Transcript 5. International Debt Crisis:a

1980’s debt crisis
In the aftermath of the 1973 oil shock, many commercial banks
suddenly found themselves with sizeable amounts of funds
deposited by oil producers. In the rush to recycle that cash,
many banks lent to governments of LDCs.
1979-1980 second OPEC oil price increase.
Another situation of excess world savings
lead to a rise in developing countries’
debt.
U.S. federal reserve in 1979 adopts anti inflation
monetary policy that helped push the world economy
into recession by 1981.
U.S. interest rates up and dollar appreciates.
Since much developing countries’ debt is denominated
in dollars, developing countries’ real value of debt
service is up. Exports are down because of world
recession.
In the early 1980’s, when commodity prices
fell, the terms of trade swung against LDCs.
On August 12, 1982 Mexico declared a temporary
moratorium on interest payments. Mexicoannounced that
it has left with zero international reserves and can no longer meet
its debt obligations.
Many commercial banks were left with large amounts
of defaulted syndicated loans. In 1983, a market
for swapping loans was created. European and US
banks began to swap their defaulted loans. The
transactions made economic sense in part due to
US accounting practices and to the inability of US
banks to write down their loans to their economic value.
Starting in 1987, many banks began to set aside reserves
against their LDC exposure and were able to sell
those loans at a discount.
The secondary market for LDC debt was born.
Debt relief formulas were implemented :
Debt Buy backs
Swapping Loans into exit bonds,
Conversion of loans into local currency for equity investment,
Exchanging loans for Brady Bonds
Brady Bonds are securities that have
resulted from the exchange of commercial
bank loans, sometime defaulted loans, into
new bonds. Many Brady Bonds have their
principal and two or three semi-annual interest payments
, which roll over, collateralized by 30-year
zero-coupon bonds and by high quality assets.Should a Brady
bond whose principal is collateralized default, investors can
only collect the principal when the bonds mature.
Costs and benefits of sovereign default
Costs:Seizure of assets
exclusion from future borrowing
reduction of gains from international trade
Benefits
debtor escapes paying debt -RESURCE TRANSFER from creditors to debtors.
Managing Debt Crisis
Concerted lending and debt recontracts.
Muddling through.
Market based debt reductions:voluntary market transactions.