Bank Lending to Developing Countries Recent Developments in Historical Perspective This article was prepared by David P. Dod of the Board's Division of International Finance. Developing countries of Latin America, Asia, and Africa became important borrowers from international banks during the 1970s and have stepped up their borrowing over the past two years. Part of the recent increase can be attributed to demands by the developing countries for external credit to cushion the impact of external strains on their economies. The prominent contributing factors have been the escalation of world oil prices in 1979-80, the related slowdown of economic activity in industrial countries and downturn of world prices for nonfuel commodities, and the rising interest cost of outstanding borrowings by developing countries from world financial markets. A large share of the recent borrowing by developing countries might have been expected in any event, in view of their tendency to sustain external deficits and in light of the international banking relationships they have built up over the past decade. For a number of developing countries, a long-range program of borrowing from international commercial banks has been a specific objective of public policy. Central governments and state enterprises have undertaken substantial long-term borrowing from international banks. Governments in most developing countries have significantly regulated the terms on which private companies may borrow abroad and have often applied direct financial incentives or disincentives. An increase in public-sector and private borrowing combined has been necessary in view of economic policies in developing countries that have contributed to higher, sustained deficits in the current account of their balance of payments. The persistence of high levels of borrowing from international banks by some developing countries has shifted markedly the composition of their external debt and has created a more complex task of debt management than they faced a decade ago. Compared with debt to foreign official lenders, which were once the predominant creditors for all developing countries, debt to banks bears shorter maturities and requires more frequent refinancing. It also bears higher and more variable interest costs. Major borrowers from banks have therefore had to pay increasing attention to external debt-service obligations when formulating objectives for their balance of payments and their domestic economies. BALANCE OF PAYMENTS NEEDS Needs for external financing of the developing countries apart from those in the Organization of Petroleum Exporting Countries have risen sharply during 1979-81 (chart 1). For some Korea, Taiwan, Thailand costs for oil imports have 1. Current account deficits of the non-opec developing countries Percent of GNP 6 4 9L 1973 1975 1977 1979 1981 Current account is balance of payments for goods, services, and private and official transfers. SOURCES. IMF, World Bank, and Federal Reserve staff estimates.
648 Federal Reserve Bulletin 2. Economic activity and inflation in the non-opec developing countries Percent per annum 1973 1975 Percent per annum 1977 1979 1981 Inflation is change in consumer prices. GDP is gross domestic product. SOURCE: IMF World Economic Outlook and Federal Reserve staff adjustments. increased by 4 to 5 percent of national income, a more severe impact, relatively, than that experienced in any of the major industrial countries. For others, the 1980-81 slowdown in economic growth of the industrial countries has slowed the growth of export markets and has contributed to the cyclical weakening in world market prices for their exports of primary commodities. For countries with high levels of net external debt, rising interest rates on world financial markets have imposed additional needs for external financing. Recent external forces affecting the non-opec developing countries have been broadly similar to those at work following the first world oil shock of late 1973. The initial responses of policymakers in the developing countries have also been broadly similar, as they have again sought to maintain reasonably high levels of economic activity and, on average, have been willing to tolerate some acceleration in price inflation (chart 2). It depends in part on factors that are beyond their control, notably future shifts in their terms of trade that may offset or compound their recent setbacks. It also depends upon their view of the average level of current account deficit that they believe is desirable over the longer term and upon the willingness of foreign creditors to supply the implied financing. Developing countries have not been adjusting quickly to the oil shock of 1979-80, judging by relative growth in the volume of exports and imports. Rapid export expansion has been maintained on average, but growth in the volume of imports does not yet appear to have slowed significantly (chart 3). At this stage, non-opec developing countries appear to be adjusting less vigorously to recent adversities than they did in response to the oil shock of late 1973 and to the related collapse of nonfuel commodity prices in 1974-75. To some extent the recent slow adjustment may be attributed to a lag in curtailing expansionary fiscal policies adopted by many developing countries in 1979-80, before the full dimensions of the second oil shock became clear. 3. Volume of exports and imports by non-opec developing countries 1973=100 130 Exports I 120 Imports 110 1973 I 100 1974 1975 1976 1977 1978=100 THE ADJUSTMENT PROCESS While the circumstances of individual countries vary, most developing countries now confront a need to adjust to adverse developments in their external payments positions. The adjustment process must basically consist of policies to expand the volume of their exports and to restrain the volume of imports. The severity of the required adjustment effort by developing countries is somewhat uncertain. 1978 1979 1980 1981 SOURCES. IMF World Economic Outlook and Federal Reserve staff adjustments.
Bank Lending to Developing More recently, the tendency of some countries to resist depreciation of their currencies against the U.S. dollar has inhibited balance of payments adjustment. As the exchange value of the dollar has risen strongly over the past year against European and Japanese currencies, such resistance has eroded the competitiveness of the internationally tradable goods and services of many developing countries. The apparent sluggishness of recent actions toward balance of payments adjustment may signify only a lag by developing countries in recognizing their adjustment needs. Or it may signify a perception by many of these countries that they can aim for and sustain higher levels of current account deficits in the future than they sustained in the 1970s (chart 4). In the latter case, the external debt of developing countries would be expected to expand at a correspondingly more rapid pace through the 1980s. 4. Average current account deficits in relation to GDP Countries 649 EXTERNAL FINANCING FROM BANKS IN THE 1970S Bank lending to developing countries has taken three principal forms: short-term private trade financing; long-term loans guaranteed by the governments of industrial countries to promote exports of capital goods; and long-term, nonguaranteed loans arranged in large blocks through syndicates of international banks. The volume of each form of bank lending expanded rapidly through the 1970s. Before the sharp increase in needs for balance of payments financing that followed the oil shock of 1973-74, external borrowing from banks by developing countries was already growing vigorously (chart 5). The early 1970s had been a period of unusually favorable terms of trade, strong external payments positions, and rapidly rising reserves for most developing countries. Yet the fragmentary data that are available suggest that their debt to banks more than doubled in dollar terms between the end of 1970 and the end of 1973, reaching about $35 billion. The fastest growing component of that debt was medium-term syndicated loans from commercial 5. Net external borrowing from banks by the non-opec developing countries Billions of dollars The ten major borrowers are Argentina, Brazil, Chile, Colombia, Korea, Mexico, Peru, the Philippines, Taiwan, Thailand. SOURCES. IMF and World Bank. A high-deficit, high-debt strategy by developing countries is sometimes rationalized as a means to finance a higher level of capital formation, which, if effectively utilized, facilitates more rapid economic growth by the borrower. Although some countries (Colombia, Taiwan, Malaysia) have prospered without recourse to this strategy, the high-deficit approach to economic growth remains appealing to many developing countries. The feasibility of such a strategy, however, depends on the ability of the borrowing country to attract external financing from banks and other foreign creditors. banks J2ZQ 1222 \m 197fi' ' 1978' ' 1980 Total is lending from U.S. banks and banks headquartered in other industrial countries whose authorities provide statistical reports to the Bank for International Settlements (BIS). U.S.-chartered banks include U.S. offices and foreign branch offices and exclude lending denominated in local currency. SOURCES. BIS, Fifty-First Annual Report, 1980/1981, BULLETIN table 3.20, and Federal Reserve staff estimates.
650 Federal Reserve Bulletin banks. Measured on the basis of new credit announcements, the flow of such loans rose from less than $1 billion in 1971 to %AVi billion in 1973, with the bulk of the loans being arranged.for borrowers in four Latin American countries Brazil, Mexico, Peru, and Argentina. A critical institutional innovation helping to popularize syndicated term loans among the banks was the use of "floating" rates of interest, adjusted at regular intervals to reflect market conditions. In a period of relatively volatile and rising interest rates, banks favored that feature of internationally syndicated loans as a means of avoiding the interest-rate risk inherent in alternative, fixed-interest investments such as bonds and mortgages. During 1973-74, demands by developing countries for external, trade-related financing also accelerated sharply. Fueled by high levels of public spending, the volume of their imports jumped about one-third. Meanwhile, the prices of their imports rose by two-thirds, under the combined influence of the sharp increase in oil prices by OPEC and the general uptrend of world inflation. Immediate needs for balance of payments financing during the mid-1970s generated higher demand by developing countries for all types of bank lending (chart 5). On the supply side, three factors helped to ease their access to international banking markets: the rapid buildup of deposits with international banks by OPEC members, the downturn in loan demand in industrial countries that were experiencing a deep recession, and the expansion in guarantees and subsidies by governments of the industrial countries on certain export credits extended by banks. The surge of bank lending to developing countries since 1978 has again been in response to rising overall needs for balance of payments financing, associated with rapid import growth and, more recently, their deteriorating terms of trade. However, the composition of bank lending seems to have shifted toward short-term financing and toward private-sector borrowers. Publicsector borrowers in several major borrowing countries Argentina, Chile, Colombia, Mexico, and Peru appear to have reduced their role in arranging external financing from banks. In each case, upward adjustments in domestic interest rates or changes in the exchange rate system offered effective inducements to banks and nonbank private borrowers to assume a compensating, more active role in foreign borrowing. OFFICIAL AND NONBANK PRIVATE CAPITAL FLOWS Throughout the 1970s nonbank private investors provided relatively little new external financing for developing countries, considering that they had entered the decade with a larger stock of claims on these countries than the banks. Direct investment in foreign-controlled companies (financed by equity capital or by loans from the parent company) has been and continues to be the most important vehicle for nonbank private capital flows to developing countries. Such flows appear to have amounted to about $8 billion in 1980 (chart 6), but they may be subject to somewhat more undercounting than other capital flows. Official external grants and loans recorded by the non-opec developing countries averaged about 2Vi percent of their gross national product through the 1970s. Those resources have been heavily and increasingly concentrated upon lower-income countries by both the governments of the industrial countries and the multilateral development banks. For the 10 major borrowers 6. Major sources of official and nonbank private financing SOURCES. IMF Annual Reports and World Economic Outlook and Federal Reserve staff estimates.
Bank Lending to Developing from banks (see note to chart 4), the relative importance of foreign official capital inflows declined sharply during the 1960s and 1970s. Most developing countries borrowed from the International Monetary Fund at some point during the 1970s. Net disbursements from the IMF tend not to be an important source of financing because of the revolving character of its resources. Nevertheless, those resources play an important role in meeting needs for exceptional financing during periods of global economic strain. EXTERNAL INDEBTEDNESS OF THE DEVELOPING COUNTRIES A decade of relatively high current account deficits, and of increased dependence upon nonconcessional loans, has markedly altered the structure of external debt for the major developing-country borrowers (chart 7). As a result, interest costs are relatively higher and the average maturity of their debt is much shorter than in 1970. These characteristics of the current debt $65 billion Official creditors Banks Other creditors Ten major borrowers $215 billion Others $150 billion SOURCES. World Bank, BIS, and Federal Reserve staff estimates. 651 profile demand increased skill in debt management and flexibility in adapting economic policy to changing circumstances. Flexible exchange rate and interest rate policies have proven to be important tools for managing balance of payments financing problems of many of the major borrowers. In a number of recent instances, upward adjustments in interest rates have been used to induce increased external borrowing and to reverse capital flight by the private sector. In other instances, countries that have clung to a rigid structure of interest rates and foreign exchange rates have found their fundamental problems of external adjustment exacerbated by private capital outflows. For most low-income developing countries external debt through the 1970s continued to take the form mainly of concessional (low-interest), long-maturity loans from foreign official lenders. Debt of these countries to foreign banks has consisted predominantly of short-term credits or externally guaranteed loans related to the purchase of specific imports. IMPACT 7. External debt of the non-opec developing countries, by type of credits Countries OF RISING INTEREST RATES The upswing in world interest rates over the past two years has had a varying impact on the debt burdens of developing countries. Judged against conditions in the 1970s, the burden of their market-based debt has certainly risen. Market rates of interest have moved up faster than inflation rates in the major capital-market countries, especially during the past 18 months. Thus the "real" cost of borrowing, approximated by the difference between the external interest rate facing borrowers of dollars, marks, or yen, and the concurrent rate of inflation in world prices measured in the respective currency, has risen to exceptionally high levels. For most low-income developing countries, changes in world inflation have had the decisive influence on the real burden of external debt over the past decade (chart 8). Fixed-interest, concessional loans have remained the principal component of their external debt, and the average nominal interest rate on concessional debt has actually declined since 1970. As part of an effort to increase real transfers of resources to low-
652 Federal Reserve Bulletin 9. Indicators of real interest cost of major borrowers from banks 8. Indicators of real interest cost confronting low-income developing countries Percent per annum 30 20 10 World inflation is unit value of world trade in SDR terms. Cost of fixed-interest debt (all currency denominations) is an average for all developing countries, based on reports from creditor sources; average cost of fixed-interest debt of the low-income countries is less. SOURCES. I M F a n d O E C D. income countries during the 1970s, bilateral-aid donors within the Development Assistance Committee of the Organisation of Economic Cooperation and Development have striven to increase the average degree of concessionality (that is, the discount from market terms) on economic development assistance. Interest rates on other fixed-interest debt of the developing countries notably, official and guaranteed export credits and loans from the multilateral development banks have risen since the mid1970s but have lagged far behind contemporary market rates of interest. The resulting average rate of interest on all forms of fixed-interest debt has risen by only 2 percentage points since 1970. Because of high average rates of world inflation, the real interest cost of external debt for most low-income countries has been strongly negative throughout the past decade. The major borrowers from banks also enjoyed low real costs of borrowing during the 1970s but, subsequently, have experienced by any measure an abrupt increase in such costs. One contributing factor has been the large fraction of their total debt that is subject to variable, market rates of interest. Short-term commercial and syndicated term loans loom large for these countries, and the interest rates payable on such debt have been marked up quickly in response to the rising short-term rates of interest in world financial markets (chart 9). A second factor has been the high proportion of dollar-denominated debt in the overall exter World inflation is unit value of world trade in dollar terms. SOURCES. IMF and Federal Reserve staff estimates. nal indebtedness of the major borrowers. More than four-fifths of the external debt to banks of the 10 largest borrowers cited previously is estimated to be denominated in U.S. dollars. Over the past two years, U.S. dollar rates of interest have risen more than interest rates on other major currencies. More recently, the dollar has also appreciated sharply in foreign exchange markets, and this development has tended to reduce, in dollar terms, the prices of goods and services traded in world markets. As a result, dollar debtors in the world economy must export a larger volume of goods and services in order to help finance the debt-service payments on their dollar-denominated debt. This situation reverses that of 1973, when a sharp depreciation in the exchange value of the dollar produced windfall gains for dollar debtors. The balance of payments impact of rising interest rates depends not only on the changing level of these rates but also on the size of a country's external debt. Moreover, rising interest payments on a country's external debt may be counterbalanced by rising interest receipts on its external assets (chart 10). For the 10 major bank borrowers, more than half the increase in net external interest payments during the past two years can be attributed to growth in net external debt; rapid growth in gross external debt has been accompanied by less rapid growth or sharp decline (Brazil) in their external assets. Recent increases in net external interest burdens of major developing countries are large in relation to those of any other modern episode.
Bank Lending to Developing 10. Interest payments and receipts Billions of dollars Payments and receipts are external interest payments and receipts of the ten major borrowers. SOURCES. National balance of payments data and Federal Reserve staff estimates. However, even at the current level of interest rates, net interest payments abroad exceed 4 or 5 percent of national income in only a few countries. The capacity to finance such interest transfers appears on average to be well within the means of the borrowing enterprises. The total of tax revenue and operating income of major borrowing entities within these countries the government sector and private investors often amounts to more than half of national income. Countries 653 lasting unsettling effects on a borrower's access to international capital markets. In addition, rescheduled external bank debt normally bears an interest cost as high as, or higher than, that on the original loans. Nevertheless, debtor governments have requested rescheduling of their external bank debt more frequently in the past two years (table 1). One factor contributing to bank reschedulings has been the linkage to debt reschedulings by official creditors under the informal Paris Club framework. Borrowing governments have been seeking and obtaining more frequent debt rescheduling from official creditors, some of which have offered interest rate concessions. As a condition of Paris Club agreements, creditor governments normally oblige the debtor to seek a comparable rescheduling of its debts to other major creditors. Fulfillment of this condition in several instances has required a separate rescheduling arrangement involving only the commercial banks. A second institutional factor leading to publicized debt reschedulings by developing countries has been the dispersion among small banks of participations in syndicated long-term loans to public-sector borrowers. A wider body of creditors raises the need for a formal negotiating framework and has increased the public visibility of debt reschedulings. CONSTRAINTS ON BANK LENDING TO DEVELOPING COUNTRIES Risk and Return While the external interest burdens on developing countries may appear to be modest in relation to the real resources that they command, the priority of claims by foreign creditors over other claims on a country's resources can never be fully assured. There is a risk that government borrowers, under adverse political or economic circumstances, will accommodate domestic needs at the expense of their obligations to foreign creditors. Where the government restricts the access of private borrowers to foreign exchange, private borrowers may also face no alternative but to suspend payments on their external obligations. These so-called country risks in international lending may lead borrowers to request rescheduling of their debt-service obligations. Recourse to delays in debt service and to formal requests for debt rescheduling may have on Bank Lending During the 1970s the returns to U.S. banks on foreign loans were attractive, on average, while loan losses were low. Loan losses reported by banks on their international loans were and have remained lower than those reported on domestic loans. The loss experience on loans to developing countries has also been favorable, although banks seldom cite separately statistics for that component of their international lending. The returns to U.S. banks on their international lending have become less attractive compared with returns on domestic lending since the mid1970s. On international syndicated credits, a decline has occurred in the average "spread" earned by the lender above the base rate of interest on interbank funds in the Eurodollar market. Moreover, in 1980-81, the base rate in the Eurodollar market has also declined relative
654 Federal Reserve Bulletin 1. Recent cases of multilateral debt rescheduling requested by national governments from international banks Participating creditors Date of agreement Country September 19781 April 1978 July 1981 J December 1978 Jamaica commercial banks Peru Turkey Pending Sudan April 1980 1 Under negotiation/ Zaire September 1980 and pending December 1980 Pending Bolivia commercial banks, preceded by separate rescheduling by foreign governments commercial banks, preceded and followed by separate reschedulings with foreign governments and nonbank private creditors commercial banks, preceded by separate rescheduling by foreign governments commercial banks, preceded and followed by separate reschedulings by foreign governments commercial banks June/August 1979 Nicaragua Poland Under negotiation Liberia Under negotiation Costa Rica commercial banks commercial banks, preceded by separate rescheduling by foreign governments commercial banks, preceded by separate rescheduling by foreign governments commercial banks to the prime rate of interest established for borrowers in the domestic U.S. market for bank loans. As a result of these two factors, the apparent average yield on new syndicated loans to developing countries, which had averaged about 1 percentage point higher than the U.S. prime rate during 1973-78, has fallen significantly below prime during 1980-81. In the late 1970s, U.S. commercial banks responded to the apparent declining relative profitability of syndicated term loans by sharply 11. Outstanding external bank claims on non-opec developing countries Billions of dollars Types of debt to banks rescheduled or restructured short-term government-guaranteed debt short- and long-term debt of government borrowers f < nonsyndicated long-term debt of I government borrowers short- and long-term debt of government borrowers restraining their exposure in the long-term end of the market. Since mid-1979, however, their short-term lending to developing countries has grown rapidly, suggesting that yields on unpublicized, short-maturity loans may have become somewhat more attractive. Banks headquartered in other industrial countries also shortened the average maturity of their loans to developing countries during 1980 (chart 11). The interest and participation by U.S. banks in syndicated term loans to developing countries appear to have revived since late 1980, partly because banks now face financially more attractive options to set the floating interest rate on many such loans at some margin above the prime rate in the United States rather than to link it to the interbank rates prevailing in the Eurodollar market. Country Exposure Long-term 1976 1977 1978 _ 1979 1980 SOURCES. BIS, U.S. country exposure lending survey, and Federal Reserve staff estimates. of Banks While the competition among banks may suffice to maintain a reasonable balance over time between risk and return on banks' loans to developing countries, the loan exposure of some banks in some countries still warrants close analysis. As a bank's loans to a given country rise to a high level relative to the capital of the bank, that "country exposure" tends to arouse anxiety:
Bank Lending to Developing among the bank's management, who are averse to a possible severe loss; among bank supervisors, whose agencies may insure or must otherwise protect the bank's depositors; and among the authorities of the borrowing country, whose ability in the event of need to expand or even to maintain that country's access to external bank credits may come into question. These factors place a real, if indeterminate, limit on the exposure in a country that bank creditors, as a group, or the government of the borrowing country will find acceptable. Overall exposure of U.S. commercial banks in developing countries has tended to rise in relation to the banks' capital funds during the past two years. This development follows a period in which the bulk of new lending was provided by large, non-u.s. banks that previously had borne lower levels of exposure in developing countries than the largest U.S. banks. In that period, U.S. banks in all size classes, including those with low loan exposure in developing countries, had abruptly slowed the pace of their net lending to developing countries (chart 12). 12. U.S. bank exposure in relation to bank capital Countries 655 The exposure of a bank in all developing countries combined is not necessarily a matter for concern. The economic fortunes, financial behavior, and repayment capabilities of foreign borrowers are highly diverse probably more diverse than those of domestic borrowers. High concentration of a bank's loans in a single foreign country is in principle a more valid point for concern. Since the mid-1970s, U.S. banks on average have maintained loan exposures in Brazil and Mexico that are exceeded only by their claims on the United Kingdom or Japan but, of course, are only a small fraction of the claims on borrowers in the United States. The exposure of U.S. banks in Brazil and Mexico has grown less rapidly on average over the past few years than their exposure with other developing-country borrowers. Just as there is diversity among countries in the management of external debt, there is also diversity in the performance of different categories of borrowers or credits within a particular country. Policies that limit a government's ability to service its debt may not prevent privatesector borrowers from meeting their debt-service obligations. Conditions that lead to disruption or rescheduling of term loans may not cause serious delays in the repayment of trade-related loans. 2 Balance of Payments Borrowing Needs 1.3.2 Objectives and Policies and objectives for balance of payments adjustment by developing countries tend to determine their needs for external borrowing from banks. Alternative sources of financing have been and are likely to remain less responsive to shifts in current account deficits. Changes in external reserves may act as a buffer to short-run variations in the current account and, thus, may increase (as in 1972-73 and 1976-78) or relieve (as in 1974-75 and 1980-81) the need for external borrowing. For the longer run, the scope for attracting external capital from new nonbank sources institutional investors, nonfinancial corporate investors, direct public issues of bonds on international capital markets appears rather narrow. That narrowness of alternative, nonbank
656 Federal Reserve Bulletin channels of finance has been a principal subject of scrutiny for the multilateral World Bank-IMF Development Committee that was established in 1974. Progress toward widening these channels has been slow, and techniques proposed to achieve faster results have encountered philosophical objections from governments of the prospective investing and recipient countries. Constraints on official and nonbank private inflows of capital imply that decisions by developing countries to maintain high current account deficits will require high ongoing levels of external borrowing from banks. A set of fiscal and monetary policies and policies on wages, prices, and exchange rates that produced a lower deficit in the current account would, conversely, generate a lower level of borrowing. Proponents of capital flows to developing countries postulate that investment begets growth and that net foreign savings, which finances the current account deficit, begets investment. However, there may be slippages in the transmutation of foreign savings into incremental investment. In particular, the tighter fiscal policy that would help a country to achieve a lower current account deficit would at the same time tend to produce a higher level of domestic savings. There may also be uncertainty over the value of benefits to be achieved from that incremental investment. Such slippages and uncertainty warrant careful reevaluation by national authorities in light of the higher real cost that borrowings from international capital markets now appear to carry.