How to ease rising external debt-service pressures
AS 2024 starts, the good news is that there haven’t been any notable requests by a low-income country for comprehensive debt relief since Ghana’s, more than a year ago. Despite this, vulnerabilities remain, with high debt servicing costs a growing challenge for low-income countries.
Financing pressures due to relatively high interest payments and the pace at which low-income countries need to repay debt are straining budgets. That prevents these countries from spending more on essential services or the critical investment needed to attract business, create jobs, improve prosperity, and build climate resilience.
One important metric is the share of revenues the government collects from its population through taxes and other fees that goes to pay its foreign creditors. While the scale of the burden differs greatly across countries, it’s generally about two and a half times higher than a decade earlier.
This means for a typical low-income borrower the share has risen to about 14 percent, from about 6 percent, and as much as 25 percent, from about 9 percent in some economies. This is one of the key indicators used in the framework for assessing debt sustainability that signals a country might be at risk of needing financial support from the IMF or of missing a debt payment.
Low-income countries also have significant debt repayments falling due in the next two years. They need to refinance about $60 billion of external debt each year, about three times the average in the decade through 2020.
But with many competing demands for financing, including from advanced and emerging market economies that are also trying to adapt to climate change, there’s a significant risk of a liquidity crunch—failure to raise sufficient financing at an affordable cost. That could in turn lead to a destabilizing debt crisis. To address this financing challenge, we must understand why it’s happening and what affected countries and the broader international community can do to help.
Exacerbating liquidity squeeze
One factor was higher government borrowing and deficits to mitigate the impact of the pandemic and other external economic shocks. This has increased the level of debt and consequently the cost of servicing it. It’s encouraging that this trend is reversing as countries bring primary deficits back in line with pre-pandemic levels.
In addition, central banks have significantly raised borrowing costs to tame inflation. That makes it costlier for governments to raise new debt or refinance existing debt. While central banks may be done raising rates, it is not clear when they will start to cut, and this uncertainty may be reflected in volatile financial market conditions.
Low-income countries have also increas- ingly borrowed from the private sector — with about one third of financing coming from private creditors in the last decade compared with about one fifth in the previous decade.
This reflected a slowdown in financing from multilateral development banks (MDBs) in the earlier part of the decade and through official development assistance (ODA) agencies over 2020-22 compared to borrowing needs. This shift has increased both financing costs and vulnerability to global financial shocks.
Avoiding a costly debt crisis
Building resilience in the face of these trends requires countries to act. Some countries have made progress— for instance, Angola,The Gambia,Nigeria, and Zambia have taken steps to implement significant energy subsidy reforms to create space for development spending.
But many are lagging behind, especially in efforts to increase revenues, such as broadening the tax base, reducing tax exemptions, and increasing the efficiency of tax administration. For instance, the typical Sub-Saharan African country raised only 13 percent of gross domestic product in revenues in 2022, compared with 18 percent in other emerging economies and developing countries and 27 percent in advanced economies. — IMF News