1 Chapter 15 Foreign Debt Norton Media Library Dwight H. Perkins Steven Radelet David L. Lindauer

2 Following WWII, Mexico borrowed little from international banks and foreign investors (shares in local firms) and official lenders (i.e WB) In late 1960s and 1970s the capital market instruments got more sophisticated and costs fell. Mexico and many other countries started to look for more financing Mexico foreign borrowing has tremendous impact on its economic growth, macroeconomic stability, job creation, and political dynamics Following WWII, Mexico borrowed little from international banks and foreign investors (shares in local firms) and official lenders (i.e WB) In late 1960s and 1970s the capital market instruments got more sophisticated and costs fell. Mexico and many other countries started to look for more financing Mexico foreign borrowing has tremendous impact on its economic growth, macroeconomic stability, job creation, and political dynamics

3 In 1970: Mexico foreign borrowing from private creditors was 1% of GDP 1980: 8% of GDP.... more than half of the debt was “short term”: had to be repaid within 1 year At first, borrowing seemed to help: GDP per capita rose 2.4% But it turned out that Mexico had borrowed “too much too quickly” In 1982 Mexico announced it could not service its debts In 1970: Mexico foreign borrowing from private creditors was 1% of GDP 1980: 8% of GDP.... more than half of the debt was “short term”: had to be repaid within 1 year At first, borrowing seemed to help: GDP per capita rose 2.4% But it turned out that Mexico had borrowed “too much too quickly” In 1982 Mexico announced it could not service its debts

4 Investment fell, negative growth rates.... Mexican crises cascaded out to many other heavily-borrowed- developing countries Some countries are still affected! By 2003, developing countries as a whole were repaying more to official creditors than they were borrowing! Investment fell, negative growth rates.... Mexican crises cascaded out to many other heavily-borrowed- developing countries Some countries are still affected! By 2003, developing countries as a whole were repaying more to official creditors than they were borrowing!

5 Since the 1980 several countries in the region have experienced a surge in economic development and have initiated debt management programs in addition to debt relief and debt rescheduling programs agreed to by their international creditors. The following is a list of external debt for Latin Americadebt reliefexternal debt Since the 1980 several countries in the region have experienced a surge in economic development and have initiated debt management programs in addition to debt relief and debt rescheduling programs agreed to by their international creditors. The following is a list of external debt for Latin Americadebt reliefexternal debt

6 CountryExternal DebtYear Mexico Cuba Bolivia Honduras Costa Rica

7 Prudent borrowing has been an important part of the development strategy for some developing countries Most countries in Western Europe (And USA in 19th century) relied on foreign borrowing to finance its development strategy. Borrowing permits a country to invest more than it can save and import more than it can export If the additional funds finance productive investment sufficient returns recall that low-income countries have the potential to realize higher rate of return! Prudent borrowing has been an important part of the development strategy for some developing countries Most countries in Western Europe (And USA in 19th century) relied on foreign borrowing to finance its development strategy. Borrowing permits a country to invest more than it can save and import more than it can export If the additional funds finance productive investment sufficient returns recall that low-income countries have the potential to realize higher rate of return! ADVANTAGES AND DISADVANTAGES OF FOREIGN BORROWING

8 Therefore, foreign borrowing can help support growth and development and yield attractive returns to lenders Some countries prefer foreign borrowing over FDI..... can you explain? Think: Tax holiday, ownership, fast and ease.... Yet debts must be paid Borrowing to finance consumption or bad investment! Therefore, foreign borrowing can help support growth and development and yield attractive returns to lenders Some countries prefer foreign borrowing over FDI..... can you explain? Think: Tax holiday, ownership, fast and ease.... Yet debts must be paid Borrowing to finance consumption or bad investment!

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10 Debt sustainability How much aggregate debt can a country take before it begins to get into trouble? As long as the country’s loan can be serviced, the loan is sustainable Different factors determine country’s ability to repay debt: Debt size, trade and budget deficit, interest rate on debt, loan mix, GDP growth rate, economic factors, exports, government revenues Debt service: the amount due for principle and interest payments in a given year How much aggregate debt can a country take before it begins to get into trouble? As long as the country’s loan can be serviced, the loan is sustainable Different factors determine country’s ability to repay debt: Debt size, trade and budget deficit, interest rate on debt, loan mix, GDP growth rate, economic factors, exports, government revenues Debt service: the amount due for principle and interest payments in a given year

Country’s Capacity to Pay 3 measures: GDP, exports, and government tax revenues The larger a country’s productive capacity and corresponding income, the greater its ability to repay debt For foreign debt, the country’s ability to earn the dollars (or other currencies) needed to repay the debt dominated to foreign currency is important 3 measures: GDP, exports, and government tax revenues The larger a country’s productive capacity and corresponding income, the greater its ability to repay debt For foreign debt, the country’s ability to earn the dollars (or other currencies) needed to repay the debt dominated to foreign currency is important 11

Escape from the crises, for some countries Refinancing: making new loans to repay the old Rescheduling: to allow longer repayment and possibly low interest Reduction Buyback: the debtor buys the loan from the creditor Debt-equity swaps: creditors are given equity in a company in return for eliminating the debt outstanding Refinancing: making new loans to repay the old Rescheduling: to allow longer repayment and possibly low interest Reduction Buyback: the debtor buys the loan from the creditor Debt-equity swaps: creditors are given equity in a company in return for eliminating the debt outstanding 12

Conclusion Advantages and disadvantages of foreign debt “loans solve liquidity problems not economic crises”! Utilization of foreign loans? Absence of economic vision Foreign loans and macroeconomic policy Independence and freedom? Advantages and disadvantages of foreign debt “loans solve liquidity problems not economic crises”! Utilization of foreign loans? Absence of economic vision Foreign loans and macroeconomic policy Independence and freedom? 13

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21 End Chapter 15 This concludes the Norton Media Library Slide Set for Chapter 15 W. W. Norton & Company Independent and Employee-Owned Economics of Development SIXTH EDITION By Dwight H. Perkins Steven Radelet David L. Lindauer