THE BURDEN OF EXTERNAL DEBT

Entering into debt distress is often a painful process, which may threaten macro-economic stability and set back a country’s development for years.

ADEREMI MEDUPIN

 Two broad types of debt 

Let us start with the most obvious but essential restatement: public debt or sovereign debt falls into two broad categories: domestic and foreign. Happily, both are self-explanatory but the latter is the more problematic and hence the focus of our discussion. Foreign or external debt represents the amount a country (both public and private sector) owe to other countries. As simplified on online Economics page, foreign debt can involve:

• Outstanding loans to foreign private banks (both principal and outstanding interest)
• Due payments to international organizations, notably the world Bank and IMF

• Outstanding payments for a current account deficit, with country owing money for imports

Debt includes both i) short-term liabilities –embracing loans which need to be paid in near future (usually within one year); and ii) long-term liabilities – that is, loans which are scheduled to be repaid over a longer term.

The most critical concern about sovereign debt is its sustainability by the debtor-nation. This importance registers in Nigeria through the establishment of a Debt Management Office (DMO) that monitors and guides the government on that index. Although the easiest guide is to look at the level of external debt to GDP, increasing attention is being given to debt service-to-revenue ratio as the more realistic measure of sustainability. This explains the basis for the argument made by the Lagos Chamber of Commerce and Industry (LCCI) in April 2022 against the federal government’s position with emphasis on Debt-to-GDP ratio, insisting instead, that: “the government must review its borrowing parameters on the basis of the country’s Debt-to-Revenue Ratio, which currently calls for concerns”. Thus, whereas there are no precise rules for when external debt becomes a problem, a key factor is whether a country can satisfactorily meet debt interest payments from export earnings.

Origins and rationale of public debt

Extant literature shows that sovereign debt and its associated challenges are not a new phenomenon. Of course, as Richard M. Salsman noted while examining the subject on in his 336-page book, “The Political economy of Public Debt” published in 2017, private borrowing existed since recorded history and preceded the development of public borrowing by many centuries. However, with time, “public borrowing became common, even as it initially involved loans in kind (commodities) instead of in money, for shorter rather than longer periods, and for war or idiosyncratic purposes rather than as a permanent funding source”.

In contemporary era, public debt has assumed the norm with growing public expenditure rationalized on the premise of the so-called Wagner’s Law couched as the law of increasing state spending which holds that for any modern economy, public expenditure rises with growing national income. More recently, fuel has been added to the rationalization fire by Keynesian economists who while seeking to preserve the capitalist economic system acknowledge its weaknesses of inherent instability and incapacity to guarantee full employment without huge spending by government. The combined outcome of these intellectual offerings is the fiscal deficit experienced across literally all the economies of the world and the inevitable resort to public borrowing with its consequences of problematic status.

In the Foreword to the 2020 World Bank Group’s publication entitled: “Global Waves of Debt-Causes and Consequences”, its President, David Malpass, provided an insightful update on debt at the global scene, recalling how, “Waves of debt accumulation have been a recurrent feature of the global economy over the past fifty years  . . . and has reached $55 trillion in 2018”.

According to the United Nations Department of Economic and Social Affairs (UNDESA), the root cause of the debt problem stems from a combination of two factors:

1. Lack of proper predictability of economic models, as they misguided policy makers; the models did not factor in market imperfections, information asymmetry, complexities of behavioural economics and the financial industry and as such their predictability results have come into question; and
2. Weak governance of economic policy design and implementation; even though globalization has fast integrated the world, the laws, policies and institutional mechanisms remain fragmented and do not induce confidence.

Whichever factor is rated as more influential, the experience of African countries depicts an unsavory scenario.

The African story

The first point to note is that there is in effect a debt trap for developing economies especially those on this continent. The basic story line is that African countries were structured by the colonial masters to transfer their wealth to them even after independence all in the name of servicing bad debt. Statistics show that Africa has been transferring its resources to the developed countries since 1985, from as low as 1.7 billion in 1985 to nearly 7 billion by 1997 and the situation has only worsened. In essence, therefore, Africa’s wealth is being repatriated back to the richer countries in the West, just like in the colonial era. The only difference is that this time, it has been hidden under the tag of “debt servicing”.

Fiona Robertson has pinpointed six reasons “why Africa’s debt crisis could be here to stay”, based especially on the COVID-19 experience and shared on November 17, 2021 via online platform, One, along with its damaging effects, namely:

i) African countries’ debt rose to US$625 billion during the pandemic. Countries around the world spent significant amounts of money in 2020 to combat the health and economic impacts of the coronavirus. This spending made sense to tackle COVID-19 — but even before the pandemic, many African countries were already nearing the limits of how much spending they could afford. Despite the existing strain, debt across the continent rose a further US$45 billion or by 8% in 2020. Twenty-one African countries are either bankrupt or at high risk of going bankrupt.

ii) African countries spent US$58 billion on debt repayments in 2020. Despite initiatives to reduce debt repayments during the pandemic, most creditors still got paid. The Debt Service Suspension Initiative (DSSI) has helped postpone US$10.3 billion in repayments to G20 countries so far. And the IMF cancelled about US$850 million for the poorest countries. But private-sector creditors received US$34.3 billion (or 60% of the total) in repayments in 2020, including bondholders, banks and other private sources. And high-income governments, as well as international organizations like IMF and World Bank, still received a significant amount in repayments: US$12.8 billion and US$10.7billion, respectively.

iii) The World Bank lent more money but didn’t suspend debt. The World Bank announced that it mobilised US$157 billion to fight the pandemic. But once repayments are factored in, debt inflows from the World Bank to Africa were lower in 2020 than in 2019. Overall, African countries received US$17 billion from official lenders, up from US$14 billion in 2019.

iv) Private lenders received more in debt repayments than they lent in 2020. Private lenders received US$8 billion more in debt repayments than they lent to African countries. This means that they prioritised collecting payments — rather than offering financial support — during the first year of the pandemic.

v) Africa’s debt payments will remain high. Africa still had to pay US$69 billion in debt repayments in 2021, with another US$185 billion due between 2022 and 2024. Foreign debt payments were 15.5% of Africa’s exports in 2020 — up from 11.7% in 2019 and three times the 5.3% in 2011. Debt repayments will come at the direct expense of using this income to fight the pandemic.

vi) Efforts to tackle Africa’s debt crisis still don’t make all lenders participate. Big shifts in who owns African debt have happened in the last decade. The share of Eurobonds (private investors charging commercial rates) in Africa’s debt rose by 11.2% points since 2010 to 28.7% in 2020. Whilst multilaterals like the IMF and World Bank remain big players with about one-third of Africa’s total debt, China alone now holds 12%, up from 5% just a decade earlier- and has been Africa’s top lender for 10 years in a row. Any solution to Africa’s accelerating debt crisis would need to involve all lenders.

At the global level, UNCTAD staff have shown how developing country external debt surpassed combined export earnings since 2016; long-term creditor holdings fall to 68 per cent of total external debt, shares of PPG and PNG external debt are almost equal, and short-term external debt rises to over 30 per cent in 2018. In 2000, long-term debt still accounted for 87 per cent of total external debt of developing countries, and PPG for three quarters.

 Consequences of Debt

Countries with foreign debt have to meet the interest payments on the debt. This can only be met with: a) Foreign currency earnings from exports, b) Gold reserves / foreign currency reserves, and c) Further borrowing. As offered on Economics platform, foreign debt can become a problem under the following scenarios:

• Excessive confidence in borrowing to promote economic growth and development. Equally, there could be over-confidence in lenders to lend money in short-term without evaluation of possible problems.
• Investment that is misplaced and fails to achieve a decent rate of return to help pay the debt interest payments. For example, developing countries may struggle to make use of funds for industrialization if they lack the necessary skills and infrastructure.
• Unexpected devaluation in the exchange rate, which increases the real value of debt interest payments denominated in dollars.
• A decline in commodity prices which leads to a decline in the terms of trade for developing economies and relative fall in export earnings.
• Demand-side shock which reduces GDP. For example, conflict or global recession which hits demand and GDP.
• Servicing external debt (paying debt interest payments) ceteris paribus, reduces GDP because the monetary payments flow out of the country. These debt payments reduce the amount available to invest in improving public services, which can help economic development.
• Growing levels of debt can discourage foreign and private investment because of concerns that the debt is becoming unsustainable.
• If a country is struggling to meet interest payments, they may be tempted to borrow to meet debt interest payments, but then the problem can spiral and magnify.
• Countries in regional areas may suffer from a regional downgrade in credit assessment. For example, many Sub-Saharan African countries experienced rising external debt ratios, and this made investors reluctant to lend at cheap rates.

Weaving all these together, what we find is that in the long run, the debt burden affects economic growth negatively. It reduces the GDP growth, causes a decrease in assets from investments and profits or capital formation, and increases the tax rate in the future to extract more money to service the debts. Thus, it is evident that the realization of the SDGs by the targeted date of 2030 is under threat.

Addressing Debt Challenge                                             

It was in recognition of the debilitating effects of the debt burden that in an ironic sense, suggestions on how to address the problem flowed from the least expected sources: the American establishment. Way back in 1989, the American Treasury Secretary, Nicholas Brady, launched an initiative in which he proposed reducing the developing countries' bank debt. More recently, because of the problem associated with rising external debt, there has been pressure for developed countries for an outright cancellation of outstanding debt of developing economies. The argument is that debt cancellation can make a significant contribution to improving economic development because it frees up resources to invest in the recipient country – rather than send abroad in debt interest payments.

It is pertinent to recall that the debt crisis that had erupted in 1982 with Mexico’s announcement that it could not honour its debt obligations. This is what is called sovereign default, where a government suspends debt repayments; there have been series of such defaults compiled by Wikipedia-from which a sample of the following is drawn:

• Russia in 1918: Repudiation of Tsarist debts by Bolshevik revolutionaries
• Argentina in 2001: Following years of instability, the Argentine economic crisis (1999–2002)came to a head, and a new government announced it could not meet its public debt obligations
• Venezuela in 2017: Venezuela defaulted on US$65 billion in external debt in November 2017 after years of unsustainable borrowing and a crash in global oil prices
• Barbados in 2018: Defaulted on its Eurobondsafter the uncovering of its high sovereign debt in terms of debt-to-GDP ratio

It is important to highlight our earlier reference to the COVID-19 pandemic in relation to the debt challenge because it substantially raised the stakes. As the Director of the IMF’s Strategy, Policy and Review Department noted:

. . . the pandemic has exacerbated existing debt vulnerabilities in many countries”. . . Debt levels were already at record high levels before the crisis and the COVID-19 crisis is pushing them to new heights. The pandemic is adding to spending needs as LICs seek to mitigate the health and economic effects of the crisis, while revenues are falling due to lower growth and trade, increasing these countries’ debt burdens.

Instructively, the IMF has warned how it is critical that governments are able to continue servicing their debt and that their debt burden remains sustainable. Entering into debt distress is often a painful process, which may threaten macro-economic stability and set back a country’s development for years.

Enduring solutions to sovereign indebtedness

There’s the typical IMF perspective that countries with high debt vulnerabilities need to tackle them through a combination of adjustment and measures to restore growth. The starting point for the IMF model is transparency which undoubtedly resonates with diverse stakeholders. According to the global financial institution, “Debt transparency is critical to prevent a build-up in debt vulnerabilities. Without the full picture of a government’s outstanding debt and contingent liabilities, as well as its terms, debtors and creditors cannot take informed decisions to ensure debt remains sustainable, and accountability is weakened by a lack of public information on public debt. That said, debt transparency is not an easy fix and depends on a multitude of factors, such as a country’s institutional capacity, legal frameworks, governance, and civil service organization more broadly”.

In his Remarks at the 2021 Public Debt Management Forum, FDMD Okamoto harped on the primacy of transparency in debt management, arguing that:

A lack of transparency increases uncertainty, risk, and borrowing costs: if creditors are not able to determine what a country owes, to whom, and on what terms, creditors cannot make informed decisions. And in a world of increased debt risks, this could be the difference between maintaining and losing market access. The benefits to full transparency can be significant as well. Recent IMF research shows that increased fiscal and debt transparency can more than pay for itself by meaningfully lowering bond spreads for Emerging Markets, and critically important during these uncertain times, it also increases foreign investors’ willingness to hold EM sovereign debt

Beyond the incontestable fact of transparency imperative in governance, a discussion of this status would pass as incomplete without anchoring it to the abiding structure of the respective debtor nation’s economy because the fall into debt trap is caused principally by that factor of economic structure. This explains why it is mostly poor countries of the continents of Africa, Asia and Latin America along with the Caribbean that are saddled with the most acute burden of external debt. Of course, a lot depends also on the orientation of the political leadership which defines how the local economy is managed as well as its relationship with and attitude towards the contemporary global economic order. Leaders who seek servile accommodation with foreign interests will not be averse to piling up debts to the detriment of long-term development. On the other hand, leaders guided by genuine patriotism informed by the abiding interests of their compatriots as well as coming generations will chart the line of autonomous development with reduced reliance on external assistance that typically turns counterproductive with its exacerbation of dependency and the enactment of a vicious cycle of periodic escape and return to indebtedness. I come in peace, please.