Debt of developing countries

Debt of developing countries

The debt of developing countries is external debt incurred by governments of developing countries, generally in quantities beyond the governments' political ability to repay. "Unpayable debt" is a term used to describe external debt when the interest on the debt exceeds what the country's politicians think they can collect from taxpayers, based on the nation's gross domestic product, thus preventing the debt from ever being repaid.

The causes of debt are a result of many factors, including:

  • Legacy of colonialism — for example, the developing countries’ debt is partly the result of the transfer to them of the debts of the colonizing states, in billions of dollars, at very high interest rates.
  • Odious debt, whereby debt is incurred as developed countries loaned money to dictators or other corrupt leaders when it was known that the money would be wasted. South Africa, for example shortly after freedom from apartheid had to pay debts incurred by the apartheid regime.
  • Mismanaged spending and lending by the West in the 1960s and 70s.[1]

Some of the current levels of debt were amassed following the 1973 oil crisis. Increases in oil prices forced many poorer nations' governments to borrow heavily to purchase politically essential supplies. At the same time, OPEC funds deposited in western banks provided a ready source of funds for loans. While a proportion of borrowed funds went towards infrastructure and economic development financed by central governments, a proportion was lost to corruption and about one-fifth was spent on arms.


Debt abolition

There is much debate about whether the richer countries should be asked for money which has to be repaid. The Jubilee Debt Campaign gives six reasons why the third world debts should be cancelled. Firstly, several governments want to spend more money on poverty reduction but they lose that money in paying off their debts. Secondly, the lenders knew that they gave to dictators or oppressive regimes and thus, they are responsible for their actions, not the people living in the countries of those regimes. For example, South Africa has been paying off $22 billion which was lent to stimulate the apartheid regime. Also, many lenders knew that a great proportion of the money would sometime be stolen through corruption. Next, the developing projects that some loans would support were often unwisely led and failed because of the lender's incompetence. Also, many of the debts were signed with unfair terms, several of the loan takers have to pay the debts in foreign currency such as dollars, which make them vulnerable to world market changes. The unfair terms can make a loan extremely expensive, many of the loan takers have already paid the sum they loaned several times, but the debt grows faster than they can repay it. Finally, many of the loans were contracted illegally, not following proper processes.[2]

A seventh reason for cancelling some debts is that the money loaned by banks is generally created out of thin air, sometimes subject to a small capital adequacy requirement imposed by such institutions as the Bank of International Settlements. Maurice Félix Charles Allais (born 31 May 1911), 1988 winner of the Nobel Memorial Prize in Economics commented on this by stating “The ‘miracles’ performed by credit are fundamentally comparable to the ‘miracles’ an association of counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases, the stimulus to the economy would be the same, and the only difference is who benefits.”[3]

Critics of the practical point in this argument might question whether or not unpayable debt truly exists, since governments can refinance their debt via the International Monetary Fund (IMF) or World Bank, or come to a negotiated settlement with their creditors. However, this is not an argument that can withstand a glance at the state of the essential services supposedly being provided by many of the heavily indebted countries. There is evidence that governments have financed their debts through instigation of austerity policies directed at essential services and subsidies for essential goods.[citation needed] The history of Mali, for example, from 1968 onwards, provides a clear illustration of this. In fact, the requirement that governments should service debts at the expense of their populations is integral to the strategies adopted by the Washington institutions in 1982 to solve the banking crisis triggered by the Mexican Weekend in August that year. Austerity was one of the ways in which interest payments could continue to be serviced, preventing liquidity problems in the US money-centre banks. The same principle is evident in the design of the Heavily Indebted Poor Countries Initiative. While refinancing has taken place (particularly to lessen private creditor exposure subsequent to 1982) this has come with conditions which have caused a crisis of development. London School of Economics professor Stuart Corbridge has described the 1982 debt crisis as a banking crisis which was transformed into a development crisis, brokered by the Washington Institutions.

Consequences of debt abolition

Some people, such as the anti-globalists argue against forgiving debt on the basis that it would motivate countries to default on their debts, or to deliberately borrow more than they can afford, and that it would not prevent a recurrence of the problem. Economists refer to this as a moral hazard.

Debt as a mechanism in economic crisis

An example of debt playing a role in economic crisis was the Argentine economic crisis. During the 1980s, Argentina, like many Latin American economies, experienced hyperinflation. As a part of the process put in place to bring inflation under control, a fixed exchange rate was put into place between Argentina's new currency and the US dollar. This guaranteed that inflation would not restart, since for every new unit of currency issued by the Argentine Central Bank, the Central Bank had to hold a US dollar against this – therefore in order to print more Argentine currency, the government required additional US dollars. Before this currency regime was in place, if the government had needed money to finance a budget deficit, it could simply print more money (thus creating inflation). Under the new system, if the government spent more than it earned through taxation in a given year, it needed to cover the gap with US dollars, rather than by simply printing more money. The only way the government could get these US dollars to finance the gap was through higher tax of exporters' earnings or through borrowing the needed US dollars. Of course a fixed exchange rate was incompatible with a structural (i.e., recurrent) budget deficit, as the government needed to borrow more US Dollars every year to finance its budget deficit; eventually leading to an unsustainable amount of US dollar debt.

Argentina's debt grew continuously during the 1990s, climbing above $120 billion USD. As a structural budget deficit continued, the government kept borrowing more, creditors continued to lend money, while the IMF suggested less state spending to stop the government's ongoing need to keep borrowing more and more. As the debt pile grew, it became increasingly obvious the government's structural budget deficit was simply not compatible with a low inflation fixed exchange rate – either the government had to start earning as much as it spent, or it had to start (inflationary) printing of money (and thus abandoning the fixed exchange rate as it would not be able to borrow the needed amounts of US dollars to keep the exchange rate stable). Investors started to speculate that the government would never stop spending more than it earned, and so there was only one path for the government – inflation and the abandonment of the fixed exchange rate. In a similar fashion to Black Wednesday, investors began to sell the Argentine currency, betting it would become worthless against the US dollar when the inevitable inflation started. This became a self-fulfilling prophecy, quickly leading to the government's US dollar reserves being exhausted. The crisis exploded in December 2001. In 2002, a default on about $93 billion of the debt was declared. Investment fled the country, and capital flow towards Argentina ceased almost completely.

The Argentine government met severe challenges trying to refinance the debt. Some creditors denounced the default as sheer robbery. Vulture funds who had acquired debt bonds during the crisis, at very low prices, asked to be repaid immediately. For four years, Argentina was effectively shut out of the international financial markets.

Argentina finally got a deal by which 77% of the defaulted bonds were exchanged by others, of a much lower nominal value and at longer terms. The exchange was not accepted by the rest of the private debt holders, who continue to challenge the government to repay them a greater percentage of the money which they originally loaned. The holdouts have formed groups such as American Task Force Argentina to lobby the Argentine government, in addition to seeking redress by attempting to seize Argentine foreign reserves.

Recent debt relief

A number of impoverished countries have recently received partial or full cancellation of loans from foreign governments and international financial institutions, such as the IMF and World Bank.

Under the Jubilee 2000 banner, a diverse coalition of groups joined together to demand debt cancellation at the G7 meeting in Cologne, Germany. As a result, finance ministers of the world's wealthiest nations agreed to debt relief on loans owed by qualifying countries.[4]

A 2004 World Bank/IMF study found that in countries receiving debt relief, poverty reduction initiatives doubled between 1999 and 2004. Tanzania used savings to eliminate school fees, hire more teachers, and build more schools. Burkina Faso drastically reduced the cost of life-saving drugs and increased access to clean water. Uganda more than doubled school enrollment.[5]

In 2005, the Make Poverty History campaign, mounted in the run-up to the G8 Summit in Scotland, brought the issue of debt once again to the attention of the media and world leaders. Some have claimed that it was the Live 8 concerts which were instrumental in raising the profile of the debt issue at the G8, but these were announced after the Summit pre-negotiations had essentially agreed the terms of the debt announcement made at the Summit, and so can only have been of marginal utility. Make Poverty History, in contrast, had been running for five months prior to the Live 8 announcement and, in form of the Jubilee 2000 campaign (of which Make Poverty History was essentially a re-branding) for ten years. Debt cancellation for the 18 countries qualifying under this new initiative has also brought impressive results on paper. For example, it has been reported that Zambia used savings to drastically increase its investment in health, education, and rural infrastructure. The fungibility of savings from debt service makes such claims difficult to establish. Under the terms of the G8 debt proposal, the funding sources available to HIPC countries are also curtailed; some researchers have argued that the net financial benefit of the G8 proposals is negligible, even though on paper the debt burden seems temporarily alleviated.[6]

The 2005 HIPC agreement did not wipe all debt from HIPC countries, as is stated in the article. The total debt has been reduced by two-thirds, so that their debt service obligations fall to less than 2 million in one year. While celebrating the successes of these individual countries, debt campaigners continue to advocate for the extension of the benefits of debt cancellation to all countries that require cancellation to meet basic human needs and as a matter of justice.

To assist in the reinvestment of released capital, most International Financial Institutions provide guidelines indicating probable shocks, programs to reduce a country’s vulnerability through export diversification, food buffer stocks, enhanced climate prediction methods, more flexible and reliable aid disbursement mechanisms by donors, and much higher and more rapid contingency financing. Sometimes outside experts are brought to control the country's financial institutions.

The 2004 Indian Ocean earthquake

When the 2004 Indian Ocean earthquake and tsunami hit, the G7 announced a moratorium on debts of twelve affected nations and the Paris Club suspended loan payments of three more.[7] By the time the Paris Club met in January 2005, its 19 member-countries had pledged a total of $3.4 billion in aid to the countries affected by the tsunami.

The debt relief for tsunami-affected nations was not universal. Sri Lanka was left with a debt of more than $8 billion and an annual debt service bill of $493 million. Indonesia retained a foreign debt of more than $132 billion[8] and debt service payments to the World Bank amounted to $1.9 billion in 2006.

G8 Summit 2005: aid to Africa and debt cancellation

The traditional meeting of G8 finance ministers before the summit took place in London on 10 and 11 June 2005, hosted by then-Chancellor Gordon Brown. On 11 June, agreement was reached to write off the entire US$40 billion debt owed by 18 Highly Indebted Poor Countries to the World Bank, the International Monetary Fund and the African Development Fund. The annual saving in debt payments amounts to just over US$1 billion. War on Want estimates that US$45.7 billion would be required for 62 countries to meet the Millennium Development Goals. The ministers stated that twenty more countries, with an additional US$15 billion in debt, would be eligible for debt relief if they met targets on fighting corruption and continue to fulfill structural adjustment conditionalities that eliminate impediments to investment and calls for countries to privatize industries, liberalize their economies, eliminate subsidies, and reduce budgetary expenditures. The agreement came into force in July 2006 and has been called the "Multilateral Debt Reduction Initiative", MDRI. It can be thought of as an extension of the Heavily Indebted Poor Countries (HIPC) initiative.

Opponents of debt cancellation suggested that structural adjustment policies should be continued. Structural adjustments had been criticized for years for devastating poor countries.[9] For example, in Zambia, structural adjustment reforms of the 1980s and early 1990s included massive cuts to health and education budgets, the introduction of user fees for many basic health services and for primary education, and the cutting of crucial programs such as child immunization initiatives.

Criticism of G8 debt exceptions

Countries that qualify for the HIPC process will only have debts to the World Bank, IMF and African Development Bank canceled. Criticism was raised over the exceptions to this agreement as Asian countries will still have to repay debt to the Asian Development Bank and Latin American countries will still have to repay debt to the Inter-American Development Bank. Between 2006 and 2010 this amounts to $1.4 billion (USD) for the qualifying Latin American countries of Bolivia, Guyana, Honduras and Nicaragua.[10]

See also


External links

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