Country's policies potentially affect a country’s vulnerability to debt-serving problems, particularly if the external economic environment becomes unfavorable.
According to Cuddington( 1989, pp32), the policies would effected include external borrowing strategy, exchange rate management, trade orientation and aggregate demand policies. This essay would explain two key policies.
Foreign borrowing policy
When considering the foreign borrowing policy, two questions need to be addressed:
Did the developed countries borrowed too much and Were the borrowed funds used efficiently?
1) Did the developed countries borrowed too much?
Statistical evidence showed that at the year of 1983,$315 billion borrowed by Latin America, or 50% of its GDP. So obviously the borrowed amount is over its payback ability.
2) Were the borrowed funds used efficiently?
Ostensibly, the funds were intended to help to finance productive development projects,such as factory and manufacturing line. Some of the funds did go for such purpose such as Brazil, which achieved significant advances in its industrial infrastructure during the 1970s. But for the most parts, the loans financed less respectable activities. The Latin American borrowing was wasteful or unjustified in that it primarily financed projects such as consumptions of high living by the elites, government deficits and capital flight. Between 1976-81, total amount borrowed that estimated by all Latin countries amounted to $272.9 billion, 91.6 percent went for capital flight, debt servicing, and building up dollar reserves. Only 8.4 percent was used for domestic investment, and of that, much was squandered. In Africa, the magnitude of borrowing was only a small fraction of that in Latin America, furhtermore as George writes, the extent of waste and corruption was even proportionally higher.
According to George (1988, pp16), at that time, the spirit of unabashed consumerism drove people with loan money to purchase Western consumer goods to show the modernization. In Chile, loans have been spent almost entirely on current consumption. How would this happened? Chile positively encourage imports during 1979-82, by " allowing people to exchange their pesos freely against dollars and by keeping the peso unrealistically overvalued". Chile inflated their currency and pegged local salaries to the inflation rate. Consequently, with more pesos on hands and fixed exchange rate to dollar, import goods became cheaper. Also, with comparatively higher price for exports, Chilean firms couldn't export products and even couldn't sell in their own country because the import products were more attractable. As a result, trade deficits and unemployment soared. To finance trade deficits, Chile government needed to keep borrowing and end up with highest per capita debts in all Latin American countries. $11 million of its $19 billion debts can be ascribed to this consumption policy.