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The Eurozone crisis is unresolved and the purpose of loans into the big Debtor nations was in large part to buy goods from big Creditor nations. Greece has, for example, purchased large amounts of arms from German and French companies, financed with loans from German and French banks.

How does that differ from the 1970s and 80s where export credit loans defaulted and all the loans had to be rescheduled via the Paris club?

The sole difference is that the existence of the euro inferred that sovereign risk loans in euro to eurozone member states carried a credit risk that made Export Credit Guarantees superfluous.

International banking in the 1970s and 80s was largely to do with recycling oil surpluses (Petrodollars) as export credits to LDCs. The supposed benefit for the LDCs was in the form of infrastructure projects that were to result in economic growth i.e. to create the wealth with which to continue to pay for oil imports.

The lenders of Eurodollars were major international banks like Citibank, Manufacturers Hanover Trust and Lloyds Bank International.

LDC governments were a questionable credit risk so Western governments encouraged lenders by backing the loans with Export Credit Guarantees or insurance policies. Most Western countries had their insurance scheme – Hermes in Germany, ECGD in the UK, NCM in the Netherlands, SACE in Italy.

Export Credit was the lifeblood of Lloyds Bank International. A typical LDC-borrower transaction was this one, upon which the writer was the deputy account executive while based in LBI Amsterdam:

BorrowerFederal Republic of Nigeria
AmountNLG189,000,000 split into:

  1. 15% downpayment financing with no repayment until six months after completion of the build = NLG28,350,000
  2. 85% paid out during the two-year build = NLG160,650,000
PurposeConstruction of dry docks in Lagos and Port Harcourt
TermTwo year build and 10 year repayment in equal semi-annual instalments
Risk
  1. downpayment financing and 5% of build financing – sovereign risk on Nigeria = NLG36,382,500
  2. 95% of build financing – Dutch government risk through insurance policy issued by NCM – Nederlandsche Credietverzekering Maatschappij = NLG152,617,500

 

The carrot for taking Nigerian risk was the earnings of 5/8% p.a. on Dutch government risk: a very generous return for real sovereign risk ~ an obligation of a government denominated in its own currency.

The only problem arises when the sovereign risk mantra is broken, that sovereigns always repay their debts.

In 1983 Mexico defaulted on its foreign currency debt, as did Nigeria, leading to an alteration of the mantra to the one we are still clinging to today: sovereigns always repay their debts in their own currency.

The second LBI deal is interesting because it was to a country, classified then as an LDC, that is now a Eurozone periphery country in bailout:

BorrowerGabinete da Area de Sines
GuarantorRepublic of Portugal
AmountUSD150,000,000 split into:

  1. 15% downpayment financing with no repayment until six months after completion of the build = USD22,500,000
  2. 85% paid out during the two-year build = USD127,500,000
PurposeConstruction of port facilities at Sines near Setubal, the contractor again being supported was Royal Dutch Harbourworks
TermThree year build and 10 year repayment in equal semi-annual instalments
Risk
  • downpayment financing and 5% of build financing – sovereign risk on Portugal = USD28,875,000
  • 95% of build financing – Dutch government risk through insurance policy issued by NCM = USD121,125,000

 

The carrot, again, was the earnings of 5/8% p.a. on Dutch government risk ~ but note that it is not real sovereign risk, although at that time the difference did not lead to a price adjustment: the insurance policy obligation of the Dutch government was denominated in USD and not in its own currency.

The loans were forced on the borrowers by Western governments, anxious to create employment in Western countries: 70% of the content of the contract should be manufactured in the country offering the Export Credit insurance.

How different is that from Portugal? It could raise almost unlimited funds in euro on international markets or from the European Investment Bank to pay for whatever projects were deemed by its government – or by the macro-economists in Brussels – to be mandatory for its development.

No credit risk was deemed to attach to loans in euro to the Portuguese public sector. Basel II assigned a 0% Credit Conversion Factor. The loans met the classic definition of sovereign risk: a loan to a government in its own currency.

The euro has been the lubricant to oil the wheels of this 1970s re-run, but we now have to add the third version of the mantra for sovereign risk:

  1. “sovereigns never default” (formula before Mexico et al defaulted on foreign currency debts in 1983)
  2. “sovereigns never default on obligations in their own currency” (formula after Mexico’s default)
  3.  “sovereigns never default on obligations in their own currency as long as it is a currency over which they have sovereign powers” (new formula to cover eurozone default)

It has been highly convenient for politicians in eurozone countries to overlook the difference between 2 and 3 above. The Bank Capital Adequacy and supervisory regimes overlooked the difference and allowed banks to over-extend themselves, without the bank’s home governments having to offer credit insurance/guarantees: because the currency of the loan was deemed to incorporate a guarantee.

The banking system is now constipated with these loans as it was with Export Credit loans in the 1980s. At that time governments were explicitly on the hook for 85% of the loans. They had to set up the Paris Club, and such inventions as Brady Bonds.

Now government guarantees are essentially embedded into the euro itself – an invention of governments. Time to face reality: rent some office space in Paris for Club II.

PDF of ‘Euro crisis is the Paris Club all over again’ – Cititrust EDGE magazine Q3 2012

Link to Cititrust Q3 2012 article online