Developing countries and debt sustainability

The global financial crisis which erupted in 2008 has raised the spectre of external debt difficulties for a larger group of countries. Reduced export earnings have diminished the resources available to service existing debt while balance - payments difficulties have required a number of developing countries to increase their external borrowing.

These developments point to the need for a broader multilateral framework if the international community is to deliver fully on its commitment in the Millennium Declaration to “deal comprehensively with the debt problems of developing countries.”

Export revenues of developing economies nearly doubled between 2003 and 2007, giving countries more resources with which to service their external debt. For the average developing country, the burden of servicing external debt fell from almost 13 percent of export earnings in 2000 to four percent in 2007. The ratio declined in every region but remained above 10 percent in Western Asia in 2007 and was between five and 10 percent in Latin

America and the Caribbean, and South Asia, in that same year. In all other regions, it had fallen below five percent by 2007. In the last quarter of 2008, however, export revenues of developing countries began to fall because of the global economic crisis. Although consistent up-to-date data are not available at the time of writing, the ratio of debt-service payments to export revenue for developing countries is expected to have reversed its downward trend in 2008.

The global economic showdown has affected the external debt situation of developing countries through a variety of channels which mostly originate in the decline in export earnings that has afflicted the majority of developing countries. The situation has been particularly severe for the commodity-exporting countries because of the decline in both the quantities and the prices of commodity exports after mid-2008. The fall in foreign earnings encountered by most developing countries increased the burden of existing debt-servicing obligations in relation to exports.

The collapse in export receipts has been accompanied by higher costs for imported food and fuel, resulting in overall balance-of-payments difficulties for many developing countries. Some developing countries had built up their foreign-exchange reserves when export revenues were growing rapidly and have been able to use such reserves to finance shortfalls over the short-term. In some countries (such as Brazil, Kenya, South Africa and Thailand), strains on the balance of payments, coupled with the turmoil in world financial markets, have resulted in depreciation of national currencies.

The weakened external payments position has been accompanied by a deterioration in many developing-country fiscal positions. Depreciations have increased the domestic cost of servicing external debt and have raised the ratio of debt to gross national product (GNP). At the same time, the fall in export earnings has reduced foreign-currency earnings from taxes on such exports as minerals and, to the extent that imports have been curtailed, from import duties and value added tax (VAT). On the other hand, devaluations will have boosted government revenues from these trade taxes in the national currency.

Where a country’s external debt was large initially, the increased cost of servicing debt is likely to outweigh the revenue benefits of currency depreciation. Countries with large foreign-exchange reserves or fiscal stabilization funds may be able to cushion the effects of a decline in public revenues. In other countries, a weakened fiscal position and the need to meet debt-service obligations may put public expenditures on development activities in jeopardy unless additional resources are forthcoming.

Many developing countries that lack domestic resources require additional external resources to help counteract the impact of the crisis, but borrowing could pose serious risks for countries that already have a high debt burden.

The IMF has identified 28 countries with debt in excess of 60 percent of gross domestic product and its simulations suggest that the debt ratios of another three countries could exceed this level if they undertook additional borrowing to cover the shortfalls in their external financing.

Some post-completion point HIPC countries that already have elevated levels of debt distress may be among those that face difficulties. On the other hand, HIPCs that have not yet reached their completion point should be able to achieve debt sustainability with the potential debt relief available to them under the HIPC and MDRI initiatives. Overall, however, the crisis is aggravating the external debt situation of countries that have not received debt relief in the recent past and is compromising the progress made under these two initiatives.

Apart from the increased difficulties of servicing debt and borrowing funds to finance larger balance-of-payments deficits, many developing countries - even those that do not have debt-servicing problems - have faced problems in rolling over their increasingly large stock of existing private sector external debt, particularly corporate borrowing, since the global availability of credit in this regard has declined precipitously as a result of the financial crisis. Where available, interest rates for such credit have risen.

At their meeting in April 2009, the leaders of the Group of Twenty (G-20) reached agreement on a number of arrangements to increase the external financing available to developing countries. They announced as $ 1.1 trillion package both to help affected countries meet the immediate financial needs that have arisen from the crisis and to boost economic activity worldwide. Of this amount, the IMF was expected to triple its resources from $250 billion to $ 750 billion. At its meeting on April 26, 2009, the World Bank/IMF Development Committee underlined the need to translate these commitments into action and urged all concerned to provide the additional resources.

At the Conference on the World Financial and Economic Crisis and its Impact on Development in June, United Nations Member States agreed that debtor countries could seek, as a last resort, to negotiate agreements on debt standstills to help mitigate the adverse effects of the crisis for a larger group of countries.

Reduced export earnings have diminished the resources available to service existing debt while balance-of payments difficulties have required a number of developing countries to increase their external borrowing. These developments point to the need for a broader multilateral framework if the international community is to deliver fully on its commitment in the Millennium Declaration to “deal comprehensively with the debt problems of developing countries.”

From the MDG Gap Task Force Report 2009 titled “Strengthening the Global Partnership for Development in a Time of Crisis