Defaults Loom as Poor Countries Face an Economic Storm

WASHINGTON — Developing nations are facing a severe debt crisis in the coming months as inflation accelerates, growth slows, interest rates rise, and interest rates rise. strengthen the dollar combined into a perfect storm that could create a messy wave of defaults that would cause economic damage to the world’s most vulnerable people.

By some calculations, poor countries owe rich countries, multilateral development banks and private creditors up to $200 billion. Rising interest rates have increased the value of the dollar, making it harder for foreign borrowers with U.S. dollar debt to repay.

A default on a large number of loans would make the borrowing costs of vulnerable countries even higher and could trigger a financial crisis when Nearly 100 million people have been pushed into poverty this year due to the combined effects of the pandemic, inflation and Russia’s war in Ukraine.

The danger poses another headwind for the world economy, which is already heading towards recession. The leaders of the world’s advanced economies have grappled separately in recent weeks over how to avert financial crises in emerging markets such as Zambia, Sri Lanka and Ghana, but they have struggled struggled to develop a plan to accelerate debt relief as they faced their own economy. bane.

As rich countries braced for a global recession and struggled to cope with high food and energy prices, capital inflows into developing countries declined and major creditors, especially Chinaslow debt restructuring.

Mass defaults in low-income countries are unlikely to trigger a global financial crisis due to the relatively small size of their economies. However, the potential is causing policymakers to rethink debt sustainability in an age of rising interest rates and increasingly opaque lending deals. This is partly because default could make it harder for countries like the United States to export goods to indebted countries, slow the world economy further, and could lead to widespread famine and social unrest. wide. As Sri Lanka moved closer to default this year, the country’s central bank was forced to arrange an exchange agreement pay for Iran’s oil with tea leaves.

David Malpass, president of the World Bank, said in an interview at the Group of 20 summit last month in Bali: “Finding ways to reduce debt is important for these countries to look at. light at the end of the tunnel. , Indonesia. “This burden on developing countries is very heavy, and if it continues, they will continue to get worse, which will then impact advanced economies in terms of increased migration flows. and lose the market.”

The urgency comes after the coronavirus lockdowns in China and Russia’s war in Ukraine, which have slashed global output and sent food and energy prices soaring. The Federal Reserve was quick to raise interest rates in the United States, strengthen the dollar and forced developing countries to import essentials for populations struggling with rising prices.

Economists and global financial institutions such as the World Bank and the International Monetary Fund have voiced alarm at the severity of the crisis. The World Bank expects this year that about one dozens of countries could face default next year and the IMF has calculated that 60% of developing countries have low income are in dire straits or are at high risk of indebtedness.

Since then, developing country finances have continued to deteriorate. The Council on Foreign Relations said last week that 12 countries now have the highest default ratings, up from three in the previous 18 months.

Brad Setser, a senior member of the board, estimates that $200 billion in national debt in emerging markets needs to be restructured.

“It is certainly a systemic problem for the affected countries,” Mr. Setser said. “Because of an unusually large number of countries that borrowed from the market and borrowed from China between 2012 and 2020, there was an unusually large number of countries in default or at risk of default.”

Debt restructuring can include providing a grace period to repay the loan, lowering interest rates, and writing off some principal. The United States has traditionally led broad debt forgiveness initiatives such as the “Brady Bonds” plan for Latin America in the 1990s. However, the emergence of commercial creditors lending at high interest rates and abundant loans from China – which does not like to take losses – have complicated efforts to reduce international debt.

Fitch, the credit rating agency, warned in a report last month that “more defaults are possible” in emerging markets next year and lamented that the so-called Common Framework that The Group of 20 set up in 2020 to facilitate debt restructuring “has not proven effective in resolving the crisis quickly.”

Since the framework was established, only Zambia, Chad and Ethiopia have sought debt relief. It was a honing process, involving creditor committees, the International Monetary Fund and the World Bank, all of which had to negotiate and agree on how to restructure the loans that countries have. in debt. After two years, Zambia is finally close to restructuring its debts to Chinese state-owned banks, and Chad reached an agreement last month with private creditors, including Glencore, to refinance. debt structure.

Bruno LeMaire, French Finance Minister, said that progress with Zambia and Chad is a positive step, but there is more work to be done with other countries.

“Now we should speed up,” Mr. Le Maire said on the sidelines of the G20 summit.

China, which has become one of the world’s largest creditors, remains an obstacle to bailout. Development experts have accused it of setting a “debt trap” for developing countries with a loan program of more than $500 billion, described as predatory.

“This is really about China’s unwillingness to acknowledge its lending as a source of money,” said Mark Sobel, a former Treasury official and President of the Official US Monetary and Financial Institutions Forum. unsustainable and China is reluctant to reach agreements.

The United States regularly calls on China to be more lenient and complains that Chinese loans are difficult to restructure due to unclear contract terms. It described China’s lending practices as “unusual”.

Brent Neiman, an adviser to Treasury Secretary Janet L. Yellen, said in a speech in Washington in September: “China is not the only creditor hindering the quick and efficient implementation of the plan. particular. “But in the context of international lending, China’s lack of participation in coordinated debt relief is the most common and has the most serious consequences.”

China has accused Western commercial creditors and multilateral institutions of not doing enough to restructure debts and denies that they have engaged in loan sharking.

“This is not a ‘debt trap’, but a monument of cooperation,” said Chinese Foreign Minister Wang Yi. said this year.

China’s own economy is slowing due to the country’s severe “no Covid” policy, which includes mass testing, isolation and population blockade. A domestic real estate crisis has also made it harder for China to accept losses on loans it has lent to other countries.

IMF officials will travel to Beijing next week for a “1+6” roundtable with leaders of major international economic organizations. During those meetings, they will help China better understand the debt restructuring process through a common framework.

Ceyla Pazarbasioglu, director of strategy, policy and evaluation at the IMF, acknowledged that agreeing to the terms of debt relief could take time, but said she would pass the urgency to officials. China.

Ms. Pazarbasioglu, who is traveling to China, told reporters at the IMF last week: “The problem we have is that we don’t have the time right now because countries are very fragile in terms of dealing with the possibility. debt vulnerability.

At the annual meetings of the IMF and World Bank in Washington in October, policymakers said the pace of debt restructuring was too slow and called for coordinated action between creditors and borrowers to Find a solution before it’s too late.

In a panel discussion on debt restructuring, Gita Gopinath, first deputy managing director of the IMF, said countries and creditors need to avoid the kind of fantasy that leads to default.

“There is a lot of tendency to gamble for redemption,” Miss Gopinath said. “Creditors are more likely to hope to gamble for redemption, and then to settle for nothing.”

But at the end of group meeting 20 in November, it seems that little progress has been made. In a joint statement, the leaders expressed concern about the “worsening debt situation” in a number of vulnerable middle-income countries. However, they offer some specific solutions.

“We reaffirm the importance of joint efforts by all parties, including private creditors, to continue working towards enhanced debt transparency,” the statement read.

The statement included a footnote stating that “one member has different views on debt matters.” That country, according to people familiar with the matter, is China.

In the interview, Mr. Malpass said that China is open to discussing debt relief, but “it’s hard to understand the details” when it comes to restructuring loans to reduce the debt burden.

The World Bank President predicts that the financial problems facing developing countries are unlikely to turn into a global debt crisis as happened in the 1980s when many Latin American countries were unable to foreign debt repayment. However, he suggested that there is a moral imperative to do more to help poor countries and people who have been pushed deeper into poverty during the pandemic.

“There will be a continuing reversal in development in terms of poverty, hunger and undernutrition, which are already increasing,” Mr. Malpass said. “And it is coming at a time when countries need more resources, not less.”