As governments converge on Washington for the International Monetary Fund (IMF)-World Bank Spring Meeting (April 10-16), they are confronted with the daunting prospect that 2023 might be the year that the world will be hit by a developing country debt crisis much like the one that took place in the early 1980s, which led to the infamous lost decade in Latin America and Africa.
A number of defaults on debt repayments over the last three years have served as the alarm bells for a possibly even bigger implosion. Carrying a debt load of $324 billion that came to 90 percent of its gross domestic product, Argentina defaulted on a scheduled payment in May 2020. Zambia followed suit in November 2020, missing a $42.5 million payment on a Eurobond loan. It was followed by defaults by Sri Lanka, Suriname, and Lebanon. it was Sri Lanka’s default in April 2022 that drew the attention of the world to the potential explosiveness of the emerging debt crisis in the global South, perhaps owing to the downfall of a political dynasty, the Rajapaksa family, amidst blackouts, long queues for food and other basic commodities, and massive street protests.
Perilous Parallel: Reckless Lending, Followed by Tight Money
A striking similarity is how in both the 1970s and the last few years, a period of easy money or reckless lending was followed by the reign of tight money as the U.S. Federal Reserve sought to combat inflation by raising interest rates, leading to the formal or informal default of countries ensnared with insupportably greater debt repayments.
Owing to the recession provoked by the 2008 global financial crisis, the Federal Reserve brought the prime rate down to zero in order to revive the U.S. economy by encouraging firms to borrow and invest. Seeking better opportunities elsewhere, the big Western banks tried to attract sovereign borrowers or governments with low interest rates. Also seeking to make a profit were private investors who bought developing country bonds, whose yields were higher than U.S. Treasury bonds, though they carried a higher risk. As one report put it, “While the number of bond issuances slumped owing to market volatility at the peak of the global financial crisis in 2008, starting in 2010, as risk appetite improved and global interest rates further declined, international investors, inclined to diversify their asset portfolio, resumed their search for yield in a low-interest rate environment and sovereigns took advantage of low global interest rates to finance themselves in international markets. As a result, bond issuances picked up considerably.”
In other words, discouraged by stagnation in the United States and recession in Europe, reckless lenders trekked to the global South. And though their debt-to-GDP ratios remained quite high, developing country governments succumbed to the seemingly attractive terms because they had the illusion that continued economic growth would generate the financial resources to service the debt.
A New Debt Crisis Gains Momentum
That illusion came apart with the coming of COVID-19 in 2020, when world trade went into a downspin, health systems collapsed and demanded massive government rescues, food crises broke out, and economic growth came to a screeching halt. With their financial resources dwindling even as their payments on interest to their creditors continued, developing countries were in a tight fix. By 2021, a new developing country debt crisis was gaining momentum. It was accelerated by the sharp rise in oil and food prices triggered by the war in Ukraine in 2022.
The response of the multilateral system was the so-called Debt Service Suspension Initiative (DSSI), which suspended debt servicing for participating countries from May 2020 to December 2021. Forty-eight out of 73 eligible countries participated in the initiative before it expired. According to the World Bank, the initiative suspended $12.9 billion in debt-service payments owed by participating countries to their creditors. However, only one private creditor participated.
Along with the DSSI, the G20, the IMF, and the World Bank drew up the so-called “Common Framework” that was supposed to provide a blueprint for future debt relief. However, the Common Framework was a dud. Only four countries—Zambia, Chad, Ethiopia, and Ghana—have agreed to participate, and only Chad was able to complete the process.
Three factors were identified as making it a non-starter. First was what one analyst described as “a grinding process, involving creditor committees, the International Monetary Fund, and the World Bank, all of which must negotiate and agree upon how to restructure loans that the countries owe.” The second was the reluctance or unwillingness of private banks and bondholders to participate. The third was that eligible countries simply could not face the political consequences of imposing more IMF austerity measures on populations already suffering from the consequences of COVID-19.
Fighting Inflation in the North, Bankrupting the South
It was in these already painful circumstances that the U.S. Federal Reserve and other Western central banks began an aggressive campaign to raise interest rates in 2022 in order to contain inflation in their economies, strengthening the dollar and resulting in a flight of Western capital back to the developed countries. In June 2022 alone, $4 billion flowed out of emerging-markets bonds and stocks. With the interest rate hikes, the number of emerging markets with bonds trading at “distressed levels”—that is, with yields more than 10 percentage points above that of similar-maturity Treasury bills—more than doubled in just six months. Developing country-issued bonds collapsed in value, leading investors to dump them at a loss, with deep discounts ranging from 40 to 60 cents on the dollar.
Drastic action was called for, since it was clear that there was no way the massive debt payments coming due could be met, as even a brief survey of some of the most indebted countries quickly showed. Egypt had some $7 billion due in debt service payments between November 2022 and February 2023. Pakistan owed at least $41 billion from mid-2022 to mid-2023. With trade declining owing to the continuing economic impact of COVID-19 and thus fewer dollars coming in, 25 developing countries saw their external debt payments come to more than 20 percent of their total government revenues.
The West Engages in a Blame Game
Despite advance warnings, there is no plan in place to avert the impending implosion. The so-called Common Framework devised by the G-20, the World Bank, and the IMF is grossly inadequate. Instead, the Western financial powers have indulged in a blame game, that is, identifying China’s lending practices as the problem.
This charge has little basis since the record shows that China has, in fact, been quite generous in forgiving the debt of poor countries, especially in Africa. A brief fact-check shows that the Chinese claims are neither bogus nor exaggerated. The record shows that China wrote off $72 million owed by Cameroon in 2019, $72 million owed by Botswana and $10.6 million owed by Lesotho in 2018, and $160 million owed by Sudan in 2017. The Rhodium research group found 40 instances of renegotiations of debts to China amounting to $50 billion across 24 countries since 2000. In his 2010 UN Millennium Challenge speech, then Prime Minister Wen Jiabao revealed that China cancelled debt owed by 50 heavily indebted poor countries (HIPCs) and least developed countries (LDCs) worth 25.6 billion yuan ($3.8 billion).
The real agenda of the “Blame China” lobby is to corral China into a common front that would impose stringent conditionalities on the indebted countries as the price for debt relief, an approach that China has rightfully pointed out has not worked because it does not address the structural roots of the developing country debt problem.
What is to be Done?
Yet the current crisis can, in fact, be turned into an opportunity. Nothing short of a bold, just, and effective approach is needed that would abandon the haphazard, conservative, anti-development programs of debt relief that were devised to meet the crisis of the 1970s and 1980s and situate a program of massive debt cancellation within a transformative paradigm supportive of sustainable development, the radical reduction of poverty and inequality, and climate justice.
The first and most urgent step is clear: extend the moratorium on debt payments from the end of 2021 as governments work out a solution, a process that will take months to achieve a modicum of consensus.
Second, neither the multilateral meetings dominated by the IMF and World Bank nor the G-20 any longer provide a viable setting for settling the debt issue. A more representative, more democratic setting is needed, one that will allow equitable participation by the indebted countries and where diverse views can be expressed beyond the still-dominant Washington Consensus. It is time to create and hold an international conference to come up with a progressive resolution to the developing countries’ debt, perhaps under the auspices of the UN General Assembly.
Third, the magnitude of the problem is such that it demands a fairly drastic solution, one that acknowledges that not only debtors must take the responsibility for the state of default but also the creditors for reckless lending, a principle that is now accepted in debt restructuring. The UN Development Program calls for a 30 per cent “haircut,” or reduction in outstanding payments for the 52 most indebted countries from 2021 to 2029. This can certainly serve as the starting point for initial discussions, though negotiators must be open to bigger magnitudes. In a paper prepared for the OECD publication Development Matters, economists Rachid Bouhia and Patrick Kacmarczyk assert that a “vast debt cancellation campaign for Low Income Countries and Middle Income Countries “is…not only doable, fair and desirable, but would also give many distressed economies a fresh start.”
Fourth, a debt relief program must make as a central consideration the fact that the highly indebted poor countries are also often the ones that are most at risk when it comes to climate change and that they are owed an ecological debt by the global north, which has contributed by far the greatest amount of carbon emissions historically. If this dimension is taken into consideration, and also given that their original debt has already been repaid many times over, then the cancellation of the least developed countries’ debt should be on the agenda.
Fifth, austerity and structural adjustment must be abandoned as a framework for debt restructuring for they have created structures that have increased the vulnerability of developing country economies to debt crises. What is needed is a framework that assists countries to develop comprehensively and sustainably and allows them to create buffers to the negative impacts of a global economy that is increasingly unstable and volatile.
Finally, governments must cease using the debt negotiations as a forum for advancing their geopolitical agendas. In particular, Washington must cease using the IMF-World Bank/Paris Club system to isolate China.
The developing country debt problem is indeed a crisis of massive proportions. But it can also be the opportunity for the creation of a more equitable and just global order.