. Our ability to help next year will be even more limited with the recent Presidential decision not to use CCC guarantees for balance of payments financing in FY 85.³ In the case of EXIM guarantees, there are doubts that these are an effective source of funds for the LDCs. For example, the low level of Mexican growth and investment has left a large portion of EXIM credit lines underutilized. Thus there is a problem with the current level of official finance as well as its effectiveness.

— The strength of the OECD recovery has thus far improved LDC export revenues only modestly. And despite recovery, there has been a very weak cyclical response in commodity prices, stalling efforts to increase revenues by countries dependent on commodity exports. For exporters of metals and tropical agricultural products in particular (Peru, Philippines, Chile, Morocco), prices remain extremely depressed.

A more general question regarding OECD growth trends is whether average annual growth will be in the 3% range over the medium term. This level is assumed necessary by most scenarios, including those by Cline, Morgan Guaranty and the SIG–IEP assessment which underpins the U.S. policy, to allow a reduction in debt service ratios and the resumption of moderate growth in the LDCs. OECD growth for 1983 is expected to be 2¼% and 3½% in 1984, with the strongest performance in the second half of 1983 (4¾%) and the first half of 1984 (3¼%). Beginning with the second half of 1984 and through mid-1985, the OECD forecasts a 2½% annual rate of growth with considerable uncertainty for the period beyond. Treasury and Wharton estimates of OECD growth for 1984 are a little more optimistic, but still leave little margin for error. Even with recovery, unemployment is expected to remain a problem, particularly in Western Europe. This, combined with the over-valued dollar, will encourage the growth of protectionism in Europe and the U.S., complicating an export-led recovery in the LDCs and our domestic political situation.

— We are also concerned about the nature of LDC adjustment. In most high-debt countries the structural reforms necessary to break the link between public sector deficit spending and growth have not made much headway. Thus far domestic adjustment has taken place almost exclusively in external accounts, resulting in nearly all cases from sharply curtailed imports due to a mix of official controls, devaluations and currency controls, and lower demand from negative or weak levels of domestic output.

Longer-Term Effects on Development Strategy

By focusing on the short-term needs of individual countries, the current U.S. policy does not address the impact of sharply reduced levels of commercial bank financing on LDC development strategy and growth prospects. Our concern about the lack of resources is not directed primarily at the major debtors or even at the majority of debt-burdened LDCs. Mexico and Brazil probably have enough economic leverage to extract greater concessions from the IMF and banks if the adjustment path is too tough. Except for the Philippines, nearly all of South East Asia as well as Turkey have weathered the debt storm and should be able to manage their medium-term futures. And the poorest of the LDCs face different barriers to growth and development.

However, several second-tier countries, including Peru, Chile, Morocco, and Nigeria do not have the same leverage with the banks as do Mexico and Brazil, although their relative needs are as great and they are dealing with volatile political situations. Alternative sources of funds will be required for these countries until prospects for borrowing development capital on private markets improve—which will likely be many years. Until then, increasing medium- and long-term official credits and assistance in tapping credit markets on appropriate terms can improve their mid-term economic and political outlooks. One option is to expand temporarily the role of existing multilateral institutions, principally the World Bank, as a means of addressing the burden sharing issue among developed countries and of enhancing official flows for the structural adjustment required in LDCs. Your attention to these issues may be required to underscore the foreign policy risks of failing to address the capital needs of the second-tier LDCs while they adjust their economies.

If you agree that there are weak areas in our current policy, we and EB would like to examine the options for improving medium- to long-term official flows to the LDCs and to focus on the needs of the second-tier countries.⁴

1. Source: Department of State, Executive Secretariat, S/P Records, Memoranda/Correspondence From the Director of the Policy Planning Staff to the Secretary and Other Seventh Floor Principals, Lot 89D149: March 1–15, 1984. Confidential. Drafted by Barbara Griffiths (S/P); cleared in S/P. A stamped notation reading “GPS” appears on the memorandum, indicating Shultz saw it. Hill initialed and wrote the dates “3/5, 3/21, 3/22” on the memorandum. An unknown hand wrote “SB noted on a cy to PB that it looked like we had go ahead. 3/26/84” and a line was drawn through this note.
2. See Document 138.
3. A December 13, 1983, memorandum from Darman and Fuller to Block and Stockman and copied to Meese and Baker forwarded Reagan’s handwritten approval of “Option 4” on the Agriculture/CCC budget decision. In the memorandum, Darman and Fuller explained that after 1984, Reagan “directed that the CCC budget be set at $3 billion. Balance of payments assistance should be sought separately as part of our foreign assistance program.” (Department of State, Files of the Under Secretary of State for Economic Affairs, W. Allen Wallis, Chrons; Memo to the Secretary/Staff and Departmental/Other Agencies: Memos to the Files; White House Correspondence, 1987–1987, Lot 89D378: Memoranda to the Secretary 1984 #1, Jan–June)
4. Shultz initialed the “Approve” option on March 24.