From Surplus To Debt

Avinash Jha


The foreign debt of sovereign nations is about the foreign exchange, which a country borrows for buying things from other countries. These things may be things of genuine need, things of luxury consumption, or tools, technologies, and expertise to manufacture other goods in the home country. A country will earn foreign exchange by exporting goods or by lending foreign exchange to others. But if it spends more than it sells it will have to borrow. Some of these things that have  to be paid for in foreign exchange are bought directly by the government, some are bought under government guarantee, and some are directly bought by sections of population of the country. But all of these contritbute to the foreign debt, which shows up on the debit side of balance of payments. The nation-state as a whole becomes the debtor. A country can overcome this deficit by means of the reserve of foreign exchange it may hold. Once the reserves are exhausted or are insufficient, it has to rely on borrowings. When a country has to start borrowing to service its earlier debts, the debt has reached a crisis point.


The government’s economic policies, working within international constraints, determine the composition and volume of this debt. Who or what has power over the government determines what those policies are. In some countries, the consumption of luxury goods will be the largest factor in foreign debt. This is likely to be the case if the country governed by a corrupt and rich ruling class with a craving for foreign goods. A country may be forced into debt, if the export of commodities on which its foreign exchange earnings depend is hampered either by natural calamities, or by unequal terms of trade. A lot of third world debt was incurred in importing what was considered necessary for industrialisation tools, technology, expertise.


It is most surprising for our generation to learn that  at the end of second world war, many third world countries actually had huge reserves of foreign exchange. This had come about because of the war itself. The main combatants, who were in most cases highly developed capitalist countries, consumed more than they produced during the war. They imported a lot of materials from their colonies and they had very little surplus to export at the time. In many cases, former colonial powers imposed restrictions on the use of these reserves, usually as part of the price of political independence. In any case, most of these reserves were irresponsibly spent on imports.


India had reserves amounting to 1,200 million pound sterling (the British currency). It was in the form of sterling secutities, i.e., Britain had the legal obligation to pay for these. India opted for rapid planned industrialisation through new public sector industries in a market relatively sheltered from imports. Private sector industry was allowed to operate within some controls. A policy of self-reliance within national economy was envisaged.But the requirements of 'rapid industrialisation' very soon exhausted the reserves.

It should be noted here that the strategy adopted and operated at that time satisfied large sections of the middle class, business class, bureaucracy, and the political class. They all wanted to put India on the industrial map of the world. They had internalised the image of India as underdeveloped and backward (if not a cowardly) country. Moreover, the  middle class had education and jobs, business class had the luxury of no competition from foreign goods and the bureaucracy had the controls. In any case, the foreign reserves required for this strategy and the complacency of the elites soon had India asking around for foreign aid. The idea was to raise investement without curtailing consumption. Instead of raising more money from taxing the rich, it allowed a large import surplus and sought aid from abroad. However, it is doubtful whether anything short of a radically different development strategy would have led anywhere else.


The developed countries, the IMF and World Bank were only too willing to aid. Aid schemes on the whole are known to operate as export subsidies for the aid-giver countries, since aid is usually tied up with requirement of imports from those countries. But slowly, the U.S., in conjunction with IMF and World Bank, developed a system to have a leverage over the economic policies of the host countries in return for aid and loans. These, in the course of time, became Stabilisation Plans, and then developed into the Structural Adjustment Programmes (SAPs). It is another momentous fact that SAP’s have not helped any country to get out of the debt trap. Perhaps because they are not designed for that. One of the main concerns of the IMF is to maitain the flow of trade and investment in the international economy. Debts are dangerous only when they threaten this flow and when they threaten the lending institutions themselves. There is nothing mysterious about it. Every mahajan who thrives on lending knows this. Encourage borrowing and see to it that the borrower does not go under. If you have goods to sell to the borrowers from their borrowed money even better.


The IMF’s stabilisation programmes consist of several interrelated policy changes which governments are required to make. First on the agenda is to abolish or ‘liberalise’ control on foreign exchange dealing and imports. This is required to maintain the flow of capital and trade. Now since the control on foreign exchange have been made to conserve foreign exchange however efficiently, their removal normally leads to worsening of the deficit.


Once the controls are gone, the next step is devaluation. The value of the currency has to be brought to realistic levels with respect to other

currencies. A debt crisis develops only in a situation where the demands or need for foreign exchange is greater than its supply. Goverments try to control this demand by restricting imports and  imposing other restrictions on foreign exchange. Once the controls are gone, the scarcity of foreign exchange continues, so the value of local currency goes down even within the country. Bringing the official exchange rate of the currency closer to the market rates results in a devalution of the local currency. As we have seen earlier, devaluation may indirectly impede imports by making them more expensive. This effect of devaulation is offset by the new credit flowing to the country, which finances and encourages further imports.


It is not enough to devalue the currency; it has to be stabilised, so that you do not have to go on devaluing it. If the currency is devalued repeatedly, foreign investors have a problem. To stabilise the currency, anti-inflationary monetary and fiscal policies are recommended. These consist of


Control of Bank Credit by increasing  rates and having higher reserve requirements;


Control of government deficit: curbs of expenditure increase in taxes and prices of government services, abolition of subsidies:


Control of wage rises;


Greater hospitality to foreign investment.


These as we can see are the cornerstones of monetarist policy. Now we may wonder whether it isn’t a good thing to have low inflation, i.e., a slow increase in prices. There are two ways we can look at inflation. One is to see it in concrete terms of our incomes and the prices that we need to pay for things and services we use. Seen this way, things get worse with the above anti-inflationary policies. Wages are held down, the prices of government services go up. Travel, housing, medical treatment, power becomes more expensive, whereas real income goes down and more taxes have to be paid. For the Monetarist, this is not what matters. What matters is the overall balance between money supply and the volume of goods and services in the economy, so that the value of money is not depreciating, now also tied to foreign exchange.


Avoiding this inflation is good for foreign investors. They can make reasonable estimates about future costs and incomes. Unstable and unpredictable exchange rates make it impossible to estimate returns on capital especially in terms of foreign exchange. Thus we have already come to the last component of the stabilisation policy package, which is greater hospitality to foreign investment. The IMF encouraged foreign investment as a means of solving balance of payment problems of third world countries, ignoring the fact that future profit repatriation from such investment will further worsen the debt situation.


One may ask: why did these countries accept these conditions? That was because in a moment of payments crisis, the IMF provided a loan to cover the deficit which helped postpone the cirsis. There were internal as well as external constraints in following radically different policies. Repudiating the debt could have the consequence of trade and other sanctions. All countries are dependent on at  least some goods that have to be improted. Even if that is not so, the alternative policies may require unpopular decisions and the opposition party/ies might come to power in the next elections.


As a matter of fact, even stabilisation programmes under the IMF’s advice were extremely unpopular. Opposition parties in several countries came to power on the anti-IMF platform. Once they came to power they continued to follow or were forced to follow the same set of policies. In some countries, such policies could be implemented only after the crisis had led to a military coup. In Indonesia, Brazil, Cambodia and Argentina, the military seized power coups. IMF missions arrived to advise these governments on economic policies. In some countries, as we have seen, coups had to be engineered  since the governments there were bent on following policies ‘harmful to the flow of trade and investments’.


It should be kept in mind that it is as a package in given circumstances that stabilisation programmes serve the purposes of the IMF. The different elements of these policies can be used for different purposes under different circumstances.


Before 1970, the largest proportion of debt which the third world owned was to the developed country governments or to international agencies like the IMF and the World Bank. Private banks had not been too keen to lend because of the experience of 1930s when these debts had been repudiated. But international agencies and the U.S. kept encouraging such commercial lending to third world, with guarantees and other means. Such lending started in the 1960s,but it really picked up in the early 70s. At this time, as we have seen, there was a great amount of money supply in the private financial system. Some of the third world countries were doing fairly well on exports because of the rising export prices. A wave of commercial lending began which precipitated a serious debt crisis and we are still living under all those debts of this as well as earlier periods.