212. Letter From Secretary of the Treasury Baker to Vice President Bush1
This letter provides background material for you to use at your discretion in reply to the letter you received from Mr. Henry R. Breck, dated March 6, 1987.2
I do not agree with Mr. Breck’s assertion that a series of defaults by major debtor countries is imminent. While it is true that Brazil suspended interest payments to commercial banks and Ecuador went into arrears in January on its own bank interest payments, I believe that both of these countries will soon normalize their relationship with bank creditors. In the case of Peru, we are dealing with a more difficult case, as President Garcia has chosen to make the debt issue a domestic political issue.
Looking at the debtor countries as a whole, it is hard to generalize about the impact the foreign debt is having on them. For example, with the exception of the Philippines, we find that the Asian debtors have carried their debt burden—which is no lighter than most troubled debtors—without jeopardizing their growth prospects. Thailand, Malaysia and Korea are just a few names that readily come to mind.
The problem countries have by and large been in Central and South America. It appears to me that the reason for the concentration in this Hemisphere can be found in economic mismanagement. Why did Mexico run into financial problems in 1982 after several years of high oil earnings? Why did Brazil run into problems this year, after several years of trade surplus? I can increase the list, but the answer would be the same. What got them into trouble was bad economic policies: overvalued exchange rates, large public sector deficits, excessive government intervention, and a generally anti-export, inward-looking approach to economic development.
At the outset of the international debt crisis in 1982, a high level Treasury task force looked into the threat to the international financial system that might stem from temporary suspension of payments, moratoria and outright defaults by the debtor nations. Contingency [Page 541] operations and courses of action to address the debt problem were analyzed and evaluated.
It was decided at that time to pursue the international debt problem on a case by case, cooperative approach. We believed at that time, and still do, that most of the debtors intend to repay the banks. Our approach, which is flexible and is open to refinement, enables the creditors, both U.S. and foreign, and both official and private, to work with the debtor to devise a mutually acceptable debt workout arrangement. It also recognizes that each debtor faces a unique set of circumstances, including debt burden, ability to repay and different economic and political environments.
That strategy was strengthened and modified in October 1985 when I proposed the Program for Sustained Growth to the international financial community in Seoul, Korea during the annual meeting of the International Monetary Fund (IMF) and the World Bank. The Program for Sustained Growth focuses on the fundamental need for strong, sustainable growth and increased foreign exchange earnings in the debtor nation as a prerequisite to restoration of creditworthiness and ultimate resolution of the debt problem. Achieving stronger growth in the LDCs requires: (1) economic reforms designed to use resources more efficiently; (2) supportive financing by the international financial community; and (3) strong, open markets in the developed nations.
The IMF has established new economic adjustment linked standby programs with 8 of the 15 major debtor nations since October 1985. Meanwhile, the World Bank has negotiated new policy based loans with ten of them.
The international financial community has supported the Program for Sustained Growth from the outset. All major creditors recognize that we are in this problem together. While there has been reluctance recently on the part of some commercial banks, we believe that the banking community will do its part on a case by case basis during the coming months to overcome this problem. Treasury has encouraged the commercial banks to consider innovations if these will help ensure fair burden sharing.
Treasury also is working with the other developed nations to coordinate economic policies so as to provide strong and open markets for all trading nations. The LDCs will benefit from increased export earnings which in turn should enhance their growth and ability to repay debts.
At the same time, the banking regulators have been encouraging the commercial banks to increase their capital and reserves so as to be in a better position to cope with loan losses, both domestic and foreign. For example, the banks have been required to set aside special reserves for those countries that have had protracted difficulties in servicing [Page 542] debt. As a result, U.S. banks have reduced their vulnerability to the international debt crisis by about 50 percent since 1982 through significant increases in capital and general loan loss reserves. Banks in other creditor nations have followed similar practices. Moreover, U.S. and U.K. banking regulators recently announced their intention to adopt a new capital adequacy policy that will place more weight on risk factors in determining what is the appropriate level of capital for an individual bank.
While some of the debtor nations face political and social strains, we do not believe that major debtors intend to repudiate their debt. They want to restore their creditworthiness and obtain adequate new commercial bank loans to finance future investment and growth. I believe that we should be working with these countries to restore their creditworthiness and access to voluntary lending from the markets—which is what we are trying to do with our debt strategy—and not looking for ways (like debt write-offs) which would prevent them from returning to the financial markets for years to come. There certainly will be individual problems and payments interruptions. These do not constitute a systemic crisis and our approach is flexible enough to deal with such interruptions on a case-by-case basis. In addition, there are adequate regulatory, accounting and supervisory mechanisms in place or available to deal with such eventualities.
I hope that this material will be useful to you as you prepare a reply to Mr. Breck.
Sincerely,
- Source: Princeton University, Mudd Manuscript Library, James A. Baker III Papers, Box 81, Folder 19, Bush, George H.W., 1985–1987. No classification marking.↩
- The letter is attached but not printed. In a March 15 letter from Bush to Baker, Bush asked Baker to advise him on the March 6 letter he received from Henry Breck. Bush’s letter is ibid.↩
- Baker signed “Jim” above his typed signature.↩