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

170. Memorandum of Conversation¹

Washington, May 25, 1984, 7:30–8:50 a.m.

SUBJECT

• Breakfast Meeting on International Debt Crisis

PARTICIPANTS:

• Robert C. McFarlane, Assistant to the President for National Security Affairs
• Jacques de Larosiere, Executive Director of the International Monetary Fund
• Martin Feldstein, Chairman, Council of Economic Affairs
• Roger W. Robinson, Senior Director of International Economic Affairs, NSC

Mr. de Larosiere initiated the discussion with a rather lengthy review of progress to date concerning the IMF’s management of the international debt problem and where he sees the process going. He made the following points:

— Things in general are going better than they were one year ago, but the debtor nations have not yet “worked through the process.”

— The debtor countries are understandably fed up with negative growth. Mexico, Chile, and Peru are all demanding more growth.

— The IMF projects a $25–26 billion increase in imports by the debtor nations between 1985–86.

— One year ago, the international financial system was near collapse. Now the system is better equipped (IMF reinforced), more resilient and better organized. Very complicated packages (i.e. $6.5 billion for Brazil late last year) have been successfully concluded.

— Important to note that it was the countries themselves that recognized the need to maintain “negative” austerity measures and that the days of living off of borrowed resources were over.

— Currently the problem is the lag in the general perception that things are going better (tested debt strategy, improved economic environment, better debtor understanding). This perceptual lag is shared by many in the banking community.

— In addition, “lines of demarcation” have been drawn between the commercial banks. The European banks have made better provisions for loan losses than the U.S. banks which have “insufficient provisions.” This is largely attributed to their (U.S. banks) “short term concept of their profit positions.”

Mr. de Larosiere went on to describe the aspects of the debt problem which he is “worried about.” These concerns include:

— Interest rates—“The U.S. economy is booming and causing tension on money markets due to your high deficits.” He stated “so far interest rates are digestible.” The Fund projects higher exports from the debtor countries in spite of the recent increase in rates.

— An interest rate cap “is not that overwhelming a problem.” Fund cannot, however, become “paralyzed” by interest rates even if they should become indigestible.

— The Argentina situation is serious—“the one big uncertainty—all others have come in.”

— The Fund has been holding discussions with Argentina since the start of the year. Their excuses for not coming to terms with the Fund “no longer wash.” Finance Minister Grinspun is the major player, but he cannot forge a consensus. “Technically (Argentina and the Fund) are very close.”

— There is uncertainty concerning whether Argentina has the political will to “play the game”. Many in Argentina take an irresponsible attitude and argue, for example, that Argentina should unilaterally declare that x percent of their export earnings will be used to service debt. Argentina is therefore “not lost but questionable”.

IMF Strategy for Mexico and Brazil

— Turning to Mexico, de Larosiere termed it “the one country performing very well”. The Fund’s objective is to move ahead now and get Mexico back on the credit market “under their own strength”.

— Mexico has no new money needs for 1985 but will encounter a debt amortization problem in the area of $10–12 billion annually in 1985 through 1987. Therefore, de Larosiere will propose a multiyear rescheduling for Mexico to permit them “to regain access to the market”. He will use a prestigious banking conference in Philadelphia on June 4 to go public with this proposal. He talked very recently with President de la Madrid about this scheme (a 4–5 year multiyear rescheduling). President de la Madrid responded “absolutely—we must work together”. Silva Herzog (Mexican Finance Minister) will work with Mr. de Larosiere in getting this done.

— Brazil—Mr. de Larosiere went through the background of Brazil’s problem and concluded by quoting Delfim Netto (Minister of Planning) as stating “we have a booming economy”. Inflation remains a problem. He linked Brazil to the Mexico strategy stating that if Brazil stays on track until autumn, it would be the second candidate for a multiyear rescheduling. The broad objective is “to get Mexico and Brazil under control—that doesn’t make everything better but it’s like isolating sectors in fighting a fire. You limit the damage and avoid a catastrophe.” He stated that the Fund may need to isolate Argentina.

— Argentina—de Larosiere stated, “the IMF cannot accept a weak program—its credibility is at stake.” Argentina will encounter a “credibility” problem in trying to form a debtors cartel. At the same time, “we cannot let a nervous situation develop into a cartel—by all means we must avoid that.”

Mr. de Larosiere briefly mentioned the financial conditions of other countries:

— Chile—agreed to comply with the Fund program—“things are not too bad.”

— Brazil—in autumn a new money package for 1985 must be raised but it will be “nothing like the $6.5 billion of last year—it should have the effect of containing things.”

— Venezuela—has not yet approached the Fund. Problem is that the restructuring of its debt was too short-term. He stated “banks would be more comfortable if Venezuela was doing the right things.” The Fund may seek a “very discreet way to help the banks successfully restructure Venezuela’s debt.”

On the interest rate cap, Mr. de Larosiere continued:

— He stated concern over the “polarization” caused by interest rates. “We have no offer on an interest rate cap yet on the table.”

— He remarked, “If there were to be a further hike pushing interest rates substantially higher, we would have to reconsider the chemistry and fabric of the programs and that would be very difficult.”

Mr. de Larosiere cited four types of caps:

— One approach would be “to put more money in the (financial) packages to cope with the excess interest cost above a certain level—we were on the verge of that last year with Brazil.” This may be the easiest approach as it can be implemented at a time when countries negotiate a new package and would require no change in the system—“only increase the envelope.” The con argument is that the countries incur more debt to be serviced in the future.

— The second approach “is the more ambitious pure cap.” This would entail a fixed interest rate at a certain reference point with the understanding that if rates go higher the debtor countries pay that amount and no more. De Larosiere termed this approach the “most radical” and indicated he does not believe “there is any chance banks will swallow that.” He referenced having talked to the banks and there having been a consensus that this would be a destructive approach for the banking community.

— The third approach involves a fixed maximum interest rate, with a view toward placing a ceiling on cash payments by the debtor countries. The excess interest would be converted into capital and added on to principal at the end of the loan. He stated, “that is workable—it is not unlike the first approach but may have more appeal politically”.

— Finally, the fourth variety of “cap” would be for international or government institutions to provide a guarantee against moves in the interest rates to keep rates low. He stated “this would be politically difficult as it would be bailing out banks.” The Fund has no compensatory fund to finance this approach.

A discussion followed Marty Feldstein’s explanation of the third approach to the interest “cap”:

— Feldstein stated that Mr. Preston (Chairman of Morgan) was prepared to endorse this third approach.²

— de Larosiere questioned if Preston would do it for one year or on a multiyear basis. When Feldstein responded it would be acceptable on a multiyear basis and the U.S. regulators could live with this development, de Larosiere stated “this is very interesting”. He stated he would talk to Preston.

— de Larosiere stated that the Fund could deal with a further 1% increase in interest rates. Robinson responded that even a ½% move in this highly charged environment could be very serious and result in just the kind of irresponsible unilateral or collective action by debtor countries that we all seek to avoid.

— de Larosiere agreed that this was indeed possible and that perhaps the Fund was not accurately assessing the political environment. Mr. McFarlane inquired about an IMF move toward more growth-oriented programs. Mr. de Larosiere responded that “two-thirds of the Fund’s thirty-six clients were now expected to grow in 1984–85”.

— Going back to our preferred approach to a cap, de Larosiere stated “Citibank doesn’t like it”. He believes Citi’s principal concern is that this concept could eventually spread to the capitalization of new money. This would be appealing to European banks which would prefer a shift toward capitalization “even for new money”. Countries would then be tempted to try to fix unilaterally the amounts of new money to be capitalized and the amounts they would agree to service.

— de Larosiere seemed to initially share Citibank’s concern that the process of fixing a cap and capitalizing the remainder was rather arbitrary and debtor countries would be tempted to make their own rules. Mr. Feldstein corrected this view by stating that there would be sufficient discipline imposed by U.S. bank regulators so that this would not represent a problem.

— Finally, Mr. de Larosiere stated that some bankers favor such a cap because they prefer not to have to go back to their Boards to justify new money for some of the countries. In addition, he cited Citibank’s other concern that a cap may be a recipe to move countries even further from restoring market conditions. Mr. Feldstein also addressed this issue by stating that the type of cap under consideration would be market-oriented and compatible with a return to the market when appropriate.

1. Source: Reagan Library, Roger Robinson Files, Chronological File, Robinson Chron May 1984; NLR–487–11–6–17–5. Top Secret. The meeting took place at Feldstein’s residence. Drafted by Robinson. Sent under a May 31 covering memorandum to McFarlane, in which Robinson wrote: “As per your request, attached is the memcon on our breakfast meeting at Marty Feldstein’s. This represents as detailed an account of the proceedings as I could muster from hastily scribbled notes under the table. If anything, I erred on the side of detail, as this was a very important session that will help guide us through the troubled months ahead. I hope it is useful in dealing with this issue in London.”
2. Reference is to Lewis Preston, Chairman of J.P. Morgan and Company.