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

193. Memorandum from Secretary of the Treasury Baker to President Reagan¹

Washington, October 29, 1985

SUBJECT

• U.S. Initiative on LDC Debt Problem

This memorandum summarizes the status of our initiative regarding LDC debt.

Background

In preparing for the IMF/World Bank annual meetings, it was apparent that we faced a deteriorating international economic and political climate, particularly in Latin America, which could have led to radical proposals to deal with the LDC debt problem and severe criticism of the United States. Garcia of Peru and Fidel Castro were visibly trying to recreate interest in some form of “debtors’ cartel.” While their proposals were generally viewed as extreme, responsible LDC leaders were nonetheless showing a declining interest in resisting the politicization of the debt issue.

As I discussed with you and Don Regan, it was essential that the U.S. present constructive proposals at the meetings which would respond to LDC concerns and defuse a potentially explosive situation. Accordingly, we worked closely with George Shultz and Paul Volcker to develop the proposals which the U.S. presented at the Seoul meetings.² The “Program for Sustained Growth” which I outlined builds on the case-by-case approach of the global debt strategy adopted in 1982/83 and initiates the next phase by focusing on the fundamental economic reforms necessary to achieve long-term, non-inflationary growth in the principal debtor countries.

The Program

The Program for Sustained Growth incorporates three essential and mutually reinforcing elements:

○ First and foremost, adoption by the principal debtor countries of comprehensive short and long-term economic and structural policies to promote non-inflationary growth and financial stability. The focus is on strengthening the economic foundation essential for preserving democracy in the key Latin countries which are having difficulty in obtaining financing from private markets. These countries are being asked to implement growth-oriented economic policies that will enhance reliance on market forces and the private sector. In this next phase, they would be expected not only to bring inflation and their balance of payments under control (as in the first phase); but also to adopt “supply-side” policies for longer term growth—policies that would re-attract flight capital and foreign investment, reduce the relative share of public investment, and provide market-incentives for long-term growth.

○ Second, a continued central role for the IMF, complemented by increased and more effective lending by the multilateral development banks (MDBs). We are seeking reforms by the World Bank and Inter-American Development Bank (IDB) which would permit a 50 percent increase in disbursements by the institutions to the principal troubled debtors over the next three years—conditioned upon the adoption by these countries of market-oriented policies for growth.

○ Third, increased lending by the commercial banks (both U.S. and foreign) in support of sound economic programs by the roughly 2½ to 3 percent annually or about $20 billion over the next three years, would reduce the risks to the banks by encouraging the sound policies by the borrowers necessary to improve the quality of outstanding loans. The banks have not been asked to write a blank check. The increase in lending is itself to be conditional—it would only take place in a context where conditions one and two above had been met.

Initial Reactions

The initial reaction to the U.S. proposals has been quite positive. We have avoided the politicization of the debt issue. And there is broad recognition among the countries, commercial banks and international institutions that there is no real alternative to a cooperative approach in which each must do its part for all to reap the benefits from increased growth. We are moving ahead quickly to build on the momentum that has been achieved by obtaining commitments by each participant.

Next Steps

In this context, we are seeking implementation of specific measures that provide a clear signal that each participant is willing to meet its responsiblities.³

○ Principal debtors. Our initial contacts will be with Argentina to determine their willingness to adopt a comprehensive program for growth that could be supported by the international community. Mexico has already begun negotiations on a new IMF program which will require courageous action by the government. We will follow the negotiations closely in order to be in a position to be as helpful as possible.

○ Commercial banks. Paul Volcker and I have been in contact with the banks regarding their participation. We anticipate a general statement of support in the near future although our plan leaves to the banks the means to implement the commitments to provide additional financing.⁴

○ International institutions. The World Bank and IDB have been told that U.S. support for capital increases is contingent upon adoption of reforms that improve the efficiency and quality of their operations. The IDB replenishment negotiations are scheduled to begin in January and provide a first test of the willingness of Latin countries to implement fundamental reforms in the institutions and their economies.

At this stage, the U.S. proposals do not require increased budget commitments—and we have made none. However, if all participants do their part and an increase in quality lending materializes, a capital increase for the IDB and World Bank will be necessary in due course. The timing and scope of the capital increases will depend on negotiations and Congressional action on the budget deficit. It is our intention that replenishments for the institutions should result in budget outlays which are lower than current U.S. commitments. Any costs to the U.S. would be substantially less than the consequences of dealing with a threat to the stability of the banking system.

In Sum

The U.S. proposals have served to strengthen our leadership role in the world economy and provide a positive approach to achieving sustained global growth. The successful implementation of the program should serve to ameliorate the political and social pressures in Latin America arising from the perception that the only solution to the debt problem was prolonged austerity and reduced living standards.

I am encouraged by the initial reactions. But, as of course you know, we are still a long way from having “solved” the third-world debt problem.

1. Source: National Archives, RG 56, Records of the Office of the Secretary of the Treasury, Official Files of the Executive Secretariat, 1985, UD–11W, 56–88–79, Box 62, Memo/Ltr for the President, Jan–Dec ’85. Confidential. “FYI” was typed at the top of the memorandum.
2. See Document 192.
3. Treasury staff developed a paper, “Program for Sustained Growth: Next Steps,” which provided more detail on the next steps for the international debt strategy outlined by Baker at Seoul. Conrow forwarded the paper and its annexes to Baker under an October 25 covering memorandum. (National Archives, RG 56, Records of the Office of the Secretary of the Treasury, Official Files of the Executive Secretariat, 1985, UD–11W, 56–88–79, Box 66, Memo to the Secretary, October ’85)
4. In an October 18 memorandum to Baker, Mulford summarized discussions held with bankers on October 17 on the U.S. international debt strategy rolled out at Seoul. Mulford attached an October 18 covering note to the memorandum for Baker detailing that after the meeting, two bankers criticized the OCC, “claiming its actions and attitudes are a major impediment to the success of your program.” (Ibid.) In an October 23 memorandum to Baker, Mulford summarized reactions of the banking community to the Baker debt proposal voiced at the Annual Convention of the American Bankers Association held in New Orleans October 21. (National Archives, RG 56, Records of the Office of the Secretary of the Treasury, Official Files of the Executive Secretariat, 1985, UD–11W, 56–88–79, Box 57, [illegible] ’85)