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

223. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Mulford) to Secretary of the Treasury Baker¹

Washington, June 19, 1987

SUBJECT

• A Strengthened Debt Strategy

This memo proposes a plan for strengthening the debt strategy which would allow you to take a significant initiative in the near future with a realistic prospect of reaching agreement on these changes by the time of the October IMF/World Bank meetings.²

Principal Considerations

We should recognize that the recent reserve actions by the commercial banks will further reduce their willingness to lend for strictly balance of payments purposes.³ The U.S. banks believe that they are in a stronger position to negotiate both with the debtor and the creditor governments. At the same time, foreign banks fear that large numbers of U.S. banks will withdraw altogether, thereby seriously undermining the credibility of U.S. banks as a group to carry their fair share of the overall financing burden.

The commercial banks’ primary objectives appear to be:

○ To achieve greater official involvement. This means not only more official flows but also arrangements which will allow the banks to distinguish between new money commitments and old loans (epitomized by their seeking World Bank preferred creditor status and direct World Bank guarantees).

○ To make a strong input at an earlier stage into the negotiations for reforms and conditionality which apply to debtor nations.

○ To develop options for participation that move them towards “specific purpose lending” with a private sector orientation, and away from general lending to finance budget and balance of payments deficits. In practice, unless the banks understand that they will have to make up any shortfall in “specific purpose lending” with new balance of payments loans, this is likely to result in less overall lending by the banks, who in future will justify their withdrawal by claiming that opportunities for “specific purpose lending” failed to develop.

At the moment, the banks have not clarified their thinking as to how to achieve the above objectives. The menu approach clearly has appeal. However, it is not yet clear to what extent the banks will seek to enhance their menus with official inducements.

As World Bank lending grows, supplemented in due course by the GCI, and further concessions are made in the Paris Club, commercial banks will seek to allow official financing flows to replace their declining share of new financing. Unless we develop a strategy to prevent this, they are likely to succeed in this effort. We need, therefore, to determine how we wish to manage this process in order to strengthen bank participation in the debt strategy, or at least to avoid a decline in bank resources that increases even further the pressure on debtor and creditor governments.

Our strategy should be to reaffirm the basic principles of our debt strategy, particularly the need for growth-oriented reforms by debtor countries. To strengthen the strategy, we have to reassert our leadership in the areas over which we have a substantial degree of control, such as the IMF, the World Bank, and certain regulatory issues. However, we should also be willing to play a more visible role in other areas of the debt strategy, such as with the banks in improving the new money negotiating process and in developing the “menu” approach.

Our most immediately pressing dilemma is how to avoid a clear and obvious bailout by the public sector, while recognizing there may be a need for official inducements to maintain bank participation. There are essentially two approaches we can pursue, which are not necessarily mutually exclusive:

(1) More official financing through the IMF and World Bank, with no fundamental changes in present policies. This would maintain the present character of these institutions, but would not induce sufficient bank participation. As a result, the IFIs would end up picking up the shortfall in commercial bank lending in order to close financing gaps.

(2) Changes in IMF and World Bank policies, including in particular, greater use of World Bank concessions to leverage commercial bank financing. By selective use of preferred creditor status and/or guarantees of commercial bank loans, we should be able to induce broader and larger bank participation (identifiable additionality), thereby minimizing commercial bank withdrawal from LDC lending. This approach would reduce the potential magnitude of future official lending to fill financing gaps, but would open the door to use of techniques we have not so far supported on a general basis in the World Bank. (See Tab B for summary of pros and cons relating to preferred creditor status or guarantees.)⁴

Suggested Approach

Our aim should be to set and manage an agenda for strengthening the debt strategy, but without altering its fundamental principles. I think the best way to proceed is the following:

(1) We should first seek the views of the chief policy officers of major U.S. banks to determine what is essential to maintain their participation. To do this, however, we must have an idea of what we are prepared to put on the table and what we will seek from them in turn (for example, new financing and the terms that apply to old debt). We should leave the banks in no doubt that a lack of new money commitment by them will be met on our part by a reduced concern for their future debt service flows. The goal of these consultations would be to develop in Treasury a view of what constitutes the minimum requirements for keeping the larger banks in, and then to reach a firm understanding with the banks on a common approach which will insure their participation. This should be done on an individual basis and should be followed up by a meeting between these bankers and the Secretary of the Treasury and the Chairman of the Federal Reserve. At this meeting a specific understanding should be obtained from the banks shortly before you make public our new proposals.

(2) We would also consider how to consult with the IFIs and other creditors at an appropriate stage of this process.

Following these discussions/commitments, we would go public with the following approach:

(1) Reaffirm the present debt strategy and call on the IMF and the World Bank to intensify their efforts, in close cooperation with the commercial banks, to improve the growth elements and consistency of application of their programs.

(2) Announce that we favor moving forward with a GCI for the World Bank provided we can reach agreement on the general outlines of expanded World Bank lending to debtor nations, including the resolution of certain policy issues, such as fast-disbursing loans, conditionality, direct investment, debt/equity swaps and improved coordination with the banks on private sector lending. We would also have the option here to indicate the course we intend to follow with respect to World Bank cofinancing. (See Tab A).⁵

(3) Announce that we favor creation of a new External Contingency Facility (ECF) in the IMF which would enlarge the resources available to debtor countries on a more diversified basis and with stronger conditionality to replace the Compensatory Financing Facility (CFF). This would involve follow-up negotiations with the Fund and other major creditors between now and October but would hold out the prospect of an increase in the flow of new resources from the IMF to the debtors. (See Tab C).⁶

(4) Announce that we are commencing a review of U.S. bank regulatory arrangements to assure that the regulatory framework permits U.S. banks to provide a broad spectrum of mechanisms to support debtor reforms and help alleviate debt burdens. (Still seeking OCC and Fed views).

(5) Announce that we favor earlier and closer participation by the banks with international institutions in negotiations with debtor countries and outline a consultative arrangement for accomplishing this. We would have here a variety of options, including a coordinating mechanism or some form of formal debt facility. (See TAB D.)⁷

(6) At the same time we should indicate a willingness to work with the banks in implementing their menu of options, including exploring ways of distinguishing new from old debt. The aim would be to insure sufficient bank financing to maintain their fair share of financing gaps under specific economic reform programs.

The perception of movement toward strengthening the debt strategy is very important to establish soon. Reaching a critical mass for Argentina was an important milestone, but cannot itself be definitive for the future of the debt strategy.⁸ The banks see Argentina as a transitional deal, having come during a period of commercial bank reassessment of LDC lending. Having taken additional reserves, they are likely to be less willing to provide new loans the next time. Brazil therefore will be a critical test both for the further evolution of the menu approach and continued bank participation.

If we wish to seize the initiative, we should aim to make our announcements in late July/early August when Argentina is financed, Brazil has begun its bank negotiations, and Mr. Greenspan is close to assuming the Chairmanship of the Federal Reserve.⁹

1. Source: Washington National Records Center, RG 56, Executive Secretariat, Congressional Files, 1987, 56–90–29, Box 44, [no folder title]. Confidential. Mulford’s stamped initials appear next to his name in the “From” line.
2. See footnote 3, Document 221.
3. In a June 4 memorandum to Shultz, McCall reported on Citicorp Bank’s and Chase Bank’s decisions “to boost their loan-loss reserves.” McCall analyzed the implications of these decisions for the administration debt strategy, commenting that “Citicorp’s announcement has been widely billed as a death blow to the Baker Plan. More likely, however, it will lead to more variety in the ways that commercial banks take part. The other key features—LDC reform and MDB adjustment lending—remain as valid as ever.” (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: S/P Chron–June 1987)
4. Tab B, an undated and untitled paper, is attached but not printed.
5. Tab A, “Proposals for IBRD Cofinancing,” undated, is attached but not printed.
6. Tab C, “Proposal for an IMF External Contingency Facility,” dated June 19, is attached but not printed.
7. Tab D, “Proposal for an International Debt Facility,” undated, is attached but not printed.
8. See Document 224.
9. Reagan nominated Greenspan to be Chairman of the Board of Governors of the Federal Reserve System on June 2. For his remarks, see Public Papers: Reagan, 1987, Book I, pp. 597–598. Greenspan was sworn in as Chairman on August 11.