High debt burdens leave low-income countries vulnerable to crises
WE KNOW THAT BORROWING makes sense for all countries — rich and poor — if it finances schools, hospitals, and physical and digital infrastructure. These are smart investments that can boost growth and improve the economic wellbeing of individuals and communities.
This is especially true for low-income countries and emerging economies that tend to have a lower capital base to start with, and where global capital is likely to be the most productive. But we also know that, over the past decade, government debt as a proportion of GDP has reached new highs. In advanced economies, public debt is at levels not seen since the Second World War. Emerging markets’ public debt is at levels last seen during the 1980s debt crisis. And if recent trends continue, many low-income countries will face unsustainable debt burdens.
In emerging markets and low-income countries, the buildup shows the impact of rapid spending, only partly used for public investment. And let us not forget the impact of various shocks — from low export prices for commodity producers to natural disasters, conflicts, and epidemics, which hit low-income countries hard.
The bottom line is that high debt burdens have left many governments more vulnerable to a sudden tightening of global financial conditions and higher interest costs. For emerging market and frontier economies, concerns about debt levels in this environment could contribute to market corrections, sharp exchange rate movements, and further weakening of capital flows. How fast should public debt be reduced? What are the best conventional and unconventional tools for debt reduction? And how can we encourage more effective debt restructuring processes?
Developing new policies and sharing fresh ideas can help move the sovereign debt needle in the right direction.
But rapidly growing debt burdens could jeopardise their development goals, as gov-
ernments spend more on debt service and less on infrastructure, health and education. High debt can also create uncertainty, which deters investment and innovation. We estimate that the median debt level among low-income countries increased from 33 per cent of GDP in 2013 to 47 per cent. Low-income countries often have a more limited capacity to raise public revenue and carry debt.
Again, this buildup of debt reflects a range of factors — from low commodity prices, to natural disasters and civil conflict, to high investment spending on projects that were not productive. Of course, ample global liquidity made it easier for governments to borrow more — which brings me to the lenders.
Historically, low-income countries relied on international institutions and traditional bilateral creditor countries, which can use the Paris Club to co-ordinate their actions on debt issues. Today, low-income countries rely more heavily on non-traditional lenders — from bond investors to foreign commercial banks, to commodity traders, to creditor countries outside the Paris Club. The shift towards new borrowing sources generally means higher interest rates and shorter maturities. Borrowing from non-paris Club lenders also means that creditor co-ordination will likely become more complicated.
Managing these debt vulnerabilities is critical. We estimate that 40 per cent of low-income countries already face significant debt challenges. A key challenge is preventing “debt surprises,” which can be driven by poor governance, off-balance sheet borrowing, and weak debt recording and reporting.
So, what can governments do? It is worth remembering that the word “credit” comes from the Latin word for “trust”— which underpins the financial system. Let me highlight three policy priorities that can help make a difference in low-income countries. First, greater effo=rts are needed to make borrowing more sustainable. This means proceeding prudently in taking on new debt, focusing more on attracting foreign direct investment, and boosting tax revenues at home. It means focusing on investment projects with credibly high rates of return. It also means increasing the responsibility of lenders, who need to assess the impact on the borrower’s debt position before providing the new loans.
Second, we need to ensure that all countries adhere to rigour and transparency in their borrowing and lending. For example, there is room to significantly strengthen the institutions that record, monitor, and report debt in individual countries.
One-third of low-income countries do not report debt guarantees for state-owned enterprises; and fewer than one in 10 report debt of public enterprises. Greater transparency can help prevent these contingent liabilities from turning into massive government obligations.
The IMF is using its debt sustainability analysis to shine a light on potential risks. Last year, we conducted assessments in 55 low-income countries, and we are now rolling out our new enhanced debt sustainability framework for these economies.
Third, we need to encourage stronger collaboration between borrower countries and lenders. For example, we have seen a sharp rise in the number of cases where debt contracts are not publicly disclosed by either the borrower or the lender. By working together, both parties can ensure better disclosure, which reduces risk and increases accountability. We also need better collaboration to prepare for debt restructuring cases that involve non-traditional lenders. With substantial non-paris Club debt, we need to think about new ways in which official creditor co-ordination — often so critical to debt crisis resolution — can take place.
If obstacles that inhibit smooth debt restructuring can be addressed, the IMF would more easily play its traditional role in providing financial support and acting as a catalyst for additional flows, including from the World Bank and other major lenders.
We are deeply engaged in this reform process by providing advice and a platform for dialogue.
Let me conclude with the adage that trust arrives on foot, but leaves on horseback. Building trust in sovereign borrowers is now more important than ever, especially for low-income countries.
We need to ensure that all countries adhere to rigour and transparency in their borrowing.”