First as tragedy, now as farce
In August 1982, a Mexican default set off a broader debt crisis that would undermine economic progress in the region. Thirty-five years on, and with the threat of debt distress looming over the developing world, it is high time to heed the lessons from the Latin American experience.
by Mark Perera
As the saying goes, history repeats itself because no one was listening the first time. August marks the 35th anniversary of an event that sparked a debt crisis across the developing world. It was a crisis triggered by low interest rates in the Global North, a reckless boom in lending and borrowing to Southern countries over-reliant on commodity exports, and a fall in the price of those same commodities. Sound familiar?
The parallels with today’s developing-world debt crisis are stark, and looking back at how the 1980s crisis arose and how it was dealt with, there are worrying signs that very little has been learnt despite repeated calls by the European Network on Debt and Development (Eurodad) and other civil society organizations for a comprehensive, UN-backed debt workout mechanism.
A crisis begins
On 12 August 1982, Mexican Finance Minister Jésus Silva Herzog made a series of phone calls to the US authorities and the International Monetary Fund (IMF) to inform them that his country would no longer be servicing its outstanding debts. This unilateral halt on debt payments was unexpected – mainly because the warning signs had been largely ignored that Mexico, like many other developing countries, was in debt distress.
In a short space of time, many countries followed in Mexico’s wake, with defaults occurring across the Global South: within four years, more than 40 countries had agreed some form of debt restructuring with creditors, 16 of them in Latin America alone. But the crisis, and the solutions designed to deal with it, deeply damaged the region’s economic and social development, leading to rising poverty levels and widening inequality between 1980 and 1990. This period was subsequently dubbed the “lost decade for development” by the UN Economic Commission for Latin America and the Caribbean.
In the run-up to its default, the Mexican economy was heavily dependent upon oil exports, boosted by new reserves discovered in the mid-1970s. High oil prices had fuelled confidence in the country’s prospects, and it borrowed heavily from willing lenders, mainly to fund physical capital investment.
In 1979, interest rates rose sharply on the back of moves by the US Federal Reserve to counter inflation caused by a hike in oil prices, and remained high as President Reagan took office, cutting taxes and financing increased defence spending with external and domestic credit. The high rates meant Mexico found servicing its debts increasingly difficult. As global oil demand waned, export revenues fell and international reserves depleted rapidly. Domestic currency devaluations caused the debt burden to increase, and the August 1982 default became inevitable. At the time of its default, Mexican sovereign debt amounted to around $80 billion, largely held by private banks in the US, Europe and Japan.
Like other commodity-rich developing states, Mexico had capitalized on a credit boom from commercial lenders. This was fuelled by an overabundance of liquidity in global capital markets and a hunger for returns in the face of low interest rates in the US and other industrialized countries. High commodity prices during the 1970s meant many countries in the Global South had seen steady growth – but many like Mexico were over-dependent on one or two key commodities, and inherently vulnerable to shocks in market prices. Overconfident lenders recklessly ignored warnings – including from the then Chair of the US Federal Reserve – and kept on lending.
It ain’t over till it’s over
While the debt crisis signalled that decisive policy action was needed, it took years for a sustainable solution to be agreed. The immediate response from an unprepared international community was to organize hasty bailouts in order to keep the debt service to the banks flowing artificially. But focusing on the solvency of overexposed Northern banks meant they also avoided facing the consequences of irresponsible lending decisions. As a result, debt stocks actually rose as countries took on more bridging loans while imposing harsh structural adjustment, ultimately shrinking their economies.
After repeated attempts at rescheduling debts, and years of negotiations, it was not until the 1989 Brady Plan that real debt relief by the private banks was agreed, and it took eight years for the Paris Club of official bilateral creditors to allow for minimal reductions in debt stocks for the poorest countries involved in the crisis. They had to wait until 1996 for the door to be opened to comprehensive debt reduction via the HIPC Initiative of the World Bank and the IMF. Nevertheless, it was not until the Multilateral Debt Relief Initiative in 2005 that debt levels in most low-income countries could genuinely be reduced to sustainable levels, allowing for a fresh start. This came a full 23 years after the outbreak of the crisis, during which the populations of the countries affected paid a heavy social cost.
Could such a crisis be resolved more swiftly and decisively today? For a start, none of the debt relief schemes mentioned above could benefit a developing country running into payment problems now. The continued lack of a regime for debt crisis resolution means countries would probably face the same chaotic and protracted process as Mexico did in the 1980s.
The need for a sovereign debt workout mechanism has long been championed by Eurodad, other civil society organizations and the UN: political will, particularly amongst leaders in the Global North, is vital to establish such a mechanism to ensure fair, speedy and sustainable solutions to debt crises. When devising these solutions, obligations to creditors need to be weighed against a country’s non-financial obligations, such as those under international human rights law, to minimize the detrimental social costs for citizens. Of course, prevention is better than cure, and truly responsible lending and borrowing is critical to averting the emergence of unsustainable debt burdens in the first place.
If nothing else, the 1982 Mexico crisis shows that we cannot afford to ignore red flags when they are waving in front of us. A new developing-world debt crisis is already upon us – now is the time to act.
Mark Perera is Senior Networking and Advocacy Officer with the European Network on Debt and Development (Eurodad). This article is reproduced from Eurodad’s website (eurodad.org).
Third World Economics, Issue No. 644, 1-15 July 2017, pp5-6