Debt Relief May Be the Only Hope

The Latin American debt crisis is re-emerging with a vengeance. In Brazil, economic conditions brought on by policies aimed at servicing the debt have led to demonstrations and rioting. And Brazil has been considered a relative success story, whose debt service problems were among the most manageable. Many other nations in the region, along with less developed nations from other parts of the world, are in far deeper economic trouble.

From the start of the crisis in the summer of 1982, when Mexico first needed special help to service its debts, the policy of the United States and other creditor governments has focused on maintaining the flow of interest payments to the banks. These governments, working in tandem with the International Monetary Fund, have extracted severe economic austerity from the debtors in exchange for assuring the renewal of their bank loans and providing some new loans from official sources such as the IMF.

Up to a point, such measures serve a useful purpose. The debtors need to earn more foreign exchange by reducing domestic consumption and diverting resources to producing exports. Some budgetary and monetary austerity is needed to accomplish this. Austerity is always politically difficult, and pressure from the IMF traditionally has been a way to make it inevitable and therefore more palatable.

But in the present situation, austerity has sent many debtor nations into economic depression, with severe and protracted income losses. In many Latin American nations, real per-capita income has declined by 15% to 25%. As a byproduct of the austerity programs, trade balances have improved throughout the region, as they were supposed to. The improvement has not been enough, however, to prevent the foreign debt from continuing to grow because so much of these countries’ trade earnings go to meeting interest payments.

U.S. Banks’ Exposure

The large U.S. banks that hold the bulk of the LDC, or less-developed-country, debt have done well. Except for isolated instances, they have continued to receive interest payments on their outstanding loans. And as a result of some substitution of official lending agency debt for bank debt and a steady rise in bank equity, their exposure has declined noticeably since 1982. Their LDC loans are widely regarded as risky, but because interest payments have been met, the banks have not been forced to write down their value and show losses.

Last year, when Treasury Secretary James Baker announced a new initiative on the LDC debt problem, he was acknowledging that most of the debtor nations were not recovering from their deep economic slump and were having renewed trouble in servicing their debt. But his new initiative offered mainly more of the same to the debtors--help in getting new money to continue paying interest on the debt, together with the hope that stronger economic growth in the industrial world would expand markets for LDC exports. Thus far interest payments to the banks continue to be met, but the hoped for economic growth has not materialized.

More recently, Sen. Bill Bradley (D-N.J.) proposed selective and partial debt relief--including both forgiving some principal and reducing interest rates charged--in exchange for economic reforms in the debtor nations. Because the plan would provide only partial debt forgiveness, it would not threaten banks’ solvency, but it would force banks to recognize losses and would thereby reduce their profits for a time.

The difference between debt relief, as proposed by Bradley, and the debt reschedulings that have constituted past and present policies is crucially important. Debt relief would restore some hope that debt service could be made manageable and consistent with economic recovery. By contrast, present policies are crippling the debtor economies while very likely only postponing the day when banks will have to write down part of their LDC debts.

Banking Versus Foreign Policy

Most nations in Latin America are governed by democratically elected moderate governments. But political stability in the region is historically fragile, and governments are vulnerable to coups from both the right and left. If LDC debt were considered a matter of foreign policy, we would find ways to reduce the debt burden and restore economic growth to the region to enhance its political stability. But because the debt has been treated as a matter of banking policy, we have been willing to see it grow and to see many Latin economies fall into depression so long as interest payments were met.

If we do not develop a workable plan of debt relief, the debtors may do it for us. Recently the Brazilian Finance Minister, Dilson Funaro, announced that he would negotiate for concessions on the bank loans to his country. Funaro wants to negotiate, but if the bankers and Administration officials will not, Brazil and other debtor nations could decide to reduce debt payments unilaterally. What prevents debtors from repudiating debt is the fear that they will be unable to borrow again, and that they will suffer other reprisals as well. A country will take such risks only if the alternative seems unbearable. It is not in our national interest to bring debtor nations to such a point.

Along with our budget and trade deficits, the LDC debt problem looms as a legacy of Reaganomics, which kept real interest rates at historic highs throughout the early years of the decade. The combination of high real interest rates and weak economic growth increased the cost and difficulty of servicing debt. If the Administration does not change to a strategy that begins to bring down the debt burden, the likely outcomes range from bad to worst. Bad would be holding the problem for a time in its present unresolved state. Worse would be the major debtor nations unilaterally limiting the interest payments they would make, as little Peru already has. Such unilateral action could disrupt the U.S. and international financial systems, and could well bring retribution from the creditor governments that would worsen the plight of the LDCs. Worst would be repudiation of debt by dictatorships that overthrew the present governments on a wave of rebellion against foreign creditors.