The Third World: Living with Debt?

By Cook, Mark | Contemporary Review, May 1992 | Go to article overview

The Third World: Living with Debt?


Cook, Mark, Contemporary Review


With the Gulf war, the break-up of the Soviet Union, the democratisation of Eastern Europe, the Single European Market and this year's elections in the US and the UK, one area of concern has taken a back seat, that is Third World debt. Ignoring the problem, however, will not make it go away; external debt problems are here to stay imposing costs, lower standards of living and development problems for many Less Developed Countries (LDCs).

Why this more low key approach to the debt crisis and can there be any painless way of resolving LDCs' debt problems? To answer these and other questions requires us to examine, briefly, how the debt crisis arose and the methods by which the developed countries, the international banking system and the IMF have attempted to come to terms with the problems.

History points to the oil prices hikes of 1973/74 and 1979 as a major step in the growing indebtedness of LDCs. The industrialised West and the non-oil LDCs ran up huge balance of payments deficits as their economies could not adapt quick enough. At first the international banks were eager lenders to the Less Developed Countries (LDCs), since the LDCs appeared to be reasonable credit risks. The prices of their export commodities were high, they had growth rates and so could reasonably be expected to pay back the loans at some future date. Furthermore, the international banks believed that the existence of |lender of the last resort' arrangements with their central banks meant that this facility would be on offer to them if the LDCs were unable to pay off their debts, thus some commercial banks took on riskier portfolios in return for higher returns.

By 1976 debts by the LDCs totalled $228 billion with bank debts at $49 billion. For the LDCs creditwoorthiness had become a problem. Commercial banks may well have wished to reduce their lending, but for US banks, a loan which serviced for 90 days must be declared as |non-performing' and may no longer be |booked' as an asset. So it was imperative for them to keep earlier loans |alive'. Some LDCs which were oil producers received larger export earnings but also sought even more ambitious growth programmes, financed by foreign bank debt. In the US after the 1979 oil price rise, the tightening of supply growth and a loose fiscal stance served to raise interest rates both in nominal and real terms. Since the majority of LDC debt was denominated in dollars the impact on these countries of high interest rates was enormous. In addition, the recession in industrialised countries and the adverse terms of trade effects all boded ill for the LDCs. External debts became unmanageable and by August 1982, Mexico unilaterally announced that it could no longer meet the interest and capital repayments on its $80 billion overseas bank debt. Within months, dozens of other LDCs followed suit.

The problem with the debt crisis was a two-fold one; commercial bank exposure to debt and the difficulties in servicing debt repayments. Solutions concentrated on these two areas with a bias towards the former in the early 1980s. Initial policies, therefore, were aimed at keeping the pressure on debtor nations so that the debt could be serviced whilst at the same time looking for ways to relieve the pressure on the banks. Five major proposals have been tried and tested:

1. Debt rescheduling: this is renegotiation of the terms of the loan,

that is postponing and extending the repayment of principal and

interest.

2. Debt/Equity Swaps: developing countries debts are exchanged for

equity in commercial projects in the debtor country. The existence

of these debt/equity swaps has stimulated growth of a |secondary'

marketing where creditor commercial banks may sell their developing

country debt. The buyers in this market can then trade this debt

for an equity position in the debtor country. …

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