Full text of Economic Commentary (Federal Reserve Bank of Cleveland) : The International Debt Situation, January 3, 1984

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against taxes, but extensive loan
write-offs probably would affect
bank profits and shareholders'
earnings. Write-offs also could
affect bank capital. Banks must
maintain capital against loans,
although the required amount is
only a small share of total loans.
Consequently, any reduction in
capital could restrict bank lending
and raise interest rates. Higher
interest rates and reduced lending,
moreover, could slow domestic economic activity, but the extent of
this effect would depend on the
monetary policy of the Federal
Reserve System.
Debtor-country defaults on outstanding loans also would greatly
restrict their ability to conduct
international trade. A default
would leave the debtor nation
unable to obtain foreign credits to
import vital commodities. This in
turn could impinge on its ability to
produce other goods for domestic
consumption and for exportation.
Without exports, these countries
would find it difficult to earn foreign exchange. Moreover, the
developing countries are important
markets for developed-country
exports. In 1982 the United States
exported approximately $84 billion

to the developing countries, an
amount equal to 38 percent of total
U.S. exports. The contraction of
these markets would further
reduce economic growth and employment in the United States.

A Climate for Improvement
Just as changes in the economic
climate contributed to the crisis
atmosphere in international lending, an improvement in the international economic environment would help resolve the
international debt situation.
Dooley, Helkie, et al. (1983) and
Cline (1983) describe such an outlook. Both studies recognize the
importance of real growth and suggest industrial-country growth of
approximately 3 percent per year to
reduce the burden of debt in developing countries. This assumption
seems to preclude another worldwide recession in this decade. Both
studies recognize the importance of
low interest rates but differ somewhat in the relative importance
attached to attaining them. Dooley,
Helkie, et al. emphasize that a
reduction in real interest rates
could have a larger near-term effect
than more rapid growth in industrialized countries. Cline also notes

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

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that further sharp declines in oil
prices could have a detrimental
impact on the debt situation. Oilexporting countries owe large
amounts of debt, and the effects of
an oil-price decline are more severe
for oil exporters than beneficial to
oil importers. Both studies assume
an increase in oil prices in their
scenario for an improved debt
situation. In addition, the developing countries should adopt policies
to reduce domestic consumption,
restrict imports, and encourage
exports. They also would need
additional external credits to
finance their imports of vital com
modities. In the absence of such
credits, their economic growth
could falter and inhibit the reduction of their debt burdens.
The dangers posed by the international debt situation will not easily,
or quickly, be defused. There is
always a chance that some desired
aspect of international economic
conditions would not materialize,
creating new tensions and pressures. Only by recognizing what all
nations stand to lose as a result of
crisis mismanagement will we
have the patience and courage to
prevent a true crisis.

BULK RATE
Paid
Cleveland,OH
Permit No. 385

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Federal Reserve Bank of Cleveland

January 3, 1984
rSSN 0428-1276

The International
Debt Situation
by Owen E Humpage

The precarious international
debt situation clouds the economic
outlook, worrying bank regulators
and complicating international
commerce. The world's developing
countries, excluding members of
the Organization of Petroleum
Exporting Countries (OPEC), have
debts outstanding totaling approximately $575 billion. Of this
amount, U.S. banks hold approximately $100 billion.' The economic
climate of the past few years has
left many developing countries
unable to meet the interest and
principal payments on their debts
according to their original loan
agreements. Although no country
has repudiated its debt, many have
entered into negotiations with their

creditors to extend repayment
schedules. A default or major disruption in meeting payments on
debts might shake confidence in
the U.S. banking system, producing
a contraction in both domestic and
international bank lending. Such
developments could reduce international trade and slow the pace of
the economic recovery worldwide.
This Economic Commentary
provides some perspective on the
development and implications of
the international debt situation,
focusing on Argentina, Brazil, Mexico, and Venezuela. These four
Latin American countries account
for roughly 63 percent of all U.S.
bank loans to developing nations.
Situations in these countries are
fairly typical of economic trends in
other developing economies. Argentina and Brazil are oil-importing
countries, while Mexico and Venezuela are oil-exporting countries.

The Gathering Storm
The most important factor underlying the debt build up was the oilprice shocks of 1973 and 1979. Following the initial price hike, gross
oil imports of the non-OPEC developing countries jumped from
$4 billion in 1973 to $15 billion in
1974. Gross oil imports for these
countries subsequently grew more
slowly and steadily to $20 billion
in 1978, but the second oil-price
shock in 1979 lifted their gross oil
imports to $50 billion in 1980.2
Many oil-importing countries
initially borrowed to finance their
higher oil-import bills. Borrowing
permitted these developing countries to mitigate the immediate
impacts of the oil shocks on their
standards of living and presumably
provided them with time for adopting longer-term adjustment policies. International banks played an
important role in this adjustment
process by recycling funds from
surplus countries to borrowing
countries. Despite initial concerns,
the recycling process went rather
smoothly following the 1973 oilprice shock.
Ironically, the sharp oil-price
increase also encouraged many oilproducing countries to borrow

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corrected mailing label to the Federal Reserve Bank
of Cleveland, Research Department, P.O. Box 6387,
Cleveland, OH 44101.

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Economist Owen Humpage follouis the international sector for the Federal Reserve Bank of
Cleveland.
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors
of the Federal Reserve System.

1. For data on total debt, see remarks by Paul A.
Volcker, Chairman of the Board of Governors
of the Federal Reserve System, Annual Convention of the American Bankers Association, Honolulu, HI, October 10, 1983, p. 3; processed.

2. For data on oil imports, see statement by
Paul A. Volcker, Chairman, Board of Governors
of the Federal Reserve System, before the Committee on Banking, Finance and Urban Affairs,
House of Representatives, February 2, 1983,
Table 1; processed.

heavily. Some, like Mexico, initially
borrowed to develop their oil-proTable 1 Outstanding LOans to Non-Oil Developing Countries
ducing capacity. Many countries
Total capital
Total assets
borrowed against expected future
Nine
Nine
Nine
oil receipts to expand and diversify
All
largest
All
largest
All
largest
reporting
reporting
reporting
reporting
reporting
reporting
their industrial bases.
Number of
banks
.banks
banks
banks
banks
banks
reporting
The oil-price shocks in themPercent
Date
banks
Billions of dollars
Percent
selves did not create an unmanage12177
124
115
163
46.9
30.0
6.5
8.1
able debt situation. As a group,
31.0
6178
164
124
115
48.7
6.5
8.0
the developing countries demon33.4
176
12178
129
52.2
6.3
116
7.9
strated excellent real GNP growth
54.4
6179
166
128
35.0
6.3
115
7.8
throughout the 1970s despite
61.8
12179
182
130
6.6
39.9
124
8.2
higher oil-import bills. Between
41.9
66,2
6,6
6/80
143
182
8.2
123
1973 and 1982, on average, the
75.4
12/80
153
7.1
199
47.9
9.0
132
major industrialized countries
7.4
51.6
6/81
158
82.3
9.3
137
206
experienced real GNP growth of
12/81
159
92.8
57.6
8.0
10.2
148
220
2.5 percent per year; the develop6/82
167
98.6
60.3
8.3
10.6
149
222
ing countries enjoyed real GNP
12/82
11,0
171
103.2
64.2
8.2
146
222
growth of 4.7 percent per year,
11.0
6/83 '
190
212
103.7
8.1
64.1
139
while developing countries in the
SOURCE: Federal Financial Institutions Examination Council.
western hemisphere experienced
real GNP growth of 4.5 percent per
year.' Moreover, not all developing
with expertise in the area. The
equaled $30 billion in 1977, or
nine largest U.S. reporting banks,
163 percent of their capital. Lendcountries experienced trade deficits
for example, held 62 percent of the
ing by the nine largest reporting
during the 1970s. Argentina and
banks increased at a 16.5 percent
Venezuela, for example, usually ran total reporting-bank claims on developing countries as of June 1983.
average annual rate through 1982.
trade surpluses, while Brazil and
This amount equaled 212 percent
Again, foreign loans rose relative
Mexico had trade deficits that were
of the large banks' capital.
to total assets and capital.
not strikingly large.
It is difficult to define what
U.S. banks have concentrated
The excellent growth potential of
would constitute a "too-high" level
their international lending to a relthe developing countries, the relaatively small group of "middleof foreign lending. Total bank loans
tively high returns on capital that
typically exceed bank capital many
income" developing countries. The
this growth implied, and a foreign
world's poorest nations rely priloan-loss record no worse than that . times over. Observing changes in
the data over time provides a clue
marily on international organizaof domestic loans attracted U.S.
banks to the international lending
tions such as the World Bank to
(see table 1). Although the total.
market. As of June 1983, the 190
finance their development. Argennumber of reporting banks has
U.S. banks reporting to a lending
tina, Brazil, Mexico, and Venezuela
changed since the FFIEC survey
survey of the Federal Financial
began, blurring comparisons, the
account for 63 percent of the total
U.S. reporting-bank claims, with
Institutions Examination Council
nine largest reporting banks have
(FFIEC) had claims on non-oil
remained the same in this period.
Brazil and Mexico accounting for
developing countries of nearly
In 1977, the first year of 'the FFIEC
20 percent and 24 percent, respec$104 billion, an amount equal to
tively. Loans to Argentina, Brazil,
survey, the 124 reporting banks
139 percent of the capital of these
lent non-oil developing countries
Mexico, and Venezuela equal 88 perbanks.' Although many regional
cent of the total reporting-bank
$47 billion, or 115 percent of their
and small banks entered the intercapital. Over the next five years,
capital and 131 percent of the capinational lending market in the
tal of the nine largest reporting
total reporting-bank claims grew at
1970s" international lending rebanks. Consequently, banks are
an annual average pace of approxmained the domain of large banks
vulnerable to adverse developments
imately 17 percent, and foreign
in these countries.
loans rose as a share of total assets
and capital. For the nine largest
reporting banks, total claims

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3. For data on growth rates, see Nancy H.
Teeters and Henry S. Terrell, "The Role of
Banks in the International Financial System;'
Federal Reserve Bulletin, vol. 69, no. 9 (Septernber 1983), pp, 663·71.

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4, The Federal Financial Institutions

Exarnination Council includes the Office of the Compo
troller of the Currency, the Federal Deposit Insurance Corporation, and the Board of Governors
of the Federal Reserve System. Its Country
Exposure Lending Survey is conducted biannually and currently covers 190 U.S. banking

organizations, The data are released approximately six months after the surveys are
conducted.

A Changing Climate
Although the ultimate causes of
debt-servicing problems often are
endemic to a specific country,
events of the late 1970s and early
1980s drastically altered the international debt climate, making it
difficult for many developing countries to service their debts. World
interest rates rose sharply in the
late 1970s. U.S. Treasury bill rates,
for example, averaged 6.3 percent
in December 1977 but rose to
14.9 percent by December 1980:
Throughout much of the 1970s,
real interest rates (nominal rates
adjusted for inflation) remained
low and often negative. Negative
real interest rates reduce the real
burden of debt servicing. In the late
1970s and early 1980s, as an inflationary psychology became widespread and the Federal Reserve
System and other central banks
adopted disinflation monetary policies, both nominal and real interest rates rose sharply. Also reflecting the inflationary psychology of
the late 1970s, banks began writing
international lending agreements
in such a way as to permit frequent
adjustments of interest payments
to changes in market rates. Consequently, the sharp rise in market
interest rates in the late 1970s and
early 1980s rapidly translated into
increased debt-servicing costs for
developing countries.
Soon after the sharp rise in real
interest rates, world economic
activity began to slow. Economic
growth among the industrialized
countries was very sluggish in 1980
and 1981, and economic activity
fell 0.2 percent in 1982, a decline
equal to that experienced in industrial-country output in the world-

wide recession of 1975. The industrialized nations constitute the
major market for developing country exports; as the economic
growth of major industrial countries slowed, so did the volume of
exports of developing countries.
The worldwide recession also
depressed commodity prices, which
fell approximately 15.0 percent in
1981 and 12.0 percent in 1982, after
rising nearly 15.0 percent per year
on average since 1973. The exports
of many developing countries are
concentrated in commodities and,
hence, are very sensitive to commodities' price trends. As a result
of these price and quantity trends,
the dollar value of exports fell
11.5 percent in 1982 for Argentina,
Brazil, Mexico, and Venezuela after
increasing at an average annual
17.5 percent since 1973. Export
growth is crucial to debtor nations,
as it is the primary means by
which these nations earn foreign
exchange to service their debts.
For that reason, economists often
measure a country's foreign-debt
burden relative to its exports.
Because of higher interest rates
and a decline in exports, the debtservice ratios (interest payment
and amortization divided by
exports) of developing countries
grew rapidly after 1982. According
to one expert, the combined debtservice ratios of Argentina, Brazil,
Mexico, and Venezuela increased
from 172 percent in 1981 to
269 percent in 1982.5
As previously suggested, the
debt-servicing problems of certain
countries largely reflect specific
debt-management and economic
policies of those countries. The
Latin American countries, for
example, generally have permitted
inflation rates well above world
standards and have maintained
exchange rates at artificially high

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5, William R. Cline, International Debt and the
Stability 0/ the World Economy, Policy Analysis
in International Economics, No, 4, Washington, D,C,: Institute for International Economics,
September 1983,

levels. As the economic climate in
these countries worsened in recent
years, wealthholders moved funds
out of these countries, fearing capital controls or currency devaluation. The shift of investable funds
outside these developing countries
increased their need to borrow
externally for investment purposes.
A significant portion of total external borrowing has financed capital flight in Argentina, Brazil, Mexico, and Venezuela/'
Banks have become increasingly reluctant to extend further
credits to developingcountries.
The
growth of total reporting bank
claims to non-oil developing countries slowed in 1982, as the seriousness of the international debt
situation became widely understood. Between December 1982 and
June 1983, claims of banks in the
lending survey showed virtually no
growth. In part because of this
reluctance to lend, the reporting
banks have been able to improve
their exposure over the past year
relative to their capital.

The Impact of Loan Losses
It is difficult to speculate on the
effects of a major disruption in the
servicing of international loans,
such as a moratorium or repudiation, as much depends on the
extent of the disruption and the
response of regulatory agencies,
commercial banks, shareholders,
and depositors. U.S. banks consider
a loan as non performing when borrowers have not made interest and/
or principal payments for a period
of 90 days. The banks have some
recourse to tax laws that permit
losses to be carried back and offset

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6, See Michael Dooley, William Helkie, et aI.,
"An Analysis of External Debt Positions of Eight
Developing Countries through 1990;' International Finance Discussion Papers, No. 227,
August 1983, especially table 1.

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