World Bank Document

4 Foreign borrowing and developing-country policies
Foreign borrowing has two potential benefits for a brief description of the variety of country experideveloping
country. It can promote growth, and it ences with foreign capital over the past twenty
can help an economy to adjust to internal and years, based on a sample of forty-four developing
external shocks. However, recent experience has countries. (For a listing of these countries, see Stagraphically
illustrated that borrowing also has tistical Appendix, Table A.11.)
potential disadvantages. It can be wasted on ineffi- This is followed by a discussion of the two main
cient investment. It can allow a government to uses of external finance. First, it may be used sysdelay
essential economic reforms. And the accu- tematically to raise investment and growth to a
mulation of debt can make an economy more vul- higher level than could be financed by domestic
nerable to financial pressures from the world econ- savings. Second, it may be used to finance balance
omy.
of payments disequilibria, caused either by inade-
How can a developing country obtain the bene- quate domestic policies or by external or internal
fits of capital inflows while taking reasonable pre- shocks. The discussion explores the questions of
cautions to avoid debt-servicing difficulties? This when borrowing for balance of payments purposes
chapter draws on the experience of the past two is appropriate and how governments can borrow
decades to identify the criteria for success in using to facilitate adjustment rather than to postpone it.
international capital. It deals primarily with debtcreating
capital; equity investment is discussed in Country experience over two decades
Chapters 5 and 9. This chapter's main theme is
that the economic policies of developing countries The diversity of developing countries' experience
are the fundamental determinant of the level of with foreign capital is illustrated in Figure 4.1.
capital inflows, the efficiency with which they are Countries' rankings differ according to the indicaused,
and a country's capacity to service its debts. tors chosen. For example, countries with similar
This is not to say that policy failings have been debt to GNP ratios may have very different debt to
the only cause of recent debt-servicing problems. export or debt service ratios. These differences are
Nor is it to imply that sound macroeconomic poli- explained by the degree of openness of an econcies
and less borrowing would have avoided those omy and the structure of its debt. In 1980-82, for
difficulties. Chapter 3 has shown that the combina- instance, countries that were relatively "closed"-
tion in the early 1980s of world recession and rising much of Latin America, but also others such as
real interest rates was unusual and severe; it is not Yugoslavia and Pakistan-had relatively low debt
clear that developing countries should seek to pro- to GNP ratios but high debt to export ratios. Those
tect themselves fully against all risks including with a large export base-some East Asian counthose
that have little chance of materializing with tries (Korea, Malaysia, and Thailand), oil and gas
any frequency. But flexibility in policymaking and exporters (such as Algeria, Indonesia, and Veneeconomic
structures can cushion the impact of zuela) and Africa's main commodity exporters
external shocks, however severe. (Ivory Coast)-tended to have relatively low debt
There is, of course, no single set of policies that to export ratios.
is right for every country. The extent to which a However, high ratios of debt to GNP or debt to
country should borrow from abroad depends on exports do not necessarily imply high debt service
the external environment that it faces in world ratios. Low-income countries such as India, Sri
trade and capital markets, its natural and human Lanka, Sudan, and Tanzania, as well as countries
resources, and its economic and political struc- such as Egypt, tend to receive much of their capital
tures. In view of this, the chapter begins with a inflows in low-interest, long-maturity loans (see
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