By Pedro-Pablo Kuezynski, vice-president, Kuhn, Loeb & Co, New York
In the May issue of Euromoney I looked at the possible broad range of impact of the higher oil prices upon the economies of the Third World. Since that time a substantial effect has already been felt by the poorest countries, which by and large are also those most dependent on imported fuel (the Indian sub-continent, sub-Saharan Africa, Central America, plus a few higher-income countries which faced financial problems before the increase of oil prices at the end of 1973). In a few other countries, such as Brazil and Korea, which had very high rates of economic growth, the impact has been a dampening of expansion but not major financial troubles. And in most countries except those of the Indian sub-continent the continuation of world inflation and the ensuing high level of commodity prices has postponed the massive problems foreseen earlier on.
However, few doubt that major difficulties are in store for the future. These problems are not exclusively the result of higher oil prices; clouds on the horizon were already visible more than a year ago. But now major difficulties look much more imminent: several major industrial countries have begun a recession which might develop into something worse; the commodity price explosion shows clear indications of slowing down (copper, coffee, cotton and wool); the international banking system is showing signs of strained confidence; and all of this is making it much more difficult for developing countries to borrow in the Eurodollar market, which has been the only major market open to at least some of them on a significant scale.
It is true that the published statistics do not always support these dark omens. The IMF Survey* reports a World Bank estimate that in the first six months of 1974 the developing countries obtained US$6 billion in medium- and longer-term loans in the Euromarkets, or an annual rate higher than ever before. Many of these loans, however, were in fact arranged (rather than advertised on 'tombstones’, the source of the statistics) in January and February, before the present stringency began in term lending through the Eurodollar market. Some of the loans were in fact arranged and signed in 1973, such as the $500 million facility to Mexico managed by Kuhn, Loeb & Co and First Boston (Europe) in December 1973.
The prospective current account deficit of the non-OPEC developing countries in 1974 is about $20 billion compared with an actual deficit of $8 billion last year. Of the deterioration of about $12 billion, slightly over half is the estimated direct payments impact of the increase in oil prices after taking into account the lag in payments for oil by importing countries (see 1974 annual report of the International Monetary Fund, Chapter 1). The countries of the Third World thus need a very large injection of capital if they are to avoid a drastic curtailment of growth with all sorts of unforeseeable consequences. Can we realistically expect that a large part of this inflow will come from petrodollars? Let us look at the sources of funds.
The most obvious source is direct lending by the petroleum countries themselves. Will the petroleum countries, themselves Third World club members, significantly help their less well-endowed brothers? So far there have been some signals, especially in the case of Venezuela.
The Venezuelan investment fund, which was created in May in order to insulate the economy from the pressures to monetize rapidly increasing international reserves and also in order to invest the oil revenues into economic diversification, has already made a number of large commitments, including the purchase of a $500 million placement by the World Bank ($100 million of which was denominated in bolivares), an as yet undefined sum of a similar magnitude to the special fund of the Inter-American Development Bank, and promises in the $30 to $100 million range to the Andean Development Corporation, the Central American Bank for Economic Integration and the Caribbean Development Bank.
The Central Bank of Venezuela was the first to make a firm commitment – of SDR 450 million or about US$540 million equivalent – to the special oil facility of the IMF. It is not yet known exactly how much of the oil facility will be channelled to the developing countries in the IMF, but it will be the largest part. The speed with which Venezuela's various contributions, totalling about $1.5 billion, are to be disbursed is not yet known, but it is clear that Venezuela will be contributing a high proportion of its current account surplus to recycling, mostly to developing countries through international multilateral institutions. If the money were disbursed in one year, a not unlikely event, Venezuela would be contributing about 35% of its current account surplus in the form of official development assistance to the Third World. The paradox is that this munificence comes from the country probably with the smallest surplus among the major OPEC producers: Venezuela has a low level of measured crude reserves, its domestic economy is large, and there are substantial needs for domestic social and 'infrastructure' expenditures. At the same time, of course, it is recognized that Venezuela is also the most economically advanced of the OPEC countries.
Existing OPEC commitments
The commitments of the Middle East oil producers to the Third World are expanding rapidly but are still of uncertain size. An Islamic Development Bank is in the formative stages; the Arab Fund for Social and Economic Development and the Kuwait fund are being expanded; various special commitments to African countries have been announced; Iran announced a commitment of $150 million earlier in the year to IDA, the soft loan window of the World Bank; Iran has also granted a number of large credits for oil imports, notably to India, and is preparing a programme of loans to developing countries; the Saudi Arabian Monetary Agency has guaranteed a $200 million Eurodollar loan on commercial terms to the Development Bank of the Sudan; the Asian Development Bank, Philippines and Brazil have borrowed small sums in Kuwait and Lebanon; Brazil has held apparently promising discussions with Saudi Arabia; the World Bank borrowed the equivalent of US$462 million during its fiscal year ended June 1974 in some of the Middle Eastern countries, but more than half was in local currency-denominated loans with a high exchange risk, which is then passed on to the ultimate borrower; and five Middle East countries (Abu Dhabi, Iran, Kuwait and Oman and Saudi Arabia) have agreed to contribute a total of SDR2.1 billion (or about US$2·5 billion) to the special oil facility of the IMF. However, a number of Middle East countries continue to abstain from membership in the IMF SDR scheme, to which they would otherwise undoubtedly be major contributors.
The various OPEC commitments put together, including the compensating financing through the IMF, may add up to US$4 to $5 billion in disbursements in the next year or so, of which a large but as yet uncertain proportion would go to developing countries. As might have been expected, the bulk of the petrodollars is being channelled into (a) imports, most of which come from the industrial countries, (b) into the major capital markets, and also ( c) in some cases into special arrangements with industrial countries (à la Krupp or for defence equipment). In addition, a few large direct credits have been made to prime European organizations, such as the Coal and Steel Community, the European Investment Bank and a Canadian province.
Even if one assumes that developing countries will do a considerable amount of belt tightening, additional sources of compensatory financing for developing countries will be needed. The question then arises whether the bulk or at least a large part of these additional funds will come from petrodollars, and, if so, what the respective roles of the capital markets and the international financial institutions will be.
To begin with the capital markets, the question is basically whether the Euromarkets are likely to be a significant channel of recycling to the developing world. The answer is a qualified yes and no. On the positive side, the Eurodollar market has shown in the last three years that it could mobilize large sums for some developing countries, largely the resource-rich and semi-industrial higher-income countries. On the other hand, Eurodollar financing (a) is undergoing serious difficulties of market mechanics, (b) is not available to the poorer countries, which are the ones most seriously affected by the present conundrum in international finance, and (c) represents a heavy burden on debt service.* Bankers who in the morning proclaim their faith in the market as a recycler will tell a caller in the afternoon that the 'premium is too thin', 'the fee is too low', or simply 'no interest'. In short, good commercial reasons, since the majority of developing countries are low on the credit rating list.
The problem of the insufficient creditworthiness of many developing countries for market borrowing is augmented by the recent change in the structure of the Euromarkets, where a few major banks have in recent months been assuming the role of primary recipients of petrodollars. Banks of deficit countries and banks of smaller size have increasingly found themselves obliged to borrow from the 'prime' institutions. The 'tiering' of the market is of particular importance for developing countries, which in the past were the beneficiaries of aggressive lending by the second group of banks, which now no longer have the leeway for such lending. With the possible uncertainty in the creditworthiness of some international clients, major banks are being quite selective in their lending policies.
A discussion of the possible role of market finance is hampered by the lack of complete publicized information about where the oil countries' reserves are being invested. A recent US Treasury estimate for the first eight months of 1974 stated that, of the balance-of-payments surplus of OPEC countries of US$25 to $28 billion in that period, perhaps US$7 billion was invested in the United States (of which about $4 billion was in US Government marketable securities) and another US$3 billion in Britain. It is likely that most of the remainder was placed in the Euromarkets. It is known that much of this has been placed at very short maturities, and that some has gone into the Euro-Deutschemark and EuroSwiss franc markets.
Certain possible deductions emerge from these various 'guesstimates': (a) the investible surplus of the oil countries is somewhat less than was expected at the beginning of 1974, despite higher oil prices since then; (b) this is probably because an unexpectedly large portion of the additional petroleum income has gone into imports, which in the first instance benefit mostly the industrial countries; (c) a large part of the money market investments abroad has been in forms (such as US Treasury bills, sterling balances, call or seven-day deposits in the Euromarkets) which do not easily lend themselves to recycling to developing countries or indeed to any medium-term international lending; and (d) despite the inflow of funds into the Euromarkets, the huge demand for balance-of-payments loans by European countries has meant very tough competition for even the most creditworthy developing countries to obtain medium- and longer-term finance.
Will the situation in the Euromarkets change? It is too early to guess, although the changes for an early reversal look slim. In any case, one wonders if a large increase in financing on market terms could be serviced by developing countries. Interest alone on the external public debt of non-OPEC developing countries in 1974 could total about $4 billion. Clearly, the most creditworthy of the developing countries will be able to continue that access to market finance, although at present on terms which reflect the current domestic and international credit squeeze. For the others some special means must be found.
Will the Witteveen plan work?
The international financial organizations, especially the World Bank and the IMF, have made rapid progress in the last few months to gear up for an increased flow of compensatory financing to developing countries. But the funding is still inadequate in relation to the needs. And for the future there is the question of whether the oil producers will put sufficiently large sums of money in organizations where their representation is very small. Big changes may have to occur here if international organizations are to develop relationships of close mutual trust with their new sources of finance. In the meantime one possibility worth restudying would be the old idea of having either the Bank or the Fund guarantee market obligations of developing countries. The Bank has the authority to issue guarantees but has not done so because it was felt that it could itself obtain the money cheaper and could do a better development job than the market. At the moment a key ingredient of that job – if, as seems probable, oil prices stay at or near their present level – is to provide substantial and timely balance-of-payments assistance. Significant departures from the past practices of international finance will be needed if this is to be even partially done. New instruments may have to be devised to minimize the effect on the World Bank's creditworthiness in the capital markets.
Recycling by itself is not an answer to the problem of most developing countries. If investment was hard enough to finance in a less complex world, what are we to think of financing essential current consumption through borrowing? Recycling can alleviate an existing shortfall, but it cannot be relied on to provide long-term finance for development.
* It is argued by some that world inflation is lowering the real impact of debt service for developing countries. This is true only if world inflation improves their earnings faster than their payments, as was true for non-food importing developing countries as a whole in 1973. It is certainly not true for most developing countries in 1974, with the unit cost of their industrial imports going up in price by close to 20% annually and of their oil by 250% (or a weighted average of total unit import costs going up by about 25%). Debt service may still be going down as a percentage of gross export earnings, but it is hard to argue that the point is of much importance when most countries are facing very large deficits in their current account balance of payments.