Why Should the Reemergence of a Debt Crisis across Developing Countries Matter?
By admin August 14, 2018

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With financial turmoil in Turkey rolling the country’s assets, elsewhere in the world the risks of the reemergence of a global sovereign debt crisis is looming. A new report by the International Monetary Fund (IMF) indicates that government debt in some of the world’s poorest countries is rising to risky levels.  Another study by the Jubilee Debt Campaign, a UK-based charity focused on the connections between poverty and debt, reported that at the end of 2017, 28 countries, mostly in the developing world were rated as in debt distress or at high risk of debt distress. A debt crisis refers to a situation in which a country is unable to repay its debt and is usually the case when the country reaches a high debt-level and suffers from low economic growth.

The crisis in Turkey is reminiscent of other debt emergencies across the world, especially those building up in the developing world. Where the other debt crises (e.g., the debt crisis of the 1980s and early 2000s) generally involved government borrowing, the current situation in Turkey and a majority of developing countries is mostly private sector driven, thus raising fears that this crisis may potentially escalate and quickly turn to contagion.

The IMF has identified two issues that amplify the risks associated with the current public debt levels in low-income countries. First, there has been a marked change in the composition of debt since the completion of the Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiatives (MDRI), pushing up servicing costs and making debt resolution harder. Second, reliable assessments of debt vulnerabilities require complete data sets, which are often not available for low-income countries. The new forms of private creditor often come at shorter maturities and higher interest rates, yielding more substantial debt service burdens. However, even where the terms from these private sector lenders appear favorable, unlike the Paris Club members, the private actors do not have ready mechanisms for coordination with other creditors, which is likely to make any needed debt resolution more difficult.

A majority of developing countries have sought for more private-sector investment because debt relief and western aid has witnessed a considerable decline over the last few years. However, the absence of domestic revenue or foreign aid is not a carte blanche for countries to pursue borrowing recklessly and hiding under the economic mantra that “borrowing for domestic investment” is good. The IMF has found evidence that a significant number of developing countries have used borrowed funds to finance current consumption(s).  Even when the loans are directed at capital projects, most of those projects are not productive and do not deliver the cash flows that are required to repay the loans in the future. Furthermore, private sector lenders have limited or no incentive to enforce straight compliance with terms of the credits for obvious reasons. Thus, as more developing countries consider options to finance domestic investment, caution should be taken in the determination of the source of financing and the viability of the projects to be untaken. Anything short of this will divert future revenue away from essential social services and sustain the vicious cycle of poverty in the developing world.

For Further Reading:

Are we heading for another developing world debt crisis?

IMF: Managing debt vulnerabilities in Low-Income and Developing Countries

Jubilee Debt Campaign

Why Turkey debt crisis could be different

A Debt Crisis Seems to Have Come Out of Nowhere.

Thanks for sharing !

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