National Debt
National Debt
One of the consequences of the rapid increase in the cost of oil during the
1970s was the equally rapid increase in debt as developing countries sought
assistance from private or government institutions in other countries to fi-
nance oil imports and other products necessary for development. Debt in the
developing countries increased from less than $100 billion in 1970 to $1336.6
billion in 1990.22 The two largest borrowing regions were Latin America and
Africa.
Figure 2.7 identifies the major developing country debtors. Note the tre-
mendous size of the debt in countries such as Brazil and Mexico. It is inter-
esting to note that in 1986 South Korea was in third place, whereas it
dropped to tenth place in 1988. A major problem with debt is that countries
have a difficult time paying it off. The debt service ratio, the ratio of interest
payments plus..principal amortization to exports, is quite high, especially in
the western hemisphere. This suggests that countries are not able to use as
much of their export earnings as they would like for economic development.
An increasing share of those earnings is going to service their debt.
As debts rise, crises are inevitable. The first crisis occurred in the inter-
national banking community in Poland in the 1970s. At that time it appeared
that Poland would have to default (not pay its obligations), and many experts
were unsure what impact this would have on the international financial com-
munity. The next crisis came in August 1982, when Mexico, with nearly four
times the debt of Poland, could not fulfill its debt-service obligations. As a
result, it was forced to reschedule principal and interest payments. When a
country reschedules debt, it changes the interest rate of the loan and/or the
timing of the payments of principal and interest. Most of the large debtors,
especially Brazil and Argentina, were in the same position and had to go
through reschedulings at the same time.
In 1987 the crisis, especially among the Latin American debtors, reached
critical proportions. Brazil declared a moratorium on interest and principal
payments to commercial creditors—basically a suspension of payments—ar-
guing that it could not afford the $5 billion in annual interest payments, an
amount that was 12 percent of its federal budget.23 As a result of the high
degree of uncertainty in Latin American loans, many banks set aside large
reserves in case the loans could not be repaid. Banks establish reserves by
reducing earnings and increasing the reserve account. This allows them to
reduce earnings a little each year, especially in profitable years, rather than
waiting for a major default and reducing earnings all at once. This reduction
in earnings is problematic because it also reduces the banks' lending ability
and financial strength.
Latin countries also were trying to create novel ways to reduce the debt
pressure by, for example, converting debt into equity. A debt-equity swap is
based on a foreign lender's exchanging its dollar debt in a developing country
for real assets in that country, such as equity in a local business.
An example of a debt for equity swap is the sale of Aerolineas Argentinas
to Iberia mentioned before. Iberia is paying $260 million in cash and assum-
ing $2.01 billion in debt paper for its 85 percent interest in Aerolineas Argen-
tinas.
The International Monetary Fund has played a crucial role in helping thg_
debtor nations restructure their economics. In country after country the IMF
has recommended strong economic restHcTions as a precondition for receiving
loans from the IMF. These loans are almost a prerequisite for persuading the
international commercial banks to reschedule their loans. Restrictions have
involved a combination of export expansion, import substitution, and ajdras-
tic reduction in public spending. In Mexico, for example, the government
deficit was running at an estimated 17.6 percent of GDP in 1982, and the IMF
gave the government a target of 5.5 to 6.5 percent, a substantial reduction in
government spending.24
In many developing countries, these radical requirements have touched
off heated debate and have sorely tested the political stability of the govern-
ments in power. Once the IMF sets targets, it monitors those targets periodi-
cally as a precondition to releasing funds. The private international banks
olien use the results of this monitoring to determine their policies.
MNE management is concerned about the high debt situation because it
is.dillkull to operate in that type of environment. Imports are often curtailed,
and hard currency is difficult to obtain. In addition, governments might in-
stitute a variety of macroeconomic measures to control debt, including slow-
ing down economic growth, which would have a negative impact on sales
opportunities for firms.
One of the consequences of the rapid increase in the cost of oil during the
1970s was the equally rapid increase in debt as developing countries sought
assistance from private or government institutions in other countries to fi-
nance oil imports and other products necessary for development. Debt in the
developing countries increased from less than $100 billion in 1970 to $1336.6
billion in 1990.22 The two largest borrowing regions were Latin America and
Africa.
Figure 2.7 identifies the major developing country debtors. Note the tre-
mendous size of the debt in countries such as Brazil and Mexico. It is inter-
esting to note that in 1986 South Korea was in third place, whereas it
dropped to tenth place in 1988. A major problem with debt is that countries
have a difficult time paying it off. The debt service ratio, the ratio of interest
payments plus..principal amortization to exports, is quite high, especially in
the western hemisphere. This suggests that countries are not able to use as
much of their export earnings as they would like for economic development.
An increasing share of those earnings is going to service their debt.
As debts rise, crises are inevitable. The first crisis occurred in the inter-
national banking community in Poland in the 1970s. At that time it appeared
that Poland would have to default (not pay its obligations), and many experts
were unsure what impact this would have on the international financial com-
munity. The next crisis came in August 1982, when Mexico, with nearly four
times the debt of Poland, could not fulfill its debt-service obligations. As a
result, it was forced to reschedule principal and interest payments. When a
country reschedules debt, it changes the interest rate of the loan and/or the
timing of the payments of principal and interest. Most of the large debtors,
especially Brazil and Argentina, were in the same position and had to go
through reschedulings at the same time.
In 1987 the crisis, especially among the Latin American debtors, reached
critical proportions. Brazil declared a moratorium on interest and principal
payments to commercial creditors—basically a suspension of payments—ar-
guing that it could not afford the $5 billion in annual interest payments, an
amount that was 12 percent of its federal budget.23 As a result of the high
degree of uncertainty in Latin American loans, many banks set aside large
reserves in case the loans could not be repaid. Banks establish reserves by
reducing earnings and increasing the reserve account. This allows them to
reduce earnings a little each year, especially in profitable years, rather than
waiting for a major default and reducing earnings all at once. This reduction
in earnings is problematic because it also reduces the banks' lending ability
and financial strength.
Latin countries also were trying to create novel ways to reduce the debt
pressure by, for example, converting debt into equity. A debt-equity swap is
based on a foreign lender's exchanging its dollar debt in a developing country
for real assets in that country, such as equity in a local business.
An example of a debt for equity swap is the sale of Aerolineas Argentinas
to Iberia mentioned before. Iberia is paying $260 million in cash and assum-
ing $2.01 billion in debt paper for its 85 percent interest in Aerolineas Argen-
tinas.
The International Monetary Fund has played a crucial role in helping thg_
debtor nations restructure their economics. In country after country the IMF
has recommended strong economic restHcTions as a precondition for receiving
loans from the IMF. These loans are almost a prerequisite for persuading the
international commercial banks to reschedule their loans. Restrictions have
involved a combination of export expansion, import substitution, and ajdras-
tic reduction in public spending. In Mexico, for example, the government
deficit was running at an estimated 17.6 percent of GDP in 1982, and the IMF
gave the government a target of 5.5 to 6.5 percent, a substantial reduction in
government spending.24
In many developing countries, these radical requirements have touched
off heated debate and have sorely tested the political stability of the govern-
ments in power. Once the IMF sets targets, it monitors those targets periodi-
cally as a precondition to releasing funds. The private international banks
olien use the results of this monitoring to determine their policies.
MNE management is concerned about the high debt situation because it
is.dillkull to operate in that type of environment. Imports are often curtailed,
and hard currency is difficult to obtain. In addition, governments might in-
stitute a variety of macroeconomic measures to control debt, including slow-
ing down economic growth, which would have a negative impact on sales
opportunities for firms.
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