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International Trade and Finance

Notes account deficits. At the same time, at least until recently, high interest rates raised the costs of financing
current account deficits and refinancing maturing debt. As a result, many non-OPEC developing
countries have found it difficult—and sometimes impossible—to meet their debt service obligations.
High interest rates, which resulted primarily from the inflationary surge that preceded the 1981 to
1982 recession, had an even more devastating impact on the ability of some LDCs to meet their debt-
service obligations. During the inflationary surge of the late 1970s, the interest rates at which Eastern
bloc nations and LDCs borrowed were generally below the U.S. inflation rate. As a result, the real
cost of carrying external debts was negative during this period. However, market interest rates rose
dramatically in the 1979 to 1981 period, only recently have they dropped below 1979 levels. As short-
term market interest rates rose, loan rates also rose both on new and maturing loans and on debt
subject to variable or floating interest rates. In 1981 and the first half of 1982, the interest rates paid on
debt subject to floating interest rates averaged substantially higher than the U.S. inflation rate. For
nations with a large part of their debt consisting of floating-rate loans, the consequences were deadly.
The OECD 1982 Survey estimates that for Argentina, Brazil, Mexico, and their residents, “about three-
quarters of their total [gross] debt was due to private markets at variable interest rates and without
official support from OECD governments [compared with under 20 percent for most developing
countries].” A 1 percentage point increase in the London Interbank Offered Rate (LIBOR) means an
increase in yearly net interest payments, calculated on 1982 indebtedness, of $593 million for Mexico,
$455 million for Brazil, and $205 million for Argentina. It is easy to see how higher interest rates in the
1981 to 1982 period greatly strained the abilities of these nations to meet their debt service obligations.
That will reduce the burden of their debts. But even though the bomb need not go off, and in my view
won’t, it might. The merchandise trade surpluses of developing nations will not increase automatically
in future years. Investment income will not necessarily grow. Loan interest rates, which have fallen
substantially since the spring and summer of 1981, might rise again. If the trade and investment
accounts of developing nations do not improve, or if they worsen, and if interest rates rise again, then
in the absence of generous loan reschedulings or heroic official aid, widespread, major formal defaults
are inevitable. It is important, therefore, to understand how widespread, major debt repudiation would
affect the U.S. banking and monetary systems and how it would affect U.S. exports, GNP, and
employment. Whether we should help developing nations cope with their debts depends crucially on
the analyses of these issues. Before analyzing these issues, however, it is useful to discuss the dimensions
of the external debts of Eastern bloc and less developed countries, the exposure of U.S. banks, the
abilities of individual countries where U.S. bank loans are concentrated to meet their debt service
obligations, and whether our banks have enough capital to absorb defaults.

The “debt-bomb” can be disarmed. Economic recovery is under way in the United
States and other developed countries. That will increase developing countries’
capacities to service their external debts. Interest rates are down.

28.2 The External Indebtedness of Developing Countries

How much do Eastern bloc nations and LDCs owe in total ? Hobart Rowan wrote (Washington Post,
19 October 1982) : “No one really knows.” But he reported that “a high-level World Bank official said
that if everything were known about the super-secret world of banking, the real global total would
probably add up to something close to $750 billion.” Official estimates are somewhat lower.
The World Bank estimates that at year-end 1981 the medium- and long-term debts of 98 developing
countries totaled $462 billion. The International Monetary Fund estimates that the medium- and
long-term external debts of non-oil developing countries totaled $437 billion at year-end 1981 and
rose to $502 billion at year-end 1982. The OECD estimates that the outstanding disbursed medium-
and long-term external debts of non-OPEC developing countries, including Eastern bloc nations,
totaled $445 billion at year-end 1981 and increased to $520 billion at year-end 1982. Including members
of OPEC, the medium- and long-term indebtedness of the world’s developing countries is estimated
to have been $530 billion at year-end 1981 and to have increased to $626 billion at year-end 1982.

314 LOVELY PROFESSIONAL UNIVERSITY