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Box 5.3 Estimating the grant element The grant element in a loan is defined as the difference In theory, the discount rate should be carefully chosen between the original face value of the loan and the dis- to reflect the cost of capital. In practice, a 10 percent rate counted present value of debt service, as a percentage of is usually assumed for all currencies and time periodsthe original face value. As Box table 5.3A shows, the the convention used in the grant element tables pubgrant element is greater the lower the interest rate on the lished by the OECD. However, using any single inflexiloan and the longer its maturity or grace period. ble rate has obvious drawbacks, as it does not take account of changes in market interest rates or of big differences in rates for different currencies. Box table 5.3A Grant element of selected loan terms A better alternative is to set the discount rate equal to the rate of interest at which commercial finance with the Loain termns same maturity could be borrowed in international mar- Interest rate Maturity Grace period Grant element, kets at the time and in the particular currency of the loan 10 percent discount rate in question. In many instances, of course, commercial 0 30 5 77 percent funds would not be available for such long maturities, so 6 20 0 23 percent a premium should be added to the discount rate to make 6 10 0 15 percent allowance for this. The effect of a discount rate that var- 6 10 5 21 percent ies according to currency and over time is to lower the 15 percent discount rate grant element for official loans from countries in which 6 10 5 40 percent interest rates are low and to raise it for loans from couna. Assumes immediate disbursement of loan and equal annual repay- tries in which rates are high and during periods of high ments. international rates in general. Box 5.4 Three innovative financial instruments and their use by developing countries Three financial instruments that are increasingly used in * Graduated payment loans. Debt service payments are domestic financial markets (notably the mortgage mar- initially low and gradually build up. In the early years of ket) have not yet been used by developing countries, but a loan, amortization may even be negative. This instrumay have certain merits for them. ment could be particularly suitable for project finance, * Flexible maturity loans. Instead of variable interest where earnings and debt-servicing capacity rise as the rates, loans carry a variable maturity. Debt service pay- project matures. By matching the stream of debt service ments are held constant in absolute terms (or, perhaps, obligations with the expected foreign exchange earnings in relation to a borrower's income). When interest rates of a project, debt managers would avoid tying up foreign rise, the amortization part of debt service declines and reserves for debt servicing. the loan's maturity increases accordingly. With a large * Shared equity loans. Lenders would accept belowrise in interest rates, negative amortization will occur; market interest rates in return for a share in the equity of lenders will effectively be providing new money to bor- projects. For the borrower, the risk involved in a project rowers. Flexible maturity loans offer advantages to both is shared with the lender. However, since a project's borrowers and lenders. Borrowers are certain of their earnings depend on what price is charged for its output, debt-servicing obligations. Lenders are able to manage a loan agreement would have to contain some pricing their assets with less worry about debt rescheduling and formula. This would give lenders some influence over possible write-offs. For developing countries, this would the management of the project (though it would also be doubly attractive if debt service payments could be raise their administrative costs). Lenders might also tied to export receipts, as it would reduce the uncertainty want to stipulate some compensation procedure or over volatile commodity prices. insurance against political risks. nerability of borrowing countries to rising interest Debt managers may sometimes be able to raise the rates. For those developing countries that have proportion of debt at fixed terms. For example, offirecently rescheduled their debts, the proportion of cial export credits can often substitute for commercial debt at floating rates (34 percent at the end of 1983) borrowing (see Chapter 7). New financial instruwas nearly twice that of nonrescheduling coun- ments, such as flexible maturity and shared equity tries. Similarly, the interest to exports ratio of loans, are becoming available to developing counreschedulers was more than twice that of nonre- tries (see Box 5.4). And some middle-income counschedulers and rose much faster between 1980 and tries are already using interest rate swaps to ex- 1982. change floating rate for fixed rate loans (see Box 5.5). 78
The maturity structure of debt early 1983, short-term debt of developing countries had increased to an estimated $130 billion, roughly Recent debt-servicing difficulties have often been one-quarter of all developing-country debt. caused or exacerbated by a shortening of the matu- For many countries, the shortening of maturities rity structure of foreign debt. The average maturity was not a deliberate policy that then led to difficulof total medium- and long-term debt of the major ties. Often they faced a choice between borrowing borrowing countries fell from 17.9 years in 1972 to short term or not borrowing at all, since commer- 12.7 years in 1981. The average maturity was even cial creditors were no longer willing to lend longer lower for the largest borrowers: Brazil, 9.7 years in term. Heavy short-term debts were therefore at 1981; and Mexico, only 8.7 years. In part this least as much a symptom as a cause of difficulties. occurred because commercial bank debt rose much But in many instances they should have signaled faster than ODA and other official financing. The the need to change economic policies before those sharp increase in short-term debt, especially after changes were forced upon policymakers by credi- 1979, has further shortened the debt structure. By tors during rescheduling negotiations. Table 5.3 Indicators of vulnerability to rising interest rates (percent) Country and indicator 1973 1975 1977 1979 1980 1982 1982 1983 Argentina* Interest/exports 12.3 13.7 8.2 9.6 12.9 17.2 25.0 23.3* Debt at floating rates 6.8 17.5 39.4 48.0 57.1 59.4 70.0 75.0 Brazil* Interest/exports 10.6 20.6 14.9 26.4 27.1 29.4 39.8 31.5* Debt at floating rates 34.8 51.8 54.3 59.6 61.2 67.3 69.6 76.5 Costa Rica* Interest/exports 5.6 6.1 5.3 10.5 14.0 11.2 9.7 45.0* Debt at floating rates 19.3 29.2 32.0 46.6 46.5 52.1 51.9 57.0 Indonesia Interest/exports 3.6 4.6 5.6 6.8 5.3 5.7 7.4 8.2 Debt at floating rates 4.5 19.4 18.7 14.5 16.8 17.8 20.0 22.7 Kenya Interest/exports 4.0 4.5 3.8 7.2 8.3 9.2 11.6 10.9 Debt at floating rates 3.8 2.9 5.1 8.3 11.4 13.0 11.0 9.1 Korea Interest/exports 5.9 5.3 3.8 4.7 6.0 6.4 7.2 6.2 Debt at floating rates 8.7 21.0 23.0 27.8 29.0 37.5 40.9 42.1 Mexico* Interest/exports 10.4 16.9 18.7 20.5 18.3 19.6 26.7 30.1* Debt at floating rates 40.0 51.2 53.3 69.7 71.1 74.8 76.0 82.4 Philippines* InterestJexports 3.6 3.6 5.0 7.5 6.9 9.1 10.5 10.3 Debt at floating rates 8.0 21.0 21.9 24.9 29.5 30.8 36.2 36.0 Turkey* Interest/exports 4.5 5.8 8.0 8.3* 17.2* 13.9* 12.0 15.0 Debt at floating rates 0.5 0.8 7.8 29.2 22.7 22.1 23.3 25.0 Developing countries, Interest/exports 4.3 5.0 5.0 6.7 6.9 8.2 10.1 9.8 Debt at floating rates 6.4 9.4 11.8 15.5 17.3 19.0 20.2 21.6 Reschedulersb Interest/exports 7.0 7.4 7.0 9.9 10.5 12.4 16.5 17.0' Debt at floating rates 11.9 17.2 23.1 29.9 31.2 33.2 34.9 38.3 LIBOR (3 months) 9.2 11.0 5.6 8.7 14.4 16.5 13.1 9.6 Note: Asterisk denotes rescheduler and time of rescheduling. (The Philippines rescheduled in 1984.) The interest to exports ratio reflects interest actually paid on medium- and long-term debt. Exports include goods and services. Debt at floating rates refers to public medium- and long-term debt. a. Arithmetic average for ninety developing countries. Because of the averaging method used, data differ from those in other chapters. b. Average for twenty-seven countries rescheduling between 1975 and 1984, as indicated in Figure 4.1. For details, see Box 2.4. c. Estimate. Source: <strong>World</strong> <strong>Bank</strong> data. 79
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Public Disclosure Authorized Public
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World Development Report 1985 Publi
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Foreword This is the eighth World D
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Contents Definitions and data notes
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A.4 Population and composition of G
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Definitions and data notes Capital
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culated without making deductions f
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Part I Overview and Historical Pers
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Figure 1.2 Trends in selected debt
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countries depend on three variables
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ties includes many countries in Lat
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intermediation of the World Bank an
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In dealing with all these issues, t
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tury. By contrast, net capital infl
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tees on terms that seldom preserved
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mid-1960s and France a few years la
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Table 2.2 (continued) Country group
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Table 2.3 Net resource receipts of
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anking assets and liabilities. They
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Box 2.3 How inflation affects loan
Page 41 and 42: Box 2.4 The changing nature of debt
Page 43 and 44: agreement has been reached with Ecu
Page 45 and 46: Part II Role of Economic Policies 3
Page 47 and 48: Table 3.1 Current account balances
Page 49 and 50: eceipts minus social security outla
Page 51 and 52: expected to be high-a view consiste
Page 53 and 54: story. Difficulties had started ear
Page 55 and 56: Box 3.4 The costs of protecting sug
Page 57 and 58: 4 Foreign borrowing and developing-
Page 59 and 60: World Development Indicators, Table
Page 61 and 62: Box 4.1 The debt cycle hypothesis A
Page 63 and 64: guarantee that enough foreign excha
Page 65 and 66: Figure 4.5 Borrowing and growth in
Page 67 and 68: Box 4.4 Guidelines for borrowing De
Page 69 and 70: have been forced to reschedule thei
Page 71 and 72: happened to different developing co
Page 73 and 74: Figure 4.6 Change in investment, sa
Page 75 and 76: Figure 4.7 The composition of credi
Page 77 and 78: tion started increasing consumer su
Page 79 and 80: Box 4.6 Capital flight in the South
Page 81 and 82: and tighter fiscal and monetary pol
Page 83 and 84: Export Rehabilitation Program to pr
Page 85 and 86: 5 Managing foreign finance The prev
Page 87 and 88: Box 5.2 Integrated debt management:
Page 89 and 90: vate borrowing more carefully. In M
Page 91: available to the country. Some tech
Page 95 and 96: developing countries greatly. For e
Page 97 and 98: help to develop debt management sys
Page 99 and 100: Part III Mechanisms for Internation
Page 101 and 102: Box 6.1 The growth and distribution
Page 103 and 104: Box 6.2 The deployment of the OPEC
Page 105 and 106: Box 6.3 The international interbank
Page 107 and 108: investment grew steadily for much o
Page 109 and 110: "graduation" of some developing cou
Page 111 and 112: Figure 7.1 Net receipts of official
Page 113 and 114: issue is the right balance between
Page 115 and 116: tive performance of different count
Page 117 and 118: tion of aid directly supports priva
Page 119 and 120: happened in the absence of aid. Two
Page 121 and 122: gram. This involves close collabora
Page 123 and 124: Box 7.8 Aid coordination Aid coordi
Page 125 and 126: Figure 8.1 Net position of developi
Page 127 and 128: Box 8.2 Arab banks and internationa
Page 129 and 130: default clauses would ensure that a
Page 131 and 132: perceived creditworthiness of devel
Page 133 and 134: Debt rescheduling and the banks Ban
Page 135 and 136: Box 8.7 Increasing the flexibility
Page 137 and 138: Box 8.9 World Bank cofinancing The
Page 139 and 140: 9 Direct and portfolio investment T
Page 141 and 142: Box 9.1 Direct foreign investment i
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however, there has been a positive
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By contrast, some of the newly indu
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ecognition of the relevance of this
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Table 9.2 Return on investment in e
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Part IV Perspectives and Policies f
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ently estimated at slightly more th
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mies would continue to grow faster
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Middle-income countries Major expor
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Table 10.6 Net financing flows to d
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cies and performance against the me
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Table A.3 GDP, 1980, and growth rat
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Table A.7 Consumption, savings, and
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Table A.9 Change in export prices a
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Table A.12 Composition of debt outs
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problems in the Latin American coun
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Interbank Market: A Descriptive Stu
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Diversification in the Nineteenth C
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Contents Key 168 Introduction 169 M
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Table 21. Labor force 214 Populatio
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Introduction The World Development
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that it is a weighted average; the
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Life expectancy The map classifies
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GNP per capital Life Area Average a
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Average annual growth rate (percent
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GDP' Distribution of gross domestic
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Average annual growth rate (percent
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Distribution of gross domestic prod
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Value added Food aid Fertilizer con
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Distribution of manufacturing value
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Energy consumption Average annual e
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Merchandise trade Average annual gr
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Percentage share of merchandise exp
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Percentage share of merchandise imp
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Destination of merchandise exports
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Destination of manuiactu red export
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Receipts Gross international reserv
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Public and publicly guaranteed medi
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External public debt Interest payme
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Average interest Average Average Co
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OPEC Amount 1975 1976 1977 1978 197
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Average annual growth Hypothetical
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Crude Crude Percentage Percentage o
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Percentage of population of Pretgof
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Urban population Percentage of urba
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Life expectancy at Iniant birth (ye
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Daily calorie supply Population per
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Number Number enrolled in enrolled
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Percentage of total expenditure Hou
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Percentage of total current revenue
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Percentage share of household incom
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appropriateness of the exchange rat
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and electricity, water, and gas. Al
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import unit value index, this indic
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The summary measures in this table
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Data are mainly derived from the Wo
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and other training institutions by
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Bibliography of data sources Nation
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World Devlelopment Report 1985 focu
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