Current Debt Crisis in Developing Countries: Reasons, Consequences and Solutions

by | Nov 18, 2023

This blogpost highlights the debt crisis that is currently unfolding in developing countries across the globe. More specifically, it will analyze the reasons and consequences of this massive problem, before considering possible solutions.

Reasons

The Fall-Out of rising interest rates

It’s hard to imagine a worse combination of events than that, which has brought us here.

First, we had years of low interest rates across the world. As central banks kept interest rates close to zero, or even negative, investors were increasingly flocking to countries with greater risk. Thus, as the investors came piling in, many developing countries got to borrow more easy money than they probably should have.

But then came Covid-19, with its travel and work restrictions and supply-chain disruptions and the war in Ukraine, which drastically increased certain commodity prices. Especially expensive were, for example: food, fuel, and fertilizers – key imports for many developing countries, especially in Africa and the Near East.

But that wasn’t it. In response to these crises and the now rising inflation, big countries’ central banks suddenly began to quickly raise interest rates. The most important market, the U.S, has seen the fastest interest rates hikes in the past 40 years. Global financial streams usually follow high interest rates and avoid inflation, and thus, money quickly flowed back to richer countries, which looked safer than the increasingly struggling developing countries.*

This got public finances in developing countries under massive stress. Outstanding debt became harder to roll over, as borrowing new money became difficult. Also, old debt became more expensive if it was denominated in foreign currencies (such as US-Dollars), as interest hikes made these currencies stronger.

Imagine you used to have to convert 200 Sri Lankan rupees into 1 USD, but now the same Dollar costs 350 rupees. Hence, certain countries, started defaulting on their foreign debt, or at least got closer to that point.

A Strong Dollar

Second, the stronger Dollar also made everything else that is traded in USD more expensive for other countries. This, developing countries were struggling to pay for imports of oil and other natural resources. The Dollar strength pushed many countries closer to the cliff, and a few (like Sri Lanka) over it. The next act in the drama is developing countries now having to raise their own interest rates, to prop up their currencies – but meanwhile suffocating the domestic economy.

Consequences

What we have seen thus far amounts to what some call “the worst debt crisis the Global South has faced since global records have begun” (Debt Service Watch). But what does it actually mean on the ground?

Debt becomes unbearable

First, the obvious: Developing countries debt ratios are rising. The average government debt burden is believed to rise to 78% of GDP by 2028 (IMF forecasts) compared with over 53% a decade earlier. Yet, for individual countries, like Lebanon, this looks much, much worse: the International Monetary Fund (IMF) warns that public debt could reach 547% of GDP by 2027.

Equally obvious: interest rates on new debt are rising, sometimes making it prohibitively expensive to take on new debt. Take Ghana: In 2016, it borrowed $1 billion for 10 years, at an interest rate of 8%. Today it would probably be around 35%. Pakistan is at roughly 40% (NY Times).

Austerity

With these interest rate increases debt repayments get more expensive and make up an ever-larger part of overall revenue and spending of governments.

In sub-Saharan Africa, the ratio of interest payments to government revenues has more than doubled in the last decade (Reuters). Mexico, Morocco and Madagascar, for example, all spend about 50% of their government revenue on servicing their debt.

This, quite naturally, crowds out public spending on other very important things. Ghana, for instance, now pays 7.5 times more on debt service than it pays on education. Turkey spends six times more on debt repayments than it spends on health care (Debt Service Watch). This is not always just a function of simply higher debt servicing costs, but often also a result of cuts in the government budget. Angola is going through what its finance minister calls “extreme austerity” and Kenya has scrapped 10% of its proposed budget for 2024.

Individual hardship

What does all this mean for individuals?

The repercussions can be manifold. You could face 20% inflation, as people do in Nigeria. You could be looking at an abrupt end to food or fossil fuel subsidies from your government, as Egyptians have. You could be banned from importing Whiskey, as Argentinians are. Or you could be running out of necessary medical supplies, as Sri Lankans do (NY Times). The list of hardships is endless.

To see all this in action, look at Egypt. The country is very dependent on food and fuel imports. With the war in Ukraine and the strong US-Dollar, prices for both have increased. Wheat has become so expensive that the government can’t afford its bread subsidies, which people depend on. Its external debts have ballooned and can barely be refinanced, especially given that the Egyptian pound has been devalued by 50% since February 2022. Egypt now spends 30% of GDP and 200%(!) of government revenue only to service its current debts, and 16 times more on debt service than it spends on education and 28 times more on debt service than on public health (Debt Service Watch). This is a country on its way into the abyss.

Long-term trouble in the Global South

In the longer term, much economic activity in developing countries might also dry up, given the lack of key imports, the rising interest rates, and the lack of domestic spending power. All of this could lead to a widening chasm between the rich countries in the Global North, which can afford measures to prevent these crises, and the Global South, which simply must stall all investments into its future.

In short: we are risking a humanitarian crisis right now, but also might be looking at decades of slowed growth for developing countries, which are stuck in a permanent debt trap and might further fall behind in the global economy.

Lastly, it is also not impossible that this economic and humanitarian crisis translates into a political crisis in certain countries. We have seen before that rising food prices or shortages can easily lead to public discontent and political instability, and, potentially, translate into violence, government repression, coups and wars. Countries like Ghana and Kenya have already seen “violent protests against tax hikes and subsidy removals” in the early stages of the current crisis (Reuters).

Solutions

Creditors response

One thing that is already happening, is the IMF negotiating with several countries over bridge loans and bailout packages. Some countries, like Pakistan, also get cash infusions by other countries, like Saudi-Arabia and the United Arab Emirates (Reuters).

In the long run, however, this will not be sufficient. As we have seen, the problems of the countries in question are fundamental and will not go away, but only aggravate in the long run. Short-term relief cannot do much about the fundamental issues at hand.

A step in the right direction was the G20 Common Framework, a coordinated effort to take on debt relief for the poorest countries, with creditors actually accepting losses on their loans.

The problems, however, are manifold: First, the whole process is extremely slow. Second, all creditors, including private ones, would have to be treated more or less the same. If some accept losses, but others don’t, the latter can hold up the whole process, or undermine the formers’ willingness to continue taking a loss.**

Third, there’s the role of China, which has been reluctant to disclose the details of its loans to developing countries. This does not work if all creditors are supposed to be treated equally. In general, China seems to be reluctant to write off debt, instead preferring to defer repayment over and over, thus treating the problem as one of illiquidity rather than insolvency (Channel News Asia). It seems that Chinese banks are too exposed in emerging markets to be able to handle high losses, especially given the difficulties in the domestic Chinese market right now.

Public Attention and Good Will

So, what can be done in the meantime by individuals?

It seems, what we really need is more attention on the issue. People in the Global North must get interested and demand from their governments that relief should be given to the poorer nations in the Global South. The mechanisms and instruments named above, from debt restructuring, over bridge loans, to debt cancellation could all be implemented at sufficient speed – if everyone really cared.

After all, it probably wouldn’t even cost us much. According to the UN Development Program “Debt relief would be a small pill for wealthy countries to swallow, yet the cost of inaction is brutal for the world’s poorest”.

But so far, it keeps being treated as a minor problem. Western countries, China, private investors – they all seem to be playing games, trying to get as much out of it as possible, while ignoring the human tragedies unfolding in developing countries.

Also, ask yourself, how often are major newspapers reporting on these issues? Have you seen it being discussed on the news? Not much. So, as a civil society, we now have to push the issue!

Taking Responsibility

Probably it is our duty in the Global North to start caring and to stop kicking the can down the road. After all, there is a good argument to be made that it’s not really the Global South that owes us money, but that we owe the Global South:

Not just for the atrocities of the past centuries, but also for “our disproportionate responsibility for climate breakdown” as Fanning and Hickel call it in a recent article. These researchers have calculated that “a compensation of US$192 trillion would be owed to the undershooting countries of the global South for [our] appropriation of their atmospheric fair shares by 2050.”

If we start with that, the entire debt of developing countries, totaling about US$30 trillion would be much more than cancelled.

* quantitative tightening has also been a part of the policy mix and created very similar results, but shall be omitted here.

** to make up for the shortfalls of established solutions more complicated and novel ideas have been floated recently, such as the idea of new “Brady bonds”, or debt-for-climate-swaps. Here we can’t go into any detail on these instruments, but it must suffice to say that if and when such mechanisms could ever get off the ground is highly questionable, and whether they would address the underlying fundamental problems sufficiently, remains unclear.

Sources