The Debt Crisis in Developing Countries

Written By TBG

In May 2020, the World Bank and the International Monetary Fund urged the G20 to establish the Debt Service Suspension Initiative (DSSI) to help least developed countries concentrate their resources on “fighting the pandemic and safeguarding the lives and livelihoods of millions of the most vulnerable people”. From May 2020 to December 2021, the DSSI suspended $12.9 billion in debt-service payments for 48 countries, which expired at the end of December 2021. However, the Russia - Ukraine conflict has escalated debt situations in developing countries. According to the IMF, 60 percent of low-income countries are at high risk of/or already in debt distress. Middle-income countries have experienced the highest debt-service burdens in three decades. High inflation, slower growth, and tightening financial conditions are likely to undermine debt sustainability, further impeding investments in climate resilience.

Unsustainable debt and climate changes:

Ulrich Volz, a professor and director of the center for sustainable finance at SOAS University of London mentioned the vicious circle of climate vulnerability and the cost of capital, which is proven by several empirical studies and talks about how limited fiscal space increases increase climate vulnerability. 

High levels of public debt service may cause insufficient fiscal and monetary space, which deteriorated by the COVID-19 pandemic and Russia’s invasion of Ukraine, further causing the decrease in investments in climate adaptation and rising the vulnerability of low countries. As financial markets increasingly price climate risks and global warming accelerates, the climate risk premium of these climate-vulnerable developing countries will be higher than before. Therefore, these countries need more debt due to the higher cost of capital, finally entering the vicious circle - the fiscal space would be diminished again. For example, because of Eritrea’s high public debt-to-GDP ratio - 175.6 percent, it remains in debt distress. It does not invest enough in climate change, such as droughts, deforestation, and land degradation.

In Sri Lanka, one-third of the debt is owned by international bondholders and other large creditors like China, India, and Japan. Its deepening economic crisis - depleted foreign currency reserves, shortages of imports and fuel, and skyrocketing inflation - has increased the risk of default. The debt crisis impedes climate financing in Sri Lanka. Also, some observers believe that Sri Lanka would default on their debts during the pandemic, like Belize, Ecuador, Suriname , and Zambia. At the same time, some people still think this country will survive the economic crisis by boosting its tourism and exports. 

Egypt, the largest IMF borrower after Argentina borrowed $8 billion in 2020 to mitigate economic pressure resulting from the pandemic, has experienced investment withdrawal in recent months, which adds further pressure on its currency. 

The Russia-Ukraine conflict has increased the risk of defaults and caused the pulling out of billions of dollars in developing countries. Countries like Ghana and Pakistan are also on the brink of bankruptcy. However, developing countries are forced to raise debt and attract more investments by increasing interest rates to meet repayments and existing debt. This further reduces their fiscal and monetary space, escalates their economies, and causes even higher costs of climate adaptation costs. Therefore, there is an urgency to address sovereign debt problems.

How to address sovereign debt problems?

According to a report by Olufemi Táíwò - Georgetown University philosophy professor - and Patrick Bigger - the Climate and Community Project’s research director, “the developing world’s current debt crisis has its roots in colonialism and slavery.” Less labor and resources in the Global South - countries in Latin America, Asia, Africa, and Oceania - gave the Global North the opportunity to develop the economy. This left the Global South behind and caused the Global South with little choice but to borrow money from developed countries, multilateral lenders like the World Bank and the International Monetary Fund, and private lenders. As a result, Táíwò and Bigger support the proposal of canceling developing countries’ publicly held debt and analyzed that 19 of the world’s 20 most climate-vulnerable countries can easily choose to write off their debts to free up fiscal space and invest in climate adaptation. Moreover, they also suggest the Global North should increase climate-related investments in the Global South to ensure climate-resilient development in these countries.

Marcello Estevão, the Global Director for the Macroeconomic for Trade & Investment Global Practice at the World Bank Group, mentioned the crucial role of the G20 in tackling debt crises and suggested that the World Bank and the IMF should offer a roadmap to help developing countries. This will entail  establishing a clear timeline, suspending debt-service payments, and expanding the Common Framework’s eligibility requirements.

In addition to debt cancellation and offering a clear roadmap, appropriate coordination mechanisms will be vital in addressing debt crises in less developed countries. Since DSSI, the increased diversity of creditors improves the accessibility of developing countries borrowing money and raises significant coordination challenges. Lacking incentives and mechanisms to bring debtor governments, government creditors, and private creditors like wealthy individuals and companies slows down the negotiation and restructuring of debt of developing nations. Establishing coordination mechanisms is essential and helps debt restructurings accomplish speedily, smoothly, and efficiently.

In the longer term, with the impacts of debt and climate crisis, there is no doubt that climate-related disasters and high global interest rates will jeopardize growth and progress with SDGs. However, the multilateral programs that developed countries and international organizations provide are not going far enough. Addressing this mounting debt problem in the developing world needs the establishment of more efficient coordination mechanisms and the participation of more private lenders

EDITOR’S NOTE: TBG provides global solutions focused on Sustainability, Innovation and Impact. We leverage a Global Network comprised of more than 1000 experts in over 150 countries. Through TBG Consulting, TBG Global Advisors, TBG Purpose and TBG Capital, we undertake global projects — from Kenya to Kazakhstan — and transform challenges into opportunities.

References:

The debt and climate crises are escalating - it is time to tackle both. https://www.brookings.edu/blog/future-development/2022/07/08/the-debt-and-climate-crises-are-escalating-it-is-time-to-tackle-both/

Why developing economics are drowning in debt. https://www.trtworld.com/magazine/why-developing-economies-are-drowning-in-debt-56071

Restructuring debt of poorer nations requires more efficient coordination. https://blogs.imf.org/2022/04/07/restructuring-debt-of-poorer-nations-requires-more-efficient-coordination/

Are we ready for the coming spate of debt crises? https://blogs.worldbank.org/voices/are-we-ready-coming-spate-debt-crises

Developing country external debt: A cascade of crises means more countries face debt distress. https://sdgpulse.unctad.org/debt-sustainability/

Debt crisis looms for developing countries amid 'perfect storm'. https://www.dw.com/en/debt-crisis-looms-for-developing-countries-amid-perfect-storm/a-62246014#:~:text=By%20the%20end%20of%202019,in%20the%20past%20three%20decades.

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