How to spare low-income countries from ‘economic collapse’

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: John Letzing, Digital Editor, Strategic Intelligence, World Economic Forum

• Many less-wealthy countries face worsening debt problems as the pandemic lingers.

• Some say the design of the global financial system is inherently unfair to them.

• An initiative designed to ease their debt burden is due to expire soon.

The world’s economic “firefighter” recently warned of an impending blaze that just might engulf a significant portion of the global population.

More than half of all low-income countries are now nearing or already in debt distress and some face “economic collapse,” according to the International Monetary Fund (IMF). That is, unless efforts are stepped up to ease their burden.

A bad situation for these countries has only gotten worse during the health crisis. Now, following a period of pandemic-related suppression, interest rates are set to rise and make their debt payments even more expensive in the process. That’s prompted louder calls to overhaul what many see as inherently unfair global financial architecture.

The 60% of low-income countries the IMF says are now near or in debt distress compares with less than 30% as recently as 2015. And while public debt has also increased in wealthy countries during the pandemic, that’s a relative bump in the road for a place like the US – which has the world’s reserve currency and a reliable lender of last resort.

US public debt has equaled 123% of GDP recently, yet the country pays less than 2% interest on a 10-year loan. Zambia, with a public debt-to-GDP ratio estimated at 115%, pays 25% on 10-year borrowing. Uganda, which has a debt ratio of about 50%, pays nearly 15%.

To alleviate pressure on low-income countries during COVID-19, the G20 established a debt-suspension initiative. But that’s slated to expire at the end of this month.

The right credit-rating system for everyone?

Buddhist monks recently sprinkled holy water on bullet trains that would soon be circulating between China and Vientiane, the capital of Laos, thanks to a $5.9 billion railway project. The Laotian government reportedly took on more than $1 billion in debt for the effort, raising questions about whether it can be repaid.

Late last year, Laos had its credit rating cut to a level meant to indicate to lenders that default is a real possibility, due to cited shortcomings in “institutional capacity” and controlling corruption.

The tendency of rating agencies to apply the same blanket criteria to less-wealthy countries as they do to their more comfortable peers – and raise their cost of borrowing in the process – has come under scrutiny.

Some critics have argued for a new type of ratings system that wrests influence from entrenched agencies, and places more focus on the human rights of countries in need.

Still, ratings may be only part of the issue. One study pointed to an unaccountable “investor bias” that’s forced governments in sub-Saharan African to pay about $300 million extra in interest every year, on top of what might simply be attributed to a credit rating.

New ways to solve old debt problems

The treatment of low-income countries in need of financing is just one of many deficiencies drawn in sharper detail by the pandemic.

In some of these places, governments’ past perceived failures to get a handle on their debt situation have sparked protests, and calls to stop borrowing further from the global institutions that serve as a backstop.

Others say these institutions should actually play a larger role, by making more resources available to developing countries – and that wealthier countries should provide more debt-for-nature swaps, which cancel financial obligations in exchange for firm commitments to things like preserving forests and protecting endangered species.

Proponents say efforts like these are merited by an uneven playing field. While most countries in the world have suffered economic declines during the pandemic, poorer nations generally started from already-precarious levels, and continue to endure relatively daunting circumstances.

The collective economy in sub-Saharan Africa, for example, is expected to grow at the slowest rate of any region in the world this year – due at least partly to the unequal global distribution of COVID-19 vaccines, which have been in short supply in many African countries.

More reading on troubling debt and COVID-19

For more context, here are links to further reading from the World Economic Forum’s Strategic Intelligence platform:

• Last year, government debt in emerging-market and developing economies jumped to a three-decade record of 63% of GDP, according to this analysis, which argues for greater coordination to ease this burden. (VoxEU)

• Belize’s big blue debt deal: it repurchased a chunk of outstanding debt at a discount, and repaid creditors via bonds designated to foster ocean health. According to this piece, such swaps can truly help highly-indebted governments. (Center for Global Development)

• The unorthodox monetary measures taken by wealthy countries amid COVID-19 “make a mockery” of conditions the IMF applies to developing-nation borrowers, according to this piece, which argues that African leaders need more fiscal and policy breathing space. (Chatham House)

• Debt through a climate prism – this paper defines what countries owe the world based on their contributions to climate change. On these terms, at least, it’s the rich nations that are drowning in debt. (Center for Global Development)

• The answer to the biodiversity crisis is not more debt – according to this piece, funding from wealthier countries for projects to preserve Earth’s richness should be delivered in grants, and not as a reward for taking out loans. (Nature)

• The IMF recently announced plans to revive a $6 billion bailout for Pakistan, but according to this analysis the country’s efforts to comply with IMF terms have triggered not-so-popular higher food prices. (The Diplomat)

• Sub-Saharan Africa has done an admirable job of keeping case counts low during the pandemic, according to this piece, but at an economic cost that countries have tried to address with borrowing – often with significant consequences. (Brookings)

On the Strategic Intelligence platform, you can find feeds of expert analysis related to COVID-19, Financial and Monetary Systems and hundreds of additional topics. You’ll need to register to view.