Chapter 13 Balance of Payments – Deficits and Debt

Chapter 13 Balance of Payments – Deficits and Debt

Debt Crisis of 1980’s • Find information on current account and capital account (IMF or Wikipedia) • External debt is accumulated when • Domestic saving rates are low • Current account deficits are high • Imports of capital are needed for industrialization • Debt servicing costs are high

Dimensions of LDC debt burden • Debt to GDP ratio • Debt-service ratio (as a % of exports)

Reasons for debt-crisis (1980’s) • Oil-prices high during 1974-1979 • Growth rates in DC fell affecting outward looking policies (export) of LDC’s • Fear of painful stabilization policy – avoided IMF • Heavy borrowings from commercial banks and private sector lenders • External debt of LDC’s doubled from $180 billion (1975) to $406 billion (1979) • 40% of the debt was non-concessional • Countries affected – Brazil, Argentina, Mexico – IMF Stabilization Program

Asian Crisis of 1997 • Property bubble • Banks failed • Currency values fell by 33% • IMF bailout of South Korea, Thailand, Indonesia ,and Philippines

Basic Transfer Equation • FN = dD (13.1) • Where, FN = net capital inflow • D = total accumulated foreign debt • d = rate of increase of total debt • BT = dD = rD = (d – r) D • BT = Basic Transfer • rD = total interest payments • Thus, basic transfer is simply the net capital inflow minus interest payments • BT will be positive if d > r • BT will be negative if r > d

Basic Transfer Equation • In the early stages of debt accumulation, • LDC’s D and d are high • Most of the debt come from official sources like IMF, so r is low and BT is positive • In this stage accumulation of debt will not pose any serious threat as there is positive capital flow which can be used for productive development project earning rate of return higher that interest rate (r) • In the later stage • D is too large, d slowly falls • Most debt comes from commercial banks and private sector lenders, r is high and BT is negative

Six Factors • In the later stage, d is low and r is high for the following reasons • Very large D, d declines as amortization rises • Switch from official to private sector lenders, resulting in high r • Adverse terms of trade and balance of payment deficits • Global recession, oil-shock • Loss of confidence in currency of LDC’s • Capital flight • Thus, debt crisis becomes self-reinforcing

Chapter 13 Balance of Payments – Deficits and Debt