**Policy, Research, and External Affairs**

# **Oebt ar,d International Finance**

# WPS 785

This papcr - a product of thie Debt **and** ltlernatiorial **Finance** DiviSion, International Ecoinomics Department -is panl of a largcr effort in [IRE to understand **thc** relationshiip between **macroccononlic** policies and cxtcrnal indicltcdricss ot'dc\vlopiig countrics. Copies are av'ailable f'rce 'rom the \World BanTk, IXf11fStreetNW,.' WshlingtoniDC20433.. PleaseacontactSheilahilinig}-\ Wa;tson,roomnSX-(4O, extension 31(47 (26 pages). Octobehr 1991.

If a country's macroeconomic policies are gencrally sound and microcconomic diRtortionn minimal, sporadic episodes of ovcrbolITowing or inadequate atteintion to the terms, maturity, **and** curtcnc) composition of external debt will generally **iioi** make a difren-ciice in its decbt picture.

In China, India, ai Kolioma. investment rates **wvere** relativelv hiih, financed mostly from domestic savinos: forcign loans **xxere** use judiciously, as a compllemieint to domcstic savings. Forcign capital accounted for **only** 2 to 3 percent of GDP in thcsc counitrics, although investmcnt ratcs **averaged** _3(0_ percent of GDIP.

But acts of indiscretion in extemal dcht management tend to be magifiiied **when** those basic policies arc inadequate. The reccnl upturin in Latin American economies --- parlicularly in Chiile, Mexico, and Vcnczu.'ia, **xkhich** are now, successfully pursuing maci, ,conomic a(ijusiment -- supports ltlC validity **olf these** f'iiings.

B\ contrast, thle Latin Anmericani **govern-** menis expanded extemnal **borrok inigs** to offset **ihc** effects of exterial shocks. **In** Bra,il, foreign resources **were** substiluted lor domestic sa\ ilgs to support an imporl substitution strategy; in Mexico. fiscal deficits were finaniced by extemal **borr)Wiliw.** l]ow did the Asian countries avoid **the** debt crisis? Husain answers thali question partlk bN contrasting thcir behavior with that of' 12 higlily indcbtcd Latin American and African counities studied by the Bank in the mid- 198(s.

The Asian counitries, itli a fcew exceptions. pursued an outward-oriented stratcg\ and prudenlt imacrocconiomiiic policies [hey inade ing cxpenditures, expanding cxpoinis. and curtailing consumptiol. Mlost horrowed and locally raised funds were invested in productive uses, improving the cconorn\'s abilil\ to rcpay thie debt. 'hese countries relic( heavilx oni doiiestic savinigs aid resources to finance investmenits Thcy did not allow, crises to drift or he aggravated.

At thc samc time. the residents of' these couninies transferred billions ot dollars abrotd. liusaini atitibutes this massive capital 'light to overnalued cxch:tnoc **r'it.- I:i nd -r-n 1i1mi\io** intercst rates. 'hlcsC wcre initcln(ded to curb inflation **htii** instcad cro(ded creditx orthincss because of iteir depressinig effict. oni exports and salvings expericnce(i thc mia,ssive flighlt of private capital while thc\ were stepping up exicnal borrov ing - courtcd trouble %kith debt servicing, because much of the borrowed mioney \Yas not invcs,ted in higih-retuni projects. 'Ihat flight capital has begun to return **to** Mexico and \'Venezula. both of which embarked on successful economlic relorn in 1987.

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