Debt Crisis Management
After World War II country risk became an issue of prime concern for the international financial community. Various methods have been used by the risk rating agencies to determine the extent of country risk, integrating a range of qualitative and quantitative information on alternative measures of political, economic and financial risk to evolve composite risk indices. Country risk analysis is a complex task and demands a holistic vision, expert skills and consistency in measurements.
The analyst must follow standard procedures to assure coherency in its studies, using reliable and useful sources of data, including rating agencies, official institutions and other several sources. The country-risk analysis reports show the strengths and weaknesses of a country, after dealing with the macroeconomic, socio-political and financial aspects in order to define a risk level and, consequently, a related price for the asset in risk.
Managing the risks of a portfolio demands a systematic follow up concerning the external and internal environment, governmental policies’ outlook provided by rating agencies, and so on.
During the 1970s, the sharp increase in the oil prices, followed by worldwide inflation, a collapse in commodity prices, global recession and high interest rates walloped the economies of the developing countries the world over. When oil prices shot up, these countries borrowed heavily at high interest rates to prevent the economic downfall. The international financial institutions lent money to developing countries along with official subsidies and such aid grew very rapidly during this period.
As a result of the irresponsibility of both creditor and debtor governments (e.g., corruption, private projects benefitting only the rich, etc.), the countries did not use the money for productive investment; rather, they spent these new dollars on immediate consumption and the countries were unable to repay such amassed debt. Consequently, the total medium and long-term debt of developing countries quadrupled in nominal terms, from about$ 140 billion at the end of 1974 to about $560 billion in 1982. The debt trap got stiffer for these countries and the borrowings had reached $2.4 trillion by the end of 1998.
The debt crisis has had a deep impact on the economic growth of the developing countries. The situation became alarming and of major concern to the international community. International institutions including IMF, and the World Bank sought to find ways of reducing the impact of continuing debt of the developing countries. A framework to reduce the burden of debt was evolved at two levels wherein the debtors needed to grow faster and export more and to pull down the cost of debt service. During the process of overcoming the debt crisis, most countries sought IMF assistance for debt relief. As a crisis managing institute, the Fund assumed a new role as financial organizer for the troubled debtor nations.
The IMF required ‘structural adjustment programs in these countries. Debtor governments had to agree to impose very strict economic programs on their countries in order to reschedule their debts or borrow more money. Put simply, countries had to cut spending to decrease their debt and stabilize their currency. The governments limited their costs by slashing social spending (e.g., education. health, social services, etc.), devaluing the national currency (via lowering export earnings and increasing import costs), creating strict limits on food subsidies. cutting workers’ jobs and wages (especially workers in government industries and services), taking over small subsistence farms for large-scale export crop farming and promoting the privatization of public industries.
Most countries experienced the economic trauma of a recession and often a depression; and the poorest of the poor were the most affected. In 1982, Mexico declared that it was unable to repay its debts. Mexico owed vast sums of money to commercial banks in the West and the default posed a serious threat to the stability of the international financial system. The commercial banks, in conjunction with the International Monetary Fund (IMF), worked out a system whereby indebted countries could spread out or reschedule their debts rather than default.
It was during this time that the IMF and World Bank began to take over much of the debt owed to commercial banks. These institutions offered developing countries new loans with strict conditions attached. Since the 1980s, the IMF and the World Bank have been in control of the debt crisis. Indebted countries were required to follow policies favoured by the IMF and World Bank to get new loans or even aid money. These policies directly affected the lives and livelihoods of the people in the indebted countries