Opinion: Debt problems are contagious

go through Patrick E. Shea

Countries around the world are heading for a debt crisis. A slowing economy and rising inflation have increased demand for spending, making it nearly impossible for many governments to pay back what they owe.

Under normal circumstances, these countries could simply replace old debt with new debt. But international conditions make it more difficult to do so. As a result, some people close to their repayment deadlines simply cannot meet. Sri Lanka and Zambia are already in arrears, throwing the two countries into economic chaos and potentially signaling looming global problems.

Reserves dwindle

One of the main reasons for this worrying situation is that countries around the world are basically forced to borrow in dollars or euros and keep foreign reserves for future debt payments. But these reserves face other important needs. They need to buy oil and other imports, as well as maintain the credible value of their national currency.

Unfortunately for many emerging economies, they simply don’t hold enough reserves to meet all of these needs — especially after energy prices soared after Russia’s invasion of Ukraine. At the same time, foreign currency has become more expensive to buy as the Federal Reserve and the European Central Bank are raising interest rates. Sri Lanka reportedly has no reserves, while Pakistan is said to operate on a monthly basis.

Countries typically issue new bonds (think of them as tradable IOUs) to roll over old ones, and the process works well—until it doesn’t work. No emerging countries issued any new bonds in July, a sign that investors are concerned about the risk of low currency reserves and are no longer interested in lending to them.

Since the start of the pandemic, China has also scaled back its lending to limit its exposure to global risks. So without a bond market or China, countries are turning to other sources of credit. Kenya and Ghana, for example, recently used bank loans to alleviate budget shortfalls. While the exact terms of these loans are unclear, banks typically demand higher interest rates and shorter repayment terms, which may only increase the level of financial stress in a country.

Others are turning to some of the oil-rich Gulf states that are currently profiting from high energy prices. Egypt and Pakistan receive loans from Saudi Arabia, the United Arab Emirates (UAE) and Qatar, while Turkey also borrows from the UAE. These loans may be a welcome lifeline, but they also create opportunities for rich countries to effectively buy influence and generate dependencies.

Overall, many factors are working against some of the world’s poorest and most indebted countries. If a global debt crisis does occur, political turmoil is expected to follow. Sri Lanka’s default sparked widespread protests that forced the president to resign. Research shows that extremist parties perform better after the financial crisis.

fluidity

But it is not too late for the international community to help avoid that.

First, the US and EU should slow down the pace of rate hikes. As the United Nations has warned, these interest rate hikes by the United States and the European Union have slowed global growth and are draining countries’ foreign exchange reserves.

It is also unclear whether these rate hikes are addressing domestic inflation. If richer countries want to reduce inflation without triggering a global debt crisis, they should lower trade barriers that artificially inflate prices. For example, both the United States and the European Union impose tariffs on imported agricultural products, which raise food prices for consumers.

Second, the International Monetary Fund (IMF) should abandon or at least relax the austerity requirements associated with its emergency lending. For example, Zambia’s new agreement with the International Monetary Fund calls for lower government subsidies for fuel and food when prices rise. Politically unpopular, these policies have instead encouraged countries to turn to China and oil-rich countries for help.

Those countries forced to borrow from the IMF face the risk of inciting extreme political factors. Now is not the time to pursue orthodox fiscal demands whose validity is questionable. Instead, in these difficult economic conditions, the IMF should prioritize global liquidity.

transparency

Finally, China should play a leading and transparent role in debt negotiations. Many countries facing debt problems owe China money, a process that is often kept secret. For example, we know that China has agreed to participate in restructuring talks in Zambia, but has not done so in Sri Lanka. China has provided emergency loans and debt relief to Pakistan and Argentina, but the effectiveness or extent of such aid is unclear.

A more transparent approach would reduce uncertainty in global markets and allow other creditors to coordinate with China. While Chinese lending has so far been opaque, more transparency would benefit China’s overseas investments as well as global debt markets.

Time is running out for many debt-troubled countries to face repayment dates. Debt problems are contagious, such as the Latin American debt crisis in the 1980s, the Asian financial crisis in the 1990s, and the Eurozone debt crisis in the 2010s. The international community should work together to avoid another global economic spiral and help millions avoid unnecessary suffering.

(The author is Senior Lecturer in International Relations and Global Governance at the University of Glasgow. theconversation.com)