South Africa: Debt Rescheduling and Potential for Financial Sanctions

Published by the Government Accountability Office on 1990-02-16.

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                  Lwnited States   General   Accounting   Office
                  Briefing Report to Congressional

February   1990
                  SOUTH AFRICA
                  Debt Rescheduling and
                  Potential for Financial
                  Sanctions :,& I,
                   United States
                   General Accounting  Office
                   Washington, D.C. 20548

                   National Security and
                   International  Affairs Division


                   February 16, 1990

                   The Honorable Paul Simon
                   Chairman, Subcommittee on
                     African Affairs
                   Committee on Foreign Relations
                   United States Senate

                   The Honorable Edward M. Kennedy
                   United States Senate

                   On November 2,1989, you requested that we analyze South Africa’s
                   financial situation and the U.S. options for imposing further financial
                   sanctions against that country. As agreed with your office, we are pro-
                   viding an interim report analyzing South Africa’s debt, loan reschedul-
                   ing arrangements, and the feasibility of excluding South Africa from
                   funds transfer systems that facilitate international trade and payments.

                   In 1985, because of political pressure, American banks refused to extend
Background         existing short-term credit lines to South Africa. Other international
                   banks followed, and a financial crisis occurred.

                   Because no short-term credit was made available, South Africa did not
                   have the resources to pay off its short-term debt when it came due. As a
                   result, South Africa continued to pay interest on this debt but in 1985
                   unilaterally froze repayment of much of the principal. In subsequent
                   years, South Africa announced, after limited negotiation with its credi-
                   tors, a series of three loan rescheduling arrangements to gradually pay
                   off part of the frozen loans.

                   In response to South Africa’s policy of racial segregation, the U.S. Con-
                   gress passed the Comprehensive Anti-Apartheid Act of 1986 that
                   imposed economic sanctions against that country, including selective
                   import and export bans, a prohibition on new lending and investment,
                   and restrictions on air transportation between the United States and
                   South Africa. Subsequently Congress has debated whether more finan-
                   cial sanctions should be imposed.

                   Since 1985, South Africa’s debt has declined by about $4.7 billion
Results in Brief   because of repayments on some loans and the reluctance of international
                   banks to make new loans.

                   Page 1                                         GAO/NSIAD9@109BR   South Africa

                         Differing opinions exist about the extent to which the third rescheduling
                         arrangement, announced in October 1989, puts financial pressure on
                         South Africa. South Africa had to reschedule its debt because it could
                         not pay. However, there are some groups who believe that the duration
                         of the agreement should have been shorter, and the amount to be repaid
                         should have been greater. Our review indicated the arrangement was
                         particularly favorable to South Africa because it allowed the country to
                         smooth out its debt services burden by increasing repayments of the fro-
                         zen short-term debt only as scheduled payments on other debt

                         Two major systems for facilitating international payments that are criti-
                         cal to international commerce include an electronic dollar transfer sys-
                         tem and a communication system. South African banks have been
                         directly excluded from the electronic dollar transfer system, but it
                         would be difficult to effectively exclude South Africa from participating
                         indirectly through other nations’ banks. It would be difficult formally to
                         exclude South African banks from the second system because it is a pri-
                         vate system based in a foreign country. Even if South Africa could be
                         effectively excluded from these major systems, it could use other means
                         to facilitate trade and payments,

                         At the end of 1988, South Africa had a debt of $21.2 billion, according to
South Africa’s Foreign   South Africa’s Reserve Bank. About two-thirds of this debt was owed to
Debt                     international banks, and the majority of the balance consisted of bonds
                         owed to holders outside South Africa.

Debt Profile             The Bank for International Settlements, an organization of central banks
                         of industrialized nations, reported that about $14.6 billion was owed to
                         international banks at the end of 1988. Approximately 83 percent of
                         this debt (or $12.5 billion) was owed to banks of five nations. The
                         nations and their lending exposures are listed in table 1.1.

                         Pbge 2                                        GAO/NSIAD90-109BR   South .Urica
Table 1.l: South Africa’s Bank Debt and
Major Creditors                             Dollars In bllhons
                                                                                                       Lending Exposure
                                            Creditor                                           _-         (yearend 1966)
                                            United Kingdom                                                            $4 1
                                            hted States                                                                25
                                            France                                                                      26
                                            West Germany                                                                19
                                            Swrtzerland                                                                 14
                                                    r countries                                                         2.1

                                            Of the $2.5 billion owed to U.S. banks, about 39 percent comes due in
                                            1 year or less, 25 percent in 1 to 5 years, and 36 percent in longer than
                                            5 years. About 74 percent of debt to the United States is owed by the
                                            South African private sector, and the balance is owed by South African
                                            government entities.

Changes in the Debt                 -4%. South     Africa imposed a moratorium on repayment of the principal on
                                            many of its short-term debts in 1985. Since that time, South Africa’s
                                            outstanding bank debt has d         by about $4.7 billion. Outstanding
                                                                                declined from a high of about $5
                                                                                billion in September 1989.

        -                                                     repaid&t% that was raot su&ct to the moratorium+
                f                                              and debt guaranteed by the South African govem-
            *                               ment, and a small portion of the debt covered by two rescheduling
                                          . With the exception of short-term credit to facilitate trade and some
                                            extensions of existing lo*    most internationst banks have been reluc-
                                            tant to p&Qde new loans to South Africa.

The Nature of South                         According to international bankers we interviewed, South Africa’s
                                            financial difficulties are different from those of nations with heavy debt
Africa’s Financial                          burdens. South Africa has a liquidity problem because most of its debt
Difficulties                                comes due in the short term, and it cannot obtain new loans to help
                                            make payments.

                                            Page 3                                         GAO/NSLUMK%109BR   South .Mrica

                      Unlike other nations with debt problems, South Africa gets few new
                      loans because of foreign perceptions of increased lending risks associ-
                      ated with its political situation and the potential for turmoil.’ South
                      Africa has also been excluded from access to loans from international
                      organizations, such as the International Monetary Fund. Therefore, it
                      must repay existing debt by running a current account surplus.’ To do
                      this, it has had to restrict the money supply and slow its economy to
                      reduce imports while attempting to increase exports in the face of inter-
                      national boycotts of its products. In sum, receiving no new loans slows
                      the South African economy.

                      South Africa’s liquidity problem contrasts with the difficulties of other
                      nations heavily in debt, whose economies cannot support the burden. In
                      fact, some bankers have said that for a gross domestic product of its
                      size, the South African economy is “underborrowed.” South Africa’s
                      special situation is illustrated by the fact that South Africa’s debt is sold
                      for a much higher price on the secondary market than the debt of most
                      countries with heavy debt burdens. According to Salomon Brothers
                      Inc’s Indicative Prices for Less Developed Country Bank Loans, in
                      December 1989, South Africa’s debts sold for about 70 on an index of
                      100, while Mexico’s sold for about 36, Brazil’s about 23, and Argentina’s
                      about 13.

                      After South Africa declared a moratorium on repayment of principal in
South Africa’s Debt   1985, which eventually froze payment of about $14 billion, it negotiated
Rescheduling          debt repayment with its principal international creditors. An interim
                      arrangement, lasting 15 months (from April 1986 to June 1987) pro-
                      vided that South Africa would repay about $500 million. A second
                      arrangement, lasting 36 months (from July 1987 to June 1990), pro-
                      vided that South Africa would pay about another $1.3 billion. The sec-
                      ond arrangement also provided creditors with the option of taking
                      lo-year exit loans, which convert frozen shorter-term loans to unfrozen
                      longer-term loans with a higher priority of repayment, although repay-
                      ment does not begin for several years. Over $4 billion in moratorium
                      debt was converted to exit loans, which will leave about $8 billion in
                      frozen debt at the expiration of the second arrangement.

                      ‘South Africa is experiencing   political   turmoil because of its apartheid   system.

                      ?he current account is exports of goods and services plus dividends and interest (eamrd from never-
                      seas investments and lending) minus imports of goods and w-vices and dividends and mtcw-rt paid
                      to overseas entities).

                      Page 4                                                                GAO/NSIAD!W1O!3BR   South .Vrica

                                    A third interim arrangement was reached in October 1989 and will last
                                    42 months (from July 1990 to December 1993). The arrangement pro-
                                    vides for repayment of about another $1.5 billion. All three interim
                                    arrangements allow creditors up to 1 percent additional interest pay-
                                    ments above a loan’s current interest rate.

                                    The payment schedule estimate for the third rescheduling                      arrangement
                                    is shown in table 1.2.

Table 1.2: South Africa’s Payment
Schedule Estimate Under the Third                                                                               Percent
Rescheduling Arrangement                                                                                              Of       Dollars
                                                                                                              remaining              (in
                                    Payment                                                                    Mncipal        millions)
                                    1990:   December                                                                 1.5%         $120
                                    1991:          February                                                          2.5           197
                                                   Auaust                                                            3.0           230
                                    1992.          Februarv                                                          30            224
                                                   August                                                            30            217
                                    1993.          February                                                          30            210
                                                   August                                                            3.0           204
                                                   December                                                           15            99
                                    Total                                                                           20.5%       51,502

                                    South Africa’s overall payment schedule for frozen debt and other debt
                                    is shown in table 1.3.

Table 1.3: South Africa’s Overall
Payment Schedule                    Dollars in Millions
                                    Type of Payment                                      1990         1991         1992            1993
                                    Princioal oavments on frozen debt
                                        -r-   8~   I
                                                                                         %2W          $427                         $513
                                           . oavments
                                              .,       on other debt
                                    Total payments                                     $1,640       $1,127       $1,140            __
                                    %cludes last payment of the second interim arrangement on June 15, 19%.

                                    In December 1993, at the end of the third interim arrangement, about
                                    $6.5 billion will still remain frozen and need rescheduling.

                                    The third interim arrangement favorably affects South Africa by
                                    smoothing its payments over time, increasing payments on frozen debt
                                    only when payments on other debt decrease. In particular, the arrange-
                                    ment requires a lower payment for frozen debt in 1990, a year when
                                    other debt payments are the highest. South Africa has about $1 billion

                                    Page 5                                                       GAO/NSLiDg@109BR          South .Africa

in bonds maturing in 1990, most of it held by institutions and individu-
als in European countries. These bonds could not easily be rescheduled,
making it important to South Africa to minimize repayment of principal
on frozen debt in 1990, so funds will be available to retire the bonds.

South Africa’s payments also have been smoothed and delayed by some
creditors’ opting to take lo-year exit loans under the second interim
arrangement. These lenders obtain higher priority repayment by con-
verting frozen debt to longer-term loans that are not frozen, but pay-
ments do not begin until 5 years after the conversion. Payment in full by
installments is received in the subsequent 5-year period. Over $4 billion,
or a little less than one-third of the original $14 billion caught in the
moratorium, has already been converted from frozen debt to exit loans.
In the third interim arrangement, South Africa tightened exit loan provi-
sions so that creditors taking lo-year exit loans would be paid during
the first 3 l/2 years at the same rate as lenders still having frozen loans.
For the next 4 years there is a grace period free from payments. In the
final 2 l/2 years, South Africa would resume payments.

There are several advantages for a lender in taking an exit loan rather
than having its loan remain frozen: (1) repayment of exit loans is not
frozen and is thus a higher priority for South Africa; (2) a higher inter-
est rate can be negotiated; (3) payment could actually be attained sooner
because of the slow rate of payment associated with frozen loans; and,
(4) a bank will no longer be pressured by anti-apartheid groups because
it is no longer party to the rescheduling negotiations on frozen debt. Dis-
advantages to the lender include the initial bad publicity and the possi-
bility of higher rates of repayment for frozen debt if South Africa’s
financial situation improves.

International bankers we interviewed stated that South Africa umlater-
ally declared what it would pay on principal owed on frozen debt. But
they also acknowledged that the banks had some negotiating leverage
because it is very important to South Africa to maintain some standing
with the international financial community so that it might eventually
get new loans. Unlike some other problem debtors, South Africa has
honored the payment schedules as promised under debt rescheduling

Differing opinions exist about the extent to which the third interim
rescheduling arrangement, announced in October 1989, puts financ iit1
pressure on South Africa. South Africa had to reschedule its debt
because it could not pay. However, there are some groups who b+~l~t~~tl

 Page 6                                         GAO/NSIAIMO-109BP   ‘inuth   \frica
that the duration of the agreement should have been shorter, and the
amount to be repaid should have been greater. American church groups,
prominent members of the anti-apartheid movement, believe the third
interim arrangement, announced in October 1989, was reached too early.
To maintain uncertainty in South Africa’s financial situation, they
would have preferred that the third arrangement not have been com-
pleted until the second interim arrangement, expiring in June 1990, had
almost elapsed.

These groups also wanted only a l-year arrangement with a $1.6 billion
 repayment, instead of a 3 l/2-year arrangement with a cumulative
repayment of $1.5 billion. They preferred to keep pressure on the new
South African President to reform the political system in 1990. The
church groups believe, based on their projections of South Africa’s cur-
 rent account balance derived from making assumptions about the gold
 price, that South Africa could have paid more than the bankers pro-
jected. In contrast, most bankers said that it was in their business inter-
 est to get South Africa to pay as much as it could without going into
 default. They believe they achieved this solution in the third arrange-
 ment. The bankers argue that the arrangement will make South Africa
 pay more over a shorter period than the country originally wanted.

Because South Africa is concerned about its standing in the intema-
tional financial community, it will more than likely honor the third
arrangement as it did the first two. If revenues from exports (primarily
through increases in the price of gold and increased exports resulting
from further depreciation of South Africa’s currency) do not generate
enough surplus on the current account to make debt repayments, South
Africa wilI probably create the surplus by slowing its economy to reduce
imports. Thus, the more debt repayments South Africa is required to
make, the more likely economic growth will be restrained.

If Western nations demanded immediate payment of all debt coming due
because of government sanctions or action by the banks, South Africa
would probably refuse to pay. If this happened, South Africa’s balance
of payments would be helped in the short term by ending the drain of
loan repayments, but it would probably further erode its standing in the
international financial community. This additional loss of standing
might further dim any prospects for new loans in the future. In any
case, South Africa would probably continue interest payments to avoid
being declared in technical default.

Page 7                                          GAO/NSlAD9@1OlBBE   !katb   Africa

                   International bankers we interviewed also want to avoid declaring a
                   nation in default because of the legal complexities, It is difficult for
                   international bankers to seize assets of a defaulting nation because they
                   must sue the debtor for each loan separately and can effectively seize
                   only the debtor’s assets that are actually in the bankers’ countries - for
                   example, a visiting airliner. Furthermore, bankers want to avoid the pre-
                   cedent of declaring a nation in default. No nation has been declared in
                   default since the worldwide depression in the 1930s. Even during the
                   recent debt crisis for lesser developed countries, banks avoided declar-
                   ing the nations in default.

                   The two primary systems used to facilitate international trade and pay-
Feasibility of     ments are the Clearing House Interbank Payments System (CHIPS), oper-
Excluding South    ated by the New York Clearing House Association, and the SWIFT
Africa From Fund   telecommunications system, operated by the Society for Worldwide
                   Interbank Financial Telecommunication, S.C. CHIPS has been in exis-
Transfer Systems   tence since 1970 and is the primary electronic funds transfer system for
                   processing U.S. dollar transfers between the United States and interna-
                   tional banks. The SWIFTsystem is a major international message and
                   communications processing system used by banking institutions world-
                   wide to transmit information that is critical to initiating international
                   electronic funds transfers.

                   Banks use the SWIFTsystem to give instructions to other banks about
                   sending payments, while the actual dollar transfer is sent through the
                   CHIPS system. Approximately   80 percent of CHIPS dollar transfers are ini-
                   tiated by sm messages. Although other systems exist, the interna-
                   tional financial community considers CHIPS and Swim to be the most
                   efficient and largest systems of their kind.

                   CHIPSis a private sector system that links depository institutions and
                   branch offices and acts as a conduit for moving dollar transactions,
                   including letters of credit, collections, reimbursements, foreign exchange
                   transactions, and the sale of short-term Eurodollar funds. In 1988. CHIPS
                   served 139 national and international depository institutions and
                   processed about 34 million transfers valued at $165 trillion.

                   The SWIFTtelecommunications system, operational since 1977, is owned
                   and operated by a Belgian cooperative society. As of December 1988. the
                   system provided more than 70 types of messages, including intema-
                   tional payment orders and other messages associated with international

                   Page 6                                         GAO/NSIAD9@109BR   South Africa
                               financial transactions. In 1988, SWIFT served 2,537 financial participants
                               and processed 255 million messages.

                               Advocates of placing further financial sanctions against South Africa
                               have proposed excluding it from international trade and payments sys-
                               tems. The possible impact of imposing these sanctions is discussed

Effects of Excluding   South   South Africa no longer is a member of CHIPS. Nedbank, a South African
                               bank, was admitted in 1984 but was asked to leave in 1986. South
Africa From CHIPS              Africa now participates indirectly in the system through other coun-
                               tries’ member banks. South Africa is able to continue to use CHIPS
                               because other member banks maintain its accounts and act as
                               intermediaries by processing its dollar transactions.

                               It would be difficult to stop South Africa from using CHIPSin this way
                               because the ultimate beneficiary of a financial transaction is usually
                               unknown. Transfers between banking institutions may pass through a
                               number of banks in the course of a transaction, and the ultimate benefi-
                               ciary is rarely identified. During a CHIPStransaction, only the participat-
                               ing banks performing the transaction are identified. South Africa could
                               use intermediaries if it wanted intentionally to hide its transactions to
                               continue participation in CHIPS.These intermediaries would most likely
                               be European banks.

                               Even if South Africa were somehow excluded from using CHIPS alto
                               gether, there are still a number of other mechanisms available to it to
                               move dollars. Although these other dollar clearinghouse systems are
                               much smaller in dollar volume than CHIPS,alternatives currently exist in
                               London and Tokyo, and more could be created.

                               South African exports consist mostly of primary products, which are
                               traded in dollars. If South Africa were to be cut off from CHIPS, the larg-
                               est of the dollar clearinghouse systems, it might choose to do its transac-
                               tions in other currencies. Even though this option may cost more
                               because currency conversions from dollars to other currencies would be
                               needed, there are a number of nondollar clearinghouse systems available
                               in other countries, including the United Kingdom, Japan, Switzerland,
                               and Germany.

                               It also appears that U.S. banks hold and handle South African dollar
                               accounts to clear dollars. U.S. banks expressed concern that if they were

                               Page 9                                         GAO,‘NSLU%9&1O9BB   soclcb Africa

                               not allowed to handle South African dollar accounts, they would be giv-
                               ing business to Europe.

Effects of Excluding   South   Because SWIFT is a privately owned foreign company and is considered
                               to be apolitical, the U.S. government might have difficulty in trying to
Africa From SWIFT              persuade it to stop doing business with South Africa.

                               Banks, rather than countries, are members of SWIFT. Seventeen South
                               African banks belong to SWIFT.If US. banks moved to expel South Afri-
                               can banks from SWIFT’, they would need the cooperation of banks from
                               other countries. Procedures exist to remove a member bank from SWIFT
                               for violation of its articles of association. Expelling a bank would
                               require a majority of shares voted to ratify such action if it were taken
                               by a majority of SWIFT’S24-member board. Two U.S. banks and one
                               South African bank are members of the board.

                               Even if the United States could exclude South African banks from SWIFT,
                               there are several alternatives to SWIFT that are only slightly slower and
                               more costly. Messages facilitating payments could be sent by using telex,
                               fax, and mail instead of using SWIFT.Telex and mail were the common
                               methods of facilitating payments before SWIR.

                               Even though it would be difficult to effectively exclude South African
                               banks from SWIFTand CHIPS, barring them from these systems might
                               have the symbolic effect of excluding South Africa from yet another
                               international system.

                               rescheduling, we interviewed and obtained documentation from repre-
 Methodology                   sentatives of the major banks involved in lending to South Africa in New
                               York, London, and Frankfurt, and from independent researchers and
                               other knowledgeable private sector sources. We obtained information on
                               international trade and payments systems from representatives of the
                               New York Clearing House Association, a member of the Society for
                               Worldwide Interbank Financial Telecommunication, S.C. (SWIFT). and a
                               member of the SWIM board of directors. In addition, the above sources
                               provided information on the potential impact of excluding South Xfrica
                               from international trade and payments systems.

                                Cur review was conducted between November 1989 and February 1990.
                                As agreed, we did not obtain agency comments on this report.

                                Page 10                                       GAO/NSIALW@109BR   South .Mrica

           Unless you announce its contents earlier, we plan no further distribution
           of this report until 30 days after its issue date. At that time, we will
           send copies to the Secretaries of State and Treasury, the Director of the
           Office of Management and Budget, congressional committees responsible
           for overseeing implementation of the act, and to other interested parties
           upon request.

           This report was prepared under the direction of Allan I. Mendelowitz,
           Director, International Trade and Finance Issues. He can be reached on
           (202) 275-4812 if you or your staff have any questions. Other GAOstaff
           members who made major contributions to this report were Steven
           Sternlieb, Project Director, Ivan Eland, Project Manager, and Alison
           Pascale, Staff Member.

           Frank C. Conahan
           Assistant Comptroller   General

(486012)   Page 11                                       GAO/NSIAD9@109BR   South Africa


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