Defiant Debtor

The inaugural address delivered last week by Alan Garcia Perez, Peru's new President, was more than an impassioned speech to his people. It was a blunt message to the foreign banks and governments that have loaned Peru money. Determined and defiant, Garcia vowed to renegotiate Peru's $13.7 billion debt during the next twelve months, and said that while doing so he would devote no more than 10% of his country's export earnings to making interest payments.

Since Peru's exports may bring in only $3 billion this year, 10% of that total would cover less than one-third of the $ 1.1 billion in interest that the country owes for 1985. But at a time of extreme economic hardship and social unrest in Peru, Garcia declared, the demands of foreign creditors would have to come second to the needs of his countrymen. Said he: "Let the peoples of the world hear me. President Alan Garcia knows that Peru has a great and first creditor: its own people."

Garcia's action will cause no immediate distress for creditors. Peru's debt is relatively small, and the country is already far behind on its payments. Indeed, the U.S. Government last week suspended new aid to Peru because of a law requiring a cutoff of funds to countries that are more than a year in arrears. But his policy might set a dangerous precedent: if such debtors as Mexico, Brazil and Argentina, which together owe more than $200 billion, were to limit payments to a fraction of export earnings, many large U.S. banks might face a squeeze on profits.

Peru's gambit comes at a time when talk of default is in the air. As Garcia took office, 1,200 delegates from Latin America and the Caribbean gathered in Havana for a debt conference, and Fidel Castro urged his guests to repudiate their obligations. Bankers remain confident, however, that the Latin American countries will not default. Such a drastic strategy would cut them off from international credit, which for some is the only means of paying for vital imports like food and fuel.

Garcia had no choice politically but to resist foreign creditors. Peru's fragile democratic government, only five years old, must contend with a rebel guerrilla insurgency as well as an economy in crisis. Inflation runs at 250%, and about two-thirds of the labor force is either unemployed or working part time. Worst of all, Garcia alleges, wealthy Peruvians have been frantically buying U.S. dollars and putting money into bank accounts abroad. To stop this capital flight, Garcia shut down Peru's banks after he became President. When he allowed them to reopen two days later, accounts containing U.S. dollars were frozen. In addition, he devalued the sol, the local currency, by 12% to stimulate exports and slashed interest rates to spur economic activity.

Bankers are counting on Garcia to turn Peru's financial situation around. In the meantime, the creditors will have to hope that other Latin American debtors do not demand the same easy terms.