Serious debt distress facing developing countries

Many of the developing countries are net importers of oil whose price has been rising, only recently to a seven-year high of above US$ 90 per barrel. A February 4 Bloomberg article ‘Oil market keeps getting stronger as prices blow through $92’ add to already high inflation worries for developing countries, especially when the outlook for price rise is showing no sign of relenting. The article has pointed out ‘Oil rocketed to a fresh seven-year high above $92 a barrel, and almost every indicator is pointing to the rally extending.’

Moreover, as to some of the reasons for this rally to continue, the article highlighted: ‘“The rally in crude prices is showing no signs of slowing down as both supply and demand drivers remain very bullish,” said Ed Moya, Oanda’s senior market analyst for the Americas.

“Geopolitical risks that include Russia-Ukraine tensions and Iran nuclear talks are also wildcards for oil prices as they seem more likely to lead to a tighter market over the short-term. All of that is coming as OPEC+ struggles to lift output by the 400,000 barrels a day it has pledged each month.’

In addition, global demand for oil has already fed in a lot, as highlighted by options market, and which gives strong credence to oil prices breaking the $100 a barrel mark, about which the same Bloomberg indicated: ‘The rally means a return of $100 oil is growing increasingly likely by the day.

For months, options markets have been abuzz with trading of contracts above that level. There are the equivalent of almost 112 million barrels of $100 calls for the global Brent benchmark over the next 12 months. Call options sold by banks in the $90s are also likely contributing to oil’s move higher.’

These are alarming signs for developing countries, including Pakistan, in particular. These countries are already under immense pressure to curtail import bills. These are testing the limits of macroeconomic policy instruments to deal with the impact of high component of imported inflation in overall high price rise rate numbers from which they are suffering for some time now. In addition, tightening of monetary policy stance globally will further worsen the already dwindling situation of debt sustainability.

A number of developing countries appear to be on the verge of debt default as pointed out, for instance, by a recent Financial Times (FT) article ‘Argentina’s IMF deal offers a warning on emerging market debt’ by Gillian Tett. According to it: ‘David Malpass, World Bank president, warned last month that the world is now heading into a swath of “disorderly defaults” among poorer nations.

Meanwhile, the IMF reckons that 60 per cent of low-income countries now face debt distress. This is double that of 2015.Investors are bracing for potential defaults by LICs such as Sri Lanka, Ghana, Tunisia and El Salvador – as well as middle-income countries such as Lebanon, Turkey and Ukraine. Rising US interest rates will make the pressure on these countries worse.’

In the case of Sri Lanka, for example, a debt default appears quite imminent, as pointed out by a recent FT article ‘Sri Lanka on brink of sovereign debt default, warn investors’ whereby it indicated as follows: ‘Sri Lanka owes $15bn in bonds, mostly dollar-denominated, of a total $45bn long-term debt, according to the World Bank.

It needs to pay about $7bn this year in interest and debt repayments but its foreign reserves have dwindled to less than $3bn.The government’s next big challenge is a $1bn bond repayment due in July. If it fails to pay, it would join countries including Suriname, Belize, Zambia, and Ecuador in defaulting on its debt following the pandemic.’

Moreover, rising interest rates globally are not only adding to current debt servicing pressures, but also pose a big cost on rolling debt and building up reserves, through floating bonds. Countries like Pakistan, with high debt servicing needs but are entering the bonds markets more aggressively now, are already therefore late – the era of cheap credit is already behind them.

And recourse to International Monetary Fund (IMF) programmes for primarily much cheaper loans nonetheless leads to fundamentally damaging consequences for economy since these pro-cyclical programmes acutely diminish a recipient country’s capacity to achieve growth rates needed to deal with pandemic-causing recessionary environment, and in turn, increase tax revenue and exports that come as a consequence of counter-cyclical policies, and not at the cost of choking growth, and employment.

This debt distress calls upon major sovereign creditors to introduce a major debt relief effort. But the framework to do so has already unravelled over the changed underlying composition of debt over the years, and needs a meaningful deep reform effort. The same FT article by Gillian Tett indicated in this regard the following: ‘During the second half of the 20th century, the western world organised restructurings of poor-country debt by using the “Paris Club” framework.

This enabled creditor nations to cut deals backed up by institutions such as the IMF and the “London Club” of commercial lenders.…a decade ago, low-income countries had about $80bn of public external bilateral debt (excluding multilateral and private loans). Two-thirds emanated from Paris Club lenders. Today, these debts top $200bn, and under one-third is lent by the Paris Club. The rest is mostly owed to China… This radical change makes the Paris Club mechanism less relevant…’

A recent Bretton Woods Committee report ‘Debt transparency: the essential starting point for successful reform’ pointed out some ways to reform the debt relief/restructuring process, and as highlighted in the same FT article as follows: ‘The Bretton Woods report argues that one crucial step would be for governments to create a unified, transparent database of their debts. It calls on rating agencies, multilateral banks and investors with environmental and social governance mandates to lobby for this. It also argues that the old Paris Club framework should be overhauled to give China a proper seat at the table. Finally, it calls for private sector lenders to be incorporated into negotiations at a much earlier stage.’

Overall, there is an urgent need for the IMF to return from its pro-cyclical policy mindset, and as strongly reflected usually in its programme prescription/conditionalities, for instance in the case of Pakistan, but as not as in the very rare case of Argentina.

Moreover, there is a need for a more balanced policy stance by central banks in both rich, advanced countries, and in developing countries, as pointed out, for instance, by a recent Roosevelt Institute published article ‘A balanced response to inflation’ by Nobel laureate in economics, Joseph Stiglitz.

As per the article, ‘Although it is anyone’s guess what will happen next with inflation, the data show that there is no reason to react rashly with large across-the-board interest-rate hikes. …Although some supply shortages were anticipated as the global economy reopened after the COVID-19 lockdowns, they have proved more pervasive, and less transitory, than had been hoped. …Nonetheless, my biggest concern is that central banks will overreact, raising interest rates excessively and hampering the nascent recovery.’ In addition, rising interest rates will add to already high pressures on global debt sustainability, especially with regard to debt issues facing developing countries in general.

(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund)

He tweets@omerjaved7

Copyright Business Recorder, 2022