[PEN-L:2018] Debt Trap

[ceyhun@xxxxxxxxxxxxxxxxxx (Fikret)]

        Trond Andresen had an interesting post on debt polarization, which
is reproduced below.

        I would like to add the followign note which explains why Third
World debt grows as it does. The table is a simulation based on some
assumptions, which are not too unrealistic. And if we look at the Third
World debt data, we observe its accumulation as the simulation table
indicates.

THE DEBT TRAP:
1. New borrowing needs:
        M - X = new borrowing or debt refinancing.
        M + debt service = X + new loans.
        M=imports       X=exports
where:  NL= new loans
        DS= debt service
        M = X + (NL - DS)
        NT=(NL-DS): net resource transfer  or net proceeds
        M = X + NT

2. As  NT declines, M declines too. And NT becomes negative, then part of
the export earnings will have to be allocated to debt service and a
fraction to imports. This sets a crisis in the debt-ridden country.

3. Here are the assumptions:
        Interest rate is 10 percent;
        Debt amortization is 5 percent
        New borrowing needs grow 10 percent, due to development projects

        Calculations are explained by formulas given at the bottom of the
table

        New         Debt Service       Net        Debts
        Loans Interest Principal Total Transfers  Outstanding
Year     (1)     (2)    (3)      (4)    (5)        (6)
1       2000    200     100     300     1700      1900
2       2200    410     210     620     1580      3890
3       2420    631     331     962     1458      5979
4       2662    864     464     1328    1334      8177
5       2928    1111    611     1721    1207     10495
6       3221    1372    772     2143    1078     12944
7       354     1649    949     2597    946      15538
8       3897    1944    1144    3087    810      18292
9       4287    2258    1358    3616    671      21222
10      4716    2594    1594    4187    528      24344
11      5187    2953    1853    4806    381      27678
12      5706    3338    2138    5477    229      31246
13      6277    3752    2452    6205    72       35070
14      6905    4198    2798    6995    -90      39177
15      7595    4677    3177    7855    -260     43595
16      8355    5195    3595    8790    -435     48355
17      9190    5754    4054    9809    -619     53490
18      10109   6360    4560    10920   -811     59039
19      11120   7016    5116    12132   -1012    65043
20      12232   7728    5728    13455   -1223    71548
--------------------------------------------------------------
Column (1)t = (1)t-1(1.1)
Column (2)t  = [(1)t + (6)t-1]
Column (3)t  = [(1)t/20 + (3)t-1]
Column (4)t  = (2) + (3)
Column (5)t  = (1) - (4)
Column (6)t  = [(1)t + (6)t-1] - (3)t


EXTERNAL DEBT OF LESS DEVELOPED COUNTRIES (COMBINED)
(Billions of  US dollars)
                         1970           1975    1980    1985    1990
TOTAL DEBT(EDT)         $68 bil.        167     573     966     1,281
DEBT SERVICE(TDS)       $5.5bil.        4.5     92.0    128.7   143.4
NET TRANSFERS           $4.5bil.        19.0    30.2    -17.6   -21.6
DEBT SERVICE/EXPORTS    9.6%             9.1     21.1    27.9    19.8
TOTAL DEBT/GNP          10.3%           12.4    28.0    46.1    41.8

LOW-INCOME COUNTRIES
                                         1980    1985    1990
Total Debt Stocks (EDT)                 $129 bil. 242     407
Total Debt Service (TDS)                 $13 bil  25      37
Net Transfers                            $11 bil   5       7
Total Debt Service/Exports [TDS/XGS]      10.3%   21.7   20.0
EDT/GNP                                   16.4%   28.6   41.4
Source: World Bank, World Debt Tables, 1988-89 and 1990-91 editions.
Low Income Countries are those in which 1990 GNP per capita was no more
than $610, and Middle Income Countries are those in which GNP per capita
was more than $610 and less than $7,620.


THE LOST DECADE:  An unusual comment by a conservative US weekly.
 Excerpts from U.S. News & World Report, Oct. 2, 1989, p.51.
        There is a widespread sense that the 1980s have been a "lost
decade" for much of the developing world, especially for the deeply
indebted nations of Africa and Latin America. Nor is the emerging approach
of the 1990s necessarily cause for celebration. Unless the debt burden is
scaled back dramatically, it will continue to be a very serious problem
that will stifle development for years to come....

        Statistics tell much of the decade's grim story. National income
per capita among developing countries either stalled or fell substantially.
Fueled by rising interest rates and a fall off in exports, debt service as
a share of export earnings climbed. At the same time, new commercial
bank-lending dried up; as a result, the developing world, which had
recorded a $29 billion net inflow in financial resources for 1982, saw a
staggering $100 billion outflow from 1985 through 1988. The implication of
this hemorrhage for capital-starving nations are harrowing.  Cutting the
debt overhang and reversing the net transfer are critical to reducing
poverty and spurring growth.

         Mexico and commercial banks last week completed work on the first
arrangement reached under the Brady plan; creditors now have a choice
between making new loans to Mexico or writing off 35% of their existing
loans. To prepare for those losses, the nation's major banks have been
setting aside billions of dollars in loan-loss reserves in recent weeks.

        Kind regards,
        Fikret Ceyhun




Accidentally I deleted Trond Andresen's beginning comments.

>Financial polarization is proceeding within the richer countries, not
>only between rich and poor countries. It also proceeds within the poor
>countries.
>
>I think the indebtedness explanation also sheds light on the
>explosive growth of financial sectors worldwide: When society gets more
>financially polarized, there is an increasing market for mediating and
>handling of debt/asset relationships.
>
>I have launched these views on and off for a couple of years now, and I
>still haven't heard any explanation why the reasoning is wrong. I have
>a suspicion that the simple accumulation mechanism of compound interest
>(dividends) leading to exponential* asset/debt growth, known since
>ancient times and condemned by f.inst. Aristotle, in The Bible and the
>Qura'an, is considered too quaint (can a serious modern economist
>support an explanation which is recognized already in the Old
>Testament?) and too trivial, to play a central part in explaining the
>dynamics of complex, modern capitalism.
>
>It is IMO a case of not seeing the forest for all the trees.
>
>One important factor that IMO confuses the issue for many economists,
>is the phenomenal real growth observed in most countries for a
>significant part of the last 50 years. But such growth may occur, and
>may give all members of a society increasing living standards, IN
>PARALLELL WITH INCREASING INDEBTEDNESS.  The presence or absence of
>productivity increase and production increase has no important bearing
>on the financial polarization process.This process is fundamentally
>similar in antique society and today, as long as money and interest is
>present. And the crisis one bogs down into is also essentially the
>same. In antique societies, which were static agrarian ones, the debt
>crisis led to catastrophe with people being sold off for slavery/dying
>from hunger. Under modern dynamic capitalism, real growth is (or has
>been) so fast due to technological developments that the effects of
>indebtedness are ameliorated. But financially the mechanism is similar
>and just as serious, and as i said in an earlier message, if further
>polarization due to accumulation shall be (homeostatically) held in
>check _only_ by a high rate of insolvencies ensured by feedback from
>the fragility that follows from indebtedness, then the world (in an
>average sense) will stay bogged down in this situation.
>
>One solution (beside large scale debt forgiveness; a "jubilee") is to
>lower the interest rate. One may show that an interest rate
>
>i < d * (1-s)/s
>
>ensures a reversal of polarization, i.e. debts are paid off faster than
>they may accumulate.
>
>Here
>
>i = average interest rate [per cent/time unit]
>d = average rate of repayment [per cent/time unit]
>s = average creditor savings rate out of incoming financial flows [per cent]
>
>Thus low savings rates and/or high rates of repayment allow a higher
>interest rate without polarization occuring.
>
>-------------------
>
>* Note that an exponential path is characterized by a small slope
>for a fairly long initial period, before it explodes. Thus polarization
>may proceed (slowly) for decades without alarms being raised.
>
>
>regards,
>
>Trond
>
>-------------------------------------------------
>| Trond Andresen  (Trond.Andresen@xxxxxxxxxxx)  |
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