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Managing the less developed countries' debt problem 1989

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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 t h i s 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) i i A B S T R A C T MANAGING THE LESS DEVELOPED COUNTRIES' DEBT PROBLEM The underlying problem i n debt management has been the a l l o c a t i o n of the global adjustment burden between the c r e d i t o r s and the debtors and to make them less s e n s i t i v e to the c o l o s s a l economic s a c r i f i c e attendant to the adjustment. The Brady Plan seems to s t r i k e a balance between the opposing interests of the par t i e s involved. But the question of whether such a balance can be sustained i n the long run i s s t i l l open. A l l the debt management strategies evaluated i n t h i s work seem inadequate i n so far as they could not abate the recurrence of the problem. But they nevertheless, appear to be the best that can be offered i n the face of the r e a l i t y of the world economic s i t u a t i o n . The s u s c e p t i b i l i t y of the Less Developed Countries (LDCs) to foreign indebtedness i s rooted i n the poor structure and r e l a t i v e l y u n d i v e r s i f i e d nature of t h e i r economies. Thus the economic growth of these countries seems a panacea to the debt problem. To t h i s end, the LDCs have to ensure that t h e i r economies undergo vigorous economic reforms congruent with the present and prospective r e a l i t i e s of the world economy, aimed at l i f t i n g supply constraints, a t t r a c t i n g foreign i i i i nvestments and encouraging d e b t - e q u i t y swaps which seems t o be making a c o n s i d e r a b l e i n r o a d t o e f f e c t i v e debt management i n t h a t i t saves debtor c o u n t r i e s steep f o r e i g n exchange commitment needed f o r i n t e r n a t i o n a l t r a d e and debt s e r v i c i n g . The economic interdependence of n a t i o n s makes the success o f t h i s s t r a t e g y c o n t i n g e n t upon a 3% minimum GDP growth r a t e i n the i n d u s t r i a l i z e d c o u n t r i e s t o generate not o n l y good market f o r LDCs 1 t r a d e a b l e s but a l s o t o f o r e s t a l l exogenous f a c t o r s t h a t promote the r e c u r r e n c e of the problem. C l e a r l y , t h i s matter i s not w i t h i n the p r o v i n c e of i n t e r n a t i o n a l law. The problem i s b a s i c a l l y economic and must be p r a c t i c a l l y handled and r e s o l v e d i n the same c o n t e x t . In the context of the debt problem and management, i n t e r n a t i o n a l law cannot make p o s s i b l e what i s e c o n o m i c a l l y i m p o s s i b l e . Debtors are t h e r e f o r e a d v i s e d t o save themselves the problem of i n t e r n a t i o n a l indebtedness by matching e x p e n d i t u r e s w i t h a v a i l a b l e r e s o u r c e s a t a l l times w h i l e the c r e d i t o r c o u n t r i e s themselves tamper t h e i r economic p o l i c i e s t o check the exogenous f a c t o r s which promote the r e c u r r e n c e of the problem. IV TABLE OF CONTENTS PAGES ABSTRACT i i - i i i TABLE OF CONTENT i v - v i ACKNOWLEDGEMENT v i i INTRODUCTION v i i i - X X 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 - 1 0 CHAPTER TWO A. INTERNATIONAL MANAGEMENT OF THE DEBT PROBLEM 1 1 - 2 3 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 6 1 - 6 5 II F o r e i g n D i r e c t 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 I n t e r n a t i o n a l Law And The Debt Problem 8 6 - 8 8 a) The D o c t r i n e Of Fundamental Change Of Circumstances 8 8 - 9 1 b) The D o c t r i n e Of Force Majeure 91 - 92 I I Loan T r a n s a c t i o n Between C r e d i t o r And Debtor Governments • 92 a) The A p p l i c a t i o n Of The D o c t r i n e s Of Changed Circumstances And Force Majeure To I n t e r n a t i o n a l Loan T r a n s a c t i o n s 92 - 100 b) The D o c t r i n e Of Odious Debt 100 - 102 I I Loan T r a n s a c t i o n s Between F o r e i g n P r i v a t e C r e d i t o r s And Debtor C o u n t r i e s 102 - 104 I I I S o v e r e i g n Immunity Defense For A Debtor In D e f a u l t 104 - 110 IV The A c t Of S t a t e D o c t r i n e Defense 111 - 113 v i V Expropriation Of Debt 113 - 116 VI Legal E f f e c t s 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 138 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 143 - 151 v i i ACKNOWLEDGEMENT I owe immense t h a n k s t o t h e o n l y l i v i n g a n d m o s t h i g h God, t h e f a t h e r o f o u r L o r d a n d S a v i o u r J e s u s C h r i s t w i t h o u t whose g r a c e a n d s t r e n g t h I c o u l d n o t h a v e b e e n a b l e t o c o n d u c t my r e s e a r c h a n d c o m p l e t e t h i s w o r k . I t h a n k my s u p e r v i s o r s , P r o f e s s o r s C h r i s Thomas an d D. C o p i t h o r n e f o r t h e i r e x p e r t i s e a n d u n f l i n c h i n g c o o p e r a t i o n i n d i r e c t i n g t h e c o u r s e o f t h i s w o r k . I a l s o t h a n k t h e UBC M a i n a n d Law L i b r a r i e s f o r P r o v i d i n g me w i t h r e s e a r c h m a t e r i a l s . v i i i INTRODUCTION When i n 1982, Mexico declared a moratorium on the payment of i t s debt, the world began to appreciate and address i n a greater dimension the magnitude of the inter n a t i o n a l debt problem. The problem has adversely affected the standard of l i v i n g 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 l e v e l . In keeping with t h i s goal, therefore, one i s quickly saddled with fashioning a better way of addressing t h i s concern. In as much as one i s mindful of the e f f o r t s of scholars i n dealing with and appraising t h i s subject, needless to say that i t i s safer not to underestimate the problem or proceed on the premise that i t i s amenable to a r h e t o r i c solution. Owing to the economic interdependence of nations, hardly can any one nation, i r r e s p e c t i v e of i t s wealth and economic management s k i l l , be free from one debt ob l i g a t i o n or another. Therefore, debt s i m p l i c i t a without adverse economic consequences on the standard of l i v i n g of the people i s hardly a problem. This work i s not concerned with such debt. The primary focus of t h i s work i s debt which exceeds a manageable l e v e l and ix graduates into a c r i s i s proportion, derogating from a reasonable standard of l i v i n g of the people concerned. Perhaps i t i s important to add that the most important question i s 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 o f f both the o r i g i n a l and additional debts i s often aborted by world economic recession. Thus v i c i o u s l y , debt i s incurred to service debt. I t i s only reasonable and r e a l i s t i c to canvass for a bias-free and workable strategy to managing the problem. Although s t r i k i n g a balance between the in t e r e s t s of the creditors and the debtors explains the whole l o t of the d i f f i c u l t i e s i n a solu t i o n to the problem, e f f o r t s nevertheless, have not relented or waned i n t r y i n g to bring creditors and debtors to terms of mutual understanding, help, commitment and cooperation i n dealing with the problem. Interestingly, i t has become a lesson that the demise of the debt problem i s f o r a common good. Since t h i s work i s looking at the debt problem from the perspective of the LDCs, i t i s pertinent to mention at the outset that there are d i f f e r e n t X categories of LDCs. There are poor and r i c h LDCs. There are even r i c h e r of the r i c h f o r 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 i t belongs. .̂ The product composition of trade of each of the LDCs has always determined the impact of r e l a t i v e p r i c e changes on terms of trade, while the composition and si z e of external debt has determined how f a r the debt burden has r i s e n i n response to increases i n national i n t e r e s t rates. The degree of balance of payments adjustment required to o f f s e t the impact of declines i n terms of trade or increases i n debt service payments has varied widely among the LDCs even when they have the same foreign exchange losses r e l a t i v e to t h e i r UNCTAD TD/328/Add.l (A p r i l 13, 1987) p.34. The growth rate of Asian LDCs f e l l from an annual average rate of 4.7% i n 1973 - 79 to 3.1% i n 1980 - 85; that of Latin American countries f e l l from 4.7% to 1.0% during the same period; while that of Af r i c a n countries f e l l from 2.7% to 1.0% also during the same period. Performance among d i f f e r e n t groups of LDCs also varied. The major petroleum exporting countries suffered drop i n 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. x i Gross Domestic Product (GDP). The reason i s because of the differences i n t h e i r export bases. 2 The d i f f e r e n t categories of LDCs i s also owed to the fa c t that they d i f f e r i n t h e i r underlying p o t e n t i a l for adjustment owing to differences i n the s i z e and d i v e r s i t y of t h e i r tradeable goods sectors and the l e v e l of income consumption and investment, as well as the over a l l siz e , geographic location, climate, natural resource base and population. Moreover, the domestic p o l i c i e s of the LDCs have been s i g n i f i c a n t i n determining the extent to which external shocks have affected t h e i r economic performance. Some manage t h e i r economies better than others. Generally, v u l n e r a b i l i t y to f i n a n c i a l shock seems to have been greater where increased indebtedness has not been adequately matched by export growth. In other words, countries at higher l e v e l of economic development have always been better equipped to contain external shocks than the low-income commodity-producing LDCs. While i t i s important to keep i n mind the d i f f e r e n t categories of LDCs, t h i s work does not address on a case by case basis, the problem and management of the LDCs' indebtedness. Rather, i t sees 2 Id 3 Id x i i and addresses the problem as one common to a l l the LDCs by reason of the fac t that c e r t a i n fundamental factors underlying the problem are common to a l l the LDCs regardless of categories. The most outstanding of the fundamental factors are the unequal bargaining power and poor economic base of the LDCs r e l a t i v e to t h e i r counterpart developed countries. Nevertheless, where necessary some LDCs are mentioned. Again, i n so f a r as t h i s work acknowledges that there might be some differences i n the debt management strategies suitable to each LDC depending on i t s pecu l i a r economic problems, base and performance, i t however maintains that there are c e r t a i n strategies which may be applicable to LDCs i n general, for example, matching expenditure with avai l a b l e resources and no more. There seems to be a consensus of opinion among writers that a country needs foreign c a p i t a l to achieve and accelerate economic growth so as to increase future income, repay i t s loans and improve the standard of l i v i n g of i t s people. A u s t r a l i a , Canada and New Zealand are often c i t e d as countries that have succeeded i n t h i s way.4 Indeed the LDCs need foreign loans for 4 Jones, G.S. and Sunkel 0., Debt and Development C r i s i s i n Latin America: The End of An I l l u s i o n . Clarendon Press, Oxford 1986, p.34; Barth, J.R., x i i i economic development. Most LDCs are primary commodity producers. They do not have d i v e r s i f i e d economies. Thus they are more susceptible to incurring foreign debts for economic development. But the problem i s with the management of the foreign loans and some external factors which m i l i t a t e against the economic a b i l i t y of the LDCs to pay o f f these loans. The commercial banks, i n making most of these loans, f a i l e d to exercise some lending d i s c i p l i n e . They were not mindful of the economic a b i l i t y of each debtor country to repay the loans. When therefore, the LDCs could no longer service t h e i r debt as expected, a l l the c r e d i t o r s quickly adopted measures to protect t h e i r i n t e r e s t s . The o f f i c i a l c r e d i t o r s have s h i f t e d from concessional (soft term) lendings to non concessional lendings to the LDCs because they want to minimize the e f f e c t of a default. The commercial banks have also s h i f t e d from voluntary (increased exposure) lendings to involuntary lendings to the LDCs i n order to circumvent huge losses i n the event of a default and consequently protect the i n t e r e s t s of t h e i r shareholders and depositors, who otherwise may lose confidence i n them. The LDCs, on and et a l , Understanding International Debt Crisis.19 Case W. Res. J . I n t ' l Law 1987, pp. 31- 52. xiv the other hand, while demanding more loans from t h e i r c r e d i t o r s i n order to finance economic growth and consequently be able to service t h e i r 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 p o l i t i c a l l y t o l e r a b l e . International debt having emerged, the issue of the proper framework within which to appraise i t s problem and management emerges even cl e a r e r . Sergio Amaral r i g h t l y opines that what i s at stake i n achieving economic growth i n the LDCs and solving the debt problem, i s the sharing of the burden of global adjustment among the c r e d i t o r governments, the commercial banks and the LDCs. 5 To reach a compromise of these major c o n f l i c t i n g i n t e r e s t s i s the central issue i n the management of the int e r n a t i o n a l debt problem. The issues to be addressed i n t h i s work are manifold. They include the adequacy of the current i n t e r n a t i o n a l debt management strategy, the r o l e of the International Monetary Fund (IMF),the World Bank, the 5 Amaral,S., The Foreign Debt from L i q u i d i t y C r i s i s to Growth C r i s i s . 19 Case W. Res J . I n t ' l Law. 1987 pp. 17 - 30. XV Paris Club (creditor governments) , and the London Club (commercial banks) i n the management of the problem, the part of international law i n dealing with the problem, the debtors' attitude to the problem and the guest f o r a New International Economic Order. This work i s divided into four chapters. Chapter one dwells on the o r i g i n of the debt problem. At independence the LDCs engaged i n development competition with the developed countries. Though the idea was to a t t a i n a vi a b l e economy and consequently improve the standard of l i v i n g of t h e i r people, the mismanagement associated with i t 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 i n the o i l boom days i n 1973/74 and 1979/80. Thus the gate was opened f o r the emergence of the debt problem and i t s attendant recurrence. The global economic recession i n the l a t e 1970s and early 1980s aggravated the s i t u a t i o n . Chapter two focuses on the international management of the debt problem. This thesis i s 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 i n s t i t u t i o n s i s o r i g i n a l l y intended to manage a debt problem. The IMF Stand-By Arrangement i n which i s enshrined the IMF adjustment program f o r debt management, had no l e g a l recognition i n both the o r i g i n a l and the 19 69 amended save the 1978 amended IMF A r t i c l e s of Agreement. The World Bank (formerly the International Bank for Reconstruction and Development) (IBRD) was o r i g i n a l l y concerned with the financing of the reconstruction of Europe a f t e r the devastation of World War I I . Thereafter, the Bank started a program of project lending to the Third World. The Bank did not concern i t s e l f with debt management u n t i l early 1980s when i t introduced a program of Structural Adjustment Loans (SALs) f o r LDCs facing debt problems. The Paris Club and the London Club reschedule o f f i c i a l and commercial debts respectively. Their i n a b i l i t y to manage the debt problem i s c l e a r from the fa c t that they entrust the f u l f i l l m e n t of the conditions for granting of debt r e l i e f to the IMF and more recently, to the World Bank. Therefore, the process whereby the granting of debt r e l i e f i s t i e d to the f u l f i l l m e n t of the conditions of the IMF, the World Bank, the Paris Club and the London Club, a l l at x v i i the same time as the f a i l u r e i n meeting the conditions of any one of them tri g g e r s o f f the f a i l u r e to obtain r e l i e f from any one of them, i s a debt trap and part of the LDCs' d i f f i c u l t y i n coping with the problem. The Paris Club and the London Club, as creditors* c a r t e l s have the leverage of greater bargaining power in the negotiation process with each i n d i v i d u a l debtor LDC. This has f a r reaching e f f e c t s i n the context of the conditions and the l e g a l clauses introduced i n loan agreements. While the strategies employed by these i n s t i t u t i o n s may o f f e r temporary r e l i e f , they nevertheless f a i l to insulate the debtor LDCs against a recurrence of the problem. I t i s against t h i s background that the argument concerning the inadequacy of the debt management strategies becomes somewhat f o r c e f u l and p l a u s i b l e . I t i s however, not out of place for one to take the view that the current strategies are the l i m i t that can be offered i n the face of the world economic recession a f f e c t i n g a l l the p a r t i e s , i f indeed, the i n t e r e s t s of the creditors and the debtors are to be on a balance. The chapter also examines how debt-equity swap and foreign d i r e c t investment can help i n dealing with the problem. F i n a l l y , i t looks into debt management x v i i i constraints and evaluates the debt management strategies with a view to es t a b l i s h i n g t h e i r adequacy or otherwise. Chapter three examines the international l e g a l regime of the debt problem. International loan transactions are usually governed by the choice of law of the p a r t i e s which almost invariably i s the law of the c r e d i t o r state. The dominance of municipal law clogs the development of international law i n t h i s area. International law i n i t s e l f i s not a debt manager. Moreover, even i f a debt management strategy anchored on international law i s to evolve , i t must not evolve without a base. I t must evolve based on the r e a l i t y of the international economic s i t u a t i o n . Therefore, i t w i l l hardly make any s i g n i f i c a n t difference from what i s presently i n operation. While the binding character of contract i s recognized to bind pa r t i e s to an i n t e r n a t i o n a l loan agreement, the doctrine of Changed Circumstances and Force Majeure which are supposed to be exceptions to i t are argued to have no application i n international loan transactions. The defenses of Sovereign Immunity and Act of State are r a r e l y tenable i n i n t e r n a t i o n a l loan transactions, i n large part, because of the commercial nature of the transactions. The doctrine of odious debt xix i s hardly tenable because of the p r i n c i p l e of continuity of states. Worse s t i l l , i n a genuine hopeless case, there i s no international law of bankruptcy to a v a i l a debtor country. This part w i l l also look into two major clauses usually enshrined i n int e r n a t i o n a l loan transactions. Chapter four discusses debtors 1 response to the debt problem and t h e i r quest f o r a new in t e r n a t i o n a l economic order. While some debtors have repudiated or reneged t h e i r debt obligations or have declared moratoria on amortization and i n t e r e s t payments, others have u n i l a t e r a l l y l i m i t e d debt s e r v i c i n g to a c e r t a i n percentage of t h e i r foreign exchange earnings. Debtor countries complain that while they are being urged to undertake adjustment programs aimed at boosting t h e i r foreign exchange earnings f o r debt servic i n g , the c r e d i t o r countries themselves are maintaining economic p o l i c i e s of protectionism, subsidies and reduced terms of trade against them. The LDCs maintain that the solution to the debt problem can only be found i n a new international economic order which w i l l develop t h e i r economic base and give them equal bargaining power with the c r e d i t o r countries. But the c r e d i t o r s are not w i l l i n g to y i e l d to t h i s request X X and so balancing of these two c o n f l i c t i n g i n t e r e s t s i n i t s e l f another big concern. 1 C H A P T E R O N E THE ORIGIN AND CAUSES OF THE DEBT PROBLEM The o r i g i n and causes of the debt problem have both remote and immediate factors and are of i n t e r n a l and external dimensions. INTERNAL CAUSES OF THE DEBT PROBLEM The post c o l o n i a l period ushered i n a new endeavor on the part of the LDCs. They sought to transform t h e i r economies to meet with the demands of the dynamic world, a thing which colonialism f a i l e d to achieve f o r them. Most LDCs do not have a d i v e r s i f i e d economy. They are mainly primary commodity producers. There i s therefore the need to import some technology with a view to d i v e r s i f y i n g t h e i r economies. Foreign exchange has to be expended and i n most cases foreign loans have to be contracted to procure the necessary technology. Unfortunately foreign loans contracted f o r the purpose of economic development are often mismanaged and the r e s u l t i s that there i s no economic return to pay o f f the loans. In Nigeria, for example, the b u i l d i n g of a new c a p i t a l c i t y overnight which has taken over h a l f of the country's fortune without physical improvements of equal value to show for i t , c e r t a i n l y has no economic rationale since the new c a p i t a l cannot generate foreign exchange to o f f s e t the foreign debt incurred on i t s behalf. Mismanagement of the country's resources i s also seen i n the so c a l l e d s t e e l factory, a 2 project on which has been expended b i l l i o n s of borrowed d o l l a r s , and which nevertheless, cannot turn out a single product f o r export. I t i s perhaps only i n Nigeria, can a r e f i n e r y , one of the largest i n the OPEC, be b u i l t i n a l o c a t i o n where there i s no o i l deposit, an idea which necessitated the construction of o i l pipelines running well over 2000 miles from an o i l r i c h l o c a t i o n at a very high economic cost and l o s s . In Zaire, the leader committed the country to foreign debt i n the name of building an expensive a i r p o r t i n his home town, a geographically unsuitable l o c a t i o n f o r 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 i s not d i f f e r e n t . The Marcos government embarked on an unviable and needless nuclear plant project which engulfed more than $ 2 . 3 b i l l i o n with no economic re t u r n s . 2 Unfortunately, t h i s kind of mismanagement takes place j u s t at the time when a large crosssection of the LDCs1 population i s dying of hunger, s u f f e r i n g unemployment and the poorest standard of l i v i n g i n the world. 1 Wieser, E., Domestic and External Causes of the Latin American Debt C r i s i s , i n "The P o l i t i c a l Economy of the North- South Relations." Edited by Toivo MilJ a n . Canada: Broadview Press, (1987) pp.423-428. 2 Briones, L.M., The Morning After, pp.2-8. Reproduced i n "The Debt Trap: How To Get Out Of I t " Papers and Proceedings of the Symposium j o i n t l y sponsored by the International Studies I n s t i t u t e of the Philippines and the University of Philippines. Aug.24, 1987. 3 The domestic p o l i c i e s of the debtor countries also contributed to the debt problem. Argentina, Mexico, Venezuela and Chile, for example, maintained overvalued currencies i n the l a t e 1970s and early 1980s. This discouraged exports by making them r e l a t i v e l y more expensive and encouraged imports (causing balance of payment d e f i c i t s ) by making them r e l a t i v e l y less expensive, and consequently, the overvalued currencies l e d to c a p i t a l f l i g h t 3 (ie a massive conversion of l o c a l currency to foreign exchange for safe keeping abroad). In addition, most debtors refused to cut down on public sector d e f i c i t s and to r e s t r a i n expansion of money supply to control i n f l a t i o n . B r a z i l , for example, pursued a p o l i c y of growth based on the accumulation of external debt. 4 This scenario i s summed up thus: ... I t came as no great surprise to f i n d that by l a t e 1988, a l l the debtor countries we v i s i t e d , with the exception of Zimbabwe, Thailand, and Papua-New Guinea, were i n a state of insolvency or pre-insolvency i f one assumes that economic growth needs to keep pace with the increase of the population ( and does not even consider the p o s s i b i l i t y of a rate of development s u f f i c i e n t to catch up, i n the medium or long run, with the more advanced economies). The reasons for t h i s Eskridge, W.N.,Jr. Santa Claus and Sigmund Freud: Structural Context of the International Debt Problem i n "A Dance Along the Precipe: The P o l i t i c a l and Economic Dimension of International Debt Problem". Edited by Eskridge, W.N. J r . , Lexington Books, D.C.Heath and Co.Lexington. (1985) pp.31-79; Cline, W. International Debt and the S t a b i l i t y of the World Economy. In s t i t u t e of International Economics, Washington D.C. (1983) pp.20-28. Cline, W. pp. 20-28. 4 i n a b i l i t y to l i v e up to the external debt s e r v i c i n g obligations are no doubt i n part endogenous: poor economic planning and f i s c a l management, and u n r e a l i s t i c public investment c l i m a t e . 5 Good management of resources would have saved these countries the embarrassment of foreign indebtedness. EXTERNAL CAUSES OF THE DEBT PROBLEM The r i s e i n o i l prices forced the i n d u s t r i a l i z e d countries to adopt p r o t e c t i o n i s t and t i g h t monetary p o l i c i e s aimed at protecting t h e i r economic i n t e r e s t s . Consequently the world economic recession came i n a greater dimension. The e f f e c t of t h i s was f a r reaching on the LDCs so much so that between 1980 and 1983, t h e i r growth rate f e l l to 0.1% per annum. Their exports f e l l on the average by 8.2% per annum with t h e i r terms of trade d e t e r i o r a t i n g to 6.7% on the average. The poor economic performance of these countries increased t h e i r debt on the average by 10.6% per annum between 1980 and 1983. 6 Konz, P. The Third World Debt C r i s i s . 12 Hastings I n t ' 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 C r i s i s , March 25, 1989. Mr Konz p a r t i c i p a t e d i n the survey of external debt management of the Third World countries c a r r i e d out on behalf of the U.N. Development Program i n 1988. Both the Bretton Woods i n s t i t u t i o n s and the Common Wealth Secretariat assisted i n the survey. Abbott, G.C., Debt R e l i e f s for the Poorer Developing Countries 19 Case W. Res. J . I n t ' l Law (1987) pp.1-16 ; Jones G.S.and Nichols, L. New Direction i n Debt Management. 19 Case W. Res. J . I n t ' l Law (1987), pp.53- 73. 5 According to estimate, the Non O i l Developing Countries (NODCs) alone l o s t approximately $141 b i l l i o n i n high i n t e r e s t payments, lower export receipts and higher import cost as a consequence of adverse macroeconomic developments a f t e r 1978. 7 Cline i n h i s research stated that external factors added $401 b i l l i o n to the external debt of o i l importing LDCs between 1974 and 1982. He made a break down of the figures as follows: a) $260 b i l l i o n resulted from increases i n o i l prices, 1974 - 1982; b) $41 b i l l i o n resulted from the sharp r i s e of d o l l a r r e a l i n t e r e s t rates i n 1981-1982 over 1961-1980 average; c) $21 b i l l i o n resulted from losses i n export volume due to world wide recession i n 1981-1982; and d) $79 b i l l i o n was due to the drop i n commodity prices and other terms of trade i n 1981-1982. He also stated that the t o t a l debt of the NODCs stood at $130 b i l l i o n i n 1973 but increased by $482 b i l l i o n to a t o t a l of $612 b i l l i o n as at 1982. According to Cline, out of the additional $482 b i l l i o n , $401 b i l l i o n i s attributed to the impact of events (external) beyond the control of the debtor c o u n t r i e s . 8 Schirano, L.G., A Bank's View. pp. 19-24 i n (A Dance Along the Precipe: The P o l i t i c a l and Economic Dimensions of International Debt Problem) note 3. Cline, W. pp.24-25,(Table 4). 6 Interest on Mexico's and B r a z i l ' s loans for example, accounted f o r 70% and 62% of t h e i r debts respectively i n 1980. A one percent increase i n in t e r e s t rates l e d to $2.5 b i l l i o n a dditional debt for some of the LDCs with the Phil i p p i n e s and Argentina incurring 159 m i l l i o n and 600 m i l l i o n d o l l a r s respectively. Commenting on the e f f e c t of external causes of debt problem on debt management, the UNCTAD Secretary General stated: I t i s equally important to recognize the p o s s i b i l i t y that debt problem may a r i s e despite good management. A developing country may apply the soundest of p r i n c i p l e s i n regard to the use of the c r e d i t s i t has incurred, i t may invest i t s funds i n terms of very proper c r i t e r i a , i n every productive sector of investments, but i f , to take an example, there i s a collapse i n the external pri c e s of i t s exports, then no matter how prudently i t has developed i t s resources, i t can run into debt service d i f f i c u l t i e s - d i f f i c u l t i e s that are externally induced and which have nothing to do with the p r i n c i p l e s of sound domestic management.10 In l i n e with t h i s statement, the Quito Declaration of January, 1984 by the presidents of Argentina, B r a z i l , Columbia and Mexico lamented the v u l n e r a b i l i t y 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 . I n t ' l Law and P o l i t i c s , 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 C r i s i s and the Process of Redemocratization i n Latin America, pp. 207-29 i n (A 7 The economic dependence of one country on another has been defined as follows: By dependency we mean a s i t u a t i o n i n which the economy of c e r t a i n countries i s conditioned on the development and expansion of another economy to which the former i s subjected. The r e l a t i o n 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 s e l f - s u s t a i n i n g , while other countries, the dependent ones, can do t h i s only as a r e f l e c t i o n of that expansion, which can have eit h e r a p o s i t i v e or a negative e f f e c t on t h e i r immediate development. 1 2 Indeed the dependence of the LDCs1 economies on the western countries, makes them vulnerable to external debt at the s l i g h t e s t negative economic p o l i c i e s of the i n d u s t r i a l i z e d countries. But there i s hardly any one country i n the world which has attained economic independence. Even the developed countries depend on one another to some extent. This i s a r e a l i t y of the economic l i f e of nations. A l l nations of the world know t h i s and have increasingly learned to l i v e with i t . However, the extent of dependence i s important. With the d i v e r s i f i c a t i o n of the LDCs1 economies, they might be r e l a t i v e l y l e s s susceptible to adverse macroeconomic p o l i c i e s of the developed countries. Though protectionism and subsidies to l o c a l l y manufactured goods by the developed countries have been part of t h e i r economic p o l i c i e s long before the debt c r i s i s , Dance Along the Precipe: The P o l i t i c a l and Economic Dimensions of the International Debt Problem) note 3. The Structure of Dependence. 60 Am. Econ. Rev.(1970) p. 231 8 e f f o r t s should be made to tamper these p o l i c i e s i n response to the debt s i t u a t i o n . Beside the preceding causes of the debt problem, i t i s important to mention that lack of lending d i s c i p l i n e on the part of the banks which resulted i n overlending contributed to the problem i n no small measure. In the face of the LDCs1 craze f o r foreign loans for overnight i n d u s t r i a l i z a t i o n , the banks who were already over burdened with large deposits of petrodollars receipts were quick to lend considerable amount of foreign c a p i t a l at f l o a t i n g i n t e r e s t rates to these c ountnes. The banks were lured into excessive lending by the huge p r o f i t they made therefrom. S t a t i s t i c s put the rapid p r o f i t s of some American banks as f o l l o w s : 1 4 Banks 1972 (profits) 1976 (profits) Bank of America 21% 40% Citibank 54% 72% Chase Manhattan 34% 78% Manufacturers Hanover 29% 56% J.P.Morgan 35% 53% Bankers' Trust 31% 64 Chemical Bank 14% 44% The above data shows that by 1976, some of the banks were making twice the p r o f i t they made i n 1972. The banks were c a r r i e d away by t h i s trend and before they knew i t , 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 I t " . See note 2 - quoting Sampson, The Money Lender, London, 1983, p. 158. 9 borrowers could no longer service t h e i r debt as before. As r i g h t l y observed: A l l t h i s started i n the seventies when conservatively dressed gentlemen with elegant b r i e f cases hurried from country to country i n the Third World, o f f e r i n g inexpensive loans with f i v e or ten year maturities. Interest rates were barely j u s t 2% above LIBOR. This generously offered ready money consisted of petrodollars which had been deposited i n European and US banks. 1 5 A finance minister of a Latin American country was quoted as saying: I remembered how the bankers t r i e d to corner me at conferences to o f f e r me loans. They wouldn't leave me alone. I f you are t r y i n g to balance your budget,it's t e r r i b l y tempting to borrow money instead of r a i s i n g taxes, to put o f f the agony. 1 6 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 s t o r i e s , c a p i t a l f l i g h t and int e r n a t i o n a l debt are part of the same story. In some cases, the wealthiest classes of poor countries have a c t u a l l y sent more money out of t h e i r countries than foreign borrowing has brought i n , and often, i t i s the same money American banks have promoted, and p r o f i t e d from, both sides of the transaction. The r e a l r o l e has been to take funds that t h i r d world e l i t e s have stolen from 1 5 Briones, L.M. pp. 2-8 1 6 Magallona, M.M. Some Remarks on the Debt Problem, pp 35 i n "The Debt Trap: How to Get Out Of I t " see note 2. 10 t h e i r governments and to loan them back, earning a nice spread each way. 1 7 Apart from the world economic recession and ce r t a i n economic p o l i c i e s of the developed countries, i n large part the mistakes of the banks and the mismanagement of resources by the i n d i v i d u a l LDC debtor governments l e d to the debt problem. I f countries had prudently managed t h e i r resources by t a i l o r i n g t h e i r expenditure to the avail a b l e resources, and i f the banks had exercised some lending d i s c i p l i n e , the magnitude of the present debt problem would have been averted. L o t t i l a , R.P.M., Selective Disengagement of Foreign Sovereign Debt: Some P r i n c i p l e s Relevant to the Phil i p p i n e s ' Dilemma, p.9, i n " The Debt Trap: How to Get Out of I t " note 2 - quoting James S. Henry, The Third World Debt Hoax: Where the Money Went. The New Republic 14th A p r i l , 1986. CHAPTER TWO INTERNATIONAL MANAGEMENT OF THE DEBT PROBLEM The emergence of the international debt problem ine v i t a b l y r a i s e s the question of how to approach the problem with a view to bringing i t to a l e v e l that does not adversely a f f e c t the standard of l i v i n g of the LDCs. There are some inte r n a t i o n a l i n s t i t u t i o n s currently involved i n managing the debt problem namely, the IMF, the World Bank, the Paris Club and the London Club. Before discussing the a c t i v i t i e s of these i n s t i t u t i o n s regarding the debt problem, i t might be proper to give a general account of the international debt management approach. T r a d i t i o n a l l y , the problem of in t e r n a t i o n a l indebtedness has been viewed i n a s t r i c t l y commercial context i n which debtor countries were expected to honour t h e i r obligations i n f u l l and on time regardless of the d i f f i c u l t y i n debt s e r v i c i n g because i t was assumed that they had mismanaged t h e i r economies. 1 The c r e d i t o r s were then obliged to grant new loans, reschedule and refinance e x i s t i n g 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 i n i t i a l 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 s t a b i l i z a t i o n programs. 3 I t was believed that the problem was b a s i c a l l y i l l i q u i d i t y rather than insolvency of the debtor countries and so needed rescheduling and involuntary lending of new c r e d i t s to help the debtor economy to grow i n a short term, and to be able to service i t s 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, a l l adjustments made and r e l i e f granted have been of l i t t l e help r e l a t i v e to the amount of debt and have not been able to abate the recurrence of the problem. The question i s , f o r how long would adjustment and r e l i e f measures continue i n the face of the world economic recession which seems to have become permanent. International debt strategy appears to draw a d i s t i n c t i o n between o f f i c i a l debt (owed to cr e d i t o r 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 le a s t 3% rate of economic growth i n the OECD and the LDCs, the national i n t e r e s t rates, the pri c e of o i l and concluded that the problem i s as a r e s u l t of i l l i q u i d i t y and not insolvency of the LDCs and so he suggested that by 1986, a l l things being equal, debtor countries w i l l resume creditworthiness. 13 As to the former, i t i s believed that there i s considerable l a t i t u d e and p o s s i b i l i t y of converting them to aids and grants. 5 But debts i n the l a t t e r category are to be repaid regardless of the problems being faced by the countries concerned. At best t h e i r amortization and i n t e r e s t payments are rescheduled. In some cases, new loans are made only to be used to keep debt s e r v i c i n g c urrent. 6 Commercial banks prefer to deal with the problem i n t h i s way because of the accounting and regulatory practices i n c r e d i t o r countries. In the U.S. f o r example, where there i s a default i n debt servicing, the Federal Reserve Board, declares the loans as non performing and compels the banks concerned to set aside reserves to negate the e f f e c t of such non performing loans. To avoid t h i s r e s u l t , the banks make new loans for the purpose of keeping i n t e r e s t on old loans current. For the M u l t i l a t e r a l 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 t h e i r loans might jeopardize t h e i r f i n a n c i a l stance and objective. The abysmal f a i l u r e of the short term management approach ushered i n a new i n i t i a t i v e i n 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 i n favour of a program o for sustained growth of the LDCs. According to Baker, the U.S. i s not i n favour of debt forgiveness and l i b e r a l inflow of c a p i t a l to the LDCs for the following reasons: (a) A write o f f w i l l preclude the debtors from gaining access to c r e d i t markets including v i t a l trade finance. The problem, he maintained, i s not the l e v e l of debt as to warrant forgiveness, but the a b i l i t y to service i t . In hi s view, as the investments i n the LDCs are not earning t h e i r way, a big part of the solution i s to improve the productivity of t h e i r investments. He argued that even i f the debt i s cancelled, the proceeds therefrom would not be enough for LDCs* economic development, neither would i t make them not to depend on the developed countries any more. In addition, banks would s u f f e r losses as a r e s u l t of a write o f f 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 p o l i c y 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 i n The P o l i t i c a l Economy of North South Relations edited by Toivan Miljan (1987) pp. 352-58. See Chapter 1, note 1. 15 to debtors' a b i l i t i e s to generate earning power for investment and achieve sustainable economic growth. 9 Again, the problem with debt forgiveness i s the c r i t e r i a that would be f a i r i n a p a r t i c u l a r circumstance to determine countries that should have the b e n e f i t . 1 0 Moreover, an across the board debt r e l i e f would t r e a t a l l debtors equally and would dampen the zeal of the countries making adjustment e f f o r t s , a dangerous precedent i n d e e d . 1 1 Nevertheless, the recognition of the need f o r some debt r e l i e f i s not a recent development. The U.S. Secretary of Treasury r e f e r r i n g to Europe's indebtedness to the U.S. a f t e r World War I, said: 9 Id. 1 0 Lovett, W.A. Managing the World Debt C r i s i s : Economic Strains and Alternative Solutions. 21 Stanford. J . of I n t ' l Law (1985) pp. 499-543. 1 1 Hudes, K., Coordination of Paris and London Clubs Reschedulings, 17 NYU J I n t ' l Law & P o l i t i c s (March/April, 1985) pp. 553-71. 16 Under these circumstances, an impenetrable b a r r i e r e x i s t s which makes i t impracticable for these governments to pay i n d o l l a r s the amount of i n t e r e s t due from them to the U.S. This involves no question as to the insolvency or f i n a n c i a l i r r e s p o n s i b i l i t y of those governments... but r e s u l t s from the condition of the foreign exchange market....If the Treasury does not defer c o l l e c t i o n of i n t e r e s t and thus adds to the present d i f f i c u l t i e s i n the f i n a n c i a l and economic r e h a b i l i t a t i o n of the world by demanding an immediate cash payment of i n t e r e s t before the industry and trade of Europe have an opportunity to revive, we should not only make i t impossible for Europe to continue needed purchases here and decrease t h e i r ultimate capacity to pay t h e i r debts to us but should hinder rather than help the reconstruction which the world should hasten. The c r e d i t o r s these days have been accused of not taking the same measure i n respect of the LDCs' debt despite the f a c t that LDCs1 s i t u a t i o n i s akin to that of Europe then. The creditors wait u n t i l there i s a c r i s i s before granting r e l i e f , thus making recovery d i f f i c u l t for debtors who i n turn f a i l to service t h e i r debt on a regular b a s i s . 1 3 The foremost need of the LDCs, according to Baker, i s s t r u c t u r a l p o l i c y changes to create economic in f r a s t r u c t u r e for sustained growth so that t h e i r economies could a t t r a c t v i a b l e foreign investments which i n turn would generate foreign exchange needed for debt se r v i c i n g . To a t t a i n t h i s goal, the Baker Plan stands for increased c a p i t a l flow to LDCs from both the o f f i c i a l and Abbott, G.C. note I p. 211 - a s i m i l a r step was taken by U.S. President Hoover, when he delared a moratorium i n 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 p o l i c y improvements. In addition, the IMF loans and the World Bank s t r u c t u r a l adjustment loans are to be mobilized subject to the debtor country's willingness to undergo s t r u c t u r a l economic reforms under the supervision of these i n s t i t u t i o n s . 1 4 However, the Baker Plan recognizes the fac t that t h i s cannot be achieved overnight because of constraints posed by p o l i t i c s , history, culture and sociology differences i n l o c a l economies. According to Baker, because each country's l i m i t a t i o n s and potentials are d i f f e r e n t , a case by case approach t a i l o r e d to s u i t the p e c u l i a r i t y of each s i t u a t i o n i s i n d i s p e n s a b l e . 1 5 The p r i n c i p a l s i g n i f i c a n c e of the Baker Plan i s the express emphasis on the need to move the restoration of growth of the LDCs to the center of the international debt strategy. This i s to be achieved through sound f i n a n c i a l measures and increased reliance on market-oriented development strategies. The Plan recognizes the longer term character of the process of overcoming d i f f i c u l t i e s of growth and debt and recognizes the need to tamper austerity measures with fresh c r e d i t flows. I t believes that "any plan which j u s t involves more lending, more borrowing, more 1 4 Id. 1 5 Id. 1 6 UNCTAD note 2. 18 i n t e r e s t payments, more repayment requirements, i s not a t o t a l plan for success." 1 7 I t also supports equity investment as a very important factor permitting the LDCs1 economies to grow. The Baker Plan i s now superseded by the Brady Plan unveiled i n March, 1989. Under the Brady Plan, c r e d i t o r s and debtors are given considerable l a t i t u d e for negotiated debt r e l i e f by way of bank debt reduction or forgiveness, and continued bank lending to the debtor countries i s r e s t r i c t e d . According to Mr Brady, the Baker Plan which emphasizes continued bank lending stands " To produce losses of revenue and c a p i t a l for a l l banks that go well beyond anything implied i n our p r o p o s a l . " 1 8 He i s 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 c o l l a t e r a l , or to otherwise support the debt reduction p r o c e s s . 1 9 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 s e r v i c i n g reduction on a voluntary b a s i s . 2 0 Amaral, S. The Foreign Debt from L i q u i d i t y C r i s i s to Growth C r i s i s 19 Case W. Res. J . I n t ' 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. 2 0 Id. 19 Though d e t a i l s of the Plan are yet to be made public , i t i s 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 l o c a l business i n debtor countries. The means of reduction i s made workable by some special measures offered to countries l i k e Mexico and Venezuela which are implementing not only sound economic reform programs under the supervision of the IMF but are also making progress i n bringing back c a p i t a l that was taken abroad by t h e i r c i t i z e n s . 2 2 The measures include: (a) The r i g h t to use ce r t a i n 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 s e c u r i t i e s to e f f e c t i v e l y guarantee or assure the banks that i n t e r e s t s would be paid on loans for which i n t e r e s t rates or p r i n c i p a l 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 j o i n t waiver of standard clauses i n t h e i r loan agreements that impede debt 2 1 Id. 2 2 Id. reduction. Then the bank would be requested to negotiate a reduction and write-down some portion of the old loans i n return f o r getting a guarantee on the p r i n c i p a l or i n t e r e s t of the bonds. 2 3 The U.S. Treasury Department estimates that under the Plan, $20 b i l l i o n could be discounted out of the debt of 39 countries owed to the banks over three years with the maturity period of whatever i s l e f t extending to 30 y e a r s . 2 4 The estimate envisages 20% bank debt reduction on the assumption that the IMF and the World Bank would provide between $20 to $25 b i l l i o n to the banks. 2 5 But there seems to be indications that the banks might not o f f e r any more debt reduction than they can be compensated for by the IMF, the World Bank and Japan. For example, i n the current debt reduction negotiation with Mexico, the banks are w i l l i n g to make only about $5 b i l l i o n or 11% reduction of t h e i r outstanding loans to Mexico i n return f o r about $6 b i l l i o n from the IMF, the World Bank and Japan. 2 6 E s s e n t i a l l y , the Brady Plan i n d i r e c t l y s h i f t s the burden of bank debt reduction from the banks to the IMF and 2 3 Id. 2 4 "U.S. Plan May Cut Debt 20% For 39 Countries" The Wall Street Journal, March 16th, 1989, pp. A3, A9. 2 5 Id. 2 6 "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 l i m i t e d f i n a n c i a l resources of these i n s t i t u t i o n s r e l a t i v e to the amount of outstanding debt, i t i s feared that these i n s t i t u t i o n s and Japan might not be able to pay or guarantee the banks enough money to induce them to write-down the difference e s p e c i a l l y where i t i s substantial. Therefore, for the Brady Plan to succeed i n t h i s regard, the IMF and the World Bank have to receive more money from t h e i r subscribers. Interestingly, the Plan seems to recognize that the banks might not be w i l l i n g to forgive enough amount of debt to enable the debtor countries to finance economic growth. To t h i s end, i t allows for new money flows supported by m u l t i l a t e r a l f i n a n c i a l i n s t i t u t i o n s . This Plan has been endorsed by many f i n a n c i a l commentators. One of them commented: A more d e f i n i t i v e approach - the only one which can presumably solve the debt c r i s i s to the s a t i s f a c t i o n of lenders and borrowers, and of the s o c i e t i e s they represent - resides i n negotiated debt restructuring that would involve debt r e l i e f , assurance of new money flows and, to that end, a new supporting r o l e for the m u l t i l a t e r a l f i n a n c i a l i n s t i t u t i o n s . This seems i n f a c t to be the l i n e the Brady Plan t a k e s . 2 7 Negotiated debt r e l i e f (by way of debt forgiveness) makes sense provided i t i s understood as an exceptional measure of c r i s i s management, and w i l l not become a permanent feature i n sovereign borrowing. Otherwise Konz, P. at 535, see chapter 1, note 5. f i n a n c i a l f l o w s w o u l d d r y up more r a p i d l y , a n d LIBOR r a t e s w o u l d a p p r e c i a t e i n a n t i c i p a t i o n o f f u t u r e d i s c o u n t s . 2 8 T h e r e a r e h o w e v e r , many q u e s t i o n s y e a r n i n g f o r a n s w e r . W o u l d t h e c o m m e r c i a l b a n k s b e w i l l i n g t o t a k e l o n g t e r m r a t h e r t h a n a s h o r t - t e r m a p p r o a c h t o d e b t f o r g i v e n e s s ? W o u l d t h e home g o v e r n m e n t s o f t h e b a n k s s u p p o r t t h e m b y a p p r o p r i a t e r e g u l a t o r y a n d t a x p o l i c i e s ? W o u l d t h e c r e d i t o r g o v e r n m e n t s come up w i t h a p p r o p r i a t e t r a d e p o l i c i e s t o g i v e t h e d e b t o r c o u n t r i e s t h e means t o s e r v i c e t h e i r f u t u r e d e b t ? I n t h e f a c e o f p o l i t i c a l p r e s s u r e a n d s o c i a l c o s t , w o u l d d e b t o r c o u n t r i e s i m p l e m e n t s o u n d e c o n o m i c m e a s u r e s t o a t t r a c t new money, w h e t h e r i n f o r m o f l o a n s o r i n v e s t m e n t ? The P l a n a p p e a r s t o be s i l e n t o r n o t t h o r o u g h o n t h e i s s u e o f t h e r e p a y m e n t o f o f f i c i a l d e b t . The d e b t owed t o t h e IMF, The W o r l d B a n k a n d J a p a n b y r e a s o n o f t h e i r c o n t r i b u t i o n i n t h e b a n k s d e b t r e d u c t i o n a n d s u p p l y o f new money n e e d s t o b e r e p a i d . M o r e o v e r , i t d o e s n o t a d d r e s s t h e e x t e r n a l f a c t o r s p r o m o t i n g t h e d e b t p r o b l e m . N e v e r t h e l e s s , t h e P l a n s h o u l d b e p r e f e r r e d t o t h e B a k e r P l a n . The r e a s o n i s t h a t i t p r o v i d e s f o r b o t h new money f o r e c o n o m i c g r o w t h o f t h e d e b t o r c o u n t r i e s a n d d e b t a n d d e b t s e r v i c i n g r e d u c t i o n . A l s o , i t o f f e r s t h e b a n k s a b e t t e r d e a l t o g e t r i d o f t h e i r b a d d e b t a n d s a v e s t h e m t h e t r o u b l e o f c o n t i n u o u s l e n d i n g w i t h o u t p r o s p e c t o f r e p a y m e n t . The B a k e r I d a t 534. Plan provides only f o r new loans to finance foreign exchange-generating investments but f a i l s to address the external factors which m i l i t a t e against the foreign exchange earnings of the debtor countries. Whatever i s the merit of the debt management strategy employed, the fact remains that though i t i s a consensus of opinion that the growth and high demand of exports of the LDCs and the stable economic growth of the i n d u s t r i a l i z e d countries would help end the debt problem, the i n d u s t r i a l i z e d countries' p r o t e c t i o n i s t p o l i c i e s intended to avoid d e - i n d u s t r i a l i z a t i o n and unemployment m i l i t a t e against t h i s hope. 2 9 Therefore, balancing the i n t e r e s t s of the LDCs and the i n d u s t r i a l i z e d countries i n t h i s regard i s yet another problem facing debt managers. THE ROLE OF THE IMF IN DEBT MANAGEMENT The IMF was born at the Bretton Woods Conference i n 1944. A r t i c l e I of i t s o r i g i n a l A r t i c l e of Agreement as amended i n 1968 and e f f e c t i v e i n 1969, and as amended i n A p r i l 1, 1978, sets the objective of the IMF as follows: i) To promote international monetary cooperation through a permanent i n s t i t u t i o n which provides the machinery for consultation and collaboration on international monetary problems. i i ) To f a c i l i t a t e the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high l e v e l s of employment and r e a l income and to the development of the Lovett, W.A., pp.499-543. 24 productive resources of a l l members as primary objectives of economic p o l i c y . i i i ) To promote exchange s t a b i l i t y , to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation. iv) To a s s i s t i n the establishment of a m u l t i l a t e r a l system of payments i n respect of currency transactions between members and i n the elimination of foreign exchange r e s t r i c t i o n s which hamper the growth of world trade. v) To give confidence to members by making the Fund's resources temporarily a v a i l a b l e to them under adequate safeguards, thus providing them with opportunity to correct maladjustments i n t h e i r 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 d i s e q u i l l i b r i u m i n the international balances of payments of members.30 The IMF, o r i g i n a l l y was not intended to manage inte r n a t i o n a l debt problems. There was no express mandate i n i t s objective to t h i s e f f e c t . Over the years, however, the IMF has evolved a Stand-By Arrangement approach to the debt problem. This approach though not expressly provided i n i t s A r t i c l e I, i s read into A r t i c l e I (v) , and t h i s arguably has been the l e g a l basis of t h i s approach. The A p r i l 1, 1978 amendment of IMF A r t i c l e s of Agreement defines a Stand-By Arrangement, for the f i r s t time, i n i t s section Gold, J . Standby Arrangement: IMF Washington, D.C. (1970) p. 241 (Appendix C. A r t i c l e s of Agreement of the IMF); Edwards, R.W. J r . Is an IMF Stand-By Arrangement a Seal of Approval On Which Other Creditors Can Rely? 17 NYU J . of I n t ' l Law & P o l i t i c s (March/April, 1985) p. 573-97. 30 (b) as a decision of the Fund by which a member i s assured that i t w i l l be able to make purchases from the Fund i n accordance with the terms of the decisions of the Fund during a s p e c i f i e d period and up to a s p e c i f i e d amount. •L Apart from providing f i n a n c i a l resources i n times of economic d i f f i c u l t i e s to members of the Fund, the Stand-By Arrangement also provides support programs intended to s t a b i l i z e the economies of members. Thus both o f f i c i a l c r e d i t o r s and commercial banks make loans avai l a b l e and grant r e l i e f to members on the condition that the members enter into a Stand-By Arrangement with the Fund. By t h i s , the c r e d i t o r s are assured that the member would carry out programs designed to enable i t to repay i t s debt at the due 3 p . date. * The Stand-By Arrangement i s a short term measure (spread over one year) . The inadequacy of t h i s measure led to the introduction of the Extended Stand-By Arrangement (spread over three to f i v e years). B u i l t into the Stand-By Arrangement, i s a set of c o n d i t i o n a l i t i e s and performance c r i t e r i a which a member has to meet. This i s the central focus of the IMF Structural Adjustment Program. Some of the c o n d i t i o n a l i t i e s are removal of subsidies on commodities, freezing of wages, trade l i b e r a l i z a t i o n , devaluation of l o c a l currencies and J ± Gold, J . , pp. 3-5; Edwards, R.W. J r . pp.573-97 3 2 Gold, J . , pp. 34-36. 26 cut m government expenditures, etc. These are intended to correct balance of payment d e f i c i t s of a country with a view to enabling i t to meet i t s international f i n a n c i a l obligations. The performance c r i t e r i a are the economic objective or targets set to be achieved through compliance with the c o n d i t i o n a l i t i e s . The attainment of the performance c r i t e r i a indicates that the adjustment program i s succeeding, while non attainment of them automatically r d i s e n t i t l e s the country concerned to draw further resources from the Fund and i s 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 i s an extended arrangement does not give the adjustment program enough time to achieve a meaningful r e s u l t . 3 5 The IMF Annual Report, 1965 stated at page 29: 3 3 Carvounis, C. The Foreign Debt/National Development C o n f l i c t . New York: Quorum Books (1986) pp.1-8 3 4 Gold, J . , pp. 44-49. 3 5 Gold, J . pp. 3-5. 2 7 The Fund has never agreed to refinance debt d i r e c t l y as such transactions would be outside i t s normal sphere of operations; i t s resources are av a i l a b l e for the provision of r e l a t i v e l y short term assistance to meet balance of payament d e f i c i t s . In most situations where debt renegotiation i s appropriate, there i s need for much longer term financing than could be provided under the terms of the Fund's p o l i c y l i m i t i n g the use of i t s resources to 3-5 years. Moreover, the debts are frequently large i n r e l a t i o n to the members quota and t h e i r refinancing by the Fund would serio u s l y l i m i t the Fund's a b i l i t y to meet genuinely short term balance of payments d i f f i c u l t i e s . In many instances where debt renegotiation i s only one aspect of a general s t a b i l i z a t i o n program, f i n a n c i a l assistance from the fund to meet other aspect of the balance of payments adjustment problem i s also a prerequisite f o r the program's success. This statement, while asserting emphatically that the Fund i s primarily concerned with short term assistance to correct balance of payment d e f i c i t s of member countries, admits that there could, i n some instances be a need for long term financing (measures). I t i s s e t t l e d that the debt problem i s a s t r u c t u r a l problem and needs long term, not short term management measures. I f therefore, the Fund i s only apt or interested i n 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 o u t r i g h t l y dismiss the e f f o r t s of the Fund i n debt management, there i s absolutely a need for improvement. A l l the par t i e s concerned should gear e f f o r t s towards a long term plan and progressive implementation. The c r e d i t o r s ' anxiety and hurry to get t h e i r money back, have always tuned them to a short term measure. 28 The Fund's program also e n t a i l s Compensatory Finance F a c i l i t y (CFF) and Buffer Stock Financing. Under the former, the Fund o f f e r s special f a c i l i t i e s to those members, p a r t i c u l a r l y the producers of primary commodities, who s u f f e r s h o r t f a l l s i n t h e i r export receipts provided those s h o r t f a l l s are of a short term nature and are l a r g e l y a t t r i b u t a b l e to circumstances beyond t h e i r control. Unfortunately, the effectiveness of the CFF has been reduced by the increased c o n d i t i o n a l i t y attached to i t s use as well as by the reduction of the l i m i t of access to the F a c i l i t y from 100% to 83% of an applicant's quota i n the Fund. Under the l a t t e r , the Fund helps members to avoid s h o r t f a l l s that would r e s u l t from fluctuations i n prices of exports by helping them meet t h e i r f i n a n c i a l commitments to the Buffer Stock scheme established under international commodity agreements. 3 6 Interestingly, since 1980, the Fund has somewhat s h i f t e d from i t s t r a d i t i o n a l short term loans to medium term f a c i l i t i e s i n dealing with balance of payment d e f i c i t s . In addition to i t s Stand-By and Extended Stand-By Arrangements, Compensatory Finance F a c i l i t y and Buffer Stock F a c i l i t y , the Fund has introduced Structural Adjustment F a c i l i t i e s (SAF), 3 6 Gold, J . p. 16; UNCTAD TD/328/ Add.5, 19th Feb.1987, p. 30 Enhanced Structural Adjustment F a c i l i t i e s (ESAF) and External Contingency Mechanisms programs. 3 7 The SAF was established i n March 1986 to provide concessional balance of payments assistance to low income countries facing protracted balance of payments problems and w i l l i n g to undertake a comprehensive adjustment e f f o r t s to strengthen t h e i r balance of payments p o s i t i o n . The SAF i s b a s i c a l l y on a concessional term, not subject to the usual c o n d i t i o n a l i t i e s and with 0.5% i n t e r e s t rates per annum with repayment periods stretching 51 to 10 y e a r s . 3 8 In order to increase the resources available under the SAF, i n A p r i l 1988, the Fund introduced the ESAF with the same in t e r e s t rate as the SAF. Though the amount of resources avai l a b l e to each e l i g i b l e r e c i p i e n t depends on i t s adjustment e f f o r t s and the s i z e of i t s balance of payment d e f i c i t s , the usual maximum under the ESAF i s 250% of a country's quota and up to 350% i n exceptional cases to be made ava i l a b l e over a three year period and up to 63.5% of t h e i r quota under the SAF. 3 9 The problem, however, i s that these f a c i l i t i e s are not open to a l l the debtor LDCs but only to the low income 3 7 The IMF Annual Report for 1988 of the Executive Board for the F i n a n c i a l Year Ended A p r i l 30, 1988. Washington D.C. pp. 44-58 J O Id - s t a t i s t i c s shows that 62 countries at present are e l i g i b l e for the SAF. Of t h i s , 25 SAF arrangements have been i n operation since A p r i l 30, 1988; Tomann, H. The Debt C r i s i s and Structural Adjustment i n Developing Countries. 23 Inter Econ.Rev. of I n t ' l Trade and Dev. No.5, (Sept/ Oct. 1988),pp. 203-307. 3 9 The IMF Annual Report 1988, pp. 44-58. LDCs. The c r i t e r i o n for determining a low income country (i e . where to draw the line) might not be e a s i l y d i s c e r n i b l e because of the r e l a t i v e v o l a t i l i t y of income of these countries. A major feature and of course condition of both the SAF and the ESAF i s the requirement of a p o l i c y framework paper to be prepared by the national authorities of the countries concerned i n conjunction with the s t a f f of the Fund and the World Bank. I t i s claimed that the purpose of t h i s i s to ensure that the p o l i c y reforms of e l i g i b l e countries are properly targeted to remove the obstacles of growth and balance of payment v i a b i l i t y . I t also ensures that the p o l i c y reforms are mutually r e i n f o r c i n g , f e a s i b l e 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 s o c i a l implications of p o l i c y changes, together with steps being taken to mitigate the possible adverse impact of adjustment measures on the people of the LDCs. 4 0 The External Contingency Mechanism works hand i n hand with the CFF. I t i s 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 t h e i r p o l i c y reform e f f o r t s . 4 0 Id. I t also e n t a i l s p a r t i a l compensation f o r the e f f e c t of external disturbances beyond the control of the debtor governments. 4 1 There are however,some constraints on the e f f o r t s of the Fund to manage the debt problem e f f i c i e n t l y . The IMF Annual Report f o r 1988 i d e n t i f i e s some problems with debt management to include want of economic p o l i c y reforms i n the debtor countries, adverse international economic environment with i n t e n s i f i e d p r o t e c t i o n i s t measures, high r e a l i n t e r e s t rates, r e l a t i v e l y modest growth i n world trade and i n p a r t i c u l a r , a f a l l i n terms of trade for LDCs1 exports which for example, was up to 20% from 1982 through 1987. I t i s understandable that these exogenous factors erode much of the r e a l adjustment that indebted LDCs have achieved. In the face of t h i s , i t was not unexpected when i n 1987, countries l i k e B r a z i l , Ecuador and Cote d ' l v o i r e suspended in t e r e s t payments on debts owed to commercial banks. 4 2 In response to t h i s s i t u a t i o n , i n i t s A p r i l , 1988 meeting, the IMF Interim Committee reaffirmed the case by case debt strategy emphasizing sustained implementation of growth oriented adjustment and s t r u c t u r a l reform p o l i c i e s by debtor countries, maintenance of reasonably favourable i n t e r n a t i o n a l economic environment and adequate flow of finances to debtor countries from o f f i c i a l and private Id; Tomann, H. pp.203-307 The IMF Annual Report 1988. c r e d i t o r s . J But the question of how the balance of payments support should be shared between the IMF and the commercial banks seems unresolved. This i s important because even where debtor countries have done everything required of them under the IMF program, they have i n most cases been unable to es t a b l i s h t h e i r creditworthiness with the banks. 4 4 This of course i s part of the reason why the IMF during the 1982 debt c r i s i s i n s i s t e d that banks already exposed to Mexico must lend new c r e d i t up to 7% of t h e i r aggregade outstanding loans to Mexico to the tune of $5 b i l l i o n (involuntary lending) , i n 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 t h e i r f a i l u r e to recover t h e i r outstanding loans to Mexico. 4 5 IMPACT OF THE IMF ADJUSTMENT PROGRAM Some success s t o r i e s of the IMF program have been recorded. Some studies show that although the current account d e f i c i t of a l l Non O i l Developing Countries tended to expand between 1970 and 1980, most Fund assisted countries managed to close the gaps reasonably. A 1985 report stated that i n A f r i c a , between 1981 and 1983, 21 4 3 Id. 4 4 UNCTAD TD/328/Add.2, Feb. 19th, 1987,p.50 4 5 Robichek, E.W. The IMF: An Ar b i t e r 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 p a r t i c i p a t e d i n the Fund's program, and economic growth target was achieved i n o n e - f i f t h of them. 4 6 I t i s also maintained that most of the Fund assisted countries that have been less successful are those that had long postponed adjustment e f f o r t s . And as s t a b i l i z a t i o n i s delayed, the e f f e c t becomes more adverse and adjustment becomes correspondingly c o s t l i e r and more p a i n f u l . 4 7 But according to the UNCTAD, the performance of th i r t e e n selected LDCs which have had consecutive adjustment programs through out the 1980s does not d i f f e r s i g n i f i c a n t l y from the rest of the LDCs who have not undertaken s i m i l a r programs. Table I of Appendix A sets out the countries involved and t h e i r performances. I t i s note worthy that out of the thi r t e e n countries, only Bangladesh, Somalia and Uganda secured a higher average annual rate of Gross Domestic Product (GDP) growth i n 1980- 84 than i n the preceding decade, while the remaining countries experienced a decline i n the average annual growth rate more remarkable • 4.8 than i n the group of LDCs as a whole. ° As regard current account d e f i c i t , t h i s was only minimal i n respect of s i x 4 6 Amuzegar, J . The IMF Under F i r e pp. 334-45 - "The P o l i t i c a l Economy of North-South Relations" see chapter 1, note 1. 4 7 Id. UNCTAD TD/328/Add.5, Feb.18th, 1987, pp. 15-17. 34 countries ( Bangladesh, Central A f r i c a Republic, the Gambia, . A. Q Malawi, Samoa and the Sudan) out of the t h i r t e e n . I t i s argued that the lack of c o r r e l a t i o n between the existence of an adjustment program on the one hand and economic performance i n terms of growth rates and current account improvement on the other hand, makes ske p t i c a l the appropriateness of the adjustment programs for the sit u a t i o n s of the LDCs. 5 0 Though exogenous factors d i s t o r t the progress of the programs, the programs themselves have some b u i l t - i n character which defeats good debt management. For example, adjustment programs are employed to correct balance of payment d e f i c i t s which a r i s e to a large extent from i n s u f f i c i e n t export earnings. But the measures adopted to combat i n f l a t i o n embodied i n the programs impede the a b i l i t y of domestic markets to generate l o c a l production which would have been generated by world market but for the r e c e s s i o n . 5 1 The IMF has been c r i t i c i z e d f or not seriously addressing the external causes of the debt problem which negate the economic plan of these countries. The Fund i s also accused of not addressing the debt problem as a development problem, but only as a balance of payment 4 9 Id. 5 0 Id. 5 1 Id. 5 2 Id. 35 d e f i c i t requiring new finances which i n turn create addi t i o n a l d e f i c i t s . 5 3 Moreover, although, the 1979 review of the Fund program and the new guidelines introduced were intended to harmonize adjustment c o n d i t i o n a l i t i e s with economic, s o c i a l and p o l i t i c a l p r i o r i t i e s of adjusting countries, no p r a c t i c a l steps have been taken i n t h i s r e g a r d . 5 4 I t i s submitted that the Fund should exercise r e s t r a i n t i n imposing adjustment measures. I t should be s e n s i t i v e to and take into consideration whether or not the p o l i t i c a l system of the country concerned i s amenable to any one adjustment measure. As S i l v e r Herzog, a one time Mexican finance minister stated, "austerity and democracy can not coexist for very l o n g " . 5 5 The Fund's p o l i c i e s might t h r i v e better i n adjusting countries i n terms of being p o l i t i c a l l y t o l e r a b l e i f a l l the c o n d i t i o n a l i t i e s are not undertaken at the same time i n a hurry, but on phases, one a f t e r 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 s i g n i f i c a n t differences i n adjustment capacities between an u n d i v e r s i f i e d LDC economy on the one hand and an advanced 5 3 Carvounis, C. pp. 1-8 5 4 Didzun, K. pp.163-171 5 5 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 i n a large scale as the IMF seems to suggest through i t s emphasis on export-led growth. 5 7 This explains the f a i l u r e of most of the adjustment programs. Moreover, even where export-led growth i s sparingly achieved, protectionism and d e t e r i o r a t i n g terms of trade etc m i l i t a t e against good export earnings. As a s t a f f member of the Fund reports on the operation of the Fund's program from 1978-1980, "the Fund can not be complacent about a s i t u a t i o n i n which almost h a l f the cases have not shown any progress towards balance of payments v i a b i l i t y . " 5 8 However, the Fund's adjustment programs are not without some merits. At l e a s t they have forced countries to adopt r e a l i s t i c p o l i c i e s , and have forced banks to maintain lending d i s c i p l i n e by determining a country's l e v e l of sustainable debt and a rescheduling payment terms based on that determination. At the same time, i t i s equally desirable to work out a sustainable debt s e r v i c i n g amount 5 6 Id. 5 7 Id. 5 8 Id pp.15-16 59 Eskridge, W.Jr., p.57, see chapter 1, note 3 and capacity of each debtor country based on i t s economic buoyancy. THE ROLE OF THE WORLD BANK IN DEBT MANAGEMENT The World Bank i s one of the Bretton Woods i n s t i t u t i o n s aimed at reordering the world economic system following the devastation of World War I I . B a s i c a l l y the Bank was conceived as a development i n s t i t u t i o n 6 0 which supposedly has nothing to do with debt management. The Bank i n i t i a l l y focused attention on the supply of finances and other services for the reconstruction and r e h a b i l i t a t i o n of war ravaged Europe. At the completion of t h i s task, i t became saddled with project lending to member countries i n the areas of agricult u r e p a r t i c u l a r l y , cash exportable crops , railways, power, water supply, investment and other s o c i a l s e r v i c e s . 6 1 The IBRD as the Bank was formerly known, provides i n i t s A r t i c l e of Agreement that every loan granted by the Bank must f a c i l i t a t e foreign investment i n the countries concerned. 6 2 Beside project lending, the bank makes project loans i n cases of extreme emergency, f o r example, reconstruction and r e h a b i l i t a t i o n of the economy of a member country a f t e r a o u UNCTAD TD/B/1029/Rev.1 (1986) pp.53-59 6 1 Id. 6 2 Swedberg, R., The Doctrine of Economic Ne u t r a l i t y of the IMF and the World Bank pp. 319-331 - "The P o l i t i c a l Economy of North-South Relations", see chapter 1, note 1 38 war or a severe natural disaster, a sudden f a l l i n export earnings where the economy i s c r i t i c a l l y dependent on a single export item, a sharp det e r i o r a t i o n of the terms of trade as a r e s u l t of a rapid r i s e i n import prices and cases involving s t r u c t u r a l constraints or capacity u n d e r u t i l i z a t i o n . 6 3 Between 1976 and 1979, for example, f i v e program loans to Pakistan, Zambia, Jamaica, Guyana and Peru were made to a s s i s t them i n adjusting to a decline i n the export of primary commodities. 6 4 The early 1980s saw the Bank i n the mainstream of debt management. The t r a d i t i o n a l d i v i s i o n of tasks between the IMF and the Bank whereby the IMF was responsible f o r short term balance of payment assistance and the Bank for project financing was no longer f o l l o w e d . 6 5 The Bank, along i t s project lending and program loans now undertakes Structural Adjustment Loans (SALs), a f a i r l y long term balance of payment assistance for countries with high s t r u c t u r a l current account d e f i c i t s . They are granted on the condition that the debtor implements a comprehensive s t r u c t u r a l adjustment program drawn up by the Bank i n consultation with the IMF. 6 6 Thus the d i f f i c u l t y involved i n f u l f i l l i n g the conditions of the IMF adjustment program p a r t i c u l a r l y , 6 3 UNCTAD, note 60 6 4 Id. 6 5 Tomann, H. pp.203-207 6 6 Id. p o l i t i c a l 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 s p e c i f i c p o l i c y changes and i n s t i t u t i o n a l reforms to achieve an e f f i c i e n t use of resources and thereby to contribute to a sustainable balance of payments i n the medium and long term, while maintaining growth; b) To a s s i s t a country i n meeting the t r a n s i t i o n a l cost of needed s t r u c t u r a l changes i n industry, energy and a g r i c u l t u r e by augmenting the supply of f r e e l y usable foreign exchange and c) To act as a c a t a l y s t for the inflow of other external c a p i t a l to help ease the balance of payment s i t u a t i o n . 6 8 The Bank's SALs cover programs over a period of f i v e to seven years subject to reviews of each phase to f a c i l i t a t e implementation. In February, 1983, the Bank approved a Special Action Program (SAP) comprising f i n a n c i a l measures and p o l i c y advice to help countries which are making serious e f f o r t s to implement d i f f i c u l t adjustment measures needed to restore growth. 6 9 The p r i n c i p a l elements of the program are expanded lending for high p r i o r i t y operations, supporting s t r u c t u r a l adjustment, p o l i c y changes, production f o r export, f u l l e r use of e x i s t i n g capacity and the maintenance of c r u c i a l 6 7 Carvounis, C , p. 123 6 8 UNCTAD note 60 - As at 1986, the Bank had approved 28 SALs, 6 9 Id. developmental in f r a s t r u c t u r e s . Other elements include accelerated disbursements under e x i s t i n g and new commitments to support early completion of high p r i o r i t y projects, expanded advisory work on the design and implementation of appropriate p o l i c i e s including the reordering of investment p r i o r i t i e s and strategies for debt management, and urging other lenders to make s i m i l a r e f f o r t s . 7 0 In early 1988, i n a meeting held i n Paris between the president of the Bank and the managing d i r e c t o r of the IMF on the one hand and the representatives of the i n d u s t r i a l i z e d countries on the other hand, a three year (1988-90) program, known as the Special Program of Assistance (SPA), was approved. 7 1 The program i s a form of debt r e l i e f and growth-oriented import financing for low income SubSaharan A f r i c a , p a r t i c u l a r l y those countries implementing comprehensive and vigorous p o l i c y reforms. The program also established a framework for assistance to countries on a case by case basis through concessional debt r e l i e f , a dditional concessional flows from International Development Association (IDA), increased cofinancing of adjustment operations and increased resources f o r the IMF ESAF. 7 2 Id - since i t s 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 7 2 Id. The continuous deterioration of the international economic environment p a r t i c u l a r l y during 1987, caused the Bank to introduce yet another program of assistance to LDC debtors known as the Sectoral Adjustment Lendings. In i t s view, t h i s program r e f l e c t s a broad and deep adjustment i n investment and p o l i c y reform programs. 7 3 I t i s important to keep i n mind that most of the Bank's program are for the low income countries. They are not for the middle income LDC debtors. However, f o r these countries, the Bank has i d e n t i f i e d unfavorable economic climate, slow growth i n the i n d u s t r i a l i z e d countries, r i s i n g protectionism, increasing adverse terms of trade for t h e i r exports, uncertainty i n the currency market and v o l a t i l i t y i n i n t e r e s t rate movements as p r i n c i p a l causes of the generally slow growth. 7 4 In response to t h i s , the Bank, as a way of supporting economic growth i n these countries, since 1985, has provided c a t a l y s t i c support to commercial bank lending and rescheduling agreements for Argentina, B r a z i l , Mexico, Nigeria, Chile, Philippines and Cote d ' l v o i r e e t c . . 7 5 I t has also expanded i t s r o l e i n the organization of financing packages f o r indebted countries and i n 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 i n p a r t i c i p a t i n g i n such packages. For instance, i n 1986 through 1987, the Bank pa r t i c i p a t e d i n financing packages for Mexico by providing guarantees of up to $500 m i l l i o n on a $1 b i l l i o n transport sector loan and a further $250 m i l l i o n on a $500 m i l l i o n • 7 ft growth contingency loan. The Bank also uses cofinancing as a technique to increase the confidence of other lenders i n loan packages, and t h i s has been quite successful i n a t t r a c t i n g o f f i c i a l funds. Though a general success i n improving the terms of commercial borrowings i n maturity, grace periods and i n t e r e s t spreads etc has been recorded, cofinancing with commercial banks has not evolved on a large scale. The reason i s that on repayment, the World Bank receives preferred c r e d i t o r status over the commercial banks. 7 7 More important, the Bank believes that surplus balance of payment necessary for regular debt servi c i n g , can not be attained simultaneously with esta b l i s h i n g conditions for the growth needed to secure debt s e r v i c i n g capacity i n the longer term. According to the Bank, so long as debt s e r v i c i n g continues to absorb a large share of the debtor countries* resources, involuntary new loans by commercial banks w i l l not provide enough c a p i t a l needed for development i n these countries. In i t s view, the solu t i o n to the debt / t J UNTAD TD/328/Add.2, Feb. 19th, 1987, p. 43 7 7 Id. problem l i e s on resumed growth which can only be achieved through concerted e f f o r t s of a l l concerned e n t a i l i n g i n the main, new c r e d i t flows from the cr e d i t o r s and improved economic p o l i c i e s on the part of the d e b t o r s . 7 8 A number of issues have been raised concerning the p o l i c y c o n d i t i o n a l i t i e s associated with the Bank's supported adjustment programs. The issues involve the adequacy of the p o l i c y package, the timing and sequencing of the programs • 7 9 and the collaboration between the Bank and the IMF. I t i s observed that the requirement of rapid major s t r u c t u r a l reforms might be beyond the coping capacity of most debtor countries. Moreover, t h e i r p o l i t i c a l and administrative systems might not be adequate to deal with the speed at which the formulation and implementation of p o l i c y changes i s planned. 8 0 The Bank i t s e l f has found that "there are no general solutions, the design of adjustment has to be c a r e f u l l y t a i l o r e d to meet s p e c i f i c needs and p o l i c y objectives of i n d i v i d u a l borrowers." 8 1 There i s therefore, a growing i n t e r e s t on the part of the Bank to improve i t s own understanding of the complex i n t e r r e l a t i o n s h i p s among p o l i c y measures and t h e i r impact on 7 8 Excerpts from the World Bank on Debt Service and Growth. World Bank Debt Tables 1985-86- reproduced i n The P o l i t i c a l Economy of the North-South Relation Edited by Miljan Toivo. see chapter 1, note 1 7 9 UNCTAD, note 76 8 0 Id. 8 1 Id. economic performance, to improve i t s assessment of the capacity of governments to implement reform measures, and of the time required for such implementation. F i n a l l y , to improve i t s attention to the s o c i a l 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 f u l f i l l m e n t of the conditions of the other, otherwise known as cross c o n d i t i o n a l i t y . The IMF Annual Report for 1987 stated: "In a l l questions i n connection with Structural Adjustment Loans, complete agreement between both i n s t i t u t i o n s must be reached on a l l important p o i n t s . " 8 3 For example, i n the f i s c a l year 1979 through 1985, only three of a l l the Bank's loans were approved f o r countries where the IMF's s t a b i l i z a t i o n program was not i n o p e r a t i o n . 8 4 Also i n the early 1980s, the Bank withheld a $300 m i l l i o n economic recovery loan to the Philippines for not complying with c e r t a i n IMF c o n d i t i o n a l i t i e s . I t i s submitted that the cross c o n d i t i o n a l i t y measure might lead to a delay i n implementing a program i n the event of a 8 2 Id. 8 3 Didszun, K., The Debt C r i s i s and the IMF Poli c y . 23 Inter Econ. Rev. of I n t ' l Trade and Dev. No.4, (July/Aug. 1988), pp. 163-171 4 Id p.43 disagreement between the two i n s t i t u t i o n s i n respect of a program. 8 5 According to c r i t i c s , the f i v e to seven year period of the SALs i s not long enough for the implementation of the program i n view of the fact that some l e g a l , economic and p o l i t i c a l questions need to be resolved. For example, p r i v a t i z a t i o n of state enterprise as recommended by the Bank can hardly be resolved among the a u t h o r i t i e s of the countries concerned within a short t i m e . 8 6 Moreover, there i s the tendency of the reforming zeal waning as soon as the SALs period i s over. More important, i t i s not unnoticed that some of the SALs Programs c o n f l i c t . For example, though the l i b e r a l i z a t i o n of the f i n a n c i a l market increases savings, the high i n t e r e s t rate which r e s u l t s from i t discourages foreign investment. Again the conditions attached to the SALs appear to be a standard regardless of the p e c u l i a r i t y of economic, s o c i a l and p o l i t i c a l problems facing d i f f e r e n t debtor n a t i o n s . 8 7 8 5 Shams, R. , The World Bank Structural Adjustment Loans: A Cr i t i q u e . 23 Inter Econ. Rev. of I n t ' l Trade and Dev. No.5, (Sept./Oct. 1988), pp.208-211 8 6 Id. 8 7 Id. 46 Nevertheless, the SALs, the Sectoral Adjustment Lending and the Special F a c i l i t y f o r SubSaharan Af r i c a n countries are a l l p o s i t i v e 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 f i n a n c i a l pressure, revamp t h e i r economies as well as exercise f i n a n c i a l d i s c i p l i n e . THE ROLE OF THE LONDON CLUB IN DEBT MANAGEMENT As stated i n chapter one, the p r o f i t motives of the commercial banks lured them into making big loans to the LDCs. I t was said that by 1982, the nine largest American banks had made loans exceeding t h e i r c a p i t a l to Argentina, B r a z i l and Mexico. 8 8 I t 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 i n t e r n a t i o n a l f i n a n c i a l system. 8 9 When therefore, i t was no longer p r o f i t a b l e for the banks to continue to give b ig loans, they reduced t h e i r lending exposures to the LDC debtors e s p e c i a l l y the heavily indebted ones. The idea was to minimize the e f f e c t of any possible default on the part of these countries. The decline i n bank lending appeared to have aggravated the s i t u a t i o n so much so that i n 1982, Mexico declared moratoria on both i t s a a Cline, W., pp.36-40 ,see chapter 1, note 3 8 9 Id. amortization and int e r e s t payments. B r a z i l and Argentina followed s u i t . Thus the international f i n a n c i a l system became vulnerable and was probably at the verge of collapse. At t h i s point, the inte r e s t s of a l l concerned were r e a d i l y awakened. The US and i t s western a l l i e s quickly arranged a rescue package to salvage the s i t u a t i o n . The BIS was c a l l e d i n 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 c r e d i t s . 9 1 The US made a commodity c r e d i t of $1 b i l l i o n i n favour of Mexico and another $1 b i l l i o n advance payment for the purchase of Mexican o i l . The Fund i t s e l f had to disburse $3.9 b i l l i o n 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 s i x years. The in t e r e s t rates were reduced and the domestic prime rate options f o r c r e d i t o r banks by which they choose usually high i n t e r e s t rates was eliminated. More important, Mexico was to service i t s debt i n proportion to i t s export e a r n i n g s . 9 2 I t seems the rescue package was more concerned with averting a collapse of the international f i n a n c i a l system by keeping i n t e r e s t payments on loans current rather than y u Id pp.77-79 9 1 Id pp.40-44 9 2 Tapia, pp. 1-19 48 ensuring sustained growth for the debtor c o u n t r i e s . 9 3 In other words, the fact that the rescue package would probably not have been organized i f Mexico had not declared a moratorium shows that debt strategies are only applied i n time of c r i s i s instead of at the e a r l i e s t time they are needed to prevent i t . The c r i s i s has considerably reduced the creditworthiness of the debtor c o u n t r i e s . 9 4 And i n the face of depreciating creditworthiness, export c r e d i t agencies withdraw t h e i r export c r e d i t insurance cover for goods being exported to the LDCs which are v i t a l f or t h e i r economic development. 9 5 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 C l u b . 9 6 Under t h i s forum, banks p a r t i c i p a t e through t h e i r steering committees. The London Club i s a sort of bankers* c a r t e l . This s o l i d a r i t y on the part of the banks gives them a better bargaining power i n Schirano, L.G., see chapter 1, note 7. UNCTAD TD/B/C.3/212, 11th July, 1986, pp.3-12 R i e f f e l , A., The Role of the Paris Club i n Managing Debt Problems. Essays i n International Finance No. 161, Dec.,1985 p.3 negotiating debt agreements with i n d i v i d u a l debtor c o u n t r i e s . 9 7 T r a d i t i o n a l l y , banks o f f e r rescheduling on a short term basis (year by year). They charge high i n t e r e s t 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. 9 9 Banks require that debtor countries seeking for rescheduling or/and refinancing of t h e i r debts should undertake the IMF adjustment programs. They demand that debtor countries negotiate for r e l i e f on a comparable terms with t h e i r o f f i c i a l c r e d i t o r s . 1 0 0 This p o l i c y brings delay i n granting of r e l i e f and makes room for the accumulation of debt arrears. They also i n s i s t i n some cases that a country guarantee i t s private sector's debt before i t can obtain r e l i e f i n respect of i t s public debts. When i n the early 1980s, Chile needed r e l i e f i n respect of i t s public debts, i t was compelled to r e t r o a c t i v e l y guarantee i t s private sector debts. This resulted i n a 30% expansion of 9 7 Jones, S. and Nichol L. see chapter 1, note 13 ; Jones, S.G. and Sunkel, 0. Debt and Development C r i s i s In L a t i n America: The End Of An I l l u s i o n . Clarendon Press. Oxford 1986,pp. 112-114. 9 8 Id. 9 9 Id. 100 T a p i a ^ E.C.,pp.l-19 50 Chile's debt. Guaranteeing private sector's debt, the contract of which a country can hardly monitor i s a very u n f a i r p r a c t i c e and i t has an adverse e f f e c t on a country's a b i l i t y to absorb the debt shock. The banks also demand that a l l i n t e r e s t arrears on loans be li q u i d a t e d before r e l i e f i s g r a n t e d . 1 0 2 The question i s , i f a country can pay i t s i n t e r e s t arrears, why should i t i n the f i r s t place seek r e l i e f . The t r a d i t i o n a l approach of commercial banks to the debt problem i s summed up i n an UNCTAD document thus: I n i t i a l l y involuntary lending c a r r i e d terms unfavourable to borrowers, for example, the rescheduling of loans was associated with substantial fees and increases i n the margin charged by banks over t h e i r own borrowing rates. Moreover, reschedulings under involuntary lending were also characterized by a short leash approach which enta i l e d short consolidation periods and small amount of new money. The reasons for t h i s short leash approach included the cre d i t o r s objective of buying time i n the hope that improvements i n the economic s i t u a t i o n would render more r a d i c a l schemes of debt rescheduling unnecessary, the desire to force on debtors, rapid adjustment on t h e i r external accounts and reluctance to permit possible increases i n debtors• bargaining power consequent on the resto r a t i o n of t h e i r l e v e l of exchange reserves. More recently however, there have been modifications of the regime of involuntary lending i n d i r e c t i o n s more favourable to borrowers. As an UNCTAD report puts i t : 1 0 1 Carvounis, C., pp.49,169 1 0 2 Id pp. 126-127 1 0 3 UNCTAD TD/B/C.3/212 pp.3-12 51 Commercial banks practices have also evolved i n ways that have reduced cost of rescheduling for the debtor country by lowering commissions, fr o n t - end fees, and, i n some cases, by lower spreads, d i v e r s i f y i n g the currency denomination of debt and s h i f t i n g to a lower reference i n t e r e s t rate. Recently repayment and grace periods have been lengthened too and, i n one case, the amount of new financing i s linked to the p r i c e of the debtor's major export commodity and the growth of i t s domestic economy. These developments suggest an increased willingness on the part of the c r e d i t o r s to commit themselves i n advance to further support i n the event of unforeseen and unfavourable changes i n the debtor's circumstances. 1 0 As an incentive for the adoption of v i a b l e economic p o l i c i e s , commercial banks o f f e r Multi-Year Rescheduling Agreements (MYRA) as opposed to a year by year rescheduling, to debtor countries considered to have made progress i n t h e i r 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 i t s c r e d i t o r s . In p a r t i c u l a r , by covering maturities f a l l i n g due over several years and o f f e r i n g longer repayment periods, the banks have succeeded i n providing an improved planning horizon f o r c r e d i t o r s , investors and debtor governments. The MYRA has at the same time, involved the development of s p e c i a l monitoring procedures as banks wish to be assured of the debtor countries' strong commitment to p o l i c y 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 i s not financing an adjustment program with i t s own resources, i t w i l l nevertheless supervise the program. Regrettably however, the London Club generally does not reschedule i n t e r e s t because such rescheduling has a negative income tax e f f e c t . Also new loans by banks are s t i l l l o w . 1 0 6 I t i s i n t e r e s t i n g to note that the rescheduling process at the London Club i s very complex and time consuming. Though the number of creditors are many and t h e i r i n t e r e s t s and nature of relationships with debtor countries are much more diverse, they nevertheless are required to reach a unanimous consensus on any r e l i e f to be g r a n t e d . 1 0 7 The Club proceeds on an ad hoc basis without any c l e a r l y defined p r i n c i p l e s to guide i t s deliberations. In some cases, there i s an i n i t i a l major problem of determining the precise dimension and character of a d e b t . 1 0 8 The early p r a c t i c e i n the Club's rescheduling process required a l l p a r t i c i p a n t s to sign a single document with each debtor country. But recently, once an agreement i s reached i n p r i n c i p l e , each 1 0 5 Id. 1 0 6 Hudes, K. pp.553-71; Rea, G.F., Restructuring Sovereign Debt: W i l l There Be A New International Law and In s t i t u t i o n ? Am. Soc'y I n t ' l Law Proc.(1983/84), pp.312-35 1 0 7 Hudes, K. pp.553-71 ; Rea G.F., pp.312-35 1 0 8 Rea, G.F., pp. 312-35 bank enters into a separate agreement with the debtor 1 09 country concerned, which i n e f f e c t i s a longer process. There i s also a problem associated with syndicated loans. In t h i s instance, banks i n s i s t on equal treatment by debtor countries to a l l p a r t i c i p a t i n g banks. In other words, no bank should be treated less favourably than the others. The problem l i e s i n determining what amounts to equal treatment and how to implement i t . Are banks to be paid amounts proportionate to t h e i r i n d i v i d u a l exposure to a sovereign debtor or are they to be paid the same amount generally i r r e s p e c t i v e of the degree of t h e i r i n d i v i d u a l Tin exposure? X- L U This development seriou s l y a f f e c t s debt management and the a b i l i t y of the debtors to cope with i t by reason of the fact that debtors are indi s c r i m i n a t e l y c a l l e d i n d e f a u l t . 1 1 1 For example, i f a bank refuses to p a r t i c i p a t e i n debt rescheduling and i t s loan i s repaid at the o r i g i n a l maturity, the debtor country concerned i s c a l l e d i n default by the other banks for t r e a t i n g such a bank more favourably. On the other hand, where the debtor country refuses to pay such a bank at the o r i g i n a l maturity, the debtor i s s t i l l i n default for f a i l i n g to service i t s debt at the due date. Unless t h i s i s resolved by banks, i t i s a clog to e f f i c i e n t debt management. 1 0 9 Hudes, K. pp.553-71 1 1 0 Walker, M.A., International Debt Rescheduling Am. Soc'y I n t ' l Law Proc. ( A p r i l , 1983/84) pp. 308-310 1 1 1 Id. 54 THE ROLE OF THE PARIS CLUB IN DEBT MANAGEMENT. When over fo r t y years ago, c r e d i t o r governments gathered i n Paris to negotiate debt r e l i e f f o r some debtor countries, l i t t l e d id they know that that gathering was to c r y s t a l l i z e into a routine. Thus the Paris Club (a sort of c a r t e l of c r e d i t o r governments) i s an informal gathering of cr e d i t o r governments, p a r t i c u l a r l y the members of the Organization of Economic Cooperation and Development (OECD), charged with considering and granting of request from debtor countries for debt r e l i e f i n respect of o f f i c i a l d e b t s . 1 1 2 T r a d i t i o n a l l y , the Club approaches the debt problem on a short term basis (year by year rescheduling). A report says that such reschedulings have r e l a t i v e l y l i t t l e e f f e c t i n ameliorating the debt problem i n the long run. According to the report, debt obligations are increased and experience has shown that one rescheduling leads to repeated reschedulings. The r e l i e f associated with the Club's reschedulings i s of li m i t e d scope because the reschedulings do not cover m u l t i l a t e r a l c r e ditors to which the poorer LDCs have a high and increasing l e v e l of obligations nor do they include some of the OPEC members and s o c i a l i s t countries of Eastern Europe which are some of the b i l a t e r a l TIT c r e d i t o r s of some of the LDCs. ± x z Abbott, G.C., pp. 1-16. see chapter 1, note 6. 1 1 3 UNCTAD TD/328/Add.5, 18th Feb.,1987 55 Regrettably, not a l l debts are e l i g i b l e for rescheduling under the Paris Club. For example, debts which are to mature before or i n twelve months time (contract cut o f f date) are not r e s c h e d u l e d . 1 1 4 The non rescheduling of short term debts i s a bad debt management strategy since i t means that a debtor may i n most cases, not be able to plan, u t i l i z e the loan and generate foreign exchange to repay the debt. I t i s indeed a great impasse on the e f f o r t s of debtors to cope with the debt s i t u a t i o n . As one writer puts i t : "The Paris Club mechanism has not been e f f e c t i v e i n easing A f r i c a ' s debt d i f f i c u l t i e s . The procedures adopted by the Club place s t r i c t l i m i t on the d e f i n i t i o n of the debt e l i g i b l e for debt r e l i e f . Consequently, more than h a l f of the debt service due i s not considered e l i g i b l e . Furthermore, r e l i e f i s , when provided, on only a small part of the remaining debt, and since the amount of r e l i e f i s usually i n s u f f i c i e n t to ease the l i q u i d i t y problem for more than a year or more, t h i s arrangement has led to repeated r e s c h e d u l i n g . " 1 1 5 For example, of the twenty nine countries whose debts were rescheduled between 1978 and 1984, twenty seven returned to the Club f o r further r e l i e f . 1 1 6 The Club does not reschedule debt unless the conditions of immediate default, IMF Stand-By Arrangement and • 117 comparative treatment from commercial cr e d i t o r s are met. 1 1 4 R i e f f e l , A. note 100. 1 1 5 Abbott, G.C. pp.1-16. see chapter 1, note 6. 1 1 6 R i e f f e l , A. note 100. 1 1 7 Id; R i e f f e l , A. The Paris Club 1978-1983. 23 Columbian J.Transnat"1 Law, pp.83-110; Hudes, K., pp. 553-71 By imminent default, i t means that i t i s beyond doubt that a debtor country w i l l be i n default save the Club grants a r e l i e f . In 1980 for instance, Senegal's request for a r e l i e f was turned down on the ground that i t s balance of payment p o s i t i o n as endorsed by the IMF did not indicate any danger of imminent default. Two years l a t e r , Senegal defaulted and the cost of r e l i e f became greater. This shows that the IMF assessment of a country's debt s i t u a t i o n can not always be precise as to be r e l i e d upon. Moreover, while the wisdom of t h i s condition i s to avert throwing open a flood gate of requests f o r r e l i e f even from debtors without genuine cases, the f o l l y l i e s i n i t s indifference to prevent a debt c r i s i s . One i s tempted to question the wisdom of making imminent default and the IMF adjustment program simultaneous conditions precedent for granting of r e l i e f when i n most cases a country undergoing an adjustment program would hardly be i n imminent default at the same time. By comparative treatment, i t means that a debtor negotiating for a r e l i e f with the Club must undertake to obtain s i m i l a r r e l i e f terms from commercial banks i n respect of i t s • , 1 1 0 commercial debts so that the banks are not b a i l e d out.- 1- 0 However, the problem has been the lack of a formula to determine or measure i n a given s i t u a t i o n , a comparable treatment e s p e c i a l l y when i t i s r e a l i z e d that unlike o f f i c i a l loans, commercial loans are made with the motive to Id; Carvounis, C., pp.29-30 57 make p r o f i t and so are not on concessional terms. Moreover, the Club does not reschedule i n t e r e s t arrears, future i n t e r e s t payments or loans that i t has previously • • 1 1 Q rescheduled. I t only reschedules the p r i n c i p a l amount. The procedure f o r debt r e l i e f negotiations under the Club i s ad hoc without any established r u l e to guide negotiations. By t h i s reason, some i d e n t i c a l cases are treated d i f f e r e n t l y . The Club also negotiate an umbrella agreement on behalf of a l l cr e d i t o r governments. This agreement i s not e f f e c t u a l u n t i l i t has been implemented by the i n d i v i d u a l c reditors by a separate agreement with the debtor. In the US, a t h i r d agreement i s undertaken between the debtor and the appropriate state agency, f o r example, the Eximbank. 1 2 0 This bureaucratic process brings delay i n implementing the r e l i e f , and consequently the arrears of debt accumulate. Another cause of delay i s the time taken to sort out what proportion of r e l i e f burden each c r e d i t o r should bear. There i s no cl e a r formula f o r determining t h i s . The extent of a cre d i t o r ' s exposure i s not a r e l i a b l e formula because of s t a t i s t i c a l problems and moreover, i t would put a debtor i n a t i g h t p o s i t i o n i n t r y i n g to comply with the non discriminatory clause of t r e a t i n g a c r e d i t o r no less favourable than the others. 1 1 9 Id. 1 2 0 Id. 58 Interestingly, a new era emerged i n the Paris Club approach to the debt problem, when i n 1976, the Trade and Development Board of UNCTAD, meeting i n Nairobi, came up with Resolution 165 (S-IX), otherwise known as Retroactive Term Adjustment (RTA) which came into force i n 1978. By t h i s resolution, the cr e d i t o r governments agreed to o f f e r a va r i e t y of debt r e l i e f . 1 2 1 Resolution 222 (XXI) of 1980/81 passed by the same board, contains an Agreed D e t a i l Features regarding the debt problem. The objectives are that in t e r n a t i o n a l actions should be expeditious and timely, should enhance the development prospects of debtor countries bearing i n mind t h e i r socio-economic p r i o r i t i e s , should aim at restoring the debtor countries' capacity to service t h e i r debts on both the short and long term bases and should rein f o r c e debtors' e f f o r t s to strengthen t h e i r underlying balance of payments si t u a t i o n s . F i n a l l y , that international actions should protect the in t e r e s t of debtors and cre d i t o r s eguitably i n the context of international economic cooperation. " The RTA e n t a i l s conversion of debts to aids and grants, payment i n l o c a l currency and the reinvestment of such i n the debtor's economy. I n i t i a l l y some reasonable r e l i e f was granted but with time and e s p e c i a l l y i n the face of increasing world economic recession and the i n a b i l i t y of the 1 2 1 UNCTAD TD/328 May,1987, pp. 12-13; Abbott, see chapter 1, note 6. 1 2 2 Id. 59 debtors to repay, the enthusiasm on the part of the c r e d i t o r s to continue with the scheme waned. And by t h i s reason the set objectives of Resolution 222(XXI) have not been s u b s t a n t i a l l y a c h i e v e d . 1 2 3 More recently, the Club has introduced some changes i n i t s approach to the debt problem. Measures designed to deal with rescheduling i n a way that has encouraged export c r e d i t agencies to provide new flows to debtors have been introduced, coupled with a willingness not to i n s i s t on a comparable treatment from b a n k s . 1 2 4 An UNCTAD report says: A further development i n the debt rescheduling practices of the Paris Club re l a t e s to a general improvement i n the coverage and terms of debt r e l i e f s extended to countries with severe balance of payment problems involving financing of d e f i c i t s on current account. For example, the terms of rescheduling of arrears or debt service payments a r i s i n g from previous Paris Club meetings i n recent years have been s i m i l a r to those applied to the consolidation of current maturities. As regards the coverage, arrears on short term debts have been more frequently consolidated i n the past, although maturities on such debts f a l l i n g during consolidation periods have continued to be excluded. Also l a t e i n t e r e s t due and not paid has been consolidated i n several cases, i n contrast to the practice i n previous vears when such obligations were not included. 1 Unlike i n the past, the Club i n 1985/86, granted a MYRA to scheduled repayment of p r i n c i p a l i n three cases. In these cases the c o n d i t i o n a l i t i e s usually associated with the Club's agreements involving countries r e l a t i o n s h i p with the note 121. TD/328/Add.2 , 19th Feb.,1987, p.21 1 2 3 UNCTAD 1 2 4 Id. 1 2 5 UNCTAD IMF was modified f o r one or two years, covered by the agreement during which Enhanced Surveillance procedures of the IMF were required instead of a Stand-By Arrangement. 1 2 6 Complementing the e f f o r t s of the Club, some cre d i t o r governments have provided a debt r e l i e f program for the debtor countries. The European Economic Commission for example, has introduced a scheme known as STABEX, aimed at s t a b i l i z i n g the earnings from exports of some a g r i c u l t u r a l products of some LDCs. 1 2 7 Under t h i s program which covers s i x t y s i x countries i n A f r i c a , Carribean and the P a c i f i c , compensation i s paid to i n d i v i d u a l producing countries i n case of s h o r t f a l l s i n t h e i r 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, i t s s i g n i f i c a n c e to a l l e v i a t i n g the debt problem can not be underestimated. E f f o r t s are believed to be on the way to extend i t to the other LDCs. 1 2 8 More recently, Japan submitted a proposal at the IMF and the World Bank meeting i n B e r l i n for debt r e l i e f for La t i n American countries. President Mitterand of France offered debt forgiveness to some of the LDCs, "an o f f e r r e f l e c t e d i n 'a l a carte' 1 2 6 Id. 1 2 7 Id. 1 2 8 Id. 61 approach adopted at the Western Pr e s i d e n t i a l Summit meeting i n Montreal i n the summer of 1988. 1 , 1 2 9 This was of course intended for the Afr i c a n c l i e n t - s t a t e s of the EEC. I t i s submitted that the debt burden w i l l be more re l i e v e d i f other c r e d i t o r s can take s i m i l a r i n i t i a t i v e s . DEBT - EQUITY SWAPS AND FOREIGN INVESTMENTS IN THE MANAGEMENT OF THE DEBT PROBLEM DEBT-EQUITY SWAPS The increasing international debt problem, while d e f i l i n g some management strategies, rekindles the desire for new i n i t i a t i v e s on the part of debt managers. Consequently debt-equity swaps strategy has evolved to deal with the problem. By debt-equity swaps, a poten t i a l foreign investor i n an LDCs economy converts a portion of the LDCs foreign debt into an equity investment i n a l o c a l LDC corporation. The investor does t h i s by purchasing the debt at a discount and presenting i t to the LDCs central bank for conversion at face value into l o c a l c u r r e n c y . 1 3 0 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 - W i l l the IRS Hinder U.S. Swappers, 8 V i r g i n i a Tax Review (Summer 1988) No. I. pp. 143-81. 62 For the LDCs, the p r i n c i p a l advantages of debt- eguity swaps are that they encourage equity investments i n the LDCs that would not occur otherwise, improve economic e f f i c i e n c y by a t t r a c t i n g investment from firms with needed expertize and reduce the discounted future cost of the LDCs1 external debt payments. Debt-equity swaps also encourage p r i v a t i z a t i o n e f f o r t s i n LDCs which could lead to more open economies and encourage entrepreneurship and economic e f f i c i e n c y . Viewed o p t i m i s t i c a l l y , 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 s i z e of external debt and to l i n k the s e r v i c i n g of external obligations more cl o s e l y to a country's capacity to pay, i n that the outflow of returns to investors would depend upon the earnings generated by the a c t i v i t y being f i n a n c e d . 1 3 2 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. I t also eliminates the payment of i n t e r e s t and rescheduling fees. A sizeable number of LDC debtors, mostly L a t i n American countries, has embarked on t h i s scheme. They have enacted l e g i s l a t i o n specifying the areas of t h e i r economies availa b l e f o r foreign investments, conditions for investment, p r o f i t r e p a t r i a t i o n and debts that are e l i g i b l e f o r conversion, etc. Countries l i k e Argentina match the 1 3 1 Id. 1 3 2 UNCTAD TD/328/Add. 2. 19th Feb; 1987, pp. 22-23. 63 amount of foreign c a p i t a l imported with an equivalent l o c a l 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 B r a z i l ' s , Argentina's and Mexico's debts respectively. According to World Bank Annual report for 1987, though the scheme i s f a r from o f f e r i n g a complete solu t i o n to debt s e r v i c i n g problems, i t can contribute to encouraging foreign investment, provide a channel for the return of f l i g h t c a p i t a l and reduce the foreign exchange needs of s e r v i c i n g a debtor's external debt. The major factors m i l i t a t i n g against the success of the scheme are the r e s t r i c t i o n s on r e p a t r i a t i o n of p r o f i t , fear of n a t i o n a l i z a t i o n of investments and the r e s t r i c t i o n on areas of investment by the debtor countries for fear that t h e i r economies might be under the control of foreigners. The U.S. banks are p a r t i c u l a r l y not interested i n p a r t i c i p a t i n g i n the scheme. They complain that they are unable to s e l l a substantial amount of the LDCs' debts because of the unfavourable accounting treatment on 1 3 3 E s t e l l a , 0. Making the Most of Mexican Debt Equity Swaps. I n t ' l F inancial Law Review, (Oct. 1987), pp. 3 5-3 6; Bomschil, M. , New Conversion Program i n Argentina, I n t ' l Fin. Law Review (Feb. 1988), pp. 35- 36. Rodner, J.O., Venezuela Debt Equity Swap Program I n t ' l F i n . Law Review.(July 1987), p. 32; Stuber, D. & Street, E. - B r a z i l ' s Debt Equity Swaps Program, I n t ' l F i n . Law Review (Feb. 1988), pp. 33-35. 1 3 4 Hentschel, J . Managing I n t ' l Debt -23 Inter Econ. Rev. of I n t ' 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 i s imposed. 1 3 5 Big US banks with large exposures have been reluctant to incur losses by s e l l i n g t h e i r loans at a discount which i s required under the scheme and making loan loss provisions as required under the regulation made pursuant to the International Lending Supervision Act. Moreover, most po t e n t i a l investors seem to be reluctant to invest i n countries which are plagued by economic d i f f i c u l t i e s . 1 3 6 In addition, the scheme i s constrained by the s i z e of the debt i n r e l a t i o n to the amount of foreign investment that can e a s i l y be accommodated i n a given debtor country. For example, La t i n America's external debt i s four times as large as the stock of foreign d i r e c t investment i n the 137 region. Owing to the factors above mentioned and more, the s i z e of the debt-equity swaps market has been very small. For instance, less than 2% on average of the t o t a l external bank debt of Argentina, B r a z i l , Chile, Mexico and Philippines, 1 3 5 Gottscho, G.,p.l69 1 3 6 Id. 1 3 7 Id. have been converted. Only about $5 b i l l i o n of LDCs1 debt has been swapped since the era of the scheme. According to World Bank s t a t i s t i c s , i n Chile debt-equity conversion amounted to $1.6 b i l l i o n i n 1987, $1 b i l l i o n and $2.6 b i l l i o n i n Mexico and B r a z i l respectively i n 1986, and $78 m i l l i o n and $70 m i l l i o n i n the Philippines and Nigeria respectively i n 1987. 1 3 9 I t i s suggested that t h i s scheme could be expanded with the p a r t i c i p a t i o n of c r e d i t o r countries and banks as investors i n debtor countries. Multinational corporations alone cannot buy out even h a l f of the debt of the LDCs. With better investment p o l i c i e s , p a r t i c u l a r l y a l i t t l e r e l axation of l e g i s l a t i o n on p r o f i t r e p a t r i a t i o n and n a t i o n a l i z a t i o n 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 i n s t r a t e g i c areas of t h e i r economies, for example, i n the areas of natural resources e x p l o i t a t i o n and energy, for fear of foreign control. I r o n i c a l l y , these areas y i e l d i n large part, the foreign exchange needed to service debt. So, by excluding foreign investments i n these areas , the foreign exchange y i e l d i n g capacity of the countries i s tremendously reduced. 1 3 8 UNCTAD, note 125. 1 3 9 The World Bank Annual Report for 1987. There i s the impression on the part of some LDCs that multinational corporations invest only for p r o f i t maximization rather than for genuine desire to help b u i l d a stable economy. 1 4 0 Plausible though t h i s argument may be, the f a c t remains that the LDCs would be better o f f with foreign investments at such a time as t h i s when the dynamism of world trade c a l l s for technologically improved goods, bearing i n mind that the chief factors accounting for reductions i n the growth of output i n adjusting LDC economies i s the decline i n public and private investments. 1 4 1 UNCTAD i s of the view that foreign d i r e c t investments could i f encouraged, help out countries facing external f i n a n c i a l d i f f i c u l t i e s . I t nevertheless regrets that foreign investments come only i n the private sector of the debtor's economy and might not have any s i g n i f i c a n t reduction on public sector debts. UNCTAD also recognizes the need to encourage foreign d i r e c t investment by improving the host countries' p o l i c i e s and by international e f f o r t s i n the area of removal of subsidies to industries and dismantling of p r o t e c t i o n i s t b a r r i e r s i n i n d u s t r i a l i z e d c o u n t r i e s . 1 4 2 140 Eskridge, W.N. J r . p. 64. see chapter 1, note 3 1 4 1 Id. 1 4 2 UNCTAD, note 132, p. 45, 67 DEBT MANAGEMENT CONSTRAINTS There are some constraints m i l i t a t i n g against a better debt management. Unfortunately, while some are t i e d to some uncompromising interests of the cre d i t o r s and debtors, others are due to natural d i s a s t e r s . The f i n a n c i a l and trading positions of most LDCs worsened sharply during the 1980s owing to an unfavourable international economic environment, namely depression i n demand of LDCs exports, high i n t e r e s t rates on bank loans which f o r example, increased from 20% i n 1975 to 45% i n 1984, unstable exchange rates which led to fluctuations i n commodity pri c e s of LDCs exports and terms of t r a d e . 1 4 3 These factors make i t d i f f i c u l t f o r the LDCs to plan and manage the external sectors of t h e i r economies e f f e c t i v e l y . Some of these constraints are dependent on the Gross Domestic Product (GDP) growth i n the OECD c o u n t r i e s . 1 4 4 While i t i s true that factors l i k e f l u c t u a t i o n i n GDP growth i n OECD countries and exchange rates might not be within the control of these countries, protectionism, high i n t e r e s t rates and subsidies to t h e i r industries might be within t h e i r control. Though protectionism i s i n the in t e r e s t of the su r v i v a l of the domestic economies of the developed countries, r e s t r a i n t s ought to be exercised i n i t s imposition e s p e c i a l l y when the cost on the part of the LDCs 1 4 3 UNCTAD TD/328/Add.l A p r i l 13, 1987, pp. 9-10. 1 4 4 Id. 68 outweighs the gain on the part of the developed countries. There should be a balancing of i n t e r e s t s . But the question of the c r i t e r i a to be used i n determining the balancing of i n t e r e s t s i s another big concern. Though some domestic p o l i c i e s of the LDCs, fo r example, resistance to adjustment programs i n order to avoid p o l i t i c a l c r i s i s , and overnight i n d u s t r i a l i z a t i o n constitute a hindrance to a better debt management, the e f f e c t s of p o l i c y reforms have been impaired by natural disasters i n some of the LDCs. For example, the drought i n Burkina Faso, Central A f r i c a Republic, the Gambia, Mali, Niger and Sudan, did cause a decline i n t h e i r primary commodities production. On the other hand, as a r e s u l t of improvement i n i t s terms of trade and an increase i n i t s external assistance, Samoa achieved an annual growth rate of 2.1% i n 1984 as against -1.0% and 0.4% i n the previous two years. In Togo, good r a i n f a l l and increased phosphate exports i n 1984-85, led to a growth of r e a l GDP of 5.9 i n 1985, thus reversing the negative trend of the preceding 145 years. ^ J Unfortunately the IMF and the World Bank have not been able to p r a c t i c a l l y address the exogenous constraints that have t h e i r roots i n the i n d u s t r i a l i z e d countries. They only concentrate on the i n t e r n a l p o l i c i e s of the LDC debtors. This alone might not r e a l l y bring about a better debt 5 UNCTAD TD/328/Add. 5, Feb. 18, 1987, pp. 15-17. 69 management because what i s achieved by addressing the problem on the debtors' side i s l o s t by the apathy on the c r e d i t o r s ' side. Nevertheless, the IMF acknowledges t h i s point when i t said " i n general d i f f e r e n t p o l i c y stances i n the i n d u s t r i a l i z e d countries have somewhat more influence on GDP growth i n developing countries than do the l a t t e r ' s own p o l i c i e s . " 1 4 6 The World Bank i s not oblivious of the s i t u a t i o n e i t h e r . I t stated: The need f o r adjustment i s not confined to the developing countries....Many of the f a i l i n g s i n the World economy have t h e i r roots i n the i n d u s t r i a l i z e d countries, whose f i n a n c i a l and economic weight greatly influences the economic prospects i n the developing world. 1 Statements such as these w i l l not save the s i t u a t i o n . They must be supported by action. But how these i n s t i t u t i o n s , the IMF and the World Bank, would go about persuading or compelling the c r e d i t o r countries to be more responsive to the debt problem, i s easier said than done. The administrative incompetence of the debtor countries themselves i s also a constraint to e f f e c t i v e debt management. For example, i t i s noticed that: Decision-making processes are slow and uncoordinated - usually involving the central banks, m i n i s t r i e s of finance and budgetary a u t h o r i t i e s , parliaments, as well as some of the large autonomous public sector companies. 1 4 8 1 4 6 Carvounis, C , p. 62, 1 4 7 Id. 1 4 8 Konz, P. at 530. I t i s also unfortunate that many debtor countries save countries l i k e B r a z i l , know very l i t t l e about the structure of t h e i r external sovereign debt and even private debt guaranteed by them. Though debt recording and monitoring are gradually being computerized, i t i s feared that the data being fed to the computer are too obsolete and unreliable for proper appraisal of the debt s i t u a t i o n and for a better planning h o r i z o n . 1 4 9 Owing to t h i s point, debtor countries are not only l o s t i n debt negotiation and renegotiation processes with the cred i t o r s but are also unable to properly manage t h e i r debt and debt p o r t f o l i o i n terms of r i g h t l y deciding how much, when and where to borrow. As a r e s u l t , they f a l l victims of "penalties, commitment fees for u n u t i l i z e d or under-utilized special-purpose loans, as well as i n exchange losses due to currency f l u c t u a t i o n s " 1 5 0 i n the hands of the c r e d i t o r s . EVALUATION OF THE DEBT MANAGEMENT STRATEGIES International debt management has come a long way. A l o t of e f f o r t s have been expended i n t r y i n g to manage the debt problem better. The t r a d i t i o n a l approach to the problem has been improved upon by some more recent developments as the preceding discussion shows. But i t seems there could hardly be enough improvement. 1 4 9 Id at 530-531. 150 Id at 531. 71 UNCTAD i s of the view that the adequacy of the debt strategy has to be examined i n the l i g h t of whether the objectives set out i n the Agreed Detailed Feature contained i n 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 f a i l e d to achieve the desired objectives and are i n need of improvement i f the Detailed Features are to be applied more e f f e c t i v e l y . International action has not been s u f f i c i e n t l y expeditious and timely. The development prospects of the debtor country have been assigned a secondary r o l e . E f f o r t s to restore the debtor country's capacity to service debt and to reinforce i t s own e f f o r t s to strengthen i t s underlying balance of payments s i t u a t i o n have been primarily short term i n nature. The i n t e r e s t of debtors, and p a r t i c u l a r l y t h e i r i n t e r e s t i n sustaining development, have not been protected equitably i n the context of i n t e r n a t i o n a l economic c o o p e r a t i o n . 1 5 1 Moreover, time that could be used to deal with the debt problem before i t deteriorates i s spent negotiating IMF c o n d i t i o n a l i t y . And when the c o n d i t i o n a l i t y i s f i n a l l y imposed: The absence of suitable medium-term balance of payments adjustment supported by IMF, with a more appropriate yet no l e s s rigorous type of c o n d i t i o n a l i t y , renders i t highly u n l i k e l y that debt rescheduling can adequately restore a country's capacity to service i t s debt i n the long r u n . " 1 5 2 In other words, i f debt rescheduling i s t i e d to IMF c o n d i t i o n a l i t y which i s a short term approach, how can the 1 5 1 UNCTAD TD/B/980, January 26, 1984, p. 11. 1 5 2 Id. 72 debtors be expected to service t h e i r debts regu l a r l y on a long term basis? Furthermore, UNCTAD notes that the ad hoc nature of rescheduling both commercial and o f f i c i a l debts i s not suited to a systematic a p p l i c a t i o n of the Agreed Detailed Features i n Resolution 222(XXI), p a r t i c u l a r l y 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 s e r v i c i n g capacity i n the short term. Because of i t s excessive "shortleash" character, current practice makes an inadequate contribution to the restoration of normal trade and f i n a n c i a l r e l a t i o n s , d i v e r t unnecessarily the energies of economic managers, and impedes the emergence of a medium term growth-oriented approach to resolving the country's d i f f i c u l t i e s . 1 5 - 3 ' I t seems that under the short term approach, the c r e d i t o r s are only interested i n granting the amount of r e l i e f that i s the absolute minimum necessary to restore the c r e d i t r a t i n g of the debtor country and to enable i t resume payment as quickly as possible. Rescheduling, though i t o f f e r s a temporary respite, does not solve the problem i n the long run. What the debtors need, i t i s submitted, i s not so much of time to pay t h e i r debts but time and support to restructure t h e i r economies and achieve a rate of growth 1 5 3 Id., p . l . that would improve the welfare of t h e i r people and at the same time meet t h e i r international o b l i g a t o n s . 1 5 4 Though the Paris Club has shown increased f l e x i b i l i t y i n rescheduling for countries with lowest income and the most severe indebtedness, consolidating up to 100% of p r i n c i p a l and i n t e r e s t as well as previously rescheduled debt service, and applying much longer repayment terms to some of the poorest c o u n t r i e s , 1 5 5 i t i s yet to extend t h i s benefit to a l l the other debtor LDCs. I t i s also desirable for the IMF and the World Bank to extend t h e i r 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 a l l e f f o r t s have to be directed at the expense of other sectors of the country's economy to produce exports j u s t f o r debt s e r v i c i n g . 1 5 6 The L a t i n America LDCs for example, made payments exceeding inflows of new lending by $31 b i l l i o n i n 1983, $21 b i l l i o n i n 1984 and $30 b i l l i o n i n 1985. 1 5 7 The e f f e c t of t h i s , i s lack of the c a p i t a l needed to finance economic growth i n the debtor countries. 1 5 4 Abbott, G.C., p. 189, note 1. 155 T n e W o r i d 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.) 1 5 6 Amaral, S. pp. 17-3 0, note 17; Jones, S.G. & Sunkel, 0.,p. 32. 1 5 7 UNCTAD note 103. The Commonwealth Group of Experts (London 1984) on The Debt C r i s i s and the World Economy has stated: Any s a t i s f a c t o r y solution to the present s i t u a t i o n 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 r e a l growth i n LDCs i s being s a c r i f i c e d to meet immediate debt service requirements. 5 8 This statement i s serious. In the main, i t means that a better debt management strategy should ensure that debt s e r v i c i n g i s balanced with economic growth i n the debtor countries. This can be achieved by l i m i t i n g debt s e r v i c i n g to the economic capacity of a debtor country without j e t t i s o n i n g growth. The Baker Plan which i s intended to make available more c a p i t a l f o r development purposes i n adjusting debtor LDCs has been aborted by commercial b a n k s . 1 5 9 The banks s t i l l do not want to increase t h e i r exposure to debtor LDCs for fear of l o s i n g t h e i r money. Those based i n the US complain that the bank regulations deter them from increasing c a p i t a l flow to the LDCs. Dismissing the Baker Plan, the Cartegena Group of Latin America complain that the amount ($20 b i l l i o n spread over three years) offered under the Plan does not permit orderly repayment of debt and the resumption of economic growth. The group i s of the view that the plan does nothing about the reduction of high i n t e r e s t rates, weakening commodity 1 5 8 Jones, S.G. and Sunkel, O. p. 34. 1 5 9 UNCTAD TD/328, May, 1987, p.6; Amaral, S., note 17. 75 pr i c e s , protectionism and o v e r a l l adjustment i n the i n d u s t r i a l i z e d countries, and does not introduce f l e x i b i l i t y to IMF c o n d i t i o n a l i t y . 1 6 0 Some scholars are even skeptical about the help of new loans i n r e l i e v i n g the debt burden i n the face of adverse external market s i t u a t i o n . They contend: Fresh c r e d i t s do not help ease the debt burden. They only help to augment the debt mountain. ... In theory fresh money i s given to strengthen the productive base of the developing countries so that they w i l l at some day i n the future be able to earn enough foreign exchange to service and repay t h e i r debt. In practice i t turns out that the more the developing countries produce i n terms of commodities, for instance, the lower are the world market prices for these goods. And when they venture into manufactures, they f i n d i n d u s t r i a l markets closed to t h e i r e x p o r t s . 1 6 1 The Group 2 4 States: Although an e s s e n t i a l element of the strategy followed so f a r recognizes the r e s p o n s i b i l i t i e s of i n d u s t r i a l countries to provide a stable and growth oriented economic environment... i n d u s t r i a l countries have f a l l e n short of t h i s commitment...this s i t u a t i o n of indebted countries remains most f r a g i l e . In s p i t e of continued adjustment, the debt of developing countries has continued to i n c r e a s e . 1 6 2 The height of the inadequacy of the debt strategies as implemented thus f a r has been the f a i l u r e to conceive i t within a broader strategy for accelerating growth i n the world economy. The prospect of slow growth i n the developed market economy countries now and i n the period ahead casts b U Carvounis, C. pp. 216-17. 6 1 Briones, L.M., p.7, see chapter 1, note 2 6 2 Id, p. 11. 76 doubts on the prospect for rapid growth i n export earnings of most debtor countries. Yet ra p i d l y expanding export earnings are fundamental to any successful debt strategy and without them the objectives of accelerating growth i n debtor countries and achieving f i n a n c i a l v i a b i l i t y cannot be r e c o n c i l e d . 1 6 3 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 i n the major i n d u s t r i a l i z e d countries; (2) the working out by debtors of improved domestic p o l i c i e s f o r promoting growth, to be f a c i l i t a t e d by a more predictable and more supportive external environment; (3) the working out of a de t a i l e d and operational i n t e r n a t i o n a l l y agreed set of guidelines for dealing with debt problem as preempted i n Resolution 222(XXI) s u p r a . 1 6 4 I t i s also important to have guidelines dealing with such matters as the respective roles of cre d i t o r s and debtors i n resolving debt problems, the manner i n which the achievement of adequate rates of growth can be incorporated into programs for dealing with such d i f f i c u l t i e s , and the way i n which f i n a n c i a l p o l i c i e s and practices can be made 1 6 3 UNCTAD TD/328/Add. 2 Feb. 19, 1987, p. 28, 1 6 4 Id pp. 28-29. f u l l y congruent with present and prospective external 165 earnings. I t i s however, necessary to introduce some mechanisms i n the guideline that would check spurious claims from eithe r the cr e d i t o r s or the debtors regarding t h e i r r i g h t to grant or refuse and to request for r e l i e f . Such mechanisms would be subject to review from time to time to meet changing circumstances. 1 6 6 But hardly would the creditors agree to l e g a l i z e the question of debt r e l i e f considering the f a c t that t h e i r money i s at stake. However, i f the obli g a t i o n of a debtor country i s the same as obligations under ordinary international agreements, with the doctrine of Pacta Sunt Servanda as the basis of i t s binding force, i t i s perhaps plausible to argue that debt r e l i e f being i n c i d e n t a l to international loan agreements should equally have a l e g a l content to bring the par t i e s involved to compliance when the need a r i s e s . Be i t as i t may, an overview of the debt problem of the LDCs i r r e s i s t i b l y leads to the conclusion that a better debt management requires adjustment and growth i n these countries. Growth i n the LDCs would not only require v i a b l e domestic p o l i c i e s but also an improvement of the world trading environment so as to r a i s e t h e i r foreign exchange earnings and consequently t h e i r debt s e r v i c i n g capacity. I t 1 6 5 Id p. 29. 1 6 6 Abbott, note 1, pp.189 78 must however, be understood that even with an appropriate p o l i c y programs and c a r e f u l economic management, economic progress i n LDCs might be slow, f i r s t , because of the r e l a t i v e s t r u c t u r a l weaknesses of t h e i r economies and second, because of the l i m i t e d prospects for t h e i r export expansion and the world r e c e s s i o n . 1 6 7 Perhaps i t i s true that though the current debt management strategy might be inadequate, i n large part, because i t does not abate the recurrence of the problem, i t might nevertheless, be the best that can be offered at present i n the face of world economic recession a f f e c t i n g both c r e d i t o r s and debtors, i f I n d e e d the economic int e r e s t s of both the c r e d i t o r s 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 s i t u a t i o n . I t s focus on bank debt and debt s e r v i c i n g reduction and new money for economic growth from m u l t i l a t e r a l f i n a n c i a l i n s t i t u t i o n s appears to s t r i k e 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 i s l e f t of t h e i r resources e s p e c i a l l y by ensuring that expenditures are matched with available resources at a l l times. They w i l l also do well by engaging i n 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 t h i s end, the cooperation of the developed countries i s strongly sought. 80 CHAPTER THREE INTERNATIONAL LEGAL REGIME OF DEBT MANAGEMENT Though the economic content o f the debt problem i s more s u b s t a n t i a l than the content of any o t h e r s u b j e c t , i t does not on i t s own c r e a t e an o b l i g a t i o n on the p a r t o f e i t h e r the c r e d i t o r s o r the debtors, l e t alone an e n f o r c e a b l e o b l i g a t i o n . I t i s a g a i n s t t h i s background t h a t one can a p p r e c i a t e the l e g a l content o f t h i s s u b j e c t . I n t e r n a t i o n a l law g e n e r a l l y d e r i v e s i t s f o r c e from t h e r e c o g n i t i o n of the b i n d i n g c h a r a c t e r o f law by the i n t e r n a t i o n a l community. For the impact of i n t e r n a t i o n a l law on debt management t o be f u l l y a p p r e c i a t e d , i t i s proper t o examine f i r s t , the i n f l u e n c e o f c r e d i t o r s m u n i c i p a l l e g a l systems on the matter. U s u a l l y , i n a l o a n t r a n s a c t i o n , the p a r t i e s are a d v i s e d t o choose a governing law and the s e a t of a d j u d i c a t i o n i n the event o f any d i s p u t e . U s u a l l y , c r e d i t o r s f e e l i n s e c u r e d t o a l l o w the law of the borrowing s t a t e p a r t y t o govern the t r a n s a c t i o n f o r the f e a r t h a t not o n l y can the borrowing s t a t e i n f l u e n c e i t s c o u r t but can a l s o a p p r o p r i a t e by l e g i s l a t i o n the terms of the c o n t r a c t t o i t s f a v o u r . S i n c e a t the time of c o n c l u d i n g a l o a n agreement, the c r e d i t o r i n v a r i a b l y has a h i g e r b a r g a i n i n g power and l e v e r a g e because he has t o d e c i d e whether o r not t o g r a n t the l o a n , he u s u a l l y chooses and s u c c e s s f u l l y i n s i s t s t h a t the law of h i s own s t a t e o r some o t h e r s t a t e should govern the c o n t r a c t . 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 i n t e r n a t i o n a l l e v e l . Under the German law, f o r instance, rescheduling i s j u s t f i x i n g a new date for payment of i n t e r e s t and does not cover fresh c r e d i t to the debtor ( i e . refinancing). Moreover, there i s no general duty under the German law to apply foreign public law, and i f at a l l i t i s applied, i t i s subject to a domestic review under aspects of i n t e r n a t i o n a l law and public p o l i c y . There i s no provision requiring German banks to set s p e c i a l reserves against non performing loans. Under the US law however, rescheduling and refinancing go together. 3 In 1983, the c r e d i t o r countries met under the auspices of the BIS and approved some p r i n c i p l e s for the supervision of banks with foreign establishments and established new rules f o r the supervision of international banking. Presumably unconnected with t h i s , the US Congress, while authorizing an increase i n 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 I n t ' l Law Proc. (April 9-12 1986), pp.51-56. 2 Id. 3 Id. 82 reserves and bank c a p i t a l , a l l as a way of evaluating and reducing the r i s k i n exposure of banks to debtor c o u n t r i e s . 4 The International Lending Supervision Act 1983 of the US, 5 provides i n i t s section 905(a) (i) that the bank regulators (the Federal Banking Agency) s h a l l require banking i n s t i t u t i o n s to es t a b l i s h and maintain a special reserve whenever: (A) the qu a l i t y of such banking i n s t i t u t i o n ' s assets has been impaired by a protracted i n a b i l i t y of p ublic or private borrowers i n a foreign country to make payments on t h e i r external indebtedness as indicated by such factors among others, as: (i) f a i l u r e by such public or private borrowers to make f u l l i n t e r e s t payments on external indebtedness; ( i i ) a f a i l u r e to comply with the terms of any restructure indebtedness; ( i i i ) a f a i l u r e by the foreign country to comply with any IMF program or any other suitable adjustment program; or (iv) no d e f i n i t e prospect e x i s t s f o r the orderly restoration of the debt service. The requirement on the part of banks to set spe c i a l reserves under t h i s 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 d i s c i p l i n e on banks lending to non-adjusting debtor countries. In June 1983, for example, the US bank regulators approved a regulation o b l i g i n g the seventeen largest US banks to increase t h e i r c a p i t a l to at le a s t 5% of t h e i r assets. In addition, a regulation made pursuant to the Act provides, that rescheduled loans are considered current provided i n t e r e s t payments on them are made not l a t e r than ninety days a f t e r they f a l l due otherwise the loans w i l l be categorized as non performing loans. The e f f e c t of t h i s i s that the banks concerned are required to set spe c i a l reserves against such loans. When t h i s happens, the banks concerned incur the displeasure of t h e i r shareholders whose dividends are affected as a r e s u l t . 7 Section 906(a)(i) of the Act provides: Inorder to avoid excessive debt service burdens on debtor countries, no banking i n s t i t u t i o n s s h a l l charge i n connection with the restructuring of an inte r n a t i o n a l loan any fee exceeding the administrative cost of the restructuring unless i t amortizes such fee over the e f f e c t i v e l i f e 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 i t to such a time the p r i n c i p a l 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 i s empowered to i n s t r u c t the Secretary of the Treasury, the Secretary of State and other appropriate federal o f f i c i a l s and to request the Chairman of the Board of Governors of the Federal Reserve System to use a l l appropriate means to encourage countries to formulate economic adjustment programs to deal with t h e i r balance of payment d i f f i c u l t i e s and external debts owed to private banks. The economic adjustments are expected to be designed to safeguard to the maximum extent f e a s i b l e , international economic growth, world trade, employment and the long term solvency of the banks and to minimize the l i k e l i h o o d of c i v i l disturbances i n 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 i n the IMF's guidelines, p o l i c i e s and decisions which would: a) convert short term bank debt which was made at high i n t e r e s t rates into long term debt at lower rates of i n t e r e s t ; b) assure that the annual external debt service, which include p r i n c i p a l , i n t e r e s t s , 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 i n approving any economic adjustment program, the Fund s h a l l 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 e f f e c t s that such programs w i l l have on i n t e r n a t i o n a l 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 s h a l l : (i) oppose and vote against any Fund drawing by a member where i n h i s judgment, the Fund resources would be drawn p r i n c i p a l l y for the purpose of repaying loans which have been imprudently made by banking i n s t i t u t i o n s to the member country; and ( i i ) work to ensure that the Fund encourages borrowing countries and banking i n s t i t u t i o n s to negotiate where appropriate, a rescheduling of debt which i s consistent with safe and sound banking practices and the country's a b i l i t y to pay. I t i s pertinent at t h i s point to note that a substantial amount of the outstanding LDCs' debt i s owed to the US government and banks. So, the US municipal banking laws and regulations are good examples of how c r e d i t o r s ' municipal foreign lending p o l i c i e s generally could determine or influence debt management at the i n t e r n a t i o n a l l e v e l . Developments of t h i s sort do not only play down the s i g n i f i c a n c e of international law i n managing the debt problem, but also narrows down the scope of a p p l i c a t i o n of in t e r n a t i o n a l law. Hence debt i s seen only i n the context of in t e r n a t i o n a l law of contract adorned with the p r i n c i p l e of pacta sunt servanda but denied of the defenses of rebus s i c stantibus and force majeure which arguably are exceptions to the binding force of contracts. The dominance of municipal law i n t h i s area impedes the progressive development of international law f o r the 86 management of the debt problem. For example, i t has not been considered desirable to have an inte r n a t i o n a l law of bankruptcy. Accordingly, i t i s posited that though economic development i s the only durable solu t i o n to the debt problem, int e r n a t i o n a l law can not provide a hard and fast r u l e on the matter because international law has a li m i t e d p o s s i b i l i t y . 9 INTERNATIONAL LAW AND THE DEBT PROBLEM In t h e i r relationships, states are often apt to set out t h e i r r i g h t s and obligations i n l e g a l l y enforceable documents l i k e t r e a t i e s . Loan agreements between a cr e d i t o r and a debtor governments may a t t a i n the status of a treaty i f the p a r t i e s choose to and r e g i s t e r i t as such with the United Nations Secretariat. But loan agreements between debtor governments and private persons who are not inte r n a t i o n a l persons, for example, commercial banks do not have treaty status. Such relationships are usually seen only i n the context of an ordinary i n t e r n a t i o n a l agreement or contract. The status of the parti e s to an international transaction or t h e i r choice of law determines though not invariably, the governing or proper law of the contract. For examle, loan agreements made between c r e d i t o r governments or inte r n a t i o n a l i n s t i t u t i o n s and debtor countries or Meese, K.M., pp. 51-56. 87 guaranteed by the l a t t e r , are in t e r n a t i o n a l i z e d and consequently governed by international law i n the absence of an express choice of law by the p a r t i e s . 1 0 But where the contract i s between a state and a private person, in t e r n a t i o n a l law has no application because private persons are not subject to international law. There i s no spec i a l aspect of international law dealing with debt problem. The obliga t i o n of a debtor (including a debtor country) i s the same i n a l l respect as the obliga t i o n under an. international agreement i n g e n e r a l . 1 1 In other words, a debtor i s bound to discharge h i s international contractual obligations i n good f a i t h , the p r i n c i p l e 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 i s known as the doctrine of f r u s t r a t i o n . In the German l e g a l system, i t i s referred to as Erganzende vertragsauslegung and Gaschaftsgrundlage, while under the French law, i t i s the concept of Imprevision. 1 2 Other l e g a l systems l i k e the Greek, Hungarian and the I t a l i a n give t h e i r 1 0 Siegel, K.M., The Interantional Law of Compensation for Expropriation and International Debt: A Dangerous Uncertainty. 8 Hastings I n t ' l & Comp. Law (1984/85),pp.223-247. 1 1 Starke, J.G., Introduction to International Law. 9th Edi t i o n , Butterworths, London. (1984), p.293. 1 2 N i c k l i s c h , F. , Adaptation of Contract. 5 J . I n t ' l Arb., No.3, (Sept.1988), pp. 35-42. 88 courts the statutory power to adapt contracts to changed circumstances. 1 3 The underlying purpose of t h i s doctrine i s to allow the part i e s a second chance to bring t h e i r contracts i n tune with fundamental change of circumstances which at the time of concluding the contract, they reasonably had not i n contemplation. At times, the fundamental change of circumstance could be such that destroys the substratum, the r e a l basis of the contract as a r e s u l t of which performance i s rendered p r a c t i c a l l y impossible. The question i s the extent to which t h i s doctrine operates i n the international sphere. In the following analysis, the application of the doctrines of rebus s i c stantibus and force majeure generally i n int e r n a t i o n a l law i s considered f i r s t before t h e i r a p p l i c a t i o n i n international loan transactions. THE DOCTRINE OF FUNDAMENTAL CHANGE OF CIRCUMSTANCES At the time of concluding a contract, the part i e s may have f a i l e d to envisage the circumstances l a t e r occasioning the requirement for contractual regulation. For example, the disappearance of the substratum of the contract which renders performance p r a c t i c a l l y impossible. The a p p l i c a t i o n of t h i s doctrine i n int e r n a t i o n a l law of contract i s both narrow and a r a r i t y . In fac t research has disclosed no evidence that rebus s i c stantibus has been 1 3 Id. 89 accepted as a general rule by a decision of an international t r i b u n a l . 1 4 However, A r t i c l e 79 of the United Nations Convention on International Sale of Goods (CISG) provides that a party i s not l i a b l e for a f a i l u r e to perform, i f the f a i l u r e i s due to an impediment beyond hi s c o n t r o l . 1 5 Communis Opinio (international commercial practice) provides that a fundamental change of circumstances beyond the control of the p a r t i e s a f f e c t s the e x i s t i n g contractual obligations and constitutes a ground for r e l i e f from some or a l l contractual o b l i g a t i o n s . 1 6 The p r i n c i p l e of pacta sunt servanda, doctrines of force majeure and rebus s i c stantibus are enshrined and elucidated i n the Vienna Convention on the Law of T r e a t i e s . 1 7 A r t i c l e 26 of the Convention provides that every treaty i n force i s binding upon the p a r t i e s to i t and must be performed by them i n good f a i t h (pacta sunt servanda). A r t i c l e 62 provides: A * Mehren, R.B. and Kourides, N. Interantional A r b i t r a t i o n s Between States and Foreign Private P a r t i e s - The Libyan Nat i o n a l i z a t i o n Cases. 75 AJIL (1981), pp. 476-552. 1 5 Horn, N., International Concept of Force Majeure i n "Adaptation and Renegotiation of Contracts i n International Trade and Finance" Edited by Horn, N.vol.3, Kluwer Law and Taxation Publishers, London (1985), pp. 26-28; A s i m i l a r provision i s enshrined i n UN ECOSOC Draft Code on International Corp.in UN Doc. E/C 10/1982/6, Annex 1982. 1 6 Id. I.L.M. (1969) p. 679. 90 (1) A fundamental change of circumstances which has occurred with regards to those e x i s t i n g at the time of the conclusion of a treaty, and which was not foreseen by the par t i e s may not be invoked as a ground for terminating or withdrawing from the treaty unless; (a) the existence of those circumstances constituted an e s s e n t i a l basis of the par t i e s to be bound by the treaty; and (b) the e f f e c t of the change i s r a d i c a l l y to transform the extent of obligations s t i l l 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) i f the treaty establishes a boundary; or (b) i f the fundamental change i s the r e s u l t of a breach by the party invoking i t eith e r of an ob l i g a t i o n under the treaty or of any other int e r n a t i o n a l o b l i g a t i o n owed to any other party to the treaty. (3) I f under the foregoing paragraphs a party may invoke a fundamental change of circumstances as a ground for terminating or withdrawing from a treaty i t may also invoke the change as a ground for suspending the operation of the treaty. Indeed, A r t i c l e 62 narrows down the scope of the ap p l i c a t i o n of the doctrine of changed circumstances i n that i t i s not applicable where the event complained of i s reasonably foreseen by the par t i e s or i s the f a u l t of the party r e l y i n g on the doctrine. Moreover, by A r t i c l e 1, the Convention i s applicable only between signatory states. An imperative of the rebus s i c stantibus i s that even where i t i s applicable, a party can not u n i l a t e r a l l y invoke i t to terminate or suspend i t s oblig a t i o n but must do so i n consultation and with the consent of the other party as provided i n A r t i c l e 54(b) of the Convention. And where a 91 dispute a r i s e s as to what amounts to changed circumstances, then under A r t i c l e s 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 I t i s argued that there are some hardships, the occurrence of which could render a contract incapable of being performed and would therefore release the part i e s from t h e i r obligations. A r t i c l e 61 of the Vienna Convention provides: (1) A party may invoke the i m p o s s i b i l i t y of performing a treaty as a ground for terminating or withdrawing from i t i f the i m p o s s i b i l i t y r e s u l t s from the permanent disappearance or destruction of an object indispensable for the execution of the treaty. I f the i m p o s s i b i l i t y i s temporary, i t 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 f o r terminating, withdrawing from or suspending the operation of a treaty i f the i m p o s s i b i l i t y i s the r e s u l t of a breach by that party either of an obl i g a t i o n under the treaty or of any other international o b l i g a t i o n owed to any other party to the treaty. In a debt s i t u a t i o n , v o l a t i l i t y 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 A r t i c l e 61(1) of the Convention. But t h i s might not be the case i n a s i t u a t i o n where for example, a country's sole export, say o i l , dries up as a r e s u l t 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 i s whether these defenses are availab l e i n international loan transactions. I t i s not s e t t l e d whether these defenses have a place i n int e r n a t i o n a l loan transactions, where one party, the lender has performed h i s own part of the contract and the other party, the borrower, i s yet to perform h i s own p a r t . 1 8 I f these defenses are tenable i n t h i s instance, then money having changed hands, from the lender to the borrower, i t would be grossly inequitable for the l a t t e r to keep i t . Moreover, i n practice, within the framework of actual restructuring, none of the concepts of f r u s t r a t i o n , force majeure or fundamental change of circumstances has been of any importance or app l i c a t i o n because of the problem i n t e r a l i a of determining t h e i r l e g i t i m a c y . 1 9 Assuming but not conceding that the doctrine i s applicable i n international loan transaction, i t denies the debtor the r i g h t to invoke i t where the changed circumstance 1 8 Horn, N. pp. 26-28. 1 9 Kohler, K., Private Banks and the Renegotiation of Public and Private Sectors Exposure pp. 317-334 i n "Adaptation and Negotiation of Contracts i n International Trade and Finance" by Horn, N., see note 15. i s foreseeable or due to the debtor's own default. The question, therefore, arises as to whether the i n a b i l i t y of a debtor country to service i t s debt owing to i t s own mismanagement of resources or the world economic recession i s a changed circumstance fundamental enough to absolve the debtor from performing i t s obli g a t i o n under a loan agreement. Mismanagement of economic resources i s a default on the part of the debtor country and does not therefore, e n t i t l e i t to invoke the doctrine. World economic recession, though not a default on the part of the debtor, i s nevertheless, subject to further t e s t of whether i t i s an unforeseen event to the p a r t i e s at the time of concluding the contract. Assuming the p a r t i e s d i d not foresee world economic recession as a possible change of circumstance at the time of concluding the o r i g i n a l loan agreements before the f i r s t o i l p r i c e shock i n 1973/74 as there was probably no precedent to learn from, what about at the time of concluding the several subsequent loan agreements? I t i s 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 t h i s i s a reasonably foreseeable event, i t can not be pleaded to invoke the doctrine. Therefore, t h i s doctrine might not a v a i l a debtor country i n default of i t s ob l i g a t i o n 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 i n the world economy ought not to a f f e c t 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 p a r t i e s could be said to have entered into the t r e a t y . 2 0 (for our purpose, loan agreement). Therefore, where the debtor government defaults to pay i t s debt to a c r e d i t o r government i n the absence of a waiver, i t i s an i n t e r n a t i o n a l wrong for which i t i s l i a b l e . 2 1 The plea of the doctrine of force majeure by the debtor country against the c r e d i t o r country i s both a r a r i t y and hardly successful. As r i g h t l y observed: The few i n t e r n a t i o n a l and a r b i t r a l 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 J u r i s d i c t i o n case (UK Vs. Iceland) (1973/74) ICJ. Rep. p.3, the court said that the change of circumstance must have been a fundamental one, r e s u l t i n g i n a r a d i c a l transformation of the extent of the obligations s t i l l to be performed. The change must have increased the burden of the o b l i g a t i o n to be executed to the extent of rendering the performance something e s s e n t i a l l y d i f f e r e n t from that o r i g i n a l l y undertaken. Judge S i r Gerald Fitzmaurice added i n t e r a l i a , "changed circumstances" r e l a t e s , namely one never contemplated by the p a r t i e s . White, G.M., Wealth Deprivation: Creditor And Contract Claim, pp. 158-159 - i n International Law Of State R e s p o n s i b i l i t y For Injuries To A l l i e n s . Edited by L i l l i c h , R.B., University Press Of V i r g i n i a , C h a r l o t t e s v i l l e , 1983. 95 narrowness and r a r i t y of the circumstances i n which a borrower might invoke the plea of force majeure. 2 2 Moreover, the burden of proof i s always very high. I t i s not enough that the occurrence of the event complained of makes the f u l f i l m e n t of the o b l i g a t i o n more onerous. In the Russian Indemnity Award, the Permanent Court of A r b i t r a t i o n held that Turkey had the burden to e s t a b l i s h that payment of i t s debt to the Russian government "would imperil the existence of the Ottoman empire or se r i o u s l y compromise i t s . • ? 3 i n t e r n a l or external s i t u a t i o n " . I t was reported that: Turkey had shown that f o r the previous twenty years i t had suffered f i n a n c i a l d i f f i c u l t i e s of the utmost seriousness increased by domestic and foreign events (insurrections and wars) which forced i t to make spe c i a l a p p l i c a t i o n of a large part of i t s finances, to undergo foreign control of part of i t s finances, to grant even a moratorium to the Ottoman Bank, and, generally, i t was placed i n a p o s i t i o n where i t could meet i t s engagements only with delay and postments, and even then at great s a c r i f i c e . 2 4 But because Turkey had been able to pay o f f some portion of i t s p u b l ic debt, the court rejected i t s plea of force maj eure. Considering the evidence of Turkey and the circumstances of the case, i t i s submitted that even i f the court had granted the plea, the e f f e c t would reasonably not have been a t o t a l termination of the obligations of Turkey 2 2 Id p.161. 2 3 Siegel, K.M., pp. 223-247. 2 4 White, G.M., pp. 156-157. but the deferment of them. The restructuring of debt i s apparently i n l i n e with t h i s view. Moreover, by reference to the evidence, Turkey appeared to be i n a very unique s i t u a t i o n by reason of protracted wars and insurrections. Turkey never advanced the mere reason of economic depression which the LDCs now Claim as hardship e n t i t l i n g them to be released from t h e i r obligations. Nevertheless, i t i s submitted that adaptation of i n t e r n a t i o n a l loan contract to changed circumstances i s done by re s t r u c t u r i n g the debt but without any l e g a l obligation on the part of the c r e d i t o r . 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, i t would suggest that the c r e d i t o r s admit that the o r i g i n a l time schedule for s e r v i c i n g the debt was not r e a l i s t i c or was not to be taken s e r i o u s l y . 2 5 In addition, i t i s feared that introducing l e g a l content i n the question of rescheduling might undermine the basic p r i n c i p l e of the binding force of contracts without which the i n t e r n a t i o n a l f i n a n c i a l system could not e x i s t . 2 6 No wonder most l e g a l systems do not recognize the debtor country's Horn, N. The C r i s i s of International Lending and Legal Aspects of C r i s i s Management, pp.295-316 i n "Adaptation and Renegotiation of Contracts i n International Trade and Finance". 2 6 Id. 97 i n a b i l i t y to pay as a ground for r e l i e f from contractual o b l i g a t i o n s . 2 7 The p r i n c i p l e of pacta sunt servanda i s not only v i t a l f o r the existence of the international f i n a n c i a l system but also f o r the existence of a l l kinds of international contracts. I f therefore, the defenses of fundamental change of circumstances and force majeure are tenable i n other aspects of international transactions, i t should also have a place i n loan agreement. The i n e q u i t i e s which might r e s u l t by reason of the fact that money has changed hands, are perhaps scarcely considered under a municipal bankruptcy law where a debtor i s declared bankrupt and the part of h i s debt which could not be s e t t l e d by h i s l i q u i d a t e d asset i s written o f f as a bad debt. Therefore, i f a c r e d i t o r can bear the inequity i n t h i s instance, there i s probably nothing to suggest that a c r e d i t o r government cannot bear the inequity r e s u l t i n g from i m p o s s i b i l i t y of performance due to adverse fundamental change of circumstances or force majeure save where the s i z e of write-off i s very substantial as to s e r i o u s l y and irreparably a f f e c t i t s f i a n c i a l p o s i t i o n . Unfortunately, i n a genuine bankruptcy case, for example, countries that are poverty s t r i c k e n owing to drought and other natural disasters, there i s no i n t e r n a t i o n a l law of bankruptcy to a v a i l them of t h e i r 2 7 Id. 98 obligations. Arguably, most municipal l e g a l systems have bankruptcy laws and so states' p r a c t i c e i n t h i s regard might lead to an international law of bankruptcy. However, d i f f i c u l t y a r i ses 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 l e v e l . For example, an i n t e r n a t i o n a l law of bankruptcy would need a reorganization of a state. Who would reorganize a state without i n f r i n g i n g upon i t s sovereignty? Even where a state waives i t s sovereignty, how would such a reorganization amount to a l i q u i d a t i o n of the state's assets? How would an i n t e r n a t i o n a l l i q u i d a t o r have access to the i n t e r n a l assets of the state? Moreover, there would be a valuation problem of the tangible and intangible assets of the state. In some municipal l e g a l systems, a bankrupt i s allowed to r e t a i n h i s clothes and t o o l s i n order to survive. At the international l e v e l , there would be a problem of determining the t o o l s and clothes of a state. Also, states could be apt to making spurious claim of bankruptcy even where the s i t u a t i o n i s such that can be averted with a minimal economic management and f i n a n c i a l d i s c i p l i n e . More important, what would be the standard c r i t e r i a for determining bankruptcy of states considering the f a c t that t h e i r are differences i n the economic circumstances of states? In one case, a US appeal court held that the action of the Costa Rican government i n taking economic measures for s u r v i v a l as a r e s u l t of which i t defaulted i n s e r v i c i n g i t s debt, was analogous to a reorganization of business under the US Bankruptcy Code. This decision, an attempt to e s t a b l i s h an international law of bankruptcy was reversed on a rehearing at the instance of the US government. 2 8 No wonder, S i r John Fischer William writing i n 1920s pointed out that a state can not be declared bankrupt and have i t s properties divided among i t s c r e d i t o r s . According to him, a state can not be l i q u i d a t e d or "even suspended from such of i t s functions as are of f i n a n c i a l c h a r a c t e r . " 2 9 He however, implied that j u s t as a bankrupt under some municipal l e g a l systems i s allowed to keep hi s t o o l s and clothings, a bankrupt state should be allowed to keep i t s v i t a l economic resources which of course are the minimum i t needs to 30 survive. u Even i f a state i s declared bankrupt, t h i s does not help the s i t u a t i o n . I t does not keep the state from being dependent on the developed countries (creditors) for i t s economic development. And so there i s s t i l l the tendency of incurring more debt. Tigert, R.R.,Allied Bank International: A US Government Perspective. 17 NYU J . I n t ' l Law and P o l i t i c s , (March/April 1985) pp. 511-526. L o t i l l a , R.P.M. pp.9-16 c i t i n g S i r John Fischer Williams Chapters on Current International Law and the League of Nations (1929), see chapter 1, note 17. 3 0 Id. In sum, c r e d i t o r and debtor governments usually do not accord the status of treaty to t h e i r loan agreements and so the Vienna Convention i n which i s enshrined the doctrines of fundamental change of circumstances and force majeure would not be applicable. And even i f the doctrines are recognized under customary international law, they s t i l l would not terminate the obligations of the debtor country under an inter n a t i o n a l loan agreement i n large part, because of the p e c u l i a r i t y of the transaction. The best they can do i s to defer the obligations. This i s not strange because i t i s already being done by way of debt restructuring. THE DOCTRINE OF ODIOUS DEBT I t i s argued that where a corrupt government contracts a loan for an i l l e g i t i m a t e purpose, f o r example, for personal gains of government o f f i c i a l s , to the knowledge of the lenders, a successive government owes no ob l i g a t i o n to repay such debt. Generally under international law, a change of government or i n t e r n a l p o l i c y of a state does not a f f e c t the ri g h t s and obligations of the state. Dr. Moore argues that an i n t e r n a t i o n a l o b l i g a t i o n i s owed by a state and not by the o f f i c i a l s who run the government of the state. Therefore, he maintains, i n the event the o f f i c i a l s are removed from o f f i c e by a new government, the obligations they contracted when they were i n o f f i c e s t i l l attach to the 101 state under the p r i n c i p l e of continuity of states. x However, i t appears that the concept of odious debt where succes s f u l l y pleaded against a c r e d i t o r government, might be an exception to the p r i n c i p l e 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 inte r e s t s of the state, but aims at strengthening the despotic regime, suppressing a popular insurrection etc., then t h i s debt i s to be regarded as an odious one for the people of the ent i r e state. This debt i s not binding f o r the nation; i t i s debt of the regime, a personal debt contracted by the r u l e r . Consequently, i t goes down with the demise of the regime. The reason why t h i s odious debts can not be considered within the domain of the state i s that they do not f u l f i l l 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 i n t e r e s t s of the s t a t e . 3 2 I t i s submitted that even i f t h i s doctrine as expounded by Sacks i s tenable today, i t i s applicable only between states and where a new regime succeeds a despotic one. But today, most LDC governments which corruptly contracted and s t i l l contract foreign debts are s t i l l i n power and so have the o b l i g a t i o n to repay. They can not defer payment of the Castel, J.G. and et a l , International Law, Ch i e f l y As Interpreted and Applied i n Canada. 4th Edit i o n , Emond Montgomery Publications Ltd. p.94 - c i t i n g Dr. John Basset Moore* s Digest of International Law. Id - quoting Sacks, Les E f f e t s des Transformations des etats sur Leur Dettes Publiques et outres Obligations Financiers (1927)- Translation i n Frankenberg and Knieper, Legal Problems of the Overindebtedness of Developing Countries- The Current Relevance of the Doctrine of Odious Debts. I n t * l J . of the Sociology of the Law. (1984), p. 428. 102 debt i n a n t i c i p a t i o n of a new government which w i l l have to plead the doctrine, because the cre d i t o r s want t h e i r money now. More important, the irony i s that most successive regimes, tend to be more corrupt than t h e i r predecessors. Therefore, i n sum, the doctrine of odious debt might not a v a i l much. LOAN TRANSACTIONS BETWEEN FOREIGN PRIVATE CREDITORS AND DEBTOR COUNTRIES In the absence of an express choice of law by the par t i e s , 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 a r b i t r a t i o n . Since private c r e d i t o r s are not subjects of int e r n a t i o n a l law, inte r n a t i o n a l law would not apply save where the private c r e d i t o r ' s claim i s espoused by h i s home government Therefore, public international law doctrines of rebus s i c stantibus and force majeure do not apply to private c r e d i t o r s . Accordingly, the debtor countries cannot succe s s f u l l y invoke the doctrines to suspend or terminate t h e i r f i n a n c i a l obligations to the commercial banks. Even where the part i e s choose a municipal law (for example, the English common law of f r u s t r a t i o n of contract) which recognizes the doctrines, as the governing law of t h e i r transaction, i t i s argued that they might s t i l l not be applicable because money having passed to the debtor 103 country, i t would be inequitable for i t to keep i t . But i n the absence of any law to the contrary, the debtor country might be at l i b e r t y to invoke the bankruptcy law of the municipal l e g a l system chosen to govern the transaction. The problem with t h i s , however, i s that the c r i t e r i a f or determining the bankruptcy of a state are not e a s i l y d i s c e r n i b l e as i n the case of ordinary person. This might therefore be a b a r r i e r to the invocation of the bankruptcy law. Though the doctrine of odious debt, being a public i n t e r n a t i o n a l law concept does not apply to the banks, there may be nothing that prevents i t from being extended to private i n t e r n a t i o n a l law because the banks need to r e f r a i n from making odious debt. I t i s 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 i s not enough because the Bretton Woods i n s t i t u t i o n s are primarily concerned with the balance of payment d e f i c i t s of debtor countries. They need to go into each i n d i v i d u a l projects to ascertain whether the loans made for them are s t r i c t l y being applied to the projects. The s e n s i t i v i t y and resistance of the debtor countries to t h i s measure can be countered by making such supervision a condition f o r granting of loans and debt r e l i e f . The need on the part of the banks to follow up loans made to debtor countries was recognized i n the Ar b i t a t i o n 104 Between Great B r i t a i n and Costa Rica. A r b i t r a t o r Taft held i n t e r a l i a : The case of the Royal Bank depends not on the mere form of the transaction but upon the good f a i t h of the bank i n the payment of money for the r e a l use of the Costa Rican government under the Tinoco regime. I t must make out i t s case of actual furnishing of money to the government f o r i t s legitimate use. I t has not done so. The bank knew that t h i s money was to be used by the r e t i r i n g president F. Tinoco, for h i s personal support a f t e r he has taken refuge i n a foreign country. I t could not hold h i s own government for the money paid to him for t h i s purpose. 3 3 I t i s submitted that banks i n t h i s kind of deal, ought to be treated i n no less way than the Royal Bank. I f banking regulations and laws of the states of the lending banks can be made congruent with t h i s measure, i t might help to curb the diversion of public loans from welfare and p r o f i t a b l e projects to private pockets and consequently reduce the s i z e of foreign indebtedness. SOVEREIGN IMMUNITY DEFENSE FOR A DEBTOR IN DEFAULT In the 19th century, i t was generally believed that a sovereign debtor with h i s immunity defense cannot be sued by a foreign private c r e d i t o r to recover money owed. Today, however, a state i s l e g a l l y bound towards i t s foreign private c r e d i t o r s and can be sued i n c o u r t . 3 4 There used to be a r u l e of absolute immunity available to states i n connection with t h e i r sovereign public acts 3 18 AJIL (1924) p. 147 at 168. 4 Horn, N., pp. 295- 316. 105 (acts iure i m p e r i i ) . 3 5 But as states increasingly engaged i n commercial a c t i v i t i e s not t r a d i t i o n a l l y associated with state functions , there emerged the r e s t r i c t i v e immunity doctrine under which a state i s denied immunity i n respect of i t s commercial a c t i v i t i e s (acts iure g e s t i o n i s ) . 3 6 Though s o c i a l i s t countries oppose the r e s t r i c t i v e immunity doctrine, i t i s note worthy that Soviet Union has agreed to r e s t r i c t i v e immunity i n the many b i l a t e r a l t r e a t i e s to which 37 i t i s a party. The basic problem, however, i s how to discern between acts iure imperii and acts iure gestionis and which e n t i t i e s of a state are e n t i t l e d to immunity i n any p a r t i c u l a r case. Nevertheless, courts and some state l e g i s l a t i o n on sovereign immunity indicate that as a means of determining the d i s t i n c t i o n between acts iure imperii and acts iure gestionis, reference should be made to the nature of the state's transactions or the r e s u l t i n g l e g a l r e l a t i o n s h i p s , and not to the motive or purpose of the state's a c t i v i t y . 3 8 The US Foreign Sovereign Immunities Act 1976 ( F S I A ) 3 9 , the 3 5 Parlement Beige case (1880) 5 PD. 197 and Schooner Exchange Vs. McFadden (1812) 7 Cranch 116. 3 6 Harris, D.J., p.241. 3 7 Id p. 242 - c i t i n g I.L.C. 4th Report on J u r i s d i c t i o n a l Immunities of States and t h e i r Property 1982., UN Doc. A/CN. 4/357, pp. 35 et seq. 3 8 Id p. 246; Tradetex Trading Corp. Vs. CBN (1977) Q.B. 529. 3 9 15 I.L.M. (1976) 1388; Delaume, G.R.,Three Perspectives on Sovereign Immunity: Public Debt and Sovereign 106 Canadian State Immunity A c t 4 0 and the UK State Immunity Act 1978 i n v a r i a b l y apply the r e s t r i c t i v e immunity doctrine as do the 1926 Brussels Convention for the U n i f i c a t i o n of Certain Rules Relating to the Immunity of States' Owned Vessels and the 1972 European Convention on State Immunity i n force i n 1976. 4 1 Section 3(1) of the UK State Immunity Act provides that a state i s not immune as respects proceedings r e l a t i n g to: (a) commercial transactions entered into by the state; or (b) an ob l i g a t i o n of the state which by v i r t u e of a contract (whether a commercial transaction or not) f a l l s to be performed wholly or p a r t l y i n the United Kingdom (2) This section does not apply i f the pa r t i e s to the dispute are states or otherwise agreed i n writing. (3) In t h i s section "commercial transaction" means i n t e r a l i a (b) any loan or other transaction for the provision of finance and any guarantee or indemnity i n respect of any such transaction or of any such transaction or of any other f i n a n c i a l o b l i g a t i o n . In other words, an international loan transaction under which a sovereign incurs a debt f a l l s into t h i s d e f i n i t i o n . But note that by section 3(2) where both the c r e d i t o r and the debtor are states or where the parti e s otherwise agree i n writing, the section does not apply. In other words, the Immunity: The Foreign Sovereign Immunities Act of 1976. 71 AJIL (1977) pp.399-422. 4 0 S.C. (1982) c.95 - reproduced i n Castel, J.G.,and et a l p. 307. 4 1 Harris, D.J.,pp.241, 247. 107 Act denies immunity only i n respect of a loan transaction between a sovereign debtor and a private foreign c r e d i t o r . The FSIA, the UK State Immunity Act and the European Convention on State Immunity provide that a waiver of immunity i n a written agreement i s s u f f i c i e n t and irrevocable. This secures the practice of lenders i n s t i p u l a t i n g waivers of immunity i n loan contracts with foreign sovereign borrowers and gives c e r t a i n t y to the effectiveness of lenders' action should a sovereign renege on i t s obligations under a loan c o n t r a c t . 4 2 The European Convention denies immunity to a l l e n t i t i e s of a state including i t s p o l i t i c a l subdivisions other than the foreign sovereign i t s e l f . Moreover, pursuant to i t s a r t i c l e 4, a l l contracts including loans and other f i n a n c i a l transactions between a contracting state and private persons which are to be performed i n another contracting state are subject to the non-immunity rule set f o r t h i n the Convention. But under the FSIA, the immunity ru l e applies to foreign government departments. Section 1603 provides that: (a) a foreign state except as used i n section 1608 of t h i s t i t l e includes a p o l i t i c a l subdivision of a foreign state or an agency or instrumentality of a foreign state as defined i n subsection (b): b) An agency or instrumentality of a foreign state means any e n t i t y - (1) which i s a separate l e g a l e n t i t y , person, corporate or otherwise, and Delaume, pp. 399-422. 108 (2) which i s an organ of a foreign state or p o l i t i c a l subdivision thereof, or a majority of those shares or other ownership i n t e r e s t owned by a foreign state or p o l i t i c a l subdivision thereof, and (3) which i s neither a c i t i z e n of a State of the United States as defined i n section 1332(c) and (d) of t h i s t i t l e , nor created under the laws of any t h i r d country. (d) a commercial a c t i v i t y means eithe r a regular course of commercial conduct or a p a r t i c u l a r commercial transaction or act. The commercial character of an a c t i v i t y s h a l l be determined by reference to the nature of the course of conduct or p a r t i c u l a r transaction or act, rather than by reference to i t s purpose. (e) A commercial a c t i v i t y c a r r i e d on i n the United States by a foreign state means a commercial a c t i v i t y c a r r i e d on by such state and having substantial contact with the United States. The UK State Immunity Act has an equivalent provision i n i t s section 14. But i t does not make any difference whether or not the immunity defense i s avail a b l e to p o l i t i c a l subdivisions of a state since immunity would ultimately be denied where the a c t i v i t y i s of a commercial nature i r r e s p e c t i v e of the state organ involved. Section 1605(a)(2) of the FSIA provides that a foreign state including i t s p o l i t i c a l subdivisions, agencies and instrumentalities, i s not immune from the j u r i s d i c t i o n of the US court i n any case: In which the action i s based upon a commercial a c t i v i t y c a r r i e d on i n the United States by the foreign state; or upon an act performed i n the United States i n connection with a commercial a c t i v i t y of the foreign state elsewhere, or upon an act outside the t e r r i t o r y of the United States i n connection with a commercial a c t i v i t y of the foreign state elsewhere and that act causes a d i r e c t e f f e c t i n the United States. 109 In one case, a US court held that where a debt i s to be paid i s the s i t u s of the debt and that since the debt was to be paid i n the US , the US courts had j u r i s d i c t i o n . 4 3 Though the FSIA does not state expressly the a c t i v i t i e s that are of a commercial nature, the US Sovereign Immunity B i l l 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 i n the United States, or which receives financing from a private or a public lending i n s t i t u t i o n located i n the United State (e.g. loans, guarantees, or insurance provided by the Export- Import Bank of the United S t a t e s ) . 4 * I t i s c l e a r that LDCs' debts owed to banks or public i n s t i t u t i o n s located i n the US f a l l within a "commercial a c t i v i t y " and i n the event of a default or other disputes a r i s i n g therefrom, the sovereign concerned can not a v a i l i t s e l f of the defense of Sovereign Immunity. But i n the event of execution of judgment, a sovereign enjoys a wider scope of immunity than i t s agencies or p o l i t i c a l 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 r i s e to the action that Tiggert, R.R. pp. 511-26 ( A l l i e d Bank International Case); No. 83-7714 (2d C i r . A p r i l 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 i s a s p e c i f i c waiver i n t h i s respect. But where the judgment i s against a p o l i t i c a l subdivision of the sovereign, i t can be enforced against a l l of i t s property i n the US regardless of whether there i s a l i n k between the property i n question and the commercial a c t i v i t y from which the claim a r o s e . 4 5 However, the funds held by a state's central bank for i t s own account are expressly immunized under the FSIA. 4 6 I t i s therefore c l e a r from the preceding discussion that the defense of Sovereign Immunity i s not a v a i l a b l e to the debtor country i n the event of a dispute a r i s i n g under a loan agreement with eit h e r the c r e d i t o r government or the commercial bank, a transaction considered to be of a commercial nature. However, unlike i n most c r e d i t o r countries, for example, the UK and the other signatories to the European Convention on State Immunity , i n the US , under the FSIA, enforcement of judgment i s l i m i t e d only to the property of the sovereign underlying the transaction i n question. In otherwords, even where the value of the property of the Sovereign i s less than the amount of money owed, the difference i s a loss to the c r e d i t o r . Not surpr i s i n g , there i s a move to amend t h i s provision to remove the r e s t r i c t i o n . 4 5 Delaume, pp. 399-422. 4 6 Id. I l l THE ACT OF STATE DOCTRINE DEFENSE This i s a doctrine of American law employed to excuse a state f o r acts done by that state within i t s t e r r i t o r y . F u l l e r C.J. i n George F. Underhill Vs. Jose Manuel Hernandez, declared: Every sovereign state i s bound to respect the independence of every other sovereign state, and the courts of one country w i l l not s i t i n judgment on the acts of the government of another done within i t s own t e r r i t o r y . 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. 4 7 Over the years, t h i s doctrine has spread and gained prominence across the common and c i v i l law w o r l d . 4 8 A sovereign debtor who f a i l s to meet i t s obligations cannot be absolved from l i a b i l i t y based on the act of state doctrine. The main reason i s that apart from seemingly i n a p p l i c a b i l i t y of the doctrine i n commercial transactions, the defense i s only invoked where the act i n question i s performed within the t e r r i t o r y of the state concerned. Foreign debts are usually contracted and payable i n foreign currency i n the c r e d i t o r country. Therefore, whatever act done by a debtor country which a f f e c t s the payment of the debt, must necessarily be outside of the debtor country. In A l l i e d Bank International Vs. Banco 4 7 168 US (1897) p. 250 at 252. 4 8 Castel Se et a l p. 288. 112 AO Credito A g r i c o l a de Cartagoe^ , the Costa Rican government, pursuant to economic s u r v i v a l measures enacted a decree p r o h i b i t i n g the a v a i l a b i l i t y of foreign exchange for debt s e r v i c i n g . Consequently, three Costa Rican banks defaulted i n making payments under a promissory note held i n favour of A l l i e d bank. Both the courts of f i r s t instance and appeal upheld the plea of act of state and dismissed the claim. The US government intervened, arguing that inasmuch as i t supports countries to take economic recovery measures, i t does not support u n i l a t e r a l measure by countries a f f e c t i n g binding contractual ri g h t s of c r e d i t o r s . Consequently, the case was reheard and i t was held that since the s i t u s of debts i s where they are to be paid, the act of the Costa Rican government was e x t r a t e r r i t o r i a l since i t affected the payment of the debt i n the US. The defense was therefore untenable. Needless to say, t h i s demonstrates why most cre d i t o r s i n s i s t that loan transactions must be governed by t h e i r own law. Their money seems to be more secured by t h e i r own states' laws. Generally therefore, the act of state defense i s hardly open to the debtor countries i n default of t h e i r o b l i g a t i o n under an international loan agreement with either the c r e d i t o r governments or the banks. Tigert, R.R. pp. 511-526; Youngblood, P. 1985 Survey of International Law i n the 2nd C i r c u i t - The Act of State. 12 Syracuse J . I n t ' l Law and Commerce, p. 395. EXPROPRIATION OF DEBT I t has been stated that international debt i s a property (a chose i n action) to the lender and so l i k e any other property can be expropriated by a debtor c o u n t r y . 5 0 The irony of t h i s assertion however, i s that i n the event of an expropriation, the expropriating state has to pay compensation. The question then i s , i f a state has money to pay compensation, why can i t not service i t s debt? Arguably the answer seems to be that the compensation would have to be made i n l o c a l currency and would therefore save the debtor country the foreign exchange needed to service the debt. This argument i s not tenable i f the compensation i s to be prompt, adequate and e f f e c t i v e as required under customary international law. By e f f e c t i v e , i t means that the money paid must be convertible to a foreign currency which the c r e d i t o r can u t i l i z e the way he wants. Anything short of t h i s i s an aberration of the customary int e r n a t i o n a l law standard of e f f e c t i v e compensation. Perhaps i t i s i n r e a l i z a t i o n of the d i f f i c u l t y i n meeting the international law standard of compensation, that the Third World countries used t h e i r numerical strength to pass some resolutions aimed at departing from the customary in t e r n a t i o n a l law standard of compensation. Some of these resolutions are Resolution 3171(XXVIII) 5 1 and the Charter of 5 0 Siegel, K.M. pp. 223-47. 5 1 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 i n analyzing the measure of compensation as i t r e l a t e s to the argument concerning expropriation of debt. The c o n f l i c t between these resolutions and the customary international law standard of compensation makes uncertain the measure of compensation payable i n any p a r t i c u l a r case. Arguably, the f a c t that these resolutions were passed by the majority of states, though Third World countries, s u f f i c e s to give the resolutions the status of a new r u l e of international law superseding the e x i s t i n g customary international law rule of prompt, adequate and e f f e c t i v e compensation as c o d i f i e d i n Resolution 1803 ( X V I I ) . 5 2 Brownlie observes: I t i s f a i r l y c l e a r that the Charter does not purport to be a declaration of the preexisting p r i n c i p l e s and o v e r a l l i t has a strong programmatic, p o l i t i c a l and d i d a c t i c flavour. Nonetheless, there can be l i t t l e doubt that A r t i c l e 2 para. 2(c), i s regarded by many states as an emergent p r i n c i p l e , a statement of presently applicable r u l e s . 5 3 But i n the Texaco Overseas Petroleum Co. and C a l i f o r n i a A s i a t i c O i l Co. Vs. The Government of the Libya Arab Republic 5 4 , the a r b i t r a t o r rejected the Charter as a rule of i n t e r n a t i o n a l law because the minority i n d u s t r i a l i z e d Harris, D.J., p.437. Id p.432 - quoting Brownlie i n 1962 Hague Recueil 255 (1979-1). 53 I.L.R. (1977) 389; 17 I.L.M. (1978) 1. 115 countries did not approve of i t . Moreover, according to the a r b i t r a t o r , the absence of any connection between the procedure of compensation and international law and the subjection of the procedure s o l e l y to municipal law under a r t i c l e 2(2)(c) of the Charter, could not be acceptable to the t r i b u n a l as law. I t i s submitted that the view of the a r b i t r a t o r amounts to an a r b i t r a l l e g i s l a t i o n and a r e d e f i n i t i o n of the process of what i t takes for a norm to c r y s t a l l i z e into a rule of int e r n a t i o n a l law. I t i s s e t t l e d that a norm attains the status of a ru l e of customary international law based on pr a c t i c e of states, usually the practice of a majority of states. J Therefore by i n s i s t i n g that the absence of consent to the resolutions on the part of the minority developed countries rendered the Charter of no l e g a l e f f e c t , the a r b i t r a t o r i s i n e f f e c t saying that a norm can only a t t a i n the status of a rule of international law depending on the r e l a t i v e economic and p o l i t i c a l power of states that consent to i t or otherwise. Nevertheless, these resolutions, assuming they become law, might not be applicable to expropriation of debts because they envision expropriation only i n respect of natural resources. Even i f expropriation of debts can be read into them, the payment of compensation considered to be 5 5 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 cr e d i t o r s from future lending to the LDCs. However, since private foreign c r e d i t o r s always choose t h e i r state law as the governing law of the transaction, they would be paid the measure of compensation as enshrined i n that law. I t i s submitted that t h i s might even be more than the minimum standard of compensation under in t e r n a t i o n a l law. I f t h i s i s the case, i t i s enough to discourage expropriation of debt. LEGAL EFFECTS OF SOME CLAUSES IN INTERNATIONAL LOAN AGREEMENT AND THEIR IMPACT ON DEBT MANAGEMENT There are some le g a l clauses usually introduced i n inter n a t i o n a l loan agreements for the sake of protecting the in t e r e s t of private c r e d i t o r s , but which have f a r reaching e f f e c t s i n terms of f r u s t r a t i n g the e f f o r t s of debtor countries to cope with the debt problem. NEGATIVE PLEDGE CLAUSE Customarily, international loan agreements provide that the borrower s h a l l not create l i e n s or charges on i t s assets or revenues i n favour of other lenders. A t y p i c a l Negative Pledge Clause reads: 117 The borrower w i l l not enter into any arrangement with respect to any external indebtedness or other obligations currently outstanding or hereafter incurred which arrangements would have the e f f e c t of placing any c r e d i t o r i n a p o s i t i o n of preference (by means of any incumbrance or any preferred arrangement of any kind) over the lender with respect to the a v a i l a b i l i t y of any of the assets of the borrower for the s a t i s f a c t i o n of i t s indebtedness to the lender hereunder. 5 6 This clause has the e f f e c t of securing the assets of the borrower country for the s a t i s f a c t i o n of the debt owed to a p a r t i c u l a r creditor(s) to the exclusion of a l l others. In e f f e c t , the borrower country can not give i t s assets as sec u r i t y for loans from other lenders, at l e a s t not by conceding the f i r s t charge on i t s assets to them. The d i f f i c u l t y t h i s poses for the borrower (debtor country) i s that even i n the face of emergency needs for loans, i t can not give i t s assets as security for the loans. But since the clause does not prevent an outright sale of assets, the borrower can s e l l the assets to r a i s e fund to meet an emergency s i t u a t i o n . 5 7 However, to get a ready buyer might not be easy depending on the location of the assets. Also, an outright sale might not be i n the long term i n t e r e s t of the borrower e s p e c i a l l y i f the assets are revenue generating. 5 6 Bradfield, M. and J a c k l i n , N.R., The Problems Posed by Negative Pledge Convenants i n International Loan Agreements. 23 Columbian J . Transnat'l Law (1984/85), pp. 131-142. 5 7 Id. 118 Where the assets used as a security are located i n the borrower country, i t might be d i f f i c u l t for the lender to be able to exercise h i s power of sale of the assets i n s a t i s f a c t i o n of the debt owed to him. The reason i s that the borrower country might use l e g i s l a t i o n and force to stop that. But r a r e l y i s c o l l a t e r a l required i n loan transactions with countries. Loans are made on the good w i l l of the borrower countries and recently on the reference of the IMF. The Negative Pledge Clause becomes too much of a problem i n a syndicated loan agreement containing a Cross Default Clause. Here the security provided by the borrower must be equally shared by a l l the p a r t i c i p a t i n g lenders with none being treated less favourably than the others. The problem i s that a v i o l a t i o n of the Negative Pledge Clause i n respect of one lender t r i g g e r s o f f a default i n respect of debt owed to a l l the other lenders who otherwise have no cause to c a l l the borrower i n d e f a u l t . 5 8 CROSS DEFAULT CLAUSE In a syndicated loan arrangement, a Cross Default Clause makes i t possible for the c r e d i t o r s to accelerate t h e i r loans where the debtor i s i n default i n respect of debt owed to one of them. 5 9 When t h i s happens, the debtor country's attention to i t s economic recovery program i s d i s t r a c t e d because i t i s faced with renegotiating the 5 8 Id. 5 9 Id. 119 agreement with each one of the cr e d i t o r s . I t seems banks accelerate t h e i r loans as a way of persuading debtor countries to give p r i o r i t y to repayment. I t i s however advisable on the part of the debtors to i n s i s t i n loan agreements that a Cross Default Clause can not be invoked unless at le a s t a two-third majority of the syndicate banks agree that the s i t u a t i o n i s such that warrants the invocation of the c l a u s e . 6 0 This w i l l save the problem of each c r e d i t o r invoking the clause at w i l l even when i t s own s i t u a t i o n does not c a l l for i t . DEFINITION OF "BORROWER". Where the d e f i n i t i o n of "borrower" i n a loan agreement i s too broad, that includes not only the sovereign but also h i s p o l i t i c a l subdivisions, e n t i t i e s and agencies. The ef f e c t of Negative Pledge Clause and Cross Default Clause becomes more unmanageable because a default of one of the sovereign e n t i t i e s i s automatically extended to the other e n t i t i e s , and the properties of any one of the e n t i t i e s cannot be pledged for new loans even i n emergency s i t u a t i o n s . The most important e n t i t y to exempt from the operation of these clauses i s the debtor country's central bank as i t i s the custodian of i t s foreign reserves. Better s t i l l , a 6 0 Hurlock, J.B., Advising Sovereign C l i e n t s on the Renegotiation of t h e i r External Indebtedness. 2 3 Columbia J . Transnat'l Law (1984/85), pp. 29-42. 6 1 Id. 120 sovereign debtor should i n s i s t f or a narrow d e f i n i t i o n of "borrower" i n a loan agreement. I f possible, for i t to mean only the sovereign i t s e l f . An overview of t h i s chapter shows that international law has l i t t l e or no e f f e c t i n the management of the int e r n a t i o n a l debt problem. I t may s t i l l be evolving i n t h i s regard. E s s e n t i a l l y , i t underlies the obligations of the debtors to service t h e i r debts and to keep them i n check against default. I t does not go into the economic p o s s i b i l i t y of good debt management or otherwise. In the main, the municipal laws of c r e d i t o r countries occupy a prominent p o s i t i o n i n the whole question of international loan transaction. While the binding force of contract i n municipal l e g a l systems i s transposed to the international l e g a l system as the p r i n c i p l e of pacta sunt servanda, the municipal common law doctrine of f r u s t r a t i o n or i t s equivalent i n other j u r i s d i c t i o n s has no place i n inter n a t i o n a l loan transactions. In so f a r as the debt management strategies and r e l i e f are not backed up by international law and have v i r t u a l l y no inte r n a t i o n a l l e g a l content, international law appears inadequate or o f f e r s nothing to the management of the inter n a t i o n a l debt problem. More important, even i f int e r n a t i o n a l law does o f f e r something, compliance with i t might be another problem j u s t as i t i s the case with compliace to international law generally, i n large part because some p r a c t i c a l exigencies are not amenable to the 121 process of law. Unlike international law, municipal laws are r e a d i l y complied with mainly because of the s t a t e s 1 power of enforcement. Therefore, the debt problem and i t s management are better addressed i n the context of international economics and p o l i t i c s rather than international law. 122 C H A P T E R F O U R DEBTORS' RESPONSE TO THE DEBT PROBLEM AND THE QUEST FOR A NEW INTERNATIONAL ECONOMIC ORDER One of the major complaints of LDC debtors i s that while c r e d i t o r s are urging them to embark on adjustment measures i n order to be able to generate enough foreign exchange to service t h e i r debts,the cr e d i t o r s themselves engage i n protectionism, subsidies to t h e i r domestic goods and industries, a l l of which operates against the adjustment e f f o r t s of the debtors. This development becomes more pa i n f u l when i t i s r e a l i z e d that the hardship attendant to adjustment e f f o r t s i s somewhat unbearable. In other words, the r e s u l t ,of the adjustment e f f o r t s i s 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 c r i s i s . 1 Adjustment measures have often been undertaken at the r i s k of p o l i t i c a l tensions and c i v i l disturbances i n the debtor countries. For example, i n the face of reduced standard of l i v i n g , i n f l a t i o n , wage freeze, and unemployment etc., s i x t y people were k i l l e d i n 1984 i n the Dominican Republic amidst a protest against government decision to Amaral, S. The Debt C r i s i s from the Point of View of A Debtor Country. 17 NYU J . I n t ' l law and P o l i t i c s (March/ A p r i l 1985), pp. 633-650. 123 reduce food subsidies. In Sudan, President Nimieri was over thrown for attempting to cut food subsidies to meet IMF c o n d i t i o n a l i t i e s . In Egypt an across the country demonstration effected a r e v i s i o n of IMF conditions for adjustment. In 1982, the d i c t a t o r governments of Chile and the Philippines used force to que l l c i v i l disturbances. Between l a t e 1970s and 1985, Argentina, B r a z i l and Mexico faced workers s t r i k e s that nearly wrecked t h e i r economies. 2 In 1983, labour protest compelled the B o l i v i a n government to increase the minimum wage by 42% i n v i o l a t i o n of an on going IMF adjustment program condition. The president of Argentina's central bank was j a i l e d for not representing the i n t e r e s t of the country very well during a negotiation with the IMF.3 The irony of the prejudice against the adjustment program of the IMF i s that some debtor governments themselves impose adjustment measures s i m i l a r to those of the IMF. Nigeria, for example, has over the past few years, increasingly reduced subsidies on petroleum, devalued i t s currency and frozen wages. Though there i s h o s t i l i t y attendant to the adoption of adjustment/austere measures, i t i s nevertheless believed that i f 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 f i n a n c i a l system has to adjust to accommodate t h e i r economic growth by ensuring transfer of resources from the North to the South and not v i c e versa. They pos i t that the f a i l u r e to adjust the international f i n a n c i a l system i n t h i s way has been responsible for some u n i l a t e r a l actions taken by some debtor c o u n t r i e s . 4 For example, Cuba and North Korea o u t r i g h t l y repudiated t h e i r debts i n the 1970s and early 1980s. The governments of Peru and Nigeria have u n i l a t e r a l l y l i m i t e d t h e i r debt s e r v i c i n g to 10% and 30% of t h e i r foreign exchange earnings r e s p e c t i v e l y . 5 Mexico, Argentina and B r a z i l declared moratoria on the payment of t h e i r debts i n 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' c a r t e l (a united front for debtors to have t h e i r way e s p e c i a l l y i n time of default) by the Cartegenian Group of Latin America was turned down by debtor countries. These days, each debtor country i s more interested i n maintaining creditworthiness and good rel a t i o n s h i p s with i t s creditors and s o r t i n g out issues through negotiations rather than through u n i l a t e r a l 4 Carvounis, C. , see chapter 2, note 33. 5 Id ; Cline, W. see chapter 1 note 3. 6 Cline, W. pp. 90-91. 125 a c t i o n s . 7 In 1987, B r a z i l paid the arrears of i n t e r e s t on i t s debt to end i t s moratorium having r e a l i z e d that the cost of the moratorium was quite high as new c r e d i t s needed for • ft important and urgent transactions were cut o f f . In general, debtor countries have taken some p o s i t i v e measures to combat the problem. An UNCTAD document reports that: Domestic resources, both human and f i n a n c i a l are being mobilized for development purposes; several LDCs have taken measures to control government expenditure and to streamline the operation of public enterprise; higher p r i o r i t y i s now accorded to a g r i c u l t u r a l developments and p o l i c i e s are adjusted to the need to increase s u b s t a n t i a l l y food production; increased use of the market mechanism i s being made through the l i b e r a l i z a t i o n of p r i c e 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 l o c a l production of import competing goods. However, the LDCs i n s i s t that the measure to e f f e c t i v e l y deal with the debt problem does not l i e with them but rather with the need to reorder the present i n t e r n a t i o n a l economic order. Hence t h e i r quest for a New International Economic Order. They believe that the debt problem i s rooted i n the poor and u n d i v e r s i f i e d nature of t h e i r economies. They are, therefore, strongly of the view that the i n d u s t r i a l i z e d countries have a duty to t r e a t them 7 Id. 8 Hentschel, J . Managing International Debt. 2 3 Inter Econ. Rev. of I n t ' l Trade and Dev. No.3 (May/June, 1988) pp.126-131. UNCTAD TD/328 May 1987, p. 12. 126 i n a s p e c i a l way e s p e c i a l l y by t r a n s f e r i n g technology for the transformation of t h e i r economies with a view to r a i s i n g t h e i r bargaining power to the l e v e l of that of the i n d u s t r i a l i z e d countries. The i n d u s t r i a l i z e d countries are accused of fashioning to t h e i r taste and control, the world economic system through i n s t i t u t i o n s l i k e the IMF, the World Bank and the General Agreement on T a r i f f s and Trade (GATT). With these i n s t i t u t i o n s and technology, the i n d u s t r i a l i z e d countries have maintained a considerable economic s u p e r i o r i t y which has l e f t the economies of the LDCs dependent on them. Thus i n the l i g h t of t h i s , the major impediment to LDCs1 development i s argued to be the international d i v i s i o n of labour, whereby the developed countries do the manufacturing and control the technology and the LDCs only supply some of the raw materials. 1 0 Though there may be some truth i n t h i s argument, the fac t remains that technology which i s the basis of economic growth of the i n d u s t r i a l i z e d countries i s being developed by these countries by t h e i r own e f f o r t s and along t h e i r c u l t u r a l needs. I t i s therefore r i d i c u l o u s for the LDCs to a t t r i b u t e t h e i r economic f a i l u r e to the f a c t that they are denied of technology. I t i s incumbent on the LDCs 1 0 E s k r i d g e , 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 C r i s i s i n the Fourth World, pp. 310-12.- The P o l i t i c a l Economy of the North-South Relations Edited by Toivo Miljan, see chapter l,note 1. 127 themselves to eith e r develop t h e i r own technology or purchase i t . For the LDCs, i n order to eschew the debt c r i s i s , the unequal bargaining power between t h e i r trading partners and themselves, believed to be rooted i n the way the world economic system i s fashioned, must f i r s t be arrested. Apparently, i n t h e i r view, the manifold debt r e l i e f s and debt management strategies can at best a f f o r d a temporary re s p i t e but cannot abate the recurrence of the debt problem. The i n d u s t r i a l i z e d countries are therefore urged to show more charity and concern by unconditionally fashioning t h e i r economic p o l i c i e s to accommodate the economic prosperity of the LDCs. More important, the LDCs believe that a new in t e r n a t i o n a l economic order based on j u s t the good w i l l of the i n d u s t r i a l i z e d world would not be h e l p f u l as that would mean the absence of an o b l i g a t i o n on the part of the developed countries i n t h i s regard. Therefore, i t i s more desirable, they maintain, for the content of a new i n t e r n a t i o n a l economic order to be enshrined i n a l e g a l l y enforceable document. The LDCs have i n a number of occasions used t h e i r numerical strength i n the United Nations General Assembly and the UNCTAD, to pass resolutions aimed at achieving t h i s 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 i n aggregate national income 128 through expanded international trade and an annual flow of in t e r n a t i o n a l assistance and c a p i t a l to 1% of the national income of the developed c o u n t r i e s . 1 1 . In May 1974, a res o l u t i o n 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. 1 2 The Declaration accepted as a basic p r i n c i p l e , the need to secure progress towards the equality of a l l nations through an equitable sharing of world resources, tr a n s f e r of technology,a j u s t and equitable r e l a t i o n s h i p between the pri c e s 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 r i g h t to f u l l exercise of sovereignty over t h e i r natural resources to the exclusion of external i n t e r e s t s . In the the event of n a t i o n a l i z a t i o n , the Charter provides for compensation as determined by the national law of the country concerned, a t o t a l departure from the customary in t e r n a t i o n a l rule on compensation. In h i s annual report, the UN Secretary General stated i n t e r a l i a the international dimensions of the r i g h t to development as follows: 1 1 Akinsanya, A. and Davies, A., Third World Quest for A New International Economic Order: An Overview. 33 I n t ' l and Comp. Law Q. (Jan. 1984),pp. 208-217. 1 2 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 a l l peoples underlines the necessity of sharing r e s p o n s i b i l i t y for the promotion of development, and the i n d u s t r i a l i z e d countries, former c o l o n i a l powers and some others have a moral duty of reparation to make fo r past e x p l o i t a t i o n . 1 3 I t i s important, however, to point out that t h i s statement sees cooperation on the part of the developed countries as a moral rather than a l e g a l duty. I t i s submitted that for a success to be achieved, the developed countries can only be persuaded and not l e g a l l y obliged to cooperate. Another UN resolution states: States should cooperate i n the economic, s o c i a l and c u l t u r a l f i e l d s as well as i n the f i e l d of science and technology and for the promotion of inter n a t i o n a l c u l t u r a l and education progress. States should cooperate i n the promotion of economic growth through out the world, e s p e c i a l l y that of the developing countries. 4 Unfortunately for the LDCs, the UN General Assembly resolutions have no l e g a l force save of course they are declaratory of e x i s t i n g rules of customary international law. Consequently, the i n d u s t r i a l i z e d countries contend that they are not bound by these resolutions. In the alt e r n a t i v e , they maintain that the resolutions can a t t a i n the status of new rules of international law only i f they consent to them, 3 UN Doc. E/CN.4/1334 (1979) paras. 39-54. 4 General Assembly Declaration on P r i n c i p l e s of International Law Concerning Friendly Relations and Cooperation Among States i n Accordance with the Charter of the UN 1970. reproduced i n Harris, note 12. p.783 at 785. taking into account t h e i r economic power. x : > Even i f the developed countries agree to be bound by the resolutions on a new in t e r n a t i o n a l economic order, that would not a f f e c t debt owed to the commercial banks save t h e i r governments incorporate the resolutions into t h e i r banking regulations. The quest for a new international economic order appears to be based on a wrong premise. I t seems to over look the world economic r e a l i t y and addresses the debt problem only from the perspective of the LDCs. I t does not consider how the developed countries would have to contend with the enormous economic s a c r i f i c e an absolute p o s i t i v e response to the quest e n t a i l s . The quest i s u n r e a l i s t i c i n so f a r as i t imposes a l e g a l o b l i g a t i o n on the part of the developed countries and tends to say: The i n d u s t r i a l i z e d countries, please h a l t your economic advancement to enable the LDCs catch up with you or, i n the a l t e r n a t i v e , as you advance, you have a l e g a l o b l i g a t i o n to give a l l 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 in t e r e s t s of the i n d u s t r i a l i z e d countries which they can never compromise, at l e a s t not by imposing a l e g a l duty on them as some of the UN resolutions tend to suggest. Therefore, the resolution of these basic c o n f l i c t i n g i n t e r e s t s i s very c r u c i a l to dealing 1 5 Topco Overseas Petroleum Co. and C a l i f o r n i a A s i a t i c O i l Co.Vs. Libya 53 I.L.R. 389 (1977); 17 I.L.M. 1(1978). 131 with the debt problem. Since any l e g a l proposal which seeks to a l t e r the present world economic order i s vehemently repulsed, i t i s perhaps only reasonable to p o s i t that the debt problem cannot be arrested i n the context of a l e g a l framework. To the extent that a l l the par t i e s concerned with the debt problem have to reach a consensus on a workable management strategy to solve the debt problem, diplomatic negotiations rather than l e g a l process might be a better deal. 132 C O N C L U S I O N T his t h e s i s has not i n the main been concerned with the debt already incurred but rather with the debt to be ine v i t a b l y incurred and how to avoid i t . I t i s s e t t l e d that the economic development of the debtor LDCs i s an imperative to end the recurrence of the problem and to ensure a better standard of l i v i n g . As we have seen i n t h i s study, the post c o l o n i a l LDCs adopted a p o l i c y of overnight i n d u s t r i a l i z a t i o n . This idea plunged them into foreign debts i n the proportion that exceeded t h e i r available resources and management s k i l l . The commercial banks themselves indulged i n unrestrained and reckless lending and before they knew i t , the LDCs had succeeded i n a massive mismanagement of resources including the foreign loans, and were unable to service t h e i r debt. The manifold debt management strategies and r e l i e f are not to be dismissed. Though the respites they o f f e r to the debtor countries are only ephemeral, prudent debtor countries can a v a i l themselves of the r e l i e f to manage t h e i r economies better. For example, refinanced loans can be properly invested i n foreign exchange generating areas. Moreover, mul t i - year rescheduling and adjustment programs (including the various special f a c i l i t i e s ) 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 r e s i l i e n t based on these strategies, but 133 before long, t h e i r debts w i l l accumulate to a proportion worse than before and more d i f f i c u l t to manage. South Korea which i s often alluded as a successful LDC economy i s nevertheless one of the largest LDC debtors. I t must match expenditure with available resources to be better o f f . Moreover, the strategies often over look ways of maintainning and sustaining a stable economic growth i n the i n d u s t r i a l i z e d countries e s p e c i a l l y i n the OECD countries. This i s important because the foreign exchange earnings of the LDCs depend i n large part on the growth rate i n the developed countries. U n t i l external factors which m i l i t a t e against a better debt management are addressed with equal force or even more as the domestic factors i n debtor countries, the recurrence of the debt problems might not be abated to any s i g n i f i c a n t extent. International law i s not a debt manager and scarcely can be. Even i f a debt management strategy based on in t e r n a t i o n a l law i s to evolve, i t must not evolve without a base. I t must to work, be based on the r e a l i t y of the present world economic order. In the context of the debt problem, international law cannot make possible what i s economically impossible. Therefore, the message i s 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 o f f the loans and to sustain the debtor's economy. The i r r e s i s t i b l e conclusion on t h i s point 134 i s that the debt problem i s better addressed i n the context of the r e a l i t i e s of international economics and may be, p o l i t i c s than international law. A new international economic order might help to arrest the exogenous factors that promote the debt problem. The snag however, i s that i t e n t a i l s an exceeding great weight of economic s a c r i f i c e on the part of the developed countries. For t h i s reason, the quest f o r a new inte r n a t i o n a l economic order i s not seriou s l y attended to by the developed countries. Therefore, the soluti o n to the debt problem would hardly emanate from i t . However, the LDCs with the cooperation of the developed countries can carry out most of t h e i r trade by countertrade e s p e c i a l l y by barter which does not involve foreign exchange but simply the exchange of goods for goods. This w i l l enable them obtain the technology they need f o r economic development i n t h e i r areas of comparative advantage. But the success of countertrade deals w i l l heavily depend on a stable economic growth i n the developed countries e s p e c i a l l y i n the OECD countries. I t w i l l also depend on how much need the developed countries w i l l have of the primary commodities of the LDCs. The technological advancement of the i n d u s t r i a l i z e d countries i s such that they have comparative advantage even i n the production of most of the commodities on which most LDCs w i l l depend for countertrade. Beside, countertrade i s evolutionary. I t gets more sophisticated and complicated each day. This trend 135 causes v i r t u a l l y a l l aspects of i t to yearn for foreign exchange finance i n varying degrees. Though the deal i s yet to involve substantial amount of foreign exchange, i t i s feared that countertrade might be of l i t t l e help. The debt-equity swaps approach to the debt problem can help to a l l e v i a t e the problem i f 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 w i l l otherwise be incurred. I t also reduces the amount of the outstanding debts by converting foreign currency denominated debts into l o c a l currency for investment purposes. I f the banks and the c r e d i t o r governments w i l l p a r t i c i p a t e i n a large scale i n t h i s scheme, and i f the debtor countries w i l l relax l e g i s l a t i o n on p r o f i t r e p a t r i a t i o n (without encouraging c a p i t a l f l i g h t ) , n a t i o n a l i z a t i o n and r e s t r i c t i o n s on areas of investment, the debt problem might even be r e l i e v e d on a more permanent basis. Foreign d i r e c t investments should be encouraged i n debtor countries by avoiding excessive corporate taxation , simplifying investment procedures, providing economic infrastructures and by ensuring p o l i t i c a l s t a b i l i t y f o r the safety of investments. Foreign d i r e c t investments can be a good supplement to the benefits of debt-equity swaps. The implementation of the set objectives i n resolution 222 (XXI) should not be l e f t to only the c r e d i t o r governments, commercial banks should p a r t i c i p a t e . Some of 136 the various ways of implementing the resolution include conversion of debts to aids and grants, payment i n l o c a l currency and reinvestment of such i n the debtors' economy. These had already been done to some extent by some cr e d i t o r governments pursuant to resolution 165(S-IX). Commercial banks' loans are non concessional and are made with p r o f i t motives. Therefore, though banks should r i g h t l y not be expected to cancel or convert debts owed to them to aids and grants, they should nevertheless, help debt management by p a r t i c i p a t i n g a c t i v e l y i n debt- equity swaps and the attendant investments i n debtor countries. To be true, though the LDCs would s t r i v e better with debt reduction program on the part of the c r e d i t o r s , t h i s alone cannot make them not to depend on the developed countries to finance t h e i r economic growth. The Brady Plan not only focuses on negotiated debt r e l i e f but also assures new money from m u l t i l a t e r a l f i n a n c i a l i n s t i t u t i o n s . This would therefore require more money to support the r o l e of these i n s t i t u t i o n s i f the Plan i s to be successful. I t i s also suggested that the Plan would better achieve i t s objectives i f i t can have b u i l t - i n mechanisms to check exogenous factors responsible for the recurrence of the debt problem. For example, discounting high i n t e r e s t rates for the debtors whenever there i s a f a l l i n the GDP or d e f i c i t i n the budget of the members of the OECD. In a l l , i t i s of paramount importance f o r the debtor LDCs to prudently manage and u t i l i z e every of t h e i r 137 resources, ensuring at a l l times that expenditure i s matched with a v a i l a b l e resources. 7 138 APPENDIX A TABLE 1 Performance o f S e l e c t e d LDCs i n Respect o f the IMF Adjustment Program. 1970 - 1985 Growth r a t e s C u r r e n t account d e f i c i t as percentage 1970- 80, 1980-84, v a r i a t i o n O f 1980, exports 1983, 1985 A. LDCs w i t h adjustment programs supported by IMF f i n a n c i n g Bangladesh 3. 7 3.8 + 0.1 192 114 122 C e n t r a l A f r i c a n R e p u b l i c 2. 2 -0.1 -2.4 115 99 8 5 1 Gambia 4. 1 1.6 -2.5 231 96 n.a. H a i t i 3. 8 -0.9 -4.7 65 95 92 2 Malawi 6. 0 2 . 3 -3.7 90 45 3 • • • M a l i 8. 8 -0.1 -3.9 114 122 118 N i g e r 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 s u r - p l u s 4 s u r - p l u s 1 f o r 1984 2 f o r 1982 3 Id 4 f o r 1984 139 Growth rates Current account d e f i c i t as percentage of exports 1970-80 1980-84 v a r i a t i o n 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 -5.4 162 222 5 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 93 121 6 Source: TD/328/Add.5, p.16, Calculations by the UNCTAD se c r e t a r i a t . 5 f o r 1982 6 f o r 1984 140 A P P E N D I X A TABLE 2 LDCs: D e b t a n d D e b t - S e r v i c e R a t i o s , 1980-87 ( i n p e r c e n t o f e x p o r t s o f g o o d s a n d s e r v i c e s , e x c e p t w h e r e o t h e r w i s e s t a t e d ) 1 9 8 0 , '81, *82, •83, •84, •85, '86, ' 87 T o t a l d e b t ( i n b i l l i o n s o f US d o l l a r s ) 633 744 842 894 940 1,016 1 ,102 1,217 D e b t r a t i o 7 82 95 119 133 133 150 169 158 By r e g i o n A f r i c a 92 119 155 171 171 192 239 241 A s i a 71 74 87 92 87 101 101 91 E u r o p e 127 133 141 146 144 159 167 168 M i d d l e E a s t 27 34 46 61 71 83 115 110 W e s t e r n H e m i s p h e r e 183 210 272 290 293 296 352 341 By m i s c e l l - a n e o u s c r i t e r i a c a p i t a l i m p o r t - i n g c o u n t r i e s 114 129 155 164 157 173 185 173 O f f i c i a l b o r r o w e r s 156 181 219 244 257 295 325 346 C o u n t r i e s w i t h r e c e n t d e b t - s e r v i c i n g p r o b l e m s 153 188 241 257 248 270 310 306 T o t a l d e b t a t y e a r - e n d a s p e r c e n t a g e o f e x p o r t s o f g o o d s a n d s e r v i c e s i n t h a t y e a r . 141 1980 , '81 •82 •83 •84 •85 '86 '87 Debt-service r a t i o 8 13 16 19 18 19 21 22 20 By region A f r i c a 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 m i s c e l l - aneous c r i t e r i a c a p i t a l import- countries 19 22 25 22 23 24 25 22 O f f i c i a l borrowers 14 16 17 20 23 27 25 23 Countries with recent debt- s e r v i c i n g problems 27 33 40 33 34 34 36 30 The t o t a l debt value of LDCs1 outstanding debt rose by 10.4% i n 1987 to $1,217 (as shown in table 2) which i s equivalent to 39% of aggregate GDP. Two- t h i r d s of t h i s nominal increase probably resulted from the impact of exchange rate movements on the d o l l a r value of debt denominated i n other currencies. The r e l a t i v e l y strong growth of exports of the LDCs contributed to a reduction i n the r a t i o of debt- t o - exports Actual payments of in t e r e s t on t o t a l debt, plus actual amortization payments on long term debt, as a percentage of exports of goods and services. 142 from 169 i n 1986 to 158 i n 1987. However, debt- t o - export r a t i o s f o r a l l regions remained s u b s t a n t i a l l y above t h e i r l e v e l s i n 1980. From 1980 through 1987, there was a progressive and somewhat rapid growth of the debt r a t i o . Within a space of seven years, from 1980 to 1987, the t o t a l debt of the LDCs rose from $633 b i l l i o n to $1,217 b i l l i o n . The o v e r a l l debt-servicing r a t i o of the LDCs f e l l from 22% i n 1986 to 20% i n 1987. In addition to the r i s e i n export earnings, part of the f a l l i n debt s e r v i c i n g i s owed to the debt restructuring operations, which reduced the debt-service burden i n 1987 by about 9.5% of exports, thus reducing average annual repayments by $40 b i l l i o n annually i n 1983 through 1986 and by over $70 b i l l i o n i n 1987. From 1980 through 1985, there was a progressive increase i n debt s e r v i c i n g amount for A f r i c a region but i n 1987,debt- s e r v i c i n g amount f e l l to $25 b i l l i o n as against $29 b i l l i o n i n 1986. (Data source: The IMF Annual Report for 1988, p.33) 143 BIBLIOGRAPHY BOOKS AND ARTICLES. A b b o t t , G.C. Debt R e l i e f s f o r t h e P o o r e r D e v e l o p i n g C o u n t r i e s . 19 C a s e W. Res J . I n t ' l Law, 1987. I n t e r n a t i o n a l I n d e b t e d n e s s and D e v e l o p i n g C o u n t r i e s . London: Croom Helm, W h i t e P l a i n s : M.E.Sharpe I n c . , 1979. 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