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Craxi Bettino - 7 luglio 1990



(Provisional Draft - This document represents a synthesis of the general report now under editing)


Introduction and main suggestion


The great challenge


Debt crisis and underdevelopment


Debt, rich countries and poor countries


The origins and factors of the crisis


Structural analysis of the debt issue and the economic factors of new growth


Quantitative parametres


The factors of international and domestic policy for overcoming the debt crisis


The ways out


The techniques for reducing the debt burden


Debt to equity swap


Debt to debt conversion




Development finance. New money, new regional common markets


Development finance


New Money


New regional common markets


Debt reduction vis a vis commercial banks and official creditors


The Brady plan


Debt remission with official creditors


Suggestions for regional areas and for groups of countries


Mediterranean Africa and Subsahara


Latin America and Caribbeans


East European Countries


Debt alleviation strategy by different group of countries



1. The debt often places a heavy burden on many developing countries and seriously hinders their economic and social growth. Hence the need to continue on the road already entered by the Seven in their previous Summits - namely Toronto and Paris - in order to make the required financial effort compatible with payment capacity so as to lay the foundation for future development.

The recommendations are based on the current situation and as an extension of the policies already adopted in order to ease the debt burden of developing countries.

2. The main guidelines of such policies are:

1) The problem, from the point of view of the countries where the debt burden is concentrated, it is systemic and should be faced in a systemic way calling upon all kind of creditors, i.e. not only commercial banks, but also Governments and multilateral institutions and all the institutions which may provide new finance or assist its supply.

2) Brady plan, a courageous program in the right direction must be reinforced through additional means and through a coordinated management under an agency or ad hoc committee within the IFI: to which - in each "great region" - the interested regional development banks should be added.

Regional common market areas - following President's Bush proposal for USA and Mexico - to be extended to Latin America and Carribbeans and Canada should be considered in this frame.

3) Alleviation of bilateral debt burden, in line with Toronto and Paris decisions, according to the different levels of development and of indebtedness of the countries concerned, through rescheduling of all that debt over the long term (30 to 40 years), applying concessional interest rate differentiated according to the different groups of countries.

4) Cancellation of ODA loans service for poorest countries (IDA-only).

5) Conversion of part of service of bilateral debt in local currency indexed to be invested in development, environmental and human resource projects.

6) Definition of a new "intermediate" group of countries, to which it would be granted concessional restructuring along Toronto lines and concessional multilateral finance.

7) Commitment to assure an adequate flow of public and private resources to developing countries - in favour of asian, latin american and african LDC - in order to create the conditions for future development. The objective of 0,7 % of GNP for official development assistance on the part of industrialized countries, which has been reasserted by the Ministerial Council of DAC of 14. 5th 1990 deserves confirmation as a policy goal by the Group of Seven.

8) Ratification of the case by case approach and of the distinction between various categories of loans: official debt (aid loans; publicly guaranteed loans; loans by multilateral financial institutions); private debt. In this context, the principle that loans by international institutions should preserve their "privileged" status is reaffirmed. However their concessional facilities should be reinforced.

9) Necessity for developing countries - including East European Countries to adopt rigorous domestic adjustment policies to be agreed with multilateral financial institutions. Such adjustment policies should be selective in their approach, aimed at promoting growth and, most especially, at protecting the underprivileged segments of the population.

10) Need to obtain - through appropriate incentives and coordination - more active support from the commercial banks for the "strengthened debt strategy", to further reduce interests on private debt; tax and accounting improvements in the industrialized countries for banks engaged in debt reduction and new finance. The increase of IFI's resources available for the funding of facilities on interest and for "bridging" transactions is considered. This could be also done through SDR credited to the industrial countries, employed by them to finance funds to be engaged in the Brady plan, as suggested by President Mitterrand.

11) In many indebted countries already endowed with an industrial infrastructure and plant of their own and/or rich in natural resources, further encouragement should be given to "swap" operations through the creation of joint ventures with public enterprises and through foreign capitals taking an equity share in privatized government-owned companies, and to B.O.T. (Build Operate and Transfer) and B.T.O. (Build Transfer and Operate) transactions and commodity bonds. Public insurance should allowed for these formulas. Such innovative solutions as the "debt-equity-service-swap" should also be considered.

12) Particular recognition must be given to the special financial effort needed in the case of Eastern European countries, in order to help them make the transition to market economy as quick and encompassing as possible without serious social unrest. In order to reduce accrued debt, long term reschedulings at concessional terms for public loans are considered. For private loans, it is envisaged the implementation of the "strengthened debt strategy", with particular emphasis to "debt-equity swaps" transactions and the creation of joint ventures: in the frame of the de-bureaucratization of these economies private rather than public debt should be supplied in the "new money" policy.

3. The costs for the public Budgets of the concessions on bilateral debt should not exceed the 0,1% of the GDP of the industrialized countries; in this way therefore, official development assistance of developed countries would raise from 0,35 to 0,45 of their GDP.

Special importance should moreover be granted to the creation and strengthening of Regional Banks.

After the recent creation of EBRD promoted by the EEC a new bank of the Mediterranean - also under consideration the EEC commission - is to be considered. Its institutional goal would be the economic development od an area based with problems of political instability and very rapid population growth.







1. Why the Debt Problem Concerns Us All

It is often said that the problem of developing countries is by now only their own problem, and no longer a matter of concern for the economies of industrial countries, since the crisis of the international banking system - thanks to the considerable provisioning made against those debts - is no longer a real threat.

As already remarked, the Third World debt is an issue of national security. Issued like drug trafficking, immigration from countries with a heavy debt burden and which are not able to grow, the environmental challenge, trade imbalances and the relevant obstacles to trade liberalization, plus political instability are exacerbated by the outstanding and aggravated debt paralysis.

The delicate situation faced by the big multinational financial institutions (the World Bank and the International Monetary Fund) should be a common concern, due to the debt crisis of developing and East European countries.

The World Bank funding comes from the securities it issues on the market, and whose amount is a multiple of its capital.

An increasing par of World Bank loans are lent to indebted countries and not allocated for investments; they are used by indebted countries to meet their debt service obligations. Their name is SAK (Structural Adjustment Lending).

New loans to indebted countries can be a trap, and the way out can be hard to find without a concerted action involving each party. If the World Bank issues new loans, its global risks increase, but if it does not issue them the situation of its debtors gets worse. Hence, it is not fulfilling its tasks, and the risks that its outstanding debts will not be paid back increases.

While industrial countries no longer need loans from the International Monetary Fund to carry out their adjustment programs, the quota of the loans it grants to developing countries, Southern and Eastern Europe is increasing.

As in the case of the World Bank, its loans are often granted to correct the inability to pay back old loans. Maybe the point has been exaggerated, but it shows how once again - failure to solve the debt problem affect creditors and industrialized countries alike.

On the other hand, some of the countries oppressed such a high debt that they can hardly survive and are on the verge of collapse, will not pay. Nor can they meet recovery requirements. Therefore, the Fund cannot complete their adjustments programmes. Those countries are excluded from the international financing mechanisms (export insurance by different industrial countries, private external debt, etc.) and their situation is getting worse.

The recent increase of IMF quotas has been justified by the Group of Seven as a way to provide LDCs with financial resources and to give them relief from their debt burden. It is desirable that said suggestion will be followed; but it has to be noted that the Fund's role in the debt crisis of the South and now the East will be undermined without appropriate concessional finance, such as for instance a specific issue of SDRs credited to industrial countries to offset their credits into a special fund to bring about debt relief. Lenders of last resort can play this role if they do have a monetary power - a superior seignorage - of last resort.

By reviewing all the relations interconnected with the debt of LDCs, it is self-evident that the issue is of great concern not just for debtors. It is a matter that affects us all, and which is likely to lead industrialized countries and the multilateral financial institutions they have set up - and for the most part manage - towards a "blind alley" since there is no will to launch either new financial initiatives or joint actions, at a time when "peace dividends" can be more higher.

2. The imbalance between the rich and the poor in the world.

The debt problem under scrutiny is not a normal issue of relations between creditors and debtors, but rather a problem of confrontation between lucky and unlucky human beings. There are 800 million people on one hand and 4 billion on the other; of the latter, nearly one billion run the risk of being oppressed by the debt burden. Almost 70 % of the world income is produced and consumed by 15 % of the total population. Third world countries, with a population accounting for 76 % of the total, enjoy less than 20 % of the world total income. Among Third World countries, poor countries have only 5.6 % of the global income, with more than half of the total population.

While the per capita income of poor countries in the Third World amounted in 1987 to $ 290, in industrialized countries with market economy was $ 14,500, that is to say 50 times.

While the daily calory intake in poor countries in Africa, Asia and South America is of 2,385 (it was less than 2,000 in 1965!), in industrial countries it is 3,375.

In 1987, an Ethiopian could rely on $ 130, while a Swiss had over $ 21,000, more than 150 times his purchasing power.

Life expectancy in the 42 countries with a $ 280 per capita income is only 54 years, but falls to 47 in Ethiopia and many other countries in black Africa and to 41-42 in Sierra Leone and Guinea. Rich Western countries have a life expectancy of 77 years. While in the USA only 7 newborn babies out of 100 are underweight, in Nigeria there is 1 in 4, and in India 1 in 3.

Out of 100,000 inhabitants, maternal mortality is 9 in the USA 1,500 in Nigeria and 500 in India!

Infant mortality rate is 7.6 % in low-income countries, 1% in industrialized countries and 0.7 % in Switzerland, i.e. one tenth!

Actually, in poor developing or underdeveloped countries there is only one doctor every 5,400 inhabitants, while industrialized countries there is one for every 470.

Owing to their low level of economic growth, developing countries look like dwarfs if compared to the giants of world trade: the industrialized countries and the multinational companies.

Out of a total amount of $ 2,390 billion exports and $ 2,478 imports (tax evasion plus avoidance of currency regulations largely account for the higher amount of exports against imports), Sub-Saharan countries exported in 1987 a total of $ 28 billion and imported for $ 32 billion, with a population of 440 billion: only 1,5% of the industrialized countries foreign trade. Given 100 as the terms of trade in 1980, no wonder that in 1987 the figure was 84% in Sub-Saharan Africa and 97% in industrialized countries.

Total foreign trade of Latin America and the Caribbean - among medium income countries and with a total population of 400 million - was in 1987 4% of the industrialized countries' foreign trade. The terms of trade were in that region positively 76% of 1989 levels, with a $ 25 billion surplus for rich countries, not a high figure for them but a huge amount for Latin America and the Caribbean, whose overall gross investments totaled $ 130 billion in 1980.

It cannot be denied that developing countries' economies and foreign trade - particularly in the case of the poorest countries in Africa and Latin America - depend on industrialized countries.

Such dependence becomes more visible in considering that they mainly import finished products and high technology, while their exports largely consist of commodities and raw materials.

The huge aggregate income and trade gap between the economies of industrialized countries and those of underdeveloped countries is such that the decisions (or non-decisions) implemented in the former affect the latter, which are unable to exert any significant influence.

Concerning the indebtedness of developing countries, an extremely important role is played by the real interest rate, which is determined in industrialized countries and which was remarkably modified in the '80s as compared to previous decades. The long run interest rate of the seven major industrialized countries never exceeded 4% during all the decades following World War II, and often dropped close to zero level, or was indeed negative. In the first half of the '80s, real interest rates exceeded 5% and, especially in the United States and Great Britain, even rocketed above 10%. This was due to the restrictive monetary policies adopted by many industrialized countries to make up for policy shortcomings. For some of them, it was also the result of deliberate deflation-related choices, aimed at bringing down real wages at the cost of unemployment.

Income policy - as was the case in Sweden and for some time in Italy - could have avoided unemployment through adjustments aimed at curbing wage irrationalities in industrialized countries. Yet monetary policies prevailed either for a deliberate decision or for lack of any decision whatsoever.

According to the OECD, in the period following the first half of the '80s, the high level of real interest rates was due to the persistence of budgets deficits in some important industrialized countries.

Among the causes leading to a rise in interest rates, the OECD states that there were a savings drop in industrialized countries (which is a fact) plus a rise in investments return, due to an improved productivity that led them to invest, even if money was tight.

These events are taking place in industrialized countries, but they affect the scarce amount of capital, investments and products of developing countries, which can exert no considerable influence.

The fact that indebted countries borrowed from banks at variable interest rates on international markets, thus paying a 1-2 point differential against the ordinary rate, bears witness to the above.



1. The Causes of the Wild Debt Growth, Responsibilities and Mistakes of Industrialized countries. Responsibilities and Mistakes in Developing Countries.

The total debt figure of developing countries has now reached astonishing levels, with a rapid growth between 1980 and 1990.

IMF data show a debt level currently approaching $ 1.2 trillion, while World Bank says it stands at 1.15, and 1990 projections indicate a 1.246.

The total amount was 600 billions in the early '80s.

Equally rapid was the rise in the level of debt servicing and principal payments: the figure went from 90 billions in 1980 to the current 160, with an estimated 175 for 1990.

The problem of external debt is mostly a problem of public debt confronting less developed countries, and is related to the budget deficit of the overall public sector (i.e., including the financial results of public companies, often making losses owing to management failures).

Public investments were not necessarily connected with that debt.

Their product had in any case to be compared with the debt cost and, since the agreed interest rate was in most cases variable, its rapid unexpected rise made several projects uneconomic.

Public debt was often used in projects having a very low profitability, which would not have happened - or at least not to the same extent - if said investments had been made not by a bureaucratic state economy financed with state certificates, but through specific financial operations carried out by private or public companies with budget constraints and capital autonomy and responsibility. Low productivity was partly due to wrong economic systems, based on an imitation of the collectivistic models of the USSR, Cuba, China, etc. and on a bureaucratic planning that, through artificial ceilings and food subsidies, was giving priority to the urban population and providing incentives for urbanization at the expense of rural dwellers and of private agriculture, frequently replaced by detrimental experiments of forced settlements and by the leading role of cooperatives, which were in practice state companies.

Furthermore, such external debt was often used to finance balance of payment deficits, caused both by public sector budget deficits and by the decline of raw material prices, which many countries regarded as only temporary.

Thus, the prime cause of the abnormal growth of the external debt of less developed countries lies in the lack of an international fiscal and monetary constitution: No rule has been established on the possible issuing of international public debt through the anomalous form of bank credit, or with the risky instruments of interest rates that vary with the interest rates of currencies having fluctuating exchange rates.

Such conduct became increasingly generalized in the '70s, essentially because banks operating on the Eurodollar and foreign exchange markets found themselves glutted with petrodollars, which they wanted to invest at any rate.

The result was a hectic lending rush by banks of industrialized countries, pushed by their enormous liquidities to invest, by the very good terms they could get by granting loans at variable interest rates, and by the absent role of domestic supervisors, whom they regarded as last resort guarantors. Bank managers did not operate with long term views since they were mainly concerned with presenting positive balance sheets in the short term.

A symmetric attitude could be found in those governments running into debts in search of immediate relief and thus passing the problem into those who will later take up their post.

Large public expenditure was and still is accompanied by low fiscal pressure because bureaucrats and wealthy classes who dominate the economy are strong enough to prevent the introduction of important taxes on estates and on the wide consumption of (mainly) imported goods; another reason is that a collectivistic economic planning and a system of restraints strongly reduce the total taxable incomes of entrepreneurs and real estate owners, without generating a corresponding and generalized wealth increase for all the people at large, which would have led to an increased tax yield. The superficial imitation of the tax systems of highly industrialized countries, compounded by corruption, produce tax evasion and fiscal inefficiency.

The high population growth rate combined with the erosion of savings caused by public deficit and led to strong borrowing pressure and consequent indebtedness.

To all the countries currently indebted, ample guarantees were given by public insurance bodies in industrial countries, anxious as they were to get profitable orders and contracts for large and medium sized works.

Short of international rules of monetary and fiscal constitution, individual public or private operators simply lent funds without knowing the amounts already borrowed elsewhere or still under negotiation. Old debts could be paid with fresh loans as long as those countries could manage to find lenders on the basis of their natural resources, particularly oil. It was a kind of vicious circle that had to grind to a halt. At a certain point, 'big bubbles' go flat.

But, while strong financial buffers were set up to offset the consequences of the dollar drop in 1986 and of the 1988 stock exchange crash, the same did not occur with the excessive amount of loans granted to less developed countries in the late '70s.

Quite the opposite. No account was taken of the repercussions on them when, at the beginning of the '80s, industrialized countries decided to adopt monetary squeeze and high interest rates policies to cope with their inflationary pressure.

2. The Crisis

If the primary causes of debt lie in the mistakes we have reviewed so far, the crisis was aggravated by an interplay of factors linked to the reactions prompted by excessive deflations and regulations, to the non credibility of measures first adopted and then abandoned owing to political weakness, to inflation triggered off by liberalizations, and devaluations carried out too quickly and too heavily; to the consequent decline of GDP growth and to the related decline of the country's ability to honour its debt service with revenues, as well as to the reduced amount of export earnings in foreign exchange.

The debt burden produced insolvencies and subsequent reluctance of banks grant fresh loans.

That legitimate concern was exasperated by two orders of mush interconnected factors which operated through a perverse interplay: increasing provisioning and declining secondary market debt prices.

3. Provisioning and its interplay with secondary market

It was like spiral. Massive provisioning by leading banks reflected the idea that certain countries were no longer creditworthy, with the effect of halting the flow of fresh loans to them and the result that they became even less creditworthy. What followed was a drop in secondary market bids and a further blow to their credibility for the granting of fresh funds.

The next step was a stronger request on the part of the bank supervisory board to build up provisions against new loans granted to those countries. And that was a big hurdle for obtaining ordinary loans of the usual type.

4 - The decline of GDP growth in indebted countries

The picture of the highly indebted countries is dramatic. GDP and export growth rates in highly indebted countries are low, in contrast with those of the other LDCs. Their imports decrease, instead of in the other LDCs.


Highly indebted countries All other LDCs

without debt crisis


With medium income Poor


GDP growth

rate 82-89 1.4 0.8 6.4


percentage on

GDP (82-89) 19.8 13.1 27.5

Export growth

rate (82-89) 4.9 1.1. 8.3

Import growth

rate (82-89) -0.2 -6.8 -5.5

Export growth in countries no longer affected by the debt crisis was possible thanks to the high level of investments ant to wise economic policies that provided incentives for a capital inflow, but also thanks to a favourable export trend and a lower debt service.

Investment output was in indebted countries much lower than in those countries which have now found their way out of the debt crisis.

Clearly, there are economic efficiency differentials partly caused by he troubled economic policies of the debt ridden countries and by their high interest rates.

As already stated, external debt in highly indebted countries has a negative and double impact on such accumulation rate: through the need to squeeze domestic demand and therefore domestic investments in order to generate a surplus in the balance of trade; and through the reluctance of banks and official bodies to provide new loans.

There is an economic limitation to the ability to pay. In the case of a company oppresses by debts that it is no longer able to pay for, bankruptcy or a predetermined settlement frequently allow an economic recovery with fresh resources, repaying the old debt left outstanding after the settlement.

As was noted by Jeffrey Sachs, the same should hold true for national debts towards banks, international official institutions and other countries.

Yet there is no international financial constitution providing for such rule. Nor are individual creditors interested in granting the debtor - motu proprio - a substantial discount on its debt and fresh loans to get going again: this is so because of the spillovers of that move.

In general, that prompts are increase in the debtor's ability to pay on all his debts, including those towards other creditors. What is beneficial to all creditors is not for the individual one.

Short of an appropriate international economic and monetary constitution, the market failed in the late '70s and early '80s, when the enormous amounts borrowed were far beyond the abilities to pay. And, owing to another shortcoming in the international economic and monetaryorder, market risked to fail for the second time at the end of the '80s when - by looking at the prospects - there was no perception that all creditors would have benefited from granting debtors a large discount and thus enabling them to pay, but that does not occur spontaneously, since what looks advantageous for the community at large is not for the single individual.

There is a clear need for an institution with incentives and disincentives to achieve collective agreements that do not materialize spontaneously or are inadequate.

5. Some countries came out of the debt crisis

Nonetheless, it has to be stressed that some Asian countries with a high external debt burden thanks to a high rate of savings, a high level of diversified productive investments, a business-oriented economic system, wise monetary and fiscal policies, an export rise and to domestic market reinvestments made by their operators with domestic capital.

Even Chile and Uruguay managed to restructure and to find again their way to growth and capital inflow, together with the development of democracy, although with difficulty and after mistakes also due to a few shock therapies that produced unnecessary blood and tears.

Therefore, there is a way out even in the debt crisis when public and market economy work well and when there is readiness to make sacrifices.





1. Debt service to GDP and Exports Ratio

The reason why the two ratios of debt service over national (or domestic) income and over exports are indicative of a severe situation when they are high can easily be perceived.

A debt service accounting for a large share of the domestic income means taking away resources from consumption and domestic investments and, in any case, a cutback on the present and/or future resources available to the national community, which is all the more burdensome the lower the average income and the greater the imbalance in income distribution.

Most of developing countries' debts are public. That spells problems for the public revenue, which will either have to raise taxes or cut spending, or both, or again expand its indebtedness to meet its debt service obligations, or transfer the deficit onto the whole country's economy at the price of a two - three or four-digit inflation, with the weaker layers of population ultimately bearing the brunt of it.

In order to honour a debt service when it is equal to an excessively high share of exports, it will be necessary to reduce imports by means of restrictive consumption taxes, high interest rates, or other less sound measures (as quotas on imports and on credits, import duties etc.), and all this will have an impact on living conditions and on investments, thus threatening political and social stability, as well as the process of economic growth.

On the other hand, unless accompanied by appropriate domestic macroeconomic and restrictive measures and unless real prices and wages are very flexible, the choice of encouraging exports and improving the trade balance through devaluation of the national currency may generate a costpushed and demand-pulled inflation that is higher when import and export demands are rigid.

2. Debt Stock to GDP and Export Ratio

Since by definition loans are bound to be reimbursed, the debts stock-to-national (or domestic) income ratio, and the debt stock-to-exports ratio are significant indicators of the severity of a debt, irrespective of the debt service to national income and to exports ratio.

3. Interest Rate to GDP Growth and Export Ratio

Two important theorems have emerged in the specialized financial literature of the last few years. Even if with various clauses of coeteris paribus, they seem to be of fundamental importance for assessing the ability to pay back debts and for beneficial policies aimed at facing the problem in a global and effective way, instead of adopting short run, episodic measures.

The first theorem states that for the problem of indebtedness to die out spontaneously in the course of time, a necessary but not sufficient condition is that the GDP growth rate of the indebted country, measured in the debtor's currency, must on average be greater than the interest rate expressed in the same currency. It is self-evident that if no new debts are contracted, except those deriving from the accumulation of unpaid interests, the debts stock will gradually become an increasingly smaller percentage of the indebted country's GDP.

If the debt problem is to fade away in time by itself, the second theorem asserts that an indispensable condition is that the growth rate of net exports (the export-import balance) should be higher than the growth of interest rates. Even if all interests are not paid or if they are met with a renewal of the external debt, the debt growth will be smaller than that of exports and the debt service and total interests share of exports earnings will decrease.

By taking into account the two theorems, it becomes clear how the indebtedness problem got worse during the '80s. On average, interest rates were indeed higher that GDP and export growth rates in those developing countries now confronted with debt problems.

4. Laffer Curve ant Interest Rate-toPer Capita Product Ratio

Another theorem is related to the "Laffer's curve" of the ability to pay, which links the debt value and the interest rate on the debt itself and which was originally devised for the relationship between tax revenue and rate of taxation.

When the interest rate is zero, the debt is zero too (in the assumption that there are no pre-existing debts) and this situation corresponds to point A on the curve. Given B as a very high interest rate, there would be no income left to pay the future service of the debt, whose value is again zero.

In the intermediate points between A and B, lending countries could expect a certain level of repayment of the loans they have granted. In particular, they will expect the curve to drive upwards from point A as interest rates grow. But at a certain point an excessive interest rate reduces the ability to pay and the curve will necessarily have to change direction up to point B.

Several developing countries with a debt crisis can be considered in a position to the right of point C, and therefore a reduction of interest rates will improve the situation for debtors and creditors alike.

The C level of the optimal interest rate would have to be determined on a country-by-country basis, depending on the variable that are felt to be the most critical for the specific case, but the general microeconomic guiding principle is of a relation between productivity and interest rate which - in a simplified picture - goes back to a ratio between interest rate and GDP growth per capita.



1. Sustained GDP and export growth

The analysis of theorems and parametres concerning the situation and trends of critical indebtedness suggests the strategies to be adopted for the way out.

Economic growth in one single country (particularly if it is a developing country) has a short horizon. Growth must involve several countries and extend over large geographic areas.

Secondly, the indebtedness problem of developing countries must be linked to increased export opportunities and to price stabilization of the goods and services exported by those countries.

2. Curbing Interest Rates and Raising Domestic Savings

As shown, the '80s have been a decade of high interest rates. It is necessary that the '90s do not follow suit and that inflation is curbed not by means of monetary instruments, but with radical strategies of healthy tax policies and daring income tax policies.

Indebted countries have to adopt healthy financial and market economy rules so as to put a premium on savings, attract domestic investments instead of discouraging them, raise investments return and create a framework of political and institutional certainties. Such a framework is essential to secure a sustained growth of the national product.

But it is vital to respect the principle of self-determination of developing countries while they are provided assistance in designing those changes, in accordance with the following traid:

- incentives rather than "orders"

- cooperation

- gradualism.

The adjustment cannot overlook human factors. It is not to be seen in ideological terms, but indeed targeted to the modernization and mutual opening between indebted countries and industrialized countries.

3. New Funds and Additional Development Aid

The growth policy for the underdeveloped continents must be supported by greater efforts by the Western countries and by their institutions, and they must take into account the growth requirements of LDCs when framing their policies in general, and not only when development aid is involved. Aid should gradually increase to 0.7% of GDP, regarded as necessary by the DAC in the ministerial meetings held in the last few years.

The inherent danger is of getting caught in a vicious circle if the debt reduction program does not envisage also fresh funds to give new momentum to the growth process. In this area, a major role is to be played by export credit agencies and by Regional Banks - on the model of the Overseas development Cooperation of Japan and of the Saudi Development Bank - and by Multilateral Institutions in relation to funds for investments and exports. However, given the inherent risk, the above mentioned agencies need fresh resources and sunk capital to perform their function, in addition to the funds they can obtain from banks.

All this implies an unwavering political commitment: over and above the technical efforts that can be made, and the devices of financial engineering that can be designed, in the end it will be the taxpayer of the industrialized world to be involved in one way or another.

4. Tax, Accounting and Banking Supervision Rules Favourable to LDCs for Debt Relief and New Money

The considerations above lead to the last aspect of the systemic approach, namely the regulations on taxes, bank accounting practices and bank supervisory boards monitoring in order to promote and not hamper those measures directed at reducing the debt of developing countries at at providing a more advantageous regime for new money ad new financial tools.







Institutions in indebted countries are very different from one another, as are their development stages. But, in general, debt to equity swaps connected with even partial privatizations in the framework of projects aimed at relaunching local companies and resources, should be promoted in the context on an 'industrial policy' (in the wide sense of a policy for productive sectors): they may be viewed as tools for modernization and as a means for bringing about true elements of liberalization, deregulation, and economic streamlining.

It is not so much and not only a question of boosting capital inflow in order to do away with external debt, but more of a merger between policies of debt restructuring and economic adjustments.

A World Bank survey shows that export companies benefited most from investments in debt to equity swaps. Foreign investments (at least in joint ventures or in trade partnerships) surely ease the elimination of export barriers around industrialized countries.

Debt for equity swaps could then become the stepping stone of 'new financial flows' for economic initiatives in indebted countries and for new export flows from those countries.



1. From Variable to Fixed Interest Rate

Among the restructuring operations that produce relief, of particular interest are those aiming at putting a curb on the burden of the Libor plus interest rate, often contracted when prices of raw materials exported by indebted countries were more favourable for the latter, or when the real interest rate on the market was lower.

However, a simple shift from the Libor plus to a fixed interest rate - unless the latter is concessional - may yield results not adequate for solving the problem of the debtors' ability to pay.

The restructuring operations that are carried out in peak periods could lead to fixed interest rates that - in periods of low interest rates - are higher than one on the market.

A possible solution is the introduction of a variable rate ceiling. But it gives a limited advantage in terms of downward flexibility, when the ceiling is not put on a highly discounted level (for instance 6%), while it is appropriate in the case of conversions with a small cut on interest rates.

In a world in which interest rates have been out of control for over a decade, with the prospect of high levels at least until the year 2000, confronted with countries with low growth rates in GDP and exports, another step that can be justified is the coupling with the prices of raw materials for export: when those countries have good terms of trade on the world market, their ability to pay inevitably shrinks.

2. Interests' Credit and Interest Payment in Local Indexed Currency

There are two types of debt conversion that do not seem to alter the debt terms, that may be advantageous for debtors and that involve a low cost for creditors, who can compensate them with a lower insolvency risk, provided that a sufficient number of creditors join the scheme. The first type - suggested by Prof. Dornbush (the scheme was presented by Rudi Dornbush at the Cernobbio seminar held on May 18, 1990) - consists in crediting interests (without paying them) is a creditor's account in his currency in a bank of the debtor country, without penalties for delayed payment and at a low rate for the respite thus obtained.

The second type involves the payment of at least a portion of the debt service in local currency.

The first formula only makes sense if the country in question has a real ability to pay in the long run, and if every year (with the possible backing of soft loans from International Institutions) it can actually buy back part of its debt on the secondary market to an extent higher than the accumulation of unpaid interests.

In order to raise the ability to pay, another other scheme may be used. It consists in allowing total or partial payment of the debt service in Treasury bills expressed in local currency indexed to a basket of commodities traded by the country in question. Indexation is indispensable first if all to avoid that creditors may get back their credits depreciated by unfair exchange rate mechanism. Besides, it is necessary to protect those amounts from being annihilated by inflation before they can be invested locally in properties, commodities, other goods or services which are of interest for creditors (e.g., services related to international trade).

It must be recognized that the previous scheme has limitations, and that it can be of interest only as a partial measure.

Servicing can be financed by issuing certificates of government debt, which will not raise inflation, only if the amount is not so high.

Obviously, legal safeguard of that right has to be complete for the creditor to make use of his purchasing power, and there must not be too many equities of that kind, so that creditors can find satisfactory set-offs, and so that local economies are not upset by excessive flows of investments and external purchases.

Special tax revenues may be used for the purpose of servicing the bills. If the amounts are small, as in the case above, the operation should be feasible.



1. Buybacks Must Be Immediate

When secondary market bids are low, voluntary buybacks of external debt by debtor countries seems extremely attractive. However, when it is extended and protracted it appears to be self-defective. In effect, as institutional debt buyers enter the secondary market, debt prices rise. On the other hand, a country deciding to buy back its own debt on the secondary market can be tempted to have a contradictory attitude vis-a-vis the possible inflow of new money.

Indeed, an indebted country that, confronted with payment difficulties, applies a de facto moratorium on its debt, will not encourage the inflow of new loans, but will indeed depress secondary market bids and consequently make the buyback of its debt easier.

For this reason, buybacks should be carried out in large blocs with transactions agreed upon once and for all, at a price predetermined on the basis of real indicators, in order to provide not so much a free market-rationale, but one of settlement.

Like in debt to equity swap, buybacks imply the approval of creditor banks, which are responsible for allowing debt buyback on the secondary market, the number of "free rider" cases may hence increase. They may be avoided by predetermining purchasing bids at a fixed level.

For this reason too an agreement reached on the basis of objective criteria seems to be the only practicable way leading to a large scale buy-back.

2. Buybacks by low and medium income countries need bilateral or multilateral financial assistance.

Buybacks are almost always public finance operations, since most debts are contracted by governments and other public finance institutions, or by public enterprises guaranteed by the state, thus requiring public financing.

In order to buy back its debt, a single government can be helped through loans from international institutions, which would not cause a fresh outbreak of inflation connected with the debt service. It is a hypothetical inflationary pressure that would materialize only if the country in question did not repay its debt at all.

If that country believes it will soon restore its creditworthiness, buying back its own debt on the secondary market seems not advisable since it would sanction that country's insolvency status.

In countries far from recovering their creditworthiness, "reliable" government that, after a return to democracy, succeed to others that had completely lost their reputation, will find themselves before a delicate strategic choice.

It would be wiser for them to show they are ready to buy it back in line with their ability to pay and with the secondary market value reached by the debt under the previous government. In case said value was influenced more by strategic attitudes than by a real inability to pay it back, some percentage points may be added.

Should a complete buyback be impossible in one go, the market value of the remaining part would rise in the short run and for several years.

If they are not accompanied by international financing that make global purchases possible, buybacks would result more advantageous for creditors than for debtors.

The requested sacrifice could by far exceed the real value of the benefit, consisting of the remote and uncertain return to solvency.

The assistance of multilateral or bilateral organizations should be regarded as an essential element for the success of those operations in order to:

a) provide financial backing;

b) guarantee global character;

c) ensure that the buyback, although taking place over a long period of time, sticks to a reference price established at the time of reaching to overall deal.





1. Transfers between RICH and less developed countries

Until 1983 LDC were beneficiaries of net transfers of private financial flows.

From this year a dramatic inversion of trends emerges: LDC in 1984 transfer, through market operations, 10 million dollars to developed countries. In 1985 this flow increases to 20 billion, to come close to 30 in the subsequent year, approaching then 40 billions.

Transfers originated by development aid, in this way, are completely offset. Eventually and outflow from underdeveloped countries has materialized, which it is close to 10 billion yearly' on a cash basis, but is much higher on an accrual basis.

Hardly new problems of foreign debt will be avoided, as for LDC, if the development aid policy will continue to be confined to the present modest percentages of GNP. Thus there is a dramatic contraposition between grants and concessional credit; aid to poor countries and to middle income (and intermediate) countries; need of extraordinary financing of IFI and of providing means to broadening the scope and number of regional development banks; need of sustaining growth of third world countries and of sustaining the transition to market economy of former communist countries; need to intervene in favour of middle income heavily debt burdened countries and of financing poor countries which have so for avoided these problems, because of their greater parsimony and their better capability of managing their economic and social problems.

On the other hand the principle should be accepted that deserve help only those countries who make all the efforts to solve their problems, as far as possible, with the resources of their own taxpayers and savers. To say "as far as possible" implies that one should not forget fundamental human rights which lay at the basis of the principles to which the democratic countries of the developed world must adhere.

Inevitably, the respect of these principles brings about the increase of the share of GNP of development aid from the present 0.35% toward 0.7%; a level which DAC in its Governmental level meetings continues to declare to be necessary.

Each 0.1 on the industrialized countries GDP - considering the probable GDP of 1991 - amounts to 16.5 billion $.

Togheter with the 0.1% of "budgetary losses" consequent to the reductions of official bilateral credits, with an aid of 0.7 - as required by DAC also in its 14.5.1990 meeting - one could count on another 40 billion per year. A 0.1 - through activation of concessional finance - could spur 30 billion per year of capital.

The realization of the Brady plan, through a share of this additional flow, would be much eased.

A similar reasoning applies to the new investments.

2. An International Public Debt Constitution

True public debt should be only issue through negotiable bonds. Its issuance, at the international level, should be submitted to limits, based on objective parameters, to avoid the repetition of the past pathology.

The debt that a government issue not to finance its budget in general, but for specific investment projects, is a different matter. In this case one should consider the market's project return on the investment as well as its collective economic return. If this specific second return is sizable, but not the first, the issuance of international public debt, even through bonds, if undertaken at market conditions, is a very dangerous operation, for a country with a weak public revenue, even if with a good export capacity.

A broadening of the role of the regional development institutions is required, with concessional formulas as those practiced by the Overseas Development Corporation of Japan or the sand: Development Bank (maturity 30 years, rate between 1 and 3%, grace period).

One should also explore the possibility that given tax revenues should be earmarked to service these loans.

As for the investments of public enterprises which can enjoy an income, the international provision of fund should take place especially through formulas which allow the financing entity to directly get the service of its credit, without committing the state of the debtor.

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