A helping hand

Developed economies should pitch in to stop debt crises in developing economies

Since 2020, more and more developing countries have fallen into debt difficulties. Among middle-income countries, Argentina, Lebanon and Sri Lanka have one after the other experienced debt crises. Among low-income countries, more than 60 percent of countries have been diagnosed by the International Monetary Fund as highrisk or already in debt distress.

In 2021, the total external debt of low-income countries reached $250 billion, accounting for 50 percent of their gross national income and equaling 2.3 times their exports. There are growing concerns that more countries will fall into a debt crisis.

Amid the global headwinds, no country can make itself an exception. A systemic and effective debt resolution mechanism is not only urgent for developing countries but also essential for developed countries as well. Prosperity and stability cannot be realized in a world where the poor are becoming poorer while the rich get richer.

From the perspective of building a community with a shared future for mankind, a powerful economy should take on its responsibility by providing more public goods for global economic stability and prosperity rather than taking a beggarthy-neighbor stand. Developed economies that take the lead in recovery should help the rest of the world recover and make sincere attempts to alleviate the negative spillover effects of their monetary policy adjustments.

Why should developed economies contribute to alleviating the debt burdens of developing countries?

First of all, history shows that the negative spillover effects of monetary policy adjustment in developed economies are usually an important external factor triggering debt crises.

From the perspective of interest rates, both the United States and the Europe Union have tightened their monetary policies to fight high inflation, which results in higher interest rates and tougher financing conditions in the international financial market. This will significantly add to the debt servicing burden and financing costs of developing countries, and make it much more difficult for countries to roll over their debts.

From the perspective of exchange rate and cross-border capital flows, the rise of US dollar index and interest rate will make non-US dollar assets less appealing, generate pressure of capital outflows, currency devaluation and asset price adjustment on other countries, and result in higher risk of liquidity crisis in developing countries.

From the perspective of external demand, the shift in the US’ and Europe’s monetary policies will also exert downward pressure on the global economy, and the economic momentum of developing countries will also be affected by the decline in external demand.

Second, the financial institutions of developed economies are the main private creditors of many emerging and developing countries.

Since 2021, creditors from the private sector have accounted for 61 percent of the total sovereign external debt of low- and middle-income countries. Compared with official creditors, funds from private creditors are mostly non-concessional with higher interest rates and shorter maturities, which takes up a large proportion of the intolerably large debt servicing burden for many developing countries.

Take Zambia, which recently fell into debt crisis, as an example. BlackRock, a US-headquartered financial institution, holds about 7 percent of Zambian government bonds (worth about 220 million US dollars). However, the institution enjoys a high interest return of more than 8 percent even after Zambia applied for debt service suspension support and started restructuring negotiations with other official creditors under the G20 Debt Service Suspension Initiative (DSSI) and the Common Framework (CF) for Debt Treatment after the DSSI.

Finally, developed economies have the ability and advantage to lead other creditors to participate in debt governance cooperation. Although the DSSI and CF under the G20 call for all creditors’ participation, the reality is disappointing: neither private creditors nor multilateral official creditors, have joined these debt resolution initiatives. As these non-participating creditors hold more than 2/3 of the total external debts of countries eligible for the DSSI, it is no wonder that debt negotiations cannot go smoothly due to the imbalanced benefits/costs allocations among creditors.

Developed economies have great advantages in breaking such dilemma and bringing more creditors to the negotiation table. On the one hand, governments of developed countries such as the US can do a lot in enhancing the legal environment for sovereign debt negotiations and organizing private creditors, as most international sovereign bonds are issued under the US or UK law system and most bondholders are financial firms in the jurisdiction of developed countries such as the US. On the other hand, developed economies such as the US and the EU are also major shareholders of multilateral institutions such as the World Bank, which can provide support for their participation in debt relief.

How can developed economies contribute to alleviating developing countries’ debt dilemma?

First, developed economies should try their best to avert a systemic financial crisis or global economic recession caused by overly fast or excessive contraction of monetary policy, and strengthen macro policy coordination with other countries.

Due to their highly developed financial system, there may be systemic risks within the developed economies, especially in the nonbank financial sector and the marginal economies in the monetary union system that lack supervision.

Therefore, developed economies should adjust their macro policies more cautiously and minimize the negative spillover effects. Through the G20 and other platforms, developed economies should strengthen macro policy coordination with other economies and markets, enhance the predictability of their policy adjustments, and reduce the “secondary damages” caused by over reflection of policies or market panic.

Second, developed economies can help resolve the coordination difficulty in debt disposal negotiations with their financial and legal advantages.

There is coordination difficulty because the private creditors are overly decentralized. Governments of developed economies such as the US can create a good environment for their private sectors to participate in debt negotiations by taking the lead in promoting the establishment of creditor committees representing their financial institutions, assisting in coordination with credit rating agencies, and even providing credit guarantees.

Multilateral institutions may have the concern that their participation in debt reduction will damage their credit ratings and they will lose their preferential financing capacity. Developed economies, as the major shareholders of these institutions, can provide them with support for capital increase and share expansion, so as to achieve a win-win result, driving multilateral institutions to join debt reduction while maintaining their credit ratings.

Third, developed economies should provide risk-hedging mechanisms for the negative spillover effects of their monetary policy adjustments.

They can provide more public goods to alleviate the debt plight of developing countries by increasing capital for international institutions such as the International Monetary Fund and the World Bank, promoting the redistribution of the Special Drawing Rights from the surplus countries to the deficient countries, and participating in debt negotiations under the G20 Common Framework.

Developed economies can also increase the amount of bilateral currency swaps with central banks of other countries, and fulfill their historical commitments of spending more than 0.7 percent of their gross national income on foreign aid and providing developing countries with $100 billion in climate change financing. The author is an assistant researcher of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, and the International Strategic Think Tank. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

SONG CHEN / CHINA DAILY