The Andean Countries’ Foreign Debt*
Lima, May 2001

The history of the foreign debt is not a new one. The Andean countries awakened to republican life with that debt and today, two centuries later, it continues to be of special interest in macroeconomic planning. The subregion remains dependent on external savings and in some cases, debt service is still an unresolved problem.

For the Andean countries, debt service, as can be seen in the table below, approaches and in some cases even surpasses the value of items with an important socioeconomic impact. Ecuador and Peru, unlike the rest of the Andean countries, allocate more than 10% of the central government’s budget to pay the interest on their foreign debt.

TABLE No. 1
STRUCTURE OF TOTAL CENTRAL GOVERNMENT SPENDING
As a percentage of total spending

Source: IMACRO

The foreign debt crisis erupted in the region in the 1980s, when Mexico announced in 1981 that it could not continue to pay its debt service. This touched off a series of successive and drastic structural adjustments in the Latin American countries and the abandoning of a development strategy that had begun to show signs of having become outmoded. The adjustments brought growth to a halt, with the result that the period was dubbed the "lost decade." Colombia was one of the few countries to escape a debt problem.

Capital flows to the region –particularly privately-owned funds— were generally reestablished in the 1990s. There was important economic growth, especially during the first half of the decade, and it looked as if the debt problem was being left behind. Debt effectively began to rapidly lose ground as a percentage of GDP, above all in the Andean countries, which even so, maintain higher absolute debt levels than the rest of the region or MERCOSUR.

CHART No. 1
TOTAL FOREIGN DEBT

Source: IMACRO

Insofar as the public foreign debt is concerned, countries like Venezuela (Dec. 90), Ecuador (Feb 95), and Peru (Jul 97) were able to restructure their debts under Brady schemes. This type of refinancing, introduced in late 1989, involves not only a heavy discount, but also bond issues (Brady bonds) by the countries (backed by collateral). The plan reversed the traditional role of international private banks; they were no longer the main creditors, but the bondholders.

This, however, has not been the only experience of these emerging countries with international capital markets. More than one Andean country has turned to direct bond issues to gain direct access to those markets, as witness Ecuador in 1997 and Colombia and Venezuela on several occasions (up until last year).

Bolivia was able in September 1997 to take advantage of the Initiative for Highly Indebted Poor Countries created by the World Bank and the IMF to provide debt service relief. The country began in September 1998 to obtain benefits under that program, which today have a net value of US$ 450 million (distributed over several years).

Starting in 1997, the foreign debt-to-GDP ratio began to once again turn negative in the region as a whole, spurred by the sharp slowdown in economic growth (a weighted average in the CAN of -3.9% in 1998 and –1% in 1999).

Ecuador was the first country to default on its Brady bond debt service in August 1999. It has since then regularized its situation (with a global bond issue in July 2000) and its debt restructuring efforts with the Paris Club may conclude successfully when the national Congress approves the increase in the VAT, one of the stipulated conditions for resuming negotiations.

As the following chart shows, the spread (the differential that countries must pay over and above the yield of similar U.S. Treasury bonds) has just about tripled in most of the region since the 1997 crisis. The change in policy on the part of the IMF, which, since the cases of Russia (1998) and Ecuador (1999), has made it clear that it is not an unconditional rescue source for creditors, has a lot to do with this situation.

GRAPH No. 2
SOVEREIGN BOND SPREAD VIS-À-VIS U.S. TREASURY BONDS

Source: Banco Central de Reserva del Perú
Prepared by: Andean Community General Secretariat

The differential in the return on Sovereign Bonds is dependent upon the economic agents’ perception of the risk. The standing of the Andean countries is below the world average (61.86) (a country with a perfect AAA rating is awarded 100 points).

TABLE No. 2
RATINGS*
(AS OF APRIL 17, 2001)

Source: Bradynet Inc.
*The 4 Agencies are: Moody’s, S&P, FitchIBCA Duff & Phelps, and Thomson Financial Bankwatch

This situation directly affects the possibility of refinancing the debt and of administering the short-term component that is renewed under normal conditions. Rising prices in the capital markets hinder the "rollover" of debts --the practice whereby new debt is contracted for to pay previous debt— , making it unviable. The situation is compounded by the growing complexity of debt refinancing negotiations arising out of the demand for equal treatment by all creditors, due to the existence of a larger number of commercial debtors (bond holders).

It is to be expected that for these reasons countries will turn more heavily to development banks and, in the case of the Andean countries, will deepen their financial cooperation through the CAF. At the recent Annual Assembly of the IDB, Ricardo Haussman, former senior economist of that institution, recommended doubling the IDB’s leverage so that it can raise its financial assistance to the region from US$ 7 to US$ 14 billion a year, despite the risk of a reaction by the market that would bring down its AAA risk rating, because even with a possible increase in the cost of its loans, the IDB would continue to be a substantially less expensive source of funds for the region.

* The statistics used in the Economic Report come from the Macroeconomic Information System of the Andean Community General Secretariat (IMACRO) and are based on official sources in the CAN Member Countries, together with supplementary data published by international institutions, such as the World Bank, the IDB, ECLAC, and the IMF.