Chapter 13Balance of Payments – Deficits and

Debt

Debt Crisis of 1980’s

• Find information on current account and

capital account (IMF or Wikipedia)

• External debt is accumulated when

o Domestic saving rates are low

o Current account deficits are high

o Imports of capital are needed for

industrialization

• Debt servicing costs are high

Dimensions of LDC debt burden

•Debt to GDP ratio

Debt-service ratio (as a % of exports)

1970 13.3

1980 24.4

1990 37.8

2000 37.3

2005 28.7

1970 13.5

1980 13.2

1990 9.4

2000 23.0

2005 14.9

Reasons for debt-crisis (1980’s)

• Oil-prices high during 1974-1979• Growth rates in DC fell affecting outward looking

policies (export) of LDC’s• Fear of painful stabilization policy – avoided IMF• Heavy borrowings from commercial banks and

private sector lenders• External debt of LDC’s doubled from $180 billion

(1975) to $406 billion (1979)• 40% of the debt was non-concessional• Countries affected – Brazil, Argentina, Mexico –

IMF Stabilization Program

Asian Crisis of 1997

• Property bubble• Banks failed• Currency values fell by 33%• IMF bailout of South Korea, Thailand,

Indonesia ,and Philippines

Basic Transfer Equation

FN = dD(13.1)

Where, FN = net capital inflowD = total accumulated foreign debtd = rate of increase of total debt

BT = dD = rD = (d – r) D

BT = Basic TransferrD = total interest payments

Thus, basic transfer is simply the net capital inflow minus interest payments

BT will be positive if d > rBT will be negative if r > d

Basic Transfer Equation

• In the early stages of debt accumulation,oLDC’s D and d are high oMost of the debt come from official sources like

IMF, so r is low and BT is positive

• In this stage accumulation of debt will not pose any serious threat as there is positive capital flow which can be used for productive development project earning rate of return higher that interest rate (r)

• In the later stageoD is too large, d slowly fallsoMost debt comes from commercial banks and private sector lenders, r is high and BT is negative

Six Factors

In the later stage, d is low and r is high for the following reasons

1. Very large D, d declines as amortization rises2. Switch from official to private sector lenders,

resulting in high r3. Adverse terms of trade and balance of payment

deficits4. Global recession, oil-shock5. Loss of confidence in currency of LDC’s6. Capital flightThus, debt crisis becomes self-reinforcing