Cases

Introduction | Cases | Strategy Analysis | Aggregate Model | Conclusion | Sources Used

Eastern Europe: Bulgaria

In the case of Bulgaria, a large external obligation was accumulated during the years of the Communist regime. With the fall of Communism in 1989, Bulgaria lost its protected markets in the sphere of agriculture, heavy industry, electronics and information technology. Due to strong international competition from the West and Bulgaria’s large external debt burden, the country was unable to fulfill the service of its debt and Bulgaria’s economy collapsed. As a result, Bulgaria declared a moratorium an all foreign debt payments in 1990. According to the Bulgarian National Bank (BNB), the foreign debt of Bulgaria at that time amounted to over $10 billion, which represented 74% of the country’s GDP. After three years of negotiations with the London Club, on July 28, 1994 Bulgaria signed a contract for the reduction and the restructuring of its foreign debt. This contract was signed under the Brady plan with the following general elements: 1) creditor banks would grant debt relief (cut in principle, or interest payable) in exchange for guarantees on the remaining portion of the debt; 2) loans from the World Bank and the IMF that would be used to finance the guarantees by providing collateral on the reduced value of the debt or by buying back a portion of the debt in ‘cash’ 3) debt relief would have to be linked to some assurance of economic reform that would stimulate investment and the return the flight capital. The logic that underlies the Brady plan is that the reduction of the debt service burden would play both an economic and political role in generating a “credibility shock”. Due to the increased credibility rating of the country in debt, the foreign direct investment increases, thus stabilizing the economy in crisis.

Under the Brady contract, Bulgaria negotiated the spread of the debt into four categories: repurchase, Discount Bonds (DISC) (secured with 30-year U.S. Treasury bonds), Front Loaded Interest Reduction Bonds (FLIRB) and Interest Arrears Bonds (IAB) (all three types of bonds fall into the general class known as Brady Bonds). Under the repurchase option, the IMF and the World Bank provided Bulgaria with funds to buy 20% of its debt back towards the London Club. The Brady bonds that were issued had a total value of $5.137 billion – 55% of the Bulgarian external debt.

In 2002, the Bulgarian government decided to trade its Brady bonds for global bonds as a natural continuation of the debt transformation process. Similar swaps had already been performed in some developing Latin American countries such as Argentina and Brazil. “The transformation of Brady bonds into normal credit bonds is the end of ten years of transition. Many developing countries are past the stage of restructuring their bad external debt, and now they are valuable participants in the global economy. That is definitely a sign of success,” Nicholas Brady, the designer of the plan, was quoted saying.

The positive results of the debt transformation for the country were immense. The Brady bond swap lead to the following results: the total volume of Brady bonds after the event was reduced to $2,486 million; collateral under the deal of $135 million was released; the debt maturity was extended in time; and probably the most significant impact of the debt transformation – the deal improved the Debt/GDP ratio (exhibit 1) which contributed to the establishment of a new and improved credit profile on the basis of the reconstructed external debt. Furthermore, it was the first time that US dollar denominated Brady bonds were traded for bonds denominated in Euros, differentiating the Bulgarian external debt swap from any other similar transaction made so far.

According to Milen Velchev, the Bulgarian Finance Minister at the time of the debt transformation, the fact that the external debt to GDP ratio of the country decreased substantially in the past years, contributed to Bulgaria’s solid international reputation: Bulgaria’s credit rating has been improved 14 different times by the four leading credit rating agencies. “This is unprecedented in the world - I have not heard of another country that has had its credit rating raised so many times in such a period,” said Velchev.

As one observes Bulgaria’s foreign debt management, one can see the difficult process through which a developing economy must go through to overcome the burden of a great external debt. Bulgaria’s external debt restructure, however, proves that even though an outstanding debt is a serious economic obstacle, it can be overcome through a well planed fiscal strategy, coordination with creditors, and assistance from foreign institutions. Thus, the country serves as an example to other developing market economies from the region such as Macedonia, Serbia, Montenegro and Romania.

South America: Argentina

Prior to the Lost Decade of the 1980s, Argentina was a wealthy Latin American nation characterized by a high standard of living, solid technological infrastructure, high literacy rate and a growing GDP. The decline of the rates of production in the 1980s left Argentina, like many Latin American countries, dealing with an outstanding external debt and inflation. In the 1990s, many Latin American countries adopted radical changes in their economic policies that called for liberalizing trade and privatization. In an effort to stimulate growth, Argentina lead negotiations with the IMF. The Fund agreed to short term loan assistance, under the condition that a new government replaces the existing military regime. In 1991 with the support of the IMF, Argentina managed to tie its currnency, the peso, to the U.S. dollar allowing limited monetary growth.

This strategy worked well at the beginning as inflation in Argentina temporarily decreased. Furthermore, up until 1995, the country’s real GDP was growing constantly to reach 7% growth in 1995. Moreover, Argentina was considered an apparent paragon of reform and stabilization. Since 1997, however, both external and internal factors contributed to its steadily declining economic performance which unfolded into the tragedy of 2001.

From 1999 onward, economic crises in Mexico, Brazil and several other countries further deteriorated Argentina’s economic conditions. As the US experienced inflation and the dollar devalued, so did the peso. Doubts increased worldwide that Argentina would be able to pay her debts, not to mention, sustain the value of the peso at the value of the U.S. dollar. By 2001 treasuries plummeted, and there were colossal withdrawals from banks, further dwindling consumer and investor optimism. The Argentine government’s plan to attain a "zero deficit", to stabilize the distressed banking system, and to refurbish economic growth had failed and the country was facing severe economic problems. The inability of the administration to implement reforms and restore growth, combined with well-founded doubts about Argentina's ability to meet its upcoming debt payments, resulted in an economic crisis in November and December 2000.

Argentina, often hailed as the model country or the 'poster child' for the IMF, bore out this mantra in 2001, when Argentina declared itself in an economic crisis. There were massive riots, people ransacked the banks, and foreign businesses were attacked. More than thirty died on the streets of Buenos Aires and throughout the country. Argentina for years had sustained massive borrowing from the IMF. Most of the reforms and policies the IMF imposed would have helped to liberalize the economy; however, after “two decades of misguided recommendations and nearly continuous funding, the IMF's involvement in Argentina actually strengthened the power of political vested interests at the expense of economic growth.” The Argentine government tried to halt the recession and repay IMF loans by increasing taxes and decreasing spending. This method, however proved to be devastating to the poor. Moreover, the loans from the IMF included deep cuts in government spending so that Argentina would have the ability to repay. So the Argentine government remained steadfast in their commitment to repay the loans, maintain the value of the peso, continue heavy taxation and cut social spending. The IMF backed this strategy claiming that delayed or defaulted debt payments could lead to unstable markets and escalate financial problems in neighboring countries. Unfortunately this ongoing tax and spend policy resulted in severe social consequences: steady declines in industrial production and GDP and staggering unemployment rates.

Although the IMF did not explicitly coerce the government to run fiscal deficits, it did not press Argentina authorities hard enough to be more responsible on the first place. Furhtermore, it continuously ignored the deficit targets which were not met by Argentina in 50% of the cases. Instead of suspending loan packages, the IMF opted to grant additional loans and extend repayment and target deficit dates. The situation deteriorated especially during the second half of 2000 as the recession continued. Analysts became pessimistic and began discussing a possible default on the sovereign debt of the country. At that point in time, Argentina was the largest borrower on the international credit markets. Yet in December 2000 it received an extraordinarily big support, beyond the normal practices of the IMF. Many economists considered this move extremely controversial, as there was almost no chance that Argentina would avoid default on its debt. The Fund must have had clear evidence that chances of success were greater than the risks of failure of this transfer, something that was quite dubious at that time. By the summer of 2001 this “last resort” was obviously failing, but amazingly, the country enjoyed another $9 billion in loans from the Fund, as the disbursement was the second largest in the history of the Fund. If the December transfer could be described as risky, the 2001 loan “assistance” was insanity. It was already obvious that the catastrophe was inevitable, that another injection had absolutely no chances of relieving the situation, as the best it could do was postponing the catastrophe with three months. This transfer not only did not help the government, it left Argentina with even greater, unnecessary burden of obligations. Overall, IMF policies, repeated over and over, did not spur economic growth in Argentina. On the contrary, combined with the Convertibility Plan, they highly overvalued the Argentine peso. People and businesses lost confidence in the currency as the price of sovereign bonds sharply plummeted, which resulted in a state of ongoing inflation, hyper inflation, and high unemployment.

But the Kirshner Administration finally lay down the line, and in February 2004 stood up to the IMF due to the poor economic conditions of the country. Surprisingly, the IMF, an institution used to getting its way, stepped down. The IMF uncharacteristically accepted Argentina’s non-compliance to some degree, acknowledging Argentina as a high-profile client. The IMF has been accused of providing poor advice to Argentina and employing a flawed policy of tying the national currency to the dollar. Argentina has been faulted with reckless government spending and failing to restructure debt. Argentina’s current default on $88 billion of debt represents the largest sovereign debt evasion in world history. Also in 2004, the IMF finally “owned up” to causing mistakes in Argentina and admitted their role in plunging half the population in debt.

Africa: Nigeria

Nigeria presents a really remarkable case when it comes to foreign debt accumulation and servicing. Even though the country has a good record of servicing its foreign oblications , Nigeria has accumulated an outrageous amount of external debt in the past 25 years. The problems the country faces are a direct consequence of the loans Nigeria received from the Paris Club in the 1980s. In order to analyze these problems, one would have to look at the historical development of Nigeria’s external debt.

In 1985, Nigeria's external debt was $19 billion, of which $8 billion was owed to Paris Club creditors, $2 billion to other creditor countries (e.g., Bulgaria), $8 billion to commercial creditors, and $1 billion to multilateral agencies (mostly the World Bank and the African Development Bank). Following the signing of an IMF stand-by agreement in August 2000, Nigeria received a debt-restructuring deal from the Paris Club and a $1 billion credit from the IMF, both contingent on economic reforms. Nigeria pulled out of its IMF program in April 2002, after failing to meet spending and exchange rate targets, making it ineligible for additional debt forgiveness from the Paris Club. In 2003, the government began deregulating fuel prices, announced the privatization of the country's four oil refineries, and instituted the National Economic Empowerment Development Strategy, a domestically designed and run program modeled on the IMF's Poverty Reduction and Growth Facility for fiscal and monetary management. GDP rose strongly in 2005, based largely on increased oil exports and high global crude prices. All in all however, one can say that at present the Nigeria's external debt is $36 billion. Of this amount, $31 billion is owed to Paris Club creditors, almost nothing to other bilateral official creditors, $3 billion to multilateral agencies, and $2 billion to commercial creditors.

The remarkable question that arises when one looks at this development is: How come Nigeria’s Paris Club debt increase by $23 billion over the past 20 years while debt owed to other creditors and institutions decreased by more than half? The answer can be found in the Paris Club’s policy in handling Nigeria’s debt – due to the fact that Nigeria was under a military dictatorship, the Paris Club stopped any new loans and negotiations with the country. As a result, at present there is $23 billion worth of interest arrears, interest on those arrears and penalties that accumulated over the past 20 years.

On the bright side, in November 2005, Abuja won Paris Club approval for a historic debt-relief deal that by March 2006 should eliminate $30 billion worth of Nigeria's total $37 billion external debt. The deal first requires that Nigeria repay roughly $12 billion in arrears to its bilateral creditors. Nigeria would then be allowed to buy back its remaining debt stock at a discount. The deal also commits Nigeria to more intensified IMF reviews. Furthermore, in the last year the government has begun showing the political will to implement the market-oriented reforms urged by the IMF, such as to modernize the banking system, to curb inflation by blocking excessive wage demands, and to resolve regional disputes over the distribution of earnings from the oil industry.