🎧 Debt Déjà Vu: Learning from Previous Waves of Debt Crises to Weather Current and Future Storms
Many low-income countries are facing a resurgence in their debt burdens. How did we get back here?
Many low-income countries are facing a resurgence in their debt burdens. How did we get back here?
Even before the onset of the COVID pandemic, many low-income countries were facing a resurgence in their debt burdens, including among past recipients of large-scale debt relief from multilateral and bilateral creditors. The Director of the Intergovernmental Group of Twenty-Four, Marilou Uy, joins IEG’s Jeff Chelsky to discuss the conditions that steered low-income countries into the current wave of debt crisis, the expected shocks as the Debt Service Suspension Initiative expires, and possible paths development organizations can take to prevent a new crisis.
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Jeff Chelsky: Even before the onset of the COVID pandemic, many low-income countries were facing a resurgence in their debt burdens, including among past recipients of large-scale debt relief from multilateral and bilateral creditors. How did we get here? or maybe more appropriately, how did we get back here?
Welcome to What Have We Learned? a podcast focused on the lessons learned from tackling pressing challenges in international development. I'm your host, Jeff Chelsky, Manager of the Economic Management and Country Programs Unit at the World Bank Group's Independent Evaluation Group, IEG. Today, we're going to talk about debt sustainability. Specifically, the resurgence over the last several years in the debt burden carried by low-income countries.
Let me start by talking briefly about why governments borrow. Just like for businesses, borrowing is an important source of financing for all economies, developed and developing. Borrowing allows countries to finance investments that must be paid for upfront, but for which the benefits accrue over longer periods of time. The presumption is that the social and economic returns on the investments will be greater than the interest rate paid on the money borrowed to finance it. And of course, governments might also borrow to finance counter cyclical spending, for example, to support their economies in the face of large but temporary economic shocks such as COVID.
So why is this a problem now, and for low-income countries in particular? Well, there are a lot of reasons for the surge in borrowing by low-income countries over the last decade. This includes a prolonged period of low commodity prices, which negatively affected the revenue on which many low-income countries depend to pay for the functioning of government and to service debt. At the same time, global interest rates have been low by historical standards. Many governments have taken advantage of lower interest rates and increased borrowing, including to finance infrastructure and other public investments. Concurrently, the supply of available financing increased as investors look for higher yields.
But not only did many low-income countries expand borrowing, they did so increasingly from more costly sources, including capital markets and commercial lenders. Add to that large scale lending by some non-Paris Club creditors on terms that were frequently opaque and non-concessional, and you have the situation we see today.
Low-income countries are, by definition, heavily resource constrained. This makes it particularly important that the benefits of borrowed resources exceed the cost of servicing the associated debt. This requires the kind of capacity in areas such as public finance management, public expenditure management, public investment management, and debt management that low-income country governments generally lack.
While the erosion of debt sustainability has been evident for much of the last decade, it has most certainly deteriorated further during the pandemic. A range of global initiatives have been launched by major donors, creditors, and creditor groups such as the G-20, IMF and the World Bank to help countries already laden with debt weather this storm. This includes the Debt Service Suspension Initiative (DSSI), which has delivered more than 5 billion in relief to more than 40 eligible countries and the G-20 Common Framework for Debt Resolution. The World Bank has also implemented the Sustainable Development Finance Policy (SDFP) to incentivize countries to address some of the shortcomings that contributed to the resurgence in debt levels.
Against this backdrop, I've invited my friend and former colleague, Marilou Uy, to discuss the origins of the problem and actions that institutions like the World Bank can take to help alleviate its impact on the achievement of global development goals. Marilou is Director of the G-24, the Intergovernmental Group of 24 countries on international monetary affairs and development. She's also a member of the task force on Climate and Development at the IMF. Prior to taking on her role at the G-24 she was the Senior Adviser to the Managing Director at the World Bank and also served as Sector Director for the Africa Financial and Private Sector Development Department and Director of the Financial Sector Operations and Policy Departments at the World Bank.
Marilu, before turning to the topic at hand, could you explain a bit more about the G-24, particularly for those of our listeners who may not be familiar with it?
Marilou Uy: Thanks, Jeff. And thank you for inviting me to this podcast and for the kind introduction. The Group of 24 is a forum of developing countries whose principles are the finance ministers and the Central Bank governors. The group has had a long history of advocating for the interests of developing countries, especially on issues of monetary and financial affairs, including development financing. So just as a few examples, we've advocated for a much stronger global financial safety net and the availability of liquidity support in times of stress. We've also sought improvements in the in the system for sovereign debt resolutions. And we've advocated for much stronger or more development financing from the international community and international financial institutions. We reflect our priorities in communiqués issued twice a year at the margins of the IMF and the World Bank Group Spring and Annual Meetings.
JC: Thanks very much. Let's turn to the issue of debt and low-income countries. Seeing the current debt crisis, it's hard not to feel a feeling of déjà vu. Following the granting of unprecedented levels of debt relief to the poorest countries, the World Bank and the IMF were to have helped put in place systems, and mechanisms, and policies, and other support to avoid this very situation. What happened?
MU: You gave a very good introduction on what happened in terms of debt trends and the structures of debt, especially in low-income countries. Now, were countries concerned? yes, they were. As early as 2018, they expressed strong concern about the rapid debt buildup, particularly sovereign and market-based debt. They sought increased support from the IMF and the World Bank Group, particularly on building capacity for more proactive debt management. They also sought technical assistance for public investment management, recognizing that perhaps they could use better the borrowed resources to invest in activities that would spur growth, which of course is key to debt sustainability.
Did the World Bank Group and the IMF respond? Yes, they did. They started the Multipronged Approach to Address Debt Vulnerabilities, and through this approach, key components ramped up their assistance for public debt management as well as enhancements in debt transparency and debt reporting. So, yes, there was concern at that time about debt vulnerabilities in developing countries. Now, I do want to mention something about the structure of debt that you brought up earlier on: the decline in concessional financing to low-income countries. While low-income countries were increasingly borrowing from financial markets, they were also receiving less concessional financing from the traditional donors. I mention this to highlight the need for more international cooperation to increase concessional financing for low-income countries. What’s happening with IDA20 is an example of increased interest on the value of concessional resources for low-income countries.
JC: A big part of this borrowing was directed to finance the Sustainable Development Goals and a lot of it was for infrastructure, which raises the issue of public investment management. IEG’s Evaluation of World Bank Group Support to Public Financial and Debt Management, pointed out that while the World Bank provided significant support for debt management capacity building, it did not provide equal support for low-income countries’ public investment management. And public investment management is about being able to identify the most impactful projects, essentially trying to get the best value for money. It's not just about the efficiency of the investment, it's making sure that you choose the right projects. Is this something that you see as problematic? Is it the case, perhaps, that a lot of this borrowing went to finance less than productive investments, or at least investments that underperformed relative to expectation?
MU: Well, there were assessments, as early as in 2019, of how countries used their borrowed resources. While many low-income countries invested more in infrastructure, some others, perhaps many others, were also using fiscal resources primarily for consumption purposes. From that trend alone, it clearly was worthwhile looking at how countries were using borrowed resources, with market terms and using them in areas where they could support growth and ensure debt sustainability in the future.
JC: So, in essence, from a debt-to-GDP perspective, debt was going up and GDP wasn't responding accordingly.
MU: Yes, while there were improvements in growth, they probably were helped by other factors rather than productivity improvements in the country.
JC: You referenced the resolution of debt problems and this is clearly going to need the involvement of the full range of creditors. While Paris Club creditors such as the Europeans, Canadians, Americans, provide a forum for bilateral creditors to coordinate action, not all the current major creditors are members of the Paris Club, most notably China. And non-Paris Club creditors now account for more than twice the outstanding external debt as do Paris Club creditors therefore any solution is going to require the engagement of non-Paris Club creditors. How do we bring them to the table?
MU: There is an acknowledgement in global forums, such as the G-20, of the need for a forum of creditors beyond members of the Paris Club. That was the origin of the G-20 Common Framework for Debt Treatments where G-20 lenders are all on the table of negotiators. Including China, which is, of course, the largest lender outside of the Paris Club. So that's one important progress in creditor coordination.
Now, that said, the experience from the three low-income countries that have used the Common Framework suggests that more work needs to be done to give developing countries the confidence that the process is effective and expeditious. These processes of sovereign debt resolution are very lengthy so it's hard to get the confidence that countries will benefit from the process in a timely way.
Now, that is not to say that countries do not have a role. In fact, countries will need to take the lead in seeking debt resolution when they need it, and the required creditor coordination to achieve it. That of course, is much easier said than done. A major concern of developing countries is loss of market access as their debt situation worsens. It was very notable that during the time of the DSSI, some low-income countries were very concerned about the credit rating downgrades that could happen if they availed for of that debt relief.
JC: Let me turn to a slightly different topic. As I mentioned at the outset, the resurgence of debt stress happened before the COVID pandemic. What does COVID mean for low-income countries and the sustainability of their debt burdens?
MU: There's quite a lot of data on what has happened to public finances because of COVID. And the increase in debt burdens has been quite enormous in some countries, and that's not a surprise, because their fiscal revenues also declined substantially.
Moreover, developing countries will also need to be prepared for the worst. If the risk of financial market tightening grows and interest rate increases unravel as advanced countries ease out of accommodative policies, that clearly is a risk. An immediate risk.
Achieving, or restoring, debt sustainability is going to be an important issue going forward. An essential part of getting on the path towards debt sustainability is growth. Therefore, a key concern of developing countries would be how to engineer that growth sooner rather than later.
This will depend on actions at the country and international levels. At the country level, policymakers will face difficult tradeoffs in how they use their limited resources, so it's even more important that they work towards better systems to manage these fiscal resources well. In addition, strong international assistance is critical at this difficult time.
JC: IEG’s evaluation of the World Bank Group's Support for Addressing Country Level Fiscal and Financial Sector Vulnerabilities makes the point, and draws on some preexisting evidence, that a lot of debt sustainability analysis is based on overly optimistic assumptions about growth. And in many ways, this derives from earlier discussions of the investment growth nexus which indicates that a lot of the borrowing was undertaken with the expectation that it would contribute to growth, to the extent that a lot of debt sustainability analysis was overly optimistic. How do we ensure that that doesn't happen again and that we are making decisions about public resource allocation based on realistic expectations of what the growth impact will be?
MU: I believe this was one of the important lessons from the IMF and World Bank frameworks on debt sustainability. There have been efforts to examine the realism of the assumptions behind these frameworks, both for low-income countries as well as for market access countries. One other factor is how frequently you update the frameworks, given that circumstances change drastically from year to year. Debt sustainability assessments with large gaps in between may not be useful for countries or may fail at catching sudden changes in the paths towards debt sustainability. More frequent debt sustainability assessments, possibly covering more countries, might be important given that a traditional characteristic of projections, as you know, is the tendency towards over optimism. So, one must guard against this by being much more vigilant on providing debt sustainability assessments to low-income countries and market access countries.
JC: And I guess a part of that is closer scrutiny of the quality of the investments that are supposed to be fueling growth.
MU: Yes. And there have been efforts to take greater account of the quality of investments in developing countries. And I think that's a very notable and worthy effort by both the IMF and the World Bank Group. IEG’s finding about putting more effort on assessing the quality of public investments is really a very important lesson going forward.
JC: The issue of debt transparency has been getting increasing attention, particularly from the World Bank and the IMF. As I mentioned earlier, a lot of the debt that low-income countries incurred was, shall I say, opaque? Often there were non-disclosure agreements on the terms of the lending, and in retrospect, we've seen that a lot of the lending itself was not particularly concessional. To what extent is debt transparency a priority issue and how has it contributed to the current resurgence of debt stress?
MU: Debt transparency is an essential part of being able to manage your debt appropriately. Without the data, it is simply hard to assess whether debt is growing fast, or at the speed that you think is appropriate for your economic circumstances. There also are important gaps in debt reporting. IEG’s evaluations mention the gaps on state owned enterprises, contingent liabilities for state owned enterprises. Additionally, there is lending where the contracts are not, let's say, fully transparent and where much more digging is needed to discover the terms in the contract. There is also the issue of collateralized debt which alarmed quite a few lenders. So, there is room for greater improvements in the way debt is disclosed and reported.
JC: Assuming we get past this crisis and deal with the most urgent challenges, including helping low-income countries manage their large and growing debt burdens. How do we lower the probability of a resurgence of such problems in the future? What is or at least should be the role of the World Bank in this?
MU: A lot has been written about how countries have managed recurrent debt crises. I certainly agree with a recent World Bank publication that examines the historical experience of periods of waves of debt and concludes that the solutions are not simple, nor is there a silver bullet. But there are some basic recommendations. Domestically, building institutions to manage public finances well, including debt, matter greatly. I see the importance of the World Bank Group's role in providing realistic debt sustainability assessments so countries can plan well on actions to reduce vulnerabilities.
Strengthening debt management and the management of the use of fiscal resources are two highly related pieces of work. They also go hand in hand with improving domestic revenue mobilization and domestic financial markets, which will lessen dependence on external borrowing. And of course, reforms to promote growth are an important part to achieving debt sustainability. These are all part and parcel of a medium-term agenda to support policies and institutions that lead to effective macroeconomic management and an environment that promotes growth, an agenda which the World Bank Group has historically supported and should continue to support well.
International cooperation is quite critical. One of its roles is to increase the availability of development financing, and particularly concessional financing and grants for low-income countries, to accelerate investments to promote a recovery - and sustain a recovery. Regarding debt management specifically, collective action is necessary to facilitate timely sovereign debt resolutions and give countries the confidence that they can go through the process and return to economic growth and debt sustainability sooner rather than later. In both these cases the World Bank Group can play catalytic roles.
JC: One last question. Should we have seen this coming?
MU: Probably yes. I believe that there was quite a bit of euphoria when growth restarted post crisis and I think that at least low-income countries and developing countries were experiencing very rapid rates of growth at that time. And so, with that, it was okay to borrow. However, as you know, with the global outlook being so uncertain, shocks come, and then the growth picture changes. So, I would have said in hindsight, we probably should have seen this coming, especially when debt was building up. But that probably is easier said than done. And it's not surprising that policymakers get caught by surprises in global shocks, but also, in terms of domestic shocks.
JC: I guess the adage that there are only two things that are certain in life, and that's death and taxes, probably needs to be expanded to death taxes and the fact that the party will end?
MU: Yes, probably.
JC: Fair enough. Fair enough. Which I think is in many ways the subject of the IEG Evaluation that I mentioned on Addressing Country Level Fiscal and Financial Sector Vulnerabilities. It asks the question, outside of the context of the crisis, do we do enough to build the resilience so that when shocks come, they don't have the kind of impact they do?
Let me thank you for your time and your insights. This has been great, and I hope we can do this again. I'd like to thank Marilou Uy for the excellent exchange ideas.
Anyone interested in reading the three IEG evaluations on this topic that I referred to, the World Bank Support for Public Financial and Debt Management at IDA-eligible Countries, World Bank Group Contributions to Addressing Country Level Fiscal and Financial Sector Vulnerabilities, and the early-stage evaluation of the World Bank Group's Sustainable Development Financing Policy, can visit the IEG macroeconomic and debt topic page on the IEG website. This has been What Have We Learned? the evaluation podcast from the Independent Evaluation Group, IEG. Stay tuned and stay safe.