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The 1980s Debt Crisis

INTRODUCTION: In the 1980s, the world experienced a debt crisis in which highly indebted

Latin America and other developing regions were unable to repay the debt, asking for help. The

problem exploded in August 1982 as Mexico declared inability to service its international debt,

and the similar problem quickly spread to the rest of the world. To counter this liberalization and

privatization were administered, often through the conditionality of the IMF and the World

Bank. This crisis involved long-term commercial bank debt which was accumulated in the public

sector. The governments of developing countries were unable to repay the debt, so financial

rescue operations became necessary. The 1980’s crisis was caused by official grants and loans at

low interest rates and with periods and long maturities. Secondly with offer of long- term

commercial bank loans.

There are two reasons of debt problems. One is insolvency (when the borrower or the

borrower country is unable to pay back- today or in the future) and the other is illiquidity (when

the borrower or the borrowing country is unable to pay back its debt at a very instant or now.

Many Latin American countries in 60s and 70s, Brazil,  Argentina, and  Mexico, borrowed huge sums

of money from international creditors for industrialization, especially infrastructure programs. These

countries had soaring economies at the time, so the creditors were happy to provide loans. Loan

were gathered by the World Bank. After 1973, private banks had a flood of funds from oil-rich

countries which believed that sovereign debt was a safe investment. Mexico borrowed against

future oil revenues with the debt valued in US dollars, so that when the price of oil collapsed, so

did the Mexican economy. Between 1975 and 1982, Latin American debt to commercial banks

increased at a cumulative annual rate of 20.4%. This increased borrowing led Latin America to

multiply its external debt from US$75 billion in 1975 to more than $315 billion in 1983, or 50
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percent of the region's gross domestic product (GDP). Debt service (interest payments and the

repayment of principal) grew even faster as global interest rates surged, reaching $66 billion in

1982, up from $12 billion in 1975.

HISTORY: When the world economy went into recession in the 1970s and 1980s, and oil prices

climbed sharply, it created a breaking point for most countries in the region. Developing

countries found themselves in a desperate liquidity crisis. The sharp increase in oil prices caused

many countries to search out more loans to cover the high prices, and even some oil-producing

countries took on substantial debt for economic development, hoping that high prices would

persist and allow them to pay off their debt. Interest rates increased in the United States of

America and in Europe in 1979, debt payments also increased, making it harder for borrowing

countries to pay back their debts. Deterioration in the exchange rate with the US dollar meant

that Latin American governments ended up owing tremendous quantities of their national

currencies, as well as losing purchasing power. The contraction of world trade in 1981 caused

the prices of primary resources (Latin America's largest export) to fall.

The debt crisis began when the international capital markets became aware that Latin

America would not be able to pay back its loans. This happened in August 1982 when Mexico's

Finance Minister, Jesús Silva-Herzog, declared that Mexico would no longer be able to service

its debt. Mexico stated that it could not meet its payment due-dates, and announced one-sidedly a

suspension of 90 days; it also requested a re-negotiation of payment periods and new loans in

order to fulfill its prior obligations. Most commercial banks reduced or halted new lending to

Latin America. Latin America's loans were short-term so crisis resulted when their refinancing

was refused. Billions of dollars of loans that previously would have been refinanced, were now

due immediately. To avoid financial panic, the banks restructured the debts. There were new
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loans with strict conditions, as well as the requirement that the debtor countries accept the

intervention of the International Monetary Fund (IMF). There were several strategies to reduce

and end the crisis. The IMF moved to restructure the payments and reduce government spending

in debtor countries. Later it and the World Bank encouraged opened markets. Finally, the US and

the IMF pushed for debt relief, recognizing that countries would not be able to pay back in full

the large sums they owed.

EFFECTS: The debt crisis of 1982 was the most serious of Latin America's history. Incomes

and imports dropped; economic growth stagnated; unemployment rose to high levels; and

inflation reduced the buying power of the middle classes. Real wages in urban areas dropped

between 20 and 40 percent. Investment was being used to pay the debt.

In response to the crisis, most nations abandoned their import substitution

industrialization (ISI) models of economy and adopted an export-oriented industrialization

strategy. A massive process of capital outflow, particularly to the United States, served

to depreciate the exchange rates, thereby raising the real interest rate. Real GDP growth rate for

the region was only 2.3 percent between 1980 and 1985, but in per capita terms Latin America

experienced negative growth of almost 9 percent. Between 1982 and 1985, Latin America paid

back US$108 billion.

INTERNATIONAL MONETARY FUND: Before the crisis, Latin American countries such as

Brazil and Mexico borrowed money to enhance economic stability and reduce the poverty rate.

However, as their inability to pay back their foreign debts became apparent, loans ceased,

stopping the flow of resources previously available for the innovations and improvements of the

previous few years. This rendered several half-finished projects useless, contributing to

infrastructure problems in the affected countries. During the international recession of the 1970s,
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many major countries attempted to slow down and stop inflation in their countries by raising the

interest rates of the money that they loaned, causing Latin America's already enormous debt to

increase further. Between the years of 1970 to 1980, Latin America's debt levels increased by

more than one-thousand percent. These crisis caused per capita income to drop and hence there

was an increase in poverty, young and adults were forced into business like drug trade,

prostitution, and terrorism. There was increase in the crime rate. Latin American countries,

unable to pay their debts, turned to the IMF, which provided money for loans and unpaid debts.

In return, the IMF forced Latin America to make reforms that would favor free-market

capitalism, further provoking inequalities and poverty conditions. The IMF also forced Latin

America to implement serious plans and programs that lowered total spending in an effort to

recover from the debt crisis. This reduction in government spending further worsened social

fractures in the economy and halted industrialization efforts.

The efforts of the IMF effectively aimed to transform Latin America's economy abruptly

into a capitalist free-trade type of economy, which is an economic model preferred by wealthy

and fully developed countries. Latin America's growth rate fell dramatically due to government

serious plans that restricted further spending. Living standards also fell alongside the growth

rate, which caused intense anger from the people towards the IMF, a symbol of "outsider" power

over Latin America. Government leaders and officials were ridiculed and some even discharged

due to involvement and defending of the IMF. In the late 1980s, Brazilian officials planned a

debt negotiation meeting where they decided to "never again sign agreements with the IMF".

The result of IMF intervention caused greater financial deepening and dependence on the

developed world capital flows, as well as increased exposure to international volatility. The

application of structural adjustment programs entailed high social costs in terms of

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rising unemployment and underemployment, falling real wages and incomes, and increased

poverty.