10 SEPTEMBER 1983, Page 17

In the City

Muddling through

Jock Bruce-Gardyne

The international banking crisis is coming more and more to resemble one

of those epics of the silent screen, in which each episode ended with the heroine con- fronted by imminent and inescapable death by violence, and began with a miraculous escape. A year ago Mexico was rescued on i the very brink of enforced default. Then t i

was the turn of Argentina, where for long t seemed that the junta would declare default, Perhaps more as a gesture of de- fiance to an unfriendly world environment than out of financial necessity. Next came Brazil and Venezuela, where negotiations With the central and commercial bankers have dragged on under the shadow of con- stantly deferred payments of existing com- mercial loans. Meanwhile approval by the ILJS Congress of the Bill to increase the American subscription to the International M. onetary Fund, on which the interna- tionally agreed increase in IMF quotas ucPends, hangs uncertainly in the balance. And just as it looked as though the Brazilians were prepared to grit their teeth and sign the 'letter of intent' prepared for them by the IMF, their central banker hands in his cards with a ringing declaration that the Fund's terms are quite unrealistic.

i It is all a great strain on the nerves. Is t more than that? We shall know more when We see the outcome of this week's meeting of the South American 'debtors club' under the auspices of the Organisation of American States. But on balance the odds must be that, like the heroine of the silent screen, Ave shall muddle through: with a good deal of inelegance, and the commit- ment of additional funds by commercial and central banks alike way beyond the limits of normal financial prudence to keep existing loans ostensibly 'performing' but — ut muddle through nevertheless.

If so this will not be to everybody's lik- ing: There is a powerful school or thought whichargues cogently enough that ,sovereign lending is not what commercial anks should be about, and that sooner or later -- and the sooner the better — the IMP and its member governments should i Step n and in effect take over the loans so recklessly advanced in the Seventies, super- visin,g directly the 'adjustment program- mes' of the debtor countries, and ensuring that they have access to the flow of funds they need in the meantime to continue trading There is another school of thought — to which our own Prime Minister is rumoured to belong, and which has strong support in the US Congress — which a:gue.sp with equal cogency, that, like borrower Byng, the occasional sovereign

o should be shot (i.e. driven into

formal default on its debts) to set an exam-

ple to the rest and to teach the commercial banks a lesson.

For a variety of reasons, some a good deal less compelling than others, it is hard to see either of these counsels prevailing.

Against the first school there is the argu- ment that the IMF does not begin to have the means to do the job, and is not at pre- sent likely to be given them — least of all by the US Congress. Nor is there anything in past experience to encourage the presump- tion that, if the commercial banks have been far too prone to lend for purposes — 'such as the construction of brand new steel mills in a world awash with steel — which made no obvious sense or contribution to the welfare of the recipient countries, governments could be expected to be more prudent. On the contrary, most govern- ments confronted with an invitation to con- tribute to a giant `turn-key' project lacking any obvious relevance to the economic development of the proposer, but rich in potential orders for their own domestic in- dustries, could be guaranteed to view it with a good deal more enthusiasm than the com- mercial banking system.

Two other arguments against what might be termed the 'Lever approach' (since the former Labour Minister was one of the earliest in the field with proposals for `nationalising' sovereign lending) are a good deal less impressive. One is that cen- tral bankers feel dangerously exposed if left to function on their own without an escort from the private sector. This is more a mat- ter of sentiment than logic since in practice the central bankers have their commercial counterparts in tow. But it is deeply entren- ched in central banker mentality, and would not be lightly shifted. The second argument seems even less compelling. It is that the uplifting from commercial banks of their sovereign loans would let them off far too lightly from the consequences of their own past irresponsibility. In practice, they earn valuable fees from participation in the rescheduling of their existing loans, while (so far, at any rate) the risk that some of the loans might have to be reclassified as 'non- performing', and written out of . their balance-sheets, remains academic. If these loans were taken over the commercial banks would lose their fees and could in- deed — and presumably would — be re- quired to pay for the enforced privilege of having them covered by government guarantees. An odd sort of let-off, in short. Nevertheless here again sentiment is deply entrenched, particularly on Capitol Hill.

The arguments against what could be termed the Tyng approach' are more basic. It would no doubt in theory be possible to pick upon a relatively modest sovereign borrower — Venezuela springs most ob- viously to mind in present circumstances, although I suppose Argentina would have more appeal — and say that it had dragged its feet too long over conditions that the IMF had sought to impose upon the rescheduling of its debts, and should be put into default. In practice both the political and the financial implications of such a course would surely provoke a US veto. A Latin American debtor country denied ac- cess to further credit might find the Soviet Union prepared to bale it out; and the erasure of their loans to the defaulter (even a modest defaulter in global terms) would be more than the balance-sheets of some leading US banks could bear. Nor could the commercial banking system be relied upon to bite the bullet and learn from its ex- perience. On the contrary, it could be ex- pected to run for cover. The spectacle of one sovereign debtor being left to vanish down the plug-hole would be more than enough to persuade the private sector to try and cut its losses elsewhere and provoke a disastrous stampede. Moreover, to punish the commercial banks for their past im- prudence would be pretty rough justice. For when the international financial system was rocked by the first `oil shock', governments agonised about its ability to `recycle' the massive surpluses of the sheikhs of Araby thereby thrown up. In fact the commercial banking sector did all that was hoped for. It is a bit rich for governments now to turn around and say that it behaved with crass ir- responsibility. Not that that, alone, would discourage them from doing so.

So both draconian solutions — national- isation and enforced default — look in- herently improbable. Without them things could still go wrong. It looks, for example, as if the Brazilian President is going to have to take the law into his own hands if he wants to secure acceptance of the IMF's de- mand that the indexation of wages should not compensate for the last 20 per cent of inflation; and some pretty fancy figuring is going to be needed if some of Venezuela's commercial borrowings are to continue to be presented as `performing' this autumn.

But one's instinct is that an adequate degree of fudging will be maintained. The Brazilians will sign another `letter of intent' — and then ignore its terms as they have ig- nored the terms of the previous ones. The creditors will contrive to live from hand to mouth until the Venezuelans have got their elections out of the way. The hardening of commodity prices will help the trading balances of most of the sovereign debtors (and while the oil exporters may not be get- ting more in dollars for their oil, the value of those dollars continues to appreciate).

The US Federal Reserve will continue to put its fears of the impact of higher interest rates on the sovereign debtors before its fears of the impact of exuberant growth on American inflation. The debtors will con- tinue to pay just enough lip-service to the IMF's conditions to preserve that institu- tion's credibility, while it in turn will avert its gaze sufficiently from what they actually' get up to. Not perhaps a very elegant way out of the hyper-inflation and excess credit- creation of the 1970s. But, as with old age, better than the alternative.