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

250. Paper Prepared in the Department of the Treasury¹

Washington, undated

INTERNATIONAL DEBT SITUATION

There is a growing consensus within the international community that the current debt strategy is wearing thin and that “new solutions” are needed. This is due in part to the popular perception that the major debtor nations are no better off today than they were six years ago and that the heavy claim of debt service obligations on their export earnings is politically unsustainable. While we disagree with this judgment, it is clear that the debtor nations themselves, to varying degrees, are tiring of the effort required, and that commercial banks are increasingly reluctant to provide new financing as they seek to reduce LDC exposure.

This sense of “fatigue” has been reinforced by the recent fascination with debt reduction—in debtor nations, in academic and banking circles, in Congress, and even within other industrial nations, most recently Japan and France. An easing of debt service burdens as an alternative or complement to new financial flows has been a practical element of the debt strategy from the beginning—through commercial bank debt restructuring and retiming agreements and reduction of spreads, as well as Paris Club reschedulings of both principal and interest. The current voluntary “menu” approach also provides opportunities for reducing debt and/or debt service burdens through such mechanisms as debt/equity swaps, debt/bond exchanges, and other debt conversions.

However, the common denominator of virtually all “new” debt proposals now being put forward to simultaneously ease debt service burdens and enhance debtor growth is the use of public sector resources on a grand scale to facilitate or guarantee debt reduction. The strategy which we have pursued since 1985, on the other hand, has been based on a fundamental policy limitation on the use of public funds in addressing debt problems. We have been extremely careful to avoid “bailing out” commercial banks on their existing exposure via public expenditures or acceptance of contingent liability on such debt. In addition, we have accepted World Bank guarantees on new commercial bank loans only in extremis where essential to complete financing packages and when leveraging substantial additional lending. The strategy, in short, has relied upon commercial banks to negotiate any changes in their outstanding claims on their own, while providing their fair share of new financial support for debtors’ reform efforts.

The sharp decline in commodity prices and export earnings for the major debtor countries in 1985–86 unfortunately set back efforts to improve the debtors’ capacity to service debt, reflecting the vital importance of exports to a growth-based strategy. Stronger OECD growth, a sharp reduction in LIBOR interest rates, and market-oriented debtor reform efforts have all helped to improve the debtors’ situations more recently. For the period since 1982 as a whole, substantial progress has been made in reducing the major debtors’ current account deficits, in strengthening their growth, and in reducing the risks to the international financial system. Most of the major debtors have made significant external and domestic policy adjustments and are now actively pursuing market-oriented reforms. Both imports and exports are expanding; and critical interest/export ratios have declined by nearly one-third since 1982. (More detailed data on progress under the debt strategy are attached.)²

It would be folly to move away from a strategy that is working without a concrete and coherent plan to replace it. Chaos is no substitute for steady progress.

Efforts to further strengthen the current strategy should focus on doing more to emphasize and enhance the positive role being played by the IMF and the World Bank in this process as part of creditor governments’ contribution to resolving the debt problem. Indeed, it serves U.S. interests to underscore the benefits provided by the international financial institutions (IFIs). They provide an excellent source of information and expertise for debtor governments in devising macroeconomic and structural reforms. Our contributions to the IMF and the World Bank, moreover, provide an excellent value for the U.S., resulting in substantial U.S. influence for a very small amount of paid-in capital. U.S. support for a World Bank GCI and for the IMF’s new Contingency and Compensatory Financing Facility to help shield debtors from adverse external developments exemplify recent U.S. commitments to assure strong IMF and World Bank support for debtor nations.

At the same time, it is vital to maintain continued commercial bank participation in the debt strategy. The commercial banks account for roughly two-thirds of the total external debt of the 15 major debtor nations: they must continue to provide financial support (through either new financing or an easing of financial obligations, or both) as part of the debt workout process. Creditor governments should not ask their taxpayers, through whatever mechanisms, to assume the risk on outstanding commercial bank loans, or to take on a disproportionate share of new financial support.

The grand proposals which have been suggested by the Japanese and French are fuzzy as to practical details and raise a number of unanswered questions.³ Both in effect would require substantial new financing and/or a major assumption of commercial bank risk by creditor governments or the IFIs to have any practical effect on the debt problem. By raising expectations for substantial new resources to back debt reduction on a global scale, they may well be counterproductive. Entering into prolonged discussions on such proposals—if they cannot be carried out—would in our view do more harm than good.

The key to a sound debt strategy is a practical recognition of what is feasible, and cooperative efforts to achieve that end. Stronger growth in debtor nations and a reduction of debt burdens are achievable objectives. But massive injections of new financing or a major shift in commercial bank risk to creditor governments are neither practical nor an assured means of obtaining those objectives. In the final analysis, only commercial banks themselves can agree to reduce their claims on debtor nations; a number of banks are now moving to do this on their own or as part of negotiations with debtor countries. Serious consideration of alternative “bailout” scenarios can only delay this process and increase the ultimate cost to taxpayers, while undermining the debtors’ own commitments to essential policy reforms.

1. Source: National Archives, RG 56, Records of the Office of the Secretary of the Treasury, Congressional Correspondence, 1988, UD–10, 56–10–1, Box 44, Classified Memos to the Secretary, October ’88. Confidential. Sent under an October 18 covering memorandum from Mulford to Brady, in which Mulford wrote: “Attached is a paper and background information for our meeting tomorrow on debt. We should hold this paper closely until we decide on the next steps.”
2. Not found attached.
3. See Documents 242 and 247.