WASHINGTON – Developing countries face a catastrophic debt crisis in the coming months as rapid inflation, slowing growth, rising interest rates and a stronger dollar combine in a Perfect storm that could unleash a wave of defaults and cause economic pain to the world’s most vulnerable people.
Poor countries owe, by some estimates, up to 200,000 million of dollars to rich nations, multilateral development banks and private creditors.
Rising interest rates have increased the value of the dollar, making it more difficult for foreign borrowers with US currency-denominated debt to repay loans.
Defaulting on a huge swath of loans would make borrowing costs for vulnerable nations even higher and could lead to financial crises when almost 100 million people have already been pushed into poverty this year by the combined effects of the pandemic, inflation and Russia’s war in Ukraine.
The danger poses another headwind for a global economy that has been sputtering toward recession.
In recent weeks, the leaders of the world’s advanced economies have privately debated how to avoid financial crises in emerging markets such as Zambia, Sri Lanka y Ghana,but have struggled to come up with a plan to expedite debt relief while grappling with their own financial woes.
As rich countries brace for a global recession and try to cope with high food and energy prices, investment flows to the developing world have slowed and large creditors, particularly China,have been slow to restructure the loans.
Massive defaults in low-income countries are unlikely to trigger a global financial crisis, given the relatively small size of their economies.
But the potential is making policymakers rethink debt sustainability at a time of rising interest rates and increasingly opaque loan transactions.
In part, this is because defaults can make it more difficult for countries like the United States to export goods to indebted nations, further slowing the global economy and potentially causing widespread hunger and civil unrest.
As Sri Lanka neared default this year, its central bank was forced to strike a barter deal to pay for Iranian oil in tea leaves.
“Finding ways to reduce debt is important for these countries to come to light at the end of the tunnel,” David Malpass, president of the World Bank, said in an interview at the Group of 20 summit in Bali last month ( Indonesia).
“This burden on developing countries is heavy, and if it continues like this, they keep getting worse, which then reverberates in advanced economies in terms of increased migration flows and loss of markets”.
The urgency stems from lockdowns to contain the coronavirus in China and Russia’s war in Ukraine, which have slowed global production and skyrocketed food and energy prices.
The Federal Reserve rapidly raised interest rates in the United States, reinforcing the strength of the dollar and making it more expensive for developing countries to import basic necessities for populations already struggling with rising prices.
Global economists and financial institutions, such as the World Bank and the International Monetary Fund, have sounded the alarm about the seriousness of the crisis.
The World Bank forecast this year that about a dozen Countries could default within the next year, and the IMF estimated that 60% of low-income developing countries were in debt distress or at high risk of being so.
Since then, the finances of developing countries have continued to deteriorate.
The Council on Foreign Relations said this past week that 12 countries now had their highest default rating, up from three 18 months ago.
Brad Setser, a member of the Council, calculates that it is necessary to restructure 200,000 million dollars of sovereign debt in emerging markets.
“It’s certainly a systemic problem for the affected countries,” Setser said.
“Because an unusually large number of countries borrowed from the market and borrowed from China between 2012 and 2020, there are an unusually large number of countries that are in default or at risk of default.”
Debt restructuring may include granting repayment grace periods, lowering interest rates, and forgiving part of the principal amount owed.
Traditionally, the United States has spearheaded broad debt relief initiatives, such as the “Bonos Brady” for Latin America in the 1990s.
However, the emergence of commercial creditors lending at high interest rates and prolific lending by China – which has been reluctant to take losses – have complicated international debt relief efforts.
Fitch, the credit ratings firm, warned in a report last month that “more defaults are likely” in emerging markets next year and lamented that the so-called Common Framework that the Group of 20 established in 2020 to facilitate debt restructuring “is not proving effective in resolving crises quickly.”
Since the framework was established, only Zambia, Chad and Ethiopia They have applied for debt relief.
It has been a very complicated process, in which committees of creditors, the International Monetary Fund and the World Bank have intervened, which must negotiate and agree on how to restructure the loans that countries owe.
After two years, Zambia is finally on the verge of restructuring its debts with Chinese state banks, and Chad last month reached an agreement with private creditors, including Glencore, to restructure its debt.
Bruno LeMaire, French finance minister, said progress with Zambia and Chad was a positive step, but there was much more work to be done with other countries.
“Now we must speed up,” Le Maire said on the sidelines of the Group of 20 summit.
China, which has become one of the world’s largest creditors, remains an obstacle to relief.
Development experts have accused it of tending “debt traps” to developing countries with its loan program of more than 500,000 million dollars, which has been described as predator.
“It’s really about China not being willing to admit that its lending has been unsustainable and dragging its feet to make deals,” said Mark Sobel, a former Treasury Department official and US chairman of the Monetary Institutions Forum. and Official Financial
USA he has regularly urged China to be more accommodating and complained that Chinese loans are difficult to restructure due to opaque terms of the contracts.
He has described China’s lending practices as “unconventional”.
“China is not the only creditor holding back from quickly and effectively applying the typical playbook,” said Brent Neiman, a counselor to the Treasury secretary, Janet Yellen,in a speech delivered in Washington in September.
“But across the international credit landscape, China’s non-participation in coordinated debt relief is the most common and the most consequential.”
China has accused Western trade creditors and multilateral institutions of not doing enough to restructure debts and has denied predatory lending.
“They are not ‘debt traps,’ but monuments of cooperation”Wang Yi, China’s foreign minister, said this year.
China’s own economy is slowing down due to its strict “zero COVID” policy, which has included mass testing, quarantines and lockdowns of its population.
A domestic housing crisis has also made it difficult for China to accept losses on loans it has made to other countries.
IMF officials will travel to Beijing next week for a “1+6” roundtable with the leaders of the major international economic institutions.
During those meetings, they will help China better understand the debt restructuring process through the common framework.
Ceyla Pazarbasioglu, director of the IMF’s department of strategy, policy and review, acknowledged that agreeing on the terms of debt relief could take time, but said she would convey the urgency to Chinese officials.
“The problem we have is that we don’t have time right now because countries are very fragile when it comes to dealing with debt vulnerability,” Pazarbasioglu, who will travel to China, told reporters at the IMF last week.
At the annual meetings of the IMF and World Bank in Washington in October, policymakers said the pace of debt restructuring was too slow and called for coordinated action between creditors and borrowers to find solutions before it was too late.
During a roundtable discussion on debt restructuring, Gita Gopinath, the IMF’s first deputy managing director, said countries and creditors should avoid the kind of wishful thinking which led to the defaults.
“There is a big tendency to bet on the bailout,” Gopinath said.
“There is a lot of tendency for creditors to wait for redemption, and then nothing is resolved.”
But as the Group of 20 meeting concluded in November, little progress appeared to have been made.
In a joint statement, the leaders expressed concern about the “deteriorating debt situation” in some vulnerable middle-income countries. However, they offered few concrete solutions.
“We reaffirm the importance of the joint efforts of all actors, including private creditors, to continue working on improving debt transparency,” the statement said.
The statement included a footnote saying that “a member has divergent views on debt issues.”
That country, according to people familiar with the matter, was China.
In the interview, Malpass said China had been willing to discuss debt relief, but “the devil is in the details” when it comes to restructuring loans to reduce the debt burden.
The World Bank president predicted that the fiscal problems facing developing countries were unlikely to escalate into a global debt crisis like the one that occurred in the 1980s, when many Latin American countries were unable to pay the service of its external debt.
However, he suggested that there is a moral imperative to do more to help poor countries and populations that have been plunged into poverty during the pandemic.
“There will be continued setbacks in development in terms of poverty, in terms of hunger and malnutrition, which are already increasing,” Malpass said.
“And it comes at a time when countries need more resources, not less.”
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