Debt Crisis Threatens Developing Countries Amid ‘Perfect Storm’ | Business | Economic and financial news from a German perspective | DW
When Ghana lost access to international credit markets late last year, it was a foreboding of the debt problems that awaited the developing world. The battle against COVID-19 has left governments vulnerable, burdening them with massive debts they incurred to cushion the economic blow of the pandemic.
However, now that the main central banks are raising their interest rates, these debts could become difficult to repay.
Sri Lanka defaulted on its debt just weeks ago and Pakistan is trying to avoid a similar situation. In fact, more than half of low-income countries are currently at high risk of debt distress or are already in debt distress, according to the World Bank.
On Sunday, Russia defaulted on its foreign currency debt. But in this case, the reason was not a lack of reserves. On the contrary, Western sanctions imposed on Moscow during the war in Ukraine simply do not allow Western creditors to accept payments from Russia.
What is fueling the debt crisis in developing countries?
After the 2008 global financial crisis, central banks in industrialized countries cut interest rates and made financing cheap. For global investors in the US and Europe, this meant lower returns on domestic investments.
On the other side sat the governments of the countries of the South. They wanted to take advantage of ultra-low interest rates in the North by enticing investors with their higher-rated debt denominated in US dollars rather than local currency.
At the end of 2019, this pile of so-called external debt stood at $5.6 trillion (5.28 trillion euros) in emerging economies, according to a study by the Financial Stability Board. And as a result of the global pandemic, their sovereign debt in total saw the fastest annual increase in 2020 in the last three decades.
Experts have been warning for years that once interest rates start to rise in the United States, paying interest on all that dollar-denominated debt will become more expensive.
Now “we have several things coming together in a perfect storm,” says Nils Jensen, alluding to high food and energy prices, global economic uncertainty due to the Russian war and rising interest rates around the world as central banks attempt to contain inflation.
Jensen released a report for the United Nations Development Program (UNDP) in 2021 highlighting 12 countries particularly at risk of defaulting on their debt amid rising interest rates. Among them is Ghana, which saw soaring food prices push inflation to almost 30% in May. The Ghanaian currency cedi has fallen 22% against the US dollar this year.
Ghana’s debt problems
With the COVID-19 pandemic, the amount of debt taken on by the Ghanaian government to finance expenditure has tripled. In 2020, the government of this West African country had to use 45% of its revenue for interest payments, according to IMF data. In comparison, Germany spent only 1%.
Infrastructure projects in Ghana could suffer from budget cuts in the future
Ghana “has been trying to borrow money in foreign currencies and then using that money to pay off some of its domestic debt in hopes of reducing its debt servicing costs,” the economist said. jensen. But now, with interest rates rising in the United States, Ghana will have to pay a lot more to service its foreign currency debt.
In Ghana, infrastructure projects are already unfinished and spending on hospitals is low. Moreover, as global food prices rise, “the debt burden creates a problem for fertilizer subsidies,” says John Gatsi.
The University of Cape Coast business school professor told DW the looming debt crisis is making government services to the people “poorer and poorer”.
But the problem is even worse.
Private lenders dominate the current debt crisis
Unlike previous debt crises in the developing world, such as in Latin America in the 1980s, the current turmoil puts private lenders at the center of the turmoil.
For example, 57% of Ghana’s external debt payments go to private lenders rather than multilateral institutions such as the World Bank or the International Monetary Fund (IMF), according to Debt Justice, a nonprofit based United Kingdom. Private lenders are international investment banks, hedge funds and asset managers who seek to maximize portfolios on behalf of their investors.
For the group of 37 so-called heavily indebted poor (HIPC) countries, Jensen estimates that 50-60% of their debt is owed to private lenders.
The problem with this type of debt, Jensen said, is threefold: it is usually more expensive than debt negotiated between governments. It is much more difficult to renegotiate in the event of payment difficulties because there are many players involved and, above all, it is subject to price fluctuations.
“When central banks in the North decide to raise interest rates, interest rates in international financial markets rise significantly,” Jensen said, which would prompt private lenders to demand higher interest payments. to their borrowers. “And that, of course, increases the debt service costs of countries.”
Is there a way out of the spiral of debt?
The solutions to the problem are always out of sight. After Zambia became the first country to default in November 2020 amid the spread of the coronavirus pandemic, the country entered into negotiations with the IMF. The Zambian government said at the time that it was confident of ending negotiations by September 2022. However, much of the country’s debt was held by private asset manager BlackRock, which did not showed no interest in renegotiating the debt.
Additionally, the Debt Service Suspension Initiative, put in place by the World Bank in May 2020, has had a very limited impact on the growing debt problem in the developing world. The multilateral approach only allowed the payment of the debt to be postponed to a later date, rather than easing the burden. The initiative expired at the end of 2021.
Nils Jensen noted that a later debt initiative called the G20 Common Framework is also “almost dead” in its current form due to the procedural uncertainty involved and the fact that countries using it fear stigmatization. and jeopardize their solvency in global debt markets.
For Tim Jones, head of policy at Debt Justice, the multilateral programs offered by rich countries and global institutions do not go far enough. “Debt payments must be stopped so that the money can stay in the respective countries,” he said. He argued that it was the private lenders who went after the profits, pocketing large sums precisely because of the risks associated with the debt of the poorest countries. So, in turn, they should take the biggest hit from a default.
Edited by: Ashutosh Pandey