In US spending bill, Israel could win over $1 billion in debt relief. US explores Mideast parley

In one of those thick documents that President Reagan plumped on the table during his State of the Union address last week there is a provision that could save Israel more than a billion dollars on debts owed to the United States. It would potentially allow Israel to reduce interest costs on about $5.5 billion owed for arms purchases. Eventually the provision could cost the US Treasury hundreds of millions of dollars a year.

In theory, the provision makes the same opportunity available to other nations that borrowed from the US under the Foreign Military Sales program. Egypt has eligible FMS debts of about $5 billion and Turkey, more than $500 million. Altogether, 39 nations owe debts under the program.

One expert on Capitol Hill, however, believes that among the larger FMS debtors, only Israel has a good enough credit rating to use the provision. Israel is the biggest FMS debtor.

Treasury officials disapprove of the provision, regarding it as both a costly and inappropriate way of providing extra financial assistance to Israel or the other nations.

The measure was inserted in the fiscal 1988 ``continuing resolution'' by Sens. Daniel Inouye (D) of Hawaii and Bob Kasten Jr. (R) of Wisconsin.

In a Nov. 30 letter to the two senators, Treasury Secretary James Baker III termed the plan a ``backdoor'' mechanism. The ``most honest way'' would have been an authorization and appropriation of money, one Treasury official said. But Congress ignored most of the department's objections.

A congressional staff member who supports the measure denied that the provision was ``sneaked'' into the continuing resolution, as some critics allege. A similar charge was made over a separate $8 million appropriation for a religious school for North African Jews in France. Senator Inouye yesterday said he had ``made an error in judgment'' and would ask Congress to rescind the appropriation he had won for construction of the school.

The debt provision, the aide noted, had been approved by a Senate Appropriations subcommittee and full committee in open sessions, and on the Senate floor.

``It is not our fault that reporters didn't read it or come to those meetings,'' he said.

Other congressional sources noted that there was no substantive discussion on the Senate floor of the debt provision, and that it was amended substantially both there and in the House-Senate conference committee that approved the continuing resolution.

Loans have `become a burden'

Gal Almog, an assistant economic minister in the Israeli Embassy in Washington, denied there was insufficient debate. ``This is a provision Israel has tried to get passed for three years,'' he said. He spoke of ``intensive debate'' before a House subcommittee last year.

Many FMS debts were acquired at 10 to 15 percent interest rates during the late 1970s and early '80s. Israel and the other nations used the money to buy arms, primarily in the US.

``It was in our security interest to do this,'' a congressional aide said. ``But these loans had become a burden.''

This problem has been discussed by Congress and the Reagan administration for about three years. Last year the administration made a ``military debt reform'' proposal that would have allowed early prepayment of some debts without penalty. This would have required the debtor nations to raise the money to do so on the private money markets - if they could do so at rates low enough to make this profitable.

The proposal would also have allowed a nation to ``recapitalize'' some of the debts. In other words, they would have postponed some interest payments, resulting in much larger ``balloon'' payments later. Many loans still have 25 years to go.

Hearings on this administration plan were held in the appropriate House subcommittee, but not acted on.

From the debtors' standpoint, the Inouye-Kasten provision substantially improves on the administration's plan. It allows the debtors to prepay at par ($100 on $100 of principal owed) any principal coming due after Sept. 30, 1989, on loans with interest rates of 10 percent or higher. Further, the US Treasury would guarantee 90 percent of the amount refinanced in the private market.

This guarantee could be extremely valuable to some debtor nations, because it would make refinancing debt issues more attractive to investors. The US guarantee should enable them to get loans at a rate not much above that paid by the Treasury on long-term debt issues. At present a 30-year Treasury bond yields about 8.7 percent.

Israel, it is guessed, might have to pay 1.5 percentage points more than that. If the market determines the other nations are less creditworthy, they might have to pay somewhat more and save less.

The total debt under the foreign military sales program is about $19 billion, of which $14.4 billion has interest charges of 10 percent or more and thus could qualify for the program. The average interest rate for the $14.4 billion is just under 12 percent.

Heavy cost to the US

A recent Treasury estimate puts the cost to the US government at $3.4 billion, which is the ``net present value'' should the debtor countries refinance all $14.4 billion. Present value is a way of calculating the value now of a sum arising in the future. That calculation is necessary because the debt repayments will be made over the next 25 or so years.

A Congressional Budget Office study, using the same technique, puts the Treasury loss at $1.5 billion. It assumes that only Israel, and probably Spain and Greece, would have a sufficiently high credit rating to borrow on the private money markets. Israel would account for nearly all the loss in this calculation.

Another way to look at the US loss is to note that FMS debt is worth more than its face value. This is because of the debt's relatively high interest rates. For example, a 12 percent Treasury bond with a face value of $100 maturing in the year 2004 was worth about $132 last week in public trading.

In his letter to Senators Kasten and Inouye, Secretary Baker complained: ``We oppose such refinancing because of the costs to the taxpayer, continued exposure of the American taxpayer to the borrower's defaulting, and the guarantee being called, as well as the less easily defined costs that result from government-guaranteed loans competing in the private markets with the Treasury's financing of the national debt.''

Baker was also concerned about the possibility that the refinancing provision would present ``an open invitation to all other guaranteed borrowers to descend upon Congress to demand equal treatment.''

The Inouye-Kasten provision, however, had the backing of Israel and the American Israel Public Affairs Committee, which is famed for its ability to win favors in Congress.

From Israel's standpoint, the provision is a way around a $3 billion ceiling on official annual aid that is unlikely to be raised. Israel in fiscal 1988 (as in recent years) has received a $1.2 billion grant in ``economic support funds'' and $1.8 billion in military sales money. Israel then spends $1.2 billion to cover the service charges on its total debt.

Although no one can calculate an exact amount of savings until the refinancing is accomplished, if Israel can reduce its interest charges by hundreds of millions of dollars, it will have that money free for other purposes.

In 1984, Congress appended to a similar spending bill a resolution attempting to guarantee Israel sufficient aid to pay off its US debts. But there was some debate as to whether that pledge could bind Congress in the future.

Whatever, the Inouye-Kasten provision offers Israel and perhaps other nations a new break.

``If our interests converge, there is nothing wrong with that,'' an Egyptian Embassy official noted. Egypt is considering whether it can use the provision to refinance some of its FMS debts. The question is whether Egypt's credit rating is strong enough to allow it borrow on the open market at competitive rates.

Another provision in this year's continuing resolution provides $270 million in fiscal 1989 to reduce interest charges on FMS debts - should the President make a budget request. This was, as one source noted, a way to help those countries with poorer credit ratings which may not be able to use the repayment provision.

Giving up interest later for cash now

A curious feature of the prepayment provision is that it could at first add to government revenues and presumably reduce the federal deficit. If, say, Israel refinanced $5 billion, the Treasury would receive that money up front.

But later the cash flow to the government would be reduced. That cash-flow reduction would far exceed the $5 billion over the life of the loans because it would include interest as well as principal.

The Treasury Department has 90 days, from the passage of the continuing resolution just before Christmas, to come out with regulations regarding the use of the refinancing provisions.

In the meantime, Rep. Lee Hamilton (D) of Indiana, chairman of the House Foreign Affairs Europe and Middle East Subcommittee, has sent a query to the Congressional Budget Office seeking information on the financial implications of the provision.

Similarly, David Obey (D) of Wisconsin, chairman of the Foreign Operations Subcommittee of the House Appropriations Committee, has asked the administration for an explanation of the meaning, cost, and eligibility of the new FMS provisions.

David Sadd, executive director of the National Association of Arab Americans, comments: ``You can't tell the Israelis that we believe they should not be using live ammunition and expect them to pay attention to us if we are giving them more money. This undermines the Israelis who say they shouldn't be acting in that way.''