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on delivery
9:30 A.Me, E.D.T*
Auaust Ofi 1984

Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System

before the
Committee on Foreign Affairs
House of Representatives

August 8, 1984

I am pleased to have this opportunity to review with you
the international debt situation.
It is a large and complicated problem that must be effectively
managed —

managed in our own immediate economic interest in

maintaining the domestic and international financial stability
necessary to support our own growth, and managed in our broader
interest of the economic growth, the political stability and the
democratic evolution of the developing world.
For reasons I will touch upon later, the solutions, in my
judgment, are not likely to be found in some grand new initiative
or in a single "across-the-board" approach culminating in intergovernmental negotiations among borrowing and lending countries «
Rather, the effort has required, and will continue to require,
cooperative and imaginative efforts by all the affected parties to
deal with the particular problems and needs of particular borrowing
Certainly, there are and will be important common elements in
those country-by-country approaches.

The policies of these

countries themselves are always crucial.

The major commercial

banks around the world, which are the major lenders and have so
much at stake, need to concert their approaches.
financial institutions —

The international

with the International Monetary Fund

initially in the lead, but with the World Bank potentially playing
an increasingly critical role —
and coordination.

provide a focus for leadership

And none of that will work effectively without

the understanding and support of national governments —
of all that of the United States.

and most

As ail of that implies, we face not so much a "crisis" that
can be dealt with by a single master stroke, but rather a continuing
hard-slogging effort to contain the strains and to manage a return
to "normalcy" over a period of time extending certainly for several
more years ahead.

In that context, the main danger may, in fact,

be a human tendency to procrastinate, to relax the necessary effort,
and to fail to maintain the high level of cooperation among
parties with disparate particular interests, despite the overwhelming
common interest in an orderly resolution.

That danger can be

I believe the problem is manageable.

And I also believe

that your interest and your inquiries can help assure that result.
I will not burden you with reviewing the origins of the debt
problem which by now I believe are well known —

the successive

oil price disturbances, overly enthusiastic borrowing and lending
policies fostered in substantial part by an inflationary environment
and inflationary expectations, failure to encourage and attract
more direct investment from abroad in developing countries, and
the related undermining of the confidence of those with capital
within the borrowing countries.

World recession and higher interest

rates helped account for the timing and extent of the difficulties,
but, with the benefit of hindsight, unsustainable trends had
emerged well before that time.
Suffice it to say there are lessons here for all of us for
the future.

But I want to concentrate today on assessing the

nature and dimensions of the problem and the more immediate
approaches for dealing with it.

The Extent of the Debt-Servicing Problems
In assessing the debt problems, I would first point out they
do not uniformly impact developing countries as a whole.

Many of

the larger developing countries in Asia -- including those that
are major borrowers from banks (for instance, South Korea and
Taiwan) —

have continued to meet fully and on schedule their

debt-servicing obligations; financial markets remain open to
them, and growth has continued at a rapid rate.

Their ability to

achieve and maintain high rates of export sales has been a major
factor of strength.
At the other end of the spectrum, most of the poorest of the
developing countries, concentrated on the African continent, have
been less affected by the slowing in international bank lending
for the simple reason that these countries had never been able
to borrow sizable amounts and had not become dependent on external
private sources of credit.

They do have severe development

problems, and a few of them had failed to maintain debt service
years before the more general problem arose.

But the financial

exposure of private lenders is limited.
The debt-servicing problems of more general import have been
mainly concentrated in Latin America, among several East European
countries, and in Nigeria and the Philippines.

Among developing

countries, these have generally had relatively higher incomes and
they typically had experienced rapid growth during much of the
1960s and 1970s.
faced —

While in varying degrees, these countries have

and are continuing to face —

severe external payments

difficulties, they also have diverse needs and capabilities.
Some, for instance, are large oil exporters; others are heavily
dependent on imports of energy.

Some have a sizable manufacturing

base, while others are more dependent on agriculture or mining.
Their internal economic approaches and problems differ, so that
even within this group of countries faced with large external
debts, a pragmatic and flexible case-by-case approach has evolved
toward dealing with them.
That approach has relied on several common elements:

Adjustment by Borrowing Countries
Over-extended developing countries have recognized the
need to reduce external financing requirements and to improve
economic management and incentives internally to restore
a base for sustained growth*
Continued Lending by Commercial Banks
In the process of restoring and maintaining orderly debt
servicing, current maturities need to be extended and
some new money — typically in diminishing amounts —
may need to be provided as the internal adjustments are
made. In disturbed circumstances, these arrangements
involve negotiations affecting virtually all bank lenders.


Expanded Role of the International Monetary Fund
Thirty-six countries are currently operating with
IMF-arranged and IMF-monitored stabilization programs.
The IMF also has helped in coordinating financial resources
from banks and official sources to cover financing
requirements of debtor countries. The IMF's capacity to
operate on this scale has been strengthened by the
implementation last year of the quota increase and ,the
enlargement of the General Arrangements to Borrow.


Official Bilateral and Multilateral Assistance
An expansion of official export credits and other forms
of official assistance has been essential in helping cover
the financial needs of a number of debtor countries.
Multilateral and regional lending institutions
also have redirected some of their activities to help
cover the financial requirements of borrowing countries.

-5Before bank and IMF resources come on stream,
governments and central banks (sometimes under the
aegis of the Bank for International Settlements)
occasionally have found it necessary to provide
short-term bridge financing.

Sustained Non-Inflationary World Economic Recovery
Growing markets for exports are essential over time
to enable borrowing countries to restore balance to
their international accounts. The strong recovery of
the United States has been especially helpful in this
regard; recovery in some other industrial countries
appears to be on the way and will broaden the markets
for developing-country exports. The maintenance of a
free and open trading system is essential if the borrowing
countries are to expand their exports.

As these approaches imply, debtor countries, commercial banks,
industrial countries, and international institutions must be
willing to work closely together to deal with a problem beyond the
capacity of any of those parties individually.

In other words, an

extraordinary continuing effort in international cooperation,
among countries and official institutions, and between borrowers
and private lenders, has been and will continue to be required.
The Adjustment Path of Borrowing Countries
The core of any successful effort lies in the adjustment
actions of the borrowing countries themselves -— all else rests on
the perception and the reality of their own efforts to rebuild a
base for sustained growth with reduced reliance on external funds.
In most cases, those actions have been framed in cooperation with,
and have received the financial support of, the International
Monetary Fund, and that has been a crucial ingredient in building
further financial support.
The results thus far of the adjustment efforts by some of the
most important borrowing countries have been encouraging.


-6Mexico, Brazil, and Venezuela, for example, budget deficits are
being sharply reduced by 4 percent or more of the GNP in a
single year -- the equivalent of moving the U.S. budget deficit
from its present position into balance or surplus in one fell

Other measures, including restraint on money growth, have

been taken to bring domestic demand more in line with domestic
capacity and to reduce inflationary pressures.

In order to

correct external deficits and long-standing distortions in relative
prices at home, borrowing countries have allowed sharp depreciation
of their currencies and reduced subsidies, at the expense of higher
prices of important goods and services.
In the midst of that difficult process, a number of countries
have, perhaps inevitably, experienced a sharp contraction in
economic activity.

But those countries that responded promptly

to their balance of payments and debt-servicing problems with
comprehensive adjustment programs do show substantial improvement
in their external positions.
growth are appearing.

Now, some signs of a resumption of

At the same time, the challenge remains to

restore growth over time in a manner consistent with a more
limited availability of foreign bank financing.
The results of adjustment efforts adopted by borrowing
countries in the aggregate have been impressive.

The combined

current account deficit of the non-OPEC developing countries was
almost cut in half between 1981 and 1983.

The reduction in the

deficits of 10 major borrowing countries, most of whom have
experienced debt-servicing difficulties, has been even larger •—•

-7from some $46 billion in 1981 to about $16 billion in 1983*
Table !•)


Some further progress is taking place this year*

Some key debtor countries —- Mexico and Venezuela in
Latin America, Yugoslavia and Hungary in Eastern Europe —


actually moved into current account surplusf notwithstanding their
heavy interest payments•

In others, notably Brazil, trade

surpluses are significantly exceeding expectations, and the
remaining current account deficits are smaller than anticipated*
Moreover, the payments performance of some of these countries has
allowed them to replenish their reserves? which were depleted
following the onset of the debt problem.
The large trade surpluses being recorded by these countries
are a partial counterpart of the enlargement of the U.S. trade

The strength of the U.S. economic recovery and the

appreciation of the dollar have stimulated U.S. demand for imports,
and the weakness of internal demand in many of the major developing
countries and the strong dollar have reduced foreign demand for
U.S. exports.

As a result, the U.S. trade deficit with Latin

American and Asian developing countries nearly doubled between
the fourth quarter of 1982 and the second quarter of 1984 (from
about $21.5 billion to nearly $41 billion).

Those countries that

started effective adjustment programs earlier, and have thus been
able to take advantage of growing markets in the United States
and elsewhere, have benefitted most from the factors contributing
to the widening of the U.S. trade deficit*

-8At the same time, I must emphasize that so far a disproportionate
part of the improvement on the external side has come from sharp
declines in imports.

In fact/ imports in a number of countries

have dropped to levels inconsistent with growth and development.
Over time, both imports and economic activity must expand if the
adjustment programs are to be successful, and consistent with
social and political stability.

Moreover, there are a number of

countries that, so far, have not been able to implement effective
policies, and related financing and refinancing programs are in
The difficulties in this area are apparent.

Effective measures

in practical terms mean strong and politically difficult actions
that sometimes must be shaped in the midst of blossoming democratic

That implies a need for a high degree of consensus


no simple task for those of us who have enjoyed stable democratic
governments for many years.
In this situation, concern is often and understandably
expressed that too much is expected of these countries by the IMF
in shaping its lending programs, by creditor countries or by banks.
But I question whether there can be an easy painless way to restore
equilibrium, or whether failure to adjust can be in the basic
interest of the borrowing countries themselves.
Economic growth in developing countries over a long period
ahead, and the prospects for political stability, will be dependent
on their ability to participate fully in an interdependent world.
In that world, credit-worthiness and credit availability will be
precious, for they are essential to support trade and investment.

-9Once lost, those qualities are difficult to restore —

and democracy

is not likely to flourish in the midst of accelerating inflation
and economic isolation.
In many of those countries/ their excessive debt burdens can
be traced in large part to a flight of capital by their own citizens
discouraged from investing at home.

To me, the ultimate test of

a successful economic program will not be whetherf at a moment of
time, it is acceptable to the IMF or to bank lenders, but whether
it, in fact, can restore and maintain the confidence of a nation's
own citizens -- and whether, as a consequence, its own savings are
employed productively at home.
Threats to Adjustment
At the same time, the efforts of the borrowing countries will
not be successful without a reasonably favorable economic climate

Specifically, prolonged increases in interest rates and

increased protectionism in the industrialized world can undermine
the best efforts of the borrowers.
add to debt service burdens.

Higher interest costs directly

An unwillingness on the part of

industrial countries to accept more imports would make it impossible
for the borrowing countries to earn the foreign exchange they need
to service their debts.
Recent changes in these respects are not so significant as
to thwart the adjustment process.

In fact, to the extent that the

higher interest rates are a reflection of the stronger than
anticipated U.S. economic growth, the burden is offset to a
considerable degree by the higher exports to the United States.
Nonetheless, anticipations of further changes have been a

-10source of considerable uncertainty, tending to undercut the
cooperative effort to manage the debt problems in an orderly way.
Given our own strong interest in achieving an orderly resolution
of the debt problem, these concerns reinforce the urgency of
forceful and prompt action by the Congress and the Administration
to reach agreement on ways to reduce the huge budget deficits that
have helped keep our interest rates high and indirectly aggravated
the deficit in our own trade.

Although I understand that these

hearings on the international debt situation are not intended to
result in legislation, I cannot resist suggesting that further
efforts in resolving our budget deficit problem would be the single
most important contribution the Congress could make to an easing
of international debt problems.
Financing Adjustment and Growth
In the near term, the major borrowing countries must, by
force of circumstances, bring their current account positions into
alignment with a reduced availability of external financing.


the standards of the late 1970s, new bank lending is likely to
remain restrained relative to the bank's own capital and assets?
a number of banks in the United States and elsewhere will probably
be looking to reduce their exposure relative to their capital.
The amounts of indebtedness by major borrowing countries and the
loans of commercial banks are displayed in Table 2 and 3 attached
to this statement.

As indicated there, growth of such lending has

in fact slowed, and the exposure of banks, relative to assets or
capital, has begun to decline marginally.

In a context of growth,

both in the industrialized and developing world, this relative

-11exposure could decline much more significantly, even as the total
loans outstanding rise moderately*
The financial constraints for the borrowers, and the risks to
lenders, would both be reduced by restoration of, and increases in,
the flow of direct investment to developing countries.

In the

light of the financial and economic uncertainties of the past two
years, the opposite has happened.

This emphasizes the importance

of the borrowing countries, as part of a reshaping of their
economic policies, to attach priority to approaches that will
strengthen confidence in their economic prospects abroad as well
as at home.

That process inevitably takes time, but it is urgent

that it begin.

The adjustment programs undertaken are broadly

consistent with the need, but much more could be done to deal with
specific obstacles to foreign investment.
Given smaller inflows of capital from abroad, growth in major
borrowing countries of necessity will have to be financed to a
greater extent than in the past by internal savings.


programs designed to curb inflation, to maintain realistic interest
and exchange rates, and to eliminate or reduce price distortions
are designed to be consistent with that goal.

Over time,

encouragement of domestic savings and economically rational
investment decisions can provide a far sounder base for development
than unsustainable amounts of foreign borrowing, important as
capital imports may continue to be at the margin.
In the best of circumstances, these adjustments could not
bear fruit in self-sustaining growth immediately.

And, lenders

-12need to appreciate that countries launching an adjustment effort
will need financial support from abroad for a time that will not
be forthcoming spontaneously —

that is by the uncoordinated action

of individual banks and countries.

Indeed, as debt problems first

became apparent, the understandable reaction of individual lenders
was to pull back abruptly, under the pressure of directors,
accountants, and public opinion suddenly conscious of risks that
had not been so apparent only a short while before.

But experienced

bankers quickly realized that that approach would guarantee
precisely the result they feared —

that borrowers would in fact

be unable to repay so suddenly, their economic futures would be
jeopardized, and as a result, the basic value of existing credits
would be undermined.
By cooperation, and at times with transitional support from
governments, central banks

and the IMF, a coordinated and

constructive approach has been maintained, resting on analysis
that extension of old credits —
credits —

and in a number of cases new

can be justified when necessary policies are adopted

and long-term debt servicing capacity maintained and enhanced.
That kind of approach is not new for bankers? a similar
appraisal is necessary when difficulties arise in meeting debt
service requirements of domestic business.

What is new is the

level of complexity when hundreds of lending institutions, various
governments, and international institutions are all involved with
many differing interests, different accounting and legal systems,
and historical lending relationships.

The one feature that tends

-13to bind all these efforts together is a common appreciation that
the success of the total effort depends on cooperation by all

And we can now see instances where the adjustment

effort and transitional financing appears to be strengthening the
basic credit-worthiness of borrowing countries*
A New Phase
Indeed, I believe the stage has been set for a new phase in
financing programs tailored to the progress and circumstances of
individual countries*

The bulk of the financing has been, and

will continue to be, provided by commercial banks, and is a matter
for negotiation by borrowers and lenders*

But I am glad to see

that, recognizing the progress made by certain countries, the
banks are now engaged in negotiations for multi-year restructuring
of debts on terms that both reflect the stronger credit-worthiness
of individual countries and permit planning on a more assured basis
for the future.

These arrangements, combined with prudent policies

by the lender, can pave the way for meeting any more limited further
needs for new money in the years ahead through more normal and
spontaneous market processes.
All of this seems to me entirely consistent with the conclusions of the recent Economic Summit in London: "in cases where
debtor countries are themselves making successful efforts to
improve their position," the Summit participants attached particular
importance to "encouraging more extended multi-year rescheduling
of commercial debts and standing ready where appropriate to
negotiate similarly in respect of debts to governments and
government agencies."

-14The process of renegotiating the debts to banks has
required the resolution of difficult and contentious issues
in a financially and politically sensitive environment.

In the

process, considerable experience has been developed and the
effort has become better organized and more orderly.


committees act as negotiators and perform a liaison function with
the much larger group of lending banks, and better lines of
communication have been established.
The role of the International Monetary Fund in the loan
renegotiation process has been expanded and also has been defined
more clearly.

The IMF also has improved the flow of its technical

information about borrowing countries to lending banks in a manner
that does not appear to have compromised its ongoing relationship
with its members.

But, as time has passed, shortcomings in the

process are also apparent.

The new arrangements in a situation

in which there could be no "track record" of adjustment, have
typically been for relatively short periods, and rates and terms
reflected the appreciation of extra risk.

One of the dangers has

been that, as the sense of emergency passed, the effort would
flag and a sense of frustration about continuing negotiations
would impair the effectiveness of the effort.
Now, however, the opportunity has arisen, within the
general framework of a case-by-case approach, to take a longer

Growth in the industrialized countries has

Some important borrowing countries have demonstrated

their ability to adjust their external positions and to encourage

-15export-led growth.

Lenders can recognize that progress in extending

maturities and in providing more favorable terms in other respects*
As a result, there is an opportunity to move progressively
from a "crisis" stage of debt management to longer-term arrangements
on reasonable terms.

I believe it is critically important that

that opportunity be seized.
I am aware of the difficulty of conducting negotiations with
so many borrowers and many lenders, and so many individual and
syndicated loan agreements involved.

There are concerns that

each renegotiated loan may be interpreted as a precedent for future
agreements where circumstances may not be similar.

Lenders or

borrowers have particular negotiating objectives that may be
difficult to reconcile.

But both have clear and overriding

incentives to build on the constructive attitudes and the efforts
by important borrowing countries to restore domestic and external

Relevant negotiations are underway now with Mexico

and Venezuela.

I hope they can be concluded shortly.

Concluding Observations
In sum, there are grounds for encouragement in the progress
that has been made over the past two years in dealing with the
international debt problem.

The record and the prospects do not

justify a sense of despair.

But neither do they suggest grounds

for complacency —

the threat to international financial stability

remains real, and will need the continuing attention of governments
as well as private lenders if it is to be successfully resolved*

-16In the light of all the difficulties and strains, proposals
have been made that the sloggingr difficult, continuing process of
adjustment, negotiation, and refinancing country by country be
essentially abandoned and replaced by some sweeping new initiative
to settle the problem decisively and "across the board."
proposals seem to me based on unrealistic assumptions —


on an expectation that someone else is prepared to assume large new
I do not sense, in that connection, any willingness on
the part of the U.S. Congress, or other parliaments, to provide
massive new financial assistance for countries that, in the economic
hierarchy of developing countries, are among the most advanced.
Lending banks understandably do not volunteer to provide large
interest subsidies for, or to write down, loans that can, after
allf be serviced; nor is that necessarily in the interest of
countries that will be looking to international markets for credit
to support growth in the years ahead.

Those countries are not in

the same position, in terms of their own resources and in terms of
the efforts they have made to place their own economies on a
sounder footing, and it would be difficult —

even perverse —


provide the same terms and conditions for all.
I do not minimize the real strains or, almost as important,
the sense of fatigue that can set in when a large and complicated
effort needs to be sustained.

Results take time.

That is one

reason why, as I noted above, that as progress and performance
justify it, it does seem to me critically important to move to a
new phase in which individual borrowers be able to refinance

-17maturing debt for some period ahead at reasonable termsf permitting
both borrowers and lenders to have a more certain and stable base
for planning.
As the initial adjustments under the aegis of the IMF are
made, the role for the World Bank and the regional development
banks should become relatively more important, both in helping
borrowers develop appropriate investment strategies and seeing to
it that they can be appropriately financed.

There are promising

initiatives underway in the World Bank, for instance, that could
importantly supplement the efforts of the IMF, the borrowing
countries and the banks as the total effort is viewed in a longerterm perspective.

I am thinking in part of the possibilities of

encouraging so-called "co-financing" techniques, combining the
strengths and resources of private lenders with those of international institutions.

These initiatives, it seems to me, deserve

our sympathic attention, and the institutions themselves our continuing financial support as required by prudent and effective

All of this would represent a natural evolution,

providing both a transition to "normalcy" and a basis for
constructive new patterns of international lending.
With this continuing effort, successful management of the
debt problem can continue so long as certain fundamentals are
respected —

persistent and effective adjustment efforts by the

borrowers, continuing growth among the industrial countries as a
whole, maintenance of open markets for the products of developing
countries ready to compete fairly in world markets, and reasonable

-18stability in financial markets (or better yet f declining interest
rates) which in turn rests on keeping inflation and budgetary
deficits under control*

None of that requires perfection in every

respect, and none of it will produce sudden and complete success
in every case across the board.

The process will take time.

it can work, and I believe it is working.



Table 1
Current IAccount Balances of the
Ten Largest Borrowers among Developing and Eastern European Countries
($ billions)





















































































Total of Above














All non-Opec LDCs—



1/ Includes reinvested profits.
2/ From IMF World Economic Outlook (April 1984).

International Financial Statistics and national sources.

Table 2
External Indebtedness of the Ten Largest Borrowers
among Developing and Eastern European Countries, 1979-83
($ billions; end-of-year)











debt to BIS-reporting banks
% change from previous year






debt to U.S. banks
% change from previous year






Total gross external debt
% change from previous year


Total gross external debt is all public and private debt; Federal Reserve
staff estimates based on national sources.
— Debt to BIS-reporting banks is from Maturity Distribution of International Bank
Lending, published by the BIS.
— Debt to U.S. banks is from Country Exposure Lending Survey, published by the
Federal Financial Institutions Examination Council.