Author: Julia Sun

Since 2000, the debt burden of developing countries has continued to soar. The COVID-19 epidemic has led to a significant increase in government public expenditures, but fiscal revenue has plummeted, and the risk of sovereign debt defaults in developing countries is increasing day by day. Will the COVID-19 epidemic be the last straw that triggers the debt crisis in developing countries?

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What debts and creditors do developing countries have?
Countries can finance important development plans and projects through borrowing, but the debt created by borrowing needs to be repaid. When a country's debt far exceeds its ability to repay, and it is unable to repay or is forced to postpone debt repayment, it faces the risk of a debt crisis. This problem is particularly acute in developing countries.

Sovereign debt of developing countries includes public debt and publicly guaranteed debt (PPG). Public debt includes central and local government borrowings from funds inside and outside the budget, social security fund borrowings, and borrowings from entities wholly owned by the government (such as China Development Bank and other institutions that provide long-term loans but do not accept deposits); public guaranteed debt refers to guarantees provided by the government , when the guaranteed person is unable to repay, the government needs to bear joint liability for the debt.

Creditors to developing countries include bilateral institutions (i.e. other countries and their official lending institutions), multilateral institutions (intergovernmental institutions such as the World Bank), and the private sector (such as banks and private bondholders). Sovereign debt is typically denominated in dollars and euros, so developing countries often rely on foreign exchange generated from exports and migrant remittances to service their debts.

Typically, a country's debt affordability is affected by factors such as its debt management capabilities, policies, macroeconomic fundamentals and the global economic environment. The solvency of developing countries is more susceptible to fluctuations in the international economic situation.

The debt crisis in developing countries has been dormant for a long time. Since 2000, the debt levels of developing countries have continued to rise.The debt of 111 low- and middle-income countries soared from US$600 billion in 2008 to US$1.3 trillion in 2018, more than six times higher than the 30% debt growth between 1990 and 2008. 

Slow economic growth and falling exports have led to a sharp decline in foreign exchange for debt repayments in developing countries.In the past decade, most developing countries have experienced slow economic growth, and more than 60% of them have experienced a decline in tax revenue as a share of GDP. From 2014 to 2019, the price index of commodities other than gold fell by more than 50%, resulting in a sharp decline in exports and foreign exchange earnings of developing countries that rely on raw material exports, further limiting their debt solvency. 

Debt in many developing countries has failed to translate into investment and growth.Slowing economies or falling exports have left many low- and middle-income countries running chronic current account deficits and borrowing from abroad year after year. However, the huge foreign debt is mostly used for consumption and debt repayment rather than promoting real growth through investment. From 2009 to 2018, the fixed investment growth rate in these countries fell from 12.3% in 1999 to 5.8% in 2008. 

Large-scale issuance of sovereign bonds has increased the debt burden of developing countries.Over the past decade, 58 low- and middle-income countries have issued sovereign bonds. In 2018, the annual debt service burden of sovereign bonds of low- and middle-income countries reached US$117 billion, an increase of 1.5 times on the basis of 2008. In contrast, the liabilities of low- and middle-income countries that did not issue sovereign bonds only increased by 73% during the same period.

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The new coronavirus epidemic may trigger a debt crisis in developing countries

The new crown epidemic has caused a significant increase in government public expenditures, governments of various countries have launched stimulus plans of approximately US$9 trillion so far. Affected by the epidemic, not only has the public health system been thrown into chaos, but as many as 1.6 billion people around the world have lost their livelihoods, accounting for half of the global labor force. Developing countries are stretched thin to deal with the health and unemployment problems caused by the epidemic, and it is extremely difficult to borrow again. 

At the same time, the COVID-19 epidemic has severely affected government revenue.Restrictive measures taken to control the epidemic have brought production activities and public consumption to a standstill, and the tax base has dropped significantly. World economic activities, including tourism, have almost come to a standstill. Most commodity prices have fallen sharply. Some countries that rely on tourism and commodity exports are facing severe economic difficulties. Economic stagnation and high unemployment in developing countries will plunge 140 million people into extreme poverty and create instability that will undo years of development gains.

As export earnings and migrant remittances dwindle, some developing countries are forced to use their foreign exchange reserves to pay down debt.However, before the outbreak of the COVID-19 epidemic, the debt repayment burden of many developing countries had reached more than 40% of foreign exchange reserves. The impact of the epidemic may cause foreign exchange reserves to further decline, triggering further depreciation of the currencies of these countries on the basis of this year’s depreciation of 15%, resulting in the repayment of the previous Dollar- and euro-denominated debt is even more difficult.

During the epidemic, the fiscal space of some developing countries has been severely squeezed, and the risk of sovereign debt defaults has increased. In order to prevent their governments from falling into a debt crisis, developing countries are forced to concentrate their limited financial resources on debt repayments in the coming months and no longer focus on long-term plans for the Sustainable Development Goals, which will have a negative impact on the achievement of the 2030 Sustainable Development Goals.

Do you think the COVID-19 epidemic is the last straw that leads to the debt crisis in developing countries?

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References

1. Averting Catastrophic Debt Crises in Developing Countries Extraordinary challenges call for extraordinary measures, https://cepr.org/sites/default/files/policy_insights/PolicyInsight104.pdf

2. Back to Basics: What is Debt Sustainability? https://www.imf.org/external/pubs/ft/fandd/2020/09/what-is-debt-sustainability-basics.htm

3. The Future of Financing for Development
https://oecd-development-matters.org/2020/08/12/the-future-of-financing-for-development/