Brady plan for debtor nations is working well enough -- just . . .


In April of this year, U.S. Secretary of the Treasury Nicholas Brady announced a 180-degree turn in American policy toward Third World debtor countries.

From the onset of the debt crisis in 1982 until Brady's about-face, the United States had steadfastly insisted that the way to deal with Third World debt was not to cancel it, but for the countries to grow their way out of the problem - assisted by new loans organized by the International Monetary Fund.

In future, Brady said, the United States would favor plans aimed at reducing debt; the resources of the IMF, the World Bank, and other official agencies would be used to promote schemes that cancelled part of the debt instead of rounding up new capital.

How is the Brady approach doing? The answer is typical of economic policy in these eerily calm times: It is doing well enough to avoid an immediate crisis, but the really hard tests still lie ahead. Brady's decision to reverse more than six years of debt policy and to abandon the so-called Baker Plan, which was introduced with much fanfare in 1985, reflected a judgment that most other players in the debt game had reached earlier: The strategy of growing out of debt was not working.

The clearest verdict was given by the marketplace. In the past few years a substantial secondary market in Third World debt has emerged in which banks sell off their claims to more optimistic investors or to countries that are buying back their debt.

Prices in this market have steadily declined, until by early this year the average price of the debt of troubled Third World nations was only 30 cents on the dollar. Whatever hopeful noises that bank spokesmen might make, the secondary market showed that they did not expect to get much of what they were owed.

With old debt selling at only a fraction of its face value, it also became impossible to attract new capital to debtor nations. The only entities that would lend to problem debtors were official agencies such as the World Bank and the IMF. Private capital moved the other way.

A major consideration in the shift in debt strategy was the realization that private investors in general, and banks in particular, were increasingly pulling out of the Third World, shifting the risk on to the taxpayers of the lending countries.

And so the new debt strategy was announced. The approach that Brady originally proposed was one of "voluntary," or to give a more accurate description, market-based debt reductions.

The basic idea was that the IMF, the World Bank and others (mostly the Japanese) would lend money to troubled debtors with which they could buy back their debt on the secondary market.

More complicated schemes, such as using hard currency to guarantee debt in return for interest reductions, might stretch the money a little further.

Within a few weeks after Brady's speech, however, this idea was quietly shelved. Calculations both inside the U.S. government and at the World Bank showed that buybacks of debt would be too expensive to be feasible.

There just wasn't enough public money available to permit a significant debt reduction, even at current highly depressed secondary market prices. The sums of money available would look even less adequate if, as one would expect, the effort to buy back debt drove prices up.

At this point the Brady Plan was starting to look like an embarrassing failure. Why hadn't Brady done his homework and found out whether there was enough money before announcing his plan?

(Washington gossip reports that Brady, like his predecessor James Baker, is in the habit of making policy without consulting his own staff, let alone other parts of government.)

The Mexicans chose to hear what they liked in Brady's proposal - U.S. approval for debt reduction - and to ignore what they didn't like - the principle that such debt reduction would be voluntary.

Shortly after the Brady speech, Mexican negotiators headed for the United States to demand a sharp reduction in their debt to commercial banks, with nothing voluntary about it.

Some people will claim that this was really what U.S. policy makers wanted from the beginning, that the initial emphasis on market-based solutions was nothing but ideological window dressing. But seemingly foolish statements by government should usually be taken at face value.

Only people who have never seen government decision-making from close up imagine that officials who seem naive in public have sophisticated hidden agendas.

Be that as it may, over the summer the original, essentially silly, Brady proposal evolved in the Mexican case into a fairly sensible solution. Creditors and debtors negotiated a debt reduction, with a small amount of official money thrown in to sweeten the pot.

It took months of hard negotiation to arrive at the Mexican debt package, details of which are still being worked out. Neither side got what it wanted, which is a good sign.

The Mexicans got a much smaller debt reduction than they wanted, and it is quite likely that they will be back for more in a couple of years. The banks found that U.S. promises that debt reduction would be voluntary had evaporated.

Each bank was given a choice between reducing its claims and lending substantial additional money to Mexico. But the option of doing neither was ruled out, and banks are not pleased with the rather modest value of guarantees provided by the World Bank et al.

The deal has left everyone unhappy, but for the moment the important thing is that a deal was reached, and that the new U.S. strategy of debt reduction is off to an acceptable start.

The question now is whether the Mexican debt deal can be used as a model for other debtor countries. Here the prospects are more dubious.

Mexico is in many ways the ideal problem debtor. It is run by a group of reformist technocrats who have been following sound fiscal policies and opening up markets. The Mexican government is therefore both deserving of and in a position really to use debt relief.

And Mexico's border with the United States makes it easier to justify substantial public commitment to helping its economy.

It is hard to think of other major debtors in equally good positions. Argentina hasn't been servicing its debt for quite a while, and it still has multimillion per cent annual inflation, so it's hard to see that debt relief will do it much good.

Brazil is following Argentina's path, a few paces behind. Venezuela is the least deserving of debtors, having created its debt problem entirely through irresponsible policies and capital flight.

So it is far too early to call the Brady Plan a success. Nonetheless, the first round has not gone as badly as one might have feared.

Originally published, 9.11.89