Rising global debt & developing countries

Global debt has been continuing to rise and the World Bank (WB) has reported that the debt of developing countries is at crisis levels. According to the Institute of International Finance (IIF) global debt has already hit a record US$307 trillion in 2023. This debt includes borrowing by governments, businesses and households and it is now at dangerously high levels. And it is equivalent to almost US$40,000 for every single person on the planet.

According to the International Monetary Fund's (IMF) Global Data Base, global debt went up from US$226 trillion in 2020 to US$303 trillion in 2021. This was the biggest one-year debt surge since the second world war. With the rising global debt levels, the global debt to GDP ratio has also jumped to 336 per cent. The enormity of the debt crisis is also being recognised by the major US corporate media outlet the New York Times (NYT) which in an article headlined "Debt Problem is Enormous, and the System for Fixing It is Broken" (December 16, 2023).

Before the pandemic, global debt- to- GDP ratios had risen for decades. Now it not only reached a new record level. Multiple crises in recent years have worsened the global debt problem. IMF Chief Economist Pierre-Olivier Gourinchas warned that the in the current economic situation the biggest challenge is to tackle elevated fiscal risks.  He also said that "Most countries came out of the pandemic and energy crisis with higher public debt levels and borrowing costs".

In fact, the world is awash in public debt, led by the US, Japan and China. These countries together account for about half of the total global public debt. More than 80 per cent of the 2023 debt build up has come from developed countries with the US, Japan, the UK, France and France along with China India and Brazil registering the largest increases.

The policy of very low interest rates, often reaching 0 per cent or even negative practised by central banks in industrialised countries encouraged the financing of public spending using debt and that led to a sharp rise in not only public but also private debt in both developed and developing countries. This has also reduced the cost of refinancing for developing countries. Governments in developing countries were lulled into a great sense of security by this very low-cost financing of public spending.

But developed countries have many options to dealing with their indebtedness but that is not the case with developing countries. Debt in developing, especially in low income developing countries also rose substantially over the last two decades.  A combination of the pandemic, rising interest rates in developed countries and the Russia-Ukraine conflict have now triggered a new debt crisis for most developing countries. More than half of low-income developing countries are now in high risk of debt distress. The number of low-income developing countries in risk of debt default is rapidly increasing.

It can be argued that the debt distress is one symptom of development crisis. Debt distress leads a country unable to fulfil its financial obligations such as repayments due on loans. Both the IMF and the WB estimate 60 per cent of low-income countries are at or near this situation. Many of these countries have either had, or are in the process of starting debt restructuring.

The WB in a report on the debts of developing countries published in December 2023 revealed that all developing countries dished out US$443.5 billion to pay for their public debt in 2022. 75 low-income countries have an external debt burden of US$1,100 billion which is more than twice (134 per cent) that of in 2012. These countries paid US$88.9 billion to their creditors in the same year.

The resurgence of inflation has caused major central banks to increase interest rates which have intensified debt vulnerabilities in all developing countries. Rising interest rates in the US strengthened the value of the dollar compared to developing countries' currencies as investors' demand for the US dollar grew as the dollar is viewed as a safe asset. Such an appreciation of the dollar has made it costlier for developing countries to meet their debt obligations.

To further add to the deteriorating debt situation of developing countries, the Russia-Ukraine conflict which started in February 2022 led to an increase in global commodity and food prices. This is a major concern now for global poverty and food insecurity. Household consumption and poverty are most affected by higher food and fuel prices. Many developing countries in order to respond to rising food and fuel prices and to boost growth have resorted to increased fiscal deficits pushing up public debt levels. Developing countries are now faced with how to deal with their elevated fiscal risks. If countries default on their debts, that can cause panic in financial markets and lead to economic slowdown.

The IMF warns "As higher rates and higher debt levels push government interest expenses higher, domestic debt strain are set to increase". Consequences are clear, most developing countries will have to cut their expenditures on health, education and social protection.

The rising debt levels of developing countries is also symptomatic of their development crisis where most of these countries cannot mobilise sufficient financial resources to support their development efforts. To fill in the gap, the WB and the IMF extended their loans to these countries to support economic development. While in most cases loans are obtained for development purposes, in some cases these loans are used for projects that do not meet the minimum standards of economic, social or ecological viability.

The WB and the IMF are controlled by the US and operate on a consensus basis popularly known as the Washington Consensus. This Consensus is a set of free market policy prescriptions. The Washington Consensus emphasises structural reforms in the areas of product, labour and financial markets as well as the legal system that substantially increase the role of market to be eligible for financial help from the two institutions. Some examples include free-floating exchange rates, free trade, market determined interest rates, privatising state-owned business enterprises and many others. Closely linked to these two institutions, a global network of financial institutions also plays a pivotal role in providing loans to developing countries.

It is generally suggested that that the Washington Consensus based policies were unhelpful and imposed harsh condition on developing countries to access loans from these two institutions. The free-market agenda can create a volatile economic environment as was seen during the Global Financial Crisis (GFC) of 2007-08.The Asian Financial Crisis of 1997-98 was rooted in economic growth policies that encouraged investment but also created high levels of debt (and risk) to finance it.

Most sovereign debt crises are preceded by periods of high budget deficits, already built-up debt, and some are triggered by higher real interest rates. The way out of the crisis is usually to ask the IMF and the WB or other multilateral regional development banks such the Asian Development Bank (ADB) for debt relief or debt restructuring.

The IMF and the WB require economic restructuring (Structural Adjustment Programme or SAPS) before a country can qualify for debt relief as was the case with Ghana and Sri Lanka in 2022 when they defaulted on their external debt. While in the long run (as Keynes said, we are all dead in the long run) they may help a country to become more competitive in the global market, but in the short run that can cause business failures, rising unemployment, lower wages and less investment by government in education, healthcare and other social protection programmes leading to increased levels of poverty.

Now almost close to 80 years later, multilateral development finance is at a critical juncture. Low-income developing countries pay a high price to service debt, and the cost is particularly borne by the people living in poverty. At the international level, it is the creditors alone who decide what conditions are required for a country to pay its debt. Taxes are collected in the domestic currency, but the loan repayment is in the dollar. As such the depreciation of the local currency not only elevates loan repayment in terms of local currency but also makes it unpredictable.

The NYT in its article mentioned above summed up the situation and said, "the global financial architecture is outdated, dysfunctional and unjust". In fact, these multilateral lending institutions have become the part of the problem. Now is the time for genuine reform of the multilateral development finance system to help develop a new and innovative financial architecture where developing countries will also play an equal role in setting well established development safeguards and governance.

[email protected]