How the debt crisis imperils development — and why it's getting worse

Around the world, more and more countries are facing unmanageable levels of debt. World Bank officials and economists at many global institutions now speculate about how many nations will hit such levels of debt distress that they default or become unable to import food and medicine — and when it might happen. Experts are calling it a “perfect storm,” and in the worst possible way. More than a dozen countries are particularly at risk. Sri Lanka has already defaulted. The Asian island nation is unable to pay its debts, and as a result, it has been plunged into political turmoil and economic crisis, with no end in sight. Recent weeks have seen images of protesters taking over the Sri Lankan president’s swimming pool, following months of jarring scenes of lines for fuel and soaring food prices. Sri Lanka’s problems show the potential development impact of an economic meltdown. Countries that are nearing default or generally lack hard currencies will struggle to buy food, fuel, and medicines on global markets. Debt default not only stifles investments and spending on essentials like health care but can lead to political crisis and social unrest. Debt distress can be defined as when a country has difficulty making payments on its debt. It may be judged by looking at the difference between any government’s bond and an asset like a U.S. Treasury bond, or at the cost of insuring against a default on markets. The more distressed a country is, the greater the difference will be in terms of yields. The International Monetary Fund has been warning about this for much of the past year. It now says that some 60% of low-income countries are caught in debt distress or heading that way. In interviews with Devex, some economists have argued that this percentage could be even higher. Despite this, policymakers at a July meeting of nations from the Group of 20 major economies did not heed the alarm bells about the state of the economy in lower-income countries; they came and went without a plan. “The international community doesn’t seem prepared to do much about it,” wrote Vasuki Shastry and Jeremy Mark in an Atlantic Council blog post about the crisis. Who’s in danger? A growing number of countries are turning to IMF for bailout deals, including Ghana, a lower-middle-income country that has cut its poverty rate in half in recent decades and had previously insisted it would not ask the Washington-based institution for help. The line outside IMF’s door has become a sign of the times. Zambia, which in November 2020 became the first African country to default in the COVID-19 era, only last week concluded talks with official creditors, potentially paving the way for an IMF loan. The lengthy path was fraught with complications, and the long delay meant that the country sank further into an economic malaise. Chad is struggling to even hold negotiations on what it owes, facing the problem of private sector creditors that do not want to take losses on their loans. IMF recently called out Glencore, the massive Swiss commodity trader, for not coming to the table, stressing it was important that “agreement be reached promptly.” The Council on Foreign Relations identified nine countries as having a default risk of greater than 50%, with others only slightly below this threshold. Why has debt become a problem? Debt loads were building even prior to the pandemic, but when COVID-19 hit, countries across the world doubled down and borrowed more to shore up their economies. The head of IMF, Kristalina Georgieva, called on nations to do whatever it takes. “Spend as much as you can and then spend a little bit more,” she said in January 2021. However, many countries are now facing severe hardships. Most lower-income nations borrowed heavily in dollars, as well as their own currencies. Now the dollar is strengthening quickly because the greenback is seen as a safe currency in a time of uncertainty, making dollar-denominated debt more expensive and putting pressure on other countries — an issue sometimes known as the “dollar doom loop.” Meanwhile, interest rates are rising in the U.S., Europe, and elsewhere to fight off inflation caused by supply chain woes along with rising fuel and food prices, making debt more expensive. Countries that borrowed at varying rates, or that have to roll over their debt, now have to pay elevated market rates. And global economic growth is slowing, reducing government revenues and hurting jobs. This triple-shot combination is especially painful for the lowest-income countries and risks seeing gains on fighting poverty reversed. “A rise in interest rates in advanced economies — in particular, of course, in the U.S. — leads to a balance-of-payment crisis in developing countries, given the dominance of the U.S. dollar,” said Stephanie Blankenburg, a leading expert on debt and development finance at the United Nations Conference on Trade and Development. “That's already happening in quite a lot of developing countries.” The problem has been worsened by the nature of the creditors. Previous debt crises, such as the emerging-market crisis in the 1970s and 1980s, were addressed when a group of richer nations, known as the Paris Club, went through multiple rounds of debt restructuring and forgiveness. But the world has changed since the 1980s. Notably, the nature of the lenders has changed dramatically — with China now a major player, as are private creditors on the open market. While Beijing does negotiate with some countries about debt, they tend to do so on their own and not in Western-led groupings like the Paris Club. And private sector creditors march to a beat all their own, though calls are increasing in wealthy countries for legislation to force them to the table and at least hold talks in good faith. What has worked? What hasn’t? A few actions by the international community have helped. Notably, the World Bank front-loaded tens of billions of dollars from the International Development Association, its fund for the lowest-income nations. And IMF shareholders agreed to the $650 billion issuance of Special Drawing Rights, which helped lower-income countries. But because SDRs are allocated proportionate to a country’s IMF share quota, the assets mostly went to wealthy nations, limiting the impact on those most in need. So far, wealthy nations have been slow to redistribute their SDRs to countries in need. Only a little over $58 billion has been pledged, according to a tally by the ONE Campaign and comments from the U.S. Treasury, though these numbers are in flux. The total currently pledged is about 15% of the total that the rich nations received. The United States has not yet moved any money from its reserve pool, though bills now in Congress could change this. However, the global debt suspension initiative enacted toward the start of the pandemic expired. Worse, the debt payments that were suspended were just piling up and now they are due again, adding to the loads countries have to pay back. The G-20’s so-called common framework on debt relief is intended as a solution but has only attracted three nations, including Zambia and Chad. It is widely seen as “ineffective” at best, even with the latest news of Zambia reaching a deal a year and a half after it first applied to the framework. The mechanism still lacks broad-based buy-in from creditors like private debt holders, and countries that asked for help immediately got pounded on global markets; the very fact they needed assistance was taken as a sign of riskiness. “The IMF track record of austerity has shown multiple times throughout its history that it can exacerbate economic problems.” --— William Kring, executive director, Boston University’s Global Development Policy Center At the peak of the pandemic, Ethiopia saw its credit rating downgraded after rushing to be one of the first three countries to use the framework. A similar dynamic plays out when nations turn to IMF. William Kring, the executive director at the Global Development Policy Center at Boston University warned of the “significant stigma” that came with IMF support. This means some nations delay asking for help, letting problems metastasize, or piling on debt at more expensive rates. Kring warns that dozens of countries are spending more on debt than health care, a sign of how heavy the toll has been. The more countries sink into debt crisis, the more they will struggle to pay for basic government services — from education to infrastructure — and as IMF warns, social unrest is then just around the corner. Kring also warned that IMF may impose painful austerity measures, which can cause governments trouble at home. This was recently the case in Tunisia, where labor unions opposed “painful and harmful conditions” imposed by IMF. Even with a deal now seeming closer to completion — despite a backsliding of democracy in the country — the ripple effects may last for a while. Kring questioned whether IMF’s strictest austerity policies, as enacted in the past, were effective. “Ultimately, the IMF track record of austerity has shown multiple times throughout its history that it can exacerbate economic problems, unfortunately,” he said. “These countries see slower recoveries, and ultimately the people that pay the price are the poor and the most vulnerable.” Daniel Munevar, who at the time Devex spoke with him was a policy analyst with the European Network on Debt and Development, shared a similar assessment. “The more you adjust, the more likely your economy is to contract and the more you end up in a trap,” he said. What and who to watch IMF bailout terms are known as “conditionalities.” But the more conditions, the more likely a government is to be forced into extended “dependency traps,” according to research published in the journal Governance. Each condition, the study found, increased the likelihood of a program interruption by at least 1.1%. Considering that programs have historically included on average 22 conditions, according to the study, the chance of failure, already relatively high, ends up getting boosted significantly. “Programs that have more conditions are more likely to fail,” said Bernhard Reinsberg, a lecturer in international relations at the University of Glasgow and one of the study’s co-authors. Reinsberg said some conditions can be good, such as terms that promote good governance and stem corruption. In fact, human rights groups worry when IMF is not strict enough in ensuring transparency and wise spending. The problem is when the sheer number of conditions becomes an impossible burden. Another risk is that debt default in emerging markets could hit the wider financial markets which had lent them money, causing a domino effect. Diane Swonk, who is now the chief economist at KPMG, warned of how much money in the financial markets had been bet on emerging market growth. “Largest concern is [the] mountain of debt emerging markets took on during the pandemic,” she tweeted. “No Las Vegas in [the] global economy.” Meanwhile, Raghuram Rajan, who formerly headed the Reserve Bank of India, cautioned that if crises pile up in emerging markets, the problems could affect the banks, which would then create systemic risk. But Blankenburg at UNCTAD warned that instead a “new normal” could take hold — one of perpetual crises in a number of countries that could last for years, with only minimal impact on wealthy nations. “I totally agree with a risk of contagion, but it doesn't necessarily mean that you get a kind of spectacular financial crisis,” she said. Rather, we may see a “long recessionary spiral across a wide range of lower and middle income countries.” And this could let the advanced economies become complacent, and refuse to come up with a permanent mechanism to handle debt problems. Instead, those countries may tackle the issue piecemeal every time the crisis rears its head. The question then is whether the powerful and wealthy countries will indeed find the so-called political will to take steps at the G-20 leaders’ summit in Bali this year, or just wait and see if things really do get worse.