1. Debt Problem and Development
Volkan EMRE
Danald KUGONZA

2. Presentation Summary
• Introduction
• Overview of external debt
• Origins of 1970’s – 1980’s External Debt Dilemma
• Petrodollar Recycling and OPEC’s Absorption Problem
• When is it prudent to borrow ?
• Debt Sustainability
• External borrowing, adjustment policies, and savings
• 1980’ debt crisis
• Longer term efforts to overcome the debt crisis
• Debt overhang and future economic growth
• Graphical Explanations
• Conclusions

3. External
Origins Petrodollar When Is
Overview Borrowing
of Recycling It Debt
of Adjustment
1970s- & Prudent Sustain
External Policies
1980s OPEC’s To ability
Debt &
Debt Absorption Borrow
Savings
Dilemma Problem

4. Overview of External Debt
What is an External Debt?
It is the total private and public foreign debt owned by a country (Todaro).
How is it paid ?
Its usually paid by using foreign currency.Therefore a country should have
sufficient foreign exchange for its servicing.
Less Developed Countries can‘t borrow in their local currency-Original Sin
How is it different from an internal debt?
An internal debt is a borrowing owed to the citizens or institutions of a
country.Normally borrowed and paid in the local currency.
Public Debt
A Combination of external and internal debt.
Why is an external debt a point of concern?
Its payment is dependent on foreign exchange-recall currency mismatch &
think of local curreny depreciation!

5. External Debt Stocks (% of GNI) in Developing Countries
Graph 1 (1970 & 1982) Graph 2
Source: World Bank,World Bank Development Indicators, own calculations

6. Total External Debt in Developing Countries

7. External Debt Stocks (% of GNI) in Heavily Indebted Poor
Countries (1970 & 1982)
Mauritania
Somalia
Nicaragua
Cote d'Ivoire
Togo
Guinea-Bissau
Liberia
Zambia
Gambia, The
Congo, Rep.
Sudan
Malawi
Honduras
Mali
Comoros 1982
Bolivia
Senegal 1970
Benin
Madagascar
Sierra Leone
Niger
Ethiopia
Uganda
Cameroon
Congo, Dem. Rep.
Ghana
Central African Republic
Chad
Burkina Faso
Rwanda
0 20 40 60 80 100 120 140 160 180
Source: World Bank,World Bank Development Indicators, own calculations

8. External
Origins Petrodollar When Is
Overview Borrowing
of Recycling It Debt
of Adjustment
1970s- & Prudent Sustain
External Policies
1980s OPEC’s To ability
Debt &
Debt Absorption Borrow
Savings
Dilemma Problem

9. Origins of 1970’s – 1980’s External Debt
Dilemma
Why did nations continue to inccur external debts?
 Needed to finance their current account deficit
What caused their current account deficits?
1. Arise in petroleum prices (External event)
 During the above period, OPEC hiked Oil Prices
 January 1973 = $ 2,59
 November 1973 = $ 5,18
 January 1974 = $ 11,65

10. Origins of 1970’s – 1980’s External
Debt Dilemma
Between 1973 and 1981 Oil Prices Increased
approximately by 500 %

11. Origins of 1970’s – 1980’s External
Debt Dilemma
2. Financing unproductive consumption e.g. military expenditures,
repayment of the past external debts at the expense of productive
investments which would have generated or saved foreign exchange
3.Problems and failures of internal economic policy that resulted in:
 High levels of inflation
 Over-valued exchange rates
4.Failure of economies to successfully negotiate a series of
‘’strategy switches’’ in economic policy that would have contributed
to the necessary structural transformations on the path towards greater
industrialisation and diversification of production e.g. Failed ISI

12. Origins of 1970’s – 1980’s External Debt
Dilemma
The Remedy to a current account deficit would be :
1. A Surplus on Capital and Financial Account (say by borrowing
externaly)
2. Reducing the Import Bill
3. Increasing Export Earnings
How did these economies respond ?
1. Reduced the Overall Volume of Imports moreso oil?
2. Increased export earnings?
3. Accumulated Further External Debt to Pay for More Expensive Oil and
Other desired Imports ?
1. Dilemma !

13. External
Petrodollar When Is
Origins of Borrowing
Overview Recycling It Debt
1970s- Adjustment
of External & Prudent Sustaina
1980s Policies
Debt OPEC’s To bility
Debt &
Absorption Borrow
Dilemma Savings
Problem

14. Petrodollar Recycling and OPEC’s Absorption
Problem
What exactly is Petrodollar Recycling ?
Increased Export Deposited Excess Excess Deposits in
Revenues Earnings in International Banks Amid Limited
Amid not enough Banks Clients
projects to absorb Euro- Dollar or Euro Threatens profitablity
them thus the Currency Markets ( New of banks which brings
‘‘absorption problem‘‘ York , London , Frankfurt, search for new
Tokyo ) to earn interest markets
Oil Price Hikes by OPEC Debt Serving
•Promote Econ.Dev‘t in OPEC Creation of Sovereign
through improving Borrowers
infrastructure,education,Technol Less developed oil
ogy,etc than spuring econ dev‘t payments in importing countries with
in the U.S,Europe & Japan current account deficits
exchange for oil

15. Petrodollar Recycling and OPEC’s Absorption
Problem
• Petrodollar recycling is the circulation and recirculation of petroleum revenues
from the oil-importing nations to the OPEC economies to the private
international banks and then back again to the oil-importing nations in the form
of loans, only to make the round again and again(Devlin 1989).
Trade Balances for Oil Exporting and Importing Countries between 1973 &
1981(Billions of U.S dollars)
Source: Cypher&Dietz, 2009

16. External
Petrodollar When Is
Origins of Borrowing
Overview Recycling It Debt
1970s- Adjustment
of External & Prudent Sustaina
1980s Policies
Debt OPEC’s To bility
Debt &
Absorption Borrow
Dilemma Savings
Problem

17. When is it Prudent to Borrow ?
1. If it’s to finance what’s expected to be short-term current account deficit so
as to avoid disruption of production and employment. i.e. smoothen out
consumption of imports over a short term.
2. And for Long-term, external debt accumulation must contribute to either
foreign exchange savings or earnings-consider Import substitution and
export promotion(recall, chapter 10)
3. If external debt is to be directed towards productive investments that
expand output of tradable goods and services that can generate foreign
exchange required to pay borrowed funds-self liquidating.
4. If its to finance infrastructure that can contribute to greater export
earnings or import substitution production by lowering costs
Key Issue
The undertaking should generate (exportation) or save (import substitution)
foreign exchange sufficient to pay down both the principal and interest on the
external loan over the its life time!

18. When is it Prudent to Borrow ?
Betterstill,there is no guarantee of Transformation or achievement of the
above.Why?
 Ineffective use of external debt.e.g military expenditure
 World prices might fall-Mexican Dilemma!
 Emergence of better exporters
 Inefficiencies may arise-decline in labour productivity, increase in
capital output ratios e.g. Incremental capital output ratios (ICOR) of
countries which had borrowed either remained the same (South
Korea) or rose substantially-Philippines, Argentina, and Morocco-World
Bank!
Caution
• External borrowing should be approached consciously otherwise future growth
and development prospects can be compromised
• It should be based on conservative projections i.e. based on the assumption that
future prices of exports & imports will be lower even lower than the current prices-
Mexican Dilemma!
Key issue: External borrowing should not be the wayforward!

19. External
Petrodollar When Is
Origins of Borrowing
Overview Recycling It Debt
1970s- Adjustment
of External & Prudent Sustaina
1980s Policies
Debt OPEC’s To bility
Debt &
Absorption Borrow
Dilemma Savings
Problem

20. Debt sustainability
Debt sustainability
It is the ability of a debtor country to continue meeting its debt
obligations on a continuous basis without going into default.
Determinants of external debt sustainability
1. Nominal interest rate on external debt
2. Nominal growth in export earnings(foreign exhange)
Circumstances under which the external debt is sustainable
1. When the average nominal growth in foreign exchange
earnings is greater than the nominal interest rate on the debt.
2. Case of existence of a surplus on the capital and financial
account.

21. External
Petrodollar When Is
Origins of Borrowing
Overview Recycling It Debt
1970s- Adjustment
of External & Prudent Sustaina
1980s Policies
Debt OPEC’s To bility
Debt &
Absorption Borrow
Dilemma Savings
Problem

22. External Borrowing, Adjustment Policies, and
Savings ?
The Twin Deficit and Productive Borrowing
 Assuming there is no central government deficit, and no debt accumulation
S−I=X−M=0
 If savings (S) equals investment (I)
There will be no trade!!!!
 S = s(Y/L)L s: saving ratio L= Population Y/L = Per capita income
Savings ratio (s) is likely to be smaller the lower per capita income, Y/L, which is
typical with low-income countries and thus low levels of total domestic savings
 (I = Sd + Sf). Domestic savings augmented with foreign resources. And thus the
1st equation becomes:
Sd − I = X − M < 0 since Sd − I = −Sf, which is negative for all Sf > 0

23. Debt Service Obligation: The Real Cost of Debt
Repayment
Debt Service Ratio and the Debt Burden

24. Current Account Deficits in Developing Countries
-
Source: World Bank,World Bank Development Indicators, own calculations

25. Debt
1980s Debt Longer Term Overhang
1980s
Crisis Efforts to & Graphical
Debt
International Overcome Future Explanations
Crisis
Banking the Debt Economic
Sector Crisis Growth

26. The 1980s Debt Crisis
1980s Debt Crisis…
• Originates from 1970s unsustainable debt accumulation
• Debt Accumulation was based on availability of funds from OPEC
• It started in August 1982 when Mexico anounced suspension of scheduled
debt payment ( Moratorium) for which other countries followed.

27. The 1980s Debt Crisis
What set off 1980 Debt Crisis that threatend the stability of the financial
markets ?
• By mid 1982 , the private international banks had dramatically begun
reducing their lending (petro-dollar recyling) to sovereign borrowers. Why ?
Slowdown in the growth rates of the international economy ( Inflation
in the US and UK triggerd the application of stringent monetary policies and
which led to recession)
Recession resulted into declines in income and subsequently imports
from Less Developed Countries
Decline in export earnings of LDC’s ! Yet Less Developed Countries
were using this money for debt repayment, import expenditure and
very little for productive uses

28. The 1980s Debt Crisis – Causality and Reasons
What exactly happened ?
Loan window of the private
Debtor nations faced with Without access to new loans
banks closed because of
a daunting foreign debtor nations were faced with
recession related reasons
exchange crisis difficult decissions
Countries’ import
Transformation would occur spending was now limited • Continuing to service past
primarily by repressing import to the export earnings. debt
spending . Yet exports could not be • Maintaining previous import
expanded rapidly levels
•Lower current living standards IMF and US Treasury forced
Debtor countries declared large banks into involuntary
•Lower GDP (Critical inputs for
moratarium lending to avoid collapse of
domestic industry affected by
cutbacks) international financial system

29. Debt
1980s Debt Longer Term Overhang
1980s
Crisis Efforts to & Graphical
Debt
International Overcome Future Explanations
Crisis
Banking the Debt Economic
Sector Crisis Growth

30. The 1980s Debt Crisis – International Banking Sector
Majority of total borrowed funds provided by private banks
Period 1:
 Over-lending
 Higher interest rates
 Shorter repayment schedules
 Impending crisis !!
Period 2:
 Under-lending
 Lower interest rates
Longer repayment schedules
Involuntary lending with the assistance of
IMF and US Treasury
Bridge loans for continued debt
repayment

31. The 1980s Debt Crisis – International Banking
Sector
Downgrade

32. Debt
1980s Debt Longer Term Overhang
1980s
Crisis Efforts to & Graphical
Debt
International Overcome Future Explanations
Crisis
Banking the Debt Economic
Sector Crisis Growth

33. Longer Term Efforts to Overcome Debt Crisis
1) Involuntary Lending by private banks
2) Lengthening maturities of commercial loans
3) Reducing Interest Rates
4) Capitalizing overdue payments by adding them to the principle value of loans
5) Turning loans into long term bonds
6)Debt Swaps
• An indebted country trades something of value to a holder of its debt in return for a
reduction or even a cancellation of some of the countries’ external debt
 Debt for equity swap ( e.g giving a share in a SOE through privatization)
 Debt for nature swap ( could be purchased in the secondary debt markets by NGO’s, e.g WWF)
7) Writing Downs / Cancellation
Multilateral (e.g., World Bank, IMF loans) and bilateral
(e.g.,governmet-to-government ) loans were easier to reschedule or
cancel

34. Debt
1980s Debt Longer Term Overhang
1980s
Crisis Efforts to & Graphical
Debt
International Overcome Future Explanations
Crisis
Banking the Debt Economic
Sector Crisis Growth

35. Debt Overhang and Future Economic Growth
• Debt Overhang: A situation where a debt stock of a country exceeds its
future capacity to repay it.
• Countries accumulated a lot of debt with poor economic policy decissions
compromising growth.
 Many Countries in Latin America and Sub-Saharan Africa accumulated large
external debt in the 1970s to finance unsustainable CA deficits (Lost Decade)
• Debt overhang inversely effected investment decissions of both domestic
and foreign investors, which led reduced economic growth (Expectations
towards increased tax rates in the future)

36. Debt Overhang and Future Economic Growth
• Debt overhang of accumulated external debt and its repayment blocked
the transformation towards more sustainable ,productive, efficient
economy
 Hampers formation of human capital & technology acquisition capabilities
• Countries like Korea and India managed to increase their investment rates
thus increasing export revenues
• Countries like Sudan, Tanzania and Zimbabwe do not have optimistic
future to pay their debts despite the extraordinary efforts by the
international community to delay repayments.

37. Debt Overhang and Future Economic Growth
Debt burden Ratio (D/X)
Despite the attempts , the debt ratio is still high

38. Debt
1980s Debt Longer Term Overhang
1980s
Crisis Efforts to & Graphical
Debt
International Overcome Future Explanations
Crisis
Banking the Debt Economic
Sector Crisis Growth

39. External Debt Stocks (% of GNI) in Developing Countries (1982 & 2009)
Graph 1 Graph 2
Source: World Bank,World Bank Development Indicators, own calculations

40. External Debt Stocks (% of GNI) in Heavily Indebted Poor Countries (1982 &
2009)
Mauritania
Somalia
Nicaragua
Cote d'Ivoire
Togo
Guinea-Bissau
Liberia
Zambia
Gambia, The
Congo, Rep.
Sudan
Malawi
Honduras
Mali
Comoros 2009
Bolivia
Senegal 1982
Benin
Madagascar
Sierra Leone
Niger
Ethiopia
Uganda
Cameroon
Congo, Dem. Rep.
Ghana
Central African Republic
Chad
Burkina Faso
Rwanda
0 50 100 150 200 250 300
Source: World Bank,World Bank Development Indicators, own calculations

41. Current Account Balance (% GDP) in Developing Countries- 2010
 Majority still have CA
deficits
Likeliness of continous
external debt accumulation
is high
Source: World Bank,World Bank Development Indicators, own calculations

42. External Debt Stocks (% of GNI)
- Source: World Bank Development Indicators, 2011

43. Interest Payments on External Debt (% of GNI)
Source: World Bank Development Indicators, 2011
-

44. Manufactured Exports (% of Merchandise exports)
Source: World Bank Development Indicators, 2011
-

45. Conclusions
• The rapid build up of the debt was mostly due to OPEC‘s price hikes
• Much of the external debt was owed to private commercial banks
• Most economies borrowed for wrong reasons / unproductive use
• Many economies continue to suffer from some degree of debt overhang and
current account deficits
• If countries have to borrow, a lot of conciousness and consertiveness need to be
taken inorder not to hamper future growth of a country.
Note:
• Achieving development is more than External borrowing alone.It entails more
complementary factors as discussed in the several chapters like education and
moreso the political will by leaders and citizens of the respective countries to
achieve development.

46. Thank you

47. References
Cypher&Dietz,2009, ‘’Debt Problem and Development’’ , The Process of Economic
Development .
Todaro & Smith,2009 ‘’ Economic Developement
An Examination of Banking Cases of the 1980s and early 1990s, Volume 1