LONDON: 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 percent of their annual income in the early 2000s to just over 30 percent by 2013 – freeing up resources to spend on health, education and infrastructure projects, report agencies.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 percent 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.
AdvertisementHowever, 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.