The Multinational Monitor


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Troubled Waters

While Third World countries struggle to service massive foreign debts, commercial banks are losing their enthusiasm for developing country lending. This over view examines the tensions now plaguing the inter national financial system, while close-ups probe the debt burdens of three ailing economies.

by William Taylor

A few weeks ago, at Chase Manhattan's annual shareholders meeting, bank president William Butcher told a worried audience he was assembling a"24-houro a day" crisis team to monitor political and economic, trends around the globe. Butcher explained he was taking the step in response to violent upheavals in the Middle East and Latin America, and prospects of a major recession in the developed world. Today, he lamented, Chase Manhattan faces "the most uncertain [economic climate] I can recall in my better than three decades as a banker."

Few would quarrel with Butcher's gloomy assessment of the world economy-particularly international financiers. The oil price hikes of 1979 and confusion surrounding the seizure of Iran's U.S. assets have sparked universal concern over the stability of the Eurocurrency market-the lynchpin of the international financial system-and the economic health of its. most fragile participants, the oil-importing nations of the Third World. "The situation can't get more precarious than it is now," says World Bank economist Chandra Hardy.

Developing economies are beginning to crack under the weight of external debts totalling $250 billion. Debt servicing costs-projected at $120 billion between 1979 and 1981 ---and higher import bills are draining the Third World of foreign exchange, creating skyrocketing demand for more commercial loans: On the supply side, enthusiasm for Third World lending has dried up in recent months, as bankers finally begin to question the prudence of continued participation in the ever-deepening Third World debt trap. "The commercial banks will have a lot of money over the next few years," says one official at the Agency for International Development. (AID). "The question is whether they will be willing to lend to the Third World. The more troubling question, though, is what will happen if they don't."

Bankers place responsibility for today's uncertain situation squarely on the shoulders of the oil-exporting nations. "OPEC has no intention of risking their money in loans to unstable Third World countries," argues James Gipson, an investment banker with Batterymarch Financial Management Company. "But they are quite content to let U.S. banks take the risk for them." Certainly, OPEC price rises have prompted surges in Third World borrowing in recent %ears. But the image of the world's major commercial banks as selfless institutions, pushed about by the varying demands of OPEC and the non-oil producing developing countries, is unreal. Commercial banks have by no means been passive actors in the world economy, reluctant intermediaries allocating funds between surplus and deficit nations.

In reality, the oil price hikes of 1973-1974 gave rise to a financial system largely shaped and dominated by a handful of powerful commercial lenders led by Citibank, Chase Manhattan and the Bank of America. The banks have shared the fortunes of OPEC rather than the misfortunes of Third World countries. Commercial bank' profits soared during the years of the oil price hikes, with the earnings of the nine largest U.S. banks growing at an annual average of 20 percent, mainly as a result of increased activity in the developing world. According to Morgan Guaranty, developing countries contracted less than 10 percent of all Eurocurrency credits in 1970. By 1977 that figure had reached 30 percent, and last year, credit to the Third World amounted to 40 percent of all Eurocurrency loans. Brazil alone has been a tremendous source of profits for commercial banks. In 1978, loans to Brazil generated 15 percent of Citibank's after-tax earnings.

But higher profits, over the short term, do not necessarily indicate prudent lending. A growing chorus of critics argue that the banks, in search of quick profits from their OPEC deposits, have acted recklessly, supporting development strategies they assumed with unwarranted confidence would generate sufficient foreign exchange to repay loans. Just as often, it is argued, they have acted cynically, extending loans to service the needs of Third World elites-prestige public works projects, luxury consumer goods imports and sources of easy to embezzle funds-that bankers fully recognized were unproductive, and would not facilitate repayment.

"Bankers have not been unwilling partners in all this," says William Quark of the University of South Carolina Law School. "They saw a buck in many different ways, so they lent long to borrowers who were unlikely to pay. Now they've got a problem." As early as 1976, Pierre Latour, a leading European banking analyst, expressed doubts about the repayment potential of loans bankers were extending. Bankers, he suggested, recognized their Third World lending policies were unsound. "Though it was never articulated in so many words, most bankers must ... have assumed that loans to [Third World] governments would be underwritten by the official aid programs of the developed world," he reasoned before a U.S. Congressional committee hearing.

With gathering speed, relations between the banks and developing country governments are unravelling. The crisis of Third World lending poses a grave threat to the solvency of the entire international financial system; developing countries, long the market's most unstable customers, have become its most important as well.

The possibility of a break in the "chain of payments"-caused perhaps by a major Third World debtor deciding it could no longer meet its obligations-always lurks in the shadows of international finance. Such a break might provide the impetus for a domino-effect collapse in relations between all major borrowers , lenders and depositors. A political or economic crisis could prompt banks to call in loans extended to one another (banks are their own biggest customers) or OPEC nations could decide to withdraw their Eurobank deposits in search of greater financial security.

Realistically, however, the chances of such a complete and sudden financial collapse are remote. First world governments would not sit idly by and watch the demise of a system their banks created. "Developed country governments have no intention of letting the banking system collapse," asserts Michael Hudson, an international economics scholar with the United Nations Institute for Training and Research. But major restructuring will be required in international financial relations, and this restructuring will involve some very, major costs. The central question is who shall pay. Will developed country taxpayers bear the costs of an emergency bailout or a long-term rescue through increased public lending to the debt-strained Third World? Or will banks and their shareholders absorb some of the losses as the price for imprudent lending practices?

Commercial bank-developing country relations revolve around a complex set of dynamics. Private creditors wield influence almost by fiat, as a result of the huge financial resources they command. Since the mid-seventies, commercial loans have become the primary source of external finance for middle-level developing economies. In 1973, Third World debt totaled $73 billion, with over 50 percent furnished by public lenders-the World Bank, regional development banks, and Western government agencies. By 1977, commercial lenders controlled over 55 percent of the Third World's much larger debt, totaling $177 billion. Today, developing countries owe 60 percent of their $250 billion foreign debt to private sources.

With the emergence of private lending to the Third World, "creditworthiness" became the watchword of foreign-exchange hungry developing country governments. Not all countries receive commercial loans; only those meeting bank standards of creditworthiness have regular access to private markets. By and large, commercial bankers look kindly upon countries with' plentiful natural resources, rapid rates of economic growth, and a commitment to export-led development strategies.

Commercial lenders embrace elite-dominated Third World regimes already pursuing development strategies designed to suit the needs of narrow economic interests. Interaction between developing country elites and private creditors has sharply accelerated the growth of capital-intensive export manufacturing and natural resource' exploitation projects, often at the expense of domestic agriculture and the production of goods for local consumption. Alexander Vagliano of Morgan Guaranty presents the major banks' reasoning: "There's such a huge world market, you can sell just about anything if you gear up to do it."

For developing country borrowers who have shaped their economies to the liking of commercial bankers, the questionable logic of Vagliano's pronouncements means they have failed to generate foreign exchange needed to pay their debts, and now face a serious credit squeeze. Rising oil prices served not only as a catalyst for Third World lending; their shock effect on the industrialized countries exacerbated inflation and slowed First World economic growth. By financing export-oriented projects, commercial bankers tied the Third World even closer to the international economy, an economy characterized by declining demand for developing country exports, unstable "raw material prices and increased protectionism.

The current plight of Brazil is a good example. No debtor country is more central to the world financial system than Brazil-with a foreign debt of $50 billion, it is the largest Third World customer of German, Japanese and U.S. banks. And few are in a tighter loan repayment position. Bankers estimate that this year, Brazil will need loans of between $18 billion and $21 billion to service its debt and finance imports-an awesome sum amounting to nearly 20 percent of the anticipated OPEC surplus. According to conventional wisdom, Brazil shouldn't be experiencing such problems. Its military regime has pursued industrialization at breakneck speed; and is vigorously promoting the export of raw materials and manufactures. Despite growth in exports, however, Brazil's balance of trade position continues to deteriorate, largely because it must import increasingly expensive capital goods for its manufacturing sector and staple crops to feed its population. "Brazil's economy depends totally on its overseas earnings," says Ladd Hollist of the University of Southern California. "And with stagflation in the industrialized world, I see nothing but problems ahead."

In their haste to increase exposure in the Third World, bankers ignored another central reality: the interests of the governing often times diverge sharply from the interests of the governed, and political elites' blind dedication to self-enrichment often limits a Third World government's capacity to repay debt.

Commercial lenders, led by Citibank, learned this lesson in Zaire, which has met virtually none of its debt servicing requirements since 1975. With the rise of Mobutu Sese Seko 15 years ago, Zaire launched a development strategy based on two principles: maximizing copper production for export and the income of an incomparably greedy ruling circle. Private bankers, ignoring the dangers of commodity dependence and pervasive corruption, freely poured funds into the country. "The banks and Mobutu complemented each other," says Wa Nsanga Mukendi, a former Zairian professor. "The banks were looking for business, and ' Mobutu needed money to finance his regime." But copper reserves don't guarantee debt repayment, and can't compensate for economic chaos created by a ruler who proudly labels himself the third richest man in the world. When the bottom dropped out of the copper market in 1975, Zaire left its creditors high and dry.

Until now, commercial lenders have suffered relatively few Zaire-style setbacks; unproductive or reckless lending has by and large led to 'even greater demand for credit. Unable to service existing obligations out of foreign exchange earnings, developing country borrowers have ordinarily repaid past loans by contracting new ones. Major Third World debtors such as Brazil, Chile and Argentina have returned to the Eurocurrency market again and again, rolling over payments about to fall due, and vigilantly maintaining their "creditworthiness" so as to remain eligible for further loans. According to the Brandt Commission, Third World debt servicing will total $120 billion between 1979 and 1981 and rollover demand will be greater than ever. A number of academic studies estimate that this year, one of every two dollars borrowed on the Eurocurrency market will be used to roll over existing debt. By 1985, Morgan Guaranty projects, refinancing needs will claim two of every three dollars in new Eurocurrency credits.

To commercial bankers, the short-term consequence of unproductive Third World lending has been additional Third World lending. But the exponential growth of 'developing country debt cannot continue indefinitely. Ever-rising interest rates means it becomes increasingly costly for developing countries to refinance their external obligations. In addition, as the absolute level of debt increases, the potential consequences of a major Third World repayment crisis become even more ominous for the banks. "This is all a house of cards," says law professor Quark. "And there's a question as to how long you can keep rolling over reality."

With repayment of Third World debt so heavily dependent on the extension of new loans, the most immediate threat to international financial stability is a decline of creditor confidence. By and large, bankers have offered reassuring public statements about the security of their Third World portfolios, and the future of Eurocurrency lending to developing countries. Their optimistic words ring hollow, however, in light of the serious bank-imposed constraints on supply, threatening to dry up Third World credit. Figures recently released by Morgan Guaranty point to a sharp drop in Eurocurrency activity over the last few months. In January and February, loans to developing countries totaled only $2 billion, compared with $6 billion during the same period last year. And while lending declined, Third World balance of payments deficits-a significant element of loan demand-increased sharply over 1979. "There will be less funds available for developing countries this _year," says a Congressional Budget Office (CBO) official after looking at the figures. ,

Perhaps the most sensitive gauge of commercial bank attitudes are the lending policies of regional U.S. commercial banks, for years the backbone of jumbo Eurocurrency loans organized by the giants. Without $5 million contributions from hundreds of these small, largely domestic institutions, multi-billion dollar Eurocurrency deals could not have been negotiated.. Since late last year, regional banks have been dropping out of the market with alarming speed. Declining returns on Eurocurrency loans and mounting political risk, it seems, have convinced their directors that they're better off at home.

Major international. banks can't make similar decisions. Because they are more than part-time participants in Third World lending, they have an important stake in providing additional capital-repayment of existing loans often requires extension of new credit. The giant banks, says one analyst at the U.S. Federal Reserve, "are really multinational organizations committed to a multinational portfolio."

But while Citibank, Chase Manhattan and a handful of others may be able to temporarily cover for the departure of regional institutions, such. a trend threatens to reinforce the Eurocurrency market's most glaring weakness-overwhelming concentration. While hundreds of U.S. private institutions participate in the Euromarket, for example, nine commercial banks already account for fully 63 percent of U.S. banking exposure in the Third World. As fewer banks assume a greater share of lending, the Euromarket will become even more concentrated, and additional supply constraints will emerge. The major banks will quickly reach country exposure limits set internally or by home country governments. Once these limits are reached, a bank must forego further lending. "The market is definitely becoming more oligopolistic," says a CBO analyst. "if we don't increase the participants in Euromarket loans-and it won't happen through market forces-there could be serious supply problems."

Ironically, long overdue changes in official policies of benign neglect towards the Eurocurrency market may also make funds harder to come by. Bank capital-to-asset ratios are at an all time low, and regulatory officials in developed countries worry that commercial institutions are overextending themselves. In response, several governments have moved to limit Eurocurrency activity, particularly in the Third World.

Japan has set the pace for increased regulation. Since last October, private Japanese banks have been prohibited from participating in Eurocurrency loans, with the exception of a deal last November with Brazil. The government allowed four major banks to put up $125 million-testimony to Brazil's serious debt servicing problems and its importance to the Japanese financial system.

With Third World credit needs far outdistancing commercial bank financing capabilities, major international lenders are scrambling to avoid a string of repayment crises that could send shock waves through the international financial system. In Congressional hearings, international conferences and closed-door meetings with Western governmental leaders, commercial bankers are pushing their brand of solutions. They are solutions which, from a First World perspective, will prove costly for taxpayers and, from a Third World perspective, may promote further misery among those poorer segments that have benefited least from past lending activity.

Reluctant to continue their recycling function, bankers have been calling for increased capitalization of the International Monetary Fund (IMF)-some suggest up to $100 billion-greater lending by the World Bank, and an expansion of bilateral aid. "The contraction of official lending disturbs me a great deal," says Geoffrey Bell, an investment banker with J. Henry Schroder and a prominent member of the Group of 30, an international committee of central bankers and private creditors. "Public credit has become almost infinitesimal and increasingly irrelevant," he says. "I think public institutions have to play a bigger role over the next few years," adds Morgan's Vagliano.

Along with calls for additional taxpayer-funded public lending, commercial bankers are insisting on more Third World "austerity," demanding that developing countries order economic priorities so as to continue debt servicing. Indeed, the two proposals go hand in hand, since the primary vehicle for enforcing Third World austerity, the IMF, is considered by commercial lenders a prime target for increased capitalization. "The IMF is too small to play a majoro role in the recycling problem," says Schroder's Bell. "If its resources approached the size of private markets, some countries wouldn't be as critical of the 1 M F approach."

Third World leaders increasingly view Bell's "carrot and stick" analysis as misguided at best, and disingenuous at' worst. For the most part, IMFcommercial bank programs designed to ` free up foreign exchange through currency devaluation, reductions in public spending and the elimination of subsidies for food and other essentials have proven consistently unsuccessful. According to former U.S. Congressman Michael Harrington, the rate of recidivism among countries adopting IMF stabilization programs is remarkably high. In 1977, he noted that of the 54 countries which had accepted austerity programs over the last ten years, 43 had required subsequent programs.

But the ineffectiveness of IMF austerity measures is of secondary importance, compared to the drastic toll stabilization policies have taken on the Third World's poor. Take the case of Peru. Since reaching agreement with the Fund in 1977 the country has suffered through spiraling inflation, sharp declines in real wages, lower nutritional standards and, as a result of social unrest, growing repression. A recent study by the Organization of American States (OAS) concludes, in a typically understated style, that IMF-supported policies in Peru "have entailed very high social costs." Last year, inflation in Lima reached nearly 80 percent, largely, according to the OAS, as a result of Fund stabilization measures. Real wages in the manufacturing sector dropped to 70 percent of their 1977 level, while urban underemployment hit 40 percent. Most dramatically of all, per capita protein consumption fell to under 50 percent of vital minimum requirements in 1979-a 45 percent drop since 1977.

Independent critics of commercial banking, along with many Western government officials, are skeptical of the banks' renewed interest in official credit to the developing world. By calling for additional public finance as well as Third World austerity, commercial banks are denying any responsibility for today's debt crisis, critics argue. "Pressure will inevitably fall on industrialized country governments" to ease commercial banks out of the Third World debt trap, says Karin Lissakers, the State Department's leading banking expert. Since the lion's share of future Third World loan demand is directly related to servicing existing debt, critics argue that by furnishing capital to meet balance of payments needs, public lenders will merely be bailing out commercial banks\ by easing the repayment of private credit.

Not surprisingly, bankers dispute the "bailout" argument. "I don't think it's a question of bailout at all; it's a matter of diversifying funds," says one official at Chase Manhattan. Bell is more straightforward. "If you believe there is a problem, then official institutions must play a larger role. And if that's bailing out the banks, so be it. That seems to be the least of the problems we are facing."

In rejecting a view of increased public lending as a "bailout," most commercial bankers also eschew preemptive debt rescheduling proposals designed to give Third World governments the flexibility to initiate long-term economic restructuring. in contrast to refinancing schemes, where bankers earn additional profits by extending new loans and collecting new management fees, rescheduling would force commercial lenders to absorb some of the costs involved in breaking the increasingly unstable growth of Third World debt.

Often, bankers couch their objections to the rescheduling alternative in a self-serving tautology. They argue that a country's need to reschedule is a sign of economic weakness: as such, it has a dramatic negative impact on a country's "creditworthiness," and seriously limits its ability to attract future commercial finance. -

In point of fact, opposition to rescheduling boils down to a concern far simpler than creditworthiness: profits. The profit motive and the exigencies of shareholder demands tend to promote a short-sighted view of bank health and Third World development, eliminating debt rescheduling as an option before a debtor faces a severe repayment crunch. "Bankers really believe that if they seriously talk about rescheduling, it's going to happen," says World Bank economist Hardy. Investment banker Bell agrees that up to now, commercial lenders have been unable to look beyond immediate concerns for profit. "It would be an unusual banker who would say, `Look, life is getting tough in a country so we're going to penalize our shareholders by rescheduling."'

Given the dangerously strained condition of Third World lending, financial stability may hinge on the emergence of "unusual bankers." The scenarios for commercial lending in the Third World in the -upcoming critical months and years are myriad: industrialized country government bailout, deeper misery for the already marginalized as - a result of Third World austerity programs, declining bank profits or, failing "successful" adjustment, financial collapse.

One thing is certain, however. Both in the First and Third Worlds, the conduct of commercial lending in developing economies will become an increasingly volatile issue.-In Africa, Asia and Latin America, it is a question of survival. For industrialized countries, it Is a question of the accountability of financial institutions for their own actions.

Brazil: The Giant Stumbles

In February, the widely recognized guardian of Brazil's "economic miracles" traveled to the Unite States and Europe to meet with leading commercial bankers. Antonio Delfim Netto's trip was an urgent one: this year, Brazil will need new loans of between $18 billion and $21 billion just to service its external debt and finance imports.

Netto's journey ended an abysmal failure. Rather than extending new credit, private banks and World Bank president Robert McNamara offered sobering advice: now might be the time for Brazil - far and away the giant of Third World borrowing - to submit to an IMF stabilization program.

Can the unspeakable be around the corner? For years, critics of commercial finance in the Third World have equated Brazilian default with the collapse of the Eurocurrency market. Its foreign debt now totals over $50 billion, and has doubled every three years since 1967. Private credit accounts for nearly 70 percent of the debt, with $14 billion controlled by U.S. banks. The country's financing needs for 1980 amount to 20 percent of the anticipated OPEC surplus.

Commercial bankers insist they have no worries about the country's long-term creditworthiness. "When I look at Brazil, I see tremendous opportunities for investment and lending," says Alexander Vagliano of Morgan Guaranty. Outside the banking community, however, confidence is fading. Brazil is in the midst of an unprecedented economic crisis, and government leaders are at a loss a to how to stem its drift towards economic chaos. "Brazil is falling apart," Paulo Francis, the country's leading political columnist says bluntly.

The country's current economic difficulties are two-fold. Brazil is being racked by 80 percent inflation, and harsh government measures to battle price increases have proven totally ineffective. Some officials are openly discussing Brazil's possible slide into runaway "hyperinflation," the dreaded economic disease of Latin America. At the same time, policymakers are engaged in a frantic effort to promote exports in the hope of achieving a trade balance for 1980. Brazil has experienced a string of trade deficits since 1974 and, with a debt service ratio of nearly 70 percent, can ill afford further outflows of foreign exchange via imports.

Today's economic crisis is largely the product of a development model characterized by capital-intensive export manufacturing, controlled to a unique degree by foreign corporations. Between 1964 and 1973, Brazil's exports grew at an annual rate of 20 percent; export expansion more than kept pace with increasing capital goods imports and the purchase of foreign consumer durables. After the oil price hikes of 1974 , and the onset of recession in the developed world. Brazil's overseas markets dried up, with annual export growth hovering around 5 percent. Export stagnation notwithstanding, imports continued to climb, as the generals pursued a strategy of rapid domestic growth through government spending. The capital-intensive nature of Brazil's economy means it must continue to rapidly expand, or face the specter of widespread unemployment. Now, for the first time, it looks like Brazil may have trouble raising cash. For the last few years, despite widespread doubts about the country's economic health, Brazilian officials have managed to drum up credit needed to roll over existing debt. They command one critical bargaining chip - bankers have already committed so much finance to the country that most are reluctant to face the possible consequences of refusing to extend future loans. With the economy in such rocky shape, however, commercial bank reservations are at an all-time high.

Delfim has committed himself to a crash program to hold down loan demand, and generate increased foreign exchange. He is expected to soon announce an anti-inflation package designed to put a ceiling on wage increases, reduce government-subsidized credit and limit rural development projects.

"Doing these things flies in the face of development," says Ralph Griffin of the U.S. State Department. The policies also fly in the face of abertura - the program liberalizing Brazil's political climate initiated in 1978. Even while government leaders prepare austerity measures, social critics are returning from exile opposition political parties are mobilizing, and labor unions are striking with unprecedented militancy. "The clash of these forces seriously threatens any hopes for democracy in Brazil," says Ladd Hollist of the University of Southern California.

Planning Minister Delfim, while currently enjoying support from most sectors of the military, has been given a limited lease on policy control; leading Brazilian political observers feel he has no more than 18 months to show major improvements in Brazil's economic fortunes. If he fails, they predict, a potentially violent political struggle over fundamental changes in the direction of Brazil's economy will ensue. As one U.S. official suggested, a "Brazilian Pinochet" may emerge. He would sharply curtail political rights to enforce harsh economic steps, raising foreign exchange by denationalizing sectors of the economy and pushing down returns to labor. Or as many opposition and trade union groups are demanding, the economic model may turn inward, stressing production for domestic markets and slowly exyt4ricating the country from near-total dependence on international trade.

Of course, major economic restructuring could not occur with a $50 billion foreign debt. Says USC's Hollist: "If you take that posture, you take a posture of default as well." Such a development would present the Euromarket with its most serious challenge ever.

Poland Plays Its East-West Card

Both politically and economically, Poland's debt problems are unique. Unlike troubled Third-World economies, its debt crisis is not related to rising oil costs: strong ties to the Soviet Union bring access to crude at sub-OPEC prices. Politically, its debt sits near the center of East-West tensions. In recent years, Poland has been edging towards the West. With the U.S. and Western Europe reluctant to see the country approach Moscow for financial help, and the Soviets anxious to reassert their iron-clad grip over the Poles, Warsaw may be able to play off East and West and extract substantial governmental aid to relieve its debt burden.

Who will rescue Poland is a question of major geopolitical significance. For commercial bankers, however, a dollar is a dollar. Private creditors will benefit, regardless of the source of the bailout.

Largely controlled by the Western European banks, Poland's external debt totals nearly $20 billion. The country's contracted over half the debt between 1970 and 1976, as it called on private lenders to finance what became an overambitious investment drive. During this period, state investment rose by 20 percent annually and the Poles purchased over $10 billion in Western capital equipment in a campaign to increase production of goods for domestic consumption - particularly automobiles - and for export to the European Community and the U.S.

Poland's turn to the West backfired in a number of industries. Although the country has traditionally built one of every five fishing ships on the high seas, government leaders felt sophisticated vessels would generate more hard currency. After importing millions of dollars of high-technology Western components, however, Poland was unable to market the ships competitively, and either sold them below cost or to the COMECON countries for soft currency. "Poland fell prey to the typical communist optimism about exports to the West," says one official at the U.S. Export-Import Bank.

Commercial bankers willingly cooperated with this economic program. Eyeing substantial reserves of coal, copper, zinc and sulfur, international banks - particularly from France and West Germany - fell over each other to extend credits. "The Poles wanted money and they were willing to pay for it," says Lawrence Brainard of Bankers Trust, which has an undisclosed amount of capital tied up in the country.

While Warsaw remains fully committed to paying, it no longer seems it can without massive outside help. The country now faces an almost unheard of debt service ratio of 74 percent, and equally burdensome servicing requirements over the next few years.

In its repayment effort, Poland is pursuing a two-pronged strategy, enforcing austerity at home while appealing to foreign governments for relief. Key to the austerity programs have been across-the-board import restrictions, sharp cutbacks in public investment (real investment actually declined in 1979) and slower income growth to reduce consumer demand.

While committed to domestic austerity, however, Prime Minister Edward Gierek faces political constraints. He no doubt remembers the 1970 consumer riots that toppled the regime of Vladimir Gomulka, as well as the food riots of 1976. "I just can't see Poland squeezing any harder," remarked one U.S. Treasury official.

In December, news leaked out about a highly secretive deal between the beleaguered Bank Handlowy - Poland's foreign trade bank - and the French government. Poland, unable to meet payments on a loan from the French export promotion agency, negotiated a refinancing deal. After arranging the terms, France apparently strong-armed several private French banks to put up the capital - about $300 million - while it provided an official guaranty.

In April, West Germany announced it will extend about $300 million in export credits to Bank Handlowy. Poland originally requested a $1 billion general purpose loan, but German officials rejected the suggestion as a potential cause of panic by private creditors. Most observers expect Poland will keep working on the Bonn government, capitalizing on its benevolent attitude towards Warsaw, part of Germany's unspoken compensation for the occupation of Poland during World War II. "Nobody is pushing Poland to the wall on its debts, says Hallow. "The political element is overriding."

Western fears of a Soviet bailout have been made more credible by a London banking community rumor, reported in April in the British financial press, that Warsaw recently received a major hard currency credit from the Soviets. The reports are still unconfirmed, and one Washington official cautions that Eastern Bloc financial dealings are invariably marked by secrecy and rumor. Perhaps, the official speculates, the reports are accurate and Moscow is committing itself to a major bailout. It is just as likely, he adds, that the rumor was planted by the Poles themselves, to increase their bargaining power with the West.

The Soviets face additional pressures for a Polish bailout from other members of the Eastern Bloc. Eastern European leaders worry that corporate executives consider the area a monolith; they fear a Polish financial collapse would jeopardize Western trade and investment in the entire region.

All signs point to growing governmental intervention in Poland's debt troubles. Private bankers, it seems, are less than upset by the prospect. "Bankers would be quite happy to reduce their exposure in Poland," says one U.S. official.

Not surprisingly, no bankers will publicly admit to bailout hopes. "These loans are our responsibility," insists Bankers Trust's Brainard. But given the start of what appears to be a prolonged period of heightened East-West tensions, the future orientation of Polish foreign policy has become a more salient issue, and both Poland and the commercial banks stand to gain as a result.

Still Banking on Mobutu

The past six months have been busy ones for Zaire's creditors. In April, after nearly five years of sporadic negotiations with the regime of Mobutu Sese Seko, a powerful group of international banks signed a major rescheduling agreement with the debt-plagued country. Western governmental aid officials have met in Brussels and public lenders have met in Paris to find solutions to Zaire's economic crisis. Despite the proliferation of precedent-setting agreements and positive public statements, however, no one really seems to believe the country is about to recover from its near total economic collapse. For the foreseeable future, Zaire will remain Africa's most dismal human tragedy: a land with abundant natural resources rules by a narrow clique committed only to its own personal enrichment.

Its difficult to exaggerate the social costs of Zaire's economic plight. Staple crops rot unharvested since transport is impossible without critically needed oil. Even if fuel were available, however, crops would have to be airlifted to the towns and cities; while the country had 90,000 miles of roads at independence, only 6,000 are now passable.

The population lives from day to day, facing starvation and often brutal repression. Relief workers report that one of every two children born in Zaire will die from malnutrition or disease before the age of five. Those who survive have little to look forward to: real wages are 60 percent of their 1970 level, and real gross domestic product has declined 15 percent since 1975.

From the perspective of international financiers, the most visible element of Zaire's economic crisis is its foreign debt. The government of Mobutu Sese Seko owes western creditors nearly $4 billion, 40 percent of which is controlled by private lenders. As of mid-1979, its payments were in arrears by more than $1 billion, while its foreign exchange reserves amounted to only $350 million.

Anxious to increase their exposure in Zaire during the early seventies, commercial bankers freely allied themselves with Africa's greediest ruler. "Zaire's economic system has been conceived to enrich Mobutu and a small circle of cronies," says Wa Nsanga Mukendi, formerly of the University of Zaire and now a visiting scholar in the U.S. "It's a disaster; the people starve so a few can get rich." Lenders confidently assumed that despite the regime's corruption, rich mineral deposits guaranteed repayment of loans. Events over the past five years have dashed such hopes. "Obviously everybody learns with experience," says Alexander Caldwell of Crocker National Bank, "Zaire is a case where bankers learned a lot."

Zaire's recent history serves as a powerful critique of the export-led development strategies so strongly advanced by the banks, and point up the dangers of doing business with self-interested elites. The government contracted about 75 percent of its debt between 1970 and 1974, with rising mineral prices pointing to a prosperous future via export earnings. Private financiers, led by Citibank, seemed mesmerized by the county's abundant mineral reserves and freely poured funds into the country. Their loans reinforced Zaire's dependence on two strategic minerals: copper and cobalt. By 1974, copper accounted for 65 percent of the country's export revenues, with cobalt the second leading foreign exhange earner.

Bankers became intimately involved in the politics of this central African nation by virtually throwing money at the Mobutu regime. Nearly 25 percent of all commercial loans have gone to the 1000-mile Inga-Shaba power line, an ill-conceived scheme to transmit electricity to the rich copper field of the Shaba province. The basic rationale for the line was political; Mobutu believed that by controlling this secession-minded region's energy supplies, he could increase his authority there. But politically inspired projects often fail to generate economic returns. Since its inception in 1973, Inga-Shaba has proven an unmitigated financial disaster; it has yet to transmit any power, remains 80 percent complete, and has cost twice as much as the original $327 million estimate.

Mineral dependence has left the country wide-open to fluctuations in the world economy. And each time the copper market has collapsed since 1975, Zaire has sunk with it. While providing close to $700 million for Inga-Shaba, and $420 million for air transportation, international banks unquestionably accepted development policies that completely overlooked agriculture. Only 2 percent of all commercial loans between 1970 and 1974 were earmarked for food crop cultivation. Lack of rural investment transformed the country from a net food exporter to a food importer. Last year, Zaire spend $300 million - a third of its foreign exchange - on food imports.

The roots of Zaire's economic crisis go far deeper than fluctuating copper prices. Almost limitless access to Western finance enabled Mobutu to design a "client system" of political control, argues David Gould of the University of Pittsburgh. "Theft is built into the system," he says. "At the top, everyone steals. If you don't steal, you are immediately suspect." During the heyday of commercial lending, Mobutu annually allotted 20 percent of the national budget to "presidential expenses," a slush fund he used to buy political allies. His 1973 Zairianization Decree - replacing expatriate businessmen with local officials - serves as a model of how not to nationalize an economy. It resulted in economic chaos, while creating a powerful layer of local vested interests.

Now private and public lenders are struggling to get their money back. Western public creditors recently met in Paris and agreed to reschedule 90 percent of all interest and principal payments due through 1980. Payment will be stretched over ten years, with a four-year grace period. These relatively generous terms reflect more than Zaire's desperate economic condition. Mobutu has . effectively exploited the West's uneasiness about growing Soviet influence in Africa, as well as its possessive attitude towards the country's mineral reserves. A similar agreement has been reached with Zaire's commercial lenders. Last month, 125 private banks rescheduled $400 million in loans over ten years, with a five year grace period.

Despite the unusually liberal terms of both agreements, bilateral foreign aid pledges of $206 million for 1980 and rising cobalt and copper prices, most observers doubt Zaire will be able to reactivate its economy. A recent internal World Bank study calls on creditors to stretch out payments over 30 years as the only way to permit fundamental restructuring. Several U.S' government officials, while expressing sympathy for the recommendation; call it "politically untenable"-particularly while Mobutu remains in power. "A massive rescheduling like that is a one-shot deal," remarked one U.S. Treasury Department official. "Now is certainly not the time."

Indeed, by financing the institutionalization of Mobutu's corrupt rule, commercial bankers may have indefinitely postponed the time for economic reactivation in Zaire. Although IMF officials now control part of the country's financial bureaucracy, the appetite of Mobutu and his circle of advisors for graft still seems unsatisfied.

The country's deteriorating infrastructure and communication network, as well as the virtual starvation of its population, have inhibited the growth of organized political opposition. Western governments and commercial bankers, unhappy with Mobutu but even more anxious about the rise of a Soviet-influenced regime, continue to conduct business as usual, lurching from crisis to crisis in an effort to recover at least part of their commitments. Meanwhile, through all the confusion, it is the people of Zaire who suffer.

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