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Foreign Debt

Foreign Debt

From the time of independence, Latin American nations have accumulated large foreign debts, most of them the result of loans to the respective governments. The size of these debts and repayment difficulties led to repeated debt crises during the nineteenth and twentieth centuries, generally coinciding with international economic recessions. What is referred to as the "great Latin American debt crisis," which began in 1982 and lasted most of the decade, was the largest and most devastating in its impact on the economies and societies of the region. But more recently, in the late 1990s, a new set of financial crises buffeted Mexico, Brazil, and Argentina. The nature of these crises can best be understood in the light of the long, complex history of foreign debt in Latin America. It is important to note, however, that the changing nature of financial instruments and markets over time has modified the character of foreign debt.

Foreign debt is the result of domestic agencies or residents (public or private) contracting abroad short- or long-term loans that are payable in a foreign currency. In Latin America during the nineteenth and early twentieth centuries, most such loans were taken by national, provincial, and municipal governments in the form of bonds payable in gold and issued on international capital markets, first in London and Paris, later in other European stock markets, and, after the turn of the century, in the United States, especially on the New York Stock Exchange. The bulk of Latin American foreign debt was in the form of long-term public external liabilities. The bonds usually paid between 4 and 7 percent annual interest and were amortized over ten to thirty years, depending on the loan contract. In the 1970s external bond issues declined in importance for Latin American governments, which took a larger number of direct loans from European, U.S., and Japanese commercial and investment banks. Since the 1990s most debt instruments have been equity finance, in which a large number of international mutual and pension funds invest. At the same time, private companies have gone abroad for short- and long-term loans. A brief review of the historical experience illustrates the changing nature of these loans over time, as well as changes in volume of the debt, interest rates, and impact of the debt service on the Latin American economies.

DEBT CRISES OF THE NINETEENTH CENTURY

Latin America's first foreign loans were negotiated in 1822 to 1825 by the founding fathers of the newly independent nations. Simón Bolívar, José de San Martín, Bernardo O'Higgins, and Bernardino Rivadavia negotiated loans with British bankers for their respective governments of Gran Colombia, Peru, Chile, and Buenos Aires. Most of these loans were used to finance the acquisition of military equipment and warships for the new nations. In this sense the loans were not unproductive, because they contributed to the consolidation of the Latin American independence movements. However, as a result of an international trade crisis in 1825 to 1826, most of the debtor governments were obliged to suspend payments, giving rise to the first Latin American debt crisis.

From 1828 until mid-century, all the Latin American nations except Brazil remained in default on their external debts, a situation that provoked conflicts with European creditors and cut off the flow of foreign capital until the 1850s. The nation that suffered most as a result of the debt moratorium was Mexico. As a result of its war with the United States (1845–1847), the Mexican government was obliged to use the indemnity payments received in exchange for California and the other territories ceded to the United States to pay British bondholders. Subsequently, as a result of Benito Juárez's suspension of payments on the foreign debt in 1861, Britain, France, and Spain occupied the port of Veracruz. The French troops remained and conquered the nation, establishing the empire of Maximilian (1863–1867). International debt politics in nineteenth-century Latin America were thus enmeshed with imperialist adventures and wars.

After 1850 the economic situation of Latin America improved, largely because of rising exports in primary goods and minerals: coffee, sugar, leather, wool, silver, guano, and nitrates. As a result, Latin American governments once again became good credit risks and were able to negotiate approximately fifty foreign loans in the two decades preceding the international economic crisis of 1873. Although some of these loans were used for military purposes, as had been the case in the Latin American loan boom of the 1820s, now a greater portion was utilized for financing public works, including state railways in Peru, Chile, Brazil, and Argentina. As the second loan boom gathered strength, the smaller Latin American republics entered the fray and took numerous loans, many of which were highly speculative, in London and Paris. By 1873 the boom had run its course and the subsequent economic crisis caused a new debt crisis as Peru, Costa Rica, the Dominican Republic, Paraguay, and Bolivia suspended payments.

Latin American government issues floated in England 1822–1825
Year and Borrower Nominal Value (£) Price to Public Nominal Interest (%) Real Interest (%) Sums Realized (£) Bankers
Source: Carlos Marichal: A Century of Debt Crises in Latin America, 1820–1930 (Princeton, N.J.: Princeton University Press, 1989), Table 1, p. 28.
1822
Chile1,000,0007068.6700,000Huelletts
Colombia2,000,0008467.11,680,000Herring, Powels & Graham
Peru450,0008866.8396,000Thomas Kinder; Everett, Walker & Co.
1824
Brazil1,200,0007556.7900,000Fletcher, Alexander & Co.; Thomas Wilson & Co.
Buenos Aires1,000,0008567.0850,000Barings
Colombia4,750,0008866.84,203,750Goldschmidts
Mexico3,200,0005858.61,856,000Goldschmidts
Peru750,0008267.3615,000Frys & Chapman
1825
Brazil2,000,0008555.91,700,000Rothschilds
Central America163,0007368.2188,990Barclay, Herring, Richardson & Co
Mexico3,200,0008966.72,872,000Barclay, Herring, Richardson & Co
Peru616,0007868.2480,480Frys & Chapman
Summary by state
State Total Value of Bonds Issued in London, 1822–1825 (£)
Brazil3,200,000
Buenos Aires1,000,000
Central America163,300
Chile1,000,000
Colombia6,750,000
Mexico6,400,000
Peru1,816,000
Total20,329,300
Table 1

In the 1880s the larger Latin American nations participated in a new rush of foreign loans that was combined with the first major wave of direct foreign investment in mines, haciendas, railways, and urban infrastructure. In this regard it is worth pointing out that, according to the standard economic definition, government loans constitute a different type of foreign investment, one generally defined as portfolio investment. The largest debtor of the 1880s was Argentina, which took a grand total of fifty loans by national, provincial, and municipal government entities. The not unsurprising result was the financial crisis of 1890, known in England as the Baring Crisis because the banking house of Baring Brothers was the major creditor of the Argentine government.

THE EARLY TWENTIETH CENTURY

In the years preceding World War I virtually all Latin American nations again approached the international capital markets for public loans; as a result, by 1914 the combined foreign debts of the Latin American governments approached $2 billion. During the war there was no suspension of payments; on the contrary, various Latin American countries were able to repatriate a portion of their foreign debts as a result of the extraordinary wartime export boom that provided them with substantial revenues. Nevertheless, after the war and the profound economic crisis of 1920 to 1921, most Latin American leaders began to turn to the United States for financial assistance. As a result, New York bankers agreed to provide a considerable number of loans to most of the governments of the region.

Foreign loans to Latin American governments, 1850–1875
Country Total No. of Loans Nominal Value (£ thousands) Purpose
Military (%) Public Works (%) Refinance (%)
Source: Carlos Marichal, A Century of Debt Crises in Latin America, 1820–1930 (Princeton, N.J.: Princeton University Press, 1989), Table 3, p. 80.
Argentina713,488206811
Bolivia11,700-100-
Brazil823,467301357
Chile78,502375112
Colombia22,200-991
Costa Rica33,400-100-
Ecuador11,824--100
Guatemala2650-7723
Haiti11,458--100
Honduras45,590-982
Mexico216,96070-30
Paraguay23,000-8020
Peru751,840104545
Santo Domingo1757-100-
Uruguay13,500--100
Venezuela22,500-3070
Combined Subtotals by Subperiods
Years
1850–1859910,862-3268
1860–18692056,705411247
1870–18752273,270-6040
Table 2

The loan expansion of the 1920s lost strength in 1928 and collapsed after the crash of 1929. During the first years of the Great Depression, most Latin American nations continued to pay a part of the interest on their foreign debts, but as the economic crisis deepened and international trade plummeted, one nation after another confronted rising fiscal deficits. As a result, several nations defaulted on their external debts—first Bolivia, Chile, and Peru in 1931 and 1932, soon followed by Brazil and most of the other nations of the region. Only Argentina, the Dominican Republic, and Haiti did not suspend payments during the 1930s.

This new and widespread debt crisis led to prolonged renegotiations with bankers and investors, beginning with several accords in the 1930s to maintain partial debt service, but it was not until the end of World War II that most foreign debts were restructured. In some cases, such as Mexico and Brazil, the creditors (under heavy pressure from the U.S. government) accepted steep reductions of the real value of the debts. In others, such as Argentina, all debts were paid off in gold.

During the 1950s and early 1960s most Latin American nations received little in the way of foreign loans, although they became associates of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development, or World Bank (WB), innovative multilateral institutions designed to stabilize and coordinate international capital flows. However, by the mid-1960s new economic development programs that required heavy injections of external capital led most Latin American governments to negotiate a rising level of loans from those multilateral agencies as well as from the recently created Inter-American Development Bank (IDB). Most of the loans from the IMF were used to cover deficits in the balance of payments, whereas the WB and IDB loans went basically to economic infrastructure closely linked to industrial and agricultural projects and to growing state enterprises in petroleum, electricity, steel, nuclear energy, and telecommunications.

Although loans from multilateral financial agencies were dominant until the early 1970s, after the oil crisis of 1973 the private banks of the United States, Europe, and Japan began to channel a much larger flow of loan capital to virtually all the Latin American nations, providing money for both public and private enterprises. There was a big jump in foreign indebtedness in this period, with the biggest debtors clearly being Brazil and Mexico, followed at some distance by Argentina, Peru, and Chile. No region in the world absorbed such large external debts as Latin America in the decade of the 1970s, a fact that merits more comparative reflection and discussion. The remarkable feature was that virtually all Latin America governments and public enterprises sought easy money abroad at what were argued to be low interest rates. The supply-side explanation of the lending boom was underlined by numerous economists who argued that the excess sums of petrodollars in Western banks stimulated a ferocious competition to obtain clients who would take loans. On the other hand, the lemming-type behavior of all Latin American governments in seeking loans has yet to be adequately explained in theoretical terms, although both the supply and demand sides of the equation were clearly important. In any case, any such explanation requires a political economy component to be able to explain why different types of regimes in Latin America all became engulfed in the financial frenzy.

Foreign loans to Latin American governments, 1920–1930 (in thousands of U.S. dollars)
Country No. of Loans Nominal Value Purpose
Public Works Refinance Other
Source: Data from A. Kimber, Record of Government Debts (New York: Author, 1929, 1934); Council of the Corporation of Foreign Bondholders, Annual Report (London: Author, 1928–1935); Foreign Bondholders Protective Council. Annual Report (New York: Author, 1934, 1936).
Argentina25419,418124,995281,30119,122
Bolivia366,00043,00023,000-
Brazil36641,318247,514246,821145,983
Chile18342,538200,44652,09290,000
Colombia21179,775146,1858,75021,840
Costa Rica310,9909,8001,190-
Cuba5155,97340,00079,00036,973
Dominican Republic220,00015,0005,000-
El Salvador321,609-21,609-
Guatemala39,4654,9504,515-
Haiti218,634-18,634-
Panama220,5004,50012,0004,000
Peru7110,31460,36649,948-
Uruguay570,38870,388--
Table 3

In the case of Argentina the expansion of the foreign debt took place mostly during the bloody military dictatorship of 1976 to 1983, although it had begun on a small scale before then. In 1975 the Argentine foreign debt stood at $7.9 billion, but it rose to $45 billion by 1983. A review of the bond issues of those years indicates that a large part was guaranteed by state companies such as Yacimientos Petrolíferos Fiscales, the state-owned water, electrical, and telephone companies. Great sums were expended in hydroelectric projects and highways, and an unknown amount in military expenditures. Private corporations also took debt abroad, although these debts were mostly absorbed by the state by means of exchange-rate insurance schemes in the years 1982 to 1983.

In the case of Mexico, in contrast, the reasons for increasing foreign indebtedness were linked to the need of the state political party, the Partido Revolu-cionario Institutcional (PRI), to reinforce populist strategies that could guarantee the immense party bureaucracy and its allies a continued political monopoly (not a democracy). One of the key instruments was the financing of state companies that provided jobs, bureaucratic plums, and thousands of contracts. In the 1970s two public enterprises, Petróleos Mexicanos (PEMEX), the profitable state petroleum monopoly, and Comisión Federal de Electricidad (CFE), the state electrical consortium, took the greatest number of loans. The foreign debt of PEMEX had stood at barely $367 million in 1970, but by 1981 had surpassed $11 billion, representing 27 percent of total long-term Mexican public debt. Promoting electrical expansion was also a major government priority under the administrations of presidents Luis Echeverría (1970–1976) and José López Portillo (1976–1982); this led the external obligations of the public electricity corporation, CFE, to rise from a mere $990 (i.e., less than one thousand dollars) in 1970 to more than $8.2 billion by end of 1981.

THE GREAT LATIN AMERICAN DEBT CRISIS AND RESTRUCTURING

By the early 1980s the debt service had become a major problem. The abrupt rise of interest rates in the United States in 1980 and 1981 provoked severe, international monetary instability and a decline in world trade in 1980 to 1982. At the same time, a sharp drop in petroleum prices in early 1982 added fuel to the impending financial collapse. As sources of funds dried up in the foreign capital markets and hard-currency fiscal revenues dropped, many governments of the region were confronted by the fact that they could no longer meet their debt payments. The outbreak of the debt crisis was signaled most clearly in the announcement by Mexican Finance Secretary Jesús Silva Herzog in August 1982 in which he ratified temporary suspension of payments on external debt. The upheaval that this decision caused in international money markets led to the first renegotiating program between Mexico and the creditor banks, but at first there was much doubt about whether an agreement could be reached—indeed, there was concern that a world financial crash might result from the Latin American debt crisis.

Public external debt of Latin American nations, 1970–2000 (in millions of dollars)
Country 1970 1980 1990 1995 2000
Source: The World Bank, Global Development Finance, Washington D.C., several years.
Argentina
Total external debt5.8127.15762.23298.802146.172
Annual service1.114.1826.1588.88927.345
Bolivia
Total external debt5882.7024.2755.2725.762
Annual service26366385372662
Brazil
Total external debt5.73571.52119.877159.073237.953
Annual service75214.7578.16821.67762.788
Colombia
Total external debt2.2376.94117.22225.04834.081
Annual service2879513.8894.3455.171
Ecuador
Total external debt3655.99812.10813.99413.281
Annual service431.0081.0841.4171.276
Peru
Total external debt3.2119.38620.06430.85228.56
Annual service5222.1514761.244.305
Uruguay
Total external debt3631.664.4155.3188.196
Annual service972999878621.313
Venezuela
Total external debt1.42229.34433.1735.84838.196
Annual service1206.0374.994.8675.846
Dominican Republic
Total external debt3602.0024.3724.4484.598
Annual service45379232409521
Guatemala
Total external debt1591.183.083.6554.622
Annual service38145214350438
Honduras
Total external debt911.473.7184.5715.487
Annual service6207389553578
Mexico
Total external debt6.96957.378104.442166.874150.288
Annual service1.30110.96211.31326.88758.259
Nicaragua
Total external debt2032.1910.70710.3597.019
Annual service3611516288300
Table 4

Virtually all Latin American nations suspended payments on their debts at different times during the 1980s, each time provoking a minor financial panic. Simultaneously, the IMF and the large international banks pressured Latin American financial authorities to impose drastic austerity programs. Government deficits were gradually cut, but at the expense of economic growth. As a result, the 1980s was a time of negative growth, resulting in the loss of an important part of the socioeconomic advances of the previous two decades. In particular, working sectors suffered a steep decline in real wages at the same time that educational and health services deteriorated in quantity and quality. As a result, the living standards of the vast majority of Latin Americans fell significantly, provoking social and political discontent.

By the late 1980s some countries began to experience a slight improvement that made possible more solid debt renegotiations. In 1988, with the establishment of the Brady Plan—beginning first with Mexico—it became evident that the U.S. Treasury was taking an increased role in the resolution of the debt crisis in order to stabilize world financial markets and assure the banks that they would recover most of their money. Following new restructuring agreements with the international commercial banks, a series of proposals made by successive secretaries of the United States Treasury, James Baker (1985–1988) and Nicholas Brady (1988–1993), served as the basis for a more long-term resolution of the Mexican debt crisis in 1988. The basic accord was based on the exchange of the old bonds for new so-called Brady bonds, which were long-term debt instruments with a U.S. Treasury guarantee. The net result was a limited discount of the total capital owed to banks and a drop in debt service payments.

The Mexican debt restructurings reflected the success of the alliance of the IMF, the U.S. Treasury, and the international private banks in guaranteeing continued debt service payments and at the same time impelling a dramatic restructuring of the Mexican public sector, including privatization of state enterprises and liberalization of foreign trade. This set of neoliberal policies—which were, in part, the offspring of the debt crisis and which were applied in many developing nations—came to be known as the Washington Consensus. Once neo-liberalism was generally adopted by most Latin American political and financial elites, it became possible to carry out new programs of financial engineering such as the Brady Plan, which, it was expected, could help reconcile debtor countries and their numerous international creditors.

In the early 1990s other nations undertook the process of drafting similar far-reaching agreements. As a result, there was a new boom in capital flows to the Latin American nations. According to the IMF, between 1990 and 1993 Mexico received $91 billion, or roughly one-fifth of all net inflows to developing countries. Mexico was followed by Brazil and Argentina, and throughout the region these years were a time of financial euphoria and renewed indebtedness. However, the boom was short-lived. The financial bankruptcy of the Mexican government in December 1995 not only led to a general economic crisis but also threatened international financial markets, particularly because of the large amount of Mexican debt that had been issued on the emerging markets. Bankers and investors everywhere were terrified by the prospect of capital flight from Latin America back to Europe, Japan, and the United States. As a result, the head of the U.S. Treasury, Robert Rubin (by profession a banker who had been heavily engaged in global finance), convinced the U.S. president, William Clinton, that a Mexican rescue program was urgently needed. It was the first of various rescue plans—most headed by the IMF—to confront a succession of financial crises; in fact, the IMF virtually exhausted its resources when it organized similar bailouts in the late 1990s for Indonesia, South Korea, Russia, Brazil, and Turkey, and then in 2001 for Argentina. These financial collapses demonstrate that as financial markets have become more complex in recent decades, the role of governments has been crucial in confronting crises, but also that there is a need for profound reform of the international financial architecture.

See alsoBanking: Overview; Banking: Since 1990; Bolívar, Simón; Foreign Investment; Foreign Trade; Inter-American Development Bank (IDB); International Monetary Fund (IMF); Mexico, Political Parties: Institutional Revolutionary Party (PRI); O'Higgins, Bernardo; Petróleos Mexicanos (Pemex); San Martín, José Francisco de; World Bank.

BIBLIOGRAPHY

Cline, William. International Debt Reexamined. Washington, DC: Institute for International Economics, 1995.

Marichal, Carlos. A Century of Debt Crises in Latin America: From Independence to the Great Depression, 1820–1939. Princeton, NJ: Princeton University Press, 1989.

Payer, Cheryl. The Debt Trap: The IMF and the Third World. New York: Monthly Review Press, 1974.

Sebastián, Luis de. La crisis de América Latina y la deuda externa. Madrid: Alianza, 1988.

Stallings, Barbara. Banker to the Third World: U.S. Portfolio Investment in Latin America, 1900–1986. Berkeley: University of California Press, 1987.

                                                      Carlos Marichal

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