The Gathering Storm

By Stephen Koepp

Debtor countries meet to set strategy for their confrontation with bankers

"We hear the far-off thunder of violent drums. We feel the winds of storms," warned Colombian President Belisario Betancur last week in a chilling speech to government ministers of his Latin American neighbors. His rousing rhetoric referred not to war or natural disaster but to something equally momentous: Latin America's $350 billion debt burden. Since the beginning of the year, the pressure on both the borrowers and the American banks that lent them much of the money has grown sharply. A 2% jump in interest rates has hit Latin countries with a potential increase of $5 billion in annual interest payments. Meanwhile, big-city banks in the U.S. have taken a beating on Wall Street as investors grow more worried about whether the Latin debts will ever be repaid. Says Rimmer de Vries, chief international economist for Morgan Guaranty Trust: "The world has become much more accident prone. I believe a reasonable solution can still be found, but the stock market is not giving the banks much time."

One of the major concerns among some bankers is that the Latin countries will form a debtors' cartel. Says Robert Hormats, a former Assistant Secretary of State: "We are entering a very dangerous period, so the point will be to keep the dialogue going." The danger is that the borrowers would walk away from their loans or attempt to bargain collectively for much easier terms, resulting in an international banking crisis.

When ministers from eleven debtor countries met last week in Cartagena, Colombia, to devise a strategy for getting concessions from the banks, most of them maintained a conciliatory tone and rejected the idea of a cartel. Said Chilean Economy Minister Modesto Collados: "Each country is different. To negotiate in a club makes no sense at all." But the depth of Latin restiveness could hardly be concealed. In his opening speech, President Betancur compared Latin America's financial burden to the crushing debt and reparations problems after World War I, which helped wreck the international economy in the 1930s and laid the foundation for World War II. Said he: "It is no exaggeration to say that the solution to Latin America's debt crisis is an essential ingredient for world peace."

After two days of talks, the ministers decided to set up two new groups. One will try to arrange talks with private banks and institutions like the International Monetary Fund (see following story). The debtors will tell them that the conditions set by the IMF for new loans should be aimed at fostering continued economic growth rather than austerity. The Latin Americans also agreed to propose a working group in the World Bank to deal with the global aspects of the debt crisis. The ministers plan to meet again just before next fall's IMF meeting. The next session will be held in Buenos Aires, which will put hard-lining Argentina in a diplomatically stronger position. The group last week also produced 24 proposals for easing the cost of their debt, ranging from longer periods of repayment to reduced interest rates. One plan, suggested by Mexican Finance Secretary Jesus Silva Herzog, calls for Latin borrowers to pay a level of interest tied to the rates on bank certificates of deposit, currently about 11 1/2%. This would give debtors a break of about 2 1/2%, worth some $7 billion annually, while still allowing the banks to make a slight profit on the loans. Though bankers as a group will find these proposals hard to accept, at least one leading financier buys the idea. Even before last week's meeting, Terence Canavan, head of Chemical Bank's Latin American operations, said that "the time has come for lower rates to countries that have demonstrated the willingness to get their houses in order."

Despite last week's meeting, the Latin American countries do not form a united and cohesive bloc. While the two heaviest debtors, Brazil ($93.1 billion) and Mexico ($89.8 billion), have taken drastic measures to rein in their runaway economies, Argentina ($45.3 billion) is still a maverick. Two weeks ago, Argentine President Raul Alfonsin rejected an IMF austerity demand for cuts in wages and government spending, which was designed to curb his country's 568% inflation rate. Alfonsin sent the IMF a plan that promised workers 6% to 8% wage increases on top of the inflation rate.

Argentina's complaints about the tough IMF measures failed to earn the country much sympathy last week from Latin neighbors. The nation drew criticism from Colombian Finance Minister Edgar Gutierrez Castro, whose government lent Argentina $50 million last March. Bankers and international officials attack Argentina's stance as an act of political bravura. Says a World Bank economist: "They are handling the debt the way they were handling the Falklands war. They see themselves as the center of the universe."

The worsening debt squeeze is already sending shock waves directly to the profit statements of U.S. banks. Though Argentina last week paid $100 million in interest as a good-will gesture, the country has yet to pay $350 million that this week will be three months overdue. The amount may go unpaid because Argentina's rejection of the IMF economic plan may prevent the country from getting new loans. After this week, banks will be required to subtract the missing funds from second-quarter profits. Last week the U.S. Comptroller of the Currency and the Federal Reserve Board, concerned that overly optimistic accounting is shaking public confidence in banks, reminded financial institutions that they must post as losses any long-overdue interest payments. Manufacturers Hanover Trust, the largest Argentine lender, said that if the Latin country fails to make its June 30 payment, the bank's second-quarter profits would drop by about 37%, or $35 million. Continued defaults by Latin debtors would force many banks to cut shareholder dividends, a move that would send bank stock prices sliding still further. In the past year, shares of major New York banks have fallen nearly 25% in value.

The quickest-acting tonic for the debtor countries would be a drop in U.S. interest rates, since 85% of Latin loans are written in dollars. Last week, though, came a sign that U.S. interest levels are unlikely to fall soon. The Commerce Department estimated that in the second quarter the U.S. economy will grow at an annual rate of 5.7%, making the current recovery the strongest since 1954. That pace is likely to encourage the Federal Reserve to keep a strong hand on interest rates in order to prevent inflation from flaring up again.

A robust U.S. economy is not all bad news for the Latin American debtors; it creates a hungry market for their exports. The debtors need to boost their export income sharply if they hope to have any cash for paying loans. Argentina, for instance, faces $5.5 billion in interest payments due this year, but it will have a trade surplus of only $3.2 billion. Latin leaders complain that protectionism in the U.S. and Europe hampers their export sales. Brazil last month cut steel exports to the U.S. by more than half, from 900,000 tons to 430,000, because of Commerce Department import duties.

The Latin countries stressed last week that in the short term they still need urgent relief from their loan payments. Said an Argentine official: "There is simply no way we can pay the full bill. The banks and other lenders will have to share it with us." While U.S. bankers say they are willing to make concessions, they have failed to cooperate on any specific long-range plan that would forgive some of the loans or allow the debtors a grace period for paying them. Said Lawrence Brainard, chief international economist for Bankers Trust: "The only thing on which the banks can agree is that they want their interest." Concurred one U.S. banker: "We have played into the debtor countries' hands by our own indecision and cowardice to face the facts."

With meetings like last week's in Cartagena, the debtor countries are attempting to elevate the crisis beyond just a financial dispute with banks. They see the debt shock as a political issue in which the governments of the developed countries should be helping out those of the Third World. As a sign of their intention to raise the level of debate, delegations last week included foreign ministers in addition to finance ministers. Latin leaders point out that largely because of interest payments, their financial resources are being drained away to countries like the U.S. at the rate of about $30 billion a year. This has become a kind of reverse foreign aid with the poor giving to the rich. The situation has brought criticism even from some American institutional investors, who think the banks are pumping a dry well. Says Barton Biggs, chief portfolio strategist at Morgan Stanley: "There is simply no way Citibank can continue to increase its earnings by 15% a year on the backs of millions of sullen Latin American peons."

Economists and other experts have put forth dozens of programs for easing the debt shock. Some call for banks to forgive large portions of the loans and write them off as a loss. Another plan would have the IMF buy the loans from the banks. Anthony Solomon, president of the Federal Reserve Bank of New York, has suggested that an interest-rate limit should be placed on loans to the troubled borrowers. In one such plan, interest payments above a certain level would be converted into principal to be paid later.

The basic problem, however, is that no one wants to suffer the pain that will be involved in any solution to the debt crisis. Banks are not eager to write off the bad loans and take the earnings loss, while governments in the developed countries are reluctant to halt economic growth just to please foreign moneymen. Thus, no sudden solution is likely to emerge. Says one IMF official: "It is a negotiating process that will run through most of the 1980s." Mexican Finance Secretary Silva Herzog last week recalled Economist John Maynard Keynes' dictum: "Men will do the rational thing, but only after exploring all other alternatives." Silva Herzog then glumly added that Latin American debtors and U.S. bankers probably have a lot of exploring ahead of them. --By Stephen Koepp. Reported by Gisela Bolte/Washington and Frederick Ungeheuer/Cartagena

With reporting by Gisela Bolte/Washington and Frederick Ungeheuer/Cartagena