Enter The Brady Plan

By Barbara Rudolph

As a longtime and close adviser to President George Bush, Secretary of State James Baker is one of the most powerful men in Washington. But his tenure as Ronald Reagan's Treasury Secretary has left a sorry legacy: the failure of the so-called Baker plan, the 1985 policy designed to ease the debt burden of Third World nations. The 15 largest borrowers, most of them in Latin America, have seen their debt climb to more than $500 billion, from $350 billion in 1981. The debt load has left local economies a shambles and fragile democracies threatened. After 300 people died in Venezuela two weeks ago ( during riots over austerity measures imposed to pay off foreign debt, the Bush Administration decided that the time had come to act.

In unveiling a sweeping new approach to the crisis last week, Treasury Secretary Nicholas Brady all but repudiated Baker's program, which promised new loans for debtor countries once they instituted economic reforms. Instead, he called for measures that would help reduce Third World debt. "Our objective," said Brady, "is to rekindle the hope of the people and leaders of debtor nations that their sacrifices will lead to greater prosperity in the present and the prospect of a future unclouded by the burden of debt."

The Administration has tried to minimize the change, but the break with past policy is dramatic. The Baker plan adamantly rejected the notion that debt reduction should be achieved by commercial banks writing off a significant portion of their loans. But the Administration is now encouraging U.S. commercial banks to reduce some of their Third World loans by allowing debtor countries to make smaller payments on their principal and interest obligations. Brady left many of the plan's details vague, and the initial response from bankers, Congress and Latin American finance ministers was guarded. The Mexican government called the plan a "first positive step" but cautioned that many details still need to be worked out. New Jersey Senator Bill Bradley, an outspoken critic of the old debt program, called it a "significant change in direction" and declared that the "Baker plan is dead."

Not everyone was so enthusiastic. Venezuelan President Carlos Andres Perez called the new proposals "encouraging" but only "very timid steps." Paul Volcker, former chairman of the Federal Reserve Board, warned against looking for a "magic elixir" to solve the crisis. In a speech before a conference on Third World debt in Washington, Volcker explained, "If not well managed, a process of debt reduction clearly could be hazardous to the health of debtors and creditors alike."

No one, however, was calling for a revival of the Baker plan. Baker hoped to spark economic expansion and allow debtors to grow their way out of their problems. What happened was just the opposite. Most banks simply refused to issue new loans, fearing they would be throwing good money after bad. As a result, debtor countries found themselves using more and more of their scarce currency reserves to pay their debts. Last year Latin American nations paid $26 billion in interest to their creditors but received only $6 billion worth of new bank loans. The results were stagnant growth and a rate of inflation that has soared to 400% in Argentina and 1,000% in Brazil.

The Brady proposal hopes to reverse that tide by giving lenders an incentive to ease the pressure on debt-ridden countries. A banker, for example, might be willing to accept lower interest payment on an existing loan -- 6% a year, say, as opposed to 10% -- if assured that all interest payments would be made on time. In recent years, many strapped Latin debtors have repeatedly made late interest payments. This has an immediate and painful effect on the creditor bank, since it lowers its quarterly earnings. Under the new plan, the International Monetary Fund and the World Bank would insure that interest payments are made on time.

In the past, some economists have argued that new money must be provided to make any meaningful dent in the debt load. Secretary Brady has not proposed earmarking any new U.S. funds to help solve the debt crisis. But Japanese Finance Minister Tatsuo Murayama last week pledged financial support for the Administration plan, though no numbers have yet been released.

The U.S. is under increasing pressure to find a solution to the debt crisis. Last year Mexican President Carlos Salinas de Gortari won election by the narrowest margin in his party's 59-year history over left-of-center candidate Cuauhtemoc Cardenas. In Brazil left-wing parties have mounted a serious challenge to President Jose Sarney. And a nationalist party in Argentina could win the presidential elections set for mid-May.

Politics will be very much on the minds of central bankers and finance ministers when they convene in April in Washington at the semiannual meeting of the IMF and World Bank. At a series of closed-door meetings, the world's leading moneymen will tackle the details of the U.S. proposal in earnest. They will probably have little trouble agreeing that debt relief is a worthy goal. After that, nothing will come easy.

With reporting by Richard Hornik/Washington