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

235. Memorandum From Stephen Danzansky of the National Security Council Staff to the President’s Deputy Assistant for National Security Affairs (Negroponte)¹

Washington, February 4, 1988

SUBJECT

• PRG Meeting on International Debt, 2:00 P.M., Friday, February 5, 1988, The Situation Room²

Events over the next few months will be critical for U.S. debt policy, particularly toward the major Latin debtors.

○ In Brazil, a new economic team headed by Finance Minister Nobrega is negotiating with commercial banks toward an agreement which could provide as much as $7 billion in new money through 1989 in exchange for Brazilian agreement to resume interest payments on commercial debt. Bank negotiators believe that less new money is needed (in the $4–5 billion range), and only through the middle of 1989. Agreement may hinge on Brazil’s willingness to enter into an IMF program. The banks have insisted that an IMF program be in place before any commercial funds are disbursed. Brazil has rejected any linkage. Brazil’s domestic political uncertainty makes it unlikely that meaningful economic reform measures will be implemented successfully in the near future.

○ Argentina has nearly depleted its foreign exchange reserves. It would receive $775 million in new funds from the IMF and commercial banks during the first quarter if it is found to be in compliance with the current IMF standby arrangement. The IMF has reportedly agreed to make a positive finding despite clear inadequacies in Argentina’s recent tax reforms. Argentina must remain in the Fund’s good graces to fill a financing gap of about $2 billion for the rest of 1988. CIA places the odds of Argentina declaring a moratorium on commercial interest payments sometime over the next six months at greater than 50%.

○ Mexico’s relatively large foreign exchange reserves ($14–15 billion in November) enabled it to announce its debt-for-bonds plan on December 29. Under the plan, Mexico would use up to $2 billion of its reserves to buy up to $10 billion in U.S. Treasury 20-year zero-coupon bonds to serve as collateral for Mexican bonds offered in exchange for discounted debt. Bids on the Mexican bonds will be announced on February 19. The plan is an innovative, market-based approach to alleviating the debt burden, but it is uncertain how many banks will participate and at what discount. Interest in the scheme is spreading. The Philippines have already begun pressing for a similar approach. With scarce foreign exchange reserves, however, the GOP wants $1.5 billion in grants or soft loans from the U.S., Japan and Taiwan to allow purchase of the zero-coupon bonds.

Mexico’s current IMF program ends in March, 1988, as does availability of the $7 billion new money package provided by commercial banks last year. In view of its strong reserve position, Mexico is unlikely to need another IMF program or commercial rescheduling this year.

Treasury and the Federal Reserve have effectively abandoned their hands-off stance to managing debt crises, becoming visible and activist as intermediaries between debtor governments and their foreign banks. The agreement reached in early December that avoided Brazilian debt being declared value-impaired by U.S. regulators was reached at Treasury and Fed insistence. Our concern is that excessive activism will take pressure off the commercial banks to participate in debt restructurings. It could also create pressure for official resources to reduce the debt burden.

The recent increases in reserves by international commercial banks to cover potential losses on third world loans divides the banks in terms of flexibility to deal with the debt. Provisions for losses range from 70% for major West German banks to 5% for Japanese banks. In the U.S. most money center banks have reserves of about 25%, though some (and some regional banks) have reserves in excess of 50%. Stronger reserves for potential losses allow banks to pursue more aggressive or confrontational strategies.

The debt issue receives little interagency review. The Mexican debt-for-bonds plan was not reviewed at all. Debt has been discussed occasionally at the monthly international economic breakfasts, attended by Shultz/Baker/Powell. The PRG has provided the only other senior-level forum. In addition to obtaining a report from Treasury on the status of negotiations with the three countries, it will be especially useful to encourage discussion of how the separate negotiations relate to each other and affect the broader U.S. debt strategy. State and the CIA will also be prepared to address linkages to U.S. foreign policy objectives in the region.

Jose Sorzano concurs.

RECOMMENDATION

That you use the agenda at Tab A and the talking points at Tab B³ to lead the discussion. The talkers include country-specific questions that you might ask as appropriate.⁴

1. Source: National Security Council, NSC Institutional Files, Box SR–123, PRG MTG 00099. Confidential. Sent for action. Prepared by Farrar, who initialed for Danzansky. A stamped notation at the top of the memorandum reads: “Deputy Natl Sec Advisor has seen.”
2. See Document 236.
3. Tab A, “Agenda,” and Tab B, “Talking Points,” are attached but not printed. Tab C, “Table—Basic Economic Data,” is also attached but not printed.
4. Negroponte did not indicate his approval or disapproval of the recommendation.