IV External Debt and Balance of Payments Adjustment
- International Monetary Fund
- Published Date:
- April 1984
The external payments crisis faced by a number of developing countries in 1982 affected both the ability of some of these countries to meet their scheduled debt service obligations and the willingness of their creditors to extend sufficient financing to assure the viability of their external positions. In these circumstances, borrowing countries found it necessary to undertake major adjustments of their economies, while creditors became involved in large-scale debt restructurings. Consequently, on both the lending and borrowing sides, questions are being asked about the future magnitudes and terms of international lending, the role of such lending in the further development of the borrowing countries, and the effect of the debt situation on these countries’ growth prospects.
In attempting to address these issues, this chapter begins by describing the evolution of the borrowing countries’ balance of payments and debt positions since the early 1970s, with particular emphasis on those developments that can now be seen as having contributed to the external payments difficulties since 1981. A medium-term scenario is then presented, based on a set of assumptions about developments in the external economic environment and the domestic policies of developing countries. A sensitivity analysis is developed to illustrate the likely consequences of various alternative evolutions in external conditions and domestic policies. Using this analysis, an attempt is made to define the conditions and policies under which borrowing countries would be able to attain both viable external positions and satisfactory rates of economic growth during the latter half of this decade. This analysis has certain implications for the adjustment policies that these countries will need to carry out in 1984 and in subsequent years. These policies, and the likely external financing requirements for 1984, are discussed in the final section of this chapter.
Trends in External Debt
Many developing countries have experienced at one time or another, difficulties in meeting their normal external payments. In many instances, they have not been able to obtain sufficient additional financing to avoid import restrictions, exchange controls, the accumulation of arrears, and other temporary measures to deal with foreign exchange shortages. Such difficulties have arisen from a variety of causes, but before 1982 it was only on occasion that debt service obligations could be singled out as a particularly important aspect of foreign exchange scarcities. The external payments problems of 1982–83, however, were widely identified with difficulties in meeting these obligations. Such difficulties resulted from a number of related factors: cumulative changes in the magnitude and structure of these countries’ borrowing that had been taking place since at least the early 1970s; inappropriate domestic policies, including both inadequate demand management and policies that lowered the productivity of resources made available by the borrowing; and an unusual conjuncture of adverse external developments. The greater vulnerability to external developments inherent in an increasing dependence on commercial bank financing with variable interest rates (rather than direct investment or financing from official sources) and on loans with shorter maturities became apparent during the past few years, when borrowing countries faced a combination of higher oil prices, extraordinarily high real interest rates, and a fall in the prices and volume of their exports associated with the prolonged recession. A breakdown of normal trade and credit relationships was averted only by major debt restructurings and adjustment programs that were undertaken by a large number of countries.
This section begins with a discussion of long-term trends in the external debt of developing countries. It then reviews the main developments since 1980 that contributed to the emergence of widespread debt-servicing difficulties. The impact of the various debt-restructuring exercises is discussed in the last part of the section.
Size and Composition of External Debt, 1973–84
In the following analysis on long-term trends in the size and composition of external debt, special attention will be paid to two principal groups: the non-oil developing countries, whose total debt accounted for 87 percent of all developing country debt at the end of 1983,1 and the 25 major borrowers2 (which include 4 major oil exporting countries), whose share in the debt of all developing countries was 79 percent. The total external debt3 of the non-oil developing countries grew more than fivefold from 1973 to 1983, to reach $669 billion, and is projected to increase further to $711 billion in 1984 (Appendix Table 35). A large part of this growth was accounted for by the 25 major borrowers, whose external indebtedness amounted to $607 billion at the end of 1983, compared with $126 billion at the end of 1973. The concentration of total debt is, however, even greater than suggested by these data. The 10 largest borrowers accounted for more than one half of the total external debt of all developing countries at the end of 1983, and the 5 largest accounted for more than one third. Among non-oil developing countries, countries in the Western Hemisphere accounted for the largest part of the outstanding debt (44 percent), followed by Asia (25 percent), Africa (10 percent), Europe (11 percent), and the Middle East (8 percent). As for the major oil exporting countries, the total debt of this group reported here is accounted for by the 4 countries (Indonesia, Venezuela, Algeria, and Nigeria) that are included in the group of major borrowers; the aggregate debt of the other major oil exporters is thought to be relatively small.
To properly assess the nominal magnitudes cited above, it is necessary to relate them to real flows of goods and services. One commonly used technique for doing so is to deflate them by an index of export prices of the borrowing countries, as a measure of the opportunity cost of servicing the debt. For instance, while the total external debt of the non-oil developing countries4 grew between 1973 and 1983 at an average annual rate of 18 percent in nominal terms and that of the 25 major borrowers at a rate of 17 percent, the debt of these groups increased at annual rates of only 9 percent and 8 percent, respectively, when deflated by an index of their export unit values; the growth in real terms would be somewhat less if an index of import unit values was used as the deflator (Chart IV-1).
Chart IV-1.Non-Oil Developing Countries: Total External Debt in Nominal Terms and Deflated by Import and Export Unit Values, 1973–831
1 Excluding China.
Another means of scaling the nominal debt magnitudes is to relate them to the value of exports of goods and services, although as will be shown later, this approach provides only a rough indication of an economy’s ability to sustain a particular external debt burden. The total debt of the non-oil developing countries4 rose from 114 percent of exports of goods and services in 1973 to a peak of 158 percent5 in 1983 (Appendix Table 36). All of the net increase occurred after 1980, since the rapid growth in debt between 1973 and 1980 coincided with generally buoyant growth in exports, whereas after 1980 the continued expansion of outstanding debt was combined with a slowdown in export growth caused by the world recession. The ratio of debt to exports is projected to decline slightly to about 153 percent in 1984 as a result of an expected slowdown in the growth of total debt and a modest recovery in export growth (Chart IV-2). The debt ratio of the major borrowers has been considerably larger throughout the past decade; it rose from 133 percent in 1980 to 194 percent in 1983. A decline to about 187 percent is projected in 1984, as a result of strong adjustment programs adopted by a number of the major borrowers.
Chart IV-2.Developing Countries: External Debt and Debt Service, 1975–84
1 Excluding China.
2 Amortization ratio based on amortization for medium-term and long-term debt.
The ratio of debt service payments6 to exports of goods and services of the non-oil developing countries7 increased only moderately from about 15½ percent in 1973 to about 17½ percent in 1980 but then grew rapidly to 25½ percent in 1982 under the impact of the sharp increase in world interest rates and the growing proportion of debt contracted at market rates (Chart IV-2 and Appendix Table 38). The debt service ratio declined in 1983 to 22½ percent8 as a result of substantial debt rescheduling; on the basis of current repayment schedules, it is projected to decline slightly further, to 22 percent, in 1984. Within these aggregates, the experience of different regions has varied considerably. In 1983, debt service ratios (after the impact of rescheduling) were 44 percent for the non-oil developing countries in the Western Hemisphere region, about 25 percent for African countries, and only 11 percent for Asian countries.
Since a relatively larger proportion of the debt of the major borrowers is on commercial terms, their debt service ratio has been even more sharply affected by increases in interest rates, rising from 21½ percent in 1980 to 32½ percent in 1982, before falling to 30 percent in 1983 as a result of debt rescheduling (Chart IV-2). On present repayment schedules the debt service ratio of the major borrowers is projected at 29 percent in 1984.
The rapid growth in non-oil developing countries’ external debt since 1973 can be related to developments in their current accounts, including the impact of the two oil price increases and the growing burden of interest payments on the debt, as well as to shifts in the composition of financial inflows that were already under way before 1973. Expressed as a percentage of exports of goods and services, the average current account deficit of this group reached about 24 percent in 1974–76 and 21 percent in 1980–82, compared with about 10 percent in 1973. On both occasions on which oil prices increased, only part of the widening of the current account deficit was attributable to the direct impact of higher oil prices. In fact, the deterioration in the balance on non-oil trade was almost as large as that on oil trade, as a result of slower growth in export markets and sharp increases in the cost of non-oil imports. Indeed, there was no close correlation between the level of a country’s dependence on imported oil and the extent of the deterioration in its current account. This is not surprising, since not only did policy reactions vary substantially among countries,9 but the major shifts in relative prices substantially altered the pattern of consumption and investment expenditures and consequently the pattern of current account deficits. In particular, for the net oil exporters in the non-oil group and for some of the major oil exporters, expectations of a continued rise in oil revenues led to the adoption of expenditure patterns that contributed to higher current account deficits and rising external debt.
A growing proportion of the current account deficit of non-oil developing countries has been accounted for by the deficit on net investment income—primarily the result of higher interest payments on external debt (Chart IV-3). This has meant that, although total financial inflows from external borrowing and non-debt-creating flows grew rapidly through 1981, the need to finance interest payments left a declining share of such inflows available to finance net imports of goods and services. (By 1983, net payments of investment income by the non-oil developing countries were, in fact, slightly larger than their combined current account deficit.) In interpreting these developments, however, it should be borne in mind that, during periods of rapid inflation, there is a substantial reduction in the real value of the debt and that this may be partly reflected in higher nominal interest rates paid to creditors.
Chart IV-3.Non-Oil Developing Countries: Sources and Uses of External Financial Flows, 1974–841
1 The chart shows trends in financial inflows (resulting from external borrowing or non-debt-creating flows) and their disposition through accumulation of official reserves, current account deficits (broken down into net investment income and all other elements), and a residual component. All signs are in normal balance of payments terms, that is, a plus sign indicates a surplus and a minus sign indicates a deficit.
2 Including reserve-related credits.
3 Current account on goods and nonfactor services plus private transfers.
4 Net accumulation of external assets by the private sector plus errors and omissions and valuation changes.
5 Minus implies accumulation of reserves.
The other major element accounting for the rapid growth in external debt during the past decade was a shift in the pattern of financing of current account deficits. There was a marked increase in the share of external borrowing in total financial inflows, at the expense of non-debt-creating flows (primarily official transfers and private direct investment) (Chart IV-3). For instance, in 1973, non-debt-creating flows to non-oil developing countries were almost as large as total external borrowing, whereas by 1978 and 1981 they were only one half and one third as large, respectively (Appendix Table 28). This development was mainly due to a considerable increase in commercial bank lending. Such lending had already grown rapidly in the late 1960s and early 1970s, especially for the 25 major borrowers, whose long-term debt to financial institutions increased at an average annual rate of over 30 percent between 1967 and 1973. This trend continued after the first oil price increase, when the oil exporting countries substantially increased their short-term deposits with the banks, which, in turn, undertook a larger share of the financial intermediation vis-à-vis the non-oil developing countries. Between 1974 and 1983, the stock of long-term debt of non-oil developing countries owed to financial institutions increased at an average annual rate of 25½ percent, compared with an average rate of growth of 17½ percent for total external debt and an estimated rate of growth of 11 percent in foreign direct investment (at book value). Growth in bank debt of the major borrowers was even more rapid, averaging some 27 percent per annum between 1974 and 1983. For some of the major borrowers, especially those in Latin America, part of this increased borrowing tended to be offset by an outflow of private capital.
No single indicator of debt or debt service can by itself answer the key questions in relation to a country’s debt, such as whether it is able to service a particular level of indebtedness; or whether its rate of accumulation of debt is sustainable over the long term; or whether a debt situation that is manageable at present is likely to become unmanageable if certain underlying conditions change. The answers to these questions depend on a country’s overall economic situation, including its future growth prospects, the size of its external debt relative to other components of the balance of payments, and on the ease with which resources can be shifted between the nontraded and traded goods sectors of the economy to make foreign exchange available for debt service payments. They also depend, however, on the composition and terms of the debt itself. In this regard, developments over the last decade greatly increased the vulnerability of many developing countries to the major deterioration in the external economic environment that occurred after 1979.
The principal summary statistics used in this report to describe trends in external debt are the ratios of total debt and debt service to exports of goods and services. These relate debt magnitudes to a country’s current capacity to earn foreign exchange, but they are only rough indicators of a country’s ability to service its external debt. For instance, the needed foreign exchange could also be generated by a reduction in imports: a country which embarks on sizable import-substituting investments (for example, in the energy sector) financed by foreign borrowing might experience a rising ratio of debt and debt service to exports, but this would not necessarily represent a worsening external position.10 Moreover, what is crucial is not the current foreign exchange-earning or -saving ability of a country, but its future prospects. Increasing debt and debt service ratios are to be expected as part of the normal growth pattern of developing countries with substantial opportunities for profitable investment that are not met from domestic saving. If the additional resources made available by external borrowing are used for sufficiently productive investments, they will generate future real resources that will permit servicing of the debt without affecting future consumption. In this regard, evidence presented in the 1983 World Economic Outlook suggested that, for most of the largest borrowers among non-oil developing countries, the increase in external debt during the last decade was associated with a higher rate of investment and was not used primarily to finance consumption.11
However, if the additional investment made possible by external borrowing is not sufficiently productive to cover debt service payments, these will then be at the expense of future consumption, and the country will be less able to support a particular level of indebtedness. This could occur either because the original choice of investment projects was poor, perhaps as a result of an inappropriate structure of domestic prices, or because an unexpected shift in underlying external conditions—such as the extended recession and high real interest rates of recent years—rendered previously viable investments less profitable. For instance, the low or negative real rates of interest that prevailed during 1974–78, together with expectations that such rates would continue, probably encouraged a higher level of external borrowing than would have occurred if the significantly positive real rates of interest that emerged from 1979 onward had been expected.
The changes in the composition and terms of developing countries’ debt over the past decade have greatly increased their vulnerability to developments in external financial markets. The decreased importance of private direct investment flows relative to external borrowing implies a reduction in the share of risk borne by foreign savers and an increase in risk borne internally, since payments on private direct investment are required only if the investment earns a return, whereas debt service payments must be made irrespective of the use made of the resources generated by borrowing. Moreover, the continued growth in the share in total debt of long-term debt due to financial institutions—from 17 percent in 1974 to 28 percent in 1982 for the group of non-oil developing countries, (Chart IV-4 and Appendix Table 37)—had a number of unfavorable consequences, even though it helped to cushion these countries from the immediate effects of adverse external influences. First, the shift toward greater reliance on borrowing at commercial terms magnified the impact of the sharp increase in nominal and real rates of interest. Second, since most bank lending takes place at interest rates linked to a variable base rate, the proportion of total debt of non-oil developing countries subject to variable rates increased substantially, from 7 percent in 1972 to 37 percent in 1982. The share of variable interest rate debt was even higher for the group of major borrowers, reaching 42 percent in 1982, although there were significant differences within the group; variable rate debt accounted for from one half to three quarters of the long-term debt of the major borrowers in Latin America but for well under 10 percent of the long-term debt of countries that relied primarily on official development loans (including Egypt, India, and Pakistan). The greatly increased proportion of debt at variable rates heightened developing countries’ sensitivity to developments in world financial markets and meant that the sharp increase in interest rates of recent years had an immediate and large impact on their debt service burdens.
Chart IV-4.Non-Oil Developing Countries: Trends in the Composition of External Debt, 1973–841
1 Excluding China.
The share of short-term debt in total debt of the non-oil developing countries also increased significantly, from 11 percent in 1974 to a peak of 20 percent in 1982, before declining to 15½ percent in 1983 and a projected 12½ percent in 1984, as a result of the consolidation of short-term debt that took place in some of the major reschedulings (Appendix Table 37). For the major borrowers, the proportion of short-term debt was even higher, reaching 24½ percent of all debt in 1982 before declining to 20 percent in 1983, compared with only 15 percent in 1974. The growing proportions of short-term debt exacerbated the imbalance between the maturity structure of external debt and the investment that it financed and resulted in an increased vulnerability to the emergence of serious liquidity problems when creditors were reluctant to roll over their short-term commitments.
Recent Developments, 1980–83
Although there were broad similarities in the overall external position of non-oil developing countries immediately after the first and second oil price increases, the debt-servicing difficulties that emerged in the latter period were much more severe, because of a more unfavorable world economic environment and the increased vulnerability of these countries resulting from changes in the composition of their external debt. The implications of this shift in composition—toward debts with shorter maturities and variable interest rates—were already becoming apparent by 1980, as both nominal and real rates were already increasing. Despite the lower ratio of debt to exports of goods and services, the debt service ratio was already higher in 1980 (17½ percent) than in 1974 (14½ percent). (See Appendix Table 38.)
Notwithstanding this underlying shift in circumstances, the initial response to the second oil price increase was similar to that after the first, with larger current account deficits financed by increased external borrowing. During 1980 and 1981, new commercial bank lending expanded substantially, and the total external debt of non-oil developing countries grew at an average annual rate of 19 percent, led by an even sharper growth in short-term debt of over 32 percent per annum. This growth was comparable to that in the first two years following the first oil price increase, but subsequent developments were to show that such a level of financing was not sustainable, especially in the changed economic climate prevailing at that time. By 1983 external debt had increased to an unprecedented 150 percent of exports of goods and services, and the debt service ratio had reached 21½ percent—even after a number of major reschedulings—and widespread debt-servicing difficulties had emerged (Appendix Table 36).
The key changes in external conditions that led to these developments were the extended deep recession, which resulted in a sustained deterioration in the terms of trade of the non-oil developing countries and caused a slackening of their export growth, and the sharp increase in real interest rates. The impact of the external environment was especially severe in those countries with weak demand management policies and structural imbalances (see Chapter III). The resulting problems led to a sharp cutback in commercial bank lending.
Between 1978 and 1982, the cumulative deterioration in the terms of trade of the non-oil developing countries amounted to 15½ percent. Although this was only slightly larger than the deterioration of 14 percent after the first oil price increase, the earlier deterioration was followed by a swift recovery, whereas there was only a minor improvement in the terms of trade during 1983 (Appendix Table 10). The recovery in export volumes following the sharp drop in their rate of growth in 1982 also proved to be slower than the recovery that followed the 1975 recession.
The difference in real interest rates between the two periods is even more striking. Measured as the London interbank offered rate (LIBOR) on three-month U.S. dollar deposits less the rate of change of the GNP deflator in the United States, the real interest rate increased from an average of only ½ percent during 1974–78 to more than 7 percent in 1981 and 1982, and it was still over 5 percent in 1983. The contrast between periods is even more dramatic if the real interest rate is defined in terms of LIBOR less the rate of change in export prices of the non-oil developing countries (Chart IV-5). The real burden of debt service increased as the world economy moved from an inflationary to a disinflationary environment. Interest rate spreads on new credit commitments to developing countries also rose, particularly in 1982, and there was a greater differentiation in rates among borrowers.
Chart IV-5.Trends in Nominal and Real Interest Rates, 1973–83
1 London interbank offered rate on three-month U.S. dollar deposits.
In addition, the cutback in net bank lending to non-oil developing countries from the second half of 1982 onward, especially the reduction in banks’ short-term exposure, greatly exacerbated these countries’ external financial difficulties. This cutback was largely responsible for the substantial decline in the rate of expansion of total debt to some 13 percent in 1982 and to 5½ percent in 1983.
The decline in both the volume and price of oil exports from the oil exporting countries since 1981 contributed to a weakening of the external position of these countries. While several of the countries in the group of 12 major oil exporting countries continued to have only limited recourse to external borrowing, the debt situation worsened significantly for a number of other oil exporters. Because of the adoption of more expansionary policies, the outstanding indebtedness of several oil exporters had already been growing during the period when oil revenues were increasing. Consequently, when oil revenues began to decline, a number of countries (including Nigeria and Venezuela among the major oil exporters and Bolivia, Ecuador, Mexico, and Peru among the other net oil exporters) experienced debt-servicing difficulties. The debt service ratio of the net oil exporting countries in the non-oil group rose from 22½ percent in 1980 to 31 percent in 1983, even after debt rescheduling by a few of the largest borrowing countries in the group (notably Mexico). The difficulties experienced by some of these countries were exacerbated by the high proportion of their total debt that was in the form of short-term liabilities.
Impact of Debt Restructuring
The increasingly severe external financial constraints of recent years caused a growing number of developing countries to seek a restructuring of their external debt. The number of countries concluding multilateral agreements for debt rescheduling increased from an average of less than 4 a year during 1974–78 to some 9 a year during 1978–82, while the total amount of debt rescheduled each year rose from an average of about $1¼ billion to over $4½ billion. Most of the agreements concluded during the earlier period covered loans provided or guaranteed by governments or official agencies, but the number of reschedulings of commercial bank debt, as well the amounts involved, also increased. From 1981 onward, they accounted for well over half of the debt rescheduled in each year. These trends intensified late in 1982 and in 1983, when some of the largest borrowers started negotiations with their creditor banks. In all, during 1983 some 30 developing countries, including 5 of the 10 largest borrowers and 11 of the 25 major borrowers, completed or were engaged in debt rescheduling with official or commercial bank creditors.12,13 The total external debt of these countries amounted to approximately $400 billion at the end of 1983, equivalent to more than one half of the total debt of all developing countries.
Most negotiations for the restructuring of debt were conducted multilaterally. This often made agreement easier by ensuring uniformity of treatment among creditors and by providing a framework in which creditors could be assured that debt relief was used to support an adjustment effort designed to improve the debtor country’s external financial position. In this regard, both official and commercial bank creditors usually required that a Fund-supported adjustment program be in place before debt renegotiations were concluded. Conversely, in a number of cases—most notably for Argentina, Brazil, Chile, and Mexico—where the provision of debt relief and additional financing was identified as crucial to the success of orderly adjustment, it was necessary to seek assurances that debt relief and new official and bank lending would be forthcoming before a Fund-supported program could be finalized.
Although the terms on which debt was rescheduled varied with each borrowing country, certain broad trends emerged. Generally, for debt due to official creditors, about 80 percent to 90 percent of principal and interest payments due on medium-term and long-term debt during a given period, together with arrears, were rescheduled. Most arrangements covered payments falling due over the next 12–18 months, but there was often an understanding that debt relief for future periods would be granted, if required to sustain a continued adjustment effort in the context of a Fund-supported program. The rescheduled portion of the debt generally carried a maturity of from seven to nine years, including a grace period of two to three years. Interest rates were determined on a bilateral basis, and the general principle was to avoid concessional terms so as to preserve a clear distinction between debt relief and development assistance.
Recent reschedulings of bank debt typically covered some 80 percent to 100 percent of principal payments falling due on medium-term debt (excluding previously rescheduled amounts). New maturities on the rescheduled debt were generally for seven to eight years, including grace periods of two to three years. Interest rates were usually within the range of 1¾ percent to 2¼ percent over LIBOR or the U.S. prime rate. During 1983, rescheduling fees appear to have ranged from 1 percent to 1½ percent of the amounts restructured. However, all these terms varied among borrowing countries, and those countries that were seen to be successfully implementing particularly strong adjustment programs (for example, Mexico) were often able to negotiate terms that were better than those outlined here.
Short-term bank debt was formally restructured in about half of the rescheduling agreements, and in many other cases there was an informal agreement that such debt would be rolled over so that banks would maintain their level of exposure over time. In practice, however, when no formal rescheduling of short-term debt took place, informal agreements were only partly successful and it often proved difficult to maintain short-term bank exposure after a country experienced debt-servicing difficulties. Even when trade-related credits were formally rescheduled, the treatment of interbank deposits, which were of substantial importance for some of the larger borrowers, was often particularly difficult. For instance, the attempt to restore interbank placements in Brazil fell substantially short of the initial target.
Banks remained unwilling to reschedule future interest payments and, indeed, generally required the elimination of arrears on interest payments before concluding debt-restructuring arrangements. In a number of countries, however, including many of the largest borrowers, the external disequilibrium and the size of future interest payments were such that a commitment of new funds was required for interest to be paid as scheduled. In these cases, substantial new financing commitments formed an important part of the debt-restructuring process, supplemented on occasion by the provision of bridging finance by the Bank for International Settlements (BIS). In 1983, commitments for additional financing from commercial banks amounted to about $15 billion, almost all to countries in Latin America. Substantial additional commitments are likely in 1984; for instance, preliminary agreements have been reached on the provision of further new financing to Mexico and Brazil, amounting to approximately $10 billion.
The restructuring of official and commercial bank debt in 1983 had a considerable impact on the external positions of the countries involved. Estimation of the overall impact of the various rescheduling agreements, particularly for bank debt, is complicated by the difficulty of estimating the effects of the rollover of short-term debt and by lack of full information on rescheduling fees. It is estimated, however, that debt rescheduling already undertaken reduced the debt service payments of non-oil developing countries by $8 billion in 1982 and by $19 billion in 1983, equivalent to 2 percent and 4 percent, respectively, of their exports of goods and services. In 1984, it is projected that such rescheduling will approach $20 billion. The consolidation of short-term debt that took place in a number of the rescheduling agreements also substantially improved the maturity profile of debt for the countries involved.
For the 25 major borrowers, debt rescheduling reduced debt service payments by an estimated $6½ billion (2 percent of goods and services) in 1982 and by an estimated $20 billion (6½ percent of exports of goods and services) in 1983. A reduction of about $18 billion (5½ percent of exports of goods and services) is projected for 1984. In addition, the new bank financing commitments that were closely integrated with some of the rescheduling agreements were directed almost completely to the major borrowers. The proportionate effects of debt relief for some individual countries were much larger than these average figures. For instance, in 1983, restructuring of debt (including new bank financing commitments but excluding the rollover of short-term debt) provided net debt relief equivalent to about 40 percent of exports of goods and services for Brazil and 33 percent for Mexico.
By 1983, it had become clear that, for many developing countries, it was necessary to achieve a reduction in external debt and debt service ratios, but it was less clear in what ways and over what time period this objective might be accomplished. In the short run, the requirements for further external finance and the adjustment policies of the debtor countries had to be framed in terms of the given external environment; how this occurred is discussed in Chapter III. While the need for countries with debt problems to cut back on expenditures and imports seemed imperative in 1983 and a short-run fall in income and output was often an unavoidable consequence, in the medium term the continued stagnation of output in developing countries with rapidly growing populations would be an unacceptable outcome. It is important, therefore, to understand how the evolution of world demand and interest rates, as well as other key developments in the global economy, would affect the future external financing needs and desirable adjustment policies in the developing countries.
This section contains projections of the growth of GDP, the current account of the balance of payments, external indebtedness, and debt service for the years 1985–90 for the non-oil developing countries,14 as well as for the group of 25 major borrowing countries that includes 4 oil exporting countries. A “base scenario” is developed, within an analytical framework in which links between the balance of payments of developing countries and the variables that characterize their external environment are quantified on the basis of historical experience, econometric analysis, and Fund staff estimates. (A description of the methodology underlying the scenario projections is contained in Supplementary Note 7.) Assuming moderate rates of growth in the industrial countries, some fall in real interest rates, and unchanged terms of trade, and assuming also that the non-oil developing countries continue their present adjustment policies, the conclusion is reached that most groups of these countries can achieve adequate rates of growth of GDP (although somewhat below the rates attained during the 1960s and 1970s), while restoring a manageable position with respect to their current accounts and debt service burden.
The second half of this section demonstrates the sensitivity of this outcome to changes in certain key assumptions regarding the external environment. This “sensitivity analysis” focuses in particular on the consequences for the current account, debt, debt service, imports, and growth of developing countries of alternative assumptions with respect to the rate of growth in industrial countries, the level of interest rates, the price of oil, the extent of trade liberalization, the availability of external finance, and the policies pursued by the non-oil developing countries themselves.
The Base Scenario
The principal features of the external environment faced by developing countries under the base scenario are as follows:15
—Real GNP in the industrial countries is assumed to grow at an average rate of 3¼ percent during 1985–90, compared with an average of 1.3 percent during 1980–83 and the projected rate of 3.6 percent for 1984. The projected growth rates represent an evolution of output that would result in only a marginal reduction in economic slack. As a result, while unemployment would not increase, it would nevertheless remain substantial at the end of the decade, particularly in the European countries and Canada. The projection largely abstracts from cyclical factors that might cause variations around the trend during the projection period.
—The world market price of manufactures in U.S. dollars is assumed to rise at a rate of 4 percent per annum over the entire period 1985–90.16 It is implicitly assumed that the general price level in the United States, as measured by the GNP deflator or the consumer price index, will rise at broadly the same rate and that the real exchange rates between the U.S. dollar and other major currencies will remain unchanged.
—Interest rates paid by developing countries on floating rate credits are assumed to decline gradually from 1986 onward and to reach by 1988–90 a level that is 3 percentage points lower in nominal terms than that prevailing in 1984. In making this assumption, it is assumed that monetary policies in industrial countries will continue to be directed at controlling inflation. Stability in the inflation rate would be one factor making for a decline in real interest rates; another and more important factor is the assumption that some action will be taken to reduce (although not eliminate) the U.S. federal budget deficit by 1990; and that other countries will also act to contain or reduce their structural deficits. Lastly, the improving external position of indebted countries is expected to help bring about some reduction in the spreads these countries pay over the London interbank offered rate (LIBOR).
—Oil prices are assumed to remain constant in real terms during 1986–90, that is, to increase by 4 percent per annum in nominal terms, after having remained constant in nominal terms from the end of 1983 through the end of 1985.
—After slight improvements in 1983 and 1984, the terms of trade of the non-oil developing countries are projected to remain constant for the remainder of the decade. This projection is based on the relatively modest pace of expansion projected for the industrial countries during this period, but it leaves the implied real price index of commodities exported by these countries still considerably lower than the average for the 1960s and 1970s.
—For the remainder of the decade, there are assumed to be no further trade restrictions imposed by industrial countries against exports from developing countries, but no easing of existing restrictions is assumed.
—The exposure of international commercial banks to developing countries (other than under trade-related credits) is assumed to be unchanged in real terms between 1985 and 1990. Within this total, it is assumed that exposure to those countries with heavy maturities of rescheduled debt will decline somewhat (in real, although not in nominal terms), while exposure to countries with a lesser debt burden will increase slightly. As far as import-related credits are concerned (largely trade credits and supplier’s credits), these are expected to grow at the same rate as the value of imports after 1985, having grown at a somewhat lesser rate in 1984–85.
—Official development assistance is assumed to remain constant in real terms at the level projected for 1984, that is, to increase by 4 percent per annum in nominal terms.
—Direct foreign investment is assumed to grow at a somewhat higher rate than commercial bank exposure, reflecting a greater preference for this form of investment on the part of investing countries than was the case during the past decade, a greater effort by developing countries to obtain such investment, and the fact that investment opportunities in these countries are likely to be growing more rapidly than in the industrial countries.
It is important to emphasize that the outcome of the base scenario depends not only on the environmental assumptions outlined above but also on continued efforts in the debtor countries themselves to curtail fiscal deficits and monetary expansion and to pursue the other policies—notably, exchange rate and pricing policies—that are required to promote structural changes in their domestic economies. Failure to control the growth of aggregate demand would lead to more rapidly growing imports than in the outcome of the base scenario, while backsliding with regard to “supply-side” policies would result in both lower exports and higher imports than in the base projections. These points are elaborated in connection with the sensitivity analysis presented later in this section.
The outcome of the base scenario shows a substantially improved external position for the non-oil developing countries, compared with their position in 1982–83. The current account deficit of these countries as a group, measured in relation to their exports of goods and services, declines from 12.6 percent in 1983 (itself sharply lower than the 18.7 percent deficit in 1982) to 9.7 percent in 1987, and is then little changed (10.1 percent) in 1990 (Appendix Table 46). The current account deficit of these countries would thus be considerably smaller in relation to their export earnings than at any time since 1973. It would also be significantly less than the average of 17 percent recorded during 1967–72, before the first round of oil price increases.
The external indebtedness of these countries, again measured in relation to their exports of goods and services, declines under the scenario from 150 percent in 1983 to 132 percent in 1987 and to 124 percent in 1990 (Appendix Table 47). Debt service ratios, after rising from 21.6 percent in 1983 to 24.4 percent in 1987, decline to 21.3 percent in 1990. The reduction after 1987 results both from the more rapid growth of exports and the slower accumulation of external debt taking place during the scenario period, compared with 1980–83. The rise in the debt service ratio from 1983 to 1987 results from the partially offsetting effects of a rise in the ratio of amortization payments to exports, as payments rescheduled in 1982–83 come due, and a lowering of the interest payments ratio, reflecting both interest rate reductions and the downward trend in the debt ratio (Chart IV-6).
Chart IV-6.Developing Countries: External Debt and Debt Service, 1981–901
1 Ratios for 1984–90 are projections.
2 Including China.
3 Amortization ratio based on amortization for medium-term and long-term debt.
For the 25 largest debtors among the developing countries, the projected trends for debt and debt service differ somewhat from those for the non-oil developing countries. A number of the largest debtor countries underwent large-scale reschedulings of their external debt in 1982 and 1983, as a result of which the “hump” in projected amortization payments for the 25 major borrowers, beginning already in 1985 and reaching a peak (relative to exports) in 1988, is especially large. For this group, the amortization ratio rises from 10 percent in 1984 to 19 percent in 1987, before declining to 17½ percent in 1990. At the same time, however, because of the steady fall in the ratio of interest payments to exports, the movement in the overall debt service ratio is less marked, rising from 29 percent in 1984 to 34 percent in 1987 and falling to 30 percent in 1990 (Chart IV-6).
While one would not wish to minimize the difficulties that might be caused by this rise in the debt service ratio through 1987, it should be pointed out that the growth in exports and financing assumed between 1984 and 1987 leaves these countries in a much better position to pay for their required imports than was the case in 1982 and 1983. In fact, the scenario envisages no compression of imports occurring as a result of the high amortization payments due for the major borrowing countries. Instead, it is assumed that all necessary refinancing of external debt will occur; this outcome is implicit in the assumption that trade-related credits will grow in step with aggregate imports, and that the exposure of commercial banks under non-trade-related credits will remain constant in real terms. It is understandable that concern could arise on account of the large increase in gross financing requirements: for instance, amortization payments for the 25 largest debtors are projected to rise from $35 billion to $85 billion between 1984 and 1987. Although in a few individual cases rescheduling agreements may be necessary, it should be possible to manage the bulk of the financing requirements by means of spontaneous refinancing of the credits being amortized. With moderate expansion in the world economy, with effective adjustment policies in place in the debtor countries, and with lending to developing countries occupying a declining share of total bank portfolios, it may not be unreasonable to suppose that banks would be willing to maintain a constant level of outstanding credit in real terms.
Another outcome of the base scenario is a considerable improvement in the rates of growth of GDP of the non-oil developing countries during 1985–90, compared with growth rates prevailing in 1980–83, though economic growth would still be below that achieved in the preceding two decades. Real GDP of the net oil exporters and of the major exporters of manufactures is projected in the base scenario to grow at 4.5 percent and 4.3 percent per annum, respectively, by 1988–90 (Appendix Table 48). By contrast, the low-income countries (excluding China and India) and the “other” net oil importers are projected to grow more slowly, at 3.5 percent and 4.1 percent per annum, respectively, by 1988–90. The improved growth rates for the non-oil developing countries as a whole—which average 4.6 percent over the scenario period, compared with an average of 2 percent over 1981–83 and a projected 3.5 percent in 1984—are made possible by the accelerated growth of exports projected for the medium term. The pickup in export expansion not only directly stimulates the export sectors in these countries but also removes obstacles to the growth of nonexport sectors and to domestic investment generally, by raising import capacity.
The rates of growth of export volumes projected for the non-oil developing countries for 1985–90 are considerably higher than the average rates for 1980–83, although export volumes for most subgroups would grow more slowly than their rates during 1973–80 or than the rate forecast for 1984 (Appendix Table 48). In particular, export volume growth for the net oil exporters is projected to be only 2.6 percent per annum in 1985–87 and 3 percent per annum in 1988–90; these projections assume that global demand for energy rises at a relatively modest pace throughout the 1980s. Export growth of the manufacturing exporters would reach an average annual rate of 6.9 percent in 1985–87 and 6.5 percent by 1988–90, much less than in the 1970s, but consistent with the projected growth of markets in the industrial countries. The projected rates of export growth for the low-income countries and the “other” net oil importers are somewhat lower than these. Nevertheless, for the low-income countries, this projected export growth is especially favorable compared with the experience up to 1982. It implies a continuation, although at a more moderate rate, of the better performance achieved in 1983 and in prospect for 1984. To sustain this performance over the medium term would require the continuation of strong export-oriented adjustment policies on the part of these countries. Without such export growth, however, it is likely that the annual growth of GDP for many of these countries would slip below the rate required to maintain their present level of per capita output.
These results would not be achievable if there were to be a substantial increase in protectionist measures over this period. Conversely, an easing of present trade restrictions—such as the Multifiber Arrangement, which allows for little growth to take place for present or new exporters for the specified goods—could result in a significantly improved export performance for the developing countries affected.
The growth of imports envisioned under the base scenario for the periods 1985–87 and 1988–90 implies a partial return to the rates that prevailed during the period 1973–80 (Appendix Table 48). The rate of growth of imports in 1981–83 was severely constrained by the declines in the terms of trade and export volumes experienced by most developing countries, the rise in debt service ratios, and the slowdown in the available net bank lending. Despite some improvement in these conditions, the rates of growth of exports and bank financing that are expected to occur during 1985–90 would remain lower than in 1973–80 (in the case of exports slightly lower, and in the case of bank financing, considerably lower). Reflecting these trends, import volumes of non-oil developing countries are also projected to grow more slowly than in 1973–80, at an average rate of about 6 percent a year during the entire scenario period or about 1 percent in excess of the growth in export volumes. This rate of growth of import volumes is slightly higher than that projected for 1984, except for the net oil exporters, whose projected growth of import volumes is about 5 percent, compared with a projection of 11½ percent for 1984.
As a result of imports being projected to grow more rapidly than exports, the current account balance excluding interest payments and investment income is projected to become negative in 1988 for the first time since 1982 (Chart IV-3 and IV-7). The especially high interest payments from 1981 onward, together with the cutback in available financing, had required many of these countries to run a positive trade account. The leveling off and eventual decline in the debt service ratio and the steady, if modest, growth in available financing would allow a return to trade deficits, as well as a resumption in the accumulation of international reserves.
Chart IV-7.Non-Oil Developing Countries: Sources and Uses of External Financial Flows, 1985–901
1 The chart shows projected trends in financial inflows (resulting from external borrowing or non-debt-creating flows) and their disposition through accumulation of official reserves, current account deficits (broken down into net investment income and all other elements), and a residual component. All signs are in normal balance of payments terms, that is, a plus sign indicates a surplus and a minus sign indicates a deficit.
2 Including reserve-related credits.
3 Current account on goods and nonfactor services plus private transfers.
4 Net accumulation of external assets by the private sector plus errors and omissions and valuation changes.
5 Minus implies accumulation of reserves.
Effects of Alternative Assumptions
The scenario outcome described above is, of course, sensitive to changes in the underlying assumptions. A less favorable outcome would result from either more pessimistic assumptions about the external environment or an assumption that the developing countries’ own policies would evolve in the direction of those pursued in 1979–81. With regard to the external environment, the ensuing analysis focuses on the effects of changes in the assumptions regarding the rate of growth of GDP in the industrial countries, LIBOR, the price of oil, and trade liberalization.
Assuming no other changes in the base scenario, a 1 percentage point decline in the annual growth rate of real GNP in the industrial countries would lead to a reduction of about 2 percentage points for each scenario year in the annual rate of growth of exports of the non-oil developing countries, compared with the growth rates in the base scenario. Assuming the same import levels as under the base scenario, financing the resulting current account deficit—equal to 13 percent of exports in 1987 and 18 percent in 1990—would require a much larger flow of bank lending than that assumed in the base scenario. This additional financing, in turn, would imply a rise, rather than a fall in the debt-exports ratio, which would reach 141 percent in 1990 (compared with 124 percent in the base scenario), and also in the debt service ratio (24½ percent instead of 21½ percent). (See Appendix Table 49.) If, however, such accommodating financing were assumed to be unavailable, so that the current account deficits were constrained to be the same as those projected in the base scenario,17 import growth would need to be cut back by an additional 1¾ percentage points per annum, and GDP growth would fall by 1 percentage point per annum, for the scenario period. Manufacturing exporters would be the most seriously affected by this latter development and low-income countries relatively least affected.18
The scenario outcome is also sensitive to changes in the interest rate assumption. For simplicity, it is assumed that interest payments on official debt are not affected by changes in market interest rates, but that all long-term and short-term debt to private creditors is at variable interest rates. On this basis, if interest rates on such debt were to be 1 percentage point higher in each scenario year than assumed in the base scenario, and if sufficient financing were available to accommodate such payments without affecting trade flows, a deterioration in the current account of the non-oil developing countries equal to ¾ percent of exports of goods and services in both 1987 and 1990 would occur. As a result, the debt-export ratio of these countries would be about 2 percentage points higher than under the base scenario in 1987, and 4 percentage points higher in 1990. The debt service ratio would be about 1 percentage point higher than under the base scenario in both years. If accommodating financing were not available, and consequently, the current account deficit were maintained at the levels projected in the base scenario, import growth would have to be reduced by about 1¼ percent for the first scenario year, implying a cutback of ½ percent in the rate of growth of GDP for that year. After these initial adjustments in imports and GDP, however, their growth rates for other years would be the same as those under the base scenario.
The impact on the non-oil developing countries of oil prices that are 10 percent higher than those projected in the base scenario was calculated separately for the net oil importing countries and the net oil exporters. If import levels were maintained and additional financing were available, the current account deficit of the net oil importers would increase in 1987 by an amount equal to 1¼ percent of exports, whereas the position of the net oil exporters (here including China) would show an improvement equal to almost 3 percent of exports. The resulting debt ratio for the oil importing countries becomes 1¾ percentage points higher in 1987. Alternatively, assuming no such accommodating financing, there would be an initial impact during the first scenario year of a 1 percentage point decline in the rate of growth of imports and a fall of ¼ percentage point in the rate of growth of GDP for the oil importing countries. These changes have little impact, however, on the average rates of growth over the entire scenario period.
The impact of a possible breakthrough in trade liberalization was examined next. It was assumed that such a breakthrough allowed developing countries to increase their exports to industrial countries at a rate 2 percent faster each year than in the base scenario. If there were no accompanying change in developing countries’ imports, a reduction in debt service ratios from the base scenario of 1¼ percentage points would occur in 1987 and of 4½ percentage points in 1990. If, however, the additional export receipts were used entirely to finance additional imports, so that the current account deficit remained the same as in the base scenario, imports would rise by an average of 8 percent per annum, implying an annual rate of growth of GDP of almost 5¾ percent.
Certain results of the sensitivity analysis could be combined into an alternative scenario, less favorable than the base one. Since the price of oil during this period is likely to depend in part on the rate of growth in the industrial countries, calculations have been made for a “pessimistic” scenario that includes only the assumptions of a 1 percent lower growth rate for the industrial countries and a 1 percent higher interest rate. Assuming unchanged imports and the availability of additional external financing, the combined current account deficit of the non-oil developing countries would worsen by $25 billion (or about 4 percent of exports) in 1987 and by $66 billion (9 percent of exports) in 1990, compared with the base scenario; the resulting debt ratios would be 141 percent in 1987 and 145 percent in 1990, and the debt service ratios would exceed the base scenario outcomes by about 4 percentage points in the latter year (Appendix Table 49). Alternatively, without accommodating financing to meet a worsened current account deficit, import growth would have to be curtailed by 2 percentage points per annum, while the rate of growth of GDP would be reduced by over 1 percentage point per annum.
It is likely, however, that the consequences of reduced growth in the industrial countries would be more severe for the non-oil developing countries than the results of the “pessimistic” scenario indicate. Trade restrictiveness against their exports could be increased as industrial countries attempt to protect their less buoyant markets from competition. Foreign aid as well as direct investment might be curtailed; and bank lending might also eventually decline from the level assumed in the scenario, to the extent that the lower export growth of the non-oil developing countries affects their credit worthiness.
A variant of the “pessimistic” scenario, which might be called a “crisis” scenario, was calculated on the assumption of a serious recession in the industrial countries, centered in 1987, accompanied by a slowdown in the growth of commercial bank lending to developing countries. The recession is characterized by growth rates of GDP in industrial countries of 2 percent, 1 percent, and 2 percent in 1986, 1987, and 1988, respectively, while the growth of non-trade-related bank exposure to the non-oil developing countries is assumed to be limited to 3 percent, 0 percent, and 3 percent, respectively, in those three years. The combination of the recession assumption with that of a slowdown in the growth of bank credit to the non-oil developing countries forces these countries to improve their current accounts, compared with the base scenario, by means of sharp cuts in both the growth of imports and the growth of GDP. In 1987, at the trough of the recession, imports are 6½ percent lower than in the base scenario and growth of GDP for that year is cut by nearly 3 percentage points for the group as a whole. The impact on the average rate of growth of output for the entire scenario period is over 1 percentage point (Appendix Table 49).
Finally, a scenario was calculated in which the external environment assumed for the base scenario was retained, but both demand-management and supply-side policies in the non-oil developing countries were assumed to be less firm than in the initial scenario. In this “weak policies” scenario, the rate of import growth for each scenario year is 1 percentage point higher than in the base scenario and export growth is 1 percentage point lower. This scenario results in a current account deficit in 1990 that is higher than in the base scenario by the equivalent of 8 percent of exports, a debt ratio of 136 percent (compared with 124 percent), and a debt service ratio of 23½ percent (compared with 21½ percent), all on the assumption of available additional external financing. Since a faster rate of growth of imports is the basis of this scenario, no alternative outcome based on the unavailability of additional financing was computed.
The practical conclusions that can be drawn from this medium-term scenario exercise can be summarized as follows. First, a set of external circumstances, featuring a sustained but relatively modest expansion in the industrial countries over the period 1985–90, together with a continuation of effective demand-management policies in the developing countries, could reasonably be expected to result in a steady decline in these countries’ ratio of debt to exports, an eventual decline in the debt service ratio (despite an initial rise), sustained improvements in the current account, and relatively satisfactory rates of growth of imports, exports, and GDP. Second, these outcomes are quite sensitive to key assumptions, especially with regard to growth in the industrial countries, the level of interest rates, the availability of external finance, and the policies pursued by these countries. Serious divergences of the values of one or more of these variables from those assumed in the base scenario would jeopardize the attempts of many developing countries to re-establish manageable external debt positions and simultaneously sustain adequate rates of growth of output. Finally, it should be borne in mind that the position of certain countries is particularly vulnerable and that a relatively satisfactory outcome for the groups of countries considered in this scenario may mask critical situations in individual cases.
Policy Implications in the Near Term
Financing of Current Account Deficit in 1984
The expected reduction in the current account deficit of the non-oil developing countries, from $56 billion (about 12½ percent of exports of goods and services) in 1983 to $50 billion in 1984 (Appendix Tables 24 and 25), while leaving a number of individual countries with problems, eases the financing problem faced by this group as a whole. It is, in fact, expected that many of these countries will obtain external financing in excess of that required to cover their current account deficit and will thereby be able to increase their international reserves. The ratio of reserves to imports had fallen to 16–17 percent (about two months’ imports) in 1981 and 1982, after averaging 23 percent in the preceding four years (Appendix Table 33). The perceived need to raise the level of reserves is even more acute than before in light of the experience of the debtor countries since 1981. The major borrowing countries experienced an especially large rundown in reserves, amounting to over $30 billion during 1981–83, and are also expected to partially restore their reserve positions in 1984.
The reduced importance of private lending in the financing of developing countries’ current account deficits is expected to continue in 1984. For non-oil developing countries, non-debt-creating flows are expected to grow moderately to $23 billion, largely because of a partial recovery in direct investment from the low level of 1983, and long-term foreign borrowing from official creditors is projected to grow slightly, also to about $23 billion (Appendix Table 31). Net external borrowing from private creditors (primarily bank credits) is projected at about $21 billion, virtually unchanged from 1983 and well below the levels of $60 billion to $70 billion that occurred in 1980 and 1981. The consolidation or refinancing of short-term debt into longer maturities that began in 1983 is also expected to continue. Total external debt (both short-term and long-term) is projected to grow by about 6¼ percent, compared with 5½ percent in 1983 and 13 percent in 1982 (Appendix Table 35). It is significant that after the sharp growth in the ratio of external debt to exports between 1980 and 1983 (see section on Trends in External Debt above), this ratio will begin to fall in 1984 and is projected to decline further in 1985 (Appendix Table 36).
For the 25 major borrowing countries, non-debt-creating flows and long-term borrowing from official creditors are also expected to increase modestly in 1984, to a combined total of some $24 billion (Appendix Table 27). Net external borrowing from private creditors is expected to increase to $23½ billion in 1984 from the low of only $19 billion in 1983, compared with $53 billion in 1980 and $61 billion in 1981. With a projected current account deficit of $31 billion in 1984, a significant share of the new lending would therefore go toward restoring depleted reserves and the repayment of arrears. There appears to be a reasonable prospect that a somewhat greater proportion of the new lending than in 1983 will take place under normal conditions rather than as part of large-scale negotiated financing arrangements.
One of the most uncertain elements of the financing picture concerns private capital outflows. Although a large part of these is unrecorded, the size of the “errors and omissions” component of the balance of payments suggests that such outflows have been quite large since 1980, especially for the major borrowers. It is projected here that they will diminish as a result of the adoption of more cautious financial policies and a move toward more realistic exchange rates and interest rates in a number of these countries.
Certain aspects of the external financing situation are not fully revealed by the projected figures. First, several countries are still in the process of negotiating debt-rescheduling or debt-restructuring agreements. A successful outcome to these agreements may not show up in data on net financing flows but will nevertheless have a large impact on the magnitude of debt service payments of these countries over the next several years.
Second, in public discussions of external debt problems, the distinction between “spontaneous” and “involuntary” lending is often mentioned. The second of these terms is intended to describe the attitude of lenders who agree to reschedule (or restructure) their loans, or to extend additional financing, because of pressure from their own monetary authorities or from other creditors, or out of fear that the alternative will be default on the part of the debtor. While willingness to lend is surely more a matter of degree than is suggested by the dichotomy between “spontaneous” and “involuntary” lending, the latter term does reflect the fact that certain creditors—for instance, some smaller banks in lending consortia—were initially unwilling to roll over or reschedule some of the credits that debtors found difficult to amortize in 1982–83. A possible consequence of a more manageable current account and external debt situation for debtor countries may be an increase in the average “voluntariness” of current lending. Again, this effect may not appear in aggregate statistics on financing and debt but could influence both the maturities and terms of new lending (and hence the future debt service burden of debtors), as well as the general state of confidence both in international financial markets and in the economies of debtor countries.
Finally, it should be mentioned that considerable uncertainty attaches to estimates of future lending to the private sector in debtor countries. One of the most dramatic effects of the debt crisis was a sharp fall in such lending. As exports and growth recover in these countries and arrears are eliminated, the flows of lending to private sector firms can be expected to resume. The extent to which this will already occur during 1984 is not yet clear: a stronger resurgence of such lending than that projected here would benefit both imports and investment. It also remains to be seen whether external borrowing by the private sector in debtor developing countries will continue to depend as heavily as before on bank loans or whether alternative types of financing, such as participation by foreign companies, will gradually come to play a relatively more important role.
The adjustment policies pursued by the developing countries—and not least by the major borrowers—have resulted in significant declines in rates of monetary expansion, the size of fiscal deficits relative to GDP, and the magnitude of current account deficits. While aggregate data for analytical subgroups of countries present a somewhat mixed picture (see Chapter III), the changes for some countries have been dramatic. The compression of these deficits resulted not only from tighter fiscal and monetary policies but also from exchange rate adjustments and other measures to stimulate exports, as well as from direct restrictions on imports. The response of these countries to the reduction in the supply of external finance has therefore led to an apparently diminished demand for financing, compared with that in the several years before 1983 (see section on Trends in External Debt above). At the same time, the more stringent demand-management policies followed by the debtor countries are likely, in the foreseeable future, to lead to a greater availability of external credit. Since, however, the latter may not become fully evident this year and since it would be both unrealistic and unwise for these countries to plan for any sizable increase in their indebtedness, adjustment policies in 1984 must still be framed in the light of constrained external financing availabilities.
Indeed, the medium-term scenario implies that sustaining an adequate growth of GDP and a reduction in debt service ratios will require continuation of strong adjustment policies. Those countries that have already made substantial progress toward achieving greater financial stability and a more manageable external position are aiming to consolidate previous gains, especially in those instances, where, because of constraints in the availability of external financing, there has not yet been sufficient time for tighter fiscal and monetary policies to have their full impact on inflationary expectations. The need to continue adjustment policies in a determined manner is all the greater in countries where a comprehensive package of policy measures is only now being implemented.
The rapid rate of monetary expansion that characterized most developing countries (including some of the largest borrowers) during 1980–81 was driven by two underlying and interrelated factors: growing fiscal deficits and an inflationary process fueled by rising external prices (especially, in 1979–80, oil prices) and by competing demands for higher real incomes within these societies (see Chapter III). As long as sources of external financing were plentiful, the painful political decisions required to attack inflation could be postponed, and it was possible to avoid a compression of imports following the leveling off of exports that resulted from the world recession. The postponement of adjustments in imports and in real consumption and investment until 1982 made the ultimate adjustment more abrupt and difficult.
The continuation of this adjustment process into 1984 and 1985 should be eased by the expected pickup in both exports and economic activity. The staff projections for 1984, as well as the medium-term scenario for 1985–90, show an improved external position and domestic economic performance for the non-oil developing countries; this assumes a continuation of strong policies aimed both at greater financial stability and an improved efficiency of resource allocation. These objectives are closely linked, indeed inseparable. The reduction of fiscal expenditures has proved a principal means of reducing monetary expansion, while a major area for improvement in resource allocation is typically the government sector, where in nearly all countries there is scope for better use of human resources, improved choice of investments, and rationalization of cost and price subsidy schemes.
In centrally planned economies, significant problems of macroeconomic imbalance and inefficient use of domestic resources have also emerged and been widely acknowledged by their authorities, although they have taken a form different from those in more market-oriented economies. Because prices and wages are controlled in many of these countries—even changes in foreign prices usually may only be passed through to the domestic economy by decision of various state agencies—imbalances between supply and demand are reflected in shortages of consumer goods or imbalances on the current account of the balance of payments rather than in domestic inflation or fiscal deficits. These growing imbalances, in some cases accompanied by a slowing pace of economic growth, have induced the authorities of these countries to adjust the pattern of relative prices facing domestic consumers and producers to one more similar to the structure of world prices. The authorities have also attempted to maintain more realistic (and unified) exchange rates and interest rates, to scrutinize investment priorities with greater care, and to rationalize the process of economic decision making. As several of these countries have been among those with serious external debt difficulties, further improvement in their external position will require continuation of these policy initiatives.
For most oil exporting countries, the need to control fiscal expenditures and to choose investment priorities more carefully has become far more important since 1980. The fall in petroleum export earnings has led to serious external payments difficulties for some large borrowers (such as Indonesia, Nigeria, and Venezuela) and less rapidly growing, or declining, foreign assets for oil exporting countries with generally smaller populations. For a number of the oil exporters, the drive toward more economic use of fiscal revenues, together with measures aimed at promoting more efficient use of private sector resources—policies already being implemented in some countries—will become an increasingly important part of strategies to develop the non-oil sectors of their economies.
In all market economies, there is ample scope for improving the efficiency of resource use not only within the public sector but through government policies that influence the use of resources in the private sector, especially those affecting prices, interest rates, exchange rates, and import tariffs. The use of such policies to establish an appropriate set of relative prices, by improving the internal efficiency and external competitiveness of the economies affected, would make it possible for these countries to achieve a healthier growth of exports, to attain higher rates of growth of GDP through more productive investment, and to put scarce foreign exchange to the most productive use. The assumption that such policies will be actively pursued underlies the export, import, and GDP assumptions in the base scenario, and the failure to carry out policies of this sort is a feature of the “weak policies” scenario, resulting especially in a slowing of export growth.
The same policies that improve the efficiency of resource use also strengthen the ability of the authorities in these countries to carry out their demand-management policies. During the past few years, in a large number of countries, it has become publicly acknowledged that, when interest rates remain significantly negative in real terms for extended periods, it becomes difficult either to prevent capital flight or to pursue effective anti-inflation credit policies. Similarly, there is growing official recognition that when exchange rates have been permitted to become highly overvalued, the eventual devaluation is likely to have a more disruptive economic impact than if the needed adjustment had taken place in a more timely manner. The fiscal cost and counter productive nature of price subsidies and foreign trade restrictions have also been widely recognized. In most member countries, the need to reduce fiscal expenditures that exceed available resources has become an urgent priority of the authorities.
In a number of countries, strong initiatives have already been undertaken to rectify policy biases that have been long entrenched, in some cases for decades. The tendency for real domestic interest rates to rise from negative levels in many countries, as well as the depreciation of the average real effective exchange rates of the non-oil developing countries (see Chapter III), are strong indications that this is occurring. There is considerable danger, however, that if external financing constraints are relaxed, the drive to achieve further improvements in the fiscal situation and in supply-side policies will lose its present impetus. In many developing countries, there has been a tendency to expand government expenditures whenever there was an upsurge in export receipts, in part, perhaps, because of a direct connection between export earnings and government revenues. Such a development could lead to a more rapid increase in imports than that contained in the staff projections for 1984 and 1985, thereby threatening a relapse into the external payments difficulties of the early 1980s. Looking further ahead, it could lead to the outcome illustrated by the “weak policies” medium-term scenario. It would also tend to impede further progress toward achievement of the structural adjustments required for a satisfactory and sustained rate of economic growth consistent with a manageable external position.
In a global context, the policy initiatives just described could play an important role in the long-term process of shifting a broad range of manufacturing activities from industrial to developing countries. In the long run, this process serves to raise world output, income, and trade; in the short run, however, it produces severe difficulties for the affected sectors and regions in the industrial countries. To the extent that the process is impeded by protectionist policies, not only is the growth of productivity eventually reduced in the industrial countries but, in the developing countries, the rationale for pursuing policies to improve resource allocation is weakened.
Another important aspect of adjustment policies that until recently was neglected in some borrowing countries is the management of external indebtedness. Underlying the projections contained in the medium-term scenario described earlier in this chapter is an assumption that the “hump” in amortization payments after 1985 is refinanced. While the extent to which this proves possible will undoubtedly depend on the attitudes of creditors, the actions of the debtor countries themselves will play a major role in influencing these attitudes.
With regard to the foreign indebtedness of the public sector, the eventual burdensomeness of the external debt position will depend on such factors as the amount of short-term and medium-term borrowing that is undertaken to finance investments with long gestation periods, or with low or highly uncertain rates of return, or whose effect on the capacity of the economy to earn additional foreign exchange is in doubt. Confidence on the part of creditors will depend in considerable part on whether the foreign borrowing by the public sector is judged to be imprudent or excessive by the international banking community.
Government policies will also have a substantial influence on the volume of foreign borrowing by the private sector. As the availability of foreign financing to private firms in developing countries begins to expand during 1984–85, governments will need to reconsider both their objectives with regard to the level of private borrowing from abroad and the measures to be taken to influence such borrowing. On the one hand, medium-term to long-term loans for investment projects are often easier to mobilize in foreign than in domestic financial markets and represent a genuine transfer of foreign resources. On the other hand, the inability to amortize large-scale short-term private borrowing from abroad—which in some instances had been deliberately encouraged by the monetary authorities—proved one of the major elements leading to the financial crisis of 1982–83. Therefore, the authorities of debtor countries may wish both to encourage longer-term borrowing and, through exchange rate and interest rate policies that are geared to keeping national saving in domestic financial institutions and to stemming capital flight, in order to avoid excessive recourse to short-term foreign borrowing by the private sector. Such a policy, however, needs to be complemented by a fiscal policy that does not crowd out the private sector from access to domestic resources.
The more careful monitoring of the external debt of both the public and private sector requires complete, reliable, and up-to-date statistics on debt. It is well known that there are serious gaps in the information available at present. This is especially true with regard to indebtedness of the private sector and interbank balances, but sometimes even information on public sector indebtedness has not been collected in a systematic manner. Efforts are being made to improve the collection of data, both by the private banks and by the international agencies—especially the World Bank, the Bank for International Settlements, the Organization for Economic Cooperation and Development, and the Fund. A number of national authorities have also intensified efforts to improve the quality and comprehensiveness of their debt information, but much remains to be done, and the faster this task moves forward, the better the chances are that the external debt situation will not again get out of control during the next several years.