The Third World Debt Crisis - "the Fault of the Developing Countries or "irresponsible Lending" by the Western Financial Banking Institution?"

1. Introduction				rolling over of debts , the re-scheduling of
				debt repayments, and the supplying of new
The debt crisis and loan defaults have been a				money. While agreeing to delay in the
constant feature of the global economy, the				repayments of the loans, the banks opposed
present size of the world debt problem				any reduction in the interest of the loans.
overwhelms the imagination. It is clear that
the countries in the Third World are in an				This was the structural weakness of the
inherently disadvantageous position. As				financial system. Once committed, it was
primary exporters, they are at the mercy of				practically impossible for banks to withdraw
price and demand fluctuations in				from the market.
international markets. These fluctuations are
beyond the sellers' control as they reflect				3. (C) Interest Rates and Recession
the economic health of client industries in
the West.				If higher oil prices set the stage for a
				heavy debt burden for many countries in the
The total world debt soared from				1970s, the global recession and high interest
approximately $100 billion in the early 1970s				rates of 1980-82 added sufficiently to the
to nearly $900 billion dollars by the				burden indiscreetly.
mid-1980s. Time Magazine stated, "Never in
history have so many nations owed so much				Borrowers became accustomed to low real
money with so little promise of repayment" .				interest rates in the 1970s, it made sense to
				borrow in such conditions. In 1979-80,
This paper will explain the "origins" of the				nominal interest rates were high, (LIBOR -
debt crisis problem and re-assess in detail				London Interbank Offered rate - averaged
the causes of the debt problem, and question				13.2%). Approximately two-thirds of
whether the Third World Debt Crisis was a				developing country debt is indexed to LIBOR .
crisis of debt (i.e. the fault of the
developing countries) or of credit (i.e.				However, by 1981-82, inflation fell sharply,
irresponsible lending by banks).				but nominal interest rates remained high.
				This meant very high real interest rates of
2. The "origins" of the Debt Crisis problem				7.5% in 1981 and 11% in 1982. It did not make
				sense to borrow in such conditions, but by
There are so many books and articles that				then most non-oil developing countries had no
provide detailed descriptions to the origins				choice in the matter. They had to borrow more
of the debt problem . However in my opinion,				in order to pay-off old debts, and the
the global debt problem stems from two				interest rates had an immediate effect on
periods:				debt growth.

â€¢ In particular, the forces dating to				Instead in an effort to reduce inflation,
the mid-1970s, and the first oil price shock				some Western Governments increased interest
(1973-74)				rates and adopted tight fiscal policies. The
				non-oil developing countries paid the price
â€¢ The beginning of the Reagan				of that interest rise in 1981-82. For
Administration				debtors, inflation is a good thing, as it
				erodes the debt they have to pay off. For
2. (A). The mid-1970s and the first oil price				creditors, who wanted to reduce inflation,
shock				increased interest rates were a worth-while
				price to pay for lower inflation.
The period 1974-80, played a huge part to the
debt crisis, which can summarised as follows:				The problem of this policy, was that higher
				interest rates tended to aggravate the world
Firstly the most important oil-exporting				recession, that began in the 1979-80period.
countries, (not being able to utilise				Growth rates in the OECD countries fell from
domestically the vast financial surpluses				an average of 3.2% during the 1973-9 period,
generated by oil price increases), made huge				to an average of 1.2% during 1980-81 periods.
deposits in various financial institutions.				Falling demand in the OECD countries,
				especially for primary commodities, was
Secondly, at the same time, a good number of				responsible for a fall in export values.
middle and high income oil exporting nations				Demand for primary commodities is generally
(especially those with a higher degree of				inelastic, and one reason being that there
industrialisation) decided to accelerate				was already a surplus capacity in the OECD.
their rates of economic growth, not
withstanding the increase in oil prices. That				3. (D) The Domestic Policies of the Third
policy contrasted sharply with the				World Countries
"stagflation" situation prevailing in the
OECD countries.				I must admit that, not all of the blame of
				the debt crisis should fall on the burden of
Thirdly, in order to carry out their economic				the Western financial banks. Some blame has
expansion policies, many developing countries				to go to the developing countries themselves.
requested huge loans from OECD commercial				Domestic policy errors contributed to the
banks, (in the form of Euro-dollars ), so				deterioration of the debt situation.
they are able to make massive imports of all
kinds of goods, (apart from oil: in				In Mexico, for example, the government
particular chemical products, foodstuffs and				allowed the "Peso" to become seriously
capital goods).				overvalued, and allowed budget deficits to
				surge to 16.5% of GNP in 1982, when the
Following upon this point, the OECD banks,				presidential election made authorities
with great liquidity and a weak domestic				reluctant to carry out effective
demand for funds started a wild competition				budget-cutting measures. The government stuck
to export capital to the more dynamic of the				to a strategy of high growth (8.2% annual
less-developed countries (LDC). This is a				growth in 1978-81). The strategy was based on
very critical moment, as for that very				the assumption that oil prices will always
moment, the LDCs decided to apply to the				keep rising. That probably exceeded capacity
international private banking system to				growth and failed to take adequate account of
obtain the money required to implement their				the substantial weakening of the oil market
expansive economic policies.				in 1981 .

Finally, in order to decrease the risks of				In Brazil, domestic adjustment policies were
those operations, the international private				stronger and indeed contributed to a severe
banks, decided to "change the terms and				recession that began in 1981 and continued
conditions of the loans" shifting from the				into 1983. Even so, Brazil's domestic
fixed of interest that had prevailed until				policies bear substantial responsibility for
then, to variable rates. The borrowing				the eventual crisis in 1982. Throughout the
nations accepted such changes under the				1970s, after the oil shock, Brazil
influence of the aggressive marketing				consciously followed a high-risk strategy of
techniques employed by the banks. This				pursuing high growth rate based on rapid
included attractive offers that appeared to				accumulation of external debt. The resulting
be to the borrowing nation's benefit, without				legacy of large debt proved to be an
realising the grave harm that they would				oppressive burden when the international
suffer in the future. What appeared in the				economy weakened and exports declined instead
beginning appeared as a mere technical				of continuing their earlier rapid growth .
innovation that came to be a real trap, since				Matters were made worse by overvaluation the
any increase in the interest rate would apply				"Cruzeiro" after an ill-fated attempt to
to the total outstanding debt.				bring down domestic inflation by placing a
				40% ceiling of devaluation in 1980.
2. (B). The Reagan Administration				nevertheless, in 1981, the government was
				taking adjustment measures and was considered
The second period started shortly after the				by the international financial community to
Reagan Administration in the USA (January				be managing the economy well.
1981). During this period, the situation of
the mid-1970s changed completely. Alongside a				In Venezuela and Mexico, policies led to
world economic recession, inflation became				large capital flight abroad. The basic defect
increasingly intense in the US and other				was maintenance of an overvalued exchange
industrial nations, and rates of interest				rate on a fully convertible basis, combined
escalated. The economic recession in the				with domestic interest rate policy that
central nations caused a sharp drop in prices				failed to provide sufficient attraction to
of raw materials exported by Third World				retail capital domestically. As a
countries. This was precisely the moment,				consequence, in 1982, the decline in
when the financial charges, due to interest				Venezuela's official external assets reached
payments became heavier, and when the flow of				over $8 billion, although on current account
fresh capital to the Third World began to				its deficit was only $2.2 billion .
decrease.
				Similarly, in Mexico, errors and omissions
Such was the case in Autumn 1982: Mexico was				showed outflows of $8.4 billion in 1981 and
an oil exporter, (or was at least				$6.6 billion in 1982, and short term capital
self-sufficient), declared that it could not				outflows added $2.1 billion in 1982, for
repay its debts, and the crisis in Mexico				total capital flight of $17 billion . This is
caused the full attention of the entire				almost as much as Mexico had borrowed in the
industrial nations. The crisis became				same period.
universal, and was followed by 30 other Latin
American countries in 1983, (including Brazil				In Argentina, in 1980 and 1981, errors and
and Argentina ). Latin American countries had				omissions and short-term capital outflows
to compress their imports in order to be able				registered total capital flight of $11.2
to continue paying their debt services, and				billion. To make things worse, Argentina had
for the first time, Latin America became an				a very ineffective stabilisation policy with
important "net capital exporter".				the collapse of the "Peso", and extremely
				high inflation in 1981.
The extreme problem in 1982 derived primarily
from the effects of global recession from				The hostile shock of the credit markets from
1980 to 1982, combined with hostile mental				the Falklands did not help! As this was
shocks to credit markets caused by events in				associated with the mutual freeze of assets,
individual countries. To a traditional				between the United Kingdom and Argentina .
economist: "the problem is a consequence of				Thus, the capital flight has contributed to
the development from inflation to				nearly one-third of total debt in Argentina.
dis-inflation in the world economy. Funds
that were borrowed when inflation was high,				Another problem, with the Third World
and real interest rates were low or negative,				countries was their long-term development
are no longer cheap in an environment of				strategies. Such strategies included :
lower inflation and high interest rates".
				(i). Excessive protection in programs of
3. The causes of the Debt Crisis problem				industrialisation based on import
				substitution.
Having examined the growth of debt during the
1970s, and having looked at the circumstances				(ii). Inadequate pricing of capital
which led to crises for Latin Countries
(Mexico in particular) during the early				(iii) Over pricing of labour
1980s, the next question to be answered is
"why did the debt grow so fast in the 1970s?"				(iv). Overly ambitious and ineffective
				development in many developing countries.
3. (A) The rise in oil prices
				The damaging pressures from the global
One of the most important causes of debt				economy have made it more essential that
growth was the rise in oil prices in 1973-4				distortions in basic development strategies
and 1979-80. only a few debtor countries,				be corrected. Such long-term developments
such as Mexico, Indonesia, Venezuela and				strategies consequently made their goods less
Ecuador, benefited from the rise in oil				competitive on world markets.
prices. The table below, shows the difference
between what was paid for oil and what would				A further problem was the growing reliance on
have been paid for oil, had its price not				short-term debts. This was very prevalent in
increased more than the US inflation rate.				Brazil, Mexico, Argentina and Venezuela. In
				1982 :
Impact of oil prices on the debt of non-oil
developing countries				â€¢ Brazil's short-term debt stood at
				$21.3 billion, (total debt to banks $62.7
1973-1982 (billions of US dollars)				billion)

YEAR A B A-B				â€¢ Mexico's short-term debt stood at
				$31.2 billion, (total debt to banks $62.7
1973 4.8 4.8 0.0				billion)

1974 16.1 5.3 10.8				â€¢ Argentina's short-term debt stood at
				$13.5 billion, (total debt to banks 25.5
1975 17.3 5.7 11.6				billion)

1976 21.3 6.8 14.5				â€¢ Venezuela's short-term debt stood at
				$15.3 billion, (total debt to banks $26.7
1977 23.8 7.5 16.3				billion)

1978 26.0 8.6 17.4				Over 50% of Mexican and Venezuelan debts to
				Western banks had maturities of one year or
1979 39.0 10.9 28.1				less. The assumption was that such short-term
				debt facilities would be always available: ye
1980 63.2 11.9 51.3				another incorrect assumption.

1981 66.7 12.1 54.6				4. Conclusion

1982 66.7 11.9 54.8				The global debt problem that has emerged in
				many developing countries in 1982, can be
TOTAL 344.9 85.5 259.5				traced to higher oil prices in 1973-74 and
				1979-80, high interest rates in 1980-82,
A= Actual cost of oil				declining export prices and volumes
				associated with global recession 1981-2, and
B= Cost of oil if its price has not increased				with problems of domestic economic
beyond US inflation rate				management.

C= Additional cost of oil				The global debt problem has grown to large
				dimensions, and in 1981-82 that growth
The additional increasing cost of oil over				outpaced the growth of exports that sustain
the decade was therefore $260 billion. This				the debt. Due to the magnitude of this debt,
massive transfer of resources between Third				and the widespread evidence of debt-servicing
World countries could not have taken place				difficulties, the debt problem currently
without equally massive borrowing from				poses a considerable risk to the security of
Western banks.				the international financial system. As, the
				debt crisis is likely to continue, and be an
3. (B) The Western Banks				obstacle on the growth of international trade
				through lower exports, investment and
The Western commercial banks would also have				employment.
to take some of the blame and were only too
happy to lend to sovereign states whose				ENDNOTES
export performance looked promising. Such
lending was more profitable than lending in				Time Magazine, 10 January 1984, p42
the developed First World markets. The Third
World was regarded as a growth area for new				Robert Gilpin, The Political Economy of
lending by Western banks.				International Relations, Prince town
				University Press, 1987, p317-185
The almost unlimited availability of bank
loans very often persuaded a process of				The Economist, Is Anybody Paying, 14 March
de-industrialisation. Increased debt led to				1987.
increased interest payments, which (if the
loans were not properly invested), led to				Hitesh Patel has written many articles on the
further loans. Through these changes, many				Euro-Dollar market. Further details can be
Third World countries became more vulnerable				obtained at:
to developments in the world economy.
				Mario Marcel and Gabriel Palma, The Debt
If this argument is taken into account, then				Crisis: the Third World and the British
the Western commercial banks themselves are				Banks, Fabian Society, Series number 350, May
responsible, for five reasons:				1987, p1

(i). The banks believed that countries could				IMF, World Economic Outlook and International
not go bankrupt, and that no real insolvency				Finance Statistics (Various issues) at the
crisis could occur.				British Library

(ii). Many of the loans were organised				Mario Marcel and Gabriel Palma, The Debt
through a syndicates of banks, and many of				Crises: The Third World and the British
the participating banks felt no need for				Banks, Fabian Society, Series number 350. May
their own "risk assessments".				1987

(iii). Competition for a share of the market				IMF International Financial Statistics
transformed many banks into virtual				Yearbook, 1982
"loan-pushers". The two main players being
City Bank (US) and Natwest Bank (UK).				William R Cline, "Mexico's Crisis, The
				World's Peril", Foreign Policy, No 49 (Winter
(iv). Lending at variable interest rates				1982-83), p 107-18
allowed the banks to transfer the risk
associated with inflation to the borrowers.				William R Cline, "Brazil's Aggressive
				Response to External Shock", World Inflation
(v). The absence of effective regulatory				and the Developing Countries, William R Cline
bodies in the international financial market				and Associates, (Washington: Brookings
made it easier for banks to follow their own				Institution, 1981), p102-35
short-term interests and instincts in their
lending policy, and to ignore the medium and				UN Economic Commission for Latin America,
long term effects of their actions.				Preliminary Balance of the Latin American
				Economy in 1982, Santiago, January 1983, p13
It must be remembered that in the financial
business of lending money, loans are an				M.S. Mendelson, Commercial banks and the
element of a huge commercial market, where				Restructuring of Cross-Border Debt, New york:
banks struggle for a share of the market.				Group of Thirty, 1983, p23
This is socially constructed capitalism in
practice.				Banco De Mexico, Informe Annual, Mexico City,
				1982, p230
The intention of lending money to the Third
World was a "new concept", where banks relied				IMF, International Financial Statistics, May
on a "handful of simple credit-worthiness				1983, p68
indicators", that were not helpful in
forecasting the likelihood of the crisis.				Word bank, World Development Report 1983,
Some banks even began to push their customers				Part II, Washington, 1983
to accept higher loans, by offering customers
more money than they had asked for, and by				(Short-term debt data, by country): American
easing their credit conditions.				Express International banking Corporation,
				International debt: Banks and the LDCs, AMEX
Another point to note, is that, the banks				Bank review Special Paper No 10, London
also needed to buy time to strengthen their				(American Express International Banking
capital base. Banks began to accept the				Corporation), 1984.

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The Third World Debt Crisis - "the Fault of the Developing Countries or "irresponsible Lending" by the Western Financial Banking Institution?"