Chapter 1: The 1980s Debt Crisis (2024)

Setting the scene (1970-80)

2. The early 1970s saw the disintegration of the rules-based Bretton Woods system. In 1971, the U.S. suspended convertibility of the dollar to gold, and by 1973, the system of commonly agreed par values between the major currencies had collapsed. In subsequent years, IMF responsibilities changed and expanded. As balance-of-payment imbalances grew, the frequency and size of IMF financing increased. And with fewer rules governing the international monetary system, the IMF’s surveillance role was greatly enhanced. These structural changes meant that when the 1980s Debt Crisis erupted, the IMF found itself at the core of managing the emergency.

3. During the 1970s, the risk of sovereign default was not perceived as a major concern. Most “external arrears” generated by a country were created by exchange restrictions. For example, an importer might miss a payment because the authorities were slow to release foreign exchange. Sovereign default had not been a problem since the Second World War.

Therefore, the IMF’s policy framework was not equipped to confront the complications that arose in the context of the sovereign debt difficulties that emerged in the 1980s. In fact, it took until 1980 for the IMF’s Executive Board even to agree that a default on sovereign debt should also be covered under the external arrears policy [2, 3].

4. When the IMF did provide support to its members, it could often assume that the private sector would quickly resume lending, supporting the adjustment effort. This presumed “spontaneous lending” often bore true in practice. As such, there was little need to put pressure on the private sector to explicitly commit to contribute resources to an adjustment program. In other words, “financing assurances” were implicitly assumed. Meanwhile, the official sector—principally, the Paris Club—would regularly and reliably provide financing to a program in the form of debt rescheduling (although almost exclusively on “market terms”).

5. Nevertheless, imbalances were rapidly building in many developing economies. The oil price shocks of 1973 and 1979 generated huge trade surpluses for the oil-rich, and corresponding deficits for the oil-poor. Petro-dollars were “recycled” in the form of loans to cover deficits among oil importers. In many cases, oil importers were unwilling or unable to make the necessary adjustments to close these deficits. The robust growth in living standards enjoyed during 1950s and 1960s were viewed as the norm, while the stagnant growth during the 1970s was thought of as a temporary slowdown—so why not borrow during the lean years [1, 4]? Capital account deregulation and the development of syndicated lending instruments meant that large commercial banks, particularly in the U.S., became the main intermediary of this lending. Net international bank lending grew from US$68 billion in 1977 to US$160 billion in 1980, almost a third of which went to non-oil developing countries (Boughton, 2001).

Containing the crisis (1981-83)

6. This period of high inflation, abundant global liquidity and rising indebtedness came to an end in the early 1980s. In the U.S., interest rates were raised to a peak of 20 percent in June 1981, with many other advanced economies acting similarly. A global recession ensued, and the dollar appreciated by more than 40 percent in real effective terms over 1980-85. The combination of higher interest rates and a stronger dollar significantly raised the real burden of dollar-denominated debt, and this was compounded by weak exports and low FDI resulting from the global slowdown.

7. The first serious fallout occurred in eastern Europe—with Poland, followed quickly by Romania, Hungary, and Yugoslavia—all requesting IMF-supported programs over the period 1981-82. However, it was Mexico in 1982 that marks the real beginning of the crisis. Bank exposures, especially by U.S. and Japanese banks, were so large that a default on its external debt (US$43 billion) would have had systemic implications. This, and the subsequent IMF-supported programs in Argentina, Brazil, and Chile amongst others, led to not only an unprecedented increase in IMF lending, but also a significant shift in relations between debtors, creditors, and the official sector.

8. Regulatory rules meant that any arrears on commercial bank interest or principal payments would require an immediate write-down of asset values, causing widespread solvency problems. However, with some degree of forbearance on the part of supervisors in the U.S., Japan, and Europe, maturity extensions and new lending could be tolerated. This set the constraints on private sector involvement (PSI) from the creditor side. During these initial programs, commercial banks were willing to extend maturities by 1-2 years. In many cases, however, this was not enough to fill the financing gap, and “new money” was needed to cover the interest payments on external debt. This practice become known as “concerted lending” and was also supported by Paris Club debt rescheduling. Given that these private- and official-sector maturity extensions were largely provided on market terms, and with an ongoing flow of new borrowing, debt continued to increase.

9. While the papers did not explicitly raise concerns regarding the solvency of the sovereign debtors, the IMF began seeking unprecedented commitments on financing assurances from both the private and official sector. For “concerted lending” programs, the IMF would not disburse its resources until a “critical mass” of banks had explicitly agreed to provide new money. In this way, the IMF acted to coordinate creditors who otherwise might seek to reduce exposures, which would have further exacerbated the crisis.

10. In 1983, the IMF began requiring explicit financing assurances from creditors, including from the Paris Club in cases where the country was seeking “exceptional treatment” (rescheduling on below market terms) on their debt [5-7]. But this led to a dilemma, as Paris Club practices meant that they could only provide debt relief in the presence of an agreed IMF-supported program. To solve this conundrum, the IMF adopted its “approval in principle” procedure.¹ Here, the IMF would agree a program with a member country, but hold back disbursem*nts until a deal had been reached with the Paris Club, after which the money would be immediately released [9].

11. To encourage creditor participation in these programs, the IMF also strengthened safeguards against (external) debt arrears. The policy of “non-toleration of arrears” was built into program conditionality. This sought to prevent new arrears arising under the program and often also included the full clearance of existing arrears. If new arrears arose, the program could be cancelled or postponed, leading to withdrawal of substantial official sector support. While this strengthened the negotiating position of the commercial banks, it helped the flow of new money into the crisis countries [8].

Searching for resolution (1984-87)

12. As the middle of the decade approached, the crisis in Eastern Europe and in some Asian countries had largely subsided, but Latin America remained in difficulty. The IMF began to work towards longer-term solutions to the debt crisis. Beginning in 1984, with Mexico, the multiyear restructuring exercise was launched, whereby countries would enter into multi-year restructuring arrangements (MYRAs) with commercial banks. MYRAs were designed to smooth amortization “humps,” shape a more realistic debt-servicing profile, and provide a clearer planning horizon for creditors, investors, and the debtor government than “concerted lending,” permitting a return to normal financial market relations [9-11]. At the outset, the Paris Club was hesitant to enter officially into MYRAs and continued to enter into repeated rescheduling agreements until later in the period [12, 14].

13. To catalyze commercial bank willingness to enter into MYRAs, the IMF developed “enhanced surveillance” procedures in 1985 [12]. For countries that did not have financial arrangements with the IMF, “enhanced surveillance” allowed the IMF to assess policies and economic conditions on a more frequent basis than it would do under normal surveillance policies. Enhanced surveillance was applied to several countries in the latter part of the decade, with mixed success.

14. During this period, the IMF also articulated the scope of its “duty of neutrality” in disputes between members or between member countries and their non-resident private creditors regarding non-payment of financial obligations [13]. While the IMF was adamant in maintaining neutrality on the merits of a dispute of a claim, it would, if requested, use its “good offices” to assist members in resolving disputes.

15. The financial position of banks still prohibited debt relief, and regulators continued to exercise forbearance. At the same time, indebted countries were flagging in their adjustment efforts, official support by creditor countries and multilateral institutions was fragmented, and net lending by commercial banks was dropping. In 1985, the U.S. Secretary of the Treasury, James A. Baker III, announced a vision for reorienting the debt strategy. The “Baker Plan,” broadly supported by the IMF, called for pro-growth structural reforms in countries, new and increased lending by commercial banks, and a greater role for multilateral development banks [14, 15]. However, it fell short of calling for debt relief.

16. By 1987, as bank fragmentation increased and debt problems continued, there was the growing realization that debt relief was needed. The IMF began to distance itself from concerted lending, endorsing a wider range of financing techniques, such as debt buy-backs (e.g. Bolivia 1987) and debt-for-equity swaps, as well as “menus” that gave bank creditors the option of exiting the relationship by swapping loans for equities or negotiable bonds (e.g., Argentina 1987) [16].

Debt relief (1988-89)

17. In 1988, the IMF officially called for debt relief. In March 1989, the U.S. Secretary of the Treasury, Nicholas F. Brady, announced “the Brady Plan,” which contemplated innovations with respect to the IMF’s role in the debt crisis, which were later endorsed by the Executive Board in a series of papers [17-22]. These included the following incentives for commercial bank participation in providing debt relief:

• Set-Asides: The IMF earmarked a portion of financing arrangements to support a member’s debt reduction strategy (e.g., for buy-backs).

• Augmentation: IMF resources were used to secure interest payments (and later, principal payments²) on swapped instruments. Money was deposited in escrow accounts.^{3 4}

18. The Brady Plan also called on the IMF to reconsider its policy of requiring firm financing assurances before lending, with accumulation of arrears not counting as financing. The “non-toleration of arrears” policy at the time allowed creditors to hold up IMF approval of financing until arrears were cleared, which gave banks an effective veto over approval of arrangements. Under the revised policy adopted in 1989, the IMF agreed to tolerate arrears to private creditors in some cases, although the IMF’s policy of non-toleration of arrears to official creditors remained in place [20, 23, 24].⁵

19. The change to the IMF’s policy on lending into arrears to private creditors was particularly crucial given the increasing fragmentation of the bank community and increased litigation to enforce their claims. In this context, the IMF also clarified its jurisprudence regarding its jurisdiction over exchange contracts. With respect to litigation against debtors who were in arrears to non-resident creditors due to exchange controls, the IMF explained the conditions under which, in accordance with the Articles of Agreement, a creditor’s claim would not be enforceable if the underlying exchange control regulation was consistent with the Articles [25].

20. By the end of the decade, the IMF had evolved substantially. The policies in place had changed fundamentally from the beginning of the decade. From a broader perspective, the international financial system had also deeply changed, setting the stage for the emergence of bonded debt as the primary form of sovereign financing, which would pose its own challenges in the decades to come.