PERSONAL & CONFIDENTIAL
JA L Morgan Esq CMG
MEXICO CITY
Foreign and Commonwealth Office
090/2
CMHKC090/2
Jean Interrain,
INTERNATIONAL FINANCIAL SCENE
London SW1A 2AH
25 January 1989
Miss Mar Mc Foron 1/2
Mr Wolf √307,
/ 1. I enclose the Bank of England's latest paper, which was
discussed at a meeting of Tim Lankester's group on 9 December. We spent a lot of time considering the arguments for and against debt reduction schemes, which I mentioned in paragraphs 9-10 of my last letter. Since then the Treasury, Bank and we have all produced papers on the subject. So I thought I would devote most of this letter by describing where we stand on the various proposals to reduce the value of debt owed to the commercial banks, largely but not exclusively by the middle income debtors who see 1989 as a key year.
2. This used to be a taboo subject. Camdessus has said that when asked to speak on debt reduction he still feels as if he is showing blue movies. The middle-income debt strategy rested on the assumption that the debtors were illiquid but not insolvent. They would in the long run be able to pay their debts in full if they were meanwhile lent extra money to assist with interest payments while they reformed and strengthened their economies. In contrast, debt forgiveness would threaten the banks with insolvency and give debtors an incentive for economic profligacy and default. The Baker Plan of 1985 marked only a shift in emphasis; while still stressing the importance of reforms by the debtors it called for extra lending from creditors to finance economic growth and a return to solvency.
3. The strategy has prevented a collapse of the world financial system, and the position of the banks is far stronger than it was in 1982. But, as we know, the position of the debtors has not improved comparably. The ratios of debt to GDP and debt to exports in the Baker 15 heavily indebted countries peaked in 1987, but are still substantially above their 1982 levels:
1980
1982 1985 1987
1988*
1989*
Debt to GDP
33
Debt to exports
168
42 268
46 289
50 312
47 312
45 297
* Projections
The goal of a return to creditworthiness is receding over the horizon. The increased bank lending envisaged by the Baker Plan has not materialised. The banks used to have to keep lending so that their accounts could show their interest being repaid
SS1AKR
PERSONAL & CONFIDENTIAL