Back in July 2005, the G8 summit at the Gleneagles hotel in Scotland announced a package of aid and debt relief for the world’s poorest countries. The event marked the high point of international development cooperation and was supposed to put the finances of low-income nations on a permanent sustainable footing.
For a while, optimism seemed well founded. Public debt for those countries that qualified for help dropped from an average of 100% of their annual income in the early 2000s to just over 30% by 2013 – freeing up resources to spend on health, education and infrastructure projects.
Now warning signs are flashing that another debt crisis is approaching, with concerns being raised not only by development campaign groups but by the International Monetary Fund and the World Bank. The IMF says 40% of low-income countries are either in debt distress or at high risk of being so. The Bank says debt in poor countries is a “rising vulnerability”.
Explaining how the world came to be on the brink of debt crisis 2.0 is relatively simple. It all began in the depths of the financial crisis just over a decade ago, when the response to the threat of a second Great Depression led to interest rates being slashed, to central banks boosting the supply of money through quantitative easing (QE), and to countries supporting growth through packages of tax cuts and public spending.
The biggest such fiscal package by far was announced by Beijing and it was instrumental not only in turning round the Chinese economy but also in hastening recovery elsewhere. China’s exceptionally high growth rates meant it needed oil, industrial metals and raw materials, and this was a boon to those developing countries rich in commodities.
Commodity prices rose just as all the money created by QE was looking for a home. Investors had a choice. They could plump for developed economies where growth and interest rates were low. Or they could be more daring and invest in emerging and developing countries where the risks and rewards were higher. Many opted for the latter course and as a result lending to low-income countries increased sharply. Much of the lending was from the private sector rather than the multilateral organisations, such as the World Bank, and so tended to be made at higher interest rates.
Poor countries, assuming that the commodity boom would go on forever, borrowed in foreign currencies. Sometimes the money was spent on projects designed to improve the growth capacity of their economies; too often, according to the World Bank, it was spent on current consumption.
However, the commodity boom was actually a bubble and, like all bubbles, it burst. Poor countries found themselves hit by a quadruple whammy: falling demand for their exports, lower commodity prices, higher global interest rates and depreciating exchange rates, which made their foreign-currency denominated debt more expensive to repay.
Not all low-income countries are in trouble but the IMF has warned that emerging market debt has returned to levels last seen in the early 1980s, when overborrowing brought a crisis to Latin America.
Nor are high levels of indebtedness confined to the poorer parts of the world because public debt as a share of national output in advanced countries is at its highest since the second world war. It took time for the debt crisis of the 1980s to migrate from the periphery of the global economy to its core. Today there are already worries about debt sustainability in Italy. Little wonder, then, that the IMF is concerned about the possibility that the current slowdown in the global economy turns into something more serious.
If another debt crisis does erupt, the international community is not well placed to deal with it. There is much less of a willingness to cooperate than there was in the early 2000s and a complete absence of leadership. In 2005 rich countries had solid growth and felt able to devote time to sorting out problems beyond their shores. Now they are more concerned about domestic issues.
The other big problem is the lack of a structure to deal with another debt crisis if and when it arrives. Ideally, there would be a bankruptcy procedure for countries to match those that operate for companies and individuals, and such a scheme – a sovereign debt restructuring mechanism – was floated in the early 2000s by the IMF’s then deputy managing director, Anne Krueger, in the wake of Argentina’s default. Intense opposition by the US killed off Krueger’s blueprint and, despite its current concerns, the IMF has no plans to revive it.
There are, though, things that could be done to prevent and mitigate a future debt crisis. The IMF has proposed a three-step process in which countries would take greater care to ensure any borrowing could be repaid, that there be comprehensive and transparent recording of public debts and that there should be greater collaboration between creditors to take into account the fact that much of the recent lending has been by China.
The Jubilee Debt Campaign has gone further. It is calling for the G20, which represents the leading developed and emerging economies, to set up a public registry of loan and debt data. All governments and multilateral institutions would commit to disclosing their loans to the registry. The UK and the US – and other relevant jurisdictions – would insist that for a loan to a government to be enforceable in the courts it would have to be publicly disclosed on the register within 30 days of the contract being signed.
This is a sensible suggestion. It would not deal with the stock of debts already accumulated – but it would help prevent a bad situation from getting worse.
