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Managing the less developed countries' debt problem Orie, Kenneth Kanu 1989-12-31

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MANAGING THE LESS DEVELOPED COUNTRIES' DEBT PROBLEM BY KENNETH KANU ORIE LL.B. The University of Benin, Nigeria, 1986 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS in THE FACULTY OF GRADUATE STUDIES (FACULTY OF LAW) We accept this thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA September 1989 @ Kenneth Kanu Orie, 1989 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department of The University of British Columbia Vancouver, Canada Date DE-6 (2/88) ii ABSTRACT MANAGING THE LESS DEVELOPED COUNTRIES' DEBT PROBLEM The underlying problem in debt management has been the allocation of the global adjustment burden between the creditors and the debtors and to make them less sensitive to the colossal economic sacrifice attendant to the adjustment. The Brady Plan seems to strike a balance between the opposing interests of the parties involved. But the question of whether such a balance can be sustained in the long run is still open. All the debt management strategies evaluated in this work seem inadequate in so far as they could not abate the recurrence of the problem. But they nevertheless, appear to be the best that can be offered in the face of the reality of the world economic situation. The susceptibility of the Less Developed Countries (LDCs) to foreign indebtedness is rooted in the poor structure and relatively undiversified nature of their economies. Thus the economic growth of these countries seems a panacea to the debt problem. To this end, the LDCs have to ensure that their economies undergo vigorous economic reforms congruent with the present and prospective realities of the world economy, aimed at lifting supply constraints, attracting foreign iii investments and encouraging debt-equity swaps which seems to be making a considerable inroad to effective debt management in that it saves debtor countries steep foreign exchange commitment needed for international trade and debt servicing. The economic interdependence of nations makes the success of this strategy contingent upon a 3% minimum GDP growth rate in the industrialized countries to generate not only good market for LDCs1 tradeables but also to forestall exogenous factors that promote the recurrence of the problem. Clearly, this matter is not within the province of international law. The problem is basically economic and must be practically handled and resolved in the same context. In the context of the debt problem and management, international law cannot make possible what is economically impossible. Debtors are therefore advised to save themselves the problem of international indebtedness by matching expenditures with available resources at all times while the creditor countries themselves tamper their economic policies to check the exogenous factors which promote the recurrence of the problem. IV TABLE OF CONTENTS PAGES ABSTRACT ii - iii TABLE OF CONTENT iv - vi ACKNOWLEDGEMENT viINTRODUCTION viii - XX CHAPTER ONE THE ORIGIN AND CAUSES OF THE DEBT PROBLEM 1 I Internal Causes Of The Debt Problem 1 - 4 II External Causes Of The Debt Problem 4-10 CHAPTER TWO A. INTERNATIONAL MANAGEMENT OF THE DEBT PROBLEM 11-23 I The Role Of The IMF In Debt Management 2 3 - 32 II The Impact Of The IMF Adjustment Program - 32 - 37 III The Role Of The World Bank In Debt Management 37 - 46 IV The Role Of The London Club In Debt Management 46 - 48 a) Refinancing And Rescheduling Of Commercial Debts In The London Club 48 - 53 V The Role Of The Paris Club In Debt Management 54 - 61 V B. DEBT-EQUITY SWAPS AND FOREIGN INVESTMENTS IN THE MANAGEMENT OF THE DEBT PROBLEM 61 I Debt-Equity Swaps 61-65 II Foreign Direct Investment 65 - 66 C. DEBT MANAGEMENT CONSTRAINTS 67 - 70 D. EVALUATION OF THE DEBT MANAGEMENT STRATEGIES 70 - 79 CHAPTER THREE INTERNATIONAL LEGAL REGIME OF DEBT MANAGEMENT 80 - 86 I International Law And The Debt Problem 86-88 a) The Doctrine Of Fundamental Change Of Circumstances 88-91 b) The Doctrine Of Force Majeure 91 - 92 II Loan Transaction Between Creditor And Debtor Governments • 92 a) The Application Of The Doctrines Of Changed Circumstances And Force Majeure To International Loan Transactions 92 - 100 b) The Doctrine Of Odious Debt 100 - 102 II Loan Transactions Between Foreign Private Creditors And Debtor Countries 102 - 104 III Sovereign Immunity Defense For A Debtor In Default 104 - 110 IV The Act Of State Doctrine Defense 111 - 113 vi V Expropriation Of Debt 113 - 116 VI Legal Effects Of Some Clauses In International Loan Agreement And Their Impact On Debt Management 116 - 121 CHAPTER FOUR DEBTORS' RESPONSE TO THE DEBT PROBLEM AND THE QUEST FOR A NEW INTERNATIONAL ECONOMIC ORDER 122 - 131 CONCLUSION 132 - 137 APPENDIX A 8 Table 1 Performance Of Selected LDCs In Respect Of the IMF Adjustment Program 1970-1985 138 - 139 APPENDIX B 140 Table 2 LDCs: Debt And Debt-Service Ratio - 1980-1987 140 - 142 BIBLIOGRAPHY 3 - 151 vii ACKNOWLEDGEMENT I owe immense thanks to the only living and most high God, the father of our Lord and Saviour Jesus Christ without whose grace and strength I could not have been able to conduct my research and complete this work. I thank my supervisors, Professors Chris Thomas and D. Copithorne for their expertise and unflinching cooperation in directing the course of this work. I also thank the UBC Main and Law Libraries for Providing me with research materials. viii INTRODUCTION When in 1982, Mexico declared a moratorium on the payment of its debt, the world began to appreciate and address in a greater dimension the magnitude of the international debt problem. The problem has adversely affected the standard of living of the Less Developed Countries (LDCs) of the World so much so that something needs to be done to arrest or bring the problem to a manageable level. In keeping with this goal, therefore, one is quickly saddled with fashioning a better way of addressing this concern. In as much as one is mindful of the efforts of scholars in dealing with and appraising this subject, needless to say that it is safer not to underestimate the problem or proceed on the premise that it is amenable to a rhetoric solution. Owing to the economic interdependence of nations, hardly can any one nation, irrespective of its wealth and economic management skill, be free from one debt obligation or another. Therefore, debt simplicita without adverse economic consequences on the standard of living of the people is hardly a problem. This work is not concerned with such debt. The primary focus of this work is debt which exceeds a manageable level and ix graduates into a crisis proportion, derogating from a reasonable standard of living of the people concerned. Perhaps it is important to add that the most important question is not how to deal with the debt already incurred, but rather how to abate the recurrence of the problem. The strategy of incurring more debt with a view to enhancing the economic development of the debtor LDCs and consequently, enable them pay off both the original and additional debts is often aborted by world economic recession. Thus viciously, debt is incurred to service debt. It is only reasonable and realistic to canvass for a bias-free and workable strategy to managing the problem. Although striking a balance between the interests of the creditors and the debtors explains the whole lot of the difficulties in a solution to the problem, efforts nevertheless, have not relented or waned in trying to bring creditors and debtors to terms of mutual understanding, help, commitment and cooperation in dealing with the problem. Interestingly, it has become a lesson that the demise of the debt problem is for a common good. Since this work is looking at the debt problem from the perspective of the LDCs, it is pertinent to mention at the outset that there are different X categories of LDCs. There are poor and rich LDCs. There are even richer of the rich for example, Saudi Arabia, Kuwait and South Korea etc. The poorer of the poor include Burkina Faso, Cape Verde, and Somalia etc. Keep in mind that the economic base of each LDC determines i which category it belongs. ^. The product composition of trade of each of the LDCs has always determined the impact of relative price changes on terms of trade, while the composition and size of external debt has determined how far the debt burden has risen in response to increases in national interest rates. The degree of balance of payments adjustment required to offset the impact of declines in terms of trade or increases in debt service payments has varied widely among the LDCs even when they have the same foreign exchange losses relative to their UNCTAD TD/328/Add.l (April 13, 1987) p.34. The growth rate of Asian LDCs fell from an annual average rate of 4.7% in 1973 - 79 to 3.1% in 1980 -85; that of Latin American countries fell from 4.7% to 1.0% during the same period; while that of African countries fell from 2.7% to 1.0% also during the same period. Performance among different groups of LDCs also varied. The major petroleum exporting countries suffered drop in growth rates by 7.1% points from 5.9% to -1.2%, whereas the declines were 4.4% points for the major exporters of manufactures; 2.9% points for the poorer LDCs and 1.8% points for the remaining LDCs. xi Gross Domestic Product (GDP). The reason is because of the differences in their export bases.2 The different categories of LDCs is also owed to the fact that they differ in their underlying potential for adjustment owing to differences in the size and diversity of their tradeable goods sectors and the level of income consumption and investment, as well as the over all size, geographic location, climate, natural resource base and population. Moreover, the domestic policies of the LDCs have been significant in determining the extent to which external shocks have affected their economic performance. Some manage their economies better than others. Generally, vulnerability to financial shock seems to have been greater where increased indebtedness has not been adequately matched by export growth. In other words, countries at higher level of economic development have always been better equipped to contain external shocks than the low-income commodity-producing LDCs. While it is important to keep in mind the different categories of LDCs, this work does not address on a case by case basis, the problem and management of the LDCs' indebtedness. Rather, it sees 2 Id 3 Id xii and addresses the problem as one common to all the LDCs by reason of the fact that certain fundamental factors underlying the problem are common to all the LDCs regardless of categories. The most outstanding of the fundamental factors are the unequal bargaining power and poor economic base of the LDCs relative to their counterpart developed countries. Nevertheless, where necessary some LDCs are mentioned. Again, in so far as this work acknowledges that there might be some differences in the debt management strategies suitable to each LDC depending on its peculiar economic problems, base and performance, it however maintains that there are certain strategies which may be applicable to LDCs in general, for example, matching expenditure with available resources and no more. There seems to be a consensus of opinion among writers that a country needs foreign capital to achieve and accelerate economic growth so as to increase future income, repay its loans and improve the standard of living of its people. Australia, Canada and New Zealand are often cited as countries that have succeeded in this way.4 Indeed the LDCs need foreign loans for 4 Jones, G.S. and Sunkel 0., Debt and Development Crisis in Latin America: The End of An Illusion. Clarendon Press, Oxford 1986, p.34; Barth, J.R., xiii economic development. Most LDCs are primary commodity producers. They do not have diversified economies. Thus they are more susceptible to incurring foreign debts for economic development. But the problem is with the management of the foreign loans and some external factors which militate against the economic ability of the LDCs to pay off these loans. The commercial banks, in making most of these loans, failed to exercise some lending discipline. They were not mindful of the economic ability of each debtor country to repay the loans. When therefore, the LDCs could no longer service their debt as expected, all the creditors quickly adopted measures to protect their interests. The official creditors have shifted from concessional (soft term) lendings to non concessional lendings to the LDCs because they want to minimize the effect of a default. The commercial banks have also shifted from voluntary (increased exposure) lendings to involuntary lendings to the LDCs in order to circumvent huge losses in the event of a default and consequently protect the interests of their shareholders and depositors, who otherwise may lose confidence in them. The LDCs, on and et al, Understanding International Debt Crisis.19 Case W. Res. J. Int'l Law 1987, pp. 31-52. xiv the other hand, while demanding more loans from their creditors in order to finance economic growth and consequently be able to service their debts on a regular basis, do not want to undergo the ordeal of the IMF adjustment programs (a condition precedent for granting of new loans and rescheduling of old loans) because they fear the program might not be politically tolerable. International debt having emerged, the issue of the proper framework within which to appraise its problem and management emerges even clearer. Sergio Amaral rightly opines that what is at stake in achieving economic growth in the LDCs and solving the debt problem, is the sharing of the burden of global adjustment among the creditor governments, the commercial banks and the LDCs.5 To reach a compromise of these major conflicting interests is the central issue in the management of the international debt problem. The issues to be addressed in this work are manifold. They include the adequacy of the current international debt management strategy, the role of the International Monetary Fund (IMF),the World Bank, the 5 Amaral,S., The Foreign Debt from Liquidity Crisis to Growth Crisis. 19 Case W. Res J. Int'l Law. 1987 pp. 17 - 30. XV Paris Club (creditor governments) , and the London Club (commercial banks) in the management of the problem, the part of international law in dealing with the problem, the debtors' attitude to the problem and the guest for a New International Economic Order. This work is divided into four chapters. Chapter one dwells on the origin of the debt problem. At independence the LDCs engaged in development competition with the developed countries. Though the idea was to attain a viable economy and consequently improve the standard of living of their people, the mismanagement associated with it has become one of the greatest causes of the debt problem. The demand for foreign loans by the LDCs for economic development gave the commercial banks the opportunity to lend the huge deposit of petrodollars by OPEC in the oil boom days in 1973/74 and 1979/80. Thus the gate was opened for the emergence of the debt problem and its attendant recurrence. The global economic recession in the late 1970s and early 1980s aggravated the situation. Chapter two focuses on the international management of the debt problem. This thesis is mindful of the manifold debt management strategies (rescheduling, refinancing, adjustment programs etc) currently being applied to the problem under the xv i auspices of the IMF, the World Bank , the Paris Club and the London Club. None of the Bretton Wood institutions is originally intended to manage a debt problem. The IMF Stand-By Arrangement in which is enshrined the IMF adjustment program for debt management, had no legal recognition in both the original and the 19 69 amended save the 1978 amended IMF Articles of Agreement. The World Bank (formerly the International Bank for Reconstruction and Development) (IBRD) was originally concerned with the financing of the reconstruction of Europe after the devastation of World War II. Thereafter, the Bank started a program of project lending to the Third World. The Bank did not concern itself with debt management until early 1980s when it introduced a program of Structural Adjustment Loans (SALs) for LDCs facing debt problems. The Paris Club and the London Club reschedule official and commercial debts respectively. Their inability to manage the debt problem is clear from the fact that they entrust the fulfillment of the conditions for granting of debt relief to the IMF and more recently, to the World Bank. Therefore, the process whereby the granting of debt relief is tied to the fulfillment of the conditions of the IMF, the World Bank, the Paris Club and the London Club, all at xvii the same time as the failure in meeting the conditions of any one of them triggers off the failure to obtain relief from any one of them, is a debt trap and part of the LDCs' difficulty in coping with the problem. The Paris Club and the London Club, as creditors* cartels have the leverage of greater bargaining power in the negotiation process with each individual debtor LDC. This has far reaching effects in the context of the conditions and the legal clauses introduced in loan agreements. While the strategies employed by these institutions may offer temporary relief, they nevertheless fail to insulate the debtor LDCs against a recurrence of the problem. It is against this background that the argument concerning the inadequacy of the debt management strategies becomes somewhat forceful and plausible. It is however, not out of place for one to take the view that the current strategies are the limit that can be offered in the face of the world economic recession affecting all the parties,if indeed, the interests of the creditors and the debtors are to be on a balance. The chapter also examines how debt-equity swap and foreign direct investment can help in dealing with the problem. Finally, it looks into debt management xviii constraints and evaluates the debt management strategies with a view to establishing their adequacy or otherwise. Chapter three examines the international legal regime of the debt problem. International loan transactions are usually governed by the choice of law of the parties which almost invariably is the law of the creditor state. The dominance of municipal law clogs the development of international law in this area. International law in itself is not a debt manager. Moreover, even if a debt management strategy anchored on international law is to evolve , it must not evolve without a base. It must evolve based on the reality of the international economic situation. Therefore, it will hardly make any significant difference from what is presently in operation. While the binding character of contract is recognized to bind parties to an international loan agreement, the doctrine of Changed Circumstances and Force Majeure which are supposed to be exceptions to it are argued to have no application in international loan transactions. The defenses of Sovereign Immunity and Act of State are rarely tenable in international loan transactions, in large part, because of the commercial nature of the transactions. The doctrine of odious debt xix is hardly tenable because of the principle of continuity of states. Worse still, in a genuine hopeless case, there is no international law of bankruptcy to avail a debtor country. This part will also look into two major clauses usually enshrined in international loan transactions. Chapter four discusses debtors1 response to the debt problem and their quest for a new international economic order. While some debtors have repudiated or reneged their debt obligations or have declared moratoria on amortization and interest payments, others have unilaterally limited debt servicing to a certain percentage of their foreign exchange earnings. Debtor countries complain that while they are being urged to undertake adjustment programs aimed at boosting their foreign exchange earnings for debt servicing, the creditor countries themselves are maintaining economic policies of protectionism, subsidies and reduced terms of trade against them. The LDCs maintain that the solution to the debt problem can only be found in a new international economic order which will develop their economic base and give them equal bargaining power with the creditor countries. But the creditors are not willing to yield to this request XX and so balancing of these two conflicting interests in itself another big concern. 1 CHAPTER ONE THE ORIGIN AND CAUSES OF THE DEBT PROBLEM The origin and causes of the debt problem have both remote and immediate factors and are of internal and external dimensions. INTERNAL CAUSES OF THE DEBT PROBLEM The post colonial period ushered in a new endeavor on the part of the LDCs. They sought to transform their economies to meet with the demands of the dynamic world, a thing which colonialism failed to achieve for them. Most LDCs do not have a diversified economy. They are mainly primary commodity producers. There is therefore the need to import some technology with a view to diversifying their economies. Foreign exchange has to be expended and in most cases foreign loans have to be contracted to procure the necessary technology. Unfortunately foreign loans contracted for the purpose of economic development are often mismanaged and the result is that there is no economic return to pay off the loans. In Nigeria, for example, the building of a new capital city overnight which has taken over half of the country's fortune without physical improvements of equal value to show for it, certainly has no economic rationale since the new capital cannot generate foreign exchange to offset the foreign debt incurred on its behalf. Mismanagement of the country's resources is also seen in the so called steel factory, a 2 project on which has been expended billions of borrowed dollars, and which nevertheless, cannot turn out a single product for export. It is perhaps only in Nigeria, can a refinery, one of the largest in the OPEC, be built in a location where there is no oil deposit, an idea which necessitated the construction of oil pipelines running well over 2000 miles from an oil rich location at a very high economic cost and loss. In Zaire, the leader committed the country to foreign debt in the name of building an expensive airport in his home town, a geographically unsuitable location for such a project. In addition, he embarked on an unworkable communication project intended to cover the whole length and breadth of the country.1 In the Philippines, the story is not different. The Marcos government embarked on an unviable and needless nuclear plant project which engulfed more than $2.3billion with no economic returns.2 Unfortunately, this kind of mismanagement takes place just at the time when a large crosssection of the LDCs1 population is dying of hunger, suffering unemployment and the poorest standard of living in the world. 1 Wieser, E., Domestic and External Causes of the Latin American Debt Crisis, in "The Political Economy of the North- South Relations." Edited by Toivo MilJan. Canada: Broadview Press, (1987) pp.423-428. 2 Briones, L.M., The Morning After, pp.2-8. Reproduced in "The Debt Trap: How To Get Out Of It" Papers and Proceedings of the Symposium jointly sponsored by the International Studies Institute of the Philippines and the University of Philippines. Aug.24, 1987. 3 The domestic policies of the debtor countries also contributed to the debt problem. Argentina, Mexico, Venezuela and Chile, for example, maintained overvalued currencies in the late 1970s and early 1980s. This discouraged exports by making them relatively more expensive and encouraged imports (causing balance of payment deficits) by making them relatively less expensive, and consequently, the overvalued currencies led to capital flight3 (ie a massive conversion of local currency to foreign exchange for safe keeping abroad). In addition, most debtors refused to cut down on public sector deficits and to restrain expansion of money supply to control inflation. Brazil, for example, pursued a policy of growth based on the accumulation of external debt.4 This scenario is summed up thus: ... It came as no great surprise to find that by late 1988, all the debtor countries we visited, with the exception of Zimbabwe, Thailand, and Papua-New Guinea, were in a state of insolvency or pre-insolvency if one assumes that economic growth needs to keep pace with the increase of the population ( and does not even consider the possibility of a rate of development sufficient to catch up, in the medium or long run, with the more advanced economies). The reasons for this Eskridge, W.N.,Jr. Santa Claus and Sigmund Freud: Structural Context of the International Debt Problem in "A Dance Along the Precipe: The Political and Economic Dimension of International Debt Problem". Edited by Eskridge, W.N. Jr., Lexington Books, D.C.Heath and Co.Lexington. (1985) pp.31-79; Cline, W. International Debt and the Stability of the World Economy. Institute of International Economics, Washington D.C. (1983) pp.20-28. Cline, W. pp. 20-28. 4 inability to live up to the external debt servicing obligations are no doubt in part endogenous: poor economic planning and fiscal management, and unrealistic public investment climate.5 Good management of resources would have saved these countries the embarrassment of foreign indebtedness. EXTERNAL CAUSES OF THE DEBT PROBLEM The rise in oil prices forced the industrialized countries to adopt protectionist and tight monetary policies aimed at protecting their economic interests. Consequently the world economic recession came in a greater dimension. The effect of this was far reaching on the LDCs so much so that between 1980 and 1983, their growth rate fell to 0.1% per annum. Their exports fell on the average by 8.2% per annum with their terms of trade deteriorating to 6.7% on the average. The poor economic performance of these countries increased their debt on the average by 10.6% per annum between 1980 and 1983.6 Konz, P. The Third World Debt Crisis. 12 Hastings Int'l & Comp. Law Rev. No. 3, Spring, 1989, at 53 0. This was a keynote address presented at the Hastings International and Comparative Law Review's symposium on the World Debt Crisis, March 25, 1989. Mr Konz participated in the survey of external debt management of the Third World countries carried out on behalf of the U.N. Development Program in 1988. Both the Bretton Woods institutions and the Common Wealth Secretariat assisted in the survey. Abbott, G.C., Debt Reliefs for the Poorer Developing Countries 19 Case W. Res. J. Int'l Law (1987) pp.1-16 ; Jones G.S.and Nichols, L. New Direction in Debt Management. 19 Case W. Res. J. Int'l Law (1987), pp.53-73. 5 According to estimate, the Non Oil Developing Countries (NODCs) alone lost approximately $141 billion in high interest payments, lower export receipts and higher import cost as a consequence of adverse macroeconomic developments after 1978.7 Cline in his research stated that external factors added $401 billion to the external debt of oil importing LDCs between 1974 and 1982. He made a break down of the figures as follows: a) $260 billion resulted from increases in oil prices, 1974 - 1982; b) $41 billion resulted from the sharp rise of dollar real interest rates in 1981-1982 over 1961-1980 average; c) $21 billion resulted from losses in export volume due to world wide recession in 1981-1982; and d) $79 billion was due to the drop in commodity prices and other terms of trade in 1981-1982. He also stated that the total debt of the NODCs stood at $130 billion in 1973 but increased by $482 billion to a total of $612 billion as at 1982. According to Cline, out of the additional $482 billion, $401 billion is attributed to the impact of events (external) beyond the control of the debtor countries.8 Schirano, L.G., A Bank's View. pp. 19-24 in (A Dance Along the Precipe: The Political and Economic Dimensions of International Debt Problem) note 3. Cline, W. pp.24-25,(Table 4). 6 Interest on Mexico's and Brazil's loans for example, accounted for 70% and 62% of their debts respectively in 1980. A one percent increase in interest rates led to $2.5 billion additional debt for some of the LDCs with the Philippines and Argentina incurring 159 million and 600 million dollars respectively. Commenting on the effect of external causes of debt problem on debt management, the UNCTAD Secretary General stated: It is equally important to recognize the possibility that debt problem may arise despite good management. A developing country may apply the soundest of principles in regard to the use of the credits it has incurred, it may invest its funds in terms of very proper criteria, in every productive sector of investments, but if, to take an example, there is a collapse in the external prices of its exports, then no matter how prudently it has developed its resources, it can run into debt service difficulties- difficulties that are externally induced and which have nothing to do with the principles of sound domestic management.10 In line with this statement, the Quito Declaration of January, 1984 by the presidents of Argentina, Brazil, Columbia and Mexico lamented the vulnerability and dependence of LDCs' economies on the developed market 11 economies. Briones, L.M., pp. 2-8; Hurlock, J.B., Legal Implications of Interest Rate Caps on Loans to Sovereign Borrowers. 17 NYU J.Int'l Law and Politics, pp.543-552. UNCTAD Secretariat Doc. TD/B/485; TD/B/C.3/118; TD/B/C.3/AC.8/4, June 1974. Roett, R. The Foreign Debt Crisis and the Process of Redemocratization in Latin America, pp. 207-29 in (A 7 The economic dependence of one country on another has been defined as follows: By dependency we mean a situation in which the economy of certain countries is conditioned on the development and expansion of another economy to which the former is subjected. The relation of interdependence between two or more economies and between those and world trade, assumes the form of dependence when some countries, the dominant ones can expand and can be self-sustaining, while other countries, the dependent ones, can do this only as a reflection of that expansion, which can have either a positive or a negative effect on their immediate development.12 Indeed the dependence of the LDCs1 economies on the western countries, makes them vulnerable to external debt at the slightest negative economic policies of the industrialized countries. But there is hardly any one country in the world which has attained economic independence. Even the developed countries depend on one another to some extent. This is a reality of the economic life of nations. All nations of the world know this and have increasingly learned to live with it. However, the extent of dependence is important. With the diversification of the LDCs1 economies, they might be relatively less susceptible to adverse macroeconomic policies of the developed countries. Though protectionism and subsidies to locally manufactured goods by the developed countries have been part of their economic policies long before the debt crisis, Dance Along the Precipe: The Political and Economic Dimensions of the International Debt Problem) note 3. The Structure of Dependence. 60 Am. Econ. Rev.(1970) p. 231 8 efforts should be made to tamper these policies in response to the debt situation. Beside the preceding causes of the debt problem, it is important to mention that lack of lending discipline on the part of the banks which resulted in overlending contributed to the problem in no small measure. In the face of the LDCs1 craze for foreign loans for overnight industrialization, the banks who were already over burdened with large deposits of petrodollars receipts were quick to lend considerable amount of foreign capital at floating interest rates to these c ountnes. The banks were lured into excessive lending by the huge profit they made therefrom. Statistics put the rapid profits of some American banks as follows:14 Banks 1972 (profits) 1976 (profits) Bank of America 21% 40% Citibank 54% 72Chase Manhattan 34% 78Manufacturers Hanover 29% 56% J.P.Morgan 35% 53Bankers' Trust 31% 64 Chemical Bank 14% 44% The above data shows that by 1976, some of the banks were making twice the profit they made in 1972. The banks were carried away by this trend and before they knew it, the Cline, W. p.13; Briones, L.M., pp. 2-8; Jones G.S., and Nichols, L. pp. 53-73; Tapia, E.C., Mexico's Debt Restructuring: The Evolving Solution. 2 3 Columbia J. Transnat'l Law pp.1-9. Magallona, M.M." Debt Trap: How To Get Out Of It". See note 2 - quoting Sampson, The Money Lender, London, 1983, p. 158. 9 borrowers could no longer service their debt as before. As rightly observed: All this started in the seventies when conservatively dressed gentlemen with elegant brief cases hurried from country to country in the Third World, offering inexpensive loans with five or ten year maturities. Interest rates were barely just 2% above LIBOR. This generously offered ready money consisted of petrodollars which had been deposited in European and US banks.15 A finance minister of a Latin American country was quoted as saying: I remembered how the bankers tried to corner me at conferences to offer me loans. They wouldn't leave me alone. If you are trying to balance your budget,it's terribly tempting to borrow money instead of raising taxes, to put off the agony.16 The banks did not stop at overlending. Some of them were accused of collaborating with some corrupt leaders and business men of some of the LDCs to misappropriate the foreign loans granted. The banks never bothered to know how well loans granted to the LDCs were being managed. Describing the scenario a writer stated: These two stories, capital flight and international debt are part of the same story. In some cases, the wealthiest classes of poor countries have actually sent more money out of their countries than foreign borrowing has brought in, and often, it is the same money American banks have promoted, and profited from, both sides of the transaction. The real role has been to take funds that third world elites have stolen from 15 Briones, L.M. pp. 2-8 16 Magallona, M.M. Some Remarks on the Debt Problem, pp 35 in "The Debt Trap: How to Get Out Of It" see note 2. 10 their governments and to loan them back, earning a nice spread each way.17 Apart from the world economic recession and certain economic policies of the developed countries, in large part the mistakes of the banks and the mismanagement of resources by the individual LDC debtor governments led to the debt problem. If countries had prudently managed their resources by tailoring their expenditure to the available resources, and if the banks had exercised some lending discipline, the magnitude of the present debt problem would have been averted. Lottila, R.P.M., Selective Disengagement of Foreign Sovereign Debt: Some Principles Relevant to the Philippines' Dilemma, p.9, in " The Debt Trap: How to Get Out of It" note 2 - quoting James S. Henry, The Third World Debt Hoax: Where the Money Went. The New Republic 14th April, 1986. CHAPTER TWO INTERNATIONAL MANAGEMENT OF THE DEBT PROBLEM The emergence of the international debt problem inevitably raises the question of how to approach the problem with a view to bringing it to a level that does not adversely affect the standard of living of the LDCs. There are some international institutions currently involved in managing the debt problem namely, the IMF, the World Bank, the Paris Club and the London Club. Before discussing the activities of these institutions regarding the debt problem, it might be proper to give a general account of the international debt management approach. Traditionally, the problem of international indebtedness has been viewed in a strictly commercial context in which debtor countries were expected to honour their obligations in full and on time regardless of the difficulty in debt servicing because it was assumed that they had mismanaged their economies.1 The creditors were then obliged to grant new loans, reschedule and refinance existing loans on the condition that the debtor countries undertake the IMF adjustment program.2 1 UNCTAD TD/328 - May 1987, p. 5. 7th Session, Geneva 9 July, 1987.; Abbott, G.C. International Indebtedness and Developing Countries, London: Croom Helm, White Plains: M.E. Sharpe Inc.(1979), p. 189. 2 UNCTAD TD/328/Add. 2, 19th February, 1987. pp. 17-20, 7th Session Geneva 9, July, 1987. 12 The initial phase of the debt strategy also perceived the debt problem as one that could be amenable to a short term management. Thus the strategy focused primarily on short term stabilization programs.3 It was believed that the problem was basically illiquidity rather than insolvency of the debtor countries and so needed rescheduling and involuntary lending of new credits to help the debtor economy to grow in a short term, and to be able to service its debt on a regular basis. Unfortunately, the anticipated recovery did not occur.4 This development proves the shortcomings and the inadequacy of a short term approach to the debt problem. Over the years, all adjustments made and relief granted have been of little help relative to the amount of debt and have not been able to abate the recurrence of the problem. The question is, for how long would adjustment and relief measures continue in the face of the world economic recession which seems to have become permanent. International debt strategy appears to draw a distinction between official debt (owed to creditor governments) and private debt (owed to commercial banks). 3 Id. 4 Cline W. pp. 44-58. see Chapter 1, note 3. Cline surveyed the balance of payment positions of 19 debtor countries based on at least 3% rate of economic growth in the OECD and the LDCs, the national interest rates, the price of oil and concluded that the problem is as a result of illiquidity and not insolvency of the LDCs and so he suggested that by 1986, all things being equal, debtor countries will resume creditworthiness. 13 As to the former, it is believed that there is considerable latitude and possibility of converting them to aids and grants.5 But debts in the latter category are to be repaid regardless of the problems being faced by the countries concerned. At best their amortization and interest payments are rescheduled. In some cases, new loans are made only to be used to keep debt servicing current.6 Commercial banks prefer to deal with the problem in this way because of the accounting and regulatory practices in creditor countries. In the U.S. for example, where there is a default in debt servicing, the Federal Reserve Board, declares the loans as non performing and compels the banks concerned to set aside reserves to negate the effect of such non performing loans. To avoid this result, the banks make new loans for the purpose of keeping interest on old loans current. For the Multilateral Development Banks (MDB), for example, the Bank of International Settlement (BIS), debts owed to them are not rescheduled because they have revolving funds and rescheduling of their loans might jeopardize their financial stance and objective. The abysmal failure of the short term management approach ushered in a new initiative in the 1980s. A debt management strategy known as the Baker Plan emerged. Mr ° UNCTAD, note 2. 6 Id. 7 Id. 14 Baker, a former U.S. Secretary of Treasury, unveiled the U.S. stance on the debt problem to be in favour of a program o for sustained growth of the LDCs. According to Baker, the U.S. is not in favour of debt forgiveness and liberal inflow of capital to the LDCs for the following reasons: (a) A write off will preclude the debtors from gaining access to credit markets including vital trade finance. The problem, he maintained, is not the level of debt as to warrant forgiveness, but the ability to service it. In his view, as the investments in the LDCs are not earning their way, a big part of the solution is to improve the productivity of their investments. He argued that even if the debt is cancelled, the proceeds therefrom would not be enough for LDCs* economic development, neither would it make them not to depend on the developed countries any more. In addition, banks would suffer losses as a result of a write off and consequently would be discouraged to make new loans necessary for the LDCs1 development. (b) An across the board forgiveness or debt reduction would also forgo the benefits of case by case actions to secure sound economic policy changes within debtor nations, which are fundamental Leadership and Cooperation: Developing Nations Debt: Three Conceptual Approaches to the Problem. Being part of the text speech given by the Secretary of the Treasury to the U.S. Congressional Summit on Trade and Debt. New York, Dec. 4, 1986 - Reproduced in The Political Economy of North South Relations edited by Toivan Miljan (1987) pp. 352-58. See Chapter 1, note 1. 15 to debtors' abilities to generate earning power for investment and achieve sustainable economic growth.9 Again, the problem with debt forgiveness is the criteria that would be fair in a particular circumstance to determine countries that should have the benefit.10 Moreover, an across the board debt relief would treat all debtors equally and would dampen the zeal of the countries making adjustment efforts, a dangerous precedent indeed.11 Nevertheless, the recognition of the need for some debt relief is not a recent development. The U.S. Secretary of Treasury referring to Europe's indebtedness to the U.S. after World War I, said: 9 Id. 10 Lovett, W.A. Managing the World Debt Crisis: Economic Strains and Alternative Solutions. 21 Stanford. J. of Int'l Law (1985) pp. 499-543. 11 Hudes, K., Coordination of Paris and London Clubs Reschedulings, 17 NYU J Int'l Law & Politics (March/April, 1985) pp. 553-71. 16 Under these circumstances, an impenetrable barrier exists which makes it impracticable for these governments to pay in dollars the amount of interest due from them to the U.S. This involves no question as to the insolvency or financial irresponsibility of those governments... but results from the condition of the foreign exchange market....If the Treasury does not defer collection of interest and thus adds to the present difficulties in the financial and economic rehabilitation of the world by demanding an immediate cash payment of interest before the industry and trade of Europe have an opportunity to revive, we should not only make it impossible for Europe to continue needed purchases here and decrease their ultimate capacity to pay their debts to us but should hinder rather than help the reconstruction which the world should hasten. The creditors these days have been accused of not taking the same measure in respect of the LDCs' debt despite the fact that LDCs1 situation is akin to that of Europe then. The creditors wait until there is a crisis before granting relief, thus making recovery difficult for debtors who in turn fail to service their debt on a regular basis.13 The foremost need of the LDCs, according to Baker, is structural policy changes to create economic infrastructure for sustained growth so that their economies could attract viable foreign investments which in turn would generate foreign exchange needed for debt servicing. To attain this goal, the Baker Plan stands for increased capital flow to LDCs from both the official and Abbott, G.C. note I p. 211 - a similar step was taken by U.S. President Hoover, when he delared a moratorium in favour of the German debt to U.S. during the inter-war (Great Depression) years. Id, pp. 211-12. 17 private (banks) creditors while the debtors undertake basic economic policy improvements. In addition, the IMF loans and the World Bank structural adjustment loans are to be mobilized subject to the debtor country's willingness to undergo structural economic reforms under the supervision of these institutions.14 However, the Baker Plan recognizes the fact that this cannot be achieved overnight because of constraints posed by politics, history, culture and sociology differences in local economies. According to Baker, because each country's limitations and potentials are different, a case by case approach tailored to suit the peculiarity of each situation is indispensable.15 The principal significance of the Baker Plan is the express emphasis on the need to move the restoration of growth of the LDCs to the center of the international debt strategy. This is to be achieved through sound financial measures and increased reliance on market-oriented development strategies. The Plan recognizes the longer term character of the process of overcoming difficulties of growth and debt and recognizes the need to tamper austerity measures with fresh credit flows. It believes that "any plan which just involves more lending, more borrowing, more 14 Id. 15 Id. 16 UNCTAD note 2. 18 interest payments, more repayment requirements, is not a total plan for success."17 It also supports equity investment as a very important factor permitting the LDCs1 economies to grow. The Baker Plan is now superseded by the Brady Plan unveiled in March, 1989. Under the Brady Plan, creditors and debtors are given considerable latitude for negotiated debt relief by way of bank debt reduction or forgiveness, and continued bank lending to the debtor countries is restricted. According to Mr Brady, the Baker Plan which emphasizes continued bank lending stands " To produce losses of revenue and capital for all banks that go well beyond anything implied in our proposal."18 He is of the view that the banks should be: Induced to forgive part of the debt by using money from the World Bank, the IMF and Japan. as collateral, or to otherwise support the debt reduction process.19 He argued that: The part towards greater creditworthiness and a return to the markets for many debtor countries needs to involve debt reduction. We should encourage debt and debt servicing reduction on a voluntary basis.20 Amaral, S. The Foreign Debt from Liquidity Crisis to Growth Crisis 19 Case W. Res. J. Int'l Law (1987) pp. 17-30; Treasurer Baker note 8. The Wall Street Journal of June 6, 1989 at A 17. "U.S. Strategy On Third World Debt Faces Hurdles" The Wall Street Journal, Monday March 13th, 1989, p. A4. 20 Id. 19 Though details of the Plan are yet to be made public , it is nevertheless known that debt reduction under the Plan could take any one of the following forms: (a) Swapping bank debts for bonds of lower face value; or (b) Swapping bank debts for bonds of egual face value; or (c) Swapping bank debt for part-ownership of local business in debtor countries. The means of reduction is made workable by some special measures offered to countries like Mexico and Venezuela which are implementing not only sound economic reform programs under the supervision of the IMF but are also making progress in bringing back capital that was taken abroad by their citizens.22 The measures include: (a) The right to use certain percentage of the loans from the IMF and the World Bank to buy back bank debt or to guarantee bonds to be swapped for debt at a discount; (b) Using money drawn from the resources of the IMF and World Bank as securities to effectively guarantee or assure the banks that interests would be paid on loans for which interest rates or principal has been reduced; (c) Getting Japanese loans to be used to replenish reserves, or to buy back debt or guarantee new discounted bonds; (d) Persuading the banks to negotiate a joint waiver of standard clauses in their loan agreements that impede debt 21 Id. 22 Id. reduction. Then the bank would be requested to negotiate a reduction and write-down some portion of the old loans in return for getting a guarantee on the principal or interest of the bonds.23 The U.S. Treasury Department estimates that under the Plan, $20 billion could be discounted out of the debt of 39 countries owed to the banks over three years with the maturity period of whatever is left extending to 30 years.24 The estimate envisages 20% bank debt reduction on the assumption that the IMF and the World Bank would provide between $20 to $25 billion to the banks.25 But there seems to be indications that the banks might not offer any more debt reduction than they can be compensated for by the IMF, the World Bank and Japan. For example, in the current debt reduction negotiation with Mexico, the banks are willing to make only about $5 billion or 11% reduction of their outstanding loans to Mexico in return for about $6 billion from the IMF, the World Bank and Japan.26 Essentially, the Brady Plan indirectly shifts the burden of bank debt reduction from the banks to the IMF and 23 Id. 24 "U.S. Plan May Cut Debt 20% For 39 Countries" The Wall Street Journal, March 16th, 1989, pp. A3, A9. 25 Id. 26 "Brady Urges Banks, Developing Nations To Hammer Out Debt-Reduction Pacts". The Wall Street Journal, Tuesday, June 16th, 1989, p. A17. the World Bank. But considering the limited financial resources of these institutions relative to the amount of outstanding debt, it is feared that these institutions and Japan might not be able to pay or guarantee the banks enough money to induce them to write-down the difference especially where it is substantial. Therefore, for the Brady Plan to succeed in this regard, the IMF and the World Bank have to receive more money from their subscribers. Interestingly, the Plan seems to recognize that the banks might not be willing to forgive enough amount of debt to enable the debtor countries to finance economic growth. To this end, it allows for new money flows supported by multilateral financial institutions. This Plan has been endorsed by many financial commentators. One of them commented: A more definitive approach - the only one which can presumably solve the debt crisis to the satisfaction of lenders and borrowers, and of the societies they represent - resides in negotiated debt restructuring that would involve debt relief, assurance of new money flows and, to that end, a new supporting role for the multilateral financial institutions. This seems infact to be the line the Brady Plan takes.27 Negotiated debt relief (by way of debt forgiveness) makes sense provided it is understood as an exceptional measure of crisis management, and will not become a permanent feature in sovereign borrowing. Otherwise Konz, P. at 535, see chapter 1, note 5. financial flows would dry up more rapidly, and LIBOR rates would appreciate in anticipation of future discounts.28 There are however, many questions yearning for answer. Would the commercial banks be willing to take long term rather than a short-term approach to debt forgiveness? Would the home governments of the banks support them by appropriate regulatory and tax policies? Would the creditor governments come up with appropriate trade policies to give the debtor countries the means to service their future debt? In the face of political pressure and social cost, would debtor countries implement sound economic measures to attract new money, whether in form of loans or investment? The Plan appears to be silent or not thorough on the issue of the repayment of official debt. The debt owed to the IMF, The World Bank and Japan by reason of their contribution in the banks debt reduction and supply of new money needs to be repaid. Moreover, it does not address the external factors promoting the debt problem. Nevertheless, the Plan should be preferred to the Baker Plan. The reason is that it provides for both new money for economic growth of the debtor countries and debt and debt servicing reduction. Also, it offers the banks a better deal to get rid of their bad debt and saves them the trouble of continuous lending without prospect of repayment. The Baker Id at 534. Plan provides only for new loans to finance foreign exchange-generating investments but fails to address the external factors which militate against the foreign exchange earnings of the debtor countries. Whatever is the merit of the debt management strategy employed, the fact remains that though it is a consensus of opinion that the growth and high demand of exports of the LDCs and the stable economic growth of the industrialized countries would help end the debt problem, the industrialized countries' protectionist policies intended to avoid de-industrialization and unemployment militate against this hope.29 Therefore, balancing the interests of the LDCs and the industrialized countries in this regard is yet another problem facing debt managers. THE ROLE OF THE IMF IN DEBT MANAGEMENT The IMF was born at the Bretton Woods Conference in 1944. Article I of its original Article of Agreement as amended in 1968 and effective in 1969, and as amended in April 1, 1978, sets the objective of the IMF as follows: i) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems. ii) To facilitate the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the Lovett, W.A., pp.499-543. 24 productive resources of all members as primary objectives of economic policy. iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation. iv) To assist in the establishment of a multilateral system of payments in respect of currency transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade. v) To give confidence to members by making the Fund's resources temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity. vi) In accordance with the above to shorten the duration and lessen the degree of disequillibrium in the international balances of payments of members.30 The IMF, originally was not intended to manage international debt problems. There was no express mandate in its objective to this effect. Over the years, however, the IMF has evolved a Stand-By Arrangement approach to the debt problem. This approach though not expressly provided in its Article I, is read into Article I (v) , and this arguably has been the legal basis of this approach. The April 1, 1978 amendment of IMF Articles of Agreement defines a Stand-By Arrangement, for the first time, in its section Gold, J. Standby Arrangement: IMF Washington, D.C. (1970) p. 241 (Appendix C. Articles of Agreement of the IMF); Edwards, R.W. Jr. Is an IMF Stand-By Arrangement a Seal of Approval On Which Other Creditors Can Rely? 17 NYU J. of Int'l Law & Politics (March/April, 1985) p. 573-97. 30 (b) as a decision of the Fund by which a member is assured that it will be able to make purchases from the Fund in accordance with the terms of the decisions of the Fund during a specified period and up to a specified amount. •L Apart from providing financial resources in times of economic difficulties to members of the Fund, the Stand-By Arrangement also provides support programs intended to stabilize the economies of members. Thus both official creditors and commercial banks make loans available and grant relief to members on the condition that the members enter into a Stand-By Arrangement with the Fund. By this, the creditors are assured that the member would carry out programs designed to enable it to repay its debt at the due 3 p . date. * The Stand-By Arrangement is a short term measure (spread over one year) . The inadequacy of this measure led to the introduction of the Extended Stand-By Arrangement (spread over three to five years). Built into the Stand-By Arrangement, is a set of conditionalities and performance criteria which a member has to meet. This is the central focus of the IMF Structural Adjustment Program. Some of the conditionalities are removal of subsidies on commodities, freezing of wages, trade liberalization, devaluation of local currencies and J± Gold, J., pp. 3-5; Edwards, R.W. Jr. pp.573-97 32 Gold, J., pp. 34-36. 26 cut m government expenditures, etc. These are intended to correct balance of payment deficits of a country with a view to enabling it to meet its international financial obligations. The performance criteria are the economic objective or targets set to be achieved through compliance with the conditionalities. The attainment of the performance criteria indicates that the adjustment program is succeeding, while non attainment of them automatically r disentitles the country concerned to draw further resources from the Fund and is an occasion to renegotiate the program to be more amenable to the economic circumstances of the country.3 4 The revolving character of the IMF resources by reason of which IMF loans are expected to be repaid within one year except there is an extended arrangement does not give the adjustment program enough time to achieve a meaningful result.35 The IMF Annual Report, 1965 stated at page 29: 33 Carvounis, C. The Foreign Debt/National Development Conflict. New York: Quorum Books (1986) pp.1-8 34 Gold, J., pp. 44-49. 35 Gold, J. pp. 3-5. 27 The Fund has never agreed to refinance debt directly as such transactions would be outside its normal sphere of operations; its resources are available for the provision of relatively short term assistance to meet balance of payament deficits. In most situations where debt renegotiation is appropriate, there is need for much longer term financing than could be provided under the terms of the Fund's policy limiting the use of its resources to 3-5 years. Moreover, the debts are frequently large in relation to the members quota and their refinancing by the Fund would seriously limit the Fund's ability to meet genuinely short term balance of payments difficulties. In many instances where debt renegotiation is only one aspect of a general stabilization program, financial assistance from the fund to meet other aspect of the balance of payments adjustment problem is also a prerequisite for the program's success. This statement, while asserting emphatically that the Fund is primarily concerned with short term assistance to correct balance of payment deficits of member countries, admits that there could, in some instances be a need for long term financing (measures). It is settled that the debt problem is a structural problem and needs long term, not short term management measures. If therefore, the Fund is only apt or interested in dealing with the problem on a short term basis, then a better management of the debt problem would reasonably not be expected from the Fund. In as much as one does not outrightly dismiss the efforts of the Fund in debt management, there is absolutely a need for improvement. All the parties concerned should gear efforts towards a long term plan and progressive implementation. The creditors' anxiety and hurry to get their money back, have always tuned them to a short term measure. 28 The Fund's program also entails Compensatory Finance Facility (CFF) and Buffer Stock Financing. Under the former, the Fund offers special facilities to those members, particularly the producers of primary commodities, who suffer shortfalls in their export receipts provided those shortfalls are of a short term nature and are largely attributable to circumstances beyond their control. Unfortunately, the effectiveness of the CFF has been reduced by the increased conditionality attached to its use as well as by the reduction of the limit of access to the Facility from 100% to 83% of an applicant's quota in the Fund. Under the latter, the Fund helps members to avoid shortfalls that would result from fluctuations in prices of exports by helping them meet their financial commitments to the Buffer Stock scheme established under international commodity agreements.3 6 Interestingly, since 1980, the Fund has somewhat shifted from its traditional short term loans to medium term facilities in dealing with balance of payment deficits. In addition to its Stand-By and Extended Stand-By Arrangements, Compensatory Finance Facility and Buffer Stock Facility, the Fund has introduced Structural Adjustment Facilities (SAF), 36 Gold, J. p. 16; UNCTAD TD/328/ Add.5, 19th Feb.1987, p. 30 Enhanced Structural Adjustment Facilities (ESAF) and External Contingency Mechanisms programs.37 The SAF was established in March 1986 to provide concessional balance of payments assistance to low income countries facing protracted balance of payments problems and willing to undertake a comprehensive adjustment efforts to strengthen their balance of payments position. The SAF is basically on a concessional term, not subject to the usual conditionalities and with 0.5% interest rates per annum with repayment periods stretching 51 to 10 years.38 In order to increase the resources available under the SAF, in April 1988, the Fund introduced the ESAF with the same interest rate as the SAF. Though the amount of resources available to each eligible recipient depends on its adjustment efforts and the size of its balance of payment deficits, the usual maximum under the ESAF is 250% of a country's quota and up to 350% in exceptional cases to be made available over a three year period and up to 63.5% of their quota under the SAF.39 The problem, however, is that these facilities are not open to all the debtor LDCs but only to the low income 37 The IMF Annual Report for 1988 of the Executive Board for the Financial Year Ended April 30, 1988. Washington D.C. pp. 44-58 JO Id - statistics shows that 62 countries at present are eligible for the SAF. Of this, 25 SAF arrangements have been in operation since April 30, 1988; Tomann, H. The Debt Crisis and Structural Adjustment in Developing Countries. 23 Inter Econ.Rev. of Int'l Trade and Dev. No.5, (Sept/ Oct. 1988),pp. 203-307. 39 The IMF Annual Report 1988, pp. 44-58. LDCs. The criterion for determining a low income country (ie. where to draw the line) might not be easily discernible because of the relative volatility of income of these countries. A major feature and of course condition of both the SAF and the ESAF is the requirement of a policy framework paper to be prepared by the national authorities of the countries concerned in conjunction with the staff of the Fund and the World Bank. It is claimed that the purpose of this is to ensure that the policy reforms of eligible countries are properly targeted to remove the obstacles of growth and balance of payment viability. It also ensures that the policy reforms are mutually reinforcing, feasible and supported by appropriate amount and forms of external financing. The framework paper which covers a three year period, discusses public investment program and financing requirements of the country, and outlines the social implications of policy changes, together with steps being taken to mitigate the possible adverse impact of adjustment measures on the people of the LDCs.40 The External Contingency Mechanism works hand in hand with the CFF. It is designed to provide additional financing to support programs that might be impeded by adverse exogenous factors, and thereby encouraging members with Fund supported programs to sustain their policy reform efforts. 40 Id. It also entails partial compensation for the effect of external disturbances beyond the control of the debtor governments.41 There are however,some constraints on the efforts of the Fund to manage the debt problem efficiently. The IMF Annual Report for 1988 identifies some problems with debt management to include want of economic policy reforms in the debtor countries, adverse international economic environment with intensified protectionist measures, high real interest rates, relatively modest growth in world trade and in particular, a fall in terms of trade for LDCs1 exports which for example, was up to 20% from 1982 through 1987. It is understandable that these exogenous factors erode much of the real adjustment that indebted LDCs have achieved. In the face of this, it was not unexpected when in 1987, countries like Brazil, Ecuador and Cote d'lvoire suspended interest payments on debts owed to commercial banks.42 In response to this situation, in its April, 1988 meeting, the IMF Interim Committee reaffirmed the case by case debt strategy emphasizing sustained implementation of growth oriented adjustment and structural reform policies by debtor countries, maintenance of reasonably favourable international economic environment and adequate flow of finances to debtor countries from official and private Id; Tomann, H. pp.203-307 The IMF Annual Report 1988. creditors. J But the question of how the balance of payments support should be shared between the IMF and the commercial banks seems unresolved. This is important because even where debtor countries have done everything required of them under the IMF program, they have in most cases been unable to establish their creditworthiness with the banks.44 This of course is part of the reason why the IMF during the 1982 debt crisis insisted that banks already exposed to Mexico must lend new credit up to 7% of their aggregade outstanding loans to Mexico to the tune of $5 billion (involuntary lending) , in the absence of which the Fund was ready to decline adjustment program for Mexico. The banks complied knowing that the consequence of that would have been their failure to recover their outstanding loans to Mexico.45 IMPACT OF THE IMF ADJUSTMENT PROGRAM Some success stories of the IMF program have been recorded. Some studies show that although the current account deficit of all Non Oil Developing Countries tended to expand between 1970 and 1980, most Fund assisted countries managed to close the gaps reasonably. A 1985 report stated that in Africa, between 1981 and 1983, 21 43 Id. 44 UNCTAD TD/328/Add.2, Feb. 19th, 1987,p.50 45 Robichek, E.W. The IMF: An Arbiter In The Debt Restructuring Process. 23 Columbian J. Transnat'l Law (1983/84) pp. 143-154; Cline, W. see chapter 1 note 3, pp. 40-44; Carvounis C.,p.24; Tapia, pp.1-19, see chapter 1, note 13. countries participated in the Fund's program, and economic growth target was achieved in one-fifth of them.46 It is also maintained that most of the Fund assisted countries that have been less successful are those that had long postponed adjustment efforts. And as stabilization is delayed, the effect becomes more adverse and adjustment becomes correspondingly costlier and more painful.47 But according to the UNCTAD, the performance of thirteen selected LDCs which have had consecutive adjustment programs through out the 1980s does not differ significantly from the rest of the LDCs who have not undertaken similar programs. Table I of Appendix A sets out the countries involved and their performances. It is note worthy that out of the thirteen countries, only Bangladesh, Somalia and Uganda secured a higher average annual rate of Gross Domestic Product (GDP) growth in 1980- 84 than in the preceding decade, while the remaining countries experienced a decline in the average annual growth rate more remarkable • 4.8 than in the group of LDCs as a whole. ° As regard current account deficit, this was only minimal in respect of six 46 Amuzegar, J. The IMF Under Fire pp. 334-45 - "The Political Economy of North-South Relations" see chapter 1, note 1. 47 Id. UNCTAD TD/328/Add.5, Feb.18th, 1987, pp. 15-17. 34 countries ( Bangladesh, Central Africa Republic, the Gambia, . A. Q Malawi, Samoa and the Sudan) out of the thirteen. It is argued that the lack of correlation between the existence of an adjustment program on the one hand and economic performance in terms of growth rates and current account improvement on the other hand, makes skeptical the appropriateness of the adjustment programs for the situations of the LDCs.50 Though exogenous factors distort the progress of the programs, the programs themselves have some built-in character which defeats good debt management. For example, adjustment programs are employed to correct balance of payment deficits which arise to a large extent from insufficient export earnings. But the measures adopted to combat inflation embodied in the programs impede the ability of domestic markets to generate local production which would have been generated by world market but for the recession.51 The IMF has been criticized for not seriously addressing the external causes of the debt problem which negate the economic plan of these countries. The Fund is also accused of not addressing the debt problem as a development problem, but only as a balance of payment 49 Id. 50 Id. 51 Id. 52 Id. 35 deficit requiring new finances which in turn create additional deficits.53 Moreover, although, the 1979 review of the Fund program and the new guidelines introduced were intended to harmonize adjustment conditionalities with economic, social and political priorities of adjusting countries, no practical steps have been taken in this regard.54 It is submitted that the Fund should exercise restraint in imposing adjustment measures. It should be sensitive to and take into consideration whether or not the political system of the country concerned is amenable to any one adjustment measure. As Silver Herzog, a one time Mexican finance minister stated, "austerity and democracy can not coexist for very long".55 The Fund's policies might thrive better in adjusting countries in terms of being politically tolerable if all the conditionalities are not undertaken at the same time in a hurry, but on phases, one after the other, provided however, that the non imposition of one does not hinder the success of the one imposed. More important, the Fund does not take into account the significant differences in adjustment capacities between an undiversified LDC economy on the one hand and an advanced 53 Carvounis, C. pp. 1-8 54 Didzun, K. pp.163-171 55 Carvounis, C. pp. 10-14 integrated economy on the other hand. b The economies of most LDCs are probably not amenable to a rapid short term transformation from domestic market production to export manufactures or other tradeables in a large scale as the IMF seems to suggest through its emphasis on export-led growth.57 This explains the failure of most of the adjustment programs. Moreover, even where export-led growth is sparingly achieved, protectionism and deteriorating terms of trade etc militate against good export earnings. As a staff member of the Fund reports on the operation of the Fund's program from 1978-1980, "the Fund can not be complacent about a situation in which almost half the cases have not shown any progress towards balance of payments viability."58 However, the Fund's adjustment programs are not without some merits. At least they have forced countries to adopt realistic policies, and have forced banks to maintain lending discipline by determining a country's level of sustainable debt and a rescheduling payment terms based on that determination. At the same time, it is equally desirable to work out a sustainable debt servicing amount 56 Id. 57 Id. 58 Id pp.15-16 59 Eskridge, W.Jr., p.57, see chapter 1, note 3 and capacity of each debtor country based on its economic buoyancy. THE ROLE OF THE WORLD BANK IN DEBT MANAGEMENT The World Bank is one of the Bretton Woods institutions aimed at reordering the world economic system following the devastation of World War II. Basically the Bank was conceived as a development institution60 which supposedly has nothing to do with debt management. The Bank initially focused attention on the supply of finances and other services for the reconstruction and rehabilitation of war ravaged Europe. At the completion of this task, it became saddled with project lending to member countries in the areas of agriculture particularly, cash exportable crops , railways, power, water supply, investment and other social services.61 The IBRD as the Bank was formerly known, provides in its Article of Agreement that every loan granted by the Bank must facilitate foreign investment in the countries concerned.62 Beside project lending, the bank makes project loans in cases of extreme emergency, for example, reconstruction and rehabilitation of the economy of a member country after a ou UNCTAD TD/B/1029/Rev.1 (1986) pp.53-59 61 Id. 62 Swedberg, R., The Doctrine of Economic Neutrality of the IMF and the World Bank pp. 319-331 - "The Political Economy of North-South Relations", see chapter 1, note 1 38 war or a severe natural disaster, a sudden fall in export earnings where the economy is critically dependent on a single export item, a sharp deterioration of the terms of trade as a result of a rapid rise in import prices and cases involving structural constraints or capacity underutilization.63 Between 1976 and 1979, for example, five program loans to Pakistan, Zambia, Jamaica, Guyana and Peru were made to assist them in adjusting to a decline in the export of primary commodities.64 The early 1980s saw the Bank in the mainstream of debt management. The traditional division of tasks between the IMF and the Bank whereby the IMF was responsible for short term balance of payment assistance and the Bank for project financing was no longer followed.65 The Bank, along its project lending and program loans now undertakes Structural Adjustment Loans (SALs), a fairly long term balance of payment assistance for countries with high structural current account deficits. They are granted on the condition that the debtor implements a comprehensive structural adjustment program drawn up by the Bank in consultation with the IMF.66 Thus the difficulty involved in fulfilling the conditions of the IMF adjustment program particularly, 63 UNCTAD, note 60 64 Id. 65 Tomann, H. pp.203-207 66 Id. political intolerance on the part of the debtors, applies with equal force to the implementation of the Bank's SALs. The objectives of SALs are stated as follows: a) To support a program of specific policy changes and institutional reforms to achieve an efficient use of resources and thereby to contribute to a sustainable balance of payments in the medium and long term, while maintaining growth; b) To assist a country in meeting the transitional cost of needed structural changes in industry, energy and agriculture by augmenting the supply of freely usable foreign exchange and c) To act as a catalyst for the inflow of other external capital to help ease the balance of payment situation.68 The Bank's SALs cover programs over a period of five to seven years subject to reviews of each phase to facilitate implementation. In February, 1983, the Bank approved a Special Action Program (SAP) comprising financial measures and policy advice to help countries which are making serious efforts to implement difficult adjustment measures needed to restore growth.69 The principal elements of the program are expanded lending for high priority operations, supporting structural adjustment, policy changes, production for export, fuller use of existing capacity and the maintenance of crucial 67 Carvounis, C, p. 123 68 UNCTAD note 60 - As at 1986, the Bank had approved 28 SALs, 69 Id. developmental infrastructures. Other elements include accelerated disbursements under existing and new commitments to support early completion of high priority projects, expanded advisory work on the design and implementation of appropriate policies including the reordering of investment priorities and strategies for debt management, and urging other lenders to make similar efforts.70 In early 1988, in a meeting held in Paris between the president of the Bank and the managing director of the IMF on the one hand and the representatives of the industrialized countries on the other hand, a three year (1988-90) program, known as the Special Program of Assistance (SPA), was approved.71 The program is a form of debt relief and growth-oriented import financing for low income SubSaharan Africa, particularly those countries implementing comprehensive and vigorous policy reforms. The program also established a framework for assistance to countries on a case by case basis through concessional debt relief, additional concessional flows from International Development Association (IDA), increased cofinancing of adjustment operations and increased resources for the IMF ESAF.72 Id - since its inception more than 12 SAPs have been approved. The World Bank Annual Report for 1988. The World Bank, Washington D.C.20433, pp.31-40 72 Id. The continuous deterioration of the international economic environment particularly during 1987, caused the Bank to introduce yet another program of assistance to LDC debtors known as the Sectoral Adjustment Lendings. In its view, this program reflects a broad and deep adjustment in investment and policy reform programs.73 It is important to keep in mind that most of the Bank's program are for the low income countries. They are not for the middle income LDC debtors. However, for these countries, the Bank has identified unfavorable economic climate, slow growth in the industrialized countries, rising protectionism, increasing adverse terms of trade for their exports, uncertainty in the currency market and volatility in interest rate movements as principal causes of the generally slow growth.74 In response to this, the Bank, as a way of supporting economic growth in these countries, since 1985, has provided catalystic support to commercial bank lending and rescheduling agreements for Argentina, Brazil, Mexico, Nigeria, Chile, Philippines and Cote d'lvoire etc..75 It has also expanded its role in the organization of financing packages for indebted countries and in the analysis of such countries' problems and prospects, thus boosting the Id; The World Bank Annual Report for 1987, pp.15-40 The World Bank Annual Report for 1987, pp.15-40 The World Bank Annual Report, 1988. confidence of commercial banks in participating in such packages. For instance, in 1986 through 1987, the Bank participated in financing packages for Mexico by providing guarantees of up to $500 million on a $1 billion transport sector loan and a further $250 million on a $500 million • 7 ft growth contingency loan. The Bank also uses cofinancing as a technique to increase the confidence of other lenders in loan packages, and this has been quite successful in attracting official funds. Though a general success in improving the terms of commercial borrowings in maturity, grace periods and interest spreads etc has been recorded, cofinancing with commercial banks has not evolved on a large scale. The reason is that on repayment, the World Bank receives preferred creditor status over the commercial banks.77 More important, the Bank believes that surplus balance of payment necessary for regular debt servicing, can not be attained simultaneously with establishing conditions for the growth needed to secure debt servicing capacity in the longer term. According to the Bank, so long as debt servicing continues to absorb a large share of the debtor countries* resources, involuntary new loans by commercial banks will not provide enough capital needed for development in these countries. In its view, the solution to the debt /tJ UNTAD TD/328/Add.2, Feb. 19th, 1987, p. 43 77 Id. problem lies on resumed growth which can only be achieved through concerted efforts of all concerned entailing in the main, new credit flows from the creditors and improved economic policies on the part of the debtors.78 A number of issues have been raised concerning the policy conditionalities associated with the Bank's supported adjustment programs. The issues involve the adequacy of the policy package, the timing and sequencing of the programs • 79 and the collaboration between the Bank and the IMF. It is observed that the requirement of rapid major structural reforms might be beyond the coping capacity of most debtor countries. Moreover, their political and administrative systems might not be adequate to deal with the speed at which the formulation and implementation of policy changes is planned.80 The Bank itself has found that "there are no general solutions, the design of adjustment has to be carefully tailored to meet specific needs and policy objectives of individual borrowers."81 There is therefore, a growing interest on the part of the Bank to improve its own understanding of the complex interrelationships among policy measures and their impact on 78 Excerpts from the World Bank on Debt Service and Growth. World Bank Debt Tables 1985-86- reproduced in The Political Economy of the North-South Relation Edited by Miljan Toivo. see chapter 1, note 1 79 UNCTAD, note 76 80 Id. 81 Id. economic performance, to improve its assessment of the capacity of governments to implement reform measures, and of the time required for such implementation. Finally, to improve its attention to the social costs associated with adj ustment programs.8 2 The cooperation between the IMF and the World Bank leans towards making lending by one dependent on the fulfillment of the conditions of the other, otherwise known as cross conditionality. The IMF Annual Report for 1987 stated: "In all questions in connection with Structural Adjustment Loans, complete agreement between both institutions must be reached on all important points."83 For example, in the fiscal year 1979 through 1985, only three of all the Bank's loans were approved for countries where the IMF's stabilization program was not in operation.84 Also in the early 1980s, the Bank withheld a $300 million economic recovery loan to the Philippines for not complying with certain IMF conditionalities. It is submitted that the cross conditionality measure might lead to a delay in implementing a program in the event of a 82 Id. 83 Didszun, K., The Debt Crisis and the IMF Policy. 23 Inter Econ. Rev. of Int'l Trade and Dev. No.4, (July/Aug. 1988), pp. 163-171 4 Id p.43 disagreement between the two institutions in respect of a program.85 According to critics, the five to seven year period of the SALs is not long enough for the implementation of the program in view of the fact that some legal, economic and political questions need to be resolved. For example, privatization of state enterprise as recommended by the Bank can hardly be resolved among the authorities of the countries concerned within a short time.86 Moreover, there is the tendency of the reforming zeal waning as soon as the SALs period is over. More important, it is not unnoticed that some of the SALs Programs conflict. For example, though the liberalization of the financial market increases savings, the high interest rate which results from it discourages foreign investment. Again the conditions attached to the SALs appear to be a standard regardless of the peculiarity of economic, social and political problems facing different debtor nations.87 85 Shams, R. , The World Bank Structural Adjustment Loans: A Critique. 23 Inter Econ. Rev. of Int'l Trade and Dev. No.5, (Sept./Oct. 1988), pp.208-211 86 Id. 87 Id. 46 Nevertheless, the SALs, the Sectoral Adjustment Lending and the Special Facility for SubSaharan African countries are all positive responses to the debt problem even though they might not keep the problem from recurring. They have to some extent helped debtor countries to absorb external financial pressure, revamp their economies as well as exercise financial discipline. THE ROLE OF THE LONDON CLUB IN DEBT MANAGEMENT As stated in chapter one, the profit motives of the commercial banks lured them into making big loans to the LDCs. It was said that by 1982, the nine largest American banks had made loans exceeding their capital to Argentina, Brazil and Mexico.88 It was the consensus of expert opinions that a default by these countries might lead to insolvency of the banks and consequently, the collapse of the international financial system.89 When therefore, it was no longer profitable for the banks to continue to give big loans, they reduced their lending exposures to the LDC debtors especially the heavily indebted ones. The idea was to minimize the effect of any possible default on the part of these countries. The decline in bank lending appeared to have aggravated the situation so much so that in 1982, Mexico declared moratoria on both its aa Cline, W., pp.36-40 ,see chapter 1, note 3 89 Id. amortization and interest payments. Brazil and Argentina followed suit. Thus the international financial system became vulnerable and was probably at the verge of collapse. At this point, the interests of all concerned were readily awakened. The US and its western allies quickly arranged a rescue package to salvage the situation. The BIS was called in to make bridge loans pending when the IMF was able to negotiate adjustment programs with the countries concerned, and the banks able to release new credits.91 The US made a commodity credit of $1 billion in favour of Mexico and another $1 billion advance payment for the purchase of Mexican oil. The Fund itself had to disburse $3.9 billion to Mexico over a period of three years as part of an extended Fund arrangement. In addition, Mexico's debts were rescheduled to eight to fourteen year periods with a grace period extending to six years. The interest rates were reduced and the domestic prime rate options for creditor banks by which they choose usually high interest rates was eliminated. More important, Mexico was to service its debt in proportion to its export earnings.92 It seems the rescue package was more concerned with averting a collapse of the international financial system by keeping interest payments on loans current rather than yu Id pp.77-79 91 Id pp.40-44 92 Tapia, pp. 1-19 48 ensuring sustained growth for the debtor countries.93 In other words, the fact that the rescue package would probably not have been organized if Mexico had not declared a moratorium shows that debt strategies are only applied in time of crisis instead of at the earliest time they are needed to prevent it. The crisis has considerably reduced the creditworthiness of the debtor countries.94 And in the face of depreciating creditworthiness, export credit agencies withdraw their export credit insurance cover for goods being exported to the LDCs which are vital for their economic development.95 REFINANCING AND RESCHEDULING OF COMMERCIAL DEBTS IN THE LONDON CLUB In the early 1970s, a group of bankers conceived the idea to reschedule and sometimes refinance debts owed to them by debtor countries under a common forum which became known as the London Club.96 Under this forum, banks participate through their steering committees. The London Club is a sort of bankers* cartel. This solidarity on the part of the banks gives them a better bargaining power in Schirano, L.G., see chapter 1, note 7. UNCTAD TD/B/C.3/212, 11th July, 1986, pp.3-12 Rieffel, A., The Role of the Paris Club in Managing Debt Problems. Essays in International Finance No. 161, Dec.,1985 p.3 negotiating debt agreements with individual debtor countries.97 Traditionally, banks offer rescheduling on a short term basis (year by year). They charge high interest rates and Q Q fees on rescheduled loans. The short term rescheduling not only disrupts the economic plans of the debtor countries, but adds to the debt burden by reason of rescheduling fees and higher spreads.99 Banks require that debtor countries seeking for rescheduling or/and refinancing of their debts should undertake the IMF adjustment programs. They demand that debtor countries negotiate for relief on a comparable terms with their official creditors.100 This policy brings delay in granting of relief and makes room for the accumulation of debt arrears. They also insist in some cases that a country guarantee its private sector's debt before it can obtain relief in respect of its public debts. When in the early 1980s, Chile needed relief in respect of its public debts, it was compelled to retroactively guarantee its private sector debts. This resulted in a 30% expansion of 97 Jones, S. and Nichol L. see chapter 1, note 13 ; Jones, S.G. and Sunkel, 0. Debt and Development Crisis In Latin America: The End Of An Illusion. Clarendon Press. Oxford 1986,pp. 112-114. 98 Id. 99 Id. 100 Tapia^ E.C.,pp.l-19 50 Chile's debt. Guaranteeing private sector's debt, the contract of which a country can hardly monitor is a very unfair practice and it has an adverse effect on a country's ability to absorb the debt shock. The banks also demand that all interest arrears on loans be liquidated before relief is granted.102 The question is, if a country can pay its interest arrears, why should it in the first place seek relief. The traditional approach of commercial banks to the debt problem is summed up in an UNCTAD document thus: Initially involuntary lending carried terms unfavourable to borrowers, for example, the rescheduling of loans was associated with substantial fees and increases in the margin charged by banks over their own borrowing rates. Moreover, reschedulings under involuntary lending were also characterized by a short leash approach which entailed short consolidation periods and small amount of new money. The reasons for this short leash approach included the creditors objective of buying time in the hope that improvements in the economic situation would render more radical schemes of debt rescheduling unnecessary, the desire to force on debtors, rapid adjustment on their external accounts and reluctance to permit possible increases in debtors• bargaining power consequent on the restoration of their level of exchange reserves. More recently however, there have been modifications of the regime of involuntary lending in directions more favourable to borrowers. As an UNCTAD report puts it: 101 Carvounis, C., pp.49,169 102 Id pp. 126-127 103 UNCTAD TD/B/C.3/212 pp.3-12 51 Commercial banks practices have also evolved in ways that have reduced cost of rescheduling for the debtor country by lowering commissions, front-end fees, and, in some cases, by lower spreads, diversifying the currency denomination of debt and shifting to a lower reference interest rate. Recently repayment and grace periods have been lengthened too and, in one case, the amount of new financing is linked to the price of the debtor's major export commodity and the growth of its domestic economy. These developments suggest an increased willingness on the part of the creditors to commit themselves in advance to further support in the event of unforeseen and unfavourable changes in the debtor's circumstances.10 As an incentive for the adoption of viable economic policies, commercial banks offer Multi-Year Rescheduling Agreements (MYRA) as opposed to a year by year rescheduling, to debtor countries considered to have made progress in their adjustment programs. This helps to eliminate the accumulation of loan maturities which would hinder the restoration of normal market relationships between the debtor country and its creditors. In particular, by covering maturities falling due over several years and offering longer repayment periods, the banks have succeeded in providing an improved planning horizon for creditors, investors and debtor governments. The MYRA has at the same time, involved the development of special monitoring procedures as banks wish to be assured of the debtor countries' strong commitment to policy adjustment and reform even when the borrowers are no longer using IMF resources. This has led to the development of a program known as 4 UNCTAD TD/328/Add.2, 19th Feb.,1987, p. 21 Enhanced Surveillance by the IMF. This means that even when the IMF is not financing an adjustment program with its own resources, it will nevertheless supervise the program. Regrettably however, the London Club generally does not reschedule interest because such rescheduling has a negative income tax effect. Also new loans by banks are still low.106 It is interesting to note that the rescheduling process at the London Club is very complex and time consuming. Though the number of creditors are many and their interests and nature of relationships with debtor countries are much more diverse, they nevertheless are required to reach a unanimous consensus on any relief to be granted.107 The Club proceeds on an ad hoc basis without any clearly defined principles to guide its deliberations. In some cases, there is an initial major problem of determining the precise dimension and character of a debt.108 The early practice in the Club's rescheduling process required all participants to sign a single document with each debtor country. But recently, once an agreement is reached in principle, each 105 Id. 106 Hudes, K. pp.553-71; Rea, G.F., Restructuring Sovereign Debt: Will There Be A New International Law and Institution? Am. Soc'y Int'l Law Proc.(1983/84), pp.312-35 107 Hudes, K. pp.553-71 ; Rea G.F., pp.312-35 108 Rea, G.F., pp. 312-35 bank enters into a separate agreement with the debtor 1 09 country concerned, which in effect is a longer process. There is also a problem associated with syndicated loans. In this instance, banks insist on equal treatment by debtor countries to all participating banks. In other words, no bank should be treated less favourably than the others. The problem lies in determining what amounts to equal treatment and how to implement it. Are banks to be paid amounts proportionate to their individual exposure to a sovereign debtor or are they to be paid the same amount generally irrespective of the degree of their individual Tin exposure? X-LU This development seriously affects debt management and the ability of the debtors to cope with it by reason of the fact that debtors are indiscriminately called in default.111 For example, if a bank refuses to participate in debt rescheduling and its loan is repaid at the original maturity, the debtor country concerned is called in default by the other banks for treating such a bank more favourably. On the other hand, where the debtor country refuses to pay such a bank at the original maturity, the debtor is still in default for failing to service its debt at the due date. Unless this is resolved by banks, it is a clog to efficient debt management. 109 Hudes, K. pp.553-71 110 Walker, M.A., International Debt Rescheduling Am. Soc'y Int'l Law Proc. (April, 1983/84) pp. 308-310 111 Id. 54 THE ROLE OF THE PARIS CLUB IN DEBT MANAGEMENT. When over forty years ago, creditor governments gathered in Paris to negotiate debt relief for some debtor countries, little did they know that that gathering was to crystallize into a routine. Thus the Paris Club (a sort of cartel of creditor governments) is an informal gathering of creditor governments, particularly the members of the Organization of Economic Cooperation and Development (OECD), charged with considering and granting of request from debtor countries for debt relief in respect of official debts.112 Traditionally, the Club approaches the debt problem on a short term basis (year by year rescheduling). A report says that such reschedulings have relatively little effect in ameliorating the debt problem in the long run. According to the report, debt obligations are increased and experience has shown that one rescheduling leads to repeated reschedulings. The relief associated with the Club's reschedulings is of limited scope because the reschedulings do not cover multilateral creditors to which the poorer LDCs have a high and increasing level of obligations nor do they include some of the OPEC members and socialist countries of Eastern Europe which are some of the bilateral TIT creditors of some of the LDCs. ±xz Abbott, G.C., pp. 1-16. see chapter 1, note 6. 113 UNCTAD TD/328/Add.5, 18th Feb.,1987 55 Regrettably, not all debts are eligible for rescheduling under the Paris Club. For example, debts which are to mature before or in twelve months time (contract cut off date) are not rescheduled.114 The non rescheduling of short term debts is a bad debt management strategy since it means that a debtor may in most cases, not be able to plan, utilize the loan and generate foreign exchange to repay the debt. It is indeed a great impasse on the efforts of debtors to cope with the debt situation. As one writer puts it: "The Paris Club mechanism has not been effective in easing Africa's debt difficulties. The procedures adopted by the Club place strict limit on the definition of the debt eligible for debt relief. Consequently, more than half of the debt service due is not considered eligible. Furthermore, relief is, when provided, on only a small part of the remaining debt, and since the amount of relief is usually insufficient to ease the liquidity problem for more than a year or more, this arrangement has led to repeated rescheduling."115 For example, of the twenty nine countries whose debts were rescheduled between 1978 and 1984, twenty seven returned to the Club for further relief.116 The Club does not reschedule debt unless the conditions of immediate default, IMF Stand-By Arrangement and • 117 comparative treatment from commercial creditors are met. 114 Rieffel, A. note 100. 115 Abbott, G.C. pp.1-16. see chapter 1, note 6. 116 Rieffel, A. note 100. 117 Id; Rieffel, A. The Paris Club 1978-1983. 23 Columbian J.Transnat"1 Law, pp.83-110; Hudes, K., pp. 553-71 By imminent default, it means that it is beyond doubt that a debtor country will be in default save the Club grants a relief. In 1980 for instance, Senegal's request for a relief was turned down on the ground that its balance of payment position as endorsed by the IMF did not indicate any danger of imminent default. Two years later, Senegal defaulted and the cost of relief became greater. This shows that the IMF assessment of a country's debt situation can not always be precise as to be relied upon. Moreover, while the wisdom of this condition is to avert throwing open a flood gate of requests for relief even from debtors without genuine cases, the folly lies in its indifference to prevent a debt crisis. One is tempted to question the wisdom of making imminent default and the IMF adjustment program simultaneous conditions precedent for granting of relief when in most cases a country undergoing an adjustment program would hardly be in imminent default at the same time. By comparative treatment, it means that a debtor negotiating for a relief with the Club must undertake to obtain similar relief terms from commercial banks in respect of its • , 110 commercial debts so that the banks are not bailed out.-1-0 However, the problem has been the lack of a formula to determine or measure in a given situation, a comparable treatment especially when it is realized that unlike official loans, commercial loans are made with the motive to Id; Carvounis, C., pp.29-30 57 make profit and so are not on concessional terms. Moreover, the Club does not reschedule interest arrears, future interest payments or loans that it has previously • • 1 1 Q rescheduled. It only reschedules the principal amount. The procedure for debt relief negotiations under the Club is ad hoc without any established rule to guide negotiations. By this reason, some identical cases are treated differently. The Club also negotiate an umbrella agreement on behalf of all creditor governments. This agreement is not effectual until it has been implemented by the individual creditors by a separate agreement with the debtor. In the US, a third agreement is undertaken between the debtor and the appropriate state agency, for example, the Eximbank.120 This bureaucratic process brings delay in implementing the relief, and consequently the arrears of debt accumulate. Another cause of delay is the time taken to sort out what proportion of relief burden each creditor should bear. There is no clear formula for determining this. The extent of a creditor's exposure is not a reliable formula because of statistical problems and moreover, it would put a debtor in a tight position in trying to comply with the non discriminatory clause of treating a creditor no less favourable than the others. 119 Id. 120 Id. 58 Interestingly, a new era emerged in the Paris Club approach to the debt problem, when in 1976, the Trade and Development Board of UNCTAD, meeting in Nairobi, came up with Resolution 165 (S-IX), otherwise known as Retroactive Term Adjustment (RTA) which came into force in 1978. By this resolution, the creditor governments agreed to offer a variety of debt relief.121 Resolution 222 (XXI) of 1980/81 passed by the same board, contains an Agreed Detail Features regarding the debt problem. The objectives are that international actions should be expeditious and timely, should enhance the development prospects of debtor countries bearing in mind their socio-economic priorities, should aim at restoring the debtor countries' capacity to service their debts on both the short and long term bases and should reinforce debtors' efforts to strengthen their underlying balance of payments situations. Finally, that international actions should protect the interest of debtors and creditors eguitably in the context of international economic cooperation. " The RTA entails conversion of debts to aids and grants, payment in local currency and the reinvestment of such in the debtor's economy. Initially some reasonable relief was granted but with time and especially in the face of increasing world economic recession and the inability of the 121 UNCTAD TD/328 May,1987, pp. 12-13; Abbott, see chapter 1, note 6. 122 Id. 59 debtors to repay, the enthusiasm on the part of the creditors to continue with the scheme waned. And by this reason the set objectives of Resolution 222(XXI) have not been substantially achieved.123 More recently, the Club has introduced some changes in its approach to the debt problem. Measures designed to deal with rescheduling in a way that has encouraged export credit agencies to provide new flows to debtors have been introduced, coupled with a willingness not to insist on a comparable treatment from banks.124 An UNCTAD report says: A further development in the debt rescheduling practices of the Paris Club relates to a general improvement in the coverage and terms of debt reliefs extended to countries with severe balance of payment problems involving financing of deficits on current account. For example, the terms of rescheduling of arrears or debt service payments arising from previous Paris Club meetings in recent years have been similar to those applied to the consolidation of current maturities. As regards the coverage, arrears on short term debts have been more frequently consolidated in the past, although maturities on such debts falling during consolidation periods have continued to be excluded. Also late interest due and not paid has been consolidated in several cases, in contrast to the practice in previous vears when such obligations were not included.1 Unlike in the past, the Club in 1985/86, granted a MYRA to scheduled repayment of principal in three cases. In these cases the conditionalities usually associated with the Club's agreements involving countries relationship with the note 121. TD/328/Add.2 , 19th Feb.,1987, p.21 123 UNCTAD 124 Id. 125 UNCTAD IMF was modified for one or two years, covered by the agreement during which Enhanced Surveillance procedures of the IMF were required instead of a Stand-By Arrangement.126 Complementing the efforts of the Club, some creditor governments have provided a debt relief program for the debtor countries. The European Economic Commission for example, has introduced a scheme known as STABEX, aimed at stabilizing the earnings from exports of some agricultural products of some LDCs.127 Under this program which covers sixty six countries in Africa, Carribean and the Pacific, compensation is paid to individual producing countries in case of shortfalls in their export earnings. The repayment conditions of the scheme are believed to be generous and contains grants of a considerable magnitude and the poorer segments of the LDCs are even exempted from repayments. Though the scheme does not cover the whole of the LDCs, its significance to alleviating the debt problem can not be underestimated. Efforts are believed to be on the way to extend it to the other LDCs.128 More recently, Japan submitted a proposal at the IMF and the World Bank meeting in Berlin for debt relief for Latin American countries. President Mitterand of France offered debt forgiveness to some of the LDCs, "an offer reflected in 'a la carte' 126 Id. 127 Id. 128 Id. 61 approach adopted at the Western Presidential Summit meeting in Montreal in the summer of 1988.1,129 This was of course intended for the African client-states of the EEC. It is submitted that the debt burden will be more relieved if other creditors can take similar initiatives. DEBT - EQUITY SWAPS AND FOREIGN INVESTMENTS IN THE  MANAGEMENT OF THE DEBT PROBLEM DEBT-EQUITY SWAPS The increasing international debt problem, while defiling some management strategies, rekindles the desire for new initiatives on the part of debt managers. Consequently debt-equity swaps strategy has evolved to deal with the problem. By debt-equity swaps, a potential foreign investor in an LDCs economy converts a portion of the LDCs foreign debt into an equity investment in a local LDC corporation. The investor does this by purchasing the debt at a discount and presenting it to the LDCs central bank for conversion at face value into local currency.130 The advantages of debt-equity swap strategy are summed up thus: Konz, P. at 532. Gottscho, G. Debt-Equity Swap: Financing of Third World Investment - Will the IRS Hinder U.S. Swappers, 8 Virginia Tax Review (Summer 1988) No. I. pp. 143-81. 62 For the LDCs, the principal advantages of debt-eguity swaps are that they encourage equity investments in the LDCs that would not occur otherwise, improve economic efficiency by attracting investment from firms with needed expertize and reduce the discounted future cost of the LDCs1 external debt payments. Debt-equity swaps also encourage privatization efforts in LDCs which could lead to more open economies and encourage entrepreneurship and economic efficiency. Viewed optimistically, debt-equity swaps may ultimately provide LDCs with a second chance to develop the productive capacity that the huge amounts of external debt incurred was intended to finance. 1 The scheme seeks to reduce the size of external debt and to link the servicing of external obligations more closely to a country's capacity to pay, in that the outflow of returns to investors would depend upon the earnings generated by the activity being financed.132 The scheme saves a debtor country the need and the trouble to borrow new money for economic development because already the investments attracted by the scheme are serving the purpose. It also eliminates the payment of interest and rescheduling fees. A sizeable number of LDC debtors, mostly Latin American countries, has embarked on this scheme. They have enacted legislation specifying the areas of their economies available for foreign investments, conditions for investment, profit repatriation and debts that are eligible for conversion, etc. Countries like Argentina match the 131 Id. 132 UNCTAD TD/328/Add. 2. 19th Feb; 1987, pp. 22-23. 63 amount of foreign capital imported with an equivalent local currency. This ,is a good incentive that has won the enthusiasm of foreign investors. In 1985, a well managed debt equity swap scheme financed about 2%, 6% and 5% of Brazil's, Argentina's and Mexico's debts respectively. According to World Bank Annual report for 1987, though the scheme is far from offering a complete solution to debt servicing problems, it can contribute to encouraging foreign investment, provide a channel for the return of flight capital and reduce the foreign exchange needs of servicing a debtor's external debt. The major factors militating against the success of the scheme are the restrictions on repatriation of profit, fear of nationalization of investments and the restriction on areas of investment by the debtor countries for fear that their economies might be under the control of foreigners. The U.S. banks are particularly not interested in participating in the scheme. They complain that they are unable to sell a substantial amount of the LDCs' debts because of the unfavourable accounting treatment on 133 Estella, 0. Making the Most of Mexican Debt Equity Swaps. Int'l Financial Law Review, (Oct. 1987), pp. 3 5-3 6; Bomschil, M. , New Conversion Program in Argentina, Int'l Fin. Law Review (Feb. 1988), pp. 35-36. Rodner, J.O., Venezuela Debt Equity Swap Program Int'l Fin. Law Review.(July 1987), p. 32; Stuber, D. & Street, E. - Brazil's Debt Equity Swaps Program, Int'l Fin. Law Review (Feb. 1988), pp. 33-35. 134 Hentschel, J. Managing Int'l Debt -23 Inter Econ. Rev. of Int'l Trade & Dev., No. 3 (May/June, 1988) pp. 126-31. 64 secondary market sales of debt. They also fear the imposition of tax under U.S. tax law on such transactions because where proceeds from debt equity swap transactions are considered a gain rather than a subsidy to encourage foreign investors, tax is imposed.135 Big US banks with large exposures have been reluctant to incur losses by selling their loans at a discount which is required under the scheme and making loan loss provisions as required under the regulation made pursuant to the International Lending Supervision Act. Moreover, most potential investors seem to be reluctant to invest in countries which are plagued by economic difficulties.136 In addition, the scheme is constrained by the size of the debt in relation to the amount of foreign investment that can easily be accommodated in a given debtor country. For example, Latin America's external debt is four times as large as the stock of foreign direct investment in the 137 region. Owing to the factors above mentioned and more, the size of the debt-equity swaps market has been very small. For instance, less than 2% on average of the total external bank debt of Argentina, Brazil, Chile, Mexico and Philippines, 135 Gottscho, G.,p.l69 136 Id. 137 Id. have been converted. Only about $5 billion of LDCs1 debt has been swapped since the era of the scheme. According to World Bank statistics, in Chile debt-equity conversion amounted to $1.6 billion in 1987, $1 billion and $2.6 billion in Mexico and Brazil respectively in 1986, and $78 million and $70 million in the Philippines and Nigeria respectively in 1987.139 It is suggested that this scheme could be expanded with the participation of creditor countries and banks as investors in debtor countries. Multinational corporations alone cannot buy out even half of the debt of the LDCs. With better investment policies, particularly a little relaxation of legislation on profit repatriation and nationalization and simple approval procedures, more investors might be attracted to the scheme. FOREIGN DIRECT INVESTMENT As already noted, the LDCs generally are reluctant to allow foreign investments in strategic areas of their economies, for example, in the areas of natural resources exploitation and energy, for fear of foreign control. Ironically, these areas yield in large part, the foreign exchange needed to service debt. So, by excluding foreign investments in these areas , the foreign exchange yielding capacity of the countries is tremendously reduced. 138 UNCTAD, note 125. 139 The World Bank Annual Report for 1987. There is the impression on the part of some LDCs that multinational corporations invest only for profit maximization rather than for genuine desire to help build a stable economy.140 Plausible though this argument may be, the fact remains that the LDCs would be better off with foreign investments at such a time as this when the dynamism of world trade calls for technologically improved goods, bearing in mind that the chief factors accounting for reductions in the growth of output in adjusting LDC economies is the decline in public and private investments.141 UNCTAD is of the view that foreign direct investments could if encouraged, help out countries facing external financial difficulties. It nevertheless regrets that foreign investments come only in the private sector of the debtor's economy and might not have any significant reduction on public sector debts. UNCTAD also recognizes the need to encourage foreign direct investment by improving the host countries' policies and by international efforts in the area of removal of subsidies to industries and dismantling of protectionist barriers in industrialized countries.142 140 Eskridge, W.N. Jr. p. 64. see chapter 1, note 3 141 Id. 142 UNCTAD, note 132, p. 45, 67 DEBT MANAGEMENT CONSTRAINTS There are some constraints militating against a better debt management. Unfortunately, while some are tied to some uncompromising interests of the creditors and debtors, others are due to natural disasters. The financial and trading positions of most LDCs worsened sharply during the 1980s owing to an unfavourable international economic environment, namely depression in demand of LDCs exports, high interest rates on bank loans which for example, increased from 20% in 1975 to 45% in 1984, unstable exchange rates which led to fluctuations in commodity prices of LDCs exports and terms of trade.143 These factors make it difficult for the LDCs to plan and manage the external sectors of their economies effectively. Some of these constraints are dependent on the Gross Domestic Product (GDP) growth in the OECD countries.144 While it is true that factors like fluctuation in GDP growth in OECD countries and exchange rates might not be within the control of these countries, protectionism, high interest rates and subsidies to their industries might be within their control. Though protectionism is in the interest of the survival of the domestic economies of the developed countries, restraints ought to be exercised in its imposition especially when the cost on the part of the LDCs 143 UNCTAD TD/328/Add.l April 13, 1987, pp. 9-10. 144 Id. 68 outweighs the gain on the part of the developed countries. There should be a balancing of interests. But the question of the criteria to be used in determining the balancing of interests is another big concern. Though some domestic policies of the LDCs, for example, resistance to adjustment programs in order to avoid political crisis, and overnight industrialization constitute a hindrance to a better debt management, the effects of policy reforms have been impaired by natural disasters in some of the LDCs. For example, the drought in Burkina Faso, Central Africa Republic, the Gambia, Mali, Niger and Sudan, did cause a decline in their primary commodities production. On the other hand, as a result of improvement in its terms of trade and an increase in its external assistance, Samoa achieved an annual growth rate of 2.1% in 1984 as against -1.0% and 0.4% in the previous two years. In Togo, good rainfall and increased phosphate exports in 1984-85, led to a growth of real GDP of 5.9 in 1985, thus reversing the negative trend of the preceding 145 years. ^J Unfortunately the IMF and the World Bank have not been able to practically address the exogenous constraints that have their roots in the industrialized countries. They only concentrate on the internal policies of the LDC debtors. This alone might not really bring about a better debt 5 UNCTAD TD/328/Add. 5, Feb. 18, 1987, pp. 15-17. 69 management because what is achieved by addressing the problem on the debtors' side is lost by the apathy on the creditors' side. Nevertheless, the IMF acknowledges this point when it said "in general different policy stances in the industrialized countries have somewhat more influence on GDP growth in developing countries than do the latter's own policies."146 The World Bank is not oblivious of the situation either. It stated: The need for adjustment is not confined to the developing countries....Many of the failings in the World economy have their roots in the industrialized countries, whose financial and economic weight greatly influences the economic prospects in the developing world.1 Statements such as these will not save the situation. They must be supported by action. But how these institutions, the IMF and the World Bank, would go about persuading or compelling the creditor countries to be more responsive to the debt problem, is easier said than done. The administrative incompetence of the debtor countries themselves is also a constraint to effective debt management. For example, it is noticed that: Decision-making processes are slow and uncoordinated - usually involving the central banks, ministries of finance and budgetary authorities, parliaments, as well as some of the large autonomous public sector companies.148 146 Carvounis, C, p. 62, 147 Id. 148 Konz, P. at 530. It is also unfortunate that many debtor countries save countries like Brazil, know very little about the structure of their external sovereign debt and even private debt guaranteed by them. Though debt recording and monitoring are gradually being computerized, it is feared that the data being fed to the computer are too obsolete and unreliable for proper appraisal of the debt situation and for a better planning horizon.149 Owing to this point, debtor countries are not only lost in debt negotiation and renegotiation processes with the creditors but are also unable to properly manage their debt and debt portfolio in terms of rightly deciding how much, when and where to borrow. As a result, they fall victims of "penalties, commitment fees for unutilized or under-utilized special-purpose loans, as well as in exchange losses due to currency fluctuations"150 in the hands of the creditors. EVALUATION OF THE DEBT MANAGEMENT STRATEGIES International debt management has come a long way. A lot of efforts have been expended in trying to manage the debt problem better. The traditional approach to the problem has been improved upon by some more recent developments as the preceding discussion shows. But it seems there could hardly be enough improvement. 149 Id at 530-531. 150 Id at 531. 71 UNCTAD is of the view that the adequacy of the debt strategy has to be examined in the light of whether the objectives set out in the Agreed Detailed Feature contained in the Trade and Development Board Resolution No. 222 (XXI) of 1980/81 supra have been achieved. According to UNCTAD: Present arrangements have, by and large failed to achieve the desired objectives and are in need of improvement if the Detailed Features are to be applied more effectively. International action has not been sufficiently expeditious and timely. The development prospects of the debtor country have been assigned a secondary role. Efforts to restore the debtor country's capacity to service debt and to reinforce its own efforts to strengthen its underlying balance of payments situation have been primarily short term in nature. The interest of debtors, and particularly their interest in sustaining development, have not been protected equitably in the context of international economic cooperation.151 Moreover, time that could be used to deal with the debt problem before it deteriorates is spent negotiating IMF conditionality. And when the conditionality is finally imposed: The absence of suitable medium-term balance of payments adjustment supported by IMF, with a more appropriate yet no less rigorous type of conditionality, renders it highly unlikely that debt rescheduling can adequately restore a country's capacity to service its debt in the long run."152 In other words, if debt rescheduling is tied to IMF conditionality which is a short term approach, how can the 151 UNCTAD TD/B/980, January 26, 1984, p. 11. 152 Id. 72 debtors be expected to service their debts regularly on a long term basis? Furthermore, UNCTAD notes that the ad hoc nature of rescheduling both commercial and official debts is not suited to a systematic application of the Agreed Detailed Features in Resolution 222(XXI), particularly to the attainment of the objective of enhancing a country's development prospects. UNCTAD maintains that: On the whole, debt renegotiation exercises have not attached great importance to enhancing the development prospects of the debtor country, but have rather been focused primarily on restoring debt servicing capacity in the short term. Because of its excessive "shortleash" character, current practice makes an inadequate contribution to the restoration of normal trade and financial relations, divert unnecessarily the energies of economic managers, and impedes the emergence of a medium term growth-oriented approach to resolving the country's difficulties.15-3' It seems that under the short term approach, the creditors are only interested in granting the amount of relief that is the absolute minimum necessary to restore the credit rating of the debtor country and to enable it resume payment as quickly as possible. Rescheduling, though it offers a temporary respite, does not solve the problem in the long run. What the debtors need, it is submitted, is not so much of time to pay their debts but time and support to restructure their economies and achieve a rate of growth 153 Id., p.l. that would improve the welfare of their people and at the same time meet their international obligatons.154 Though the Paris Club has shown increased flexibility in rescheduling for countries with lowest income and the most severe indebtedness, consolidating up to 100% of principal and interest as well as previously rescheduled debt service, and applying much longer repayment terms to some of the poorest countries,155 it is yet to extend this benefit to all the other debtor LDCs. It is also desirable for the IMF and the World Bank to extend their recent medium and long term programs for the low income LDCs to the other debtor LDCs. The type of adjustment programs imposed on the debtors lead to a negative transfer of resouces from the south to the north, whereby all efforts have to be directed at the expense of other sectors of the country's economy to produce exports just for debt servicing.156 The Latin America LDCs for example, made payments exceeding inflows of new lending by $31 billion in 1983, $21 billion in 1984 and $30 billion in 1985.157 The effect of this, is lack of the capital needed to finance economic growth in the debtor countries. 154 Abbott, G.C., p. 189, note 1. 155 Tne Worid Bank Annual Report for 1988, pp. 31-4 0 (In 1987, Guinea Bissau, Mozambique, and Somalia were given 10 year grace period and 2 0 year repayment terms.) 156 Amaral, S. pp. 17-3 0, note 17; Jones, S.G. & Sunkel, 0.,p. 32. 157 UNCTAD note 103. The Commonwealth Group of Experts (London 1984) on The Debt Crisis and the World Economy has stated: Any satisfactory solution to the present situation must as a matter of urgency put an end to the premature out flow of resources from LDCs; The current debt management strategies mean that real growth in LDCs is being sacrificed to meet immediate debt service requirements. 58 This statement is serious. In the main, it means that a better debt management strategy should ensure that debt servicing is balanced with economic growth in the debtor countries. This can be achieved by limiting debt servicing to the economic capacity of a debtor country without jettisoning growth. The Baker Plan which is intended to make available more capital for development purposes in adjusting debtor LDCs has been aborted by commercial banks.159 The banks still do not want to increase their exposure to debtor LDCs for fear of losing their money. Those based in the US complain that the bank regulations deter them from increasing capital flow to the LDCs. Dismissing the Baker Plan, the Cartegena Group of Latin America complain that the amount ($20 billion spread over three years) offered under the Plan does not permit orderly repayment of debt and the resumption of economic growth. The group is of the view that the plan does nothing about the reduction of high interest rates, weakening commodity 158 Jones, S.G. and Sunkel, O. p. 34. 159 UNCTAD TD/328, May, 1987, p.6; Amaral, S., note 17. 75 prices, protectionism and overall adjustment in the industrialized countries, and does not introduce flexibility to IMF conditionality.160 Some scholars are even skeptical about the help of new loans in relieving the debt burden in the face of adverse external market situation. They contend: Fresh credits do not help ease the debt burden. They only help to augment the debt mountain. ... In theory fresh money is given to strengthen the productive base of the developing countries so that they will at some day in the future be able to earn enough foreign exchange to service and repay their debt. In practice it turns out that the more the developing countries produce in terms of commodities, for instance, the lower are the world market prices for these goods. And when they venture into manufactures, they find industrial markets closed to their exports.161 The Group 2 4 States: Although an essential element of the strategy followed so far recognizes the responsibilities of industrial countries to provide a stable and growth oriented economic environment... industrial countries have fallen short of this commitment...this situation of indebted countries remains most fragile. In spite of continued adjustment, the debt of developing countries has continued to increase.162 The height of the inadequacy of the debt strategies as implemented thus far has been the failure to conceive it within a broader strategy for accelerating growth in the world economy. The prospect of slow growth in the developed market economy countries now and in the period ahead casts bU Carvounis, C. pp. 216-17. 61 Briones, L.M., p.7, see chapter 1, note 2 62 Id, p. 11. 76 doubts on the prospect for rapid growth in export earnings of most debtor countries. Yet rapidly expanding export earnings are fundamental to any successful debt strategy and without them the objectives of accelerating growth in debtor countries and achieving financial viability cannot be reconciled.163 UNCTAD proposes some improvements to the present debt management strategy, which include: (1) bringing the debt management strategy into the process of macroeconomic coordination designed to promote higher growth in the major industrialized countries; (2) the working out by debtors of improved domestic policies for promoting growth, to be facilitated by a more predictable and more supportive external environment; (3) the working out of a detailed and operational internationally agreed set of guidelines for dealing with debt problem as preempted in Resolution 222(XXI) supra.164 It is also important to have guidelines dealing with such matters as the respective roles of creditors and debtors in resolving debt problems, the manner in which the achievement of adequate rates of growth can be incorporated into programs for dealing with such difficulties, and the way in which financial policies and practices can be made 163 UNCTAD TD/328/Add. 2 Feb. 19, 1987, p. 28, 164 Id pp. 28-29. fully congruent with present and prospective external 165 earnings. It is however, necessary to introduce some mechanisms in the guideline that would check spurious claims from either the creditors or the debtors regarding their right to grant or refuse and to request for relief. Such mechanisms would be subject to review from time to time to meet changing circumstances.166 But hardly would the creditors agree to legalize the question of debt relief considering the fact that their money is at stake. However, if the obligation of a debtor country is the same as obligations under ordinary international agreements, with the doctrine of Pacta Sunt Servanda as the basis of its binding force, it is perhaps plausible to argue that debt relief being incidental to international loan agreements should equally have a legal content to bring the parties involved to compliance when the need arises. Be it as it may, an overview of the debt problem of the LDCs irresistibly leads to the conclusion that a better debt management requires adjustment and growth in these countries. Growth in the LDCs would not only require viable domestic policies but also an improvement of the world trading environment so as to raise their foreign exchange earnings and consequently their debt servicing capacity. It 165 Id p. 29. 166 Abbott, note 1, pp.189 78 must however, be understood that even with an appropriate policy programs and careful economic management, economic progress in LDCs might be slow, first, because of the relative structural weaknesses of their economies and second, because of the limited prospects for their export expansion and the world recession.167 Perhaps it is true that though the current debt management strategy might be inadequate, in large part, because it does not abate the recurrence of the problem, it might nevertheless, be the best that can be offered at present in the face of world economic recession affecting both creditors and debtors, if Indeed the economic interests of both the creditors and the debtors are to balance, and not one at the expense of the other. The Brady Plan might prove to be the only way to make the best out of a bad situation. Its focus on bank debt and debt servicing reduction and new money for economic growth from multilateral financial institutions appears to strike a balance of convenience between the banks and the debtor countries. Of paramount importance, the LDCs are strongly advised to help themselves by prudently managing what is left of their resources especially by ensuring that expenditures are matched with available resources at all times. They will also do well by engaging in countertrade among themselves 7 UNCTAD TD/328/Add. 5, February 18, 1987, p. 30. 79 and with the developed countries to avoid steep foreign exchange commitments. To this end, the cooperation of the developed countries is strongly sought. 80 CHAPTER THREE INTERNATIONAL LEGAL REGIME OF DEBT MANAGEMENT Though the economic content of the debt problem is more substantial than the content of any other subject, it does not on its own create an obligation on the part of either the creditors or the debtors, let alone an enforceable obligation. It is against this background that one can appreciate the legal content of this subject. International law generally derives its force from the recognition of the binding character of law by the international community. For the impact of international law on debt management to be fully appreciated, it is proper to examine first, the influence of creditors municipal legal systems on the matter. Usually, in a loan transaction, the parties are advised to choose a governing law and the seat of adjudication in the event of any dispute. Usually, creditors feel insecured to allow the law of the borrowing state party to govern the transaction for the fear that not only can the borrowing state influence its court but can also appropriate by legislation the terms of the contract to its favour. Since at the time of concluding a loan agreement, the creditor invariably has a higer bargaining power and leverage because he has to decide whether or not to grant the loan, he usually chooses and successfully insists that the law of his own state or some other state should govern the contract. 81 There are some municipal laws or regulations which influence not only the lending practices of some foreign commercial banks, but also debt management at the international level. Under the German law, for instance, rescheduling is just fixing a new date for payment of interest and does not cover fresh credit to the debtor (ie. refinancing). Moreover, there is no general duty under the German law to apply foreign public law, and if at all it is applied, it is subject to a domestic review under aspects of international law and public policy. There is no provision requiring German banks to set special reserves against non performing loans. Under the US law however, rescheduling and refinancing go together.3 In 1983, the creditor countries met under the auspices of the BIS and approved some principles for the supervision of banks with foreign establishments and established new rules for the supervision of international banking. Presumably unconnected with this, the US Congress, while authorizing an increase in the IMF quota, made additional requirements regarding supervision and information, loss 1 Meese, K.M., The European View of Third World Debt. Am. Soc'y of Int'l Law Proc. (April 9-12 1986), pp.51-56. 2 Id. 3 Id. 82 reserves and bank capital, all as a way of evaluating and reducing the risk in exposure of banks to debtor countries.4 The International Lending Supervision Act 1983 of the US,5 provides in its section 905(a) (i) that the bank regulators (the Federal Banking Agency) shall require banking institutions to establish and maintain a special reserve whenever: (A) the quality of such banking institution's assets has been impaired by a protracted inability of public or private borrowers in a foreign country to make payments on their external indebtedness as indicated by such factors among others, as: (i) failure by such public or private borrowers to make full interest payments on external indebtedness; (ii) a failure to comply with the terms of any restructure indebtedness; (iii) a failure by the foreign country to comply with any IMF program or any other suitable adjustment program; or (iv) no definite prospect exists for the orderly restoration of the debt service. The requirement on the part of banks to set special reserves under this section, discourages banks to continually provide new loans to debtors who are not undertaking the IMF adjustment programs. Moreover, the bank regulators are 4 Section 802, US Statutes at Large. 98th Congress 1st Session (1983). Vol. 97, Public Law 98-181, Nov.30, 1983. p.1268; 97 stat.(Amended section 17 of the Bretton Woods Agreement Act 22 USC 286 et.seq.). 5 Id p.1279. 83 empowered to impose greater discipline on banks lending to non-adjusting debtor countries. In June 1983, for example, the US bank regulators approved a regulation obliging the seventeen largest US banks to increase their capital to at least 5% of their assets. In addition, a regulation made pursuant to the Act provides, that rescheduled loans are considered current provided interest payments on them are made not later than ninety days after they fall due otherwise the loans will be categorized as non performing loans. The effect of this is that the banks concerned are required to set special reserves against such loans. When this happens, the banks concerned incur the displeasure of their shareholders whose dividends are affected as a result. 7 Section 906(a)(i) of the Act provides: Inorder to avoid excessive debt service burdens on debtor countries, no banking institutions shall charge in connection with the restructuring of an international loan any fee exceeding the administrative cost of the restructuring unless it amortizes such fee over the effective life of each such loan. This provision does not reduce the amount of outstanding debt but only prevents the immediate payment of a rescheduling fee by postponing it to such a time the principal amount matures. 6 Amaral, S. pp. 17-30. see chapter 2, note 17. Cline, W. pp.105-106, see chapter 1, note 3. 7 Meese, K.M., pp. 51-56. 84 By section 806 of the US Public Law,8 the President is empowered to instruct the Secretary of the Treasury, the Secretary of State and other appropriate federal officials and to request the Chairman of the Board of Governors of the Federal Reserve System to use all appropriate means to encourage countries to formulate economic adjustment programs to deal with their balance of payment difficulties and external debts owed to private banks. The economic adjustments are expected to be designed to safeguard to the maximum extent feasible, international economic growth, world trade, employment and the long term solvency of the banks and to minimize the likelihood of civil disturbances in countries undergoing adjustments. With a view to ensuring the effectiveness of economic adjustment program supported by the IMF, the section provides that the US Executive Director of the IMF should recommend and work for changes in the IMF's guidelines, policies and decisions which would: a) convert short term bank debt which was made at high interest rates into long term debt at lower rates of interest; b) assure that the annual external debt service, which include principal, interests, points, fees and other charges required of the country involved,is manageable and prudent percentage of the projected annual export earnings of such country; and c) provide that in approving any economic adjustment program, the Fund shall take into account the number of countries applying to the Fund for economic adjustment programs and the aggregate Note 4, p. 1272 (Amending section 45 of the Bretton Woods Agreement Act 22 USC 286 et. seq.). 85 effects that such programs will have on international economic growth, world trade exports, and employment of other member countries and the long term solvency of banks. Section 807 of the same law provides that the US Executive Diretor to the IMF shall: (i) oppose and vote against any Fund drawing by a member where in his judgment, the Fund resources would be drawn principally for the purpose of repaying loans which have been imprudently made by banking institutions to the member country; and (ii) work to ensure that the Fund encourages borrowing countries and banking institutions to negotiate where appropriate, a rescheduling of debt which is consistent with safe and sound banking practices and the country's ability to pay. It is pertinent at this point to note that a substantial amount of the outstanding LDCs' debt is owed to the US government and banks. So, the US municipal banking laws and regulations are good examples of how creditors' municipal foreign lending policies generally could determine or influence debt management at the international level. Developments of this sort do not only play down the significance of international law in managing the debt problem, but also narrows down the scope of application of international law. Hence debt is seen only in the context of international law of contract adorned with the principle of pacta sunt servanda but denied of the defenses of rebus sic stantibus and force majeure which arguably are exceptions to the binding force of contracts. The dominance of municipal law in this area impedes the progressive development of international law for the 86 management of the debt problem. For example, it has not been considered desirable to have an international law of bankruptcy. Accordingly, it is posited that though economic development is the only durable solution to the debt problem, international law can not provide a hard and fast rule on the matter because international law has a limited possibility.9 INTERNATIONAL LAW AND THE DEBT PROBLEM In their relationships, states are often apt to set out their rights and obligations in legally enforceable documents like treaties. Loan agreements between a creditor and a debtor governments may attain the status of a treaty if the parties choose to and register it as such with the United Nations Secretariat. But loan agreements between debtor governments and private persons who are not international persons, for example, commercial banks do not have treaty status. Such relationships are usually seen only in the context of an ordinary international agreement or contract. The status of the parties to an international transaction or their choice of law determines though not invariably, the governing or proper law of the contract. For examle, loan agreements made between creditor governments or international institutions and debtor countries or Meese, K.M., pp. 51-56. 87 guaranteed by the latter, are internationalized and consequently governed by international law in the absence of an express choice of law by the parties.10 But where the contract is between a state and a private person, international law has no application because private persons are not subject to international law. There is no special aspect of international law dealing with debt problem. The obligation of a debtor (including a debtor country) is the same in all respect as the obligation under an. international agreement in general.11 In other words, a debtor is bound to discharge his international contractual obligations in good faith, the principle of pacta sunt servanda. But what happens where a contract cannot be performed by reason of factors beyond the control of the parties? Under the English common law, contract adaptation to changed circumstances is known as the doctrine of frustration. In the German legal system, it is referred to as Erganzende vertragsauslegung and Gaschaftsgrundlage, while under the French law, it is the concept of Imprevision.12 Other legal systems like the Greek, Hungarian and the Italian give their 10 Siegel, K.M., The Interantional Law of Compensation for Expropriation and International Debt: A Dangerous Uncertainty. 8 Hastings Int'l & Comp. Law (1984/85),pp.223-247. 11 Starke, J.G., Introduction to International Law. 9th Edition, Butterworths, London. (1984), p.293. 12 Nicklisch, F. , Adaptation of Contract. 5 J. Int'l Arb., No.3, (Sept.1988), pp. 35-42. 88 courts the statutory power to adapt contracts to changed circumstances.13 The underlying purpose of this doctrine is to allow the parties a second chance to bring their contracts in tune with fundamental change of circumstances which at the time of concluding the contract, they reasonably had not in contemplation. At times, the fundamental change of circumstance could be such that destroys the substratum, the real basis of the contract as a result of which performance is rendered practically impossible. The question is the extent to which this doctrine operates in the international sphere. In the following analysis, the application of the doctrines of rebus sic stantibus and force majeure generally in international law is considered first before their application in international loan transactions. THE DOCTRINE OF FUNDAMENTAL CHANGE OF CIRCUMSTANCES At the time of concluding a contract, the parties may have failed to envisage the circumstances later occasioning the requirement for contractual regulation. For example, the disappearance of the substratum of the contract which renders performance practically impossible. The application of this doctrine in international law of contract is both narrow and a rarity. In fact research has disclosed no evidence that rebus sic stantibus has been 13 Id. 89 accepted as a general rule by a decision of an international tribunal.14 However, Article 79 of the United Nations Convention on International Sale of Goods (CISG) provides that a party is not liable for a failure to perform, if the failure is due to an impediment beyond his control.15 Communis Opinio (international commercial practice) provides that a fundamental change of circumstances beyond the control of the parties affects the existing contractual obligations and constitutes a ground for relief from some or all contractual obligations.16 The principle of pacta sunt servanda, doctrines of force majeure and rebus sic stantibus are enshrined and elucidated in the Vienna Convention on the Law of Treaties.17 Article 26 of the Convention provides that every treaty in force is binding upon the parties to it and must be performed by them in good faith (pacta sunt servanda). Article 62 provides: A* Mehren, R.B. and Kourides, N. Interantional Arbitrations Between States and Foreign Private Parties- The Libyan Nationalization Cases. 75 AJIL (1981), pp. 476-552. 15 Horn, N., International Concept of Force Majeure in "Adaptation and Renegotiation of Contracts in International Trade and Finance" Edited by Horn, N.vol.3, Kluwer Law and Taxation Publishers, London (1985), pp. 26-28; A similar provision is enshrined in UN ECOSOC Draft Code on International Corp.in UN Doc. E/C 10/1982/6, Annex 1982. 16 Id. I.L.M. (1969) p. 679. 90 (1) A fundamental change of circumstances which has occurred with regards to those existing at the time of the conclusion of a treaty, and which was not foreseen by the parties may not be invoked as a ground for terminating or withdrawing from the treaty unless; (a) the existence of those circumstances constituted an essential basis of the parties to be bound by the treaty; and (b) the effect of the change is radically to transform the extent of obligations still to be performed under the treaty. (2) A fundamental change of circumstance may not be invoked as a ground for terminating or withdrawing from a treaty: (a) if the treaty establishes a boundary; or (b) if the fundamental change is the result of a breach by the party invoking it either of an obligation under the treaty or of any other international obligation owed to any other party to the treaty. (3) If under the foregoing paragraphs a party may invoke a fundamental change of circumstances as a ground for terminating or withdrawing from a treaty it may also invoke the change as a ground for suspending the operation of the treaty. Indeed, Article 62 narrows down the scope of the application of the doctrine of changed circumstances in that it is not applicable where the event complained of is reasonably foreseen by the parties or is the fault of the party relying on the doctrine. Moreover, by Article 1, the Convention is applicable only between signatory states. An imperative of the rebus sic stantibus is that even where it is applicable, a party can not unilaterally invoke it to terminate or suspend its obligation but must do so in consultation and with the consent of the other party as provided in Article 54(b) of the Convention. And where a 91 dispute arises as to what amounts to changed circumstances, then under Articles 65 and 66, the matter can be referred to an agreed dispute settlement procedure to determine whether the conditions for the operation of the doctrine are present. THE DOCTRINE OF FORCE MAJEURE It is argued that there are some hardships, the occurrence of which could render a contract incapable of being performed and would therefore release the parties from their obligations. Article 61 of the Vienna Convention provides: (1) A party may invoke the impossibility of performing a treaty as a ground for terminating or withdrawing from it if the impossibility results from the permanent disappearance or destruction of an object indispensable for the execution of the treaty. If the impossibility is temporary, it may be invoked only as a ground for suspending the operation of the treaty. (2) Impossibility of performance may not be invoked by a party as a ground for terminating, withdrawing from or suspending the operation of a treaty if the impossibility is the result of a breach by that party either of an obligation under the treaty or of any other international obligation owed to any other party to the treaty. In a debt situation, volatility of the world market might not be the same as a disappearance or destruction of an object indispensable for the execution of a loan agreement under Article 61(1) of the Convention. But this might not be the case in a situation where for example, a country's sole export, say oil, dries up as a result of a natural occurrence. LOAN TRANSACTIONS BETWEEN CREDITOR AND DEBTOR GOVERNMENTS THE APPLICATION OF THE DOCTRINES OF CHANGED CIRCUMSTANCES AND FORCE MAJEURE TO INTERNATIONAL LOAN TRANSACTIONS The paramount question is whether these defenses are available in international loan transactions. It is not settled whether these defenses have a place in international loan transactions, where one party, the lender has performed his own part of the contract and the other party, the borrower, is yet to perform his own part.18 If these defenses are tenable in this instance, then money having changed hands, from the lender to the borrower, it would be grossly inequitable for the latter to keep it. Moreover, in practice, within the framework of actual restructuring, none of the concepts of frustration, force majeure or fundamental change of circumstances has been of any importance or application because of the problem inter alia of determining their legitimacy.19 Assuming but not conceding that the doctrine is applicable in international loan transaction, it denies the debtor the right to invoke it where the changed circumstance 18 Horn, N. pp. 26-28. 19 Kohler, K., Private Banks and the Renegotiation of Public and Private Sectors Exposure pp. 317-334 in "Adaptation and Negotiation of Contracts in International Trade and Finance" by Horn, N., see note 15. is foreseeable or due to the debtor's own default. The question, therefore, arises as to whether the inability of a debtor country to service its debt owing to its own mismanagement of resources or the world economic recession is a changed circumstance fundamental enough to absolve the debtor from performing its obligation under a loan agreement. Mismanagement of economic resources is a default on the part of the debtor country and does not therefore, entitle it to invoke the doctrine. World economic recession, though not a default on the part of the debtor, is nevertheless, subject to further test of whether it is an unforeseen event to the parties at the time of concluding the contract. Assuming the parties did not foresee world economic recession as a possible change of circumstance at the time of concluding the original loan agreements before the first oil price shock in 1973/74 as there was probably no precedent to learn from, what about at the time of concluding the several subsequent loan agreements? It is tempting to argue that they ought reasonably to have foreseen that the obligations under the subsequent loan agreements might be affected by world economic recession. Therefore, since this is a reasonably foreseeable event, it can not be pleaded to invoke the doctrine. Therefore, this doctrine might not avail a debtor country in default of its obligation under a loan agreement. 94 More important, a lender and a borrower usually do not proceed to undertake a loan agreement based on the world economic recession or buoyancy, and so, a change in the world economy ought not to affect obligations under a loan agreement. In one case, the court accepted the argument that the circumstances alleged to have changed were not circumstances on the basis of whose continuance the parties could be said to have entered into the treaty.20 (for our purpose, loan agreement). Therefore, where the debtor government defaults to pay its debt to a creditor government in the absence of a waiver, it is an international wrong for which it is liable.21 The plea of the doctrine of force majeure by the debtor country against the creditor country is both a rarity and hardly successful. As rightly observed: The few international and arbitral decisions that bear upon international loans, whether by private or governmental lenders reveal the extreme Free Zone's case (1932) PCIJ , series A/B, No. 46, at 156-58; In the Fisheries Jurisdiction case (UK Vs. Iceland) (1973/74) ICJ. Rep. p.3, the court said that the change of circumstance must have been a fundamental one, resulting in a radical transformation of the extent of the obligations still to be performed. The change must have increased the burden of the obligation to be executed to the extent of rendering the performance something essentially different from that originally undertaken. Judge Sir Gerald Fitzmaurice added inter alia, "changed circumstances" relates, namely one never contemplated by the parties. White, G.M., Wealth Deprivation: Creditor And Contract Claim, pp. 158-159 - in International Law Of State Responsibility For Injuries To Alliens. Edited by Lillich, R.B., University Press Of Virginia, Charlottesville, 1983. 95 narrowness and rarity of the circumstances in which a borrower might invoke the plea of force majeure.22 Moreover, the burden of proof is always very high. It is not enough that the occurrence of the event complained of makes the fulfilment of the obligation more onerous. In the Russian Indemnity Award, the Permanent Court of Arbitration held that Turkey had the burden to establish that payment of its debt to the Russian government "would imperil the existence of the Ottoman empire or seriously compromise its . • ? 3 internal or external situation". It was reported that: Turkey had shown that for the previous twenty years it had suffered financial difficulties of the utmost seriousness increased by domestic and foreign events (insurrections and wars) which forced it to make special application of a large part of its finances, to undergo foreign control of part of its finances, to grant even a moratorium to the Ottoman Bank, and, generally, it was placed in a position where it could meet its engagements only with delay and postments, and even then at great sacrifice.24 But because Turkey had been able to pay off some portion of its public debt, the court rejected its plea of force maj eure. Considering the evidence of Turkey and the circumstances of the case, it is submitted that even if the court had granted the plea, the effect would reasonably not have been a total termination of the obligations of Turkey 22 Id p.161. 23 Siegel, K.M., pp. 223-247. 24 White, G.M., pp. 156-157. but the deferment of them. The restructuring of debt is apparently in line with this view. Moreover, by reference to the evidence, Turkey appeared to be in a very unique situation by reason of protracted wars and insurrections. Turkey never advanced the mere reason of economic depression which the LDCs now Claim as hardship entitling them to be released from their obligations. Nevertheless, it is submitted that adaptation of international loan contract to changed circumstances is done by restructuring the debt but without any legal obligation on the part of the creditor. Unlike other international agreements, international loan agreements do not contain any clauses on anticipated rescheduling because such an approach would give room for abuse and would be hypothetical. Moreover, it would suggest that the creditors admit that the original time schedule for servicing the debt was not realistic or was not to be taken seriously.25 In addition, it is feared that introducing legal content in the question of rescheduling might undermine the basic principle of the binding force of contracts without which the international financial system could not exist.26 No wonder most legal systems do not recognize the debtor country's Horn, N. The Crisis of International Lending and Legal Aspects of Crisis Management, pp.295-316 in "Adaptation and Renegotiation of Contracts in International Trade and Finance". 26 Id. 97 inability to pay as a ground for relief from contractual obligations.27 The principle of pacta sunt servanda is not only vital for the existence of the international financial system but also for the existence of all kinds of international contracts. If therefore, the defenses of fundamental change of circumstances and force majeure are tenable in other aspects of international transactions, it should also have a place in loan agreement. The inequities which might result by reason of the fact that money has changed hands, are perhaps scarcely considered under a municipal bankruptcy law where a debtor is declared bankrupt and the part of his debt which could not be settled by his liquidated asset is written off as a bad debt. Therefore, if a creditor can bear the inequity in this instance, there is probably nothing to suggest that a creditor government cannot bear the inequity resulting from impossibility of performance due to adverse fundamental change of circumstances or force majeure save where the size of write-off is very substantial as to seriously and irreparably affect its fiancial position. Unfortunately, in a genuine bankruptcy case, for example, countries that are poverty stricken owing to drought and other natural disasters, there is no international law of bankruptcy to avail them of their 27 Id. 98 obligations. Arguably, most municipal legal systems have bankruptcy laws and so states' practice in this regard might lead to an international law of bankruptcy. However, difficulty arises as to how to operate an international law of bankruptcy, seeing that some basic conditions which render a municipal bankruptcy law operational are not present at the international level. For example, an international law of bankruptcy would need a reorganization of a state. Who would reorganize a state without infringing upon its sovereignty? Even where a state waives its sovereignty, how would such a reorganization amount to a liquidation of the state's assets? How would an international liquidator have access to the internal assets of the state? Moreover, there would be a valuation problem of the tangible and intangible assets of the state. In some municipal legal systems, a bankrupt is allowed to retain his clothes and tools in order to survive. At the international level, there would be a problem of determining the tools and clothes of a state. Also, states could be apt to making spurious claim of bankruptcy even where the situation is such that can be averted with a minimal economic management and financial discipline. More important, what would be the standard criteria for determining bankruptcy of states considering the fact that their are differences in the economic circumstances of states? In one case, a US appeal court held that the action of the Costa Rican government in taking economic measures for survival as a result of which it defaulted in servicing its debt, was analogous to a reorganization of business under the US Bankruptcy Code. This decision, an attempt to establish an international law of bankruptcy was reversed on a rehearing at the instance of the US government.28 No wonder, Sir John Fischer William writing in 1920s pointed out that a state can not be declared bankrupt and have its properties divided among its creditors. According to him, a state can not be liquidated or "even suspended from such of its functions as are of financial character."29 He however, implied that just as a bankrupt under some municipal legal systems is allowed to keep his tools and clothings, a bankrupt state should be allowed to keep its vital economic resources which of course are the minimum it needs to 30 survive. u Even if a state is declared bankrupt, this does not help the situation. It does not keep the state from being dependent on the developed countries (creditors) for its economic development. And so there is still the tendency of incurring more debt. Tigert, R.R.,Allied Bank International: A US Government Perspective. 17 NYU J.Int'l Law and Politics, (March/April 1985) pp. 511-526. Lotilla, R.P.M. pp.9-16 citing Sir John Fischer Williams Chapters on Current International Law and the League of Nations (1929), see chapter 1, note 17. 30 Id. In sum, creditor and debtor governments usually do not accord the status of treaty to their loan agreements and so the Vienna Convention in which is enshrined the doctrines of fundamental change of circumstances and force majeure would not be applicable. And even if the doctrines are recognized under customary international law, they still would not terminate the obligations of the debtor country under an international loan agreement in large part, because of the peculiarity of the transaction. The best they can do is to defer the obligations. This is not strange because it is already being done by way of debt restructuring. THE DOCTRINE OF ODIOUS DEBT It is argued that where a corrupt government contracts a loan for an illegitimate purpose, for example, for personal gains of government officials, to the knowledge of the lenders, a successive government owes no obligation to repay such debt. Generally under international law, a change of government or internal policy of a state does not affect the rights and obligations of the state. Dr. Moore argues that an international obligation is owed by a state and not by the officials who run the government of the state. Therefore, he maintains, in the event the officials are removed from office by a new government, the obligations they contracted when they were in office still attach to the 101 state under the principle of continuity of states. x However, it appears that the concept of odious debt where successfully pleaded against a creditor government, might be an exception to the principle of continuity of states under public international law. Sacks, expounding the concept of odious debt stated: When a despotic power incurs a debt which does not meet the needs or interests of the state, but aims at strengthening the despotic regime, suppressing a popular insurrection etc., then this debt is to be regarded as an odious one for the people of the entire state. This debt is not binding for the nation; it is debt of the regime, a personal debt contracted by the ruler. Consequently, it goes down with the demise of the regime. The reason why this odious debts can not be considered within the domain of the state is that they do not fulfill the condition for determining the lawfulness of state's debt, namely, that state's debt must be incurred and the monies used to serve the needs and interests of the state.32 It is submitted that even if this doctrine as expounded by Sacks is tenable today, it is applicable only between states and where a new regime succeeds a despotic one. But today, most LDC governments which corruptly contracted and still contract foreign debts are still in power and so have the obligation to repay. They can not defer payment of the Castel, J.G. and et al, International Law, Chiefly As Interpreted and Applied in Canada. 4th Edition, Emond Montgomery Publications Ltd. p.94 - citing Dr. John Basset Moore* s Digest of International Law. Id - quoting Sacks, Les Effets des Transformations des etats sur Leur Dettes Publiques et outres Obligations Financiers (1927)- Translation in Frankenberg and Knieper, Legal Problems of the Overindebtedness of Developing Countries- The Current Relevance of the Doctrine of Odious Debts. Int*l J. of the Sociology of the Law. (1984), p. 428. 102 debt in anticipation of a new government which will have to plead the doctrine, because the creditors want their money now. More important, the irony is that most successive regimes, tend to be more corrupt than their predecessors. Therefore, in sum, the doctrine of odious debt might not avail much. LOAN TRANSACTIONS BETWEEN FOREIGN PRIVATE CREDITORS AND  DEBTOR COUNTRIES In the absence of an express choice of law by the parties, the proper or governing law of the contract can be determined by reference to the law of the place of the contract, the law of the place of execution of the contract and the law of the place of arbitration. Since private creditors are not subjects of international law, international law would not apply save where the private creditor's claim is espoused by his home government Therefore, public international law doctrines of rebus sic stantibus and force majeure do not apply to private creditors. Accordingly, the debtor countries cannot successfully invoke the doctrines to suspend or terminate their financial obligations to the commercial banks. Even where the parties choose a municipal law (for example, the English common law of frustration of contract) which recognizes the doctrines, as the governing law of their transaction, it is argued that they might still not be applicable because money having passed to the debtor 103 country, it would be inequitable for it to keep it. But in the absence of any law to the contrary, the debtor country might be at liberty to invoke the bankruptcy law of the municipal legal system chosen to govern the transaction. The problem with this, however, is that the criteria for determining the bankruptcy of a state are not easily discernible as in the case of ordinary person. This might therefore be a barrier to the invocation of the bankruptcy law. Though the doctrine of odious debt, being a public international law concept does not apply to the banks, there may be nothing that prevents it from being extended to private international law because the banks need to refrain from making odious debt. It is desirable for the banks to inquire into the legitimate use of loans made to debtor governments. Making the IMF and the World Bank adjustment programs conditions for granting new loans and rescheduling old ones is not enough because the Bretton Woods institutions are primarily concerned with the balance of payment deficits of debtor countries. They need to go into each individual projects to ascertain whether the loans made for them are strictly being applied to the projects. The sensitivity and resistance of the debtor countries to this measure can be countered by making such supervision a condition for granting of loans and debt relief. The need on the part of the banks to follow up loans made to debtor countries was recognized in the Arbitation 104 Between Great Britain and Costa Rica. Arbitrator Taft held inter alia: The case of the Royal Bank depends not on the mere form of the transaction but upon the good faith of the bank in the payment of money for the real use of the Costa Rican government under the Tinoco regime. It must make out its case of actual furnishing of money to the government for its legitimate use. It has not done so. The bank knew that this money was to be used by the retiring president F. Tinoco, for his personal support after he has taken refuge in a foreign country. It could not hold his own government for the money paid to him for this purpose.33 It is submitted that banks in this kind of deal, ought to be treated in no less way than the Royal Bank. If banking regulations and laws of the states of the lending banks can be made congruent with this measure, it might help to curb the diversion of public loans from welfare and profitable projects to private pockets and consequently reduce the size of foreign indebtedness. SOVEREIGN IMMUNITY DEFENSE FOR A DEBTOR IN DEFAULT In the 19th century, it was generally believed that a sovereign debtor with his immunity defense cannot be sued by a foreign private creditor to recover money owed. Today, however, a state is legally bound towards its foreign private creditors and can be sued in court.34 There used to be a rule of absolute immunity available to states in connection with their sovereign public acts 3 18 AJIL (1924) p. 147 at 168. 4 Horn, N., pp. 295- 316. 105 (acts iure imperii).35 But as states increasingly engaged in commercial activities not traditionally associated with state functions , there emerged the restrictive immunity doctrine under which a state is denied immunity in respect of its commercial activities (acts iure gestionis).36 Though socialist countries oppose the restrictive immunity doctrine, it is note worthy that Soviet Union has agreed to restrictive immunity in the many bilateral treaties to which 37 it is a party. The basic problem, however, is how to discern between acts iure imperii and acts iure gestionis and which entities of a state are entitled to immunity in any particular case. Nevertheless, courts and some state legislation on sovereign immunity indicate that as a means of determining the distinction between acts iure imperii and acts iure gestionis, reference should be made to the nature of the state's transactions or the resulting legal relationships, and not to the motive or purpose of the state's activity.38 The US Foreign Sovereign Immunities Act 1976 (FSIA)39, the 35 Parlement Beige case (1880) 5 PD. 197 and Schooner Exchange Vs. McFadden (1812) 7 Cranch 116. 36 Harris, D.J., p.241. 37 Id p. 242 - citing I.L.C. 4th Report on Jurisdictional Immunities of States and their Property 1982., UN Doc. A/CN. 4/357, pp. 35 et seq. 38 Id p. 246; Tradetex Trading Corp. Vs. CBN (1977) Q.B. 529. 39 15 I.L.M. (1976) 1388; Delaume, G.R.,Three Perspectives on Sovereign Immunity: Public Debt and Sovereign 106 Canadian State Immunity Act40 and the UK State Immunity Act 1978 invariably apply the restrictive immunity doctrine as do the 1926 Brussels Convention for the Unification of Certain Rules Relating to the Immunity of States' Owned Vessels and the 1972 European Convention on State Immunity in force in 1976.41 Section 3(1) of the UK State Immunity Act provides that a state is not immune as respects proceedings relating to: (a) commercial transactions entered into by the state; or (b) an obligation of the state which by virtue of a contract (whether a commercial transaction or not) falls to be performed wholly or partly in the United Kingdom (2) This section does not apply if the parties to the dispute are states or otherwise agreed in writing. (3) In this section "commercial transaction" means inter alia (b) any loan or other transaction for the provision of finance and any guarantee or indemnity in respect of any such transaction or of any such transaction or of any other financial obligation. In other words, an international loan transaction under which a sovereign incurs a debt falls into this definition. But note that by section 3(2) where both the creditor and the debtor are states or where the parties otherwise agree in writing, the section does not apply. In other words, the Immunity: The Foreign Sovereign Immunities Act of 1976. 71 AJIL (1977) pp.399-422. 40 S.C. (1982) c.95 - reproduced in Castel, J.G.,and et al p. 307. 41 Harris, D.J.,pp.241, 247. 107 Act denies immunity only in respect of a loan transaction between a sovereign debtor and a private foreign creditor. The FSIA, the UK State Immunity Act and the European Convention on State Immunity provide that a waiver of immunity in a written agreement is sufficient and irrevocable. This secures the practice of lenders in stipulating waivers of immunity in loan contracts with foreign sovereign borrowers and gives certainty to the effectiveness of lenders' action should a sovereign renege on its obligations under a loan contract.42 The European Convention denies immunity to all entities of a state including its political subdivisions other than the foreign sovereign itself. Moreover, pursuant to its article 4, all contracts including loans and other financial transactions between a contracting state and private persons which are to be performed in another contracting state are subject to the non-immunity rule set forth in the Convention. But under the FSIA, the immunity rule applies to foreign government departments. Section 1603 provides that: (a) a foreign state except as used in section 1608 of this title includes a political subdivision of a foreign state or an agency or instrumentality of a foreign state as defined in subsection (b): b) An agency or instrumentality of a foreign state means any entity-(1) which is a separate legal entity, person, corporate or otherwise, and Delaume, pp. 399-422. 108 (2) which is an organ of a foreign state or political subdivision thereof, or a majority of those shares or other ownership interest owned by a foreign state or political subdivision thereof, and (3) which is neither a citizen of a State of the United States as defined in section 1332(c) and (d) of this title, nor created under the laws of any third country. (d) a commercial activity means either a regular course of commercial conduct or a particular commercial transaction or act. The commercial character of an activity shall be determined by reference to the nature of the course of conduct or particular transaction or act, rather than by reference to its purpose. (e) A commercial activity carried on in the United States by a foreign state means a commercial activity carried on by such state and having substantial contact with the United States. The UK State Immunity Act has an equivalent provision in its section 14. But it does not make any difference whether or not the immunity defense is available to political subdivisions of a state since immunity would ultimately be denied where the activity is of a commercial nature irrespective of the state organ involved. Section 1605(a)(2) of the FSIA provides that a foreign state including its political subdivisions, agencies and instrumentalities, is not immune from the jurisdiction of the US court in any case: In which the action is based upon a commercial activity carried on in the United States by the foreign state; or upon an act performed in the United States in connection with a commercial activity of the foreign state elsewhere, or upon an act outside the territory of the United States in connection with a commercial activity of the foreign state elsewhere and that act causes a direct effect in the United States. 109 In one case, a US court held that where a debt is to be paid is the situs of the debt and that since the debt was to be paid in the US , the US courts had jurisdiction.43 Though the FSIA does not state expressly the activities that are of a commercial nature, the US Sovereign Immunity Bill states that commercial transactions having a substantial contact with the US include: An indebtedness incurred by a foreign state which negotiates or executes a loan agreement in the United States, or which receives financing from a private or a public lending institution located in the United State (e.g. loans, guarantees, or insurance provided by the Export- Import Bank of the United States).4* It is clear that LDCs' debts owed to banks or public institutions located in the US fall within a "commercial activity" and in the event of a default or other disputes arising therefrom, the sovereign concerned can not avail itself of the defense of Sovereign Immunity. But in the event of execution of judgment, a sovereign enjoys a wider scope of immunity than its agencies or political subdivisions under section 1610 of the FSIA. A judgment obtained against a sovereign can only be enforced against the property of the sovereign which forms the underlying transaction which gave rise to the action that Tiggert, R.R. pp. 511-26 ( Allied Bank International Case); No. 83-7714 (2d Cir. April 23, 1984). Delaume pp. 399-422; S.566, H.R. 3493, 93d. Congress 1st Session (1973); 12 I.L.M. 188 (1973) and H.R. 11315/ S/8877, 94th Congress 1st Session (1976); 15 I.L.M. 90 (1976); 70 AJIL (1976) 313. 110 led to the judgment save where there is a specific waiver in this respect. But where the judgment is against a political subdivision of the sovereign, it can be enforced against all of its property in the US regardless of whether there is a link between the property in question and the commercial activity from which the claim arose.45 However, the funds held by a state's central bank for its own account are expressly immunized under the FSIA.46 It is therefore clear from the preceding discussion that the defense of Sovereign Immunity is not available to the debtor country in the event of a dispute arising under a loan agreement with either the creditor government or the commercial bank, a transaction considered to be of a commercial nature. However, unlike in most creditor countries, for example, the UK and the other signatories to the European Convention on State Immunity , in the US , under the FSIA, enforcement of judgment is limited only to the property of the sovereign underlying the transaction in question. In otherwords, even where the value of the property of the Sovereign is less than the amount of money owed, the difference is a loss to the creditor. Not surprising, there is a move to amend this provision to remove the restriction. 45 Delaume, pp. 399-422. 46 Id. Ill THE ACT OF STATE DOCTRINE DEFENSE This is a doctrine of American law employed to excuse a state for acts done by that state within its territory. Fuller C.J. in George F. Underhill Vs. Jose Manuel Hernandez, declared: Every sovereign state is bound to respect the independence of every other sovereign state, and the courts of one country will not sit in judgment on the acts of the government of another done within its own territory. Redress of grievances by reason of such acts must be obtained through the means open to be availed of by sovereign powers as between themselves.47 Over the years, this doctrine has spread and gained prominence across the common and civil law world.48 A sovereign debtor who fails to meet its obligations cannot be absolved from liability based on the act of state doctrine. The main reason is that apart from seemingly inapplicability of the doctrine in commercial transactions, the defense is only invoked where the act in question is performed within the territory of the state concerned. Foreign debts are usually contracted and payable in foreign currency in the creditor country. Therefore, whatever act done by a debtor country which affects the payment of the debt, must necessarily be outside of the debtor country. In Allied Bank International Vs. Banco 47 168 US (1897) p. 250 at 252. 48 Castel Se et al p. 288. 112 AO Credito Agricola de Cartagoe^ , the Costa Rican government, pursuant to economic survival measures enacted a decree prohibiting the availability of foreign exchange for debt servicing. Consequently, three Costa Rican banks defaulted in making payments under a promissory note held in favour of Allied bank. Both the courts of first instance and appeal upheld the plea of act of state and dismissed the claim. The US government intervened, arguing that inasmuch as it supports countries to take economic recovery measures, it does not support unilateral measure by countries affecting binding contractual rights of creditors. Consequently, the case was reheard and it was held that since the situs of debts is where they are to be paid, the act of the Costa Rican government was extraterritorial since it affected the payment of the debt in the US. The defense was therefore untenable. Needless to say, this demonstrates why most creditors insist that loan transactions must be governed by their own law. Their money seems to be more secured by their own states' laws. Generally therefore, the act of state defense is hardly open to the debtor countries in default of their obligation under an international loan agreement with either the creditor governments or the banks. Tigert, R.R. pp. 511-526; Youngblood, P. 1985 Survey of International Law in the 2nd Circuit- The Act of State. 12 Syracuse J.Int'l Law and Commerce, p. 395. EXPROPRIATION OF DEBT It has been stated that international debt is a property (a chose in action) to the lender and so like any other property can be expropriated by a debtor country.50 The irony of this assertion however, is that in the event of an expropriation, the expropriating state has to pay compensation. The question then is, if a state has money to pay compensation, why can it not service its debt? Arguably the answer seems to be that the compensation would have to be made in local currency and would therefore save the debtor country the foreign exchange needed to service the debt. This argument is not tenable if the compensation is to be prompt, adequate and effective as required under customary international law. By effective, it means that the money paid must be convertible to a foreign currency which the creditor can utilize the way he wants. Anything short of this is an aberration of the customary international law standard of effective compensation. Perhaps it is in realization of the difficulty in meeting the international law standard of compensation, that the Third World countries used their numerical strength to pass some resolutions aimed at departing from the customary international law standard of compensation. Some of these resolutions are Resolution 3171(XXVIII)51 and the Charter of 50 Siegel, K.M. pp. 223-47. 51 Harris, D.J., p.431; 68 AJIL (1974) p.381. 114 Economic Rights and Duties of States of 1974. Though these resolutions have no provisions on debt, they are relevant in analyzing the measure of compensation as it relates to the argument concerning expropriation of debt. The conflict between these resolutions and the customary international law standard of compensation makes uncertain the measure of compensation payable in any particular case. Arguably, the fact that these resolutions were passed by the majority of states, though Third World countries, suffices to give the resolutions the status of a new rule of international law superseding the existing customary international law rule of prompt, adequate and effective compensation as codified in Resolution 1803 (XVII).52 Brownlie observes: It is fairly clear that the Charter does not purport to be a declaration of the preexisting principles and overall it has a strong programmatic, political and didactic flavour. Nonetheless, there can be little doubt that Article 2 para. 2(c), is regarded by many states as an emergent principle, a statement of presently applicable rules.53 But in the Texaco Overseas Petroleum Co. and California Asiatic Oil Co. Vs. The Government of the Libya Arab Republic 54, the arbitrator rejected the Charter as a rule of international law because the minority industrialized Harris, D.J., p.437. Id p.432 - quoting Brownlie in 1962 Hague Recueil 255 (1979-1). 53 I.L.R. (1977) 389; 17 I.L.M. (1978) 1. 115 countries did not approve of it. Moreover, according to the arbitrator, the absence of any connection between the procedure of compensation and international law and the subjection of the procedure solely to municipal law under article 2(2)(c) of the Charter, could not be acceptable to the tribunal as law. It is submitted that the view of the arbitrator amounts to an arbitral legislation and a redefinition of the process of what it takes for a norm to crystallize into a rule of international law. It is settled that a norm attains the status of a rule of customary international law based on practice of states, usually the practice of a majority of states. J Therefore by insisting that the absence of consent to the resolutions on the part of the minority developed countries rendered the Charter of no legal effect, the arbitrator is in effect saying that a norm can only attain the status of a rule of international law depending on the relative economic and political power of states that consent to it or otherwise. Nevertheless, these resolutions, assuming they become law, might not be applicable to expropriation of debts because they envision expropriation only in respect of natural resources. Even if expropriation of debts can be read into them, the payment of compensation considered to be 55 North Sea Continental Shelf Case (1969) I.C.J. Rep.3 -judgments of Justices Lach, Tanaka and Sorensen. 116 inadequate under customary international law might deter creditors from future lending to the LDCs. However, since private foreign creditors always choose their state law as the governing law of the transaction, they would be paid the measure of compensation as enshrined in that law. It is submitted that this might even be more than the minimum standard of compensation under international law. If this is the case, it is enough to discourage expropriation of debt. LEGAL EFFECTS OF SOME CLAUSES IN INTERNATIONAL LOAN  AGREEMENT AND THEIR IMPACT ON DEBT MANAGEMENT There are some legal clauses usually introduced in international loan agreements for the sake of protecting the interest of private creditors, but which have far reaching effects in terms of frustrating the efforts of debtor countries to cope with the debt problem. NEGATIVE PLEDGE CLAUSE Customarily, international loan agreements provide that the borrower shall not create liens or charges on its assets or revenues in favour of other lenders. A typical Negative Pledge Clause reads: 117 The borrower will not enter into any arrangement with respect to any external indebtedness or other obligations currently outstanding or hereafter incurred which arrangements would have the effect of placing any creditor in a position of preference (by means of any incumbrance or any preferred arrangement of any kind) over the lender with respect to the availability of any of the assets of the borrower for the satisfaction of its indebtedness to the lender hereunder. 56 This clause has the effect of securing the assets of the borrower country for the satisfaction of the debt owed to a particular creditor(s) to the exclusion of all others. In effect, the borrower country can not give its assets as security for loans from other lenders, at least not by conceding the first charge on its assets to them. The difficulty this poses for the borrower (debtor country) is that even in the face of emergency needs for loans, it can not give its assets as security for the loans. But since the clause does not prevent an outright sale of assets, the borrower can sell the assets to raise fund to meet an emergency situation.57 However, to get a ready buyer might not be easy depending on the location of the assets. Also, an outright sale might not be in the long term interest of the borrower especially if the assets are revenue generating. 56 Bradfield, M. and Jacklin, N.R., The Problems Posed by Negative Pledge Convenants in International Loan Agreements. 23 Columbian J. Transnat'l Law (1984/85), pp. 131-142. 57 Id. 118 Where the assets used as a security are located in the borrower country, it might be difficult for the lender to be able to exercise his power of sale of the assets in satisfaction of the debt owed to him. The reason is that the borrower country might use legislation and force to stop that. But rarely is collateral required in loan transactions with countries. Loans are made on the good will of the borrower countries and recently on the reference of the IMF. The Negative Pledge Clause becomes too much of a problem in a syndicated loan agreement containing a Cross Default Clause. Here the security provided by the borrower must be equally shared by all the participating lenders with none being treated less favourably than the others. The problem is that a violation of the Negative Pledge Clause in respect of one lender triggers off a default in respect of debt owed to all the other lenders who otherwise have no cause to call the borrower in default.58 CROSS DEFAULT CLAUSE In a syndicated loan arrangement, a Cross Default Clause makes it possible for the creditors to accelerate their loans where the debtor is in default in respect of debt owed to one of them.59 When this happens, the debtor country's attention to its economic recovery program is distracted because it is faced with renegotiating the 58 Id. 59 Id. 119 agreement with each one of the creditors. It seems banks accelerate their loans as a way of persuading debtor countries to give priority to repayment. It is however advisable on the part of the debtors to insist in loan agreements that a Cross Default Clause can not be invoked unless at least a two-third majority of the syndicate banks agree that the situation is such that warrants the invocation of the clause.60 This will save the problem of each creditor invoking the clause at will even when its own situation does not call for it. DEFINITION OF "BORROWER". Where the definition of "borrower" in a loan agreement is too broad, that includes not only the sovereign but also his political subdivisions, entities and agencies. The effect of Negative Pledge Clause and Cross Default Clause becomes more unmanageable because a default of one of the sovereign entities is automatically extended to the other entities, and the properties of any one of the entities cannot be pledged for new loans even in emergency situations. The most important entity to exempt from the operation of these clauses is the debtor country's central bank as it is the custodian of its foreign reserves. Better still, a 60 Hurlock, J.B., Advising Sovereign Clients on the Renegotiation of their External Indebtedness. 2 3 Columbia J. Transnat'l Law (1984/85), pp. 29-42. 61 Id. 120 sovereign debtor should insist for a narrow definition of "borrower" in a loan agreement. If possible, for it to mean only the sovereign itself. An overview of this chapter shows that international law has little or no effect in the management of the international debt problem. It may still be evolving in this regard. Essentially, it underlies the obligations of the debtors to service their debts and to keep them in check against default. It does not go into the economic possibility of good debt management or otherwise. In the main, the municipal laws of creditor countries occupy a prominent position in the whole question of international loan transaction. While the binding force of contract in municipal legal systems is transposed to the international legal system as the principle of pacta sunt servanda, the municipal common law doctrine of frustration or its equivalent in other jurisdictions has no place in international loan transactions. In so far as the debt management strategies and relief are not backed up by international law and have virtually no international legal content, international law appears inadequate or offers nothing to the management of the international debt problem. More important, even if international law does offer something, compliance with it might be another problem just as it is the case with compliace to international law generally, in large part because some practical exigencies are not amenable to the 121 process of law. Unlike international law, municipal laws are readily complied with mainly because of the states1 power of enforcement. Therefore, the debt problem and its management are better addressed in the context of international economics and politics rather than international law. 122 CHAPTER FOUR DEBTORS' RESPONSE TO THE DEBT PROBLEM AND THE QUEST FOR  A NEW INTERNATIONAL ECONOMIC ORDER One of the major complaints of LDC debtors is that while creditors are urging them to embark on adjustment measures in order to be able to generate enough foreign exchange to service their debts,the creditors themselves engage in protectionism, subsidies to their domestic goods and industries, all of which operates against the adjustment efforts of the debtors. This development becomes more painful when it is realized that the hardship attendant to adjustment efforts is somewhat unbearable. In other words, the result ,of the adjustment efforts is very marginal. They also complain generally that the short term, ad hoc and emergency nature of the present debt management strategies do not address the complex and fundamental economic problems underlying the crisis.1 Adjustment measures have often been undertaken at the risk of political tensions and civil disturbances in the debtor countries. For example, in the face of reduced standard of living, inflation, wage freeze, and unemployment etc., sixty people were killed in 1984 in the Dominican Republic amidst a protest against government decision to Amaral, S. The Debt Crisis from the Point of View of A Debtor Country. 17 NYU J. Int'l law and Politics (March/ April 1985), pp. 633-650. 123 reduce food subsidies. In Sudan, President Nimieri was over thrown for attempting to cut food subsidies to meet IMF conditionalities. In Egypt an across the country demonstration effected a revision of IMF conditions for adjustment. In 1982, the dictator governments of Chile and the Philippines used force to quell civil disturbances. Between late 1970s and 1985, Argentina, Brazil and Mexico faced workers strikes that nearly wrecked their economies.2 In 1983, labour protest compelled the Bolivian government to increase the minimum wage by 42% in violation of an on going IMF adjustment program condition. The president of Argentina's central bank was jailed for not representing the interest of the country very well during a negotiation with the IMF.3 The irony of the prejudice against the adjustment program of the IMF is that some debtor governments themselves impose adjustment measures similar to those of the IMF. Nigeria, for example, has over the past few years, increasingly reduced subsidies on petroleum, devalued its currency and frozen wages. Though there is hostility attendant to the adoption of adjustment/austere measures, it is nevertheless believed that if the measures can be given time and the necessary cooperation, they might help debtor countries to cope with the debt problem. Carvounis, C., p.196, see chapter 2, note 33. Cline, W., pp. 36 - 40. see chapter 1, note 3. 124 The LDCs are of the view that the international financial system has to adjust to accommodate their economic growth by ensuring transfer of resources from the North to the South and not vice versa. They posit that the failure to adjust the international financial system in this way has been responsible for some unilateral actions taken by some debtor countries.4 For example, Cuba and North Korea outrightly repudiated their debts in the 1970s and early 1980s. The governments of Peru and Nigeria have unilaterally limited their debt servicing to 10% and 30% of their foreign exchange earnings respectively.5 Mexico, Argentina and Brazil declared moratoria on the payment of their debts in 1982 through 1983.6 But the LDC debtors have grown to learn that the cost of default outweighs the benefit. This explains why the proposal for a debtors' cartel (a united front for debtors to have their way especially in time of default) by the Cartegenian Group of Latin America was turned down by debtor countries. These days, each debtor country is more interested in maintaining creditworthiness and good relationships with its creditors and sorting out issues through negotiations rather than through unilateral 4 Carvounis, C. , see chapter 2, note 33. 5 Id ; Cline, W. see chapter 1 note 3. 6 Cline, W. pp. 90-91. 125 actions.7 In 1987, Brazil paid the arrears of interest on its debt to end its moratorium having realized that the cost of the moratorium was quite high as new credits needed for • ft important and urgent transactions were cut off. In general, debtor countries have taken some positive measures to combat the problem. An UNCTAD document reports that: Domestic resources, both human and financial are being mobilized for development purposes; several LDCs have taken measures to control government expenditure and to streamline the operation of public enterprise; higher priority is now accorded to agricultural developments and policies are adjusted to the need to increase substantially food production; increased use of the market mechanism is being made through the liberalization of price controls and of the marketing of commodities; and exchange rates are being adjusted so as to enhance the international competitiveness of exportable goods and to encourage the local production of import competing goods. However, the LDCs insist that the measure to effectively deal with the debt problem does not lie with them but rather with the need to reorder the present international economic order. Hence their quest for a New International Economic Order. They believe that the debt problem is rooted in the poor and undiversified nature of their economies. They are, therefore, strongly of the view that the industrialized countries have a duty to treat them 7 Id. 8 Hentschel, J. Managing International Debt. 2 3 Inter Econ. Rev. of Int'l Trade and Dev. No.3 (May/June, 1988) pp.126-131. UNCTAD TD/328 May 1987, p. 12. 126 in a special way especially by transfering technology for the transformation of their economies with a view to raising their bargaining power to the level of that of the industrialized countries. The industrialized countries are accused of fashioning to their taste and control, the world economic system through institutions like the IMF, the World Bank and the General Agreement on Tariffs and Trade (GATT). With these institutions and technology, the industrialized countries have maintained a considerable economic superiority which has left the economies of the LDCs dependent on them. Thus in the light of this, the major impediment to LDCs1 development is argued to be the international division of labour, whereby the developed countries do the manufacturing and control the technology and the LDCs only supply some of the raw materials. 10 Though there may be some truth in this argument, the fact remains that technology which is the basis of economic growth of the industrialized countries is being developed by these countries by their own efforts and along their cultural needs. It is therefore ridiculous for the LDCs to attribute their economic failure to the fact that they are denied of technology. It is incumbent on the LDCs 10Eskridge, W.Jr., p.64; see chapter 1 note 3 Lombardi, R.W., Debt Trap : Rethinking the Logic of Development. New York, Praeger Publishers (1985), pp. 50-75; Wood R.E.,and Mmuya, M. , Debt Crisis in the Fourth World, pp. 310-12.- The Political Economy of the North-South Relations Edited by Toivo Miljan, see chapter l,note 1. 127 themselves to either develop their own technology or purchase it. For the LDCs, in order to eschew the debt crisis, the unequal bargaining power between their trading partners and themselves, believed to be rooted in the way the world economic system is fashioned, must first be arrested. Apparently, in their view, the manifold debt reliefs and debt management strategies can at best afford a temporary respite but cannot abate the recurrence of the debt problem. The industrialized countries are therefore urged to show more charity and concern by unconditionally fashioning their economic policies to accommodate the economic prosperity of the LDCs. More important, the LDCs believe that a new international economic order based on just the good will of the industrialized world would not be helpful as that would mean the absence of an obligation on the part of the developed countries in this regard. Therefore, it is more desirable, they maintain, for the content of a new international economic order to be enshrined in a legally enforceable document. The LDCs have in a number of occasions used their numerical strength in the United Nations General Assembly and the UNCTAD, to pass resolutions aimed at achieving this goal. In the annals of 1960s was a UN Declaration of "Development Decade" by which the LDCs were to be assisted to achieve 5% annual growth in aggregate national income 128 through expanded international trade and an annual flow of international assistance and capital to 1% of the national income of the developed countries.11. In May 1974, a resolution known as Declaration and a Program of Action on the Establishment of a New International Economic Order (NIEO) was passed by the UN General Assembly.12 The Declaration accepted as a basic principle, the need to secure progress towards the equality of all nations through an equitable sharing of world resources, transfer of technology,a just and equitable relationship between the prices of raw materials exported from and manufactured goods imported by the LDCs. The Charter of Economic Rights and Duties of States - Resolution 3281(XXIX) of 1974, gives states the right to full exercise of sovereignty over their natural resources to the exclusion of external interests. In the the event of nationalization, the Charter provides for compensation as determined by the national law of the country concerned, a total departure from the customary international rule on compensation. In his annual report, the UN Secretary General stated inter alia the international dimensions of the right to development as follows: 11 Akinsanya, A. and Davies, A., Third World Quest for A New International Economic Order: An Overview. 33 Int'l and Comp. Law Q. (Jan. 1984),pp. 208-217. 12 G.A. Resolution 3201 (S- VI); 13 I.L.M. 715 (1974); Harris, D.J. Cases and Materials on Internatioanl Law. London, Sweet and Maxwell.p. 431; Akinsanya and Davies pp. 208-17. 129 The increasing interdependence of all peoples underlines the necessity of sharing responsibility for the promotion of development, and the industrialized countries, former colonial powers and some others have a moral duty of reparation to make for past exploitation.13 It is important, however, to point out that this statement sees cooperation on the part of the developed countries as a moral rather than a legal duty. It is submitted that for a success to be achieved, the developed countries can only be persuaded and not legally obliged to cooperate. Another UN resolution states: States should cooperate in the economic, social and cultural fields as well as in the field of science and technology and for the promotion of international cultural and education progress. States should cooperate in the promotion of economic growth through out the world, especially that of the developing countries. 4 Unfortunately for the LDCs, the UN General Assembly resolutions have no legal force save of course they are declaratory of existing rules of customary international law. Consequently, the industrialized countries contend that they are not bound by these resolutions. In the alternative, they maintain that the resolutions can attain the status of new rules of international law only if they consent to them, 3 UN Doc. E/CN.4/1334 (1979) paras. 39-54. 4 General Assembly Declaration on Principles of International Law Concerning Friendly Relations and Cooperation Among States in Accordance with the Charter of the UN 1970. reproduced in Harris, note 12. p.783 at 785. taking into account their economic power.x:> Even if the developed countries agree to be bound by the resolutions on a new international economic order, that would not affect debt owed to the commercial banks save their governments incorporate the resolutions into their banking regulations. The quest for a new international economic order appears to be based on a wrong premise. It seems to over look the world economic reality and addresses the debt problem only from the perspective of the LDCs. It does not consider how the developed countries would have to contend with the enormous economic sacrifice an absolute positive response to the quest entails. The quest is unrealistic in so far as it imposes a legal obligation on the part of the developed countries and tends to say: The industrialized countries, please halt your economic advancement to enable the LDCs catch up with you or, in the alternative, as you advance, you have a legal obligation to give all necessary support to the LDCs to enable them advance at equal pace with you. Indeed the quest for a new international economic order goes to the root of the world economic interests of the industrialized countries which they can never compromise, at least not by imposing a legal duty on them as some of the UN resolutions tend to suggest. Therefore, the resolution of these basic conflicting interests is very crucial to dealing 15 Topco Overseas Petroleum Co. and California Asiatic Oil Co.Vs. Libya 53 I.L.R. 389 (1977); 17 I.L.M. 1(1978). 131 with the debt problem. Since any legal proposal which seeks to alter the present world economic order is vehemently repulsed, it is perhaps only reasonable to posit that the debt problem cannot be arrested in the context of a legal framework. To the extent that all the parties concerned with the debt problem have to reach a consensus on a workable management strategy to solve the debt problem, diplomatic negotiations rather than legal process might be a better deal. 132 CONCLUSION This thesis has not in the main been concerned with the debt already incurred but rather with the debt to be inevitably incurred and how to avoid it. It is settled that the economic development of the debtor LDCs is an imperative to end the recurrence of the problem and to ensure a better standard of living. As we have seen in this study, the post colonial LDCs adopted a policy of overnight industrialization. This idea plunged them into foreign debts in the proportion that exceeded their available resources and management skill. The commercial banks themselves indulged in unrestrained and reckless lending and before they knew it, the LDCs had succeeded in a massive mismanagement of resources including the foreign loans, and were unable to service their debt. The manifold debt management strategies and relief are not to be dismissed. Though the respites they offer to the debtor countries are only ephemeral, prudent debtor countries can avail themselves of the relief to manage their economies better. For example, refinanced loans can be properly invested in foreign exchange generating areas. Moreover, multi- year rescheduling and adjustment programs (including the various special facilities) give the debtors time and support for good economic planning. However, the current debt management strategies might not keep the debt problem from recurring. Debtors' economies might be somewhat resilient based on these strategies, but 133 before long, their debts will accumulate to a proportion worse than before and more difficult to manage. South Korea which is often alluded as a successful LDC economy is nevertheless one of the largest LDC debtors. It must match expenditure with available resources to be better off. Moreover, the strategies often over look ways of maintainning and sustaining a stable economic growth in the industrialized countries especially in the OECD countries. This is important because the foreign exchange earnings of the LDCs depend in large part on the growth rate in the developed countries. Until external factors which militate against a better debt management are addressed with equal force or even more as the domestic factors in debtor countries, the recurrence of the debt problems might not be abated to any significant extent. International law is not a debt manager and scarcely can be. Even if a debt management strategy based on international law is to evolve, it must not evolve without a base. It must to work, be based on the reality of the present world economic order. In the context of the debt problem, international law cannot make possible what is economically impossible. Therefore, the message is that wise countries must match expenditures with available resources to survive and that where foreign loans are taken, they must be properly invested and managed as to generate funds enough to pay off the loans and to sustain the debtor's economy. The irresistible conclusion on this point 134 is that the debt problem is better addressed in the context of the realities of international economics and may be, politics than international law. A new international economic order might help to arrest the exogenous factors that promote the debt problem. The snag however, is that it entails an exceeding great weight of economic sacrifice on the part of the developed countries. For this reason, the quest for a new international economic order is not seriously attended to by the developed countries. Therefore, the solution to the debt problem would hardly emanate from it. However, the LDCs with the cooperation of the developed countries can carry out most of their trade by countertrade especially by barter which does not involve foreign exchange but simply the exchange of goods for goods. This will enable them obtain the technology they need for economic development in their areas of comparative advantage. But the success of countertrade deals will heavily depend on a stable economic growth in the developed countries especially in the OECD countries. It will also depend on how much need the developed countries will have of the primary commodities of the LDCs. The technological advancement of the industrialized countries is such that they have comparative advantage even in the production of most of the commodities on which most LDCs will depend for countertrade. Beside, countertrade is evolutionary. It gets more sophisticated and complicated each day. This trend 135 causes virtually all aspects of it to yearn for foreign exchange finance in varying degrees. Though the deal is yet to involve substantial amount of foreign exchange, it is feared that countertrade might be of little help. The debt-equity swaps approach to the debt problem can help to alleviate the problem if properly planned and executed. The scheme abates the necessity of incurring more foreign debts by encouraging and providing the investments on which behalf foreign loans will otherwise be incurred. It also reduces the amount of the outstanding debts by converting foreign currency denominated debts into local currency for investment purposes. If the banks and the creditor governments will participate in a large scale in this scheme, and if the debtor countries will relax legislation on profit repatriation (without encouraging capital flight), nationalization and restrictions on areas of investment, the debt problem might even be relieved on a more permanent basis. Foreign direct investments should be encouraged in debtor countries by avoiding excessive corporate taxation , simplifying investment procedures, providing economic infrastructures and by ensuring political stability for the safety of investments. Foreign direct investments can be a good supplement to the benefits of debt-equity swaps. The implementation of the set objectives in resolution 222 (XXI) should not be left to only the creditor governments, commercial banks should participate. Some of 136 the various ways of implementing the resolution include conversion of debts to aids and grants, payment in local currency and reinvestment of such in the debtors' economy. These had already been done to some extent by some creditor governments pursuant to resolution 165(S-IX). Commercial banks' loans are non concessional and are made with profit motives. Therefore, though banks should rightly not be expected to cancel or convert debts owed to them to aids and grants, they should nevertheless, help debt management by participating actively in debt- equity swaps and the attendant investments in debtor countries. To be true, though the LDCs would strive better with debt reduction program on the part of the creditors, this alone cannot make them not to depend on the developed countries to finance their economic growth. The Brady Plan not only focuses on negotiated debt relief but also assures new money from multilateral financial institutions. This would therefore require more money to support the role of these institutions if the Plan is to be successful. It is also suggested that the Plan would better achieve its objectives if it can have built-in mechanisms to check exogenous factors responsible for the recurrence of the debt problem. For example, discounting high interest rates for the debtors whenever there is a fall in the GDP or deficit in the budget of the members of the OECD. In all, it is of paramount importance for the debtor LDCs to prudently manage and utilize every of their 137 resources, ensuring at all times that expenditure is matched with available resources. 7 138 APPENDIX A TABLE 1 Performance of Selected LDCs in Respect of the IMF Adjustment Program. 1970 - 1985 Growth rates Current account deficit as percentage 1970-80, 1980-84, variation Of 1980, exports 1983, 1985 A. LDCs with adjustment programs supported by IMF financing Bangladesh 3. 7 3.8 + 0.1 192 114 122 Central African Republic 2. 2 -0.1 -2.4 115 99 851 Gambia 4. 1 1.6 -2.5 231 96 n.a. Haiti 3. 8 -0.9 -4.7 65 95 922 Malawi 6. 0 2 . 3 -3.7 90 453 • • • Mali 8. 8 -0.1 -3.9 114 122 118 Niger 5. 0 -2 . 0 -7.0 74 57 88 Samoa • -1.9 175 66 59 Somalia 2 . 7 4.2 +1.5 209 294 332 Sudan 6. 7 1.4 -5.3 49 sur plus4 sur plus 1 for 1984 2 for 1982 3 Id 4 for 1984 139 Growth rates Current account deficit as percentage of exports 1970-80 1980-84 variation 1980, '83, '85 Togo 2.3-3.3 -5.6 38 44 49 Uganda -2.4 7.1 +9.5 38 n.a. n.a. B.LDCs with adjustment programs out side IMF agreement Bukina Faso 4.0 -1.4 -5.4 162 2225 n.a. Ruwanda 8.0 2.3 -5.7 116 13 0 99 Yemen 9.9 6.3 -3.6 6,595 7,488 4,648 C. Total LDCS 3.9 2.4 -1.5 97 93 1216 Source: TD/328/Add.5, p.16, Calculations by the UNCTAD secretariat. 5 for 1982 6 for 1984 140 APPENDIX A TABLE 2 LDCs: Debt and Debt- Service Ratios, 1980-87 (in percent of exports of goods and services, except where otherwise stated) 1980, '81, *82, •83, •84, •85, '86, ' 87 Total debt (in billions of US dollars) 633 744 842 894 940 1,016 1 ,102 1,217 Debt ratio7 82 95 119 133 133 150 169 158 By region Africa 92 119 155 171 171 192 239 241 Asia 71 74 87 92 87 101 101 91 Europe 127 133 141 146 144 159 167 168 Middle East 27 34 46 61 71 83 115 110 Western Hemisphere 183 210 272 290 293 296 352 341 By miscell aneous criteria capital import ing countries 114 129 155 164 157 173 185 173 Official borrowers 156 181 219 244 257 295 325 346 Countries with recent debt-servicing problems 153 188 241 257 248 270 310 306 Total debt at year-end as percentage of exports of goods and services in that year. 141 1980 , '81 •82 •83 •84 •85 '86 '87 Debt-service ratio8 13 16 19 18 19 21 22 20 By region Africa 14 17 21 23 26 29 29 25 Asia 9 10 12 11 11 13 14 14 Europe 25 22 23 21 22 25 26 25 Middle East 4 5 6 8 10 10 14 12 Western Hemisphere 33 42 52 41 41 40 45 38 By miscell aneous criteria capital import-countries 19 22 25 22 23 24 25 22 Official borrowers 14 16 17 20 23 27 25 23 Countries with recent debt-servicing problems 27 33 40 33 34 34 36 30 The total debt value of LDCs1 outstanding debt rose by 10.4% in 1987 to $1,217 (as shown in table 2) which is equivalent to 39% of aggregate GDP. Two- thirds of this nominal increase probably resulted from the impact of exchange rate movements on the dollar value of debt denominated in other currencies. The relatively strong growth of exports of the LDCs contributed to a reduction in the ratio of debt- to- exports Actual payments of interest on total debt, plus actual amortization payments on long term debt, as a percentage of exports of goods and services. 142 from 169 in 1986 to 158 in 1987. However, debt- to- export ratios for all regions remained substantially above their levels in 1980. From 1980 through 1987, there was a progressive and somewhat rapid growth of the debt ratio. Within a space of seven years, from 1980 to 1987, the total debt of the LDCs rose from $633 billion to $1,217 billion. The overall debt-servicing ratio of the LDCs fell from 22% in 1986 to 20% in 1987. 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