4.7. The role of international debt

4.7. The role of international debt

What is International Debt?

Like individuals and families who borrow money to pay for a house or an education, countries borrow money from private capital markets, international financial institutions, and governments to pay for infrastructure such as roads, public services, and health clinics; to run a government ministry; or even to purchase weapons. Also like individuals, countries must pay back the principal and interest on the loans they take out. But there are important differences between individuals and countries. If a person borrows money, he or she receives the money directly and can use it for purposes benefiting the borrower. But if a country borrows money, the citizens are not necessarily notified or informed of the purpose of the loan or its terms and conditions. In practice, some governments have used loans for projects that do not meet minimum standards of social, ecological, or even economic viability. At times, these loans have been used to enrich a small group of people.

In other cases, although the money was used for legitimate purposes, financial conditions beyond the government's control made loan repayment impossible. Another difference between individuals and countries is that a business or a person who falls on hard times and cannot meet his or her financial obligations over time goes bankrupt. A court is appointed to assess the debtor's situation and banks acknowledge that the debtor cannot fully pay his or her debts. But countries cannot file for bankruptcy. There is no such procedure, no arbitrator. At the international level, the creditors, not a court, decide whether and under what conditions to require a country to pay its debt.

How Did the Debt Crisis Come About?

The causes of the current debt crisis are complex, rooted in economic policies and development choices going back to the 1970s and 1980s. When the Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of oil in 1973, OPEC nations deposited much of their new wealth in commercial banks. The banks, seeking investments for their new funds, made loans to developing countries, often hastily and without monitoring how the loans were used. Some of the money borrowed was spent on programs that did not benefit the poor, such as armaments, failed or inappropriate large scale development projects, and private projects benefiting government officials and a small elite. Meanwhile, as inflation rose in the U.S., the U.S. adopted extremely tight monetary policies that soon contributed to a sharp rise in interest rates and a worldwide recession. The irresponsible lending on the part of creditors, mismanagement on the part of debtors, and the worldwide recession all contributed to the debt crisis of the early 1980s.

Developing countries were hurt the most in the worldwide recession. The high cost of fuel, high interest rates, and declining exports made it increasingly difficult for them to repay their debts. During the rest of the decade and into the 1990s, commercial banks and bilateral creditors (i.e., governments) sought to address the problem by rescheduling loans and in some cases by providing limited debt relief. Despite these efforts, the debt of many of the world's poorest countries remains well beyond their ability to repay it.

The Impact of International Debt

Poor countries pay a high price to service their debt, and this cost is particularly born by people living in poverty. The massive debt payments that poor countries owe to rich countries and to multilateral creditors like the World Bank and International Monetary Fund (IMF) take resources away from investments that benefit ordinary people and contribute to social and economic development. According to Oxfam International's April 1997 report, Poor Country Debt Relief, "Debt repayments have meant health centers without drugs and trained staff, schools without basic teaching equipment, and the collapse of agricultural extension services." The obligation to meet debt service payments also means that aid from other countries like the United States is often used to refinance debt payments rather than improving health care, education, and other social services.

The International Monetary Fund and the World Bank require economic restructuring (Structural Adjustment Programs, or SAPs) before a country can qualify for debt relief. These requirements can include reducing inflation, removing price controls, reducing tariffs and other restrictions on foreign trade, and government downsizing. While in the long run they may help a country become more competitive in the global market, in the short run they can lead to local business failures in the face of global competition, massive lay-offs, lower wages, and even less investment by government in education, health, and other social programs.

The debt crisis can also affect the environment. International debts have to be paid back in creditors' currencies, or so-called "hard currencies" like U.S. dollars. This may have exacerbated the harmful environmental practices that prevail in many countries, as governments and entrepreneurs mine their natural resources in order to generate hard cash.

The debt burden carried by impoverished countries affects citizens in the rich countries as well. Environmental damage has global repercussions. Widespread poverty means that people have less money to buy goods and services from other countries. Debt reduction for the poorest countries would not represent a new or unique policy for the United States. Over the years, we have substantially reduced debts owed by Poland, Jordan, and Egypt. After Word War II, Germany's debt was substantially reduced in order to allow it to rebuild. We have also on occasion reduced debts owed by African countries. In these cases, the U.S. has recognized that debt reduction can be sound foreign policy.

Discussion Questions

1 Who are the winners and losers in the international debt crisis?

2 What are the obligations of creditors in this crisis, and what are the obligations of debtors?

3 How is international debt similar to, and different from, personal debt? Should international bankruptcy provisions be established?

4 What are some possible solutions to the international debt crisis?

Information in this handout is based on materials from the USCC Department of Social Development and World Peace, Catholic Relief Services, the International Co-operation for Development and Solidarity (CIDSE), Caritas Internationalis, The World Bank, The International Monetary Fund, Oxfam International and Jubilee 2000/USA.

Source: http://www.usccb.org/issues-and-action/human-life-and-dignity/global-issues/debt-relief/what-is-the-international-debt-crisis.cfm, accessed Wednesday, 2^nd December 2015

External Debt

Many of the world’s poorest countries are saddled with high levels of external debt owed to other governments, institutions such as the IMF and foreign companies, banks and individuals. The near $5tn of external debts owed by developing countries costs them more than $1.5bn a day in repayments – and much of that comes from the poorest countries.

· Most of the world’s poorest countries have limited access to international capital markets – their sovereign debt does not have an official credit rating

· Without conditional loans from the IMF, World Bank and others, they would have to pay interest rates many times higher on private sector loans

· Some developing countries have chosen to borrow from other emerging economies such as China or Brazil as a way of avoiding conditional loans from international institutions

· Countries with persistent trade deficits end up accumulating large external debts, so too a government where spending greatly exceeds annual tax revenue leading to high fiscal deficits

· A country defaulting on loans will find it harder and more expensive to attract future loans.

· External debts can act as a severe constraint on growth and development – often times, the interest payments on existing public sector debt takes up a large percentage of a nation’s export revenues or annual tax revenues.

· These debt repayments have an opportunity cost; they might be better used in supporting development policies such as investment in health and education to boost the human capital of the population.

• In some cases countries have become heavily indebted requiring rescheduling of the debt payments and/or conditional assistance from international organisations including the IMF and World Bank - see documents HIPCI and MRDI

To what extent should richer nations be prepared to write-off external debts of poor countries?

The Jubilee Debt Campaign pushes for debt cancellation and debt relief avoiding where possible conditions built into debt reduction agreements that create further problems for vulnerable countries.

One option is to reschedule debt payments and change the nature of the interest rate paid on these loans.

In July 2012 a United Nations report made the case for introduced indexed loan repayments where the interest rate is tied to a country’s rates of economic and/or export growth. This would help balance the risk of loans more equally between lender and borrower. In good years when growth of GDP is strong, the borrower country would repay more of their debts. During hard times (i.e. a recession caused by a fall in export revenues), the rate of interest on debt would fall.

External Debt Data

The stock of developing countries’ external debt increased to $4.9 trillion at end 2011, but at an average of 22 percent, remained moderate in relation to Gross National Income (GNI), and to exports (69 percent).

High income countries have, on average, a much higher level of external debt: 126 percent of GDP for G7 countries in 2011 compared to 19 percent for the top ten developing countries. General government debt (external and domestic) is also much higher, with an average of 76 percent in Euro-zone (17) countries in 2011, more than twice the comparable ratio for the largest borrowers among developing countries.

Djibouti (East Africa)

The Djibouti government’s external debt has increased significantly over the last decade from 40 per cent of GDP in 2001 to 70% in 2009, and now stands at $700 million. For 2012, the IMF predicts the government will spend 14 per cent of revenues on foreign debt payments. Since 2001, over 70 per cent of lending to the country has been from multilateral institutions such as the IMF, World Bank and African Development Bank. In May 2012 the IMF agreed to lend a further $10 million to help the country meet its debt and import payments. As part of the loan programme the Djibouti government has agreed to reform diesel fuel subsidies, freeze any hiring in the public sector, except for health and education and freeze public sector pay, except for the lowest salary band. Inflation is 4% this year.

Djibouti has not yet been considered eligible for the Heavily Indebted Poor Countries (HIPC) initiative, which allows countries to have some debts cancelled in return for following IMF and World Bank economic policy conditions.

Source: Jubilee Debt Campaign Website, accessed, August 2012

Brazil writes off debt of African nations

In May 2013, the Brazilian government announced that it plans to cancel or restructure almost $900m in debt owed by African countries. The move is designed mainly to expand Brazil's economic ties with Africa and fast forward the growth of trade and investment between emerging countries and regions. In the aftermath of this move, Brazil’s future aid assistance is likely to target infrastructure, agriculture and social programmes. Among the 12 countries set to benefit are Tanzania, which owes Brazil $237m, along with oil-producing Republic of Congo and copper-rich Zambia.

Source: Adapted from newspaper reports, May 2013

World Bank on Debt Relief for the world's poorest countries

Heavily Indebted Poor Countries Initiative (HIPCI)

This is an initiative to provide debt relief to heavily indebted low-income countries. Under the initiative, the International Monetary Fund and World Bank calculate the proportionate reduction required in the country’s external debts in order to return them a level <150% of the value of the country’s annual exports – this is considered to be a sustainable level. All creditors – multilateral, bilateral and commercial – are expected to provide the proportionate reduction to achieve this. The Ivory Coast is an example of a country that has benefited from HIPCI – it has been granted external debt relief of $7.7bn. As a result the stock of Ivorian public debt decreased from 69% of GDP in 2011 to 40% of GDP in 2012.

Increasingly stark choice for many emerging economies - Borrow from Bretton Woods Institutions or China

The burden of debt has led to pressure to cancel the debt of heavily indebted countries and call for the return of capital controls to assist LEDC development