The time bomb that threatens to blow apart Toronto’s economic summit is inflation or, more specifically, the impact of high interest rates on Third World debt. Although that intricate but blunt problem has been touted as a highlight of the visiting prime ministers’ agendas, its solution defies not only their collective wisdom but the laws of economics as well. While the industrialized nations continue to bask in a period of prolonged prosperity, the welfare of the international financial system is seriously threatened by the $1.5 trillion in unresolved loans to the developing countries. Only relatively stable interest rates have allowed the crisis to remain even vaguely manageable over the past three years. Any return of substantial inflationary pressures—now part of every current economic forecast—would send the world’s banking system into a tailspin. The real problem is that about three-quarters of the Third World debt to commercial banks is at floating interest rates. Even minor upward fluctuations would wreak havoc.
Although 121 countries owe the banks money, the largest debtor by far ($148 billion) is Brazil. That obligation is viewed as the most volatile of the lot because, on Feb. 20, 1987, Brazilian President José Sarney suspended all interest payments. He has made few conciliatory gestures since. Third World countries owe Canadian banks $21.8 billion. In the case of the Montreal, Scotia and National, the amount of those loans exceeds the banks’ common equity. The Big Six have so far put away $9 billion against possible losses, with the Royal, Montreal and Commerce each owed more than $100 million in overdue interest payments from Brazil alone.
The Brazilian economic system is complicated enough: the country’s politics almost guarantee that even if the goodwill that has been lacking in the country’s international dealings were restored, the loans will never be repaid. For one thing, Brazil’s domestic inflation rate has been among the world’s highest, reaching triple-digit figures during five of the past 10 years. The monthly increase in the 1987 Brazilian consumer price index went as high as a crazy 1,510 per cent on an annualized basis. Current rents are up by a staggering 974 per cent over last year. Wage indexation laws provide for the government’s own employees to receive
pay increases every month as compensation for rising prices, but when the finance ministry tried to stop that endless spiral in 1986, the Brazilian military ministers quickly moved in to block such reforms.
Most of the debtor nations are caught in a vicious cycle. Their interest payments on old debts dramatically multiply budgetary deficits, often absorbing as much as a quarter of their gross national products. That fans in-
flation, dramatically reduces per capita incomes and cuts production and exports in the long term, so that most of those economies are perched on a slippery slope with not much hope of rescue. Brazil, for one, needs an annual $10 billion just to pay the interest on its debts and yet it cannot borrow more to stimulate international investment (and, as a result, domestic production and incomes) that might follow unless it repays the outstanding loans. During 1987, Brazil’s economic growth fell to
2.9 per cent from 8.2 per cent in the previous year, and 1988 will be worse. Domestic consumption is falling rapidly, with two-thirds of Brazilians reported to be malnourished.
Some of the wounds are self-inflicted. At a time when it should be trying to restore international confidence, the country’s constitutional congress has passed a measure seeking to nationalize foreign-owned mining companies (including the Brazilian holdings of Inco and Brascan) and limiting the rights of outsiders to explore for oil. Despite such macho tactics, Sarney is not a strong leader, and the country’s constituent assembly has recently extended his term into 1989, when direct presidential elections are scheduled. Most of the economy’s troubles are a hangover from the military regime that ruled Brazil from 1964 to 1985, using overseas borrowings to finance its country’s overly ambitious industrialization.
The first phase of the banking community’s efforts to deal with the burden of Third World debt, now threatening their own liquidity, was to extend repayment of principal terms from the original three or four years to 20 years or even more. That turned out to be little more than a holding action. “The next phase,” said Royal Bank chairman Allan Taylor, who has become a leading spokesman on the issue, “is to see the debtor nations return to creditworthiness so that renewed economic activity permits the comfortable servicing of outstanding debts. There must be significant new, long-term lending, granted under conditions of sensible economic policies being adopted by the borrowers, put in place on a case-bycase basis.”
What Taylor and other bankers resent is the notion being pushed by some debtor nations that, well, it’s too bad it had to happen, but why don’t we just write off these bothersome debts and start all over again? “Forgiveness does take place in commercial banking,” Taylor said, “but it marks the end, not the beginning, of a relationship. It is an exit device—a means for a banker to leave a customer, and vice versa. It closes the door to future involvement.”
Unless the Toronto summit produces some miraculous formula that has so far eluded every Third World debt crisis expert, forgiveness may be the only long-term option we have left. And how the world’s economic equilibrium would survive that shock wave is anybody’s guess.
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