Life after debt — II

Mahmoud Mohieldin
Tuesday 25 Jun 2024

Growing global economic fragmentation is exacerbating the debt crisis facing the developing world, writes Mahmoud Mohieldin in the second of two articles

 

The World Economic Outlook Report released by the World Bank some days ago tries to strike an optimistic note on global growth.After having slowed for three consecutive years, this is now “holding steady” and “appears to be in the final approach for a ‘soft landing,’” the report says. But then come some thunderous bangs and dissonant screeches, and we are reminded that the world has been unable to find its way back onto the path of promised prosperity.“Global growth,” the report says, “is stabilising at a rate insufficient for progress on key development goals – 2.7 per cent a year on average through 2026, well below the 3.1 per cent average in the decade before Covid-19.”Even 3.1 per cent was not sufficient to attain these goals, which require higher, more inclusive, and longer-lasting growth.

The report says that by the end of 2024, 25 per cent of the developing nations will be poorer than they were before the pandemic. About 50 per cent will see their per capita income gap widen between them and the advanced economies.

The deterioration in international economic cooperation makes prospects for growth grimmer still. With international trade restrictions tripling from pre-pandemic levels, the flow of foreign direct investment (FDI) into the developing economies has declined by nine per cent while financial flows to them have generally turned negative due, inter alia, to debt repayments and servicing obligations.

These are the signs of a global economic fragmentation that belies all the hoopla about the wonders of cooperation and pushes the UN Sustainable Development Goals (SDGs) further out of reach.

Amidst the present onrush of global crises, the developing countries are facing more than their fair share of burdens. They are doubly strained by the impacts of climate change on livelihoods. Some lack the wherewithal for digital transformation and the ability to benefit from artificial intelligence (AI).

Of more pressing and graver concern, many are reeling beneath a debt crisis that, as I mentioned in my previous article, is rapidly affecting their development capacities. Due to declining rates of growth and rising interest rates, these countries’ debt-servicing obligations have come to surpass their allocations for health, education, and other basic services combined.

According to a recent report by UN Trade and Development (UNCTAD), 12 developing countries spend more on interest payments than on public education and 34 spend more on interest payments than on public healthcare.

It goes without saying that development cannot be achieved through such a waste of resources that should be invested in human capital. This is not about past development performances needing improvement or a present riddled with obstacles and complications we wish would go away. What is at stake here is a future worthy of the coming generations, who have a right to the same opportunities to enjoy, at least, the same standards of living as their peers elsewhere in the world.

The “moral hazard effect” may help us better understand the situation. This occurs when certain incentives or conditions induce a change in behaviour that leads to a higher willingness to take unnecessary risks. For example, a person might be more inclined to drive at faster speeds if they know that their insurance company will compensate them for the results of an accident. How does the idea of moral hazard apply to the current debt crisis?In the past, despite the heavy tolls incurred by debt, there were paths that could be taken to remedy the problem. In 2000, the official creditors that make up the Paris Club of countries were responsible for around 40 per cent of the loans to the developing economies, compared to 44 per cent from other international lenders. This made it easier to come up with solutions to ward off possible defaults through restructuring, rescheduling, writing off portions of the debt, or waiving service fees.

There were many debt-management initiatives of this sort that I will discuss in a further article.

Today, however, the situation is very different. The Paris Club official creditors now control less than a quarter of the loans for which they were responsible at the turn of the century. Other international financial institutions remain at a 45 per cent share. Crucially, however, the private-sector share of the debt has increased from nine to 25 per cent, in tandem with the growing involvement of lenders from emerging markets.

This new structure of debt liabilities has put paid to effective debt-settlement mechanisms for faltering economies. The road to a remedy has become long, rocky, and uncertain, and it could hamper the prospects of obtaining new loans, especially in the event of a downgrade of a country’s credit rating.

Countries staring the spectre of default in the face would rather avoid such bleak and hazardous options. So, instead of rescheduling their debt, they desperately try to tread water by making sacrifices, even if that means cutting back on investments in human capital and development.

Some developing economies may be enticed by temporary palliatives, seizing on an improvement in the credit environment, such as lower interest rates, to take out more loans. However, I call for something more important that goes beyond the management of liquidity, assets, and debt to the need to overhaul financing growth and development as a whole.The new approach I advocate rests, firstly, on domestic savings and resources; secondly, on long term foreign direct investment; and thirdly, on strict controls over the recourse to loans from abroad, even if concessionally facilitated.I will discuss these pillars and their associated conditions in a forthcoming article.

 

This article also appears in Arabic in Wednesday’s edition of Asharq Al-Awsat.

* A version of this article appears in print in the 27 June, 2024 edition of Al-Ahram Weekly

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