The Paris Club and Indonesia
An extremely esoteric topic: Paris Club comparability.
When the Paris Club grants debt relief to a country like Iraq, it typically requires that the country seek “comparable” debt relief from its other creditors. Iraq consequently is seeking to get both Saudi Arabia (and a bunch of other countries that are not members of the Paris Club) and private investors who bought its old syndicated bank loans (along with its other private creditors)to follow the Paris Club’s lead, and to agree to reduce their claims on Iraq.
The underlying logic of comparability is simple: when say the US grants Iraq debt relief, it wants that relief to help Iraq, not to help Iraq pay either Saudi Arabia or a private investor who happened to take a punt on Iraq’s old syndicated bank loans.
The question: should this principle apply if a country hit by the recent tsunami accepts the Paris Club’s offer to let it defer debt payments?
Lex Reiffel more or less says no in Friday’s FT.
I say, yes, the principle still holds, but be flexible in its application.
There is one important difference between Iraq and Indonesia that is worth noting. As far as I can tell, the Paris Club is willing to let Indonesia defer payments, not to permanently forgive Indonesia’s debt: money not paid now still has to be paid later. That is not determinative though: private creditors can agree to defer payments too.
But should they? In general terms, yes. The goal of the Paris Club’s offer is to make sure than Indonesia (and Sri Lanka) has more money to spend helping the tsunami’s victims, not to provide funds to repay other creditors.
But there is no reason to be too rigid either. Indonesia does not — I think — have any bonds coming due in 2005, and going through the trouble of restructuring Indonesia’s bond to get a tiny bit of relief on coupon payments is not worth the effort. The fees and the damage to Indonesia’s reputation would outweigh the potential benefits. The Paris Club’s goal should be to make sure private creditors are not taking funds out, not to cause needless stress or a problem where there is not one. I agree with Reiffel on this.
I suspect, however, that the government of Indonesia has some commercial bank loans coming due in 2005 (unless something has changed in the last few years, most of these loans will be from Japanese banks). Postponing payment of principal on these loans is an easy way to provide Indonesia with a bit of relief. The loans can be rescheduled formally. Or alternatively, Indonesia could get commitments from its existing creditors to provide enough new financing to assure that there is no net payment of principal this year.
That a) is not too hard to do and b) makes sure that Tsunami aid is not used (in some very small way) to pay back commercial banks. An aside: It is true that emerging economies are now attracting substantial private capital flows, as Lex Reiffel notes. But it the aggregate macroeconomic sense, they don’t rely on this capital to fuel their growth. Savings in emerging economies right now exceeds investment in emerging economies, so emerging economies are lending their surplus savings to the developed world (read the US). Capital inflows from abroad effectively finance reserve accumulation, not more investment. FDI plays an important role in diffusing technology and best practices and all that. But, on net, private capital inflows into emerging economies are recycled back to the United States and used to fund the US current account deficit (i.e. US investment in excess of national savings), not to fund investment in emerging economies.
Look at Table 25 of the statistical appendix of IMF’s World Economic Outlook. “Emerging economies and other developing countries” have been running current account surpluses (lending to the rest of the world) since 1999 — and their surplus is growing, not shrinking …
The net flow of capital is from the developing world to the developed world. The “Bretton Woods Two” hypothesis that Asia’s defense of pegged exchange rates will finance the US, so large US current account deficits are not a problem goes a bit too far, but at least the Bretton Woods two thesis — unlike much writing about globalization — is consistent with the observed global flow of funds.
Silas sends home money to support parents and brother and sister. The money is sent to Nigeria, along with funds from many Nigerians living abroad. Now in Nigeria there is a surplus of saving, so Nigerians in turn invest in America or Europe or South Africa. Countries like Nigeria should be importing not exporting capital. How is the Nigerian government to encourage more domestic investment?
Were we fairly wealthy in Nigeria or Chile or Indonesia we might invest at home, but we would at least as readily invest abroad to diversify and protect assets. The Australian economy is a lot more sound than the Indonesian, and building in Australia makes sense for Indonesians. Then when I think about how important it is for China to assure domestic investment flows, I can understand the reason for capital controls and why attracting international investment for export industries seems so important. Keep potential investment money in China and attract all the international capital possible.
http://www.nytimes.com/2005/01/15/business/worldbusiness/15debt.html
After 100 Years, Japanese Will Go Abroad to Sell Bonds
By TODD ZAUN
TOKYO – For the first time in a century, Japanese finance officials will travel abroad next week to drum up sales for the nation’s bonds among foreign investors, with stops planned in New York and London.
It will be the first overseas excursion to sell bonds since one that began in 1904 to finance the Russo-Japanese war, which Japan won a year later. This time, the only enemy is the rapidly advancing government debt, and Japan is likely to face a much longer battle before that is brought under control.
The last two years the price of raw materials have been unusually high and maybe the third world, which is a big net exporter of raw materials, is being wish in expecting that this only temporarely so the save this windfall up. Or maybe it is because ramping up spending without warnng is difficult
raw materials is part of the explanation, but not the main part — the swing from being a net importer of capital to being a net exporter began in 97, continued in 98 and was completed (in large part) by 99 — and during that particular time, raw material prices tanked. moreover, right now asia — which imports raw materials — is a bigger exporter of savings than the resource economies.
Were we reasonably wealthy and living in Hong Kong in 1997, we would have made sure we had substantial assets and the right to residency in Canada or Australia or America or England. Protecting assets in many countries seems to me to lead to investing in the most developed economies. Real estate has been a remarkably sound investment in developed countries despite cyclical swings. Why should we be surprised that capital flows from developing economies? The need is to find ways for developing economies to attract capital as India and China especially have.
“The question: should this principle apply if a country hit by the recent tsunami accepts the Paris Club’s offer to let it defer debt payments?”
Surely!
The idea that debt forgiveness by America or Western Europe or Japan means espressly allowing for debt paymeny to other public or private parties is defeating the purpose of debt forgiveness and essentially making developed governments insurers of loans from other parties.
it is possible for flows from developed country investors seeking higher returns into developing countries to offset (or more than offset, as was the case in the mid 90s) flows from those with funds in developing countries who are to accept low yields in exchange for safety and security. (Reserve buildup is one component of a broader flow of funds from poorer countries into safe assets in developed countries). If those flows offset, significant gross flows would not result in large net flows. The “net” flow of capital would be in balance, and the developed world in total would not be running a large current account deficit with the rest of the world.
Brad,
I know there can and should be a flow of funds to “emerging markets.” But, remember the Emerging Market Stock Index at Vanguard has a 10 year return of 5.2% while the Total American Stock Index return was 12.2%. From 1994 American investors were learning not to look to emerging markets. Though we are supposed to look ahead in investing, most look behind and from the Mexican crisis in 1994 there was reason after reason in returns to look away from emerging markets.
Emerging Market Stock Index returns were anemic or negative from 1995 through 1998 in the midst of our astonishing bull market. Though the very fine emerging market returns in 1999, look at our technology returns. Then, emerging market returns were negative from 2000 to 2003. Investors were learning, stay away from emerging markets. The last 2 years were excellent, but investors take time learning.
http://www.nytimes.com/2005/01/16/magazine/16SOCIAL.html?oref=login&pagewanted=all&position=
A Question of Numbers
Since the establishment of Social Security in 1935, government actuaries have been crunching data and projecting the future of the system. Why don’t they see a crisis looming?
http://www.nytimes.com/2005/01/16/magazine/16TAXES.html?pagewanted=all&position=
Breaking the Code
Deftly, year by year, step by step, the Bush administration has been reinventing the American system of taxation. And the story of this revolution is not over.
Excellent in depth articles….
anne — tis true, many people do chase past performance, and thus run the risk of buying in at the peak … the dollar did very well from 95 to early 02; alas, the trend then changed (as it had to, or our current account deficit would be even bigger).
emerging market bonds, by the way, have done spectacularly well — notwithstanding Argentina’s widely telegraphed default — from 99-04 (i.e. ever since huge correction that accompanied Russia’s default). Some folks may chase those returns. But forecast out similar returns for this year and you get spreads at levels that to my mind are non-sensical. even chasing the extra yield is a bit risky — though probably no more so than the risks of chasing the extra yield in the corp. debt market (El-Erian of PIMCO says it is less risky, b/c EM fundamentals are so strong — mostly current account surpluses not deficits, strong primary surpluses, etc; I still worry about Turkey’s current account deficit, and very high domestic debt levels in a few key EMs)
Remembering the bond market is important. While the last 5 years have still left negative S&P returns of -2.4% a year, the Vanguard long term bond index is up 9.7%. Emerging market bonds have done even better through these 5 years, while the Emerging Market Stock Index is up 5.3% a year due to superb gains in 2003 and 2004.
http://www.nytimes.com/2005/01/17/business/worldbusiness/17oil.html
Alert to Gains by China, India Is Making Energy Deals
By KEITH BRADSHER
NEW DELHI – India’s prime minister warned on Sunday that China had moved ahead in securing worldwide oil and natural gas supplies, the bluntest expression yet of energy worries among Indian leaders. In the last two weeks, they have pursued a series of energy deals that have surprised global markets.
“I find China ahead of us in planning for the future in the field of energy security,” Prime Minister Manmohan Singh said in a speech here at the convention of India’s oil and gas industry. “We can no longer be complacent and must learn to think strategically, to think ahead, and to act swiftly and decisively.”
Like China, India has a fast-growing economy but stagnant domestic oil production, which has led to a rapid rise in energy imports, at a cost that has soared with high oil prices.
Indeed, India has become even more dependent than China on volatile producing countries in the Middle East, buying nearly three-quarters of its oil from them now, compared with less than half a decade ago.
Notice that India and China can model for each other, and this can be healthy for each country.
Paying for the Past in 2005
By Joseph E. Stiglitz
“High oil prices are a drain on America, Europe, Japan, and other oil importing countries. The increase in America’s oil import bill over the past year alone is estimated to be some $75 billion. The effect is just like a huge tax that transfers wealth to the oil-exporting countries.
“If there were any assurance that prices would remain permanently above even $40 a barrel, alternative energy sources (including shale oil) would be developed. But we are now in the worst of all possible worlds—prices so high that they are damaging the global economy, but uncertainty so severe that the investments needed to bring prices down are not being made.”
American investment in energy efficieny and production may be too limited, but is energy investment in China and India too limited or solely limited to assuring diverse supply alternatives? What of energy efficiency in China and India? Europe at least has pushed hard for more energy efficiency, but I wonder even about Japan in recent years.
Congratulations on the WSJ A1 mention.
Hi Brad.
A quick comment on Indonesia and the Paris Club.
Don’t forget the fungibility of money. Debt relief for Indonesia is simply a convenient way of transfering resources to the government in Jakarta for the humanitarian objective of easing the crisis. There are plenty of ways in which a Paris Club government could transfer these resources – writing a cheque would be the obvious alternative.
Yet if a Paris Club government did write a cheque to Jakarta to help finance the aid effort you wouldn’t dream of insisting that Indonesia’s private creditors do the same. So why is humanitarian debt relief any different? (Equally, if a Paris Club government writes a cheque to Indonesia there’s nothing really stopping Indonesia from using the cash to repay its private creditors, but maybe that’s another issue).
This whole debate about Paris Club comparability for Tsunami victims misses the point that this particular round of debt relief is motivated by factors which are entirely different from those that usually drive debt relief; Tsunami-related debt relief is a humanitarian gesture from one government to another, not an attempt to address issues of balance-sheet-sustainability (where comparability is entirely appropriate). In this case the issue of private sector comparability shouldn’t even arise.
Cheers
david — thanks for your comment. I am much more open to a “humanitarian/ disaster” exception to comparability than I am to Reiffel’s arguments, which pushed toward the view that comparability was sort of OK in retrospect in the 80s but really should be eliminated all together now, starting with the disaster relief cases.
That said, I can see some difficulties applying the “humanitarian” v. “balance sheet criteria” — both b/c a major natural disaster can create balance sheet problems, and b/c balance sheet problems can sometimes be solved by squeezing “humanitarian” spending (education, health, etc). But a carve out may be a better option than applying comparability with an unusual degree of flexibility — particularly if the “tsumami exception” can be defined and walled off and kept a one-off.
Your fungibility point is also well taken, though I would note that there is one difference between PC debt relief and cash — namely, that the PC debt deferral is in effect a loan (a new loan that is provided to pay the old loan coming due this year) while cash is cash. Both debt rescheduling and grant aid free up resources that could be used for broader purposes in the near term, but one has to be paid back (eventually).
That said, I certainly don’t think the intent of providing debt relief is to make it easier for the government of indonesia’s private creditors to cut back on their Indonesia exposure this year — even if that is sustainable in the sense that it can be financed out of the GOI’s reserves. The GOI’s public sector creditors were going to extraordinary lengths to make sure that this year, the net flow of funds to indonesia is very, very positive. The GOI presumably has a “disaster linked” need for BOP support this year — higher imports to support reconstruction/ feed survivors — etc. That financing need would go up if private creditors were pulling funds out … So, I certainly would like to see some analysis of the potential scale of private roll off on GOI and GOI guaranteed debt before automatically granting a “disaster relief is completely different” exception. The fungibility argument works both ways — the BOP impact of paying down principal owed to the GOI’s private creditors is the same as the BOP impact of paying down the GOI’s Paris Club creditors.
That said, PC comparability should not create a problem if there is no problem to begin with. If If private creditors are not likely to pull funds out (you presumably would know) over the next year, no worries. If all loans coming due are likely to be rolled over and the GOI can provide assurances to that effect, that seems more than sufficient to me. Aceh is not the heart of Indonesia’s economy.
There is another potenital issue with Indonesia. Loads of domestic GOI debt from the 97-98 crisis, lots of which has to be rolled over in the near term — debt servicing costs may be going up (most of this is in hands of the domestic banks). Lots of PC debt. Lots of overall debt. A small but growing number of international bonds. The bonds seem to trade a bit too tight for my taste, given the risks intrinsic in lending to a still very poor country with that much overall debt.
Hi Brad
Thanks for your response. Two quick points.
First, I don’t agree with those who argue that Paris Club debt relief somehow stigmatises the borrower or makes private creditors want to rush for the exits. On the contrary: if a country’s official creditors are providing debt-service relief – whether or not in PV terms – then the rational thing for private creditors is to increase their exposure, since the debt-service reduction enhances the country’s creditworthiness. The most convincing examples of this are Egypt and Poland, whose access to international capital markets was vastly expanded following substantial official debt relief in the early 1990s.
Second, I imagine the best way to give humanitarian debt relief in these cases would be to forgive (and forget) interest payments for some time. This would provide genuine PV savings and help to forge a distinction between “humanitarian” debt relief and “sustainable balance sheet” debt relief. (This assumes that the crisis caused by the Tsunami has not tipped Indonesia’s balance sheet into unsustainable territory).
Regards
David
david — let me see if I understand your proposal.
in humanitarian cases, the PC forgives and forgets interest payments, but the principal stays (presumably any principal coming due is rescheduled). in balance sheeet sustainability cases, the PC reduces principal and also, presumably, provides a new cash flow profile? (see: Iraq) That range of options, incidentally, leaves out the PC’s bread and butter, which is just to reschedule payments coming due.
There may be one problem with that proposal from a pragmatic “how to deliver the aid” point of view. I think much of the appeal of using the PC is that “deferring scheduled payments” usually does not have a budget cost to PC creditors, unlike outright grant aid or outright debt forgiveness (including forgiving interest). If you have $1 billion for aid, and want to provide $2 billion of short-term relief, you could provide $1 billion in aid and defer $1 billion in payments (no budget cost). But if you wanted to forgive the $1 billion in payments, i think you get a budget charge that eats up a decent fraction of the $1 billion. (There are experts on this who “score” or “cost out, using US government rules” debt options for the US government, for example — I am no doubt leaving things out). I do think this causes problems: the PC often selects options that are driven more by “what costs us the least” rather than “what does this do the country’s balance sheet,” but it is also a fact of life.