Debt And Democracy In Latin America

Barbara Stallings

• Publisher: Routledge
• Year: 2019
• Topic: Politics & International Relations
• eBook ISBN:
  9780429722042
• Subtopic: Democracy
• Index: Politics & International Relations

This book investigates the two-way relationship between debt and democracy in Latin America. It examines the evidence about how regime type influenced the choice of policy to deal with foreign creditors and related economic issues.

Part I
A Political-Economic Overview of the Debt Crisis

1
The Latin American Debt Problem: Anatomy and Solutions

Rudiger Dornbusch

The Latin American debt crisis now is six years old and growing. When Mexican debts trade at 50 cents on the dollar, and those of Peru at less than a dime, the debt crisis is obviously unresolved. Far from improving their creditworthiness, the debtors are falling behind. Debt ratios are far above the 1982 level, and debtor countries’ economies are showing the strains of debt service in extremely high inflation, a deep drop in income, and an unsustainable cutback of investment. The debtors cannot afford to pay, nor can they afford to walk out on the system.

On the side of creditors, reserves are built up to provide a cushion against potential losses. In the meantime, creditor banks are unanimous in their reluctance to continue lending in a situation where the debts are obviously deteriorating. Increasingly, the World Bank is filling the gap left by the debtor countries’ inability to pay and the banks’ unwillingness to lend. Former Treasury Secretary Baker’s “muddling through” remains the Reagan administration’s strategy, a treadmill of pretense and make believe in which both debtors and creditors are falling behind. There is a major public interest in changing the course and breaking the deadlock.

This chapter briefly reviews the origins of the debt crisis, then identifies the present dilemmas and recommends interest recycling as a policy that involves fair burden sharing and provides the best chance for all parties to come out ahead in what is presently a negative sum game.

Origins of the Debt Crisis

Debt crises are common in a broader historical perspective.¹ The last worldwide crisis was that of the 1930s when all of Latin America, with very few exceptions (most notably Venezuela and Argentina), went into moratorium for many years. Even as the 1930s defaults got fully underway, Winkler wrote:

The fiscal history of Latin America… is replete with instances of government defaults. Borrowing and default follow each other with perfect regularity. When payment is resumed, the past is easily forgotten and a new borrowing orgy ensues. This process started at the beginning of the past century and has continued down to the present day. It has taught us nothing.²

The cleanup of debtor-creditor relations occurred in the 1950s. Borrowing resumed in the 1960s when first Mexico and then all of Latin America made new forays into the world capital market.

Sporadic debt difficulties occurred throughout the 1970s, but the system-wide problems only emerged in 1982 when Mexico, and soon most of Latin America, had to reschedule its external debt. Three factors account for the generalized debt problem: poor management in the debtor countries, the world macroeconomy that took a singularly bad turn, and initial overlending.

In the late 1970s exchange rates in most Latin American countries were massively overvalued. This was a popular policy because it helped limit or bring down inflation without recession. But the cure was very shortlived, since the resulting loss of competitiveness soon led to large trade deficits and capital flight. The extent of overvaluation is apparent from some data for the period 1977 to 1981. Argentina experienced a real appreciation of 85 percent, Brazil 36 percent, Chile 57 percent and Mexico 30 percent. The resulting trade imbalance was financed by borrowing in world capital markets. Moreover, when capital flight became important, especially in Argentina and Mexico, external loans financed this exodus of private capital. It was a curious spectacle when a central bank borrowed in New York to obtain the dollars that it sold to private citizens who in turn deposited them in Miami.

There is considerable uncertainty about the precise extent of capital flight. One recent study, published by the Institute of International Economics,³ gives estimates for various countries over the period 1976–82. It shows Argentina with capital flight of $22.4 billion, Brazil $5.8 billion, Mexico $25.3 billion, and Venezuela $20.7 billion. To put these data on capital flight in perspective, it is important to judge them relative to the stock of debts outstanding. In the case of Argentina, for example, the 1982 stock of external debt was $44 billion. Thus capital flight accounted for no less than half of the accumulated debt.

The second element in the debt crisis was the sharp deterioration of the world economy. Under the impact of tightening U.S. monetary policy, with other industrial countries following suit, world interest rates skyrocketed, economic activity declined and real commodity prices plummeted. Table 1.1 shows the relevant data.

Each element in world macroeconomic development was unfavorable for debtors. Higher interest rates implied increased debt service burdens, while lower commodity prices and reduced activity in center countries implied a sharp drop in export earnings. Thus, between increased debt service and reduced export earnings, a large foreign exchange gap resulted. Table 1.2 shows the deterioration in debt and debt service ratios between 1979 and 1982.

Table 1.1 Aggregate World Macroeconomic Indicators, 1970-87

	Real Commodity Prices (1980=100)^a	Libor^b (%)	Inflation^c (%)	Growth Rates^d (%)
1970-79	115	8.0	11.4	3.4
1980	100	14.4	13.0	0.0
1981	96	16.5	−4.1	−7.0
1982	89	13.1	−3.5	−3.3
1983-87	84	8.5	4.0	3.2

a Measured in terms of manufactured export prices of industrial countries

b London Interbank Offered Rate, base interest rate for most Latin American loans

c Rate of increase of industrial countries' unit export values

d Industrial production

Source: IMF and Economic Commission for Latin America.

Table 1.2 Debt and Debt Service Ratios,^a 1979-82

	1979	1980	1981	1982
Debt^b	165	152	186	241
Interest and Amortization^b	27.9	25.4	32.9	40.3
Interest^b	11.1	13.1	18.6	24.2

a Countries with recent debt service problems

b As percent of exports of goods and services

Source: IMF.

Without the banks’ eagerness to lend, the debt crisis would obviously nothave occurred in the first place. In hindsight, why did banks not use more caution? That question is asked in the aftermath of each wave of default, and the answer has not yet been found. The most plausible explanation is that of Guttentag and Herring, who argue that banks have “disaster myopia”—they underestimate the true probability of infrequent events.⁴ The combination of overindebtedness and a sharp world deterioration is one such case. The combination makes for pervasive defaults, but it is a rare event.

The banks’ role in the debt crisis went beyond the initial overlending. An essential element was the halt on all lending once the debt service difficulties of lenders became apparent. Each bank’s attempt to pull out of further lending, seeking recovery of principal at the expense of other creditors, had all the appearances of a bank run. Suddenly, debtors could no longer roll over their interest payments and borrow to finance current account imbalances; they had to adjust. The main feature of the debt crisis was precisely that abrupt halt to all lending. Debtors frozen out of the world capital market learned first hand the old banking truth: “It is not speed that kills, it is the sudden stop.”

Current Problems in the Debt Crisis

Debtor adjustment programs were expected to show, in time, an improvement in creditworthiness sufficient to warrant a return to voluntary lending.⁵ That remains the official position, but the process is not on schedule, and few believe that the solution lies in the direction of more of the same. A return to voluntary lending is a very remote possibility if one observes the large discounts in the secondary market for LDC debts and banks’ attempts to relinquish anything remotely connected to Latin America.

In fact, there is concern that conditions may deteriorate. Over the past five years the non-interest current account of Latin American debtors turned toward a large surplus, and as a result they managed to pay a significant share of their interest liabilities. At the same time, however, investment declined sharply. A cut in investment may be a reasonable response to the crisis for a brief period, but when it lasts year after year it can only lead to severe trouble. Policy makers in debtor countries are concerned that they will ultimately bear the costs for prolonging what they consider a totally unreasonable decapitalization of their economies. Surprisingly no populist government has yet come to power to dramatize this issue, but it is clear that in Brazil, Mexico, and Argentina, the issue is buried only a foot deep.

On the creditor side there is also a deterioration underway. Large banks that are organizing the lending cartel are increasingly disenchanted with Federal Reserve pressure to keep up lending. They would like to see a more substantial takeover by the taxpayers, either overtly or under the cover of expanded loans and guarantees from international agencies. The problem is aggravated by the increasing unwillingness of small banks to participate in new rounds of “involuntary” lending. Their withdrawal puts pressure on loan discounts and thus highlights the fact that loans are traded significantly below par. Dissension between European and New York banks is another factor weakening cohesion.

A final dimension of the crisis is the trade issue. This aspect has been emphasized by Senator Bradley in his proposal for limited, selective and targeted negotiation of debt relief in exchange for conditioned adjustment programs and trade concessions in the debtor countries. Debtor countries today run trade suipluses to earn dollars for debt service. They have achieved these surpluses by substantially depreciating their currencies to gain competitiveness, restricting imports, and expanding exports. At the same time, this large swing in their trade is perceived as a threat to a liberal world trade regime.

Four facts summarize the lack of success of the adjustment efforts so far. First, creditworthiness has been deteriorating. The ratio of debt to exports for problem debtors has risen since 1982 from 269 percent to 350 percent, and the ratio of debt to gross domestic product (GDP) of these countries increased from 44 percent to 54 percent. Five years of adjustment thus have made debtor countries look worse rather than better, at least with respect to their debt burdens. Second, the large swing in trade surpluses that finance much of the interest payments has as a counterpart a decline in investment. Comparing the period 1982–86 with the preceding five-year average, there is an increase in Latin America’s non-interest surplus equal to five percent of GDP and an exactly equal decline in investment. When interest is paid by not investing, a serious imbalance builds up. (See Table 1.3.) Third, there is no indication of a return to voluntary lending. Loan discounts are very deep for most debtors, and the case of Colombia shows that even clean debtors cannot gain access when they face a shortage of foreign exchange. Fourth, moratoria are now widespread and discounts in the secondary market, averaging more than 50 percent, indicate that debt has come to be considered both a politica...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Acknowledgments
• Introduction
• PART I A POLITICAL-ECONOMIC OVERVIEW OF THE DEBT CRISIS
• PART II KEY ACTORS IN THE DEBT-DEMOCRACY DILEMMA
• PART III CASE STUDIES OF DEBT AND DEMOCRACY
• PART IV CONCLUSION
• About the Contributors
• Index