Causes and consequences of the 1982 Third World Debt Crisis

This paper investigates underlying causes of the debt crisis that only surfaced with Mexico’s unilateral moratorium on her foreign obligations in 1982. The paper investigates the evolutionary trend of LDC debt and the consequences for lenders, borrowers and the international financial system. The motivation of the research is to develop sound analytical understanding of the mechanics of debt accumulation as groundwork for further study of macroeconomics of debt and debt relief. The paper observes that the third world’s debt crisis resulted from an exponential increase in external indebtedness disproportionate to the debt service capacities of developing countries. The collapse of commodity prices, high interest rates and appreciation of the US $ further tightened their internal fiscal positions and balance of payments, forcing them to re-finance maturing debt from fresh loans. The paper also observes that western bankers ignored signals of an imminent debt crisis and worsened the debt portfolio of third world countries by refinancing maturing loans with shorter maturities. These countries remained on the brink of default until convergence of multiple maturities and inadequate availability of new finance caused a capital reversal. The paper argues that although developing countries had used some of the loans to finance unproductive investments [including militarization] the lenders also brought the crisis upon themselves as a result of ‘obsession’ lending aimed at offloading surplus petro-dollars deposited in western banks by oil exporting countries. Although lending was justified by apprehension to fearful consequences for world trade and political stability [if the purchasing power of the third world evaporated as a result of discontinuation of lending] the paper emphasizes the role of ‘uncritical herd instincts’ of lenders in the debt crisis. The paper concludes that the failure of the loans represent miscalculations on both sides of a transaction and distortions in the lending process itself, hence the debt crisis deserved mutual cooperation of the lenders and the borrowers. However, the closure of all financial markets to defaulting economies prevaricated cooperative resolution and, in fact, precipitated the crisis. The paper emphasizes that developing country economies are fatally dysfunctional with long standing ills that are only concealed by capital inflows; hence unilateral action of lenders in halting the supply of finance while demanding repayments opens a liquidity gap resulting in consistent economic contraction.