The views expressed are not necessarily
those of the World Bank.
AGREP Division Conference Paper
No. 4
THE WORLD FINANCIAL SITUATION AND IMPLICATIONS FOk GATT
by Delbert A. Fitchett
presented at
The Third Grain Market Conference
Brussels, Belgium, June 1987
Economics and Policy Division
Agriculture and Rural Development Department



FD   D IL  SITUATION M  DI   ItLICRTIONS EQ   fil
Delbert A. Fitchott
1.   You undoubtedly recall the turmoil on international
comFiodity markets in the middle and late 1970s, uhich served
as a somber background for the Tokvo Round of GATT
negotiations of those years. But even those tumultuous
commodity market conditions were subsequently dwarfed by the
serious train of events on international financial markets
since the earlv 1980s. This worrisome world financial
situation adds a special sense of urgency to meaningfullv
addressing in the new Uruguay Round of GATT negotiations
those trade policv issues which impede improving the
financial health of the less developed countries (LDCs).
The 5h nQg World Financial 8§noD
Z.   It is important to recognize that there have been some
notable changes in the nature of the world economy since the
The author is a Senior Economist in the Agriculture and Rural
Development Department, Operations Policy Staff:
International Bank for Reconstruction and Development (IBRO).
He wishes to acknowledge the assistance of Dr. G. E. Schuh,
Director, in preparing this presentation. The author is
solely responsible for the resulting paper. This speech was
presented at the Third Grain Market Conference in Brussels,
Belgium, June 10 -1Z: 1987. The views and opinions expressed
in this paper are entirely the responsibility of the author.
They do not necessarily reflect the views or opinions of the
IBRDz its officers or governing bodies.



1970s, some of which may not have been adequately recognized
and fully understood at the time of the Tokyo Round
negotiations. Fundamental changes in global financial and
capital markets are merely one -- but nevertheless important
--'asoect of the changes -that have been bccurring in the
world economy since the last set of those multilateral trade
negotiations which ended almost a decade ago. The volume of
financial resources generated through ne- issues on these
markets has grown to some US$ 250 billion by 1986, while the
trading turnover is manv times that, dwarfing even the total
volume of world trade in goods and services. Both developed
and developing countries have been maior participants on
these financial markets.
3. This rapid expansion of these markets has been
accompanied by some fundamental changes in the international
financial system. With the progressive deregulation of
domestic financial markets of the maior developed economies
and their closer integration, there has also appeared a wide
variety of innovative financial instruments to better permit
financial institutions to intermediate on these markets.
While to rev'iew many of these would be beyond the scope this
short presentation, I think there are three fundamental
changes of especial importance to the theme of our
discussion:



(a) The movement from fixed to variable exchange
rates for the major world currencies;
(b) The integration of international capital
markets already alluded above; and
(c) The enormous rise in developing country debt.
4.   The abandonment in the early 1970s of the Bretton Woods
arranoements on fixed exchange rates represents a irecoonition
of the importance of foreign exchanoe policy as a useful -
if potentially very abusive -- trade policy instrument for
developed and developing countries alike. While. thdre, mav be
more than occasional complaints over the ensuing "huge"
fluctuations and uncertainty in exchange rates for one
foreign currency or another. it might be good to recall the
turmoil on foreign currency markets which in the fifties and
sixties typically preceded the Noften large and usually
overdue devaluation of one currencv or another. Moreover: in
this new deregulated environment. market *instruments such as
futures and options contracts have been tailored in order to
more efficientlv hedge against such instability. In
retrospect: it seems that politicians weren't much better in
the good old days at setting the price of their country's
money than thev are at setting the price of their country's
wheat today.



S.   To the extent that we observe large movements in rates
on foreign exchange markets nowadays, they are more likelv
owing to the inability of the authorities to insulate foreign
currencv markets from the imbalances arising from their
domestic 'fiscal and monetary policy distortions-. It is.,
unrealistic in today's world of a globally integrated economy
to attempt to return to the regime of fixed exchange rates
established at the end of World War II; such a move uw.'id
eliminate an important and very powerful policv instrument
for spreading adiustments more broadly through an economy. Of
course: further important refinements to this new system:
such as moving away from the present bloc-floating currency
arrangements to more generalized floating would be
appropriate.  Similarly, broader consultation and
coordination of national economic policies such as sought
through the recent Venice Summit are a sine gg rIon of this
global economic interdependence.
6.   The large volumes of funds traded daily on international
financial and capital markets have grown to dwarf the
magnitudes of actuaal international trade flows of goods and
services. These financial markets grew rapidly and performed
a remarkable intermediation role in the middle and late 1970s
in recycling the so called petro-dollar surpluses from oil-
exporting countries to cover the current account imbalances
of other countries. Of course, these same financial markets



have in recent vears served as the vehicle by which the U.S.
has financed its exaggerated domestic resource imbalances and
grew to become the countrv with the largest external debt in
the world.
7.   During the middle'and late 1970s these global capital
markets facilitated the large financial transfers to LODCs --
primarily in the form of svndicated commercial bank loans -
- which subsequently formed the core of the international
debt problem which has afflicted so manv of these countries
in the 1980's. This debt was largelv denominated in US
dollars, it was of shorter maturity than the custom with
multilateral lending instruments, and it carried variable
(i.e.- floating) interest- rafes. -The euphoria of the
seventies: with rising commoditv prices, low or negative real
interest rates and rapid trade growth underpinned this rapid
expansion in developing country external debt. This rosv
perception of the future has been overtaken by a return to
the secular downward trend in real commodity prices-
historically high real interest rates, and slow growth in the
maJor OECD economies which has dampened market prospects for
many of these commodities.
8.   The complexion of these global financial markets has
radicallv changed in the last several vears. The spreading
inabilitv of over-extended LDCs to fully service their
external debts to commercial banks has severely impacted the



sovereign deb+ market. Voluntarily syndicated sovereign debt
operations for LDCs -- i.e., not part of a "rescue package".
often assembled under the auspices of the Paris Club and with
IMF/IBRD support -- have virtually disappeared on the part of
commercial banks. The prospects for a resumption of new
'lending of this type by these bank's, so long as presently
outstandino loans are trading in the secondary interbank
market at discounts of 30% to 80%Z are not at all bright.
For the time being. attention is rather focused: on debt-
equity swaps, write-douns, provisioning of reserves: etc.
9.   The magnitudes of outstanding debt are impressive.   At
the end of 1986, the total outrtanding debt of the LDCs was
estimated to be about US$ 1,035-billion, having grown by
almost 60% since 1980 and even bv Z5Z since the debt "crisis"
reallv came to the forefront in 198Z. Very clearly, during
the past four years, the problem does' not seem to have grown
any smaller! About 45Z of this external LOC debt is owed bv
merely thirteen highlv indebted countries --and nearlv half
of that merely by Mexico and Brazil. In some of these
countries in this group -- and man,y of the smaller'poorest
countries - debt service burdens will account for much of
(or even more than) the likelv future expansion in their
production of goods and services. The further plight of the
exceptionally poor sub-Saharan African countries, MOSt of
whose external debt already carries relativelv concessional
terms and conditions and is from official rather than



commercial sources. has rec6ntly occupied much of the
attention of the public.
Thet World Fod £.conoom
10. It is not our intention to drag before you this gloomy
portrait for the purpose of pleading for special treatment of
the agricultural sector in the LOCs. To the contrary, we
should recognize some important elements of success in the
global food system and the role played therein by LOC
agriculture. It is no exaggeration to state that never *in the
recorded historv of the world has such a large proportion of
the world's population been as adequately nourished as it is
in the 1980§.,In a recently released report by the World Bank
-- EPoer.tv snd Hig     -- we note the remarkable growth of.
world food production in the past forty years, even
surpassing an unprecedented increase in world population.
11. But is is not iust a question of food production
matching or outpacing food consumption. Because of the
increasing efficiency -- albeit some mioht claim at a
spasmodic psce -- of world food markets, .nations need no
longer pursue the will o' the wisp of strict food self-
sufficiency through national autarky in order to achieve an
adequate level and reliability of food supplies. Rather-
through a closer parti:ipation in world markets -- for
agricultural commodities as well as other goods and services
-- developing and developed countries may both pursue



resource allocation strategies twhich permit followinj a more
rapid and economically efficient growth path.
tZ. We do not mqention these notable accomplishments of the
global food economy with the intention of lulling you into a
sens'e of complacencV. The nutritional situation continues 'to
be worrisome in some parts of the world. A commonlv cited
case is that of sub-Saharan Africa. where in 198Z -3 the
index of per capita food production was IZ per cent below the
already exiguous averace level for 1969 - 71. While the
short-term situation in this Region may have marginallv
improved in the last vear, we should expect to continue to
face serious food productionr demographic/human resource and
natural resource managemen't problems in the'area for some
time to come. On the other hand. it would be entirely
inappropriate to hold the world food system responsible for
those instances in which political authorities hasT
themselves actively and intentionally prevented people at
nutritional risk from feeding themselves; time and again, for
example, we have seen governmental action tendino to disrupt
civil life a'nd normal market operations, and/or preventing
legitimate relief opoerations from going into action --
occasionally for political- religious or ethnic reasons.
A jGowing  ppre§oj oEf ħbs Poli c     Errors    the Pqt
13. With the growing articulation or "globalization" of both
financial and commodity markets, we are increasingly



appreciating how realljfutile it itsto attempt to isolate or
insulate domestic economic policies from external forces.
Whether it be questions of fiscal policy, monetary and
credit market conditions, or a government's coqmmodity price
interventions or production controls, domestic circumstances
will 5pill over into the international arena -- often with a
vengeance! The effects may show up in both the magnitudes and
directions of the flows of commodities and the principal
price -- the exchange rate -- which translates the domestic
terms of trade into their international equivalent.
14. Unfortunately, at the same time that the LDCs have been
encouraged -- and even compelled bv the chain of events -- to
more closely articulate their agricultural economies with
global markets, it appears that the OECD countries have
increasingly sought to raise protectionist barriers around
their producers- driving broad wedges between domestic and
world market prices. This has often involved shifting the
resultant production surpluses --in increasing volumes and at
increasing costs through export subsidization -- unto export
markets, too frequently with little or no regard for the
resulting turmoil on these markets. This has at times been
accompanied by additional ret-trictions on their imports of
LOC agricultural commodities. Official food donations have
occasionally been mismanagied so as to cause further turmoil
on the recipient countries domestic agricultural markets.
There have resulted hugei reversals in market posture, as



former importers have become important exporters of, for
example, cereals, beef and sugar. The budgetary co5ts aid
economic inefficiencies arising from such market distortions
have been pointed to on numerous occasions, such as the World
Bank's World Doevelom&nt Rebort published last year, in a
recent USDA report measuring government intervention in-the.
agricultural sectors of various countries, or in a series of
studies recently released by the OECD.
15. The costs to the OECD countries of implementing these
programs are so impressive as to merit citing a few examples:
(a) U.S; farm support spending reached nearly USS
Z7 billion in 1986, a contribution of almost
$700 from each non-farm family in the nation.
Programs such as that for sugar which report no
net federal budgetary outlay involved further
heavy consumer costs.
(b) Direct subsidy costs of the EEC's Common
Agricultural PoliCV stood at about the same
level; adding to that the increased
consumer costs of agricultural commodities, the
total farM subsidv amounted to about $40
billion or about $900 from every nonfarm familv
in the Common Market,



(c) Betweroin direct Clovernment subsidy payments and
higher prices paid by cons"umers, ap;'icultura1
trade policy distortio.ss in Japan cost
consumers about $57 billion in 1985.
16. -Additional impressive figures have been aiven of the
costs of these programs, burgeoning commoditv stocks- and the
related distortions in product and factor markets. The
degree of overcommitment of resources to the agricultural
sector in the OECD countries persists. Given the magnitude of
these program costs, one is frankly puzzled that consumers in
the OECD countries.have not sought to more energetically
dispute the continuation of these programs. A fundamental
step would be-to refocus these domestic farm programs away
from production incentives and towards targeted income
support and assistanice to redeploy human, natural and
financiial resources towards efficient non-farm production
activities. Thus the price support measures currentlv in
place would have to go. while the rundouns of current large
stocks would have to be phased over a reasonable time period
in order not to introduce further turmoil unto the commodity
markets in auestion.
17. It is not just a question of the farm policies of many
of the developed countries, which have so often sought to
wrao up their producers in a cocoon of stable prices and



guaranteed markets. We must also lament the oernicious
effects of a now fortunately progressively discredited policy
framework typically applied bv the ILDCs in the past. The
principal components of that framework incluJad. for example:
(a) Overvalued exchange rates which artificiallv.
maintained staple foods relativelv cheap;
(b) State agencies uhich imported foods and made
them available domestically at subsidized
prices in spite of the impact on budget
deficits;
(c) State export marketing boards which taxed farm
exports; and
(d) Inadequate'research and extension services
which discouraged private investment in
farming.
Such approaches were customarily accompanied by expanded
bureaucratic interventions in other parts of the economv,
establishment of inordinate levels of tariff protection for
pet white elephant proiects, which distorted the domestic
terms of trade against the rural ecoriomvy etc. You recognize
the model whose outlines I am sketching. The unfortunate
expoeriences of the LOCs with such policies are also well



documented in last year's World Develooment Report. While
some countries pursued these policies in the 1970s when they -
were still flush from the bonanza of their newly-found oil
export earnings or expectations of continued buoyant markets
for their other commodity exports, other countries discovered
it was easv to do so bv borrowing on the international
financial markets from commercial banks which thought that
the expression "sovereign risk" -- when applied to the loans
made to profligate LOC governments -- meant "risk free". That
bubble finally burst- of course, in 198Z.
18. Quite naturally: this development model included a
characteristicallv adverse treatment of domestic financial
institutions and financial markets. Financial institutions
tended to be unviable and financial markets were abused. Few
financial instruments were developed and their use was
primarily restricted to the government sector. As a result,
these markets remained stunted and laroely inoperative as
vehicles for mobilizing domestic financial resources and
encouragino the flow-of such resources towards economicallv
efficient production and commercial undertakings. Nor were
the links between domestic financial markets and external
financial markets nurtured or permitted to develop. Financial
flows from abroad, in either the form of debt or equity
instruments, were not permitted to be efficiently
intermediated in domestic financial markets in order to
encourage an efficient use of domestic resources or to expand



the trade links between domestic and foreign product markets.
Time after time black markets and underground economies
developed and flourished as opoen commodity and financial
markets were suppressed. Capital flight from these countries
was of epidemic proportions.
19.  Thus while the developed countries characteristically
generouslv subsidized their agricultural sectors- the custom
among the LDCs was to heavilv tax their agriculture. On the
trade policv front: the developed countries maintained that
since their agricultural policies were domestic issues5 they
were not negotiable in the MTN fora. The LOCs, rather than
aggressively pursuing the MTNs as an instrument for Joining
the international trading community on standard terms and-
conditions: instead sought to promote special treatment and
dispensations from complyino with GATT rules. Unfortunatelyv
under this guise they too often erected and shielded highly
protected and inefficient production svstems which have
subsequently proved to be untenable in a more resource
constrained world.
World bank Initiative   in j_h  Oifficult Environment
20. Once abused: financial markets can be very stern
taskmasters, whether they be domestic financial markets or
international financial markets. This is verv apparent today
on the international markets, which have swung from the
virtual unque5tioning acceptance of LOC creditworthiness



during the 1970s to the other extreme of notable reluctance
to undertake uncollateralized or sovereign lending to the
LDCs today. Both the International Monetary Fund and the
World Bank are attempting to participate in the process of
reestablishing the standing of LDCs in the international
financial markets. In the case-of the Bank: this has
involved expanding its range of lending instruments beyond
the traditional credit operations in support of specific
proiect investments. These new instruments are the structural
and sectoral adiustment loans- designed to support and abet
the LDCs' orograms and policies of structural reform.
Zt. Such loans have risen from about 8% of the World Bank's
annual loan commitments ten years ago to almost 19% in FY
1986. More than thirty countries have participated in such
operations, although the bulk of the resources so lent have
tended to be concentrated in multiple operations in about a
dozen or so countries. Under the aegis of these relatively
quick-disbursing operations, the Bank has sought to
facilitate the adiustment required to achieve sustainable
growth and the mobilization of external financing to support
a countrvys adiustment efforts. The adiustment proorams
undertaken are of a varied nature, but thev would typicallv
include:
(a) Efforts to improve domestic resource
mobilization performance, including revenue



enhancement  exoenditure rationalization, and
liberalization of domestic financial markets;
(b) Improving the efficiency of public sector
resource use, e.g., rationalizing both the
current and capital expenditure budoets and
strengthening or divesting public sector
enterprises;
(c) Reform of the structure of economic
incentives-on both the external front by
reducing the trade regime's anti-export bias
and making more transparent the nature of
protection. and on the domestic front by
disengaging the government from seeking to fix
prices and/or distort market signals; and
(d) Institutional strengthening in any of a number
of areas considered to be fundamental
underpinninos to a resumption of an efficient
growth process, e.g.. customs services- market
information services, agricultural extension
service. formation of human capital, etc. The
intention- of course-is not to further stretch
or expand the government's involvement in the
economic arena, but rather to refocus it and
concentrate its limited skilled human and



financial resources in a more supportive 'role
for the expansion of productive activities.
ZZ. Very clearly. with the Bank's total annual lending
commitments running on t1he order of $16 billion. even
allocating as much as a E'uarter of this amount to support
6diustment programs in a selective group of receptive LDCs
would make only a minor dent in the financial resource
transfer needs of these countries .n order to resume growth.
In past two years the long-term debt service bill for the
LDCs has topped US$ 100 billion. Thus the Bank has actively
sought to enlist the cooperation of commercial lenders to
cofinance with it. On some occasions, the Bank and the Fund
have also participated in broader adjustment endeavors
arising out of Paris Club agreements among the official
bilateral lendino agencies. And, of course- The
International Finance Corporation -- our private investment
affiliate -- is engaged in assisting private sector
investment and encouraging the development of domestic
private capital markets and financial instruments in order to
strengthen these countries' efforts at domestic resource
mobilization and provide a more receptive environment for
foreign orivate investment.
Can the MIfT tei1gZ
Z3. Very clearly, unless the heavilv-indebted LOCs can
expand their manufactured and agricultural exports, it would



be unlikely that their production of goods and services could
grow at a sufficient rate to permit them to resume regular
servicing of their external financial obligations --much less
to be considered as creditworthy in the international
financial markets for an expansion of capital flows on
commercial terms.   On the other hand. driven by the need to
expand their exports -- agricultural and others -- in order
achieve the current account balances which would permit
servicing their exterinal debt, LOC successes in this regard
have already been the occasion for some gnashing of teeth by
the developed country producers and legislators. These
expanded supplies of farm commodities from the LDCs have
tended to coincide with a compression of their demands for
imported agricultural commodities" thus seemingly catching
the traditional OECO commodity exporters between the blades
of a very sharp pair of scissors.
Z4. Thus, in addition to the compression of demand for
agricultural commodities owing to thr, slowdown in world
income growth during the decade of the eighties, we are
observing a reshuffling of the patterns of trade in
agricultural commodities. This reshuffling is a logical
concomi+ant of the restructuring of LDC economies which we
alluded to earlier, as thev are removing the anti-
agricultural bias which characterized their past development
policies. On the other hand. we should rather confidently
expect that a resumption of LOC growth rates would provide a



solid underpinning to the expansion of their demands for OECD
agricultural exports.
ZS. It would be futile to try to return the heavily-indebted
LDCs to acceptable levels of creditworthiness bv standard
capital market criteria solely through restructuring that
existing debt, writing it down or some other combination of
"financial e.'gineering" exercises. Nor can these countries
solely relv on the benefits of their domestic adiustment
policies -- fundamental as these may be to their longer-term
economic health -- in order to return to an efficient and
sustained growth path. Expanded trading opportunities-must
underpin this growth recuperation.
Z6.  Unfortunately, the experience of recent years appears to
be to the contrary. Thus the GATT Secretariat reported in
March of thiv. vear that for a group of sixteen of the most
indebted LOCs, o'er the five vears 1981 - 1986 their exports
were off by nearly 10X and their imports were down by more
than Z5X. This Was a mixed group of countries, including
such relatively good export performers as Thailand and South
Korea. In the same report, the Secretariat noted that in'1986
the growth of world trade in agricultural oroducts continued
to be well below the average rate of 4% per annum which was
observed during the decades of the sixties and seventies.
27. In the past, the protectionist agricultural policies of
Page 19



the developed countri-es have tried to shelter themselves
behind the claim that they are "domestic" policies rather
than trade measures and therefore non-negotiable. This
fiction is no longer tenable. The introduction of mat-ket
responsive discipline in lieu of heightened governmental
efforts to adrinistratively manaoe commodity markets must
fcrm the underpinning for future commodity trade growth. It
is hard to imagine that continued OECD agri.nultural
protection by impeding and distorting the opporl;unities for
effic,ent LDC agricultural and economic growth, can do
anything else than limit the capabilities of these countries
to regain their creditworthiness on international financial
markets. Greater recognition must be given to the role that
expanded LOC farm production, contributing to overall LOC
economic growth. will necessarily play in bringing about a
resumption of increasing demand for agricultural exports of
the OECD countries themselves.   Since agricultural trade
protectionist measures remain as one of the most glaring
exceptions to the more liberal trading environment achieved
by the consecutive rounds of MTN negotiations. it is most
appropriate that they are assigned such a high priority in
the Uruguay Round.
Page 20