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the United Nations Research Institute for Social Development

Structural Adjustment in a Changing World
The Debt Crisis

Several developments converted this indebtedness into the explosive debt crisis of the early 1980s. The first — for many developing countries which depended heavily on the export of primary products — was the severity of deterioration in commodity prices. Africa was particularly hard hit during the 1980s by this change in the market, which (despite a recent upturn for some products) is likely to constitute a continuing threat.

A second element in the debt crisis was an unprecedented jump in interest rates, encouraged by the United States Federal Reserve Board, as it attempted from 1979 onward to brake inflation and to attract foreign investment through a dramatic manipulation of the price of money. This strategy was shortly mimicked by other governments, in a bid to remain competitive with the United States. Since many Third World loans carried flexible rather than fixed interest rates, the cost of debt service quickly became unmanageable.

The third development ensuring a particularly deep and long lasting debt crisis was the imprudence of both banks and borrowers, who during the latter 1970s had often agreed upon loans which were not only economically risky, but at times frankly speculative in nature. A considerable part of the money borrowed by Third World governments, enterprises and individuals at that time found its way into private foreign bank accounts, leaving the developing country in question with a debt which corresponded to no ongoing local income-generating activity. It should be noted, however, that governments and private businesses also took out loans for projects, to increase industrial capacity or improve infrastructure, which seemed justified given the originally low level of interest rates and the abundance of capital in the international market during the latter 1970s.

The debt crisis was also worsened by the termination of all private lending to heavily indebted countries in late 1982. In the wake of the temporary suspension of payments by Mexico, the private banking system hastily withdrew from these markets, leaving foreign enterprises and governments to generate the large resources required to service their debts without access to new private borrowing. This not only ensured that any solution to the crisis would be long and painful, but also that debtor countries would be forced to depend heavily on multilateral financial organizations which controlled the only possible source of new funds.

The situation was further complicated by the foreclosure of the option of bankruptcy or default for private and public borrowers alike. While during earlier crises governments incapable of paying foreign debts declared themselves insolvent and renounced their obligations, the situation in the 1980s was very different: governments increased their own debt burden by assuming responsibility for private sector debt.

The negotiating strength of indebted countries was fundamentally weakened by the formation of lenders' cartels. Donor governments (working through what came to be called the Paris Club) supported debt rescheduling only if agreement on macro-economic reform had been reached between the debtor country and the International Monetary Fund. Meanwhile private banks (forming what became known as the London Club of creditors) refused to negotiate separately with any indebted country, while international financial institutions refused to provide assistance to countries which had not reached an agreement with the relevant group of private lenders. This situation remained in force until 1989, when the very slow progress of debt rescheduling convinced the United States government that it was time to weaken the bargaining position of the banks through holding out the possibility of multilateral assistance to countries which might not yet have satisfied the demands of private creditors.

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