The Management of External Debt by Ronald Yacat

_Volume

V, No. 2

March - April 1987

ISSN 0115-9097

Introduction Late in1983,thepreviousgovemorof the Central Bank was replaced under pressure from creditors due to an overstatement of international reserves, barely a year after he had called the debt problem "manageable". Several finance ministers in other heavily indebted countries, on the other hand, had been forced to resign for implementing tax and

THE MANAGEMENT OF

THE

EXTERNAL

DEBT

cussion is devoted to the question of timing in spite of the mor_ obvious

EDITOR'S NOTE: The Philippines is still reeling from the effects of the balance-of payments crisis that exposed the extent of external indebtedness of the national government. Government corporations and private firms, especially those which had dealings with public financial institutions, came under fire for questionable loans that later gave rise to default and liquidity problems. Three years later, and with a new government in place, the debt problem is again a burning issue. The Aquino government had had to take steps to reschedule due debts, or to renegotiate ]'or better terms, especially for new money. Several options have been entertained to manage the debt. One of the most controversial is selective debt repudiation. However, this option was dismissed by the government in its announcement that all debts will be honored in due time. Nevertheless, as pointed out by our guest writer, the policy stance to the debt problem shouM be contained in a debt package that gives due consideration to economic development objectives. Our guest writer, Dr. Felipe Medalla, reviews the current thinking Â˘bout debt management and several policies that can best support development goals. Near the end, he cites a slow growth scenario for the Philippines and discusses the areas of manueverability of the government given such conditions.

importance of achieving a more equitable sharing of the burden. This is because there are akeady clear ideas or strong

Dr. Medalla is an Associate Professor at the School of Economics, University of the Philippines. His main area of concentration is.regional economics and development.

opinions on what constitutes equitable sharing and also because, as will be pointed out later, the problems of sharing and timing are virtually inseparable in the short and medium.run.

Also contained in this issue is the full text of the speech by noted economist Dr. Rudiger Dornbusch who is a Professor at the Massachusetts Institute of Technology. The speech was delivered in a PIDS-PES luncheon symposium at the Manila Mandarin Hotel in January 198Z

austerity measures which were designed to make the foreign debt more "manageable", Still, the use of the term "manageLment" is appropriate since the country "lzas several, albeit unpalatable, choices regarding the handling of the external debt, In particular, there is some room to maneuver on the sharing and timing of the debt service burden, This article focuses on the issues of sharing and timing. A great deal of dis-

CONTENTS Page 1

The Management of the External Debt ........ ............................................ The Debt Crisis: Where It Has Been, How It Has Been and Where It is Today ................................................. UPDATE: New Publications ................................................................... Ongoing Projects ............................................... PIDS Working Papers ........ : ....................................................... PI DS Staff Papers ................................................................... Seminars .......................................................................... f

iiii i i

13 13 14 15 16

!....................

ii iii

This is not to say that a road map to the negotiating table can be plotted based only on these general principles or axioms. As Filipinos, for example, it is very tempting to say that the optimal timing is "never" and that optimal sharing means that the entire burden should fall on our creditors since many loans financed white elephants and the '_flight" of Marcos' and crony capital ,, , ,, ,, • . . any debt agreement which gives a higher priority to debt serv ice than to . economic development is not acceptable. '" Such a position, however, is naive ff not

Fortunately, as in many bargaining problems, a cooperative or conciliatory solution may existwhich is better than either unilateral ceilings on debt service or complete surrender to the creditors' objective of collecting interest in full. Regulations and accounting rules in creditor countries make it worthwhile for banks to maintain appearances that debtor countries are paying interest in full. As a result, foreign commercial banks may grudgingly accede to requests .for new money, as in tire case of Mexico and Argentina. However, in order to get the new money, the country's negotiators must be determined to get it, and of course, they must ask for it.

the purpose of this article, it should noted that even Nicaragua has notrepudiated its debt but (or maybe because) it has obtained a rescheduling of principal payments and a partial capitalization of interest payments. The point. that must be stressed is that repudiation is not an attractive alternative ff net.payments to creditors in the short and medium-run can be reduced through an agreement (as opposed to a unilaterally set ceiling on debt service payments) Which provides for both rescheduling of principal and capitalization of interest, or its equivalent in new loans, which would make it easier for the coufitry to pay interest (Cling 1983 and Milivojevic, 1985).

irresponsible. Our creditors have their Own ways of retaliation• The simple fact remains thateven ff we honor all our debts to foreign governments and multilateral fllstitutions, foreign commercial banks can stillhurtthe econ.omy by withdrawing trade credits, Which will then

The Need to Postpone Payments

One way to reduce debt service is to repudiate the debts, totally or selectively, Taken to its limit, however, such. a strategy would put the Philippines at

In short, a rescheduling agreement which includes new money would achieve one of the most important objectives of repudiation, which is to reduce net transfer of resources (interest plus amortization less new loans from the country during thenext five to ten years)

disrupt imports; by lobbying the reduction of and official creditsfor and assistance to the Philippines from the

odds with too manyby enemies. Foreign commercial banks themselves and witlrout the cooperation of creditor

creditor governments. In addition, tlre spell cast by the February i986 revolu-

governments, especially the United States, may not be in a position to inflict

"... concerted sar_c¢ions from commercial banks, multilateral

tion on tile international commurdty is no prevent creditors fromlonger takingsufficient retaliatoryto measures• Nevertheless, any dcbt agreement which gives a higher priority tO debt

much damage, but concerted sanctions fi'om rnultilateral financial,commercial institutions banks, and creditor governments wouldaffect not only our sources. of credit bu.t also ore" access to markets

.financial institutto_ and creditors governments _ould affect not only our sources of credit

service than to economic development is •unacceptable. More concretely, given that

for our exports and the level of development assistance (Cline, 1983).

our exports development

the coulatry tmilater_dly sets a ceiling on debt service no longer seems like a drastic

.Selective repudiation of "immoral" loans, on the other hand, might have been

step ff tire best offer from our creditors .consists only of temporary relief fi'om amortizations of the principal (e.g., rescheduling of debt with a sufficiently long grace period without interest capitalization or new loans to ease the burden of paying interest). This is because the very rationale for seeking an amicable scttlement with creditors is to reduce thc net outflow of resources from tile cottntry wliile tile economy is being rebuilt from

workable if it had been done within a few months after the February 1986 revolution. At this time, much of the international political capital from EDSA has been spent and the President has declared that all loans would be honored. Still, the country might face concerted sanctions even ff debts were repudiated only selectively.. (Law suits, "case-to-case disengagement," and other non-unilateral measures may be worth trying, but the

The disadvantage of new money or an interest capitalization, agreement is the fact that the total debt would grow.. If the interest rate is 9%, for example, capitalization of two4hirds of the interest would mean a 6% growth rate of the foreign debt, which is only slightly less .than the GNP growth target in the. .development plan. Clearly, the country would sink deeper into debt with interest _apitalization if

country cannot wait too long and the chances of success in litigation are hard to quantify.) At any rate; while a discussion of the likelihood and impact of sanctions is not

world interest rates become much higlae I than the currently low level of about 7%'. Moreover, even if interest rates remain low, the debt could still grow faster than the country's capacity to pay if the

the ruins left behind by the previous governnrent. Moreover, full payment of interest in hard currency is unacceptable because it renders even relatively modest socio-economic objectives unattainable I

Interest

•I

without

the risks of inviting sanction 1 "

but

also

I II

access

to markets

and the level assistance. ""

for of ,,_

III I

DEVELOPMENT RESEARCi '=, NEWS

MARCH-APRIL 1987

_onomy fails to achieve the economic targets in the development plan despite the temporary reduction of the net payments for debt service, ttowever_ if i,lterest rates remain at current levels and the economy grows rapidly during the next five or six years, -both the country and its creditors would gain. This can be easily seen by corn-

balance of payments picture drastically, unless part of the interest payments is externally financed. The cou-ntry does not have to borrow specifically for interest payments. Since money is fungible, it could borrow for a project such as land reform which would be undertaken anyway, with or without the loans,

figure also includes workers' remittances, income from tourism, foreign grants and base rentals. Thus, even if receipts from exports of goods were to increase by 6 percent every year, the country might experience another foreign exchange crisis by the end of 1988, or by the middle of 1989 if the country only manages to get loans to cover payments on the principal_

paring the debt burden of a household with a permanent income of l_10,000 a month and a debt of 1"200,000 vis-a-vis

In 1984 and 1985, imports declir/ed at a faster rate than GNP, althotlgh the de-

or to re-schedule the debt but fails to get new money or loans to facilitate interest payments. -

one with a smaller debt of P150,000 and a smaller income of P5,000. In short, it is not enough to borrow to cover part of

.......

the very rationale for seek-

The next balance of payments crisis could of course occur even before the end of 1988 ff world interest rates rise or the

the interest payments to free resources for devclopment -- development must actually take place, It is also clear, however, that a strategy of outgrowhag the debt is not without

ing an amicable settlement with creditors is to reduce the net outflOW of resources from the country while the economy is being rebuilt from the ruins left

_terms of tradeworsen.Moreover, speculative attack on the exchange rate and capital flight could hasten the occurence of a crisis once it becomes apparent that a crisis is indeed quite likely.

rim. In fact, there are fewer successes (e.g., Korea) than failures (e.g., several African and Latin American countries), To succeed, a country must not only undertake internal reforms, it must also =ce a favorable global environment.

behind ment."

"...

the

govern-

.......

One way to reduce the likelihood of the occurence of another foreign exchange crisis before the end of the decade is to reduce the rate of economic recovery through tighter monetary and fiscal policies (i.e., slower growth of money supply, higher interest rates, bigger government revenues and smaller government expenditures).

But the other options available to a government that has inherited an economy with so nmch debt but has little to show for it are even more unpalatable, As mentioned earlier, repudiation would invite sanctions. Paying the interest in

cline was more in absolute peso or dollar terms. This is only natural since imporb intensive activities such as truck assembly and investments in new equipment arc the first to be postpoaed during a foreign exchange crisis. Conversely, imports would grow taster than GNP once the economy starts to recover. In fact, it is liicely that

full, on the other hand, is to choose debt service over development. This is quite clear whether one looks at the debt service as a substantial reduction in foreign exchange available for imports or

the growth rate of imports would be twice tile growth rate of GNP during the first three to five years of the rebuilding of the economy. Titus two years of growth at NEDA target rates could

maneuver on the sharing and timing of the debt service burden."

as a major item in the public sector's budget, or even as a huge reduction in investible funds.

increase imports by nearly thirty percent (2 x 7% per year x 2 years),

A sustained growth of 3.4 Percent per year is after all better than one or two

Imports of goods in 1986 was roughly U.S. $5.0 billion. A thirty percent growth

years of rapid growth followed by one or two years of stagnation. The political cost

would push it up to $6.5 billion. Thus, if the cost of freight and insurance is rough-

of slow economic growth, however, may be quite high in a country which has al-

ly 10 percent of imports, total yearly payments for foreign goods and services would increase to $9.5 billion by the end

ready experienced a 15 percent declinein per capita income and has taken the first steps towards democratic restoration. The

The Effects

of hlterest

Payments

The arguments on the effect of interest payments on the balance of payments is most straightforward. For one, payment of interest without the help of new loans will not immediately result in a balance of payments problem because the

of 1988, assuming an annual interest expense of $2.0 billion and an annual outlay of $300 million to $400 million for other services.

"...

'_ there

'""

political nounced that the put in

..... is some

room

cost becomes even more proif it becomes public knowledge austerity and tax place upon the measures insistence were ot

_rrently low level of economic activity "_.g. GNP) has brought imports down

In contrast, exports of goods in 1986

creditors in order to service debts piled up by a discredited dictator. President

and has freed resources for interest pay. ments. Two years of growth at tile NEDA target rates, however, would change the

was only $4/3 billion and total current receipts were around $9.0 billion in 1986. In addition to exports of goods, the

Alan Garcia of Peru was perhaps not exaggerating when he said that the choice was between debt and democracy.

.. r

DEVELOPMENT RESE ]CH NEWS

MARCH-,APRIL198; ,i

This is not to say that these scenarios

many industries is the reason for this un-

will certainly occur. If the optimistic forecasts of rapid export growth from the Department of Trade and Industry are realized, for example, foreign bankers would most likely fall over each other to lend to the Philippines. But debtor countries have heard this

founded optimism. It is often overlooked that so nmch capacity is underutilized .precisely because industries with excess capacities are uncompetitive at world market prices, and that new exports would in general require new investments,

line before. They have been told that world economic recovery is around the corner and that voluntarY lending will re,me; and that the debt problem will be solved with some patience and a certain " Â°ctegree

austerity.

banks

would

affect

tt_

financial position of the public sector. As a first approximation., it can be assured that principal payments will be postponed but much of the interest will have to be paid. If the share of the public sector in interest payments is roughly

_,.

_...

_ff__2'

'_ k_ _---_-_

Realistically,

funds in more however, banksdeveloped are morecountries. likely toThese put. more advanced economies, however, are

commercial

.:_

___

__,_._ _u)

...... _ii_:i12,_ ....

year, and as result, theirthan in,ports are not not likely to agrow faster 3 percent per expected to grow much faster (Lessard

,._--4rr,_

,_ ,._'

"_..:: = .--:1.= 7_:., ,::_i_--@.-..._,.

_.mi_.2_,_.--_::_:_:i_-

i.i:Ii_ _ "i::_ .....

_ â&#x20AC;˘ " '_ : -".......

been louder protectionist noises from and Willianlson, 1985). In fact, there have these countries now than say, five or ten yearsago., It of course does not follow that

As a case in point, investment in the

equal to its share in the outstanding debt,

Philippine exports will grow at the same rate as the imports of the developed countries. Korea and Taiwan have been

shrimp industry, which is one of the " promising export industry, is not really minimal and it entails some costs to shift

the public sector's annual interest pay_ ments on the foreign debt could very weir exceed $1.0 billion.

from other traditional activities (e 4g-, sugar) to shrimp farming. â&#x20AC;˘ Finally, it is important to note that three-fourths to four-fifths of the external debt is public debt, owed by either the national government, public corporations or the Central Bank. In addition, much of the public external debt is not backed UPby assets of equivalent market value. According to news'paper reports, for example, the market value of the non-performing assets of the Philippine National Bank andtheDevelopment Bank of the Philippines is only 20 percent of their book value. Meanwhile, Central Bank losses from foreign exchange transaction swaps and forward cover were so large in certain years that its deficits nearly matched the deficit of the National Government, which in turn incurred large deficits, primarily because of the need to support the debt service of government corporations. In short, the external debt burden now falls on all citizens, many of whom are poor and did not benefit from the debt. There are no available direct estimates of the extent to which the debt talks with

This would impose a tremendous fiscal burden even if all payments on the principal are postponed. A fiscal, burden of this magnitude is quite heavy for a government that has promised to undertake fundamental social reforms but relies mainly on indirect taxes to raise revenues. In 1986, for example, the government had to rely on additional taxes on beer, cigarettes and petroleum to reduce its deficit. Yet, other means of financing the deficit could cause even greater damage. If the deficit were financed solely through money creation, double-digit inflation would be triggered if the exchange rates were allowed to adjust. To make matters worse, exchange rate adjustments would worsen the fiscal position of the government which,, as mentioned earlier, now holds most of the debt. Fixed exchange rates in the face of rapidly increasing money supply, on the other hand, would erode confidence i_ the ability of the government to defenil_ the exchange rate, thus inviting speculation and increasing the risk of another foreign exchange crisis. New bond issues also have undesirable

able to increase their exports much faster .than the growth of world trade, No_theless, even if we assume for the sake of argument that the Philippines will undertake structural reforms and use its human resources to achieve some economic success as what Korea had done, the important question still remains: Where will the capital for expamion come fi'om? This is very crucial dace the estimated net resource transfer with principal rescheduling without Financing (for at least a part of the interest payments) would be around 5-7 percent of GNP, or about one-third of national savings. Since most Filipinos are poor, much of the debt service would have to come from a reduction in the amount of domestic savings available for domestic investment, In effect, the present debt service reduces our capacity to grow and service debt in the future, Unfortunately, there is a lot of loose talk on how we can increase foreign exchange earnings without substantial additional investment. 'Very often, the presence of underutitilized capacity in 4

III

__1_

__i!_!i_ Philippine

IIIII II

__!!}_!

Exports

III

pffects. If the government issues bonds to finance its deficits, the public sector would compete with the private sector for funds and this would drive up interest rates and slow down economic recovery. Obviously, any long-term solution to the debt problem will require fundamental reforms in the structure of government and a fairer and more efficient tax system. Even a sincere Itovernment, however, will need time to institute reforms, What may seem inefficient to ordinary citizens after all may be the source of livelihood for vested interests and bureau-

reverse capital flight and voluntary lending and investment will precisely not take place since the absence of a commitment for new money increases the risks of another foreign exchange crisis before

lateral loans are not really cheaper than commercial loans. They often come with consultants, conditionalities and restrictions on the choice of suppliers. Another hnportant feature of l_fficill

the end of the decade, In addition, it is quite unlikely that direct private investments could make up for the scarcity of capital that would be brought about by full interest payments to commercial banks. Between 1980 and 1985, there has virtually been no growth in total private direct investment, with much of the investment concentrated in

and multilateral debt is that the pt,ocessing period is so long that we might have to undertake projects designed during the Marcos period l to speetl up disbursement. This is a crucial feattfe in the case of non-reschedulable multilatenll debt which increases the pressure to drum. up new prqiects just for the dubious purpose of generating funds to cover puy-

crats who will do everything in their power to obstruct reforms. The govern_ ment's problems with Marcos "loyalists"

the more advanccd newly industrializing less developed countries (World Bank, 1986).

and coup plotters should amply illustrate this. In fact, essential programs are as likely to be affected by fiscal difficulties as unproductive government activities. Even the Secretary of Finance who has been a critic of inefficiency, for example, has been quoted as saying that the proposed

It certainly would not be wise to put money in a country which might at some future time make it difficult to take the same money out. ironically, in the same way that a liquid bank will not experience a bank run, the availability of a "growth facility" makes it more likely that the facility would be redundant,

ments of non-reschedulable amortization payments. Questions can be raised too on whether there are enough funds from official and multilateral sources. Total aid

lerated land reform program is too itious,

to all developing countries actually declined between 1980 and 1985 and is expected to grow by only 2 percent annually in real terms during the next few years (Killikc, 1987). In 1986, Philippine interest and amortization payments to the World Bank exceeded new loans from the World Bank. Moreover, if half of the

Indeed, the problem with paying interest in cold cash is that the fall out. from government's loss of credibility in

"... a rescheduling agreement which includes new money would achieve one of the most

interest payments would be refinanced, relying solely on official multilateral sources would require a doubling of debts

undertaking

important

from these sources by 1992. Since we are not the only country with a debt problem, this would not be feasible. Indeed, the Baker Plan requires new lending by commercial banks because official

social reforms may rob it of

the initiative to undertake painful but necessary economic reforms, Getting

New Money

diation, transfer ,

objectives

which is to reduce of resources. '" ,J

repunet

Given that obtaining new borrowings is the least of all evils, the next question is when and where to get new money, Since the economy will not need the new money in 1987, it could be argued that the government should ask for new

Moreover, it is quite unlikely that banes would resume voluntary lending given the size of the deficit of the United States and the conditions in the internal finar:cial markets. After all, these are the same banks that passed the responsibility for new money to official and multilateral institutions and insisted on ruling

and multilateral sources are not enQughl. As Cline has pointed out, involuntary lending by commercial banks serves a social purpose by reducing the need fo_ official funds. Finally, it is important to .discuss whether commercial banks would accede. to requestsfor new money. Recent

money when the need becomes apparent to avoid payment of commitment fees. However, if government asks for new money when the need is alreadyobvious, its bargaining power would be weaker, Another argument for not asking ibr new motley from coinmercial banks now is that voluntary lending and capital inNow will resume the moment tile country _ets its economic act together. But one can stand this argument on its head by pointing out that financial uncertainties may prevent steady recovery and that

out new money and keeping thc "growth l:acility '' out of the recently concluded debt talks. (Our negotiators did not ask for new money or a growth facility clause.) The decision o t"the Philippine's debt negotiation team to free foreign cominerical banks from the obligation to provide new money has been based on the mistaken notion that new money from official and multilatera! source is cheap and is there tbr the asking_ Upon closer examination, however, official and multi-

accounts showed that Argentina _nd' Mexico got new money_ The ace up ourt sleeve is that the new money is already" with us. If they refuse to lend new money, wc can withhold interest payments. It is doubtftd-whether this would invite official sanctions since we ateonly following the rhetoric of the Buker IIkan;. that new money is needed lind that current economic conditions requll_ idjustments with growth. We ha_, as it were, done quite a bit of adjusting. Now, it is time for growth.

IIIIIII

III

II!_'_

TheDEBTCRISIS"w,oro.,s,.owi,.os oon •

The following DORNSBUSCH PES Luncheon Grand Ballroom

and .Where it is Today

is the speech delivered by PROFESSOR R UDIGER of Massachusetts Institute of' Technology during a PIDSSymposium hem in his honor last January 6, 1987 at the of Manila Mandarin

•

Hotel

The third example is Mexico, Every six years, Mexico gets a new president. The outgoing president is supposed to do wonderful things for the people. And they do indeed_ They give wage increases that

It's would to dototoday is to go a greatlike pleasure be here. What over the•debt crisis - from where it started to how it has been to where it is today. I will speak of both the Philippines and the Latin American countries and then conclude with some observations on _tow"I perceive the international negotiating environment to be today - the 3pportunities and the needs for a.country Jke the Philippines. I think it is timely _ince you are in the middle of reconsiderng your approach to debt, having firmly

completely by havhag the governwhile at theliberalized same time trade ment, Thus, anyone who saw the over_ valuation and realized .it could not last. :.ince unemployinent was increa:siug at extraordinary rates, also had the opportunity to avail hinlself of imports, particularly those of durables which had been tmobtainable for 20 years but have now become freely available. A story is told of a man who went to buy two washing machines and when he was asked why he was buying two, he

they loweroutinterest rates; productivity; they raise are totally of lhre with money growth; and they create a warm and happy atmosphere, But because the exchange rate inevitably collapses as the new government comes in, everybody knows that it's the year to. get out of Mexico with your assets and to get in with your imports while they are cheap. So in 1981, in the course of the last year of the presidetlcy, Me,co borrowed US $20 billion. If you.go around the.world, you will

.'_Cuidedto pay. The only question for is how much and when. These, I ahink.are very interesting issues where the mswers from the rest of the world look rery different from what may be per:eivedhere.

said that they were for his daughter's wedding Then, when he was reminded that his daughter is only l0 years old, he said that he's buying them now because he won't be able to get those things for a long time. Today, of course, he is righ.t., ltence, in Chile, the amount of imports had reached extra-ordinary levels, making its deficit five times larger than it had been in any time ir_ its recorded trade balance h.istory. Very much the same happened in Argentina. Here, the capital account had been completely liberal_ed_ Overvaluation of the exchange rate associated with inflation-fighting reached 70% in the end and everybody could freely • buy dollars in •anticipation of the collapse of the exchange rate. And of course, everybody did bu3/dollars as seen in the I_JS 530 billion capital outflow in the period 1978-82. The Argentinian Central .Bank financed it, persuading everybody or trying to persuade everybody that their exchange rate policy would last. Everybody was saying in turn - "'We believe you_ but for the moment, we park ourselves in dollars and watch it. And if it is true, we promise to come back". Of course, they .all came back alter the collapse of the exchange rate.

find that for every debtor country, there is some horrorstory that involves large overvaluation of the exchange rate in response to the domestic macroeconomics and financing of the spectacle through access to the world capital market in amounts that are totally unttsual by the standards of the 1950s or tire 1960s.

[_ackground of Debt Crisis Let me start with the background of :he debt crisis since that would help us tssesshow much burden-sharing is reasontble today. Of course, the general feeling s that there has been little burden-sharing ;o far and that there is a good basis for nuch more. There are three reasons for the current vorld debt crisis. One, the extraordinary nismanagement in the debtor countries, :he extent of which cannot be over_mphasized. It applies here as much as it loes in Latin America. Two, the world _conomy turning very adverse for debtor :ountries. Three, overlending by cornnercial banks just at the point when lebtswere already excessive, Let. me explain each of these reasons. (1) Mismanagement #z the debtor :ountries. Every debtor country has its )wn story. If you look at Chile, the story s one of gross exchange rate ov0rraluation, reaching 40-50°70 in 1979-80,

(2) 77_e worm economy becoming adverse. Just as all of these countries had loaded themselves with debt that were certainly large relative to GNP, to exports or to any beJJchmark, the world economy turned around, World growth Stopped in the aftermath of the US monetary policy changes. The US had an inflation rate of about 10%. To stop the inflation, in 1979-80, the US shifted to monetary gro_vth targets, resulting in interest rates reaching levels that were totally unprecedented in history. The federal funds rate went all the way up to 20% while normalix, it never exceeded 11%. Subsequently, the world econolny went into a recession. What does this mean to debtor countries? For any debtor country, debt service of a given debt doubled because the interest rate doubled_ At the same time, world recession and the strengthen7'

hag of the dollar meant that commodity prices declined. There were therefore less export revenues to service an increased debt service, and because both the cornmodity price decline was large and the debt service was literally doubled, the gap between the two became extraordinary, That gap was reinforced by recession in industrialized countries which slowed

make everything come out all right. The Act 2 in the debtstory is the period 1982 to 1986 or the "muddling through" strategy. Act 3 refers to what has been. happening since with Mexico, Brazil and other countries now in the queue for rescheduling and questioning the process of the last four years,

two things i.e_, the _vorld economy ha_" to be moving well and, if it does, it will solve the debt problem. That's an essential part of the ideology because otherwise, the story is all adjustment. Part of the ideology then is to say that when we look at the normal course of the world economy as of 1982, all the news seemed to be good. Why? Because

down or even reversed the growth in demand for manufactured exports from developing countries. So from the world

The Past Four

the 1982 Expectations

interest rates were at record levels; hence, by definition, they must come down. The dollar was grossly overvalued; by defini-

macroecouomic side, when a_ extraordinarily large shock affect_ export earnings and debt service, simultaneously, it opens financing gaps so large that the world capital market has to take another look. This takes me to. the third point in the origins of the debt crisis,

Let me now talk about what, in fact, has been happening over the last four years and how it compares with the expectationsof1982, The expectations of 1982 was that the debt problems were liquidity, not

tion, it must come down. Real cornmodity prices were exceptionally low; by definition, they must go up. Growth was negative; by definition, it must go up. If you look at every single one of the factors that made life terrible for a debtor m 1982, it was all at its worst level. Thus,

(3) overlending. In 1981, commercial banks lent US $54. billion to Latin

solvency problems. Actually, one doesr/_t really know whether a sovereign country

things could ori'ly get better. 1982 was therefore a wonderful year to talk about.

America for the sole purposes of sustaining overvalued exchange rates, capital flight, unreasonable import levels, and other extravagances. In 1985 commercial banks lent minus $500 million to Latin America. Thus, we have â&#x20AC;˘a complete reversal of lending that started in 1982, with the freezing of credits by banks that were suddmfly faced with very large Financing gaps. The banks that looked at customers who had previously borrowed

is insolvent or not because debt service is much, much less than GNP. If you could literally seize all the GNP, you could easily service the debt and amortize a lot of it. In fact, a single year's GNP, for some of the debtor countries, would pay off everything. Tile only problem, though, is that you cannot really take all of GNP because people have the irresisIible habit of wanting to eat. So there is a natural biological limit to debt servace

Everything would be better. Act 1.

to finance trade balance deficits would say that they think they can help but when they go around shopping for credits to the roll interest the interest as they have more been all payments plus some accustomed to do, they found that there was no money. And the moment it became clear that, indeed, there was no

vague: The solvency issue, ultimately, boils down to how much you can squeeze out of an orange and the period 198256 slaows give issue surprising and that that makesoranges the solvency a bit; amounts if you squeeze hard enough. The first step theretbre towards reaching that expectation is to pretend that it's

money, all voluntary lending stopped because nobody wanted to be the one to put in the new money that would provide the resources with which other people will be paid off. Hence, in 1982, following the Mexican moratorium, we have complete credit rationing applied to most debtor countries. Credit rationing changed the rules of the game. Then we enter into a phase of "muddling through" where the philosophy is that if for a few years, the debts can be kept alive and the countries can be helped to service debt, then over time, adjustments and the world economy will

a liquidity problem. Don't ask the solvency question because then you get too close to politics, Solvency is politics while liquidity is a management problem, specifically a capital market management problem. Declare, then, the debt problem to be a problem among the banks or the international agencies or the treasuries but keep it out of the newspapers. Above all, keep it away from politicians, In declaring it to be a liquidity problem, though, we have to have a good story. The good story is that if everything goes well, then the problem will go away by itself. Going well or all right means

Years vis-a-vis

,_'?iii. :_.-;}i-=_:i-_:-_.)(:_:i:,:@!i_:'.:i'_?:_:-:_-;_;:';!_ "_!

;.i_i! ..._;..:::.._:_:.:.:._:.._::._.._ _.-k-/'.:--",.:St _,',"..'-'-, 7,_! -,.,_..... .;.:?.:-.--_?.?-:__._'_I The second step is to say that these debt-ridden countries are poorly-managed economies where budget deficits are extravagant, exchange rates are .overvalued by unbelievable amounts, and where there is disorder, poor pubfic finance, trade repression, and capital markets that are chaotic. So why not have adjustments? In fact, simply by having fiscal and trade adjustments in the debtor countries, more realistic exchang_ rates, and orientation of the economy TM towards earning rather than spending foreign exchange, the debt problem will be solved. I

So 1982 is the year where we declare that the world economy would move well and that adjustments will take place in the debtor countries so that by 1990, the debt problem w_ld, without doubt, become totally Unnoticeable. We shall grow out of the debt problem smoothly and it would be in the interest of the debtors and the creditors to stick together in that process. The responsibility of the debtors is to make reasonable adjustments regarding the total obvious mismanagement while the responsibility of the creditors for the government is to provide a macroeconomic environment that is conducive to reducing the adverse conditions for debtors and for the cornmercial banks so that the latter can provide loans to pay whatever interest those countries in the short-term can be earning through their trade surpluses. The combination of these factors wo'uld then make debt-to-export ratios over time vanish and that's the carrot - in the end, there is a

the bad list for the third year in a row and had been up twice. Mexico was up four times and down five times. They do it by half-year. They do not really know who the next good guy is. Someone will have to come in and be very well-behaved, But certainly at that level, there is a lot of _latility from one year to the next. Countries do well mad also do very poorly,

"The responsibility of the debtors is to make reasonable adjustments regarding the total obvious mismanagement while the responsibility of the creditors provide a macroeconomic

is to envi-

ronment that is conducive to reducing the adverse conditions for debtors... "

The second reason why the debt problem didn't go smoothly towards the solution is closely related to the domestic macroeconomic impact. The expectation of everyone who recommends adjustments to others is that there is something free; that mismanagement is a blemish and all you have to do is wash your face and the dirt is off. But then, mismanagement by one is a standard of living for another, if you have a terrl"oly inefficient state enterprise, it is because life in it is really good. Now what inefficiency are you likely to eliminate? Certainly not the big ones because they are cherished by the beholders of that inefficiency. Other countries found that it is very diffi-' cult to eliminate mismanagement because it felt so good to the people who were the beneficiaries, it was very difficult to raise taxes. It was impossible to cut govern, ment spending. When suddenly faced with the need to fmance out of current revenues, 5-6 percent of GNP in foreign interest payments, governments were forced to print money.

return of voluntary lending. Since most _f the problematic debtor-countries were Catholic, it was totally essential that there be allusions to redemption and hell. Redemption, in this case, was the return

Reasons Why the 1982 Expectations Failed to Materialize

of Voluntary lending. That is held out as the motivation for going through Act 1 rather than choosing an easier way like in

Why is this so? Well, the first reason is that the world macroecononiic environ-

the 1930s which was to simply walk away from the debts and start fresh. Everybody knows that nothing happens to a debtor who does that. The argument was that, if

ment has not really delivered exactly as it was expected to do. Real commodity prices have not, in fact, recovered and that, of course, is the single most ira-

_'ou don't play in time and ff you don't collaborate, then you will not be able to return to the capital market and, hence, your long.term growth potential would be seriously impaired, With a very good story like that as to why the debt problem might well disappear within a 5-6 year period and with the motivation of a return to thc capital

portant determinant for commodity export earnings in debtor countries. Interest rates have declined, but along with a decline in interest rates, prices in world trade have fallen so much that real interest have not declined perceptively, Without a decline in real interest, rates and without very strong growth in industrialized countries, much of the macroeconomic scenario could not take

market as the carrot for the process, the train took off in an unending process of rescheduling which has been under way since 1982. But vis-a-vis this expectation, what has

place. The fact that the dollar went up for another three years rather than down as had been expected in 1982 certainly aggravated the problem. Thus, the macroeconomic predictions of 1982 did

A separate issue is that in order to service the external debt, these countries have to be earning dollars. To turn their economies from spending dollars into earning dollars meant the need to have a

CtUally happened since 19827 Well, cry year, there had been one country that did wonderfully. And every other year, that same country would fall into disgrace. Brazil, for instance, is already on

not happen in fact. Whatever contributions to solving the debt problem debtor countries made came out of making more adjustments than anticipated in exports' volume,

real depreciation of their currency. That poses a serious political problem. The mismanagement has largely benefitted upper income groups whose capital flight was being financed by the sale of dollars

mnul

_i n

And when they printed the money, there was, of course, inflation. When inflation happened, the real value of tax revenues eroded, making the situation more inflationary. The inflation eroded real money demand, indicating that any money creation would make it even more inflationary. You obviously have the story, then, of how forced debt service brought those countries to the verge of hyperinflation, as what happened in Argentina. There is no doubt that it is directly related to'the need to finance out of the strained budget a large external debt setvice. On fore, the revenues the debt flation.

the macroeconomic side, theredomestic need is to generate the and not to have taxes to finance service, money creation, or in-

Inl

nil i

Ill

DEVELOPMENT RESEARCH NEWS organized by the Central Bank and the military governments,

MARCH-APRIL 198

What is worse, of course, is that the outlook for the next five years is exactly

_ndidate gets appointed. There are two possibilities as to who the candidate is either it's a politician or it's the current planning minister.. The current planning minister is .the one who is in charge of running the economy, including the debt negotiations. He would say - would it be nice ff I were the president? So what would I have to do to become candidate? First, I have to deliver a good economy. How does one delivera good economy? We have to have growth. But if you have just started growing, you could have terrible deficit.in the .external balance; there would be capital flight;the exchange rate

The third reason why the debt problem was not automatically solvedl was market access. As debtor countries

the same. That. the only way that the debt service can in fact be assured is if investment does not take place. If you

would collapse; the price level would jump; the workers will want to have wage increases. Of course, you give the latter to

were in fact turning around their trade balance to generate the dollars with which to pay the interest, they were encountering 'problems because market access was difficult. When Mexico experienced a 35 percent growth in their manufacturing exports, they also got 195 counterveiling duty violations from the US; the same with Europe and other industrialized countries,

look at Latin America (and the same is exactly true here), the lack of investment in the public sector and in the private sector over time means a growing disparity between the sharply increasing labor force and the availability of jobs. Capital is barely being maintained. In fact, in many sectors, it is not being maintained at all. Infrastructure investmerit is not taking place. Hence, you have a growing gap between the growth requirements of the country to sustain tile entrants into the labor force and what in

them because you want to get elected. But then you get hyperinflation. And when you get hyperinflation, then you won't become the candidate since the country Willbe a mess.

fact is happening, if you do that long enough, then any attempt to generate that .growth at short notice would backfire in a very extreme way. So 1982-86 in the end metals that much of the interest was unfortunately being paid. I say urnfortunately because it means that it was being paid out of investment which deteriorates the longer term growth potential of ttJ.e debtor countries and, hence, the longer-run ability of those countries to pay.

extremely favorable external financial enviromnent. If they don't have that, then they can't even start. An extremely favorable external financial environment means that they must. have pounds of money sitting around for everybody to. see so that nobody will question their

Now in Act 2, interest has to be paid on the debt that was incurred in order to have the the dollfirs with which to finance the capital flow, While the capital was out and the workers were in, the workers were asked to take a cut in their real wages to be able .to pay the interest on the money that went out. This poses a huge political problem associated with a cut in the standard of living to finance the debt service on. a debt that was largely considered immoral,

In â&#x20AC;˘ summary, during the 1.982-86 period, the experience was. that the debtor country had, to a surpr.ising extent, in fact turned around their trade balances to earn much more than halt" of the interest that they owe. That certainly was a surprise - the ability to generate so nmch of a surplus. But the macroeconomic consequences and the social cost of those adjustments were totally out of line with what had been predicted in 1982. The predictions in 1982 was that all one has to do is to abolish mismanagement. Also, that the world economy would just have to improve the terms of trade and that would pay the bill.Neither of the two happened though. Hyperinflation, taxation and large cuts in the standard of living financed the interest payments in a world environment where the debtors' terms of trade continued deteriorating, If we look at the bottomline of debt service in the period 1982-86, Latin America showed a five percent of GNP improvement in the non-interest trade 10

balance toward surplus - from roughly balanced, it went to a 5 percent of GNP surplus to earn those dollars for debt service. There was a 5 percent of GNP decline in investment on average over that period, too. That meansthat debt service was assured by not investing.., if you don't invest for a year that's perfectly alright; if you don't invest for .two years, that's not alright but it's okay; if you don't invest for three years, that's terrible; by the fifth year, you're crazy.

The Current Situation: Country Examples '

Some

Now where do we stand today? The debt problem is a very active issue, especially in the aftermath of the Mexican negotiation. The Mexican came to their rescheduling negotiations with the statement that they have a very simple problem. In 1987, their new presidential

So then they take the politician. The Mexicans then said that it is qui,_ obvious that if they want to have a reasonable economy, they have to be able to produce growth with less in inflation than they have now. Essential to that is an

ability to hold the exchange rate and, hence, to hold the economy together. With that in mind, Mexico went to the banks and said that this is what theyÂ˘_ would like. There were initial n_sunderstand!rig on how much they like but in the course of the negotiations, particular.ly after Mexico left New York, everything became quite clear. In the end, everybody was forced to believe that it was a. good idea for Mexico because nobody really wanted to know what would finally at happen if they didn't get their deal. So Mexico got exactly the deal they wanted - favorable interest rates and very large commitments of new money aM sufficient contingencies so that the country ,,

"ylow has ended the destabilization period and could deliver the best kind of economy that the candidate could expect. From the external side, a clear link which stabilization requires are resources. If one can't get them, there's a problem, Another country that has made waves is Brazil. Brazil is a very inward-looking country. They pay more attention to their domestic stabilization program and to their inflation problems rather than to their external debt. But in the process, they turned around a current account surplus that was very massive in the first quarter of the year into a deficit. Within one year, the external cushion disappeared in the course of strong growth, Brazil therefore had to go to the official creditors and ask for new mol]ey from the commercial banks. The official message given them was for them to first drop by in Washington and get an IMF agreement â&#x20AC;˘before they go to the Paris ilSlub, In Brazil, an IMF agreement is a dirty word. Therefore, the Brazilian government said that they cannot go to the IMF but the creditor government said that they cannot go to tile Paris Club_ To which the Brazilians said "Well, that's very bad for you". There was an initial misunderstanding as to what they meant, but they actually meant it. Then, the flexibility that is always there became apparent in this case. The IMF created the so-called "enhanced contacts" and communicated to the Paris Club through a letter from the managing director that Brazil was a wonderful country which had undergone a significant stabilization and deserved all the considerations one could possibly get_ So the Paris Club rules were bent simply because Brazil had said that they would have started doing it. They have virtually invited the LDCs to come and discuss the kind of arrangement that they would like best. In the international financial market, there is a new climate. Where tradi_nally, negotiations call for a country to W_bmeon its knees to the banking cartel, the present climate indicates that this is not so anymore. Any country, for instance, may now explore the possibility to II

III

negotiate separately with Swiss banks or do a moratorium if they didn't get their way. International Financial Market The international financial market is more interesting in two -other ways. The first is that there is a very significant division between banks. First, therehas always been a significant division between regional banks and the large money banks. But now, a second division has spread to New York where on one side, there is the Citibank, also called "Rambo" bank, saying "no more Mexico" and on the other side, the other banks saying "be careful because you really don't know what would happen when you say 'no more Mexico'. If we're too unnegotiable, perhaps we shall have invited upon ourselves for the first time a debtor cartel where one of the guys might simply say "go and play in the traffic". The division in New York is now so extraordinary that banks will openly admit - "no, we are not Citibank". The third division which is also significant Is between the American banks and the

the possibility to negotiate separately with Swiss banks or with German banks instead of with all the banks together. The second point to note is the pollticalization of debt in the US Congress. The US has a trade problem since it has a Latin American sized budget deficit.Manufacturing looks at the trade balance deficit and says do something about it. People really don't know what to do. They say why should Koreaâ&#x20AC;˘ not appreciate its currency? Or maybe the Yen should go up? Or maybe we shouldn't have chickens from Europe, etc. However, part of our trade deficit is the result of our indecent anxiety to collect the commercial banks' debts. Because in doing so, we force those countries to export more and to import less from us_ So our trade deficit has as its counterpart the interest earnings of the commercial banks. With that in mind, the whole Senate Finance Committee has taken an interest in the debt. Senator Bradley has proposed a debt relief. Others came to a congressional summit where they proclaimed the debt problem and the trade problem are closely tied so it is well worth watching

European ban_s. While the dollar was steeply rising relative to European currencies, all the European banks had to make increasing reserve provisions against their dollar claims. Year after year, they had to put aside more and more Swiss francs as loan loss reserves against their dollar claims. By 1985, when they had built up a very large loan loss reserve, the dollar went down by 40 percent, making the value of thek loan loss reserve approximately equal to all their clainrs. European banks have substantially written off all the LDC loans and anything they get now is gravy. With gravy, you could be much more generous particularly ff it gives you an opportunity to rub the New York banks' nose h_ it. The Swiss banks have started doing it. They have virtually invited the LDCs to come and discuss the kind of arrangement they would like best. In the international financial market, there is new climate. Where traditionally, negotiations call for a country to come on its knees to the banking cartel, the present, climate indicates that this is not so anymore. Any country, for instance, may now explore

for new solutions, in that way, the US Congress has taken an interest in it. That means that any â&#x20AC;˘debtor country who, while firmly committed to pay, seeks for a reasonable treatment, would have a good audience. Now where are the answers going to come from? One direction is what conservative economists, i.e., our teachers from Chicago, say. Milton Friedman says that the priority of the day is for government to withdraw completely from the debt negotiations process. The government will no longer bend arms for countries to pay and with the other arm deliver the banks to put up some new money and keep this thing going. Pull out the government and immediately, the debt will fall into place. Debts will immediately be rewritten, country by country, to levels where the creditors have the best expectation to get their maximum money out. The conser-,ative view then is to say that something terrible is happening and that the government's involvement in insolvent debt collection is making a terrible mess, so pull the governments out_ This view is very, in-

III

IIlH

IIII

Ili

fluential

in the US. The other view in

macroeconomic

side, there is a bad news

and

here

comes

Congress is the Bradley proposal. In short,

in the mail and not good news,

countries

it points out that since the government is already involved in the process, let its role be amplified by linking trade and

Other

way to solve the wonderful.

debt relief and by changing regulations to make debt relief easier and, at the same time, to get trade concessions,

With the world macroeconomy out, there are other clever schemes to solve the debt problem. One is reversal of

Now neither of these two views is likely to happen but it is very important to see that the activist democrats and the most extreme conservative wing believe

capital flight. But reversal of capital flight is extremely unlikely. You will note that the Italian Finance Minister Einaudi is known to have said that capitalists have

that the debt problem now needs serious attention and a change in the rules of the game,

the legs of hares, the memories of elephants and the hearts of deer. They would be the very last to return to

Where do people see the changes then? The first is you always look at the world macroeconomy because if it did the right thing, at least you could say "hang in there and in two years, it will look different". Well, there's little expectation of that today. Nobody predicts sustained growth in the industrialized countries because everybody knows that the US will have to serve the battlefront and when they serve it, it means higher taxes, a cut in spending and a significant slow-down in growth. That slowdown in growth could be turned to advantages however if, at the same time, all the industrialized countries had a significantly easier, monetary policy that sustained growth. Then debtor countries would have the same growth, lower interest rates and everything will be well.

Possible

Schemes

and their

Implications

Mexicans did the calculation and they found that they had a 400-million dollar' debt-equity swap and a 400-miUion dollar decline in direct investment inflows because all the guys who would have come anyway went through the,

deep discounts in the secondary markets of New York, you begin to ask - Why not put the two together? Why not allow foreign investors to buy up the debts in New York, take the debts to the Central Bank, convert them into pesos and use the pesos to invest in the Plfilippines, in Brazil, in Mexico? You solve at least five problems at the same time. These countries desperately need investment

secondary market. So it is not a way olq getting extra foreign investment. It is dollars that you would have gotten otherwise, that you cotdd have used to build up reserves or to liberalize imports. These are all true issues, whether in fact you get the kind of investment you would want. So debt-equity swaps are first, rip-offs and second, quantitatively extremely unlikely to be the solution.

g4_2 89.1 86.8 99.5 .7,_ 8 "7_2 64.0 88,2 39.1 60.7 57._ "7_.g 64,1 59."7

Europe, in particular,

Bolivia Uruguay

4,0 3.6

Jamaica

3.4

interesting

warrant a change in their monetary and inflation policy. Unless they do, there is a significant possibility that from the

SEVENTEEN HEAVILY INDEBTED COUNTRIES Debt

Outstanding,

Total

(US$ Billion)

1985 Of Which

etivate Source (Percent)

Debt Service 1985 -87

Total

(tJss_ilUo.) OfWhich Interest

39_ 44.4 20.4 17.8 9.s 9.2 13.6 9.1 6.o 5_2 6,4 3.4 4.0 2.4

28.0 2q,2 12.7 7,8 4.9 5,0 4.0 3.1 _.4 3.1 2,5 2.1 1 .o, 0.9

39,3 82.1

1,6 1.4

24.0

1.3

Debt

Ratios j' 1985

(_rc_,t) DOD/ Interest/ GNP XGS 49,T 60.9 71,9 73.3 _6._ 12 6,e 44.1 22,9 tt 1.4 9"?.9 36.8 9t.S 135.4 136.3

_._ _il.l '_,_.4 |Â˘.4 12.3 4_ .9 IF2.4 1_l.1 12."7 ,7.9 16.4 _4_ 1_.4 _[4.0

0.6 0.8

121.1 72,7

43.0 21.8

0.s

238,5

_.$

TOTAL 445.9' 80.8 194.9 106.9 58.8 â&#x20AC;˘ Based on public andpubliel r g..... teeddebt: -_ Interest Debtoutstanding payments anddisbursed to exports of goods togross andnational services product (INT/XG,N) (DOD/GNP) Source:

a debt-equity swap. Any corporation that had planned to invest in the Philippines. And they are already there. They are practically stepping into the Central Bank and then there's someone screaming for them to hold it. Don't go in - we'll have a better deal for you. We'll do a trip through the New York secondary market and we'll get your pesos at a 25 percent discount. So, in the first place, there is a

equity swaps are touted as the new solutions. If you just take those countries all the debtor countries - and you look at the wonderful opportunities for investment that they have and then you look at the fact that their debts are traded at

r_,_it i07._ M,_i_o 99.o Argentina 50.8 Venezuela ,t3.6 phitippin_s24._ Chile 21.0 yugoslavia 19.6 Nigeria 19.3 _...... 14.o _,ru 13.4 Colombia 11.3 _euado, g.s Ivory Coast g.0 Ct,staRiea 4.2

Germany, sees the

It's

The second is debt-equity swaps. Debt

Country

as sufficiently

debt problem.

one-to-one offset between foreign direct investment (that would have taken place anyway) and debt-equity swaps. The

another world recession. That's bad news for the debt trap. If in the case of US fiscal correction, there was a collapse of the dollar, (and that is entirely possible), and it" that turned out to be very inflationary, as it was in 1973 and 1979, then US interest rates may well rise instead of fall. That would be reenacting 1980_2. We also have no real assurance that crisis

The,.,_

But in fact, it's a rip-off, Why? Well, look at who will be the first in line to do

countries from which they have rightly left and in some countries, you aren't quite sure you want them to come back.

However, it is very clear from the negotiation with Germany over the last year that they do not see any room for lower interest rates. Hence, there, is increasingly, an outlook of lower interest rates cyclicly but at the same time, of

debt

investment.

have a debt problem, here's a

World

Bank

(Development

and Debt

Service)

23,5

DEVELOPMENT RESEARCH NEWS

MARCH-APRIL 198

.=.=,Dn^T=. o,,s

CREDIT IN THE PHILIPPINES: THE SHORT-RUN EFFECTS OF INTEREST RATE DEREGULATION (Continued"frompa0e 12} Well, where does it leave you? It leaves you to the third scheme which is the direct confrontation with the

ant Professor, Ohio State University lforkingPaper Series No. 87-02

MACROECONOMIC ADJUSTMENT IN THE PHILIPPINES,

creditors or to where the debt problem in the end, always is. I11the end, the debt problem always meets the Central Banker at night when he searches his soul and says "Can I do the unspeakable? Can I confror_t the creditors with the fact? " And

The study analyzes the agricultural credit scene existing in the Philippines in

Manuel F. Montes

1984 at the time of major interest rate deregulation. The focus is on the mstitu-

VisithzgResearch Fellow Philippine Institute .for Development

normally, they turn around and say "I can't; it's unbearable". But in the 1930s,

tional costs of lending to agriculture and the immediate effects of deregulation on

Studies lÂ˘orkingPapersSeriesNo.

every developing country and most European countries did it and ha most debt crisis in the last 10,000 years, debtors have always done it_ I thiniÂ˘ that Brazil has much motivation to do exactly

these various costs. The frames of reference used in the analysis of these lending costs are the costs of lending to nonagricultural sectors and similar studies done in certain countries. There is also

This current study looks into the most recent balance of payments crisis in the Philippines which started in October 1983. A lengthy discussion is made on the main macroeconometric features of

ihat and on the home front, everybody _elieves that a very generous debt settlement in terms of interest rates and new

some discussion on banks' return from lending activities and cross-country cornparisons of lendiug costs,

the economy with a follow-up account of the adjustment program implemented from 1983 till 1985. An assessment of

money is the minimum reasonable, Argentina has an election, and the government has been served notice from the opposition that if they pay too much, there would be no end of talking about it everyday in every newspaper. Hence, the Argentinian government is "hyperinterested" that they should get a very reasonable settlement so that debt is not the Ifelection but the rather stabihzation. you go issue around world, there is a

Irma C. Corales and Carlos E. Cuevas Respectively, Deputy Executive Director, Technical Board for Agricultural Credit (TBAC), and Assist-

tural development and that more substantial reforms in the agricultural environment (e.g., promotion of rural employment, land reform, liberalization efforts) would be necessary for the rural economy to develop and grow, and subsequently, for the rural finance sector to expand and thrive.

RURAL FINANCIAL MARKET: A REVIEW OF LITERATURE Mario B. Lamberte and Joseph Lira Respectively, Research Fellow, Philippine Institute for Development Studies; and Assistant Professor, U.P. School of'Economics StaffPaper Series No. 87-02

1983-85

87-01

the adjustment program is provided in some detail and policy alternatives to the actual program are suggested towards the end of the paper.

ON GOING PROJECTS JOINT PIDS-OSU RESEARCH P R 0 J ECT 0 N R UR AL

lot of countries. What is different from

The paper surveys existing literature

two or three years ago? Well, then everybody could say - maybe if we make the adjustments which we have to make anyway, things will be all right. All these adjustments have been made and things are not all right. But now there are two pluses for a different debt strategy: one, the division of banks, and two, the fact that debt has now become a completely political issue. Therefore, a conservative

and research studies on the issues of rural finance. Moreover, the paper reviews the various schools of thought in the area of rural finance. The old and new approaches, including the "surplus school", are analyzed in some detail. The macro environment and institutional

The Institute, together with the Ohio State University, is conducting a collaborative research on Rural Finance. The joint research aims to analyze the comparative performance of banks operating in the rural areas of the Philippines.

framework affecting rural fimancial markets are discussed, and the previou._ government's credit subsidy programs (in

Several studies which use similar methodologies are envisioned to comprise the program. The lead person represent-

_asonable program of debt relief written ry a country unilaterally would now have "a lot more support and would be much

particular, the Masagana 99 program) are evaluated. A section on policy recommendations

ing PIDS in this effort is Dr. Mario Lamberte while OSU will be represented by Dr. Richard L. Meyer, Professor at the

and agenda for future research is devoted

University.

more negotiable, Thank you very much. IIIIIII

by the Itauthors towards of the study. contends that the creditendsubsidies I

IIIII

IIIIIII

FINANCE

(Continuedon page 16) IIIII

III

DEVELOPMENT

::IESEAF/CH NEWS

MARCH-APRIL

198;

PIDS STAFF PAPERS 1.

S.P. #8201

S.P. #8202

S.P. #8203

S.P. #8204

S.P. #8205

S.P. #8301

S.P. #8302

S.P. #8303

S.P. #830,1

10.

S,P. #8305

11.

S.P. #8401

12.

S.P. #8402

13.

S.P. #8403

14.

S.P. #8404

15.

S.P. #8405

16.

S.P. #8406

l 7.

S.P. #8407

18,

S.P. # 8501

An Analysis of Fertilizer in the Philippines. Cristina C David and Arsenio M. BalisaearL (Printed also in J. P.D. 1981). Credit and Price Policies in

turing. A Short Medulla.

Empirical

Note.

Erlinda

19.

S.P. #8502

20.

S.P. #8503

Shadow Prices of Goods and Resources in the Philippines: An Assessment.lz'rlinda M. Medalla An Analysis of the Behavior of the Commercial

21.

S.P. #8504

Methodology for Measuring Protection and Comparative Advantage. Erlinda M. Medulla and John 1t. Power.

Banks. Marie B. Lamberte. Exchange Rate Fle_bility and Intervention Policy in the Philippines. 1973-1981. Filologo Pante, ,11,

22.

S.P. #8505

23.

S.P. #8506

Food, Fuel and Urbanization in the Philippines. Alejandro N. Herrin. Manuel F, Mantes, Rodolfo F. Florentine. Rural Development Experience: Economic Per-

24.

S.P. # 8507

spectives. RobertE. EvensorL Financial Liberalization and the Internal

Philippine

culture. Oistina C David. Government Policies and Farm Meehmaizatiort in the Philippines. Cristina C David.

On the Use of the DRC Criterion Projects. Erlinda M, Medalla. Monetary

Aggregates

and

A Decomposition Analysis of Philippine Export and Import Performance, 1974-1982. Ponciano

Agri-

S. Intal, _JL Philippine Export and Terms of Trade lity, 1965-1982. Ponciano S. Intal. Jr:

in Selecting

Economic

Activity.

ture of

Marie R. Lamberte. Effective Protection Rates and Internal Indirect Taxes in the Philippine Setting. Rosario G. Manasan. R,:sponse to Balance of PaymentsCrisis in the 1970s, Korea and the Philippines. John H. Power. A Study Of Philippine Real Property Cayetano IV. Paderanga, Jr. Public Enterprise in the Philippines A Definitional and Taxonomical Rosario G. Manasan.

the

Capital

Markets:

lnstabi-

Strut-

The Philippine

Case. Marie B. Lambert_

Taxation.

25.

S.P, #8508

26.

S.P. #8509

27.

S.P. #8601

28.

S.P. #:8602

29.

S.P. #8603

30.

S.P. #8701

in 1982: Exercise.

Estimating the Shadow Exchange Rate, the Shadow Wage Rate and the Social Rate of Discount for the Philippines. lZ_rlinda M. Medulla. Developm_mt Finance and State Banking: A Survey of Experience. Edita A. Tan. Derived Protection for Nontraded Primary Product. Erlinda M. Medal& Modelling the Effects of Devaluation on Prices, Output and the Trade Balance: The Philippine Experience. M_ Cecilia Gonzales. The Development Bank of the Philippines and the Financial Crisis, A Descriptive Analysis. Marie B, Lamberte.

31.

S.P. # 8702

32.

S.P. #8703

The Protection Structure, Resource Flows and the Capital.labor Ratio in Philippine Manufac-

The Rural Banking

System:

Need for Reforms.

Marie B. Lamberte. Social Adequacy and Economic Effects of Social Security: The Philippine CaSe: Marie B. Lamberte. Impact of BOI Ineentives on Rate of Return, Factor Prices and Relative Factor Use: A Comparative Analysis of Incentives Under the Omnibus Investments Code of 1981 (P.D. 1789) and the Investment Incentive Policy Act (B.P. 391). Roi_ario G. Manasan. Financial Reforms and Balance-of-Payments Crisis: The Case of the Philippines. Eli Remolena and Marie Lamberte. A Macroeconomic Overview of Public Enterprises in the Philippines, 1975d984. Rosario G. Ma_zasan. Revenue Performance of National Government Taxes, 1975-1985. Rosario G. Manamn and Rosario G. Querubin. Rural Financial Markets: A Review of Literature. Marie B. Lamberte and Joseph Lira. Residential Demand for Electricity and Pricing Policy Implication in a Developing Economy: The Case of the Philippines. cisco,

Clodualdo

R. Fran-

OTHER PUBLICATIONS 1,

[_du_trial Promotion Policies in the Philippines Romeo Bau tista, John Power and Associates

P125.00

Survey of Philippine

Development

Research I

P30.00

Survey of Philippine

Development

Research II

P30.00

4. 5.

Summaries of Completed Research Projects, Vol. ! Integration, Participation and Effectiveness: An Analysis of the Operations and Effects of Five

Rural Health Delivery Mechanisms L edivina Cari_ o and A ssocia tes Essays in Development Economies in Honor of Harry T, Oshima

The Spatial and Urban Dimensions of Developmeat in the Philippines Emesto Pernia, Cayetano W Paderanga, Victorina Hermosa and Associates i

el lUll

Energy and Structural Change in the Asia-Pacific Region (Papers and Proceedings of the Thkteen

P20.00 10. P25.00

Pacific Trade and Development

Philippine Employment

11.

P125.00 12.

Conferele, e)

in the Seventies

P75.00

Rosa Linda P. Tidalgo and Emmanuel F. Esguerr_L Economic Recovery and Long-Run Growth: Agenda For Reforms Volume (Main Report) Florian A. Alburo, et al.

P50.O0 (Paperbound)

P200.00

PS0.00

Economic Recovery and Long-Run Growth: Review of the First Eleven Months of the Aquino Government

P30,O0

Dante B, Canlas, et al. Analysis of the Institutional F_amework of the Philippine Short-Term Financial Markets Victoria S. Licuanan I

P56.00

DEVELOPMENT

RESEARC.q NEWS

MARCH-APRIL

198"i

PIDS WORKING PAPERS 1. W.P. #8301

W.P. #8302

3. W.P. # 8303

Studies on the Wood-Based Furniture, Leather Products and Footwear Manufacturing Indus. tries in the Philippines, Niceto Poblador, Adria.

14.

W.P. #8405

Populatinn Pressure, Migration and Markets; hnpfications for Upland Development. Ma Concepcion C1_z.

no Solis, Roy

15.

W.P. #8406

Tenure,

16.

W,P. #8407

forestry Schemes. Ana Doris Capistrano and Sam Fujisaka. Environmental Effects of Watershed Modifi-

and

17.

W.P. #8408

The Impact of Government Policies on Philippine Sugar. GeraM Nelson and Mercedita Agcaoili_

18,

W.P. #8409

Galvez, Workshop Papers on "The Consequences of Small Rice Farm Mechanization in the Philip-

Comparative Advantage and Government Price Intervention Policies in Forestry. John 1t. Power" and Teresita Tumaneng.

19.

W.P. #8501

pines." A _Revicw of Welfare Sylvia N, Guerrero.

20.

W.P. # 8502

Financing the Budget Deficit in the Philippines. Eli M. RemoloncL

21.

W.P. #8601

Trade

Yba_ez,

Economic Policies Cristina C, David. Changing

and BienvenMo

and

Comparative

Phifippine

Advantage

Rice Production. Laurian ArsenioM. Balisacapt 4,

W.P. #8304

W.P, #8305

Government Expenditures Policies in the Philippines

Aragon. Agriculture

in Philippine Unnevehr

W.P. # 8306

W.P. #8307

W.P. #8308

W.P. #8309

Economic Incentives and vantage in the Philippine A rsenio Balisacan.

10.

W.P. #8401

lntersectoral Capital Flows and Balanced AgroIndustrial Development in the Philippines.

cations.

and Agricultural 1955-1980. Manuel

& ÂŁ deLeorL Economic Incentives and Comparative Advantag e in the Livestock Industry. Liborio S.

22.

W.P. #8602

An Analysis of the Economic Policies Affecting the Philippine Coconut Industry. Ramon

ManuelS.

of Agro-

and Cost of Watershed ReforestPantabangan and Magat, Jose A.

Liberalization

Integrated

in the Coconut

Experience

Florian

Summary

in the

Alburo

Reporl:

Industry,

Philip-

and Geoffi-ey

Population

Pres-

sure and Migration - Implications for Upland Development. 3fa. Co_zc(,l_cion .[. Cluz.

Roumasset.

23.

W.P, #8603

Comparative AdCotton Industry.

J. deLeort

and Productivity

Wilfredo P, David.

Management ation: The

pines, 1960-84. ShephercL

Cabanilla.

ClareteandJ.

Technology

Factors

Affecting

Survey of Philippines. M. Pernia,

the Choice

of Location:

Foreign and tx_cal Firms in the Ale]andro N_ Herrin and Ernesto

24.

W.P. #8701

Macroeconomic Adjustment 1983-85. Manuel1;'. Monte,_

25.

W.P. #8702

Costs of Agricultural Credit in the Philippines: The Short-Run Effects of Interest Rate De-

11.

W.P. #8402

Forest Land Management in the Context of National Land Use. Adolfo V. Rel, illa, .h'.

12.

W.P. #8403

Policy Issues on Commercial Forest Managemerit. Cerenilla A. Cruz and Marian Segura. delos Angeles;

26.

W.P. #8703

Can the Informal Leaders Be Co-Opted into Government Credit Programs? Emmanuel F. Esguerra,

13.

W.P. #8404

The Impact of Government Policies on Foresl Resources Utilization. Gerald C. Nelson.

27.

W.P. #8704

Comparative Bank Study: Mario B. Lambert_

! 3.

Asenda for Action for the Philippin e Rural Seetol_ (blai a Report). Agricultural

14,

P230.00

and _rategY Team, â&#x20AC;˘ _ksen_la for Actioa fef the Philippine Rural Sector: A Se_a_ry. Agr_itural Policy and Strategy Team

PlS.00 P18.00

16.

Monowtaph No. 111: Economic Evaluation of the Philippine Alco811t and Coco-Diesel Programs Arnmndo Armas and Denise Joyce Cryde

l_0.00

Monograph No. IV: A Survey of Materials

P32.00

Education

Monosraph

Irma

C. Corales

and

Carlos

A Background

No. V: Modelling the Impact of Small

19.

20.

21.

[,4 co.publication venture(IRRI) with ] the International Rice Research institute Monograph No. Vh Philippine Poverty: An Annotated ilibliogfaphy, 1970-1983 [A co.publication venture with the Institute Philippine Culture] Monograph No. VII: Public Policy and the Philippine Housing Market Edna Angeles Journal of Philippine Developmmat (1981, 1982, 1983, 1984, 1986, 1987)

P35.00

P45.00

of P40.O0

P40.00 per copy P75.00 ann_ subscription

Paper.

Farm Mechanization

Monograph No. 11: Industrial Policy and Deveiopmeat in the ASEAN Countries Romeo Bautista

in Introductory Economic Gerardo P. Sicat

18.

Policy

15,

17.

regulation. Cuevas;

in the Philippines:

SEMINAR ON METHODOLOGIES IN THE MEASUREMENT OF THE IMPACT EFFECTS OF THE TARIFF REFORM PROGRAM (TRP)

(Continued from oago 13) PROGRAM OF RESEARCH ON INF O RMAL CREDIT MARKETS IN THE PHILIPPINES

This research program makes an indepth analysis of a wide range of issues related to informal credit markets (ICMs)

A seminar on the methodologies employed in the measurement of the impact effects of the Tariff Reform Program (TRP) is the third in a series of

in the Philippines. Specifically, it provides an estimate of the size and trends of size of ICMs, both rural - and urban - based

seminars on the PIDS-Tariff Commission Joint Research Study on Trade Liberalization. The seminar was held at the

examines their sources and uses of funds, allocative functions, structure and determinants of interest rates, default rates

Operations Room of the NEDA sa Makati Building. Held last March 6, 1987, the seminar highlighted the important

financial instruments used, and their hnkages with the tbrmal credit markets. Attempts will be made to gather data from both lenders and borrowers in ICMs. The program is broken down into five research topics: (1) monetary and credit policies and the bank's response to the challenge of informal money lenders; (2) the overall scope of the informal credit marketsin the urbancredit sector; (3) the response of the informal market to

findings of the paper by Dr. Erlinda Medalla, Research Fellow at the PIDS, entitled "Impact Effects of the Tariff Reform Programs"; the paper by Ms. Theresa Quintos of the Tariff Cornmission on "Effective Protection Rate Methodology"; and the paper by Mr. Noli Mabida of the Tariff Commission on "Impact Effects of the Tariff Reform Program - Methodology". Comments

new market opportunities: a case history of the overseas employment boom; (4)

were heard from the representatives of NEDA and the U.P. School of Economics.

interaction of the informal and formal credit markets in the development of the rural sector: comparative case histories of traditional and cash crops; and (5) market conditions within the informal credit market and linkages to the formal credit market, with specific reference to the design for a system of economic monitoring of ICMs. The results of the first four research topics shall serve as inputs in designing, the monitoring system. DEVELOPMENT

RESEARCH

NEWS

(DRN)

SEMINAR ON THE EFFECTS OF TARIFF REFORM AND IMPORT LIBERALIZATION ON SELECTED PHILIPPINE INDUSTRIES

Tan's paper on "A Comparative Study o_ the Home Appliance industry"; Fita Mercado's paper on "A Study of the Effects of Tariff Reform and Import Liberahzation on the Paper Industry"; Virgie Pineda's study on "The Effects of Tariff Reform and Import Liberalization on the Paper Industry"; and finally, Cecille Mirabueno's paper on "The Effects of Tariff Reform and Import Liberalization on the Flour and FlourBased Products Industry." Representatires from the Philippine Chamber of Commerce and Industry, the U.P. School of Economics and other industry agencies attended the seminar. CONSULTATIVE ON ASEAN TRADE TION

MEETING COOPERA-

The Institute, together with the NEDA and the Philippine Council for Asean Corporation-Technical Board for Agricultural Credit (PCAC-TBAC), held a consultative meeting on ASEAN Trade Cooperation last April 20, 1987 at the_ Operations Room ofNEDA Makati Building. Specifically, the meeting discussed the proposal of Dr. Seiji Naya, Director of the East-West Resource Systems institute and Professor of Economics at the

The last in a series of PIDS-Tariff Commission seminars on trade liberalization and tariff reform focused on individual industry studies. Held last March 13,

University of Hawaii, as contained in his report entitled "Toward the Establishment of an ASEAN Trade Area". The meeting was convened in order to generate constructive views and ideas on the future of ASEAN trade cooperation which shall serve as inputs into the final Philippine position on the subject for

1987. at the NEDA Makati Operations Room, the seminar highlighted Elizabeth

the ASEAN Summit scheduled cenaber 14-16, 1987 in Manila.

is a bi*monthly

publication

of the

PHILIPPINE

INSTITUTE

FOR

DEVELOPMENT

STIgDIES

on.. De(PIDS).

It highlightsfindings and recommendations from PIDS-sponsoredresearchersor related studies done by other institutions. PIDSseminars,publications, ongoingand forthcomingprojects which are of interest to policymakers,planners,administratorsand researchersare also announ_d. PIDS is a non-stock, non-profit governmentresearch institution engagedin long-termpolicy-oriented research. This publication is part ,of the Institute's programto disseminateinformation to promote the utilization of researchFindings. ,. The views and opinions published here are those of the authors and do not necesserflyreflect those of the Institute. Inquiriesregardlhgany of the studies or PIDS paperscontained in this publication, as wellas suggestionsand commentsare welcome.Pleaseaddressall eorresponfle_,' ' or inquiries to: RESEARCH

INFORMATION

PHILIPPINES ROOM $15,

INSTITUTE FOR NEDA SA MAKATI

106 AMORSOLO STREET, MAKATI, METRO MANILA

DEPARTMENT DEVELOPMENT BUILDING

LEGASPI

(KID) STUDIES

(PIDS)

VILLAGE,

Re-enteredas secondclass mail at the MakatiCentralPostOfficeon April 27, 1987.Private firmsand individualsare chargedfor delivvlylandmarling servicesat an annualrate of P50.00. Students,hbraries,academicandresearchinstitutions are chargedat an annualrateof P40.00.Far foreignsubscribers,the annualrateis $12.00. ":_ 16

IIIII

IRU I