LDC debt reduction: A critical appraisal

Abstract

President Bush has initiated a major review of the LDC debt strategy. Many conclude that the LDC debt problem is intractable and want to forgive outright a sizeable portion of LDC debts. The problems with quick-fix proposals are multiple. Indeed, the ongoing process of debt reduction voluntarily negotiated between creditors and debtors is a business practice that should be continued and encouraged. After six years of involuntary lending and no assurance of eventual repayment at full value, few commercial banks are interested in further increasing their exposure to troubled debtors. Many would sooner sell or exchange existing loans at a discount, but need better ways to do so that would also pass on benefit to the debtors. The multilateral organizations should support bank-debt reduction, for example by helping debtors to issue new obligations of enhanced quality and retire existing ones as a discount. This article summarizes the economic and financial experience that has led to the current interest in debt reduction. It examines various debt-reducing mechanisms that have been tried to date which have cut the Baker 15's total foreign debt by some $27 billion to an estimated $505 billion as of end-1988. The article points out, however, that the cash-flow relief achievable by debt reduction is too often overrated. Debt reduction must go hand in hand with self-help measures by the debtor LDCs to improve confidence, spur the return of flight capital, attract fresh foreign investment and thus strengthen their future debt-carrying capacity. In sum, debt reduction is not a solution to the debtors' financial problems, but it can make a constructive contribution to their resolution.