Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

142. Memorandum From the President’s Assistant for National Security Affairs (Clark) to President Reagan¹

Washington, undated

SUBJECT

• NSSD–3–83 on US Approach to the International Debt Problem

Issue

The study ordered by you in NSSD–3–83 on the international debt problem has been completed² and the accompanying NSDD awaits your signature.³ As the debt problem is continuing to gain momentum and become increasingly unpredictable, you are presently scheduled to receive an NSC staff briefing on June 16 covering the dimensions of the problem, how it developed, why the US should be concerned and what we are doing about it.⁴ There remain substantially different views among the agencies concerning the gravity of the problem and the adequacy of our response and contingency planning. This memo outlines some of the fundamentals in the way of background.

Facts

The amount of debt overhanging the LDC debtor countries is enormous. The combined medium and long-term debt of the LDC’s and East European countries grew from only $55 billion in 1970 to $625 billion last year. In addition to this longer-term debt, these countries have about $150 billion in short-term debt. The aggregate annual debt service requirements for these countries increased correspondingly from $9 billion in 1970 to an estimated $140 billion in 1982. While the size of annual debt service was rapidly rising, the foreign exchange earning ability of many of these countries was deteriorating. For example, the drop in prices of industrial raw materials became particularly sharp beginning in 1980. At the same time, oil prices surged upward once again adding to LDCs’ import bills. Finally, a crisis of confidence among international lenders began to result in a cut-back in debtor’s ability to attract new funds for debt service purposes. These facts taken together have resulted in situations like Argentina, where the equivalent of 100% of its export earnings are dedicated merely to the servicing of debt. Traditionally, a debt service to export ratio of more than 20% was viewed as worrisome.

In 1975 only 15 countries were listed by the IMF as being behind in payments amounting to $1 billion. This figure jumped to 34 countries in 1982 with arrearages amounting to $19 billion. Some 46 countries presently are operating under or negotiating IMF adjustment programs. This is one-third of the fund’s membership with total debt of over $375 billion (60% of total LDC and East European medium and long-term debt).

The crux of the problem for the US is to enable these troubled countries to adjust to the reality that they can no longer finance deficits by borrowing as they did in the past. This adjustment must be gradual. A sudden cut-off of funds which severely erodes living standards without allowing progress on resolving underlying economic difficulties could cause a backlash against western governments and financial institutions. The debt problem could also slow the pace of economic recovery in the US and other industrialized countries due to the adverse impact on trade. It could also increase the already substantial risk of political instability in a number of key countries particularly in Latin America.

Discussion

Agencies are divided concerning whether the debt situation described represents a temporary liquidity problem which can be adequately dealt with by the present ad hoc, case by case approach or represents an emerging structural problem potentially requiring a more systematic response including detailed contingency planning. Treasury, State, and OMB view it as the former (liquidity), whereas NSC, CIA, DOD, Commerce, and CEA generally view it as the latter (structural).

Norman Bailey recently returned from the annual International Monetary Conference in Brussels and reported that European banks have already created reserves against 25% of total LDC and East European loans.⁵ If accurate, this is a very large set-off. In contrast, Japanese banks are estimated to have reserved against only 2–4% with a similar amount by US banks. Therefore, were a major debtor(s) to suspend all payments for an extended period, (which, according to some European bankers, could take place this summer) the European banks would be in a relatively good position to absorb the crisis and ours would not. According to this European scenario, they expect the Federal Reserve to step in and prevent the failure of some large US bank(s) by floating the problem away by a massive injection of liquidity into the system (potentially creating a new inflationary spiral in the US). In the meantime, several European banks continue to withdraw funds from the interbank market and increase loan loss provisions. If the European banks are genuinely acting on the basis of this unrealistic set of assumptions, it could be very dangerous and result in a self-fulfilling prophecy. Our banks are, for the most part, maintaining their foreign loan portfolios at full value rather than sacrificing some part of their liquidity and profits to adequately shore up their provisions for loan loses should the worst occur. To illustrate this problem, by 1982 the nine largest US banks had lent 140% of their total capital and reserves to the four major Latin American debtors alone and over three times their capital and reserves to all LDC borrowers.

In collaboration with other governments, central banks, commercial banks, and international agencies, especially the IMF and Bank for International Settlements, we are presently dealing with the debt problem on a case-by-case basis involving the following five elements: economic adjustment by the debtor countries; strengthening the IMF by increases in quotas and the General Arrangements to Borrow (GAB); readiness of monetary authorities to provide short-term liquidity support when necessary; encouragement to commercial banks to roll-over maturing loans, maintain credit lines, and provide new money; and general non-inflationary economic recovery and continued access to markets. The NSSD concludes that thus far, this five-part strategy has worked. Nevertheless, no quick solutions are possible, and many questions remain.

For example, we estimate $5–15 billion in additional funds will be required this year for the same debtors. The sources of these new funds are not entirely clear at this time. In addition, there are at least five medium to large debtor countries that the CIA predicts will fail to comply with their original IMF performance targets in 1983. Brazil is already in this delicate situation and will not be eligible for further IMF or commercial bank disbursements for about 30 days. Finally, nine debtor countries have already taken various kinds of unilateral actions on debt repayments (suspension of payments, declaration of limited moratoriums, etc.) and the temptation or necessity for the LDC debtors to take further such destabilizing actions is, in our view, increasing.

1. Source: National Security Council, NSC Institutional Files, Box SR–073, NSSD 3–83. Confidential. Prepared by Robinson. A stamped notation reads: “The President Has Seen.”
2. See footnote 3, Document 131.
3. See Document 143.
4. According to the President’s Daily Diary, Reagan participated in an NSC meeting on June 16 from 11:01 to 11:48 a.m. (Reagan Library) Minutes of this meeting have not been found. Briefing papers for the June 16 NSC meeting on international debt, including the staff presentation on the international debt problem, are in the National Security Council, NSC Institutional Files, Box SR–103, [Untitled folder].
5. In a May 20 memorandum to Clark, Bailey reported on his attendance at the International Monetary Conference in Brussels. (Reagan Library, Roger Robinson Files, Subject File, International Finance: 05/01/1983–06/30/1983)