Swaps IV: Protection for Third World Central Banks

Schap, Keith, Futures (Cedar Falls, IA)

Swaps IV: Protection for Third World central banks

For the central banks of developing countries, forward strip hedges using Eurodollar futures - often called synthetic swaps - can help control the cost of debt.

U.S. banks' problems with "Third World debt" have become financial legend. But concern for the lending banks should not obscure the problems of the borrowers.

When London Interbank Offered Rates (LIBOR) rose 3% in 1988, Latin American debtors faced an additional $12 billion in payments.

"That skyrocketing debt service affects standards of living for those people," points out Ed Rombach, a vice president at Emcor Risk Management Consulting in New York.

The recent World Bank annual report notes that in 1989 developing countries transferred record resources to the industrialized world. Obviously, the more of a country's output going to debt service, the less it has to develop programs to improve its standard of living.

And, as commercial banks write down huge Third World debts, they grow less willing to make new loans. Even the recent euphoria over Eastern European political changes has not overcome that reluctance.

Even as developing country debt service has trended up, disbursements of new funding have tapered. In the aggregate, Third World countries paid out $42.9 billion more than they received in new loans in 1989.

To stave off the devastating potential of that situation, says Marcus Fedder of the World Bank, the bank "advises Third World countries to explore the use of futures in hedging risk, though it cannot recommend specific exchanges or instruments."

Following the lead of Chile's central bank, which began using futures in 1987, …

Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Swaps IV: Protection for Third World Central Banks. Contributors: Schap, Keith - Author. Magazine title: Futures (Cedar Falls, IA). Volume: 19. Issue: 12 Publication date: November 1990. Page number: 44+. © 2009 Summit Business Media. COPYRIGHT 1990 Gale Group.

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