Foreign Debt: A New Face
The Ministry of Foreign Cooperation has launched a bold operation of buying back Nicaragua’s commercial debt, something quite beneficial for the country. Will it be possible to try another bold operation, one of debt exchange with Germany in order to save the National Development Bank? We make the proposal.
In the past few months, Nicaragua's foreign debt has returned to the short list of national concerns. envío has already published two articles on this issue (August 1994 and August 1995), to underscore the problem's magnitude as well as its consequences for the country's economy and, at the same time, to suggest that the debt burden could be transformed into a real opportunity to bring together very divergent interests around a common, national project.
A Technically Unpayable DebtThe dimension and complexity of the problem of Nicaragua's foreign debt requires, as part of an overall strategy, simultaneous treatment on five fronts:
* The bilateral debt with the rich countries belonging to the Paris Club.
* The debt with the former socialist bloc.
* The debt with private commercial banks.
* The debt with multilateral organizations.
* The debt with the Third World, among which Central American countries should receive special attention.
Nicaragua's key strength in putting together this strategy is, paradoxically, the severity of both its economic situation and its indebtedness. When a country has a debt it cannot pay, that debt is of less financial value to the creditor than is actually stipulated in the promissory note. And Nicaragua's current economic situation makes its debt technically unpayable: the debt it carries equals more than six years of production and 34 years of exports, a $2,600 debt per inhabitant. All three ratios debt/GDP, debt/exports and debt/ population are the highest in the world. The advantage is that it is easier to obtain a debt reduction when creditors feel that a return on their loans is very improbable or when they know the critical situation facing the debtor which is virtually the same thing.
Naturally, this advantage may vary. Not because a country's overall economic situation could improve overnight we're a long way away from that but because its capacity to pay what remains of the debt if the reduction strategy is successful increases, leading pending creditors to impose more restrictions.
That is why, even though the Ministry of Foreign Cooperation has had successes in its debt negotiations, especially during 1995, it cannot report on the new financial value of the total debt resulting from its various negotiations. Some government spokespeople, given to projecting politically favorable images, as well as to manipulating information, do not proceed with the caution of the Ministry of Foreign Cooperation. (See "A Parade of Images in Paris," envío, vol.14, no.169, August 1995.)
The debt's value on a country's economic situation and the weight of reductions already obtained on that value have a very different influence on creditors, depending on whether they are a commercial bank, foreign government or multilateral organization. The Nicaraguan government's attitude toward each of these creditors is, for that reason, also very different.
The commercial debt: To date, the debt with private international banks has not been Nicaragua's main worry, because the government is not paying on it. Nor are the current holders of that debt worried; they can wait to collect, even if only a fraction of the initial value. This debt has already been bought by speculators at prices far below its initial value, so any economic improvement in the country means a chance for them to make a profit. In fact, their very speculative activity could increase our debt's financial value, which is why this component of Nicaraguan's debt demands such careful treatment.
The bilateral debt: The debt with governments that still assist Nicaragua or give it preferential credit treatment is obviously a more pressing concern. Their reticence to completely annul our debt with them, even though they donate other resources to us, is partly due to their desire to maintain a certain right of conditionality over our economic policy and, above all, not to favor other, less generous, creditors with their own generosity. (If one creditor pardons our debt, it increases our capacity to pay others.) In the long term, the only route in countries extremely dependent on foreign aid, like Nicaragua, would be complete debt forgiveness. A form of conditioning that can be very useful in promoting development is the so called debt swap.
Multilateral Debt. In the case of the International Monetary Fund, the World Bank, the Interamerican Development Bank, etc., the notion of a debt's financial value is not applicable because these organizations simply do not permit a country to completely cancel its obligations with them. Nor can Nicaragua just stop paying them, because our key foreign financing, through the Enhanced Structural Adjustment Facility agreement (ESAF), depends on their seal of approval. The policy of these organizations toward very impoverished countries like Nicaragua is to keep extending more loans, so that the countries can roll over their previous ones. In the long run, it is a futile policy leading nowhere, but, as a small country, we lack the wherewithal to confront it. One particular case merits special attention: that of the Central American Economic Integration Bank (BCIE), which Nicaragua has now not paid for three months.
The Commercial Bank Debt: Its Origin and HistoryMuch of Nicaragua's debt with private international banks dates back to loans taken out under the Somoza dictatorship and later recognized by the Sandinista government. Of this debt, 71% is owed directly by the Nicaraguan government and 27% by Nicaraguan firms or banks that were nationalized; the remaining 2% was originally held by individuals who paid the córdoba equivalent of their part to the Nicaraguan Central Bank when it took on the total debt.
Although the contrary has been both thought and written, the Sandinista government maintained relations with its private commercial bank creditors during the 1980s. What is true is that, despite repeated efforts in 1982 and again in 1984, the Sandinista government was unable to achieve normal relations with the commercial banks. Even though it paid them some $400 million, of which $220 million was capital amortization, it was only granted new loans to the tune of $130 million.
Since commercial bank loans in the 1970s were very important for prefinancing exports and thus for the export companies that prefinanced producers total prefinancing came to represent about 50% of the country's monetary mass. We can thus understand the impact this void had in the rural economy, particularly in the area of exports. The void partly explains the dramatic drop off in the country's economic activity throughout the 1980s.
At the beginning of the 1990s, Nicaragua owed the commercial banks about $720 million in principal. To that must be added the product of a 1982 capitalization agreement and a 1984 letter of understanding signed by the Central Bank acknowledging that it had overdue interest payments and agreeing that they become part of the principal. That is to say, they were "capitalized." With that, the total amount of the principal rose to $1.05 billion. At the beginning of 1986 (following the US embargo declared against Nicaragua in May 1985), relations with the international banks were broken. Nicaragua made no further payments on the principal and new interest accumulated.
In 1985, the Central Bank had signed a second "letter of understanding," capitalizing another $253 million in unpaid interest, but, given subsequent events, that letter slipped between the cracks. The creditors continued to work with the $1.05 billion figure until very recently. When the payments made more recently by the Central Bank were calculated on the basis of that agreement, the legal amount of the debt jumped to $1.31 billion. Nicaragua's current bold operation to buy back its commercial debt at bargain prices from the speculators who purchased it is based on this amount.
Each Dollar Worth a Few CentsThe common denominator of all countries that resort to debt swapping or, more simply, try to get either the principal or the interest pardoned, is that they are incapable of paying. The debt burden affects their development possibilities in two ways. They are affected now because the debt service even when they don't pay all of it year by year and let arrears pile up leads to further imbalances in their macrofinancial flows. And they are affected in the future because the sword hanging over them diminishes their macroeconomic credibility and thus their possibility of attracting new investments.
The creditors of an over indebted country subjected to this vicious circle cannot reasonably expect to recover the total amount of the country's outstanding promissory note with them. In market terms, this means that the real value of these promissory notes is less than their face value. How much less depends on the probability of repayment, and is expressed in the value those notes acquire in the secondary bonds market.
This market is extremely volatile, reflecting changes in the attitude of speculators who specialize in debt bonds when they assess a debtor's "economic health." In recent years, Nicaragua's commercial debt bonds have, with great fluctuations, always been worth far less than their face value: 10.5 cents on the dollar in September 1991; down to 5.5 cents in January 1992; up to 16.25 in January 1994 and then another plunge to 4 in January 1995. They have been low throughout this year so far, but rumors that the Nicaraguan government was going to undertake a repurchasing operation have now brought them up again.
In cases like Nicaragua's, debt bonds are often no longer in the hands of the original creditors, but in those of a large number of institutions generally also banks that largely dedicate themselves to this kind of business. According to a 1992 study, Nicaragua's commercial debt has been shared out among 144 such holders, though the first 20 on the list hold 69% of the total. The three largest, with 33% of it, are New York's Citibank and Chemical Bank, and the Swiss Bank Corporation.
The essence of a repurchasing operation consists of offering to buy the bonds back from their holders at the low market price, then later destroy them. To be successful, the operation must be a surprise, quick and complete. To that end, it is necessary to pull together the total amount to be offered, then make the bid before the speculators get wind of the operation and start holding out in hopes of driving up the offer. It must be complete because if an insufficient amount is repurchased as happened to Bolivia, which only managed to buy back 50% of its debt the price of the rest skyrockets and becomes even more unpayable than the original total. Since the speculators have seen that there was money to buy back part of the debt once, they can wait years until more is available to buy off what is left.
Historic FirstsBuy back operations are often complemented with swaps for physical assets companies or installations in the debtor country. Nicaragua is the first to undertake this operation entirely with cash. Another "record" is that the money has been virtually donated, thanks to collaboration by the World Bank, the Interamerican Bank and friendly governments including Germany, the Netherlands, Sweden and Switzerland. It is an advantage that it is a one time fixed offer: the holders know that there will be "not another cent."
Another condition favoring the success of Nicaragua's operation is that an implicit price of 8 cents on the dollar was used to calculate the repurchase of the $1.31 billion to the banks plus $58 million in debts to commercial suppliers, which totals $109.6 million. This is an attractive offer to the speculators, who had only calculated some $1.06 million. Buying back all these promissory notes (principal plus the interest capitalized in 1982, 1984 and 1985) also cancels the non capitalized overdue interest, estimated at $810 million in 1992.
It is not yet clear that the operation will be successful. The government postponed the period initially proposed in which creditors could take advantage of the offer from October 6 to November 6. In any case, we must wait until December, when all the operation's legal ends are tied up, to learn whether the operation was accepted. If so, the country will have rid itself of a huge burden.
A Disguised External DebtThe experience of the 1980s shows that it is not easy to regain the confidence of the international banks. But conditions are better today, because it can be observed in all "developing" countries that international capital is on the lookout for new possibilities to invest in what have come to be called "emerging markets."
Nicaragua can aspire to space in these emerging markets, which could be a way to renew the export prefinancing mechanism that functioned in the 1970s. But new risks also come with the capital flowing toward these new markets. An outcome similar to what happened in Mexico could occur: the government issues bonds to finance its deficit and, since the bonds carry a higher interest rate than the US financial markets, foreign banks and other agents snap them up. Then, when a new payment crisis arises, the whole country must be mortgaged, thus making clear that the internal debt government bonds are just disguised foreign debt.
Since the key financial intermediation problem in Nicaragua is not a lack of private banks there are plenty of those but their unwillingness to take risks with subjects who are truly promoting development, such as farmers in the central regions, it is hard to imagine that foreign banks unfamiliar with the context and without specialized personnel will take risks that national private banks have rejected.
While a successful buy back operation will give Nicaragua's foreign debt a new, more humanized, face, still lacking are other measures and policies to deal with the problems of the financial system as a whole, without underestimating the eventual contribution that foreign banks could make. The key one would be to compete in the cities with local private banks, forcing them to reduce their margin of intermediation for medium sized businesses.
The Debt with Germany: Another OpportunityNicaragua's debt with Germany opens the door to important possibilities due to its size and because it is the last bilateral debt still pending negotiation within the Paris Club framework. A very positive result of the March 1995 meeting in Paris was the inclusion of this debt's arrears in the negotiations, and affording them the same treatment as given to service payments currently due: a 67% reduction. Since the largest arrears was the $582.3 million owed on loans extended by the former East Germany, applying such a reduction to that amount was like giving Nicaragua a disguised reduction of the total, leaving only $192.1 million still to be paid.
This remaining 33% must be paid in installments and with interest to be negotiated in a bilateral meeting scheduled for the end of October in Managua. This could be the opportunity to include a debt swap in the negotiations as an additional form of reduction. A proposal is also on the floor in the German Parliament to consider forgiving 50% of the debt, considering it a "war debt," then submitting the rest to the treatment spelled out in Paris. In this case, the total reduction would be 83.5%, leaving $96 million.
The rest of Nicaragua's debt with Germany was also discussed in Paris. As of December 31, 1994, there were two distinct amounts. A supplementary 17% reduction will be applied to the $90.2 million already negotiated in 1991, leaving $74.9 million outstanding. And, to the $92 million not negotiated in 1991, 67% will be applied, leaving only $30.4 million.
Considering the Bundestag proposal, the total outstanding balance would be some $200 million. Since it includes a clause authorizing a swap up to an amount of 10%, a maximum of $20 million would be available for such a swap. It could be applied to benefit nonconventional rural credit systems and even be a way to save the National Development Bank (BANADES).
Nonconventional Rural CreditNonconventional rural credit is the financial key to sustaining income generation in the countryside at the microeconomic level. It is also the key to creating the solvent macroeconomic demand for the provision of social services that would allow social service programs to succeed. To take all this on, however, the still deeply rooted conception of subsidized rural credit must give way to another conception: sustainable financial intermediation programs.
The growing interest of NGOs and rural development programs in offering credit to small rural producers reflects the demand by these economic actors, for whom the Nicaraguan financial system's "excess liquidity" is pure myth. To recover their access to financing, these producers need the commercial prefinancing mechanisms that were disarticulated in the 1980s. But that alone is not enough. They also need the existence of local financial institutions that know how to mediate credit to rural producers and have experience with the mechanisms required to protect themselves against the risks inherent to those producers' activities.
What is needed is a particular type of "nonconventional" financial institution, one sufficiently capitalized in funds and in personnel to be able to evolve towards rural savings networks that can be provided the physical protection necessary. Since investment in this "primary accumulation" is fundamental for Nicaragua, the debt swap should bolster it.
BANADES Must Be SavedThe nonconventional financial intermediation systems that already exist cannot grow fast enough to satisfy the demand of the entire rural sector, particularly that of the medium level producers who are not covered by conventional banks. Although some conventional banks are including more rural merchants and farmers in their portfolio, BANADES is currently the only one with the capacity to attend to the demand of the middle sectors, those most prone to economic reactivation and productive transformation and thus most able to contribute to national development in the short run.
BANADES is indispensable to strengthening the local intermediation systems that penetrate into regions of difficult geographic access. It is the trunk that sustains the smaller branches that bear most of the tree's foliage. Privatizing BANADES' regional offices would cut these nascent branches off from a trunk whose roots link them to the capital and to other countries.
BANADES has huge problems. Its populist credit policies in the 1980s and discretionary credit policies in the 90s have led to an arrears portfolio estimated at 30% of the total. The unpaid back debts essentially belong to dissolved cooperatives and large scale producers. BANADES no longer gives priority to small and medium rural production; of 115,000 such clients in 1989, only 23,000 remain. As a last straw, the International Monetary Fund is now recommending that BANADES begin to privatize so as to deepen the fiscal adjustment and comply with the ESAF goals (see "The Month," this issue).
BANADES could be recovered and nonconventional banks strengthened through the debt swapping mechanism, not only by injecting money into the loan supply circuit, but also by contributing to investment in human capital and to creating adequate local institutions, guaranty funds, etc. Naturally, the recovery of BANADES is inextricably linked to the health of its portfolio, without which this bank cannot again broaden out to attend to the demand of the medium sized producers.
Our ProposalThose who today supervise Nicaragua's macroeconomic policy propose destroying BANADES, by privatizing its assets the branches throughout the country instead of privatizing its liabilities and intervening to resolve the serious tendency toward favoritism in its credit policy that has brought this development bank to the brink of bankruptcy. envío proposes another way, one that could save BANADES:
* Germany hands over the $20 million in bonds of Nicaragua's public debt to an independent organization, made up of representatives of Nicaraguan civil society
* This organization trades the bonds for a 120 million córdoba fund, which it deposits in escrow in a private bank.
* The organization makes an overall offer to buy up BANADES' uncollected arrears portfolio, estimated at 500 million córdobas, at a significantly discounted price. (An audit of the bank's portfolio by an independent firm would be done previously to determine the exact amount of the portfolio.) As with the repurchase of the commercial debt, the amount offered by the organization would not be subject to negotiation.
* With the proceeds, BANADES pays off its own 120 million córdoba debt with the Central Bank of Nicaragua.
* The independent organization slowly parcels out bonds of the debt arrears to nonconventional credit organizations located in the same geographic area as the given debtor.
* These organizations look for ways to recover at least part of the bonds, with which to capitalize themselves.
* These organizations collectively name representatives to the BANADES Executive Council and auditors to any BANADES branch that exists where they are operating, to guarantee that no deviations or favoritism in the bank's credit policy occur in the future.
If our proposal is accepted, our oppressive foreign debt will begin to take on a human face.