Serious debt distress in developing countries

Neoliberalism stands exposed

‘External public debt risks in developing countries are on the rise and have been for several years. Higher debt stocks, debt service and assessed risks by international institutions have led to intensified calls to strengthen debt restructuring initiatives. …while debt stocks remain relatively low, current costs of funding make debt service hard to sustain, with an expected peak in 2024-25. …In 2022-26, we estimate that financing needs could represent USD2.5 trillion across all emerging and 4 developing countries, including USD300 billion for countries eligible to the IMF Poverty Reduction and Growth Trust (PRGT), and USD340 billion for Sub-Saharan countries. Those are large sums, which could trigger major debt crises. It is therefore essential to reduce the cost of debt and enhance the resilience to shocks.’ – Excerpt from a November 2022 ‘Finance for development lab’ published working paper ‘The coming debt crisis: monitoring liquid and solvency risk’

What the covid-19 pandemic and the climate change crisis have exposed is that years of Neoliberalism, whereby investment significantly followed market signals of maximizing profits, rather than in making resilient economies, where meaningful investments went into strengthening for instance, public health- and education sectors, and in moving towards a green, inclusive, sustainable economies.

At the same time, another offshoot of the same neoliberal assault meant less regulation, and downsizing of the public sector and public investments, mainly under the prescription that governments should primarily facilitate the private sector, and allow underlying finance, and international capital movements largely free of government interference.

That, in time, weakened the public sector’s capacity to deal with shocks as and when they arise, and even more importantly to predict them better, so that public policy should be more proactive, which on the contrary continued to become more reactive, while outsourcing of what otherwise should have been done by governments, meant that the private sector made contracts under public-private partnerships that were not always in the best interest of public, and at the same time also did not allow a balanced overall economy, which was diverse, and properly concentrated on developing sectors that, although they did not give quick profits, were nonetheless important.

To give an example, while the SARS (severe acute respiratory syndrome)– a form of coronavirus– hit in the early 2000s, and the virus continued to resurface as epidemics– like the MERS (Middle East respiratory syndrome) version a number of years later– there was little attention of the pharmaceutical industry to move towards reaching an effective vaccine, while investments continued to pour into quick profit-making endeavours like body creams. Hence, it was not until the coronavirus hit as a pandemic that panic set in, and resources set to flow towards making a vaccine. The same appears to be the situation of ‘bird flu’ which is continuing to appear as a potential source for another pandemic, yet there is much less attention on preparing the public health sector and vaccine, for instance. That needs to change quickly.

In terms of accumulation of debt in a significant way over the years, in particular of the developing countries, where the assault of Neoliberalism, both through public policy, but also through programme conditionalities and policy prescription of the IMF meant that public investments could not build a resilient, diversified economy that brought sustainable and significant growth in both domestic production– and in turn sustainably create economic growth momentum, especially that involved a larger segment of the economy, resulting in accentuating inequality– on one hand, hurting tax collection efforts as well on the other, while on the other, exports growth in general, and value-adding exports growth in particular, overall meant that developing countries invariably ran into greater deficit financing needs for both the fiscal- and current account.

Another source of debt built-up was overboard monetary tightening for tackling inflation, wrongly perceiving it in developing countries as primarily an aggregate demand side issue, where in fact, aggregate supply and lack of governance consequences together at least played an equally important, if not greater, role.

High policy rates were also kept as a wrong policy choice, to otherwise lure very volatile ‘hot money’, or foreign portfolio investment. Hence, high policy rate while they continued to cause domestic debt distress, and also hurt domestic production, exports, and tax collection, not to mention lack of public investments, also reduced economic space for greater foreign direct investment (FDI).

A lack of multilateral spirit is also not helping, whereby on one hand, easy available, long-term finance is not being made available for countries to deal with their debt distress and at the same time, avoid adopting austerity policies in an age of ‘Pandemicene’, and of the existential threat of fast-unfolding climate change crisis, requiring deep spending into the public health sector, and in creating green transformation of the economy, in addition to making welfare spending to undo the sharp consequences of a recession-causing pandemic in terms of safeguarding against poverty and inequality, both of which have seen a significant increase during the pandemic.

Hence, overboard monetary tightening under the neoliberal assault of seeing inflation as primarily a monetary phenomenon, and also lack of capital controls, or the role of the public sector in creating diversified and deep space for FDI. Hence, current account and fiscal deficits over the years, added not only significantly to the debt buildup of developing countries, but lack of resilient, inclusive and sustainable economies, with weak public sectors, meant having high vulnerability when shocks like the pandemic hit, and as the climate change crisis continues to quickly unfold.

At the same time, while the debt composition of developing countries significantly transformed from primarily consisting of Paris Club countries and multilaterals, to being debt needs heavily funded by China and a number of private sector creditors, the debt restructuring framework, on the contrary, continues to lack properly including China and private creditors. Highlighting this concern, a February 2022 editorial of The Financial Times, titled ‘The Covid aftermath requires sovereign debt restructuring’ pointed out in this regard ‘Unlike in the past, when most were countries grouped in the Paris Club, or a few large international banks forming the London Club, there is now a plethora of private and official lenders. …What is needed is a modern equivalent of the Paris Club and the London Club: a framework where all creditors can get together and share the pain. … Sovereign debt overhangs can weigh on growth for years and even decades. The only way to end them is for all creditors to accept comparable treatment. As the Covid-19 aftermath throws countries into default, they must find ways to do exactly that.’

Moreover, a January 17 FT published article ‘We must tackle the looming global debt crisis before it’s too late’ by Martin Wolf, highlighted the urgency of dealing with the significant debt distress that many developing countries find themselves in. He pointed out in this regard ‘The shocks of the past three years have hit low and lower-middle income developing countries hard. … According to Kristalina Georgieva, managing director of the IMF, “about 15 percent of low-income countries are already in debt distress and an additional 45 percent are at high risk of debt distress. Among emerging markets, about 25 percent are at high risk and facing default-like borrowing spreads.” Sri Lanka, Ghana and Zambia are already in default. Many more will follow. Something must be done urgently.’

At the same time, the article highlighted a lack of effective debt restructuring framework as ‘There exists no effective framework for bringing all these creditors together. Nor is there any credible template for restructuring that debt. The G20 created the “Common Framework for Debt Treatment”, to deal with the former difficulty. But it is in practice a Paris Club-led process. The other (and frequently much bigger) creditors are not really engaged. According to the IMF itself, the framework does not have traction. Equally, there is no approach to debt restructuring that is at all likely to deliver what is needed – a new start for heavily indebted crisis-hit countries.’

A lack of multilateral spirit is also not helping, whereby on one hand, easy available, long-term finance is not being made available for countries to deal with their debt distress and at the same time, avoid adopting austerity policies in an age of ‘Pandemicene’, and of the existential threat of fast-unfolding climate change crisis, requiring deep spending into the public health sector, and in creating green transformation of the economy, in addition to making welfare spending to undo the sharp consequences of a recession-causing pandemic in terms of safeguarding against poverty and inequality, both of which have seen a significant increase during the pandemic.

Dr Omer Javed
Dr Omer Javed
The writer holds PhD in Economics degree from the University of Barcelona, and previously worked at International Monetary Fund.Prior to this, he did MSc. in Economics from the University of York (United Kingdom), and worked at the Ministry of Economic Affairs & Statistics (Pakistan), among other places. He is author of Springer published book (2016) ‘The economic impact of International Monetary Fund programmes: institutional quality, macroeconomic stabilization and economic growth’.He tweets @omerjaved7

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