Covid-19 Compounds Developing Country Debt Burdens
By Anis Chowdhury and Jomo Kwame Sundaram, IPS
Covid-19 is expected to take a heavy human and economic toll on developing countries, not only because of contagion in the face of weak health systems, but also containment measures which have precipitated recessions, destroying and diminishing the livelihoods of many.
Limited fiscal space
Developing countries generally have limited fiscal capacities to finance relief and liquidity provision in the short-term while rebuilding economic life on a more sustainable basis in the longer-term.
The 2020 Financing for Sustainable Development Report shows debt vulnerability growing in many developing countries well before the pandemic. For example, public sector borrowings of commodity exporters increased substantially after prices collapsed in 2014-15. With these prices further depressed now, the pandemic will increase developing country debt.
Investors withdrew nearly US$80 billion from emerging markets in the first quarter of 2020 – the largest capital outflow in history, according to the Institute of International Finance – as remittances fell at least 20%, i.e., by over US$100 billion.
Most other developing countries do not have strong enough credit ratings to secure low-cost foreign sovereign debt despite low interest rates in the North.
According to the World Bank’s recent Global Waves of Debt, the past decade has seen the largest, fastest and most broad-based increase in emerging market and developing economies (EMDE) debt in the past half century.
Since 2010, total EMDE debt – both public and private – rose from 108.6% of GDP (88% without China) to more than 170% (108% excluding China), totalling US$57 trillion in 2019.
Private corporate debt accounted for much of this ballooning EMDE debt, rising from 77% of GDP in 2010 to 117% in 2018. But public debt (without China) has also risen from 38.6% of GDP in 2010 to 49.4% in 2018.
Following a sharp decline during 2000-10, total low-income country (LIC) debt rose from 51.5% of GDP (US$137 bn) in 2010 to 65.8% (US$268 bn) in 2018. Public debt is far more important in LICs, rising from 36.5% of GDP in 2010 to 45.7% in 2018, borrowing more from ‘non-traditional’ sources, notably China.
When governments can borrow on reasonable terms to invest in projects needed for sustainable development, debt may be desirable, if not necessary, especially in resource-poor countries. IMF research suggests that optimal debt levels depend on many considerations.
Nevertheless, debt can have very undesirable impacts, especially when not well used. Debt composition can also be worrisome. The recent debt build-up is particularly concerning because much of it is external.
And now, developing countries’ ability to service growing debt is constrained by falling export revenues due to pandemic-induced commodity price collapses complicated by the shift to riskier debt.
The external share of EDME government debt reached 43% in 2018, while foreign currency denominated corporate debt rose from 19% of GDP in 2010 to 26% in 2018.
Many developing countries face sovereign debt crises, unable to pay off accumulated debt or interest. An increasing share is owed to China, especially by ‘un-creditworthy’ poor countries, but European bond markets and private lenders still account for more.
African government external debt payments doubled in two years, from 5.9% of government revenue in 2015 to 11.8% in 2017. A fifth of Africa’s external debt of about US$405 bn is owed to China, 32% (US$132 bn) to bond markets and other private lenders, and 35% (US$144 bn) to multilateral institutions such as the World Bank.
Debt servicing accounts for the largest share of government spending, and remains the fastest growing expenditure item in sub-Saharan African budgets. As debt from private creditors is more expensive, 55% of interest payments go to them.
Interest payments due on private debt to African nations for the rest of 2020 are around US$3 billion. Compared to very low to negative rates in Europe, America and Japan, most African governments are paying 5~16% interest on 10-year government bonds.
African countries have been accused of borrowing too much, but the problem is that they are paying far too much interest, mainly due to rating agencies’ and bond issuers’ prejudices and practices. Thus, although Ethiopia has grown at 8~11% for over a decade, its sovereign credit rating has not improved.
Also, transparency about contingent liabilities, e.g., due to state-owned enterprise debt and public-private partnership transactions, is limited in most developing countries, especially for debt owed to commercial and non-Paris Club creditors.
Contingent liabilities may also grow during this pandemic as governments have to extend loan guarantees for the private sector to prevent total economic collapse.
Debt worsens inequality
Debt also increases inequality in at least four ways. First, debt enriches creditors and financial intermediaries, typically at the expense of borrowers. Interest and other capital gains greatly increase asset incomes, wealth and capital.
Second, government debt often enriches wealthy elites. Some of the politically well-connected profit from project financing, the burden of which is borne by the people.
A leaked World Bank study estimated that 5% of all new Bank finance to poor countries ended up in tax havens. Bank loans to 22 countries receiving aid during 1990-2010 also increased deposits in secret offshore bank accounts.
Third, fiscal arrangements involving debt typically deepen inequality. To service debt, governments often increase taxation and cut spending. While the IMF and financial interests usually insist on fiscal consolidation involving austerity, creditors may even demand ‘credible’, compliant finance ministers.
While taxes on the wealthy can be increased, the dominant trend in the last four decades has been otherwise. Instead, the IMF has urged governments for decades to increase revenue through value added and other regressive indirect taxation, usually on consumption.
Many governments have had to cut expenditure to increase revenue to service debt, usual making social spending cuts, worsening inequality and social discontent, triggering widespread protests in Kenya, Ecuador, Lebanon and elsewhere.
Relief urgently needed
The severity of current recessions, affecting most countries, and dim prospects of robust rebounds, may tip many LICs into debt distress. The United Nations Conference on Trade and Development has warned of a “looming debt disaster” in developing countries, calling for US$1 trillion in debt relief.
On 15 April 2020, G20 finance ministers agreed to a “time-bound suspension of debt service payments” for 76 low-income developing countries eligible for World Bank International Development Association consideration, while the IMF has offered debt service relief to 25 of the poorest countries.
Nevertheless, the UN believes these actions will not be enough to avoid defaults as the G20 move does not effect private lenders.
The unique, but varied and changing nature of the pandemic and efforts to contain contagion, and the specific challenges of relief, revival and reorientation imply that neither ‘one size fits all’ nor other formulaic solutions, e.g., to address financial crisis, are appropriate.
Policy measures will not only need to address the specificities of the Covid-19 crises, but must also take into consideration the legacy of earlier problems, including the burdens of accumulated debt and debt-servicing.