Managing Market-based Debt
-
Upload
michel-cames -
Category
Documents
-
view
214 -
download
0
Transcript of Managing Market-based Debt
-
8/3/2019 Managing Market-based Debt
1/13
1
Michel CAMES
Postgraduate Diploma in Development Studies
International Processes of Change and Development
University of Leeds
Essay
1995/96
The alternatives of managing market-based debt and their
prospects
This essay aims to illustrate the alternatives offered to debtors and
creditors alike, limiting its scope on commercial debt, to find an outlet of
the present situation in which the Northern banks and developing countries
are equally locked: the debt crisis which has been on the agenda for more
than 10 years. It attempts this by presenting a general overview of the
policies applied since its outbreak in 1982 and proceeds to introduce themarket-based debt-reduction schemes a la Brady with their particularities.
Then, it presents one less common but the more interesting and forward-
looking scheme: debt-for-nature swaps and the way they are presently
being implemented. The essay continues to shed light on the different
schools of thought when it comes to managing the debt crisis and finally
concludes with a personal statement about the appropriate handling of this
crisis.
The main contention of this essay is that in order to understand and settle
the debt crisis, we ought not only to grasp the ultimate facts leading to the
inability of the developing world to pay back their debt but to view it from a
wider angle and to include the self-interest of Northern banks to contract
debts, the monetarist policies pursued by their governments and the world
wide pattern of trade with decreasing terms of trade for many southern
-
8/3/2019 Managing Market-based Debt
2/13
2
countries. From this point of view, the debt crisis ceases to be a crisis solely
of the South, but it is looked upon as a burden which ought to be shared by
all instigators, including the North.
Since the debt crisis emerged by the inability of the Mexican government to
repay loans due to the private banking system and sovereign lenders, there
have been many attempts to design schemes to solve or at least alleviate
the crisis to the mutual benefit of both the debtor countries and the
creditors.
The main response to the debt crisis in the beginning was the attempt to
reschedule the debts by stretching their maturities in order to give
developing countries more breathing space to grow out of their debt
problems. This containment strategy with a decline in new bank lending set
in soon after the magnitude of the crisis was recognized and lasted until
1985. As Corbridge states, the effects of this strategy on development were
not hard to guess at: most African and Latin American countries began to
underdevelop. In Latin America, development had been sacrificed to
secure the stability of the international banking system (Corbridge, 1993, p
60).
In 1985 then a new debt initiative was announced with the Baker Plan. Its
Adjustment with Growth policy made provision of additional lending from
mainly commercial banks to a handful of severely indebted countries
contingent on market friendly, growth-oriented structural adjustment
programmes being adopted. Debt reduction was not taken into
consideration yet and the limited amount of money and countries involved
made the whole scheme turn out rather deceptive. Only four years later,
the Brady Plan was introduced. It has generally been looked upon as being
more successful. As Oxfam states, it marked a watershed in the
international debt strategy for middle-income countries, belatedly
acknowledging what had long been evident: that a large proportion of
-
8/3/2019 Managing Market-based Debt
3/13
3
commercial debt was unpayable, even with the financial squeeze applied
under adjustment programmes (Oxfam, 1995, p 176).
For commercial debt, concerted debt-reduction schemes have beenintroduced. As the African Centre for Monetary Studies points out, a
concerted debt-reduction scheme is a programme worked out by the debtor
country in collaboration with its creditors with a view to restructuring and
reducing its debt. Most important, it overcomes collective-action problems
such as the equal-sharing clauses and free rider problems whereby a bank
not participating in a debt-reduction transaction can benefit at the
participants cost. The equal sharing clause demands that if a deal is made
with one lender, the same deal must be offered to other lenders in the
consortium. The free-rider problem arises when non-participating creditors
gain as against participating creditors by reaping the benefit of the rise in
the secondary market debt value, which has only be triggered off by the
reduction scheme. According to the debt relief Laffer curve, the value of
expected repayments increases in the same degree than the face-value
debts as long as full repayment is expected. At higher levels of debt,
however, the possibility of non-payment arises and grows, so that the
expected payment line traces out a curve that falls increasingly off the full
repayment line. Beyond some point, the disincentive effects begin to
outweigh the face-value of the debt and the value of expected repayment
actually decreases with increasing debt.
Analogically, with debt reduction the Laffer curve comes closer again to the
full repayment-curve which simply means that the remaining debt will
increase in its secondary-market value to a degree which can even be
higher than before the reduction. This mechanism effectively annuls the
benefits of voluntary debt reduction and prevents it from being launched.
Or, as Jeffrey Sachs puts it: The failure to make real headway with debt
reduction is not an accident. Even when a reduction of the debt burden
would be beneficial to the broad class of creditors and debtors alike, it is
-
8/3/2019 Managing Market-based Debt
4/13
4
unlikely to emerge from the current structure of debt negotiations.
Meaningful debt reduction requires an appropriate institutional setting to
overcome important collective action problems. Instead of voluntary debt
reduction, we need concerted debt reduction (Jeffrey Sachs in AfricanCentre for Monetary Studies, 1992, p 106). The free-rider problem can
also be overcome by building into the schemes a process that turns the
potential cost to the holding-out creditor into a benefit to the debtor. By
requiring creditors who exchange less than a given amount of their debt
through standard options to provide new money, this turns out to a benefit
to the debtor. The creditor speculating to obtain the capital gain of the
secondary market will have his new provided money discounted back to the
new secondary-market price.
According to the African Centre for Monetary Studies, the Brady Initiative
aims at reducing the debt of middle-income countries owed to commercial
banks by using a menu approach, the main elements of which are: 1) the
swapping of old debt for new paper at significant discounts, or with the
same face-value but lower interest rates, 2) buy-backs of the debt at deep
discounts, 3) encouragement of the swapping of debt paper for equity
shares in private or privatised enterprises in the debtor country.
The menu provides the flexibility, whereby the creditor can exercise its
choice on reduction techniques depending upon its own assessment. Thus a
creditor that has a strong presence in the debtor country may find it most
rational to exchange a large proportion of its debt through a debt-equity
swap. A small bank, however, with limited exposure would prefer a
combination of some buy-back and some exchange into lower-interest
bonds or even simply to exit totally through the cash buy-back option.
The debt buy-back operation is the simple buy-back, for cash and at
secondary-market prices, of its own debt by the debtor. Besides the open
buy-back, secret buy back operations are carried out by an agent who
-
8/3/2019 Managing Market-based Debt
5/13
5
buys the debt anonymously on behalf of the debtor. This opens up not only
the possibility of holding the secondary-market price before the purchase
when news of the impending deal would increase the price of the debt, but
also for the debtor to take actions to depress the price artificially on thesecondary market prior to the deal by sending the appropriate signals
such as current budget deficits to the market. This might however
adversely affect future debt-reconstitution negotiations with the creditors if
it becomes public.
With a debt-equity swap, which is a transaction converting the debtor
countrys external debt into equity in a domestic firm, generally a foreign
investor acquires a participation of an enterprise by buying it at a discount
on the secondary market. This participation can be in the private sector or
in the para-public sector that is being privatized as part of the debtor
governments overall privatization programme. Also, a private companys
debt can be exchanged for equity investment in the same company.
Compared to simple buy-back operations, debt-equity conversions have
several additional benefits from the point of view of the debtor, namely the
encouragement of foreign capital flows, risk reduction by replacing debt
with equity, support of privatization programmes and the boost to the
transfer of technology. Also, the repatriation of flight capital can be
encouraged if nationals are allowed to buy into domestic enterprises by this
means.
However, there are some major drawbacks of debt-equity concessions
towards buy-back operations. First, the degree of foreign penetration of the
domestic economy has to be accepted. Second, debt-equity swaps might
only replace investment that would have been made anyway. Then there is
the serious drawback of the misallocation of resources resulting from
distortions caused by subsidies paid to investors through debt-equity
transactions when the foreign investor is allowed to undertake investment
expenditures at a lower cost than his domestic counterparts (African Centre
-
8/3/2019 Managing Market-based Debt
6/13
6
for Monetary Studies, 1992). Apart from debt-equity swaps, there are
numerous other possible combinations of swaps. Among them are debt-for-
nature, debt-for-development, debt-for-trade and debt-for-health swaps.
According to Mahony, 19 debt-for-nature swaps had been completed in tencountries by mid-1991. They implied northern environmentalists buy up
some of the loans which developing countries owed to southern banks and
which were offered at discounted prices and cancel these foreign debt
obligations in return for good behaviour by these countries, which actually
meant making payments in local currency up to the face value of the debt
to a local NGO.
However, there have been two major setbacks in their application. The first
concerns the generally voluntary or isolated action of such swaps. Not
being integrated into a concerted debt reduction scheme, these swaps just
let the remaining debt rise in its secondary-market price and consequently
the debtor countries are often left with an about equal amount of expected
repayments after having reduced the actual face-value debt.
The actual benefit from these swaps goes then integrally to the creditor
banks. Consequently, First World environmental groups have just given
money to First World commercial banks. No transfer has thus taken place
from North to South.
Also is there no guarantee that eventually the local NGOs will be founded
by the government and even if they are, other environmental spending
might be cut to make up the cost.
But even in the case when environmentalists pry out the money of their
governments, they mostly create, enlarge or administer national parks by
merely drawing a line around it on a map and issuing uniforms to a few
rangers. Thus, the natural areas will not be more protected than before as
-
8/3/2019 Managing Market-based Debt
7/13
7
this will not stop poachers, illegal loggers and landless farmers to invade
these areas (Mahony, 1992).
As Miller points out, the critical obstacle is simply that there is no way thatdebt can be reinstated on grounds of non-compliance. Non-compliance may
not be due to a lack of goodwill or of ignorance of the part of any party
involved in the recipient country, but they may be unable to take the
appropriate actions if strong political, economic or social pressures militate
against the desired corrective action. Frontiers are exceptionally tempting.
It is a rare politician that can resist or be strong-armed enough in the face
of pressure from the energy-hungry industrial-urban interests, the hungry
landless, the covetous powerful landlords allied with the mining and timber
barons. Also, pressure for non-compliance is increased when the debt
servicing obligation continue to leave little room for meeting immediate
needs (Miller, 1991).
From a southern point of view, the debt-for-nature swaps do not lead to a
democratic management of natural resources and a better quality of life for
the local population. Instead, it reaffirms the creditors political and
economic domination over the debtors and propagates a development
model which commercializes life in all its aspects. Also do they legitimize
the debt at a time when many indebted countries are putting forward the
idea that the debts were incurred illegally (Mahony, 1992). The Debt Crisis
Network points at one major call of the South: the elimination of trade
barriers in industrial countries, along with the efforts to stabilize commodity
prices (The Debt Crisis Network, 1986, p 44).
This stance is also taken by a strand of purists (Cartwright, 1992) or
advocates of what Corbridge terms the system-instability perspective.
Corbridge quotes Susan George who claims that debt was accrued mainly
because the West and some local elites were able to define the process of
development in initiative terms. This mal-development would mimic
-
8/3/2019 Managing Market-based Debt
8/13
8
without understanding and copy without controlling. She advocates a
strategy for Debt, Development and Democracy (3-D). This proposal
would recognize that debt is not an economic, but a political problem. She
suggests that countries are allowed to pay back their debt over a longerperiod of time in local currency. These payments would then be credited to
national development funds whose uses are determined by authentic
representatives of the people working with those of the state. For the
creditors, this solution would amount to cancellation since the local
currency would be used internally. Towards critics who argue that her
proposals would be utopian, she replies that the international financial
system could now bear the costs of cancellation and in the North ethical-
based movements and export-oriented lobbyists would encourage such a
scheme (Corbridge, 1993). She points out the boomerang effects to the
North in case of a further containment policy: deteriorating environment,
more drugs, lost markets, increasing immigration and rising potential of
conflicts (George, 1992).
Among this school of thought are also the proponents of the radical
repudiation strategy. It is commended as necessary and put forward as a
strategy which refuses to admit the legality of many of the debts
contracted, often by military regimes and which refuses to pay monetary
debts in human lives. This policy found some sort of expression in Peru
when under President Garcia in 1985 a 10 % ceiling on debt-service
payments as a proportion of export earnings was imposed unilaterally.
According to George, this strategy of debt repudiation will not work unless
all debtor countries agree on a total and collective repudiation of debts
(Corbridge, 1993). Indeed, Peru still suffers these days under its former
presidents policy in having to meet a particularly high degree of
conditionality when it wishes to attract foreign capital.
Following Corbridge, a more moderate stance is taken by the proponents of
the system-corrective perspective. They are attached to Keynesianism and
-
8/3/2019 Managing Market-based Debt
9/13
9
consequently aim at limiting the laissez-faire-policy and give priority to
pragmatic and aggregate conceptions instead of individual management.
They are in favour of structural adjustment policies of one sort or another,
but they are wary of the suggestion that from the ashes a new phoenix willarise. They locate a persistent weakness of the containment strategy in its
willingness to assume that an economy in debt servicing difficulties can
grow quickly on the basis of a severe pruning of its assets. Thus a
premature transfer of real resources to the creditor puts the long-run
development of the economy in jeopardy. The alternative is to act
pragmatically and to seek an equitable sharing of the burdens of
adjustment. They also point out that such a sharing has a historical
precedent in past debt crises which have usually ended in some
forgiveness. Consequently, a partial write-down of the debt is the norm,
not the exception (Corbridge, 1993, p 156 quoting Sachs, 1989, p 23). The
neo-classical counterpart of this more pragmatic stance is found in the
system-stability perspective, which suggests, according to Corbridge, that
the international economic and financial system is inherently stable and
that the responsibility for particular debt crises should be shouldered by
those who acted against the norms of economic prudence. As a major
proponent, Bauer argues that the problems of the indebted countries have
arisen from policies that have wasted resources and damaged living
standard and development. He suggests that it should be made clear that
there will be no further funds for countries in default on their debts. A ban
on debt rescheduling will encourage a proper moral fibre in such countries
.... (Corbridge, 1993). Toye refers to this strand as the new vision of
growth and concedes it would contain much common sense which in the
past has often been neglected by policy-makers. He adds however, that it
is but a short step from common sense to uncommon nonsense and
Bauers vision provides an opportunity to study how this short step has
been taken (Toye, 1989, p 88).
-
8/3/2019 Managing Market-based Debt
10/13
10
This perspective of neo-liberalism which attacks the key elements of
Keynesianism and rejects the right of the state to engage in macro-
economic planning had re-emerged into prominence among Northern
governments by the end of the 1970s and was thus to dominate thepolicies of these countries when the debt crisis broke out in 1982. It can
also be asserted that the rise of monetarist policies after 1979, when
money became scarce and interest rates began to rise, was contributing to
the ultimate outbreak of the debt crisis. The main response to the crisis in
the early years was containment, adjustment and austerity, which can be
found in the system-stability perspective.
It was only the inability of this approach which led to more pragmatic
approaches when in 1985 the Baker Plan and then in 1989, the Brady Plan
were adopted. This gradual shift to a corrective stance has been recognized
as a more appropriate approach to dealing with the debt burden even if the
magnitude of the debt relief schemes has been far too modest to cope with
more than a trillion US-$ of international debt. However, as can be
observed in Latin America, the debt crisis is far from over even if the
response of some Brady-style debt write-offs was a boom in private capital
flows to some countries previously at the centre of the debt crisis were now
figuring prominently among the newly favoured emerging markets.
According to Oxfam, a large proportion of this foreign capital is speculative
in nature and entirely disconnected from the real economy. Much of the
explosion in private capital flows represents high-risk and short-term
speculative activity. Such flows have less to do with opportunities for
productive investment and employment creation than with the pursuit of
the fast-buck in money markets (Oxfam, 1995).
All the more it has become clear how necessary initiatives a la Brady have
become. From my point of view, Brady-style menu-based concerted debt
reduction schemes are on the right track to a final settlement of the debt
crisis when it comes to commercial debt as they allow a flexible approach
-
8/3/2019 Managing Market-based Debt
11/13
11
and the free-rider problem is adequately solved. It is this system-
corrective stance which seems the most sensitive and reliable lever to deal
with the debt burden. Nevertheless, it has only been the first step to a
more honest behaviour and still has deficiencies. The future will showwhether the corrective stance, which varies widely in design, will not have
to move further into direction of the instability perspective for the mutual
benefit of all partners. Even if this latter perspective does not seem
acceptable regarding equal treatment as imprudent countries will be
rewarded for their behaviour, we somehow must admit that we do not live
in an all over equal world and to strive for settlement of any existing and
conceived injustices will only lead to turbulence, conflict and war. It is also
in this context that debt-for-nature swaps might eventually become an
opportunity window (Cartwright, 1992). As Cartwright points out, the
value of biological reserves - particularly tropical rainforests - can only
increase as our need for, and our ability to use, genetic materials grows.
Since the wealthier and more technologically advanced countries of the
North would be the first to benefit from the genetic pool, they should be
prepared to pay for its survival.
The main value however of refraining from further tropical deforestation is
the benefit in reducing or bringing to a halt a possible change in global
weather patterns. Since the countries of the North have already largely
devastated their own natural ecosystems and on top of that are by far the
largest consumers of fossil fuels thus producing the lions share of carbon
dioxide which is responsible for the greenhouse effect, they should have a
strong self-interest in supporting effective conservation measures
(Cartwright, 1992). Briefly, it comes down to a right to consume/pollute-
conservation-swap and is currently being implemented in parts of the
globe, however under a differing objective: in order to achieve the
aggregate goal of national carbon dioxide reduction agreed upon at the UN
Conference on Environment and Development in Rio de Janeiro, Northern
countries invest into conservation, reforestation and pollution control
-
8/3/2019 Managing Market-based Debt
12/13
12
measures in developing countries instead of at home because in developing
countries these measures can be implemented at much lower costs for a
given amount of biomass creation or protection regarding none or only
crude pollution control facilities in developing countries compared toNorthern countries industries with already sophisticated devices. This
questionable trick to achieve the highest productivity of capital could
however be combined with the debt burden of the developing world.
Northern countries would invest into the southern environment by merely
freeing developing countries to pay back part or all of their debt. The
reduction or cancellation of debt could thus be able to protect biomass by
the simple means of developing countries not having to finance debt
repayment by once-off environmental degradation activities such as
logging virgin rainforests, let alone the temptation to achieve debt relief by
using their territory as poison-garbage depots. It could allow the
developing world to save their face and the advanced countries to concede
that certain commodities such as water, air, the genetic pool and a
human climate cannot be consumed free of charge only by the more
wealthy part of humans. It would further the commercialization of all
assets, but would help to bend the market system to pay the full cost
(Miller, 1991, p 137). This possible outlook into the future of a further
capitalization of our common natural heritage does not appear like a
heavenly prospect, but yet it could be one possible outlet of growing
environmental conflict potential and the settlement of one of our worlds
crises - the debt crisis.
-
8/3/2019 Managing Market-based Debt
13/13
13
Bibliography
African Centre for Monetary Studies (1992), Debt-Conversion Schemes inAfrica, London, James Currey
Cartwright, John, Conserving Nature, Decreasing Debtin Wilber, CharlesK. and Jameson, Kenneth P. (1973), The Political Economy of Developmentand Underdevelopment, Fifth Edition 1992, p 618 - 630, New York, McGraw-Hill, Inc.
Corbridge, Stewart (1993), Debt and Development, Oxford, BlackwellPublishers
George, Susan (1992), The Debt Boomerang, London, Pluto Press
Mahony, Rhona (1992),Debt-for-Nature Swaps - Who Really Benefits?,The Ecologist 22/3, 1992, Dorset, Ecosystems Ltd.
Miller, Morris (1991), Debt and the Environment, New York, United NationsPublications
Oxfam (UK and Ireland) (1995), The Oxfam Poverty Report, Oxford, Oxfam
Sachs, Jeffrey D. (1989), Developing Country Debt and EconomicPerformance, Chicago, The University of Chicago Press
The Debt Crisis Network (1986), From Debt to Development, Washington,D.C., The Institute for Policy Studies
Toye, John (1987), Dilemmas of Development, Second Edition 1993,Oxford, Blackwell Publishers
Williamson, John (1989), 25 Voluntary Approaches to Debt Relief,Washington D.C., Institute for International Economics