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

186. Briefing Memorandum From the Acting Assistant Secretary of State for Economic and Business Affairs (Constable) to Secretary of State Shultz¹

Washington, August 30, 1985

SUBJECT

• Thoughts on Treasury’s Debt Strategy Paper

This paper gives you our general thoughts on the debt strategy and specific comments on the Treasury paper.² We have focused particularly on how growth fits into the overall strategy.

We need to devise ways both to present our strategy as being more growth oriented, and to make it so. The first objective is as important as the second in that most observers don’t accept the idea that properly-designed adjustment programs (whether IMF prescribed or otherwise) are meant to encourage the diversion of resources out of non-productive activity and into productive enterprise. When done right, that process does not cause austerity but adjustment to permit sustainable growth, and we need to find the right rhetorical keys to make this point.

Indeed, if the process is to work, growth and adjustment must come together. At the outset adjustment is painful, but if strong measures are implemented rapidly then longer-term structural adjustment can take place in an environment of sustained growth rather than recession. Simply easing external financial constraints can lead to a temporary uptick in economic activity, but growth can be sustained only where countries are willing to open up sheltered markets and overhaul mechanisms of production. While that type of adjustment usually involves serious political costs, it can proceed more readily in growing economies. Resources can be shifted more easily when there is alternative employment, and political opposition is more manageable in an environment that promises rising standards of living in the foreseeable future.

We make these points not because they are new, but because Treasury’s paper seems to proceed from a very different premise—that the name of the game is simply to find new sources of financing in order to avoid political fallout. It would be counterproductive to abandon the focus on economic adjustment. Treasury’s paper cites “growing resistance” to adjustment—yet over the past year many previously recalcitrant debtors have in fact begun to come around. Looking outside Latin America, we have the spectacle of a Nigerian coup replacing a corrupt, economically incompetent leader with one who calls publicly for devaluation and an IMF program.

To the extent that important debtors do face “growing political opposition” or “inadequate growth” after years of IMF and US-assisted stabilization programs, the problem is primarily traceable to the excessively slow pace of structural adjustment. Halting and uneven programs have to be continually tightened, while countries which take aggressive measures early can get the worst behind them quickly.

Rapid adjustment is not only optimal, but without it Latin America will be unable to cope with any future turn for the worse in the global environment. Treasury’s paper cites the danger of future interest rate increases as a reason to rethink an adjustment-oriented strategy—but the fact is that interest rates this year have been lower than anyone really expected. What strikes us as significant is that some key debtors have been so badly-positioned to take advantage of this, because they have left so much undone. What we need are not new ways to finance slower adjustment, but new “rewards” for good performers which will provide incentives for rapid adjustment and then permit long-term structural adjustments to continue in the context of growth rather than recession.

There are a number of the specific ideas in the Treasury paper that parallel our own thinking, but others that seem counterproductive. It is important to agree at the outset that no measures requiring significant USG appropriations are feasible unless we actually enter a violent, destabilizing crisis. The probability that Congress would fund a “bailout” was always small and it has diminished over time. We also believe that any new ideas should be capable of being targeted specifically on countries willing to take strong steps to help themselves; we should be wary of setting in motion a dynamic that favors “least common denominator” programs. On specifics:

Banks and regulation: We’re not sure it’s factually correct that new lending is “increasingly difficult.” It always was; and the Chilean and Colombian packages, while we spent a lot of time on them, had lesser elements of pressure and official financing than early, large packages. There has been recently a troubling tendency of banks to seek “every nickel” from other sources, creating some potential problems for the IMF, Paris Club and our bilateral assistance while at the same time hiding behind regulators—but this is a much smaller problem, largely tactical in nature.

It is probably a good idea to work with a regulatory group toward possible changes, but with the following caveats:

— We like the idea of “tailoring regulatory criteria to more accurately reflect potential economic performance and risk” and particularly the ideas in section A of the Treasury paper.

— While the notion of increasing incentives for new bank lending addressed in Section C is intriguing, we doubt the legality of selective write-offs since creditworthiness inheres in the borrower not the lender.

— We have grave reservations about capitalization of interest payments because it is such an uncontrollable precedent. Unless somehow compartmentalized as part of an interest-capping arrangement, interest capitalization essentially turns exposure to junk.

— We believe an even more important substantive step might be to improve means of communication in order to force banks to make decisions on their own merits rather than hiding speciously behind the regulators.

The World Bank: We believe the Bank should be the primary focus of changes in our overall strategy (although not the primary focus of the strategy itself). We need to be clear, though, why we are turning to it. We have urged expansion of the IBRD role for some time because it’s a more politically acceptable stalking horse for strong conditionality, because it has substantial untapped resources, and because we are dubious about the utility of “traditional” IBRD loans in the medium-term future. We are not, however, interested in weakening the structure of the organization (i.e. looting it so we have to later either abandon or rebuild the shell). That attitude leads to the following specific comments:

— Exposure purchase makes no sense to us as IBRD operations depend on its credit rating. Having banks take a hit immediately so IBRD can assume the risk of future repayment is not appealing.

— Similarly an expansion of IBRD guarantees makes sense, but only if we can keep them reasonably project-related. Since, as the paper hints, there is little way to assure additionality we shouldn’t have IBRD assuming enormous risk.

— We should, however, be looking quickly for ways to present a clear set of signals to the Bank that we want to see increased policy related lending, are prepared to look at temporary expansions of lending authority on the way to a GCI, and are prepared to look at expanded country loan limits. A separate memo from EB and S/P provides some additional ideas.³

1. Source: Department of State, Executive Secretariat, S/S–I Records, The Executive Secretariat’s Special Caption Documents, Lot 92D630: Not For The System: August 1985. Secret; Sensitive. Not For the System. Quinn initialed the memorandum and wrote “8/30.”
2. A draft of the Treasury paper, entitled “The International Debt Strategy: Appraisal, Key Problems, and Possible Measures to Strengthen the Strategy,” is attached but not printed. An updated version of the paper is printed as Document 185.
3. Not found.