The middle income countries
of Latin America tend to owe more money to individual banks than to governments and multilateral agencies, and their debt tends to have built up over a number of decades, while the poorest – mainly Sub-Saharan – countries have built up debt more recently owe the majority of their debt to multilateral agencies4. This has two implications: firstly, debt owed by these poorest LDC governments is more likely to divert much-needed investment from infrastructure and development projects. Secondly, multilateral agencies such as the IMF and World Bank have over time become major political players in individual countries’ economies.
Although global institutions, they are effectively controlled by industrialised countries, especially the US which has a voting power of over 17% in the IMF and over 16% in the Bank, which effectively gives it a veto over any decision made. Contrastingly, the entire Sub-Saharan region has 4.43% of IMF voting power5. These institutions almost always seek a programme of changes in policy reflecting free market ideologies, in return for new and restructured loans or debt cancellation, as is discussed later. A country that owes much of its debt to such agencies is more likely to have to alter domestic policy in favour of
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If the current debt burden of the LDCs takes different forms, then it is not evenly spread by region, as is clear from Table 1 (see Appendix). While countries in Asia and Oceania account for over a third of all debts owed to industrialised countries, the value of this debt is equal to a lower percentage of GDP than any other region. By contrast, debts owed by Sub-Saharan Africa account for less than 8% of total debts, but this represents an average of 66% of GDP.
It is worth noting that while both the amount and percentage GDP figures for Latin America are very high, nearly 70% of Latin American debt is accounted for by just three countries; Argentina, Brazil and Mexico, and that of these three, only Argentina’s debt represents an excessively high percentage of GDP at 160%6. Levels of debt differ greatly in terms of the relative incomes of LDCs. The pattern that the least developed countries owe the least is starkly evident in Table 2 (see Appendix), and yet these countries simultaneously find the most difficulty making repayments, because they have a very low GDP and few ways to raise domestic revenue or foreign currency.
How did these vast sums come to be owed by the LDCs? There are a number of different reasons cited for the build up of the debt. Cavanagh et al (1985) stresses the structural reasons behind the build-up of debt, citing the decisions made at the Bretton Woods conference in 1944 as important in setting the foundations for debt. Other arguments stress the importance of rising oil prices during the 1970’s as key to ensuring that most LDCs became net importers, resulting in widening balance of payment deficits7. Corbridge (in Desai and Potter, 2002) links rising interest rates with the burgeoning debt of LDCs that led to many countries defaulting at the beginning of the 1980’s. Gibson and Tsakalotos (in Hewitt etc al (eds), 1992) stress in addition the behaviour of international banks in the build-up of debt. Still others, including Todaro (2000) concentrate on the role of the World Bank, IMF and other multi- and bilateral lenders in investing inappropriately in LDCs in prestige projects such as dams and embassies, often without considering the ‘creditworthiness’ of individual countries. All of these factors have contributed to the current situation.
According to Cavanagh et al (1985), “large-scale borrowing … [was] virtually built into the postwar international economic system sketched out in 1944” (pp19). The pattern of trade between Latin America and Europe and North America had remained since independence, and as Sub-Saharan African countries gained independence, a similar pattern emerged. The fact that LDCs were exporters of agricultural and mineral products while net importers of manufactured products left them vulnerable, not only because the primary products tended to be worth less on the global market than manufactured goods with ‘added value’, but also because prices were more likely to fluctuate. Cavanagh describes this as an “international division of labour” (pp19) that had its roots in colonial times. Savings made through low wages in LDCs could be passed on to industrial country consumers and companies through lower prices and bigger profits. At the same time, many LDCs lacked the technology to produce manufactured goods. This pattern led to trade imbalances in LDCs.
In order to overcome this, LDCs borrowed money from commercial banks, and then later the IMF and development banks, to overcome short term balance of payments deficits. This solution ignored the fundamental trade imbalance; as LDCs experienced declining terms of trade for their primary commodities, they would never be able to improve their situation relative to the industrialised countries, and would continue to need short term loans to overcome trade imbalances. This situation, coupled with a gradual globalisation of the economy during the post-war boom, lead to a huge rise in investment in LDCs as banking organizations grew rapidly during the 1950s and 1960s. For example, the growth rate in the real domestic product of the LDCs averaged about 6 percent a year before 1973. This pattern in providing financial services contributed to the emergence of the ‘Eurodollar market’, which gave US banks access to funds with which they could undertake Third World loans on a large scale8.
The formation of OPEC in the 1970’s is also seen as key in the mounting debt crisis of LDCs. In 1973, the US$ fell in value, and with it OPEC countries experienced a fall in revenues from the Eurodollar market. In response, they limited output, quadrupling oil prices virtually overnight. As oil importers spent more money, OPEC countries made massive profits, which they deposited in Western commercial banks, while importing countries (most LDCs) experienced sharper trade imbalances. In addition, this rise in oil prices triggered a global recession through 1974-5, which saw primary commodity prices fall, further exacerbating problems in LDCs.
According to CIIR (see footnote 3), “the only way to avert a global recession was to recycle petrodollars back to the oil importers”, and this ‘private sector solution’ after 1973 saw Western banks aggressively promote loans to LDC governments for development projects and to address balance of payments deficits. Countries were encouraged by the IMF and World Bank to take these loans as interest rates were low; in some cases, the negative real interest rates offered were used to convince governments that they would be repaying less than they borrowed. In many cases, international banks either did not have the capacity to, or chose not to, conduct risk assessments, and there was a tendency that if one bank loaned money to a particular country, then others would extend credit, believing that it was a safe investment. In fact, during the 1970’s with low interest rates, it was unlikely that an LDC would default.
While commodity prices were buoyant during the 1970’s and the loans’ floating interest rates remained low, this management of money recycling by the private sector banks seemed a solution that would benefit the global economy as a whole. However, just as many of the loans made on the back of the 1973 oil crisis were due for repayment, OPEC again limited output in 1979, causing another huge rise in oil prices. This, coupled with a change in US monetary policy which saw interest rates rise rapidly, caused a further widening of budget deficits and balance of payments deficits in many LDCs. In order to combat this, LDCs pushed for a widening of exports of primary commodities, thus further fuelling the declining terms of trade discussed above.
However, this pattern of events does not explain the full extent or nature of the build up of debt. Perhaps most puzzlingly, arguments focussing on the role OPEC countries and their associated oil crises of the 1970’s as an explanation of the debt situation, tend not to explain why the most important event in the crisis in 1982, centred around Mexico – then the biggest LDC oil producer – and its threat to default on its repayments. If Mexico had benefited so much from oil profits, how did it find itself in a situation where it could no longer afford repayments? The answer seems to lie at least partly in not only the amount of money that was loaned to countries, but also what it was leant for. There is a wealth of evidence supporting the argument that banks were indiscriminate in loaning money, and in Mexico’s case, money earned through oil exports had been mismanaged9.
Gambling on future oil revenue, Mexico had borrowed huge amounts of money, and international lenders simply had not questioned the country’s creditworthiness because it produced oil. In other cases, much of the money leant to or invested in LDCs disappeared into the private coffers of dictators. In 1979, IMF advisors announced that creditors of Mobutu’s Zaire were unlikely to see any money repaid to them in the near future, and yet loans continued to flow into Zaire as a country supportive of the West in the Cold War, and Mobutu continued to move large amounts of it into Swiss bank accounts. In Argentina, “there are no records for 80 per cent of the $40 billion borrowed by the military dictatorship from 1976 to 1983 … It is claimed that New York banks knew that money was being misused, with kickbacks and fraudulent loans to companies linked to the military, and that the IMF connived with the fraud”10.
It is suggested that strategically important countries were able to borrow money during the Cold War even if international lenders knew much of it would never benefit their populations. According to Shah (2001),”the causes of debt are a result of mismanaged spending and lending by the West in the 1960s and 70s”, and certainly many projects were ill-conceived, for instance the nuclear power plant that was built on an earthquake fault line in the Phillipines11, and there are suggestions that development loans funded military spending in the Malvinas/Falklands conflict. Short-term loans granted for development projects did not give countries the opportunity to make a project profitable before the loans were due to be repaid. In addition, it is clear that by the beginning of the 1980’s, many countries, especially in Latin America, were in need of structural reforms to overcome struggles with inflation, lax budgets, overvalued exchange rates and domestic financial systems in need of overhaul12. These domestic troubles served to further exacerbate the difficulties that emerged as countries found it harder and harder to make repayments.
What is clear from this analysis is that both creditor governments and institutions, and LDC governments must share the blame for the build up of debt. But while there were underlying structural problems associated with the international financial system and patterns of trade dating back to colonial times, which led to the build-up of debt, these need not have resulted in the crisis that was to ensue in 1982. The combination of these underlying factors, coupled with the circumstances in the 1970’s involving the two oil crises, with a change in monetary policy in the US, recession in the industrialised countries, and falling revenues for LDC commodities, were all crucial. While the events surrounding the second oil crisis of the 1970’s and subsequent rises in interest rates were key in precipitating Latin America’s crisis in the 1980’s, many countries in Sub-Saharan Africa built up debt more slowly but it became unmanageable through a combination of a collapse in commodity prices and the rising interest rates (Teunissen and Akkerman, 2004).
At the beginning of the 1980’s, many countries in Latin America, Eastern Europe and Africa were unable to service the huge debts that they had built up. In the 1970’s, several countries, including Zaire and Poland, had defaulted on their external debts, and many countries had taken out further loans through defensive lending just to cover repayments on the original amounts, but it was not until Mexico threatened to default in August 1982 on its US$80 billion debt, that the international financial community began to talk about a ‘debt crisis’.
Many other Latin American countries, including Brazil and Argentina, quickly followed this move by Mexico, through a combination of synchronicity of economic position and contagion by the international banks. Suddenly, countries regarded as relatively successful in terms of economic development and prosperity, were threatening the international financial system. Banks had overlent in many cases, and it emerged that the nine largest US banks had lent over twice their combined capital base just to non-oil-producing LDCs (Gibson and Tsakalotos, in Hewitt etc al (eds), 1992). Credit dried up overnight, as most commercial banks became very reluctant to lend further to LDCs; they were already in a vulnerable position and unwilling to lend where others did not, the reverse effect of the ‘herding instinct’ that had resulted in overlending in the first place.
A number of banks that were threatened with bankruptcy turned to their governments and to the IMF for assistance. Privately, many Fund officials had made warnings about increasing indebtedness by certain LDCs, especially net oil importers, but these fears had not been voiced publicly because it was not in the IMF’s nature to do so13, and up to this point, the IMF’s role had been to provide short-term loans for balance of payments shortfalls, but now a larger solution was necessary. In immediate response, the IMF, with the assistance of the US Treasury, put together a series of huge loans, and effectively became the new international lender of last resort, backed by the BIS and the US Federal Reserve. From now on, not only would the IMF’s relationship with international banks become much closer, but effectively the IMF would become the credit assessor of countries, so that before a country accessed further commercial loans, it would have to have the Fund’s ‘seal of approval’. This was partly in order to ensure that further crises would not endanger the world financial order, as Mexico’s moratorium had done.
What measures did the IMF put into place? In the case of Mexico, the government announced only a few days in advance that it would need to default on its due payments without assistance, and so an emergency package was put together whereby the IMF granted sufficient emergency loans worth US$5bn for Mexico to continue to make repayments. This initial rescue package was assembled in August 1982, and an adjustment program was introduced in November, with initiatives that ensured that the commercial banks would help finance the program. The Fund’s approval of an extended arrangement in December and the banks’ approval of a complex package of rescheduling and new lending three months later marked the end of the efforts to avoid a financial system collapse, and a new era in the IMF’s role as global development agent.
There is little contention that the Fund was also successful in involving the banks once more. Throughout the period 1982-6, the IMF continued to step in to avert bankruptcy and defaulting, and throughout this, the central role for the Fund was to negotiate adjustment programs for countries and to support those programs with financing to cover a (usually small) portion of the external deficit, to encourage commercial banks to make loans once more. The regional Development Banks and the World Bank were at the time expanding their interests in promoting strategies for economic development, and they also played a part in formulating the ideas that would eventually become the much-maligned Structural Adjustment Programs adopted by many indebted countries throughout the 1980’s.
The Structural Adjustment Plans negotiated with indebted and defaulting countries during the early and mid 1980’s usually included a restructuring of commercial debt: lengthening the time during which payments could be made; introducing a grace period before which nothing was paid back; and loans at lower interest rates from multilaterals. Thus private borrowing gradually became public debt, as countries paid back commercial bank loans with money loaned by the IMF and other multilateral agencies. As time passed, and the amount of money that the IMF was lending grew, it began to introduce additional conditions that would have to be implemented by any country taking on a new loan.
These were designed to do three things: to facilitate the structural reforms imposed by adjustment; to ensure the repayment of the debt contracted; and to gradually enable indebted countries to accede to new private borrowing via the financial markets. Thus countries would reach a position where economic recovery could help them ‘grow out of debt’, the prevailing theory put forward through the mid-1980’s for solving the debt problem.
Structural adjustment traditionally included two main kinds of measures. The first to be implemented were usually devaluation of the country’s currency and a rising of interest rates. Devaluation imposed by the IMF regularly reached rates of 40-50%. The aim was to make the country’s exports more competitive in order to increase stocks of foreign exchange required for debt repayments, while suppressing demand for imported products and reducing money supply. Consumers’ purchasing power stagnated and economic growth stopped or went into negative figures.