Third-world debt: unsnarling the tangles
THE fundamental world debt situation hasn't changed much since the late 1970s. Developing country external debt, always increasing, was estimated by the World Bank to reach $1.035 trillion in 1986. When Citicorp and Chase announced decisions to add to their reserves to cover anticipated losses on loans to developing countries, they attracted a lot of attention, but foreign banks have been doing this for years.
Surprisingly, many banks avoid adding reserves for dubious loans and are also reluctant to use the markets to rid themselves of these assets. Middle management can be at fault for not recommending the operations, and top management for refusing to recognize reality. Why weren't reserves ensured before, and do these additional reserves alter either a bank's strength or risks in the marketplace? Is it prudent for banks to turn isolationist or should they grasp the new profitable opportunities in the debtor countries?
United States authorities are proposing risk-based insurance for banks, which would thereby pay higher fees to insure riskier portfolios.
Risk? If Citicorp's loans to developing countries total $14 billlion, a $3 billion reserve covers 21 percent of the problem. The strongest Latin American borrowers generally see their loans trade at over 30 percent discount. Larger reserves are needed. Let's not forget, even the US has caused the banks loan problems.
It is time to spread country risk among lenders and to separate loans rescheduled because they can't repay the money from those that can profitably earn foreign exchange. Maintaining rescheduled loans in one lump hampers the banks and the borrowers. Loans should be ``uncoupled'' from the general rescheduling packages, when prudent, so they can partially begin to repay their own debt directly and also give the specific borrower greater access to growth funds. Repayment on new loans to viable projects can be assured using existing regional multilateral institutions in effect to ``clear'' the export proceeds of the projects.
The banks can have greater assurance of principal and interest repayment while the borrowing entity is relieved of part of the ``country risk'' premium that would otherwise be charged in interest on new loans. The developing countries can get on with strengthening their vital sectors, implementing new profitable projects.
The devaluation of the US dollar to the Japanese yen by over 40 percent since mid-1985 actually reduces US debt by that percentage vis-`a-vis Japanese creditors. The US can have its cake and eat it too, but developing countries don't have this option. Rising interest rates will be felt by all borrowers and, consequently, lenders.
One has to ask if it isn't a conflict of interest for a regional bank's Brazil loan to be sold at, say, 65 percent of face value while the intermediary bank keeps the value of similar loans to that borrower at a higher price on its own books?
On the borrower's part, it would seem reasonable to expect that its creditors make every reasonable effort to maintain its loans at the highest secondary market value possible. The secondary market price of a country's outstanding loans reflects upon the desirability of banks to lend it funds. The higher the secondary market price for Bolivia's loans, the higher its creditworthiness is estimated by the purchasers. Do the banks have an inherent responsibility to maintain perceived creditworthiness of borrowers?
The US and its industrial allies must work together on the debt issue as part of the overall trade structure. Latin America's largest trade partner is still the US, but this can be disadvantageous with its current trade deficit problems. Helping the developing country export shoes or textiles to Japan or West Germany via joint ventures or direct investment helps take the heat off the US and strengthens the economies as a whole without large subsidies.
Reserves are a means to cushion banks from losses on debt and should be allocated when problems surface, not almost a decade after the trend is evident. Banks are looking to protect their portfolios and capital but also strive to find and open new markets to fuel growth. Risks are present in every transaction. The debt-ridden developing countries offer a great opportunity for profitability because of acute trade and general economic growth needs.
To shy away from a profitable opportunity and help individual entities in these countries open new markets at this point is as much a mistake as it was for the banks to trip over themselves lending to practically any flag that had a central bank: Let's hope it doesn't take the banks another decade to realize it.
Rodrigo D. A.-Valderrama, president of the Multilateral Group Ltd., served as senior officer in the Institute of External Finance at the Ministry of Finance in Bolivia from 1976 to 1978.