213. Memorandum From the Assistant Secretary of State for African Affairs (Crocker) to the Assistant Secretary of State for Economic and Business Affairs (McMinn)1
SUBJECT
- EB’s Memo on Changing the Debt Strategy
Thank you for sending me a copy of EB’s memo to Deputy Secretary Whitehead on changing the debt strategy.2 However, I must tell you that I was troubled by some of its conclusions. To put the matter simply, while I agree with you on the fundamental importance of adjustment and reform within the debtor countries, I disagree with your suggestion that a revised debt strategy which incorporated arrangements for conditioned debt forgiveness would endanger these countries’ reform efforts or their access to capital markets. In fact, it is my firm belief that an equitable and workable debt strategy will require just such conditioned debt relief measures.
A number of factors contribute to this belief. The first and most important is the fact that debts outstanding in many developing countries have now risen to the point where there is no hope of their final settlement without debt relief. In Africa alone, there is example after example of countries where debt ratios are such as to forestall any reasonable hope of their eventual settlement without debt relief. For instance, in Somalia, outstanding external debt is now 15 times export earnings. Its debt service on loans due multilateral institutions alone will exceed export earnings in 1987. Similarly, in Zambia, the debt due the IMF and the World Bank alone exceeds GDP; total debt now runs above 400 percent of GDP; and scheduled interest alone in 1987 will run in the range of 25 percent of GDP. In Madagascar, Zaire, Mozambique, [Page 544] Sudan and Liberia, the situation is very much the same. In each of these cases, the currently outstanding external debt has reached the point where there is no hope of adjusting economies to it. Rather, in these cases, the debt itself must be adjusted, if these countries are ever to be set on a course of stable, self-sustaining growth.
Secondly, I firmly believe that debt relief can be conditioned, tranched and delivered in support of effective reform programs. ARA’s proposal for a debt reduction facility, for instance, outlines one possibility.3 The basic point is that debt relief is an item of value for debtor countries, and, as an item of value, can provide the basis for quid pro quo negotiations regarding requisite reform measures. In that, it is no different than any other type of donor or creditor support.
Thirdly, I am not at all convinced that debt relief negotiations would be any more subject to politicization than are aid program or rescheduling negotiations. If we can handle the political pressures inherent in those negotiations, and still devote our resources effectively to the support of reform efforts, then we should be able to handle debt relief negotiations as well.
Fourthly, I was troubled by the suggestion that the greatest beneficiaries of such debt relief measures would invariably be those that deserved it least. That statement ignores the full range of factors that have contributed to the current debt crisis. Policy errors within the debtor countries have played a role, but so have the rise in real interest rates, slow industrial country growth, the resurgence of protectionism within developed countries, and the collapse in commodity prices. No one “deserved” these developments, but some—particularly those previously in debt and heavily dependent on commodity exports—have had to pay an extraordinary price for them.4
In any case, conditioned debt relief is no more a reward than any other type of conditioned financing support. Like every other type of conditioned financing support, it is an investment in change. Where it differs is only in charging that investment to original creditors, whose original lending decisions helped create the current crisis.
Moreover, the suggestion that debt relief measures will inevitably reward the least deserving ignores the fact that such a moral hazard is easily identified and treated. Such a hazard only arises in cases where a country has the capacity to pay but does not. It does not arise when a country lacks the capacity to pay entirely. A simple review of basic indicators (e.g., reserve levels, debt servicing ratios, and import trends), however, will more than suffice to distinguish these two sets [Page 545] of countries. The problem then is only to ensure that the first set of countries—those who cannot pay—receives a more generous portion of relief per unit of reform than do those whose original free choice was not to pay. The problem, in fact, is exactly analogous that faced (and solved) by the IMF every year in designing programs for countries with a poor performance record. In those cases, exactly this formula—less support, more reform—is applied to secure against the possibility of an abuse of the IMF’s lending programs.
I was also concerned by the suggestion that any form of debt relief might undercut debtor countries’ access to international capital markets. That statement ignores two basic facts—that debtor countries’ access to capital markets has already been sharply cut and is not likely to be restored until steps are taken to address what observers are increasingly calling the debt overhang—that portion of a country’s debt that is never likely to be serviced under any conceivable financial scenario. Until that is done, every potential new investor will inevitably shy from a situation where there are already too many claimants for too few dollars. Alone, of course, measures to address the debt overhang—presumably by debt relief—would not suffice to restore a country’s access to capital markets. There would also have to be signs of vigorous financial reform within the debtor country. That, however is the very point of conditioned debt relief—to link a country’s reform efforts to measures to address the debt overhang, providing in the process both the necessary and sufficient conditions for a resumption of normal capital flows. That—the fact that conditioned debt relief would help countries meet both the conditions for restored access to capital markets—is in fact the special advantage of such arrangements when compared with any other type of conditioned financial support.
In sum, I believe that some measure of conditioned debt relief will be absolutely critical to the successful implementation of our debt and growth strategy. Moreover, I am quite convinced that a workable, manageable and financeable arrangement for debt relief can quite easily [be] worked out, perhaps along the lines of the IMF-financed arrangement suggested by Congressman LaFalce.5 In any case, I sincerely hope that you will encourage your bureau and Treasury to review comprehensively all ideas in the context of the African debt group that has now started meeting. We will want to brief the Secretary on the progress of that work sometime soon.
- Source: Department of State, Executive Secretariat, S/S–I Records, Files of the Deputy Secretary of State (D), Lot 95D334: Debt. Confidential. A stamped notation on the memorandum reads: “Apr 6 1987 J.C.W. has seen.” On an adhesive note affixed at the top of the memorandum McMinn wrote: “JCW: You’ll see from the attached that AF favors some form of debt forgiveness. While I don’t agree with many of Chet’s arguments, I think it is true that, when discussing debt strategies, the least developed countries of Africa and the middle income countries of Latin America are like mixing apples + oranges—each will require different solutions. DM.”↩
- A copy of the memorandum from McMinn to Whitehead, drafted March 9, is attached but not printed. The memorandum summarized: “Debt alleviation, including ‘debt-purchase’ schemes, will weaken our leverage on reform, and will provide, over the long run, less financing for growth and development in the heavily indebted LDCs. The present strategy—perhaps with smoother application—is much more supportive of our foreign policy objectives.”↩
- See footnote 3, Document 211.↩
- McMinn highlighted this paragraph in the right-hand margin.↩
- Presumable reference to The International Debt Policy Act (H.R. 1423) introduced by Representative John LaFalce (D–NY) on March 7.↩