For Developing Economies, the Finance Landscape Becomes a Wasteland

For Developing Economies, the Finance Landscape Becomes a Wasteland

Dec 7 , 2024. By Indermit Gill ( Indermit Gill, chief economist and senior vice president for Development Economics at the World Bank, )

The poorest countries need debt relief to have a chance at sustained economic growth and lasting prosperity. A modern global system is required to ensure fair play in lending to all developing economies. It's a challenging task in this era of deepening international mistrust, but without it, we risk all major development goals, writes Indermit Gill, a chief economist and senior vice president for development economics at the World Bank, in this commentary provided by Project Syndicate (PS).

It was a bold idea encapsulated in a snappy slogan: “From billions to trillions.” When private capital sloshed into developing economies a decade ago, governments and development institutions saw an opportunity to turbocharge progress on poverty reduction and other development goals.

“The good news is that, globally, there are ample savings, amounting to 17 trillion dollars, and liquidity is at historical highs,” read a key strategy document of the time.

The bad news is that it all turned out to be a fantasy. Instead, the financing landscape for development has been upended. Since 2022, foreign private creditors have extracted nearly 141 billion dollars more in debt-service payments from public-sector borrowers in developing economies than they have disbursed in new financing. But there is one striking exception: In 2022 and 2023, the World Bank and other multilateral institutions pumped in nearly 85 billion dollars more than they collected in debt-service payments.

Thus, multilateral institutions have been thrust into a role they were never designed to play. They are now lenders of last resort, deploying scarce long-term development finance to compensate for the exit of other creditors.

Last year, multilateral institutions accounted for about 20pc of developing economies’ long-term external debt stock, five points higher than in 2019. The World Bank’s International Development Association (IDA) now accounts for nearly half of the development aid going from multilateral institutions to the 26 poorest countries. In 2023, the World Bank accounted for one-third of the overall net debt inflows going into IDA-eligible countries - 16.7 billion dollars - more than three times the volume a decade ago.

These developments reflect a broken financing system. Since capital – both public and private – is essential for development, long-term progress will depend to a large degree on restarting the capital flows that benefited most developing countries in the first decade of this century. But, the risk-reward balance cannot remain as lopsided as it is today, with multilateral institutions and government creditors bearing nearly all the risk, while private creditors reap nearly all the rewards.

When global interest rates skyrocketed in 2022 and 2023, leading to increased debt distress in the poorest countries, the World Bank followed its usual practice. It shifted from providing low-interest loans to providing grants to countries at high risk of distress. It also increased its overall financing for these countries, typically with generous repayment terms ranging from 30 to 50 years. But, private creditors headed for the exits, with high interest rates more than fully compensating them for the investment risks they had taken.

In the absence of a predictable global system for restructuring debt, most countries facing distress opted to tough it out rather than default and risk being cut off indefinitely from global capital markets. In some cases, new financing arriving from the World Bank promptly went back out the door to repay private creditors. In 2023, developing countries spent a record 1.4 trillion dollars – nearly four percent of their gross national income – to service their debt.

While principal repayments remained stable at about 951 billion dollars, interest payments surged by over one-third to about 406 billion dollars. For many developing countries, this has resulted in a devastating diversion of resources away from areas critical for long-term growth and development, such as health and education.

The squeeze on the poorest and most vulnerable countries – those eligible to borrow from the IDA – has been especially fierce. Their interest payments on external debt have quadrupled since 2013, hitting an all-time high of 34.6 billion dollars in 2023. On average, interest payments now amount to nearly six percent of IDA-eligible countries’ export earnings – a level not reached since 1999. For some countries, the burden ranges from 10pc to as much as 38pc of export earnings.

It is no wonder that more than half of IDA-eligible countries are either in debt distress or at high risk of it, or that private creditors have been retreating.

These facts imply that the world’s poorest countries are suffering not from liquidity problems but from a mmetastasisingsolvency crisis. It might be easy to kick the can down the road by providing these countries with just enough financing to help them meet their immediate repayment obligations, but doing so will simply prolong their purgatory. These countries need faster growth if they are ever going to reduce their debt burdens, but faster growth requires higher investment. Given the size of their debt burdens, that is unlikely to mmaterialise

On current trends, their ability to repay will never be restored.

We need to face reality: the poorest countries facing debt distress need debt relief if they are to have a shot at sustained economic growth and lasting prosperity. A 21st-century global system is required in order to ensure fair play in lending to all developing economies. Sovereign borrowers deserve at least some of the protections routinely afforded to debt-strapped businesses and individuals under national bankruptcy laws.

Private creditors that make risky, high-interest loans to poor countries ought to bear a fair share of the cost when the bet goes bad. Establishing these precepts will be a struggle in an era of deepening international mistrust. But without them, all major development goals will remain in peril, facing the same fate as the “billions to trillions” promise.

PUBLISHED ON Dec 07,2024 [ VOL 25 , NO 1284]

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