As foreign currency is generated through export earnings and can be used to pay off foreign debts, a key indicator of a high level of debt is the ratio of debt service payments to exports. According to the United Nations Conference on Trade and Development (UNCTAD), this indicator rose from 8.7 per cent in 2011 to 15.4 per cent in 2016 in all developing countries. Another indicator is the ratio of interest payments to government revenue. Interest payments in some countries of sub-Saharan Africa amounted to 30 per cent of the fiscal revenue, according to the UNCTAD.
A high level of foreign debt holds back a country’s development because it has to use the money for debt service payments and can no longer allocate it to key investments for achieving the Sustainable Development Goals, such as investments in infrastructure or social expenditure. This being the case, a high level of foreign debt is also a cause of poverty.
Causes of debt
There are both internal and external causes behind this critical debt situation. The main internal causes are low government revenues due to inefficient tax policies and corruption. According to IWF estimates, tax revenues as measured against gross domestic product amount to around 15 to 25 per cent in developing countries and around 35 per cent in industrialised countries. Weaknesses in the areas of Good Financial Governance and rule of law also play a role. Another internal cause is poor debt management. For one thing, loans are often used for the consumption of goods rather than for productive investment. For another, countries often fail to negotiate favourable terms of payment. To make matters worse, employees working at the ministries of finance often lack sufficient qualifications.
Among the external causes of indebtedness are mainly exogenous shocks. Structural problems such as a poorly diversified economic and export structure and a focus on raw materials can, for example, leave a country highly vulnerable to fluctuations in price and demand on the global market. Many developing countries have also been impacted by natural disasters such as floods or storms. Another factor is commodity prices, which were in decline between 2011 and 2017, resulting in lower export earnings in many developing countries. Moreover, many of these countries are especially vulnerable to the effects of climate change.
Change in the Debt Structure
The type of debt has also changed. First of all, developing countries have significantly increased their borrowing at market conditions. The share of public debt at market conditions relative to total debt of low-income countries rose to 46 per cent in 2016. These represent more expensive and higher-risk financial sources, some of which were made feasible through a hasty and premature integration into the international financial markets. The new lenders – one of them China – provided many countries in sub-Saharan Africa with a series of loans at market conditions in order to finance infrastructure projects, among other things.
Secondly, the governments of developing countries have significantly increased their financing through private creditors, since funding from public bilateral and multilateral creditors was not sufficiently available. On the other hand, private creditors were able to provide loans at favourable conditions due to low global interest rates. The share of external public debt to private creditors relative to total debt rose from 41 per cent in 2000 to 60 per cent 2016, according to the UNCTAD.
At the same time, government bond markets have greatly expanded in both local and global currencies, especially in the last five years, and contributed to an increase in foreign debt in countries such as Nigeria, Ghana and Vietnam. Even bonds in local currencies can increase foreign debt because foreigners often hold a considerable part of the local bonds.
Thirdly, private actors from developing countries are also increasingly incurring foreign debt. According to the UNCTAD, the share of private, non-guaranteed debts relative to long-term foreign debts rose from 28 per cent in 2000 to nearly 50 per cent in 2016. The debt situation in developing countries is also influenced by the level of domestic debt, which has likewise risen significantly in the last five years.
Nor does the future look much better for the debt situation in developing countries, given that global interest rates will likely rise, leading to a higher level of debt in the developing countries.
Policy measures against over-indebtedness
In order for the developing countries to be able to reach their Sustainable Development Goals and use their financial resources for investments rather than debt services, a range of measures is needed from developing countries and the international community. The developing countries themselves should reduce their debt levels through increased government revenues. This would require the development of an efficient tax system.
Within this context, it is also important to establish a broader, more effective system for managing public debt. This also includes the improvement of capacities for managing public debt and a suitable debt structure with regard to maturity and the composition of domestic and foreign currencies. At the same time, effective debt management also contributes to greater transparency and data completeness of the debt situation in developing countries. To buffer against exogenous shocks, these countries should increase the diversity of their exports for the long term. To do so, they will need to change their long-term economic structure so as to be able to expand their range of goods for export.
Then there are measures that can be taken by the international community, in particular the expansion and improvement of debt management measures. The international community should also agree on a set of uniform principles for responsible lending and borrowing. So far there have been proposals from the UN, the G20, the OECD and the Institute of International Finance – a coalition of private financial actors. Furthermore, the international community should continue to expand the use of collective clauses, which serve to facilitate the restructuring of government bonds.
Over the long term, insolvency proceedings can also play an important role for states in managing debt crises, given that they are the only comprehensive instrument that all creditor groups can coordinate. An instrument on its own can neither prevent nor manage debt crises, which is why a combination of different instruments is needed.
About the Author:
Dr. Kathrin Berensmann is Senior Researcher of the research programme "Transformation of Economic and Social Systems" at the German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE).