| East-West Debt is an international company active in asset trading, debt recovery and debt collection of overdue claims on
high risk countries. The company has set up a network of specialists, with many years of overseas experience in the recovery of claims, especially in Africa, the Middle East, Eastern Europe, Latin America and South-east
Asia.
Iraq: no solution political crisis in sight
The weapons control function of the UN in Iraq (UNSCOM) has had to be abandoned, following America and Britain's bombardment of military targets. Iraq, whose refusal to co-operate fully any longer with UNSCOM triggered the attacks, now refuses to have any further dealings whatsoever with the UN inspectorate. Moreover Iraq has rejected a French proposal for a solution to the crisis. Meanwhile the UN approved oil-for-food programme continues. On 9th March the UN announced that the previous week's oil exports under the programme were the highest since the arrangement started in 1996, involving 18.6 million barrels of oil. However this was mainly caused by a shortfall in preceding weeks, due to allied bombing of the oil pipeline to Turkey. Indeed, the recent lifting of the ceiling on Iraqi oil sales is largely symbolic since Iraq can barely export USD 3 bn's worth of its USD 5.25 bn six-month entitlement.
Financial situation Iraq
According to rough estimation the claims of exporters, banks and insurance companies are about USD 85 bn. The damages to be paid to countries such as Kuwait and Iran and the costs for the rebuilding of Iraq are enormous: estimates are about USD 100 to 200 bn and more. Taking into account the present market value for oil, Iraq's maximum income from oil exports can only amount to USD12 to 15 bn, even after the UN sanctions are lifted. So interest payments on the national debt would consume nearly the whole national income of Iraq! It is clear that Iraq is in no position to pay its international debt now nor in the near
future.
Iranian delays of payment
In 1989 the Iranian Government lost control over imports while oil prices were descending. This produced large trade deficits, financed through short-term facilities, resulting in about USD 16 billion of letters of credit, maturing over 1993 and 1994. In 1994 Iran managed to reschedule the short-term debt over six years. In January this year rescheduling payments, which were guaranteed by Bank Markazi (the central bank), did not come through. Possibly the economic or political problems of Iran will delay payments, using further rescheduling to cover the old debt with the new.
Debt-equity swaps trigger U.S. tax scrutiny
Debt-equity swaps are a popular means of financing developing country projects. While the details of putting a successful debt-equity swap in place are tedious, the economic benefits usually outweigh the added work unless, of course, an unexpected consequence occurs in the transaction. On behalf of our clients involved in countertrade and developing country debt transactions, we have been closely monitoring a U.S. tax case, G.M. Trading vs. Commission of Internal Revenue (C.I.R.), in which the U.S. Internal Revenue Service (I.R.S.) took an unwarranted position on the U.S. taxation of debt-equity swaps, which, if sustained by U.S. courts, would have effectively shut down the use of debt-equity swaps by U.S. taxpayers.
What is a Debt-Equity Swap?
A debt-equity swap, sometimes referred to as debt conversion, is a multi-step process. Below is an outline of the type of transaction involved in G.M. Trading:
The Seller holds sovereign debt of Country X which it wishes to sell for hard currency, typically at a discount because the country is in default on its obligations.
The purchaser desires to purchase Country X debt at a discount, which it will "swap" with the Government of Country X. This transaction is attractive to the Seller because it receives "hard" currency for a debt instrument of questionable value.
Country X purchases the debt at face value or at a small discount, giving the buyer its own "soft" currency in exchange. Sometimes, as was the case of G.M. Trading, the currency the Buyer receives is subject to substantial restrictions.
The G.M. Trading Decision
In G.M. Trading, the I.R.S. took the position that G.M. Trading, a U.S. company, recognized taxable income on its receipt of Mexican pesos which were restricted by the Mexican government in significant ways. The restriction arose when G.M. trading swapped dollar denominated Mexican Government debt with the Government for the pesos. The I.R.S.' position disregarded the restrictions on the pesos. Thus, the I.R.S. argued that the taxpayer had taxable gain on the swap.
Although the U.S. Tax Court found in favor of the I.R.S., the U.S. Court of Appeals for the Fifth Circuit reversed the Tax Court decision, and found in favor of the taxpayer. Fortunately, the Court of Appeals found that the restrictions could not be disregarded when analyzing the U.S. tax consequences of the transaction.
The Mexican Currency Restrictions
The restrictions included the following:
The pesos could only be used for purposes of purchasing land and outfitting an industrial plant in Acuna, Mexico.
Only Mexican companies could provide goods and services to the construction of the plant.
The Mexican government controlled the pesos and paid them directly to the vendors.
The Fifth Circuit's decision in G.M. Trading is important not only for those U.S. companies involved in debt-equity swaps, but also for all involved with foreign currency transactions with developing countries. Developing country currencies often have restrictions on their use and conversion. The G.M. Trading decision now confirms that, for U.S. tax purposes, these restrictions must be taken into consideration.
Article by Terrence R. Williams of Nobles & Associates, attorneys at law, Atlanta, Georgia, USA.
Russian debt situation
The crash of the rouble last August blew away nearly all the gains the economy had been making since the collapse of the Soviet Union. Other factors have weighed against Russia too:
- The worst harvest in 45 years is likely to result in a shortage of bread,
- Oil, the main foreign exchange earner, has crumbled in price.
In early March the Deutsche Bank and Chase Manhattan broke ranks with a consortium of banks. The consortium was negociating with the Russian governement on repayment of USD 15 bn of defaulted short-term state bonds known as GKO's. Deutsche Bank and Chase Manhattan chose to accept a deal whereby they may well end up being paid as little as 2.5% of the face value of the bonds. This enraged other members of the 19-member group.
Unfortunately, Russia's debt extends far wider than the GKO market. The external debt amounts to some USD 150 bn and this year USD 17 bn of repayments will become due. The Russian government has requested restructuring of USD 90 bn of Soviet-era debt, including a two-year payments pause. This could reduce the repayments for this year to around USD 8 bn of which USD 5 bn are due to the IMF. Russia will need the support of the IMF, but will only obtain aid by putting forward a credible economic programme.
Contributions on subjects of interest to our readers are welcome. East-West Debt News is mailed to financial professionals within banks and multinationals all over the world.
Saudi Arabia: oil prices drive deficit up
The recent OPEC agreement to reduce oil output by no means ends Saudi Arabia's budgetary difficulties. The primary question is whether the OPEC agreement will stick. The world's oil markets are awash with all product varieties and many oil exporting countries cannot afford to reduce production. Saudi Arabia's budgetary deficit is expected to rise to USD 12.8 bn from the USD 4.6 bn estimated at the start of 1998, and its GDP is assessed as having fallen by 7% last year, leaving a budgetary deficit of around 10% of GDP. The Saudi government has so far taken a few steps to restore order to its finances. Meanwhile government departments have increased the time taken to meet their outstanding obligations.
Angola: UN peace keeper quits
For twenty long years Angola has been the victim of civil war, and with the departure of the United Nations special representative, Issa Diallo, there is less cause for optimism than ever before. The shooting down of two UN transport aircraft at the turn of the year was cause for the UN to withdraw all its 1,000 observers to the comparative safety of Luanda. Now Mr Diallo's premature departure indicates despair within the international community that an agreement will ever be brokered between President José dos Santos' MPLA government and the UNITA rebels led by Jonas Savimbi.
One difficulty confronting the peace keepers is that both sides have access to economic sources of support. The government derives its income from oil sales whereas the UNITA rebels, occupying large areas of countryside, have managed to dig diamonds from the bush. Angola's economy is so heavily oriented towards oil exports that the current collapse in world oil prices has presented the MPLA government with a substantial budgetary deficit. Savimbi, whose following is largely confined to rural areas, is hoping the resultant economic crisis will en-courage city dwellers to rise against the government. In particular a combination of eco-nomic mismanagement, corruption and the sharp decline in oil prices all put trading with Angola at extreme risk.
Angolan economy
Because the world market price for oil is even lower than before, a higher oil production hardly contributes to the expansion of the Angolan economy. Now the economic growth of Angola depends on the proceeds of diamond. Foreign investments have been made, especially in the energy sector, but this did not push up the economic level of Angola. The government continues spending most of the money on defence. Many exporters are still holding uninsured trade debts, due to the fact that Banco Nacional de Angola is defaulting on letters of credit.
Indonesia debt crisis: bank reform delayed
Despite USD 40 bn borrowings from the IMF, the World Bank and the Asian Development Bank, the latest indications in Jakarta are that the promised restructuring of the banking sector is being postponed. Bank reforms have been overdue for more than a year, leaving more than 150 insolvent banks unable to lend. Indonesia's central bank directors had already gone back on pledges made in mid February of this year, proposing nationalisation instead of recapitalisation or closure. In addition banks on the shortlist for closure are known to have been reduced from 40 to 17.
Indonesian economic journals have accused the government of permitting banks with links to well-connected families to tinker with the results of international audits so that they may become eligible for the USD 30 bn recapitalisation programme. PT Bank Nusa Nasional, owned by the influential Bakrie Group, was one forecast by analysts as facing closure but it announced last week that it had raised sufficient capital to join the restructuring scheme. By curious coincidence Aburizal Bakrie, who controls the bank, happens to be a member of the advisory council which ordered the delay! Staff at the Indonesia Bank Restructuring Agency, set up jointly by the World Bank and the Asian Development Bank, are said to be depressed at the lack of progress. "The delay was a political decision and it took us all by surprise," commented one IBRA adviser.
China: foreign banks get tough
Sentiment among foreign banks lending to Chinese commerce and industry is deteriorating. Indications are that they are now calling in loans and demanding accelerated debt repayments, following the surprise collapse of Guandong province's primary financial arm, the Guandong International Trust and Investment Corporation (GITIC).
GITIC, once an active borrower on the global debt market, was declared bankrupt last October. GITIC's collapse has left foreign banks stunned. They had previously assumed that Beijing would guarantee the repayment of all foreign registered debt. Some financial institutions are resorting to the courts to reclaim their loans. High Court writs in Hong Kong show Ka Wah Finance is seeking to recover more than USD 33 million from another mainland local government backed investment agency, the Zhanjiang International Trust and Investment Corporation, in addition to a further USD 9.5 million from Nanhai Zhong Nan Power Machinery in Guangdong Province.
Prime Minister Zhu Rongji has been trying to restore confidence in the market by warning foreign creditors not to push Chinese enterprises into bankruptcy.
The consequences of another major default on mainland China would have far reaching consequences for the entire region. Hong Kong's economy and capital markets could be seriously destabilised, being heavily reliant upon China's continued stability, and it would herald another set back for the former Tiger economies of SE Asia.
The continuing lack of foreign confidence in China's economy could result in a devaluation of the currency, the yuan, to support Chinese exports. Despite Prime Minister Zhu's denial that devaluation was a current option, some foreign analysts believe it could provide a neat solution for the government. Chinese exports have been looking expensive since the Tiger countries devalued their currencies last year.
While there is no immediate need for alarm, China needs to be monitored continuously, and international creditors of China should check their outstanding positions.
Global review
Several economies in South East Asia have come under strain, Russia had an effective bankruptcy and Brazil's currency, the real, has suffered a substantial devaluation. The worst is over in SE Asia and Russia will probably squeeze a further loan out of the IMF. Brazil's economy was just going through a periodic downturn, and now ought to be on the way back up again.
Appearances deceive, regrettably enough. It is true that none of the former Asian Tiger countries have been utterly destroyed by currency devaluations, but just take a look at Indonesia, as one small example. Weakened from within by devaluation of the rupiah, the Indonesian government is struggling to keep control over its diverse possessions of land. The spectre of Indonesia falling apart is very real. And if that is true of Indonesia, what of Malaysia? The Asian Tiger economies will surely pull themselves together again in the shortest possible time. Even so, that is not of much help to an exporter in the West, waiting for payment on orders already delivered. For even the most optimistic entrepreneur it pays to proceed with caution.
East-West Debt has made every effort to ensure the accuracy of this publication.
Neither the company nor any contributor can accept any responsibility for -including but not limited to- errors, omissions, opinions or advice given. This publication is not a substitute for professional advice and all information is for guidance only.
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