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PERGAMON
ON INTERNATIONAL DEVELOPMENT
POLICY
STUDIES
International Borrowing
by Developing Countries
Marilyn J. Seiber
Pergamon Press
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Copyright (^ 1982 Pergamon Press Inc.
Library of Congress Cataloging in Publication Data
Seiber, Marilyn J., 1945-
International borrowing by developing countries.
(Pergamon policy studies on international development)
Bibliography: p.
Includes index.
1 Underdeveloped areas-Debts, External.
I. Title. II. Series
HG3891.S43 1982 336.3'433'1724 81-15875
ISBN 0-08-026332-1 AACR2
All Rights reserved. No part of this publication may be reproduced,
stored in a retrieval system or transmitted in any form or by any means:
electronic, electrostatic, magnetic tape, mechanical, photocopying,
recording or otherwise, without permission in writing from the
publishers.
Printed in the United States of America
Foreword
Luther H. Hodges, Jr.
As so well presented by the author, todayfs problem of credit to
developing countries is real. Clearly, bankers, regulators, policy-
makers, and political leaders have increasing cause for concern. Inter-
national Borrowing by Developing Countries is a very comprehensive
analysis of the current problems facing commercial banks, international
financial institutions, governments and - rather importantly - the
economies of the underdeveloped nations of the world. As outlined so
well, the recent structural and cyclical changes in the international
economy in the 1970s, characterized by increasing price levels of food,
fuel, and capital goods, combined with slower rates of growth for the
economies of the industrialized world, presented the LDCs with the
option of either a declining rate of growth or an increase in external
borrowings. Understandably, the developing countries chose the latter
alternative. Our challenge today is to be certain that such logical
decisions of the past do not lead to withdrawal of traditional sources of
credit in the face of a more difficult economic environment in the
developed nations.
Current political philosophies seem to suggest that we can leave this
problem to private financial markets, yet commercial banks cannot be
expected to assume the sole risk of lending to the poorest nations. The
mature, developed economies are quite dependent upon the growth of
LDCs for needed economic vitality. Even today some 36 percent of
total U.S. exports are to developing nations, and as the United States
becomes further dependent upon sales abroad, the LDCs will play an
increasingly important role in our economic future. Accordingly, some
public/private partnership in dealing with the financial needs of the
LDCs seems critical.
As for the private sector, the increased risks inherent in the rapid
growth in credit have not gone unnoticed by individual lenders and the
overall financial community. The banking system has responded with
such improved lending procedures as detailed country risk assessments,
IX
x FOREWORD
country lending limits, and related portfolio diversification. Moreover,
the aggregate exposure of the international banks cannot be considered
alone. Risk assessment is country specific, and the sum of individual
risk assessments is not necessarily equal to the total, as illustrated by
the fact that lenders and borrowers have differing degrees of involve-
ment loans seldom mature simultaneously; and less credit-worthy
borrowers are often balanced by stronger debtors.
Importantly, banking principles governing the extension of inter-
national credit, including that to developing countries, are not unlike
those followed in more traditional, domestic transactions. Future
earning power receives major attention so that current financial ratios,
as derived from national income accounts, are frequently balanced by
the potential of the economy in terms of the maturity of specific
projects and the development of resource potential. Brazil is an
interesting example, for that country is confronted with high inflation,
large oil payments, and sizeable debt-servicing requirements. In the
longer run, however, partly through the availability of foreign loans and
investments, that country will be able to productively employ sig-
nificant agricultural and mineral resources. Perhaps not sufficient
creditor comfort to remove concern, yet no cause for panic!
The true opportunity for a better creditor environment - and a more
constructive climate for development within the LDCs - rests with
further innovations in the international financial system. For example,
proposals to make lending more secure by utilizing an insurance
mechanism have gained much attention. Establishing such a fund to
protect against noncommercial risks would be expensive and time
consuming, yet the principle of insurance is particularly valid in this
area and the proposal should be pursued vigorously. The structural
changes to accommodate new external debt circumstances, as
suggested by the author, should also be considered.
In essence, in our increasingly international society, the financial
community must work together to evolve a more efficient, effective
flow of information. The domestic banking system in the United States,
although burdened with numerous, independent institutions, performs
well, and our system can form a pattern for a more cooperative, better
informed international financial community. Such innovations will in
turn better accommodate the long-term economic and social develop-
ment of the nations of the Third World. Clearly, the economic future of
all of us is dependent upon the healthy growth and development of those
who at present have the least.
Luther H. Hodges, Jr.
National Bank of Washington
Introduction
The external debt of developing countries is an international economic
problem that will challenge both developing and industrial countries in
the 1980s. By the end of 1981, developing countries' total external debt
will approach $600 billion. Debt-servicing obligations are claiming an
increasing share of Third World export earnings - an aggregate average
of 25 percent, but for several countries this figure exceeds 50 percent.
Debt-servicing requirements in 1980 ($8 billion) surpassed these coun-
tries' total debt in 1971 ($86.6 billion). This fast-rising debt and debt-
servicing will seriously impair developing countries' quest for economic
growth and improved living standards. It is siphoning resources that
otherwise woud support productive investments.(1) Moreover, devel-
oping countries are borrowing fresh funds to repay current debts.
Compounding this debt situation are other external economic
factors that inhibit developing countries' growth and their ability to
service debt. The petroleum price increases in 1979-80 created
staggering financial needs for the nonoil developing countries that will
be particularly difficult in the 1980-85 period. In 1980 these nonoil
countries had a combined oil bill of $55 billion and an aggregate
current-account deficit of $71 billion. Their financing needs, however,
are being met by commercial lenders with a caution generated by
renewed fears of the recycling effects on banks and the international
financial system and by new perception of risk and declining credit-
worthiness. This is occurring at a time when developing-country
financial needs will be greatest and when official sources of finance are
hindered by slowed industrial-country growth, increased inflation, and
rising unemployment. This economic sluggishness in industrial countries
adversely affects demand for developing-country exports, thereby
exacerbating their debt and debt-servicing difficulties.
The growth and volume of Third World debt has important economic
implications for industrial countries as well. The burden of developing-
country debt could interfere in the growth of world trade in the 1980s.
xi
xii INTRODUCTION
Industrial countries are relying increasingly on export growth to
support recovery of their economies, and developing countries have been
the fastest growing markets for their exports. If developing countries'
export earnings are used for servicing debt, they will not be available to
buy industrial-country export products; nor will developing countries
create the demand, through domestic investment, for industrial-country
capital goods, technology, and services. Moreover, industrial-
country banks will be affected by possible defaults and may require
official government support either to the banks or through official
assistance to the defaulting country. The international financial system,
linked through the Euromarket and cross-default Euroloan provisions,
also could be seriously affected by major Third World debt difficulties
and growing economic hardship.
The concern about Third World external debt is based on a number
of factors:
• The rapid growth in developing-country debt from $86.6 billion in 1971
to an estimated $446 billion in 1980.(2)
• The increase in debt-service burdens. By 1980 one out of every two
dollars borrowed abroad by developing countries was being used to
repay old debts.(3)
• The structure of debt. A significant shift from official to com-
mercial borrowing has shortened maturities, raised interest rates,
and bunched repayments.
• The increased international liquidity fueling competition among
commercial banks, spawning lower "spreads," longer maturities, and
a consequent mismatch of bank liabilities and claims.
• The fear of instability or possible collapse of the international
financial system in the wake of a default by a major debtor country
which could precipitate other countries following suit or creditor
banks calling in their loans.
The issue of developing- country debt has its roots in several inter-
national economic trends and events. In 1970, developing-country debt
was primarily an "official" phenomenon; that is, creditors were govern-
ments and official multilateral institutions. But from 1970 to 1973, the
world economy was expanding on the strength of industrial-country
investments, booming commodity prices, and invigorated LDC develop-
ment plans. Developing countries were eager to implement and expand
their development programs; wealthy governments and multilateral
development banks were financially supportive; and commercial banks
saw new opportunities for profits. In 1973-74 the Organization of
Petroleum Exporting Countries (OPEC) guadrupled oil prices and
crippled the world economy. (Major strains in the international economy
predate the oil crisis, however; specifically, increasingly serious
balance-of-payments problems and inflationary trends.) On the heels of
the oil price increases came a worldwide recession and a decline in
industrial-country investments. Developing countries were confronted
with declining terms of trade, a fall-off in export demand, and
INTRODUCTION xiii
increased import prices for petroleum, fertilizer, and capital goods.
Developing countries were faced with cutting back imports and develop-
ment programs but were unwilling to do so. They found it difficult and
politically unpalatable to sustain higher levels of unemployment, lower
living standards, and postponement of economic and social development
aims which a cut-back would entail. At the same time, commercial
banks were the recipients of OPEC petrodollars but found their
traditional sources of demand - industrial countries and multinational
corporations - drying up. They, therefore, turned to developing-country
customers which were being squeezed by foreign-exchange shortages
and needed balance-of-payments financing.
The developing-country debt situation in the 1980s will be difficult.
Yet, despite the volume and growth of debt and its economic implica-
tions, there is no consensus on the magnitude of the problem or on
what, if anything, to do about it. A number of factors contribute to
this. First, there is little comparability in data. Separate information
systems of the World Bank, Organization for Economic Cooperation and
Development (OECD), and the Bank for International Settlements (BIS)
collect and report information from different sources.(^) Furthermore,
all private debt is not announced. Second, the methods for assessing
debt vary and therefore affect the outcome. Analysis can include
disbursed only or committed and disbursed debt; medium and long-term
debt or medium and long-term plus short-term credit (usually trade
credits of one year or less); varying definitions of a "developing
country," i.e., whether all (152) developing countries are counted; or
Mediterranean countries are excluded; or 13 OPEC countries (or only
OPEC surplus countries) are excluded; or centrally-planned economies
are excluded; or "residual" developing countries and territories are
excluded. Third, there are political factors affecting debt (see chapters
1 and 11 ) and varying opinions among the "experts" on the subject (see
chapter 8). As a result of these factors, there are conflicting views on
the seriousness of the debt situation and disagreement on the implica-
tions of debt for the future stability of the international financial
system.
The purpose of this study, therefore, has been to develop an
accurate analysis of the developing-country debt phenomenon in order
to better formulate realistic and practical policy alternatives on
developing countries' external debt. Given the rise of Third World
external debt and the implications for adverse effects on developing
and industrial countries alike, policymakers should examine the external
debt issue comprehensively; analyze the role of official financing;
reevaluate traditional methods for dealing with debt difficulties; and
consider new facilities for recycling surplus oil dollars, tapping new
sources of financing, and developing new procedures for handling debt-
service problems. This book assists in this task.
International Borrowing By Developing Countries provides a compre-
hensive examination of developing-country debt including the theory of
borrowing, a review of official and private debt, official creditor and
debtor-country positions on debt, proposals for petrofund recycling and
xiv INTRODUCTION
debt relief, and recommended policies to deal with external debt in the
1980s. The study is an economic analysis of developing countries' debt
condition and, with the exception of chapters 1 and 11, does not
explicitly consider noneconomic factors affecting the debt issue. This
approach does not deny the importance of political factors and motiva-
tions in assessing the developing-country debt situation or in
formulating debt policies. Rather, it attests to the complexity of the
debt issue. Furthermore, the study does not include consideration of
Communist East European debt which is estimated to be over $56
billion. (Soviet Union debt to the West is about $11.5 billion.)(5) These
aspects of external debt - political considerations and Eastern Bloc
debt - would add a dimension that is beyond the scope of this book.
Specificaly, Part I addresses the role of external capital and debt in
economic development and reviews the historical debt experience of
the now-creditor countries. Part II examines official bilateral and
multilateral debt, its patterns and magnitude, and the procedures and
experience of official debt rescheduling. Part III assesses private
Eurocurrency debt; the factors in the international economy affecting
private debt, i.e., OPEC, economic adjustment, and recycling; and the
expected participation in the 1980s of private-sector lenders in pro-
viding continued support for developing countries' financing needs. Part
IV examines official positions on debt relief and reviews proposals for
recycling petrofunds and providing new sources of financing as well as
new debt-relief facilities if debt-servicing difficulties arise. Finally,
Part V concludes with a prognosis for the debt situation in the 1980s,
political factors that will affect external debt, and recommendations
for future policy.
The external debt of developing countries is an issue that will not
fade in the 1980s nor will the magnitude of the potential problem
diminish. Policymakers must recognize that previous avoidance of
major financial crises in the 1970s will not spare them major debt
difficulties in the 1980s. After examining the growth patterns of debt
and debt-servicing and the international economic factors affecting
debt, it is unrealistic to believe that the old ways of handling debt will
suffice. Policymakers must seriously consider the debt issue and deal
with it prior to the occurrence of financial crises. It is urgent that they
do so. The economic well-being of all nations depends on it.
1
The Role of External
Borrowing in Development
The economic development process normally includes the requirement
for external capital, although there is little consensus among economic
theorists and development practitioners about the exact relationship of
external capital to development. There are fundamental differences
among them as to whether external capital is essential and whether its
effects on developing countries are positive or negative.(l) The answer,
in most cases, is neither wholly positive nor wholly negative. Rather,
the precise role and contribution of external capital depends on the
type of capital; how it is used; the internal economic, political, and
social conditions of the country; and external economic and political
factors. In general, the effect of external capital on a country's debt is
a function of whether the capital is grant or concessional aid, official
nonconcessional loans, private financial flows, or private direct foreign
investment.
This chapter will review the role of capital in development, the
functions of external borrowing, and the potential contributions and
drawbacks of relying on external capital for advancing economic
development.
THEORIES ON EXTERNAL CAPITAL
Capital. The stock of goods which are used in production and
which have themselves been produced. . .Capital may be used to
mean money capital, i.e., stocks of money which are the result
of past savings. Two important features of capital are (a) that its
creation entails a sacrifice, since resources are devoted to
making non-consumable capital goods instead of goods for imme-
diate consumption; and (b) that it enhances the productivity of
other factors of production, land and labor.
A Dictionary of Economics,
Penguin Books, 1972, pp. 55-
56.
3
