What is the international debt crisis

The International Debt Crisis
What is International Debt?

Like individuals and families who borrow money to pay for a house or an education, countries borrow money
from private capital markets, international financial institutions, and governments to pay for infrastructure such as
roads, public services, and health clinics; to run a government ministry; or even to purchase weapons. Also like
individuals, countries must pay back the principal and interest on the loans they take out. But there are important
differences between individuals and countries. If a person borrows money, he or she receives the money directly and
can use it for purposes benefiting the borrower. But if a country borrows money, the citizens are not necessarily notified
or informed of the purpose of the loan or its terms and conditions. In practice, some governments have used loans for
projects that do not meet minimum standards of social, ecological, or even economic viability. At times, these loans
have been used to enrich a small group of people.

In other cases, although the money was used for legitimate purposes, financial conditions beyond the
government's control made loan repayment impossible. Another difference between individuals and countries is that a
business or a person who falls on hard times and cannot meet his or her financial obligations over time goes bankrupt. A
court is appointed to assess the debtor's situation and banks acknowledge that the debtor cannot fully pay his or her
debts. But countries cannot file for bankruptcy. There is no such procedure, no arbitrator. At the international level, the
creditors, not a court, decide whether and under what conditions to require a country to pay its debt.

How Did the Debt Crisis Come About?

The causes of the current debt crisis are complex, rooted in economic policies and development choices going
back to the 1970s and 1980s. When the Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of
oil in 1973, OPEC nations deposited much of their new wealth in commercial banks. The banks, seeking investments for
their new funds, made loans to developing countries, often hastily and without monitoring how the loans were used.
Some of the money borrowed was spent on programs that did not benefit the poor, such as armaments, failed or
inappropriate large scale development projects, and private projects benefiting government officials and a small elite.
Meanwhile, as inflation rose in the U.S., the U.S. adopted extremely tight monetary policies that soon contributed to a
sharp rise in interest rates and a worldwide recession. The irresponsible lending on the part of creditors,
mismanagement on the part of debtors, and the worldwide recession all contributed to the debt crisis of the early
1980s.

Developing countries were hurt the most in the worldwide recession. The high cost of fuel, high interest rates,
and declining exports made it increasingly difficult for them to repay their debts. During the rest of the decade and into
the 1990s, commercial banks and bilateral creditors (i.e., governments) sought to address the problem by rescheduling
loans and in some cases by providing limited debt relief. Despite these efforts, the debt of many of the world's poorest
countries remains well beyond their ability to repay it.

The Impact of International Debt

Poor countries pay a high price to service their debt, and this cost is particularly born by people living in poverty.
The massive debt payments that poor countries owe to rich countries and to multilateral creditors like the World Bank
and International Monetary Fund (IMF) take resources away from investments that benefit ordinary people and
contribute to social and economic development. According to Oxfam International's April 1997 report, Poor Country
Debt Relief, "Debt repayments have meant health centers without drugs and trained staff, schools without basic
teaching equipment, and the collapse of agricultural extension services." The obligation to meet debt service payments

also means that aid from other countries like the United States is often used to refinance debt payments rather than
improving health care, education, and other social services.

The International Monetary Fund and the World Bank require economic restructuring (Structural Adjustment Programs,
or SAPs) before a country can qualify for debt relief. These requirements can include reducing inflation, removing price
controls, reducing tariffs and other restrictions on foreign trade, and government downsizing. While in the long run they
may help a country become more competitive in the global market, in the short run they can lead to local business
failures in the face of global competition, massive lay-offs, lower wages, and even less investment by government in
education, health, and other social programs.

The debt crisis can also affect the environment. International debts have to be paid back in creditors' currencies, or so-
called "hard currencies" like U.S. dollars. This may have exacerbated the harmful environmental practices that prevail in
many countries, as governments and entrepreneurs mine their natural resources in order to generate hard cash.

The debt burden carried by impoverished countries affects citizens in the rich countries as well. Environmental damage
has global repercussions. Widespread poverty means that people have less money to buy goods and services from other
countries. Debt reduction for the poorest countries would not represent a new or unique policy for the United States.
Over the years, we have substantially reduced debts owed by Poland, Jordan, and Egypt. After Word War II, Germany's
debt was substantially reduced in order to allow it to rebuild. We have also on occasion reduced debts owed by African
countries. In these cases, the U.S. has recognized that debt reduction can be sound foreign policy.

Discussion Questions

Who are the winners and losers in the international debt crisis?

What are the obligations of creditors in this crisis, and what are the obligations of debtors?

How is international debt similar to, and different from, personal debt? Should international bankruptcy provisions be
established?

What are some possible solutions to the international debt crisis?

The international debt crisis

Developing nations have traditionally borrowed from the developed nations to support their economies. In the 1970s
such borrowing became quite heavy among certain developing countries, and their external debt expanded at a very
rapid, unsustainable rate. The result was an international financial crisis. Countries such as Mexico and Brazil declared
that they could not keep up with the schedule of interest and principal payments, causing severe reactions in the
financial world. Cooperating with creditor nations and the IMF, these countries were able to reschedule their debts—
that is, delay payments to remove financial pressure. But the underlying problem remained—developing countries were
saddled with staggering debts that totaled more than $800,000,000,000 by the mid-1980s. For the less-developed
countries as a whole (excluding the major oil exporters), debt service payments were claiming more than 20 percent of
their total export earnings.

The large debts created huge problems for the developing countries and for the banks that faced the risk of substantial
losses on their loan portfolios. Such debts increased the difficulty of finding funds to finance development. In addition,
the need to acquire foreign currencies to service the debt contributed to a rapid depreciation of the currencies and to
rapid inflation in Mexico, Brazil, and a number of other developing nations.

The wide fluctuations in the price of oil were one of the factors contributing to the debt problem. When the price of oil
rose rapidly in the 1970s, most countries felt unable to reduce their oil consumption quickly. In order to pay for
expensive oil imports, many went deeply into debt. They borrowed to finance current consumption—something that
could not go on indefinitely. As a major oil importer, Brazil was one of the nations adversely affected by rising oil prices.

Paradoxically, however, the oil-importing countries were not the only ones to borrow more when the price of oil rose
rapidly. Some of the oil exporters—such as Mexico—also contracted large new debts. They thought that the price of oil
would move continually upward, at least for the foreseeable future. They therefore felt safe in borrowing large amounts,
expecting that rapidly increasing oil revenues would provide the funds to service their debts. The price of oil drifted
downward, however, making payments much more difficult.

The debt reschedulings, and the accompanying policies of demand restraint, were built on the premise that a few years
of tough adjustment would be sufficient to get out of such crises and to provide the basis for renewed, vigorous growth.
To the contrary, however, some authorities believed that huge foreign debts would act as a continuing drag on growth
and could have catastrophic results.

What is the international debt crisis

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