International Debt Crisis/

Latin American Debt Crisis

-Arpana Chandra
-Santosh Sarate
 Introduction
• In the year 1970’s many Latin American countries
notably Brazil, Argentina and Mexico borrowed huge
sums of money for Industrialization.

• Between 1975-1982, the latin american debt to

commercial banks increased at a cumulative annual
rate of 20.4 %

• At one point of time the debtor countries found it

difficult to pay back the debt.
 1970’s
•The 1970s was an inflationary
decade.

•Collapse of Bretton Wood system.

•Oil prices rose during the year

1973 and quadrupled in the year
1979.

•One of the main reason was the

Yom Kippur war and Iranian
revolution. Both the time, OPEC
countries had cut production.

•The increase in oil prices

generated huge current account
surpluses for OPEC members.
• Every year, billions of dollars were transferred to OPEC
members from oil importing nations.

• In the Mid 1970 Saudi Arabia and other OPEC members used
their new surpluses to purchase deposits from world
commercial banks.

• At the same time, higher oil prices caused non-OPEC

developing countries greatly to increase their credit demands.

• In the mid-1970s, banks recycled OPEC’s surpluses to non-

OPEC developing nations.
1970’s
• In late 1979, Mr. Paul Volcker was appointed as a
new chairman of the US Federal Reserve Board
(i.e., American central bank).

• Immediately, he initiated an anti-inflation

campaign.

• In between the year 1975 to 1980, only 4

countries had postpone payments.
 1980’s
• From 1980, the FED tightened the money supply.

• The tightening of American monetary policy impacted indebted countries

in three ways:
As interest rates rose, debt service payments also rose sharply.
The quantitative demand for their exports fell.
As commodity prices declined, they faced lower "terms of trade"
(exports/imports)

• In the year 1982, brazil was the 1st country to accept its inability to pay back.

• By 1983, the number of countries defaulting their payments had reached

21.
 Borrowings
• Latin American
 Real Interest Rates
The 3 major reasons for
the interest rates to go up
were:

•Tight monetary policy

•Budget deficit

•Tax Incentives for

investments introduced by
the government.
Because of which it lost
$744b.
Effect on the US Exchange Rate
 Capital Flight
• Since 1982, the debt crisis has crippled the development efforts of
most Latin American economies.

• Yet even as Latin American countries have run up large foreign

debts, their own wealthiest citizens have been investing heavily
abroad, acquiring enormous stocks of foreign assets.

• This phenomenon is known as “capital flight”.

• From 1973 to 1987, capital flight from Latin America added up to

$151 billion, or about 43 percent of the total external debt acquired
during those same years.
 Causes of Capital Flight
• Capital flight occurs when (usually wealthy) individuals in
Latin America decide to reallocate their wealth from
domestic to foreign assets. For these individuals, three
basic forms of domestic asset:, are available:

 holdings of money on current account

 savings in the domestic financial system,
 or investments in real productive activity.

• Capital is sent abroad when these domestic alternatives

appear increasingly unattractive to local elites.
 Effects of Capital Flight
• Reduction in growth potential.

• Erosion of the tax base.

• Distributional Consequences.
 What Went Wrong - Debtors
Non-productive Investments
This would seem to suggest that a large proportion of borrowed funds either went into the
unproductive sector or by-passed economies of poor countries altogether. A common factor
to the two arguments is that third world countries did not devote the funds towards
increasing their own capacity to service loans.

Debt for military expansion

A clear example was the purchase of 200 aircraft by the French airforce at a discount of 25%,
after Dassault had sold 350 Mirage III’s abroad

The oil price factor

The debt crisis can also be explained – in part - by deterioration in the world economic
environment caused by the oil price rise that began to escalate in 1971; after the oil price
had dropped from $1.50 a barrel in 1960 to $1.30 a barrel in 1970 . Much of the blame for
the oil price rise is attributed to the collapse of the innovation of the Bretton Woods system
of fixed exchange rates that had allowed governments to liberate themselves from
limitations imposed by a fixed parity.
• The interest rate factor :-
There is adverse effects of weak investments on national solvency, the
tendency for developing countries to apply large proportions of borrowed
capital to unproductive uses do not seem to conclusively explain the
accumulation of foreign debt by third world countries
• Economic mismanagement factor :-
The main indictment on governments of poor countries is that should have optimised
the presence of debt by focussed their policies towards increased generation of
foreign exchange to meet future obligations for debt service. A large number of
developing countries also adopted inward looking industrial strategies, aiming at
domestic production of previously imported goods as a means of saving foreign
exchange
US Lenders
UK Lenders
 What Went Wrong- Lenders
• The Loose lending factor :-
The rapid increases in deposits in the banking systems is also notable for creating
additional financial capacity that enabled Banks to commit higher amounts in loans to
the borrowing public in the own countries most of whom deposited their money back in
the banking system. At every stage of the lending process the banks created more
deposits with the final result that the original loans were multiplied several time as
lending continued.

• Ideological Miscalculations :-
Walter Wriston, who served as head of Citibank Corporation that was still a
leading financial institution in the USA - around 1967 - was one of the proponents of the‘sovereign
risk hypothesis’. Wriston contended that a country ‘…how badly off, will “own” more than it
“owes”. He maintained that countries could not go bankrupt, nor could they disappear and that
even if they had short-term cash flow problems, the cure would be ‘sound programs and time to

allow them to work’

• Bank Euphoria :-
The banking sector in the western world also contributed to the debt crisis through the
application of methods that were outdated and insufficient for measuring credit risk. With
the benefit of hindsight there is reasonable ground to perceive naivety among the banks in
the consideration of single country loans as well as the aggregate level of their portfolios to
the third world Countries
 The Baker Plan :“Growth, the Key to Breaking
the Debt Crisis”
• The Baker Plan proposals begun in October 1985 by then US Treasurer Secretary
Baker at Seoul

• The Baker plan emphasized that the debt crisis could only be resolved through
sustained growth by the debtor countries.

To achieve the desired growth, the plan recommended programs of economic

reform and structural adjustment for the debtor countries, including greater
reliance on the private sector, curtailment of state subsidies and price controls,
steps to stimulate both foreign and domestic investment, and export promotion
and trade liberalization
• He stressed the importance of foreign investment as non-debt-creating. He also
pointed out that equity investment has a high degree of permanence and is not
debt-creating. Moreover he pointed out, it can have a compounding effect on
growth, bring innovation and technology, and help to keep capital at home.

• The Baker plan gives new importance to the World Bank and other Multilateral
Development Banks (MDBs), mainly the Inter-American Development Bank, both
by increasing their disbursements and, as a condition of this, by giving them a
bigger share of policy formation. The World Bank will be expected to increase from
11% to about 20% of total credits its non-project lending, in the form of structural
or sectoral adjustment loans, aimed at improving either the whole economy, or key
sectors such as foreign trade. In the past these loans have been linked with IMF
programs. But countries such as Brazil were anxious not to be tied to two sets of
conditions, and may regard the World Bank as more sympathetic to their pleas for
gradualism and flexibility than the IMF.
 The Brady Plan.
“key To The crisis is Debt Reduction

• On March 10, 1989 the United States approach to managing the Third
World debt took a dramatic turn. Treasury Secretary Nicholas F. Brady
acknowledged that serious problems and impediments to a
successful resolution of the debt crisis still remains. The framework
that Brady outlined in his speech is only a first step toward designing
and implementing a more effective approach to dealing with the
problem.
• The framework that Brady outlined in his speech is only a first step
toward designing and implementing a more effective approach to
dealing with the problem. The major elements of the Brady initiative
are as follows.
The Highly Indebted Poor Country Initiative
(HIPC) “Debt Forgiveness is The Key”
After the Baker plan and its call for growth failed, and then the
Brady plan and its call for debt reduction failed, HIPC came along
and proposed the ever popular proposal for debt forgiveness. In
October 1996, there was a major shift by the IMF and the World
Bank when they produced a debt relief initiative, which
contemplated for the first time the cancellation of debts, owed to
them.
The agreement also recommended a strategy to enable countries
to exit from unsustainable debt burdens. Briton’s Chancellor
proposed that the Initiative should be financed through the sale of
IMF gold. The Initiative proposed 80% debt relief by the key creditor
countries (Japan, U.S., Germany, France and Briton). The World Bank
announced the establishment of a Trust Fund to finance the
Initiative.
PRESENT DEBT
 Conclusion

• Its believe that future economic crises in developing countries

should be handled on a case-by-case, market oriented basis,
not by a predetermined arrangement supervised by
international financial institutions.

• The major reason for case-by-case approach for future

crises is the vast changes that have occurred in recent years in
international markets that have strengthened and greatly
diversified international financial flows.
THANK YOU