As the year 2022 drew to an end, the United Nations Conference on Trade and Development (UNCTAD) warned, “Developing countries face ‘impossible trade-off’ on debt”, that spiralling debt in low and middle-income countries (LMICs) has compromised their chances of sustainable development.
In early December, an opinion piece in The New York Times headlined, “Defaults Loom as Poor Countries Face an Economic Storm”. And the World Bank’s International Debt Report highlighted rising debt-related risks for all developing economies—low- as well as middle-income economies.
Debt on the rise
Debt build-up accelerated in the wake of the 2008-2009 global financial crisis (GFC). The World Bank’s, Global Waves of Debt reveals that total (public & private; domestic & external) debt in emerging market and developing economies (EMDEs) reached an all-time high of around 170% of GDP ($55 trillion) – more than double the 2010 figure – by 2018, before the onset of the COVID-19 pandemic.
Total debt in low-income countries (LICs), after a steep fall from the peak of around 120% of GDP in the mid-1990s to around 48% ($137 billion) in 2010, increased to 67% of GDP ($270 billion) in 2018.
Pandemic debt
The COVID-19 pandemic greatly lengthened the list of EMDEs in debt distress as rich nations and institutions dominated by them, e.g., the World Bank, failed to provide any meaningful debt reliefs or increase financial support to adequately respond to the health and economic crises.
The World Bank’s chief economist advised, “First fight the war [pandemic], then figure out how to pay for it”. The IMF’s managing director counselled, “Please spend, spend as much as you can. But keep the receipts”.
The World Bank’s International Debt Statistics 2022 reveals that the external debt stock of LMICs in 2021 rose to $9.3 trillion (an increase of 7.8% compared to 2020) – more than double a decade ago in 2010. For many countries, the increase was by double digit percentages.
Riskier debt
Over the past decade, the composition of debt has changed significantly, with the share of external debt owed to private creditors increasing sharply. At the end of 2021, LMICs owed 61% of their public and publicly guaranteed external debt to private creditors—an increase of 15 percentage points from 2010.
The private creditors charge higher interest rates, and offer little or no scope for restructuring or refinancing at favourable terms, as they maximise profit. The private creditors also usually offer credits for shorter duration, while development financing needs are for longer-terms.
Failed aid promises
Development needs of developing countries have increased many-folds, especially for meeting internationally agreed development goals, such as the Millennium Development Goals (MDGs) and now Sustainable Development Goals (SDGs). The LMICs’ estimated aggregate investment needs are $1.5–$2.7 trillion per year—equivalent to 4.5–8.2% of annual GDP— between 2015 and 2030 to just meet infrastructure-related SDGs. But the rich nations spectacularly failed to honour their promises of finance made at the 2015 UN conference on financing for development (FfD) in Addis Ababa.
In fact, they failed all their past aid promises, e.g., to provide 0.7% of their gross national income (GNI) as aid, a promise made over half a century ago. While aid hardly reached half the promised percentage of GNI, it in fact declined from the peak of around 0.55% of GNI in the early 1960s to around 0.34% in recent years. Oxfam estimated 50 years of unkept promises meant rich nations owed $5.7 trillion to poor countries by 2020!
At their 2005 Gleneagles Summit, G7 leaders pledged to double their aid by 2010, earmarking $50 billion yearly for Africa. But actual aid delivery has been woefully short. G7 and other rich OECD countries also broke their 2009 pledge to give $100 billion annually in climate finance until 2020.
Promoting private finance
Meanwhile institutions dominated by rich nations – the World Bank and OECD, in particular – promoted private financing of development. The World Bank, the IMF and multilateral regional development banks, e.g. Asian Development Bank jointly released From billions to trillions, just before the 2015 FfD conference.
The document optimistically but misleadingly advised governments to “de-risk” development projects for enticing trillions of dollars of private capital in public private partnerships (PPPs). While de-risking effectively meant governments bearing financial risks, or socialise private investors’ loss, PPPs are found to have dubious impacts on SDGs, especially poverty reduction and enhancing equity.
Meanwhile the OECD donors advocated “blended finance” (BF) to use aid money to leverage, again trillions of dollars of private capital. But as The Economist noted, BF is struggling to grow, stuck since 2014 “at about $20 billion a year…far off the goal of $100 billion set by the UN in 2015”, despite suspected double counting. Like PPPs, BF has effectively transferred risk from the private to the public sector. On average, the public sector has borne 57% of the costs of BF investments, including 73% in LICs.
Collateral damage
In the wake of the GFC the rich countries followed so-called unconventional monetary policies that kept interest rates exceptionally low – in some cases at zero – for a decade. This saw capital flowing from rich countries to EMDEs in search for higher returns, as exceptionally low interest rates enticed EMDE governments and businesses.
The opportunity to borrow at low rates also made the EMDE governments lazy in their domestic revenue mobilisation efforts. Such policy complacency was rewarded by the donor community, especially the World Bank, through its now discredited Doing Business Report, encouraging a harmful race to the bottom tax competition among countries to cut corporate and other direct taxations. The World Bank and IMF also advised to remove or lower easier to collect indirect taxes, e.g., excise duties in exchange for regressive and difficult to implement goods & services or value-added tax in poorer countries.
Bleeding revenues
Meanwhile transnational corporations (TNCs) continue to avoid and evade paying taxes using creating accounting, aided by tax havens, mostly situated in rich nations’ territories. Developing countries lost approximately $7.8 trillion in illicit financial flows from 2004 to 2013, mostly through TNCs’ transfer mispricing, or the fraudulent mis-invoicing of trade in cross-border tax-related transactions.
African countries received $161.6 billion in 2015, primarily through loans, personal remittances and aid. But, $203 billion was extracted, mainly through TNCs repatriating profits and illegally moving money out of the continent.
International tax rules are designed by the rich nations. They continue to oppose developing countries’ demand for an inclusive international tax regime under the auspices of the UN.
Perfect storm
Global supply-demand mis-matches due to the pandemic, the Ukraine war and sanctions are a perfect recipe for a perfect storm. The advanced countries’ inflation fight is causing adverse spill-over on developing countries.
Higher interest rates have slowed the world economy, and triggered capital outflows from developing countries, depreciating their currencies, besides lowering export earnings. Together, these are causing devastating debt crises in many developing countries, similar to what happened in the 1980s.
In October 2022, a United Nations Development Programme (UNDP) report estimated that 54 countries, accounting for more than half of the world’s poorest people, needed immediate debt relief to avoid even more extreme poverty and give them a chance of dealing with climate change.
Rich nations fail again
As pandemic debt distress became obvious, the G20 countries devised the so-called Debt Service Suspension Initiative (DSSI) for 75 poorest countries, supposedly to provide some modest relief between May and December 2020. DSSI does not cancel debt, but only delays re-payments, to be paid fully later with the interest cost accumulating – thus effectively “kicks the can down the road”. As the private lenders refused to join the G20’s initiative, unsurprisingly only 3 countries expressed interest in DSSI. Moreover, the G20 initiative does not address debt problems facing MICs, many of which also face debt servicing, including repayment issues.
Although the IMF acted innovatively at the start of the pandemic debt distress with debt service cancellation for 25 eligible LICs (estimated at $213.5 million), the World Bank’s Chief refused to supplement, let alone complement the IMF’s debt service cancellation for the most vulnerable LICs. Nonetheless, the Bank’s President hypocritically advocates debt relief as “critical”. He wants to have the cake and eat it too; apparently wanting to increase lending, but without sacrificing the institution’s AAA credit rating.
China debt trap diplomacy?
Meanwhile the rich nations accuse China of “debt trap diplomacy” that China is deliberately pushing loans to poorer countries for geopolitical and economic advantages. Less than 20% of LICs external debt is owed to China as against more than 50% to the commercial lenders.
Most Chinese loans are concessional, and China has provided more debt relief than any other country, bilaterally negotiating around $10.8 billion of relief since the onset of the pandemic.
Unsurprisingly, independent studies debunked the Western accusation. And China has emerged as a major source of development finance for poorer countries. A recent IMF study concluded, “Beijing’s foreign assistance has had a positive impact on economic and social outcomes in recipient countries”.
Damaging trade-off
Rising debt servicing in the face of higher import costs, falling export revenues and declining remittances, are forcing developing countries to a damaging trade-off. They are forced to service external debt owed to rich nations and international financiers at the cost of development.
For many African nations, the increased cost of debt repayments is the equivalent of public health spending in the continent, according to the UNCTAD. But, “No country should be forced to choose between paying back debts or providing health care.”
Anis Chowdhury is Adjunct Professor of Economics, Western Sydney University & University of New South Wales (Canberra campus). He served as a senior official at UN-DESA (New York) and UN-ESCAP (Bangkok). Prior to joining the United Nations, he was Professor of Economics at Western Sydney University.
