World bankers hold their breath after Brazil halts debt payments

Press, 18 March 1987, Page 20

World bankers hold their breath after Brazil halts debt payments

From the “Economist,” London

ONE OF Maynard Keynes’ most well-worn epigrams holds that if you owe a bank £lOO, you have a problem; but if you owe it £1 million, it has a problem.

But when it comes to Latin America’s debts of $3BO billion, it is far from plain who has the biggest problem, debtors or lenders. That question lies behind President Jose Sarney’s recent announcement that Brazil would cease, for an indefinite period, to pay interest on the $6B billion of medium-and-long-term money it owes to commercial banks.

To lessen the chance of retaliation, it also froze $l5 billion of short-term trade and interbank credits that might otherwise have been pulled out.

Brazil’s actions and the decline of its economy have come so suddenly that bankers and stockmarkets are unsure how big a problem they face. Only a month ago, bankers were saying they foresaw no big problems in Latin America. Four years spent muddling through debt problems have bred complacency. Not, however with' Mr Paul Volcker, chairman of America’s Federal Reserve Board. He worries aloud about a “domino effect” among debtor-governments and says that “borrowers and lenders are suffering from battle fatigue.” Dominoes are waiting to fall. Argentina’s Finance Minister, Mr Mario Brodersohn, has said that Argentina might suspend interest payments if creditor banks do not come up with at least $2.15 billion in new money this year. Though he stopped over in Brazil on February 24 on his way to the United States, the two countries deny collusion over debt.

Yet a well-connected Buenos Aires newspaper, “Clarin,” reported on February 24 that Mr Brodersohn had instructions from President Raoul Alfonsin to present a take-it-or-leave-it rescheduling proposal to the banks. Defiant noises are also coming from Venezuela and Ecuador.

The crisis has blown up for several reasons. Brazil’s trade surplus and its foreign reserves have slumped badly in the last six months (officially, reserves are down to $4 billion, including gold; to less, if liabilities are

deducted). This has forced it, unexpectedly, to ask for new money and a rescheduling. It anyway faces an awkward lump in its repayments of principal, of $14.7 billion this year and $13.8 billion in 1988, before bills tail off in the 19905. It needs to smooth those repayments out. At the same time, bankers’ attitudes to foreign debt have hardened. Last September, politicians and the Federal Reserve arm-twisted them into lending Mexico $7.7 billion of new money at an interest rate of only 13/16ths over the London Interbank Offered Rate (LIBOR — the rate at which banks lend to each other), the lowest spread yet granted by commercial banks to a developing-country debtor. That deal is still not stitched up because of resistance by the hundreds of small banks that have to be involved. Since then Mr John Reed, the boss of Citicorp, has said loudly that no other debtor, big or small, can expect terms as good as Mexico’s. Accordingly, Citicorp has blocked deals for Chile and the Philippines. This policy contrasts witth the more sanguine pose on debt adopted by his predecessor and patron at Citicorp, Mr Walter Wriston. It matters especially to Brazil as Citicorp chairs the banks’ negotiating committee. Brazil, it seems, decided to call the banks’ bluff. The Paris Club’s agreement in January to reschedule $4.12 billion of Brazil’s government-to-government debt without a deal between Brazil and the International Monetary Fund encouraged the country to expect soft Governments to lean on hard bankers. Certainly, confrontation so worries Mr Volcker he almost swallows his cigar. Two days before the Brazilian announcement, he hauled in the chairmen of several big American moneycentre banks. His message was chiefly aimed at Citicorp. Big banks should settle outstanding debt disputes with smaller countries and focus on the looming Brazil problem, he said. The same day Citicorp withdrew its objections to interest-rate retiming for Chile. The last time Mr Volcker intervened like this was the day before Mexico’s main creditors

agreed to last year’s big package. Who stands to lose most from a confrontation? After a few days stunned silence, stockmarkets concluded that banks will suffer, even though they are far better capitalised than in 1982 when debt first hit the fan.

The share price of Citicorp, with the biggest exposure ($4.6 billion) to Brazil, fell SSU on February 24th-25th to $52%. Shares of other exposed banks such as Chase Manhattan ($2.7 billion), Bank of America ($2.8 billion) and Manufacturers Hanover ($2.2 billion) were also weak, as were Britain’s Lloyds and Midland.

This is not chiefly because markets expect a default to bring down the financial system, though that remains rickety. •Rather, the threat is to banks’ profits. If Brazil makes no in-

terest payments after 90 days then American banks have to register the loans as nonperforming and interest due cannot be declared as income. Japanese banks, which hold about 10 per cent of Brazil's debt, and European ones face less of a problem because of their currencies' rise against the dollar.

Citicorp’s profits would be hit hard. In 1985 it made $245 million, or a quarter of its total $998 million net profits, from the Caribbean, and Central and south America. Bank analysts put Brazilian interest payments alone at worth $1.35 per share, or 18 per cent of Citicorp’s estimated 1987 earnings. Yet banks’ profits will also be hurt if they agree to new loans and reschedulings at interest rates close to Mexico’s. Brazil currently pays interest at about

1% per centage points above LIBOR. Its opening bid in negotiations is expected to be even lower than Mexico’s 13/ 16 ths. If successful, that would nearly halve its interest burden, thus nearly halving banks’ income from Brazilian loans. Imagine such rates extended to Argentina, Chile, Venezuela, the Philippines and beyond. Brazil is taking big risks, too. A default threatens trade finance, and with it essential imports. That is why President Sarney’s Government has taken the drastic action of freezing the $l5 billion of trade credit and interbank deposits that otherwise would have expired by March 31. This will keep the economy chuntering along for the time being. Brazil has oil stocks large enough to last 75 days, and Iraq, its largest supplier, will be willing to continue to sell it oil in return for arms. Brazil’s bigger risk is of shutting itself off for years from foreign capital. Although commercial banks will probably be persuaded to reschedule at generous terms, they are loth to agree anything before the I.M.F. gives Brazil’s economic policy its seal of approval. But Brazil has no policy and the I.M.F. is seen there as a sort of piranha. That is why this confrontation looks worryingly unstable. Other debtors know, too, that their interest lies in following Brazil if their interest terms are to be improved. Since 1982, banks have stopped the international debt crisis doing much damage to their profits by maintaining the fiction that the debt will be paid. This week’s events may begin to force banks to bear more of the burden and even to write down some of the debt to its market value. Brazilian debt is now trading in the secondary market at 69-71 cents, or a 30 per cent discount, against 75 cents two weeks ago. Mr Reed has argued that Brazil should pay high interest rates on its debt, because it should follow the dictates of a free market. Citicorp and the other banks might prove less keen to allow the market to set the true value of their Latin loans. Copyright — The Economist.