The Borrower Blues

YAN XUE/FOR CHINA DAILY

Monetary policy tightening in the US and EU becomes a nightmare for highly indebted developing countries

Over the past decade, the debt burden of emerging and developing countries has increased dramatically.

This year, with the Russian-Ukrainian conflict and US monetary policy tightening, many developing countries are on the brink of debt crisis and some of them have already fallen off the cliff. At the beginning of April, Lebanon and Sri Lanka announced that they were over-indebted. According to the International Monetary Fund and the World Bank, 38 of 69 low-income countries are already in debt distress or at high risk of debt distress. It is also warned that the number of countries in crisis is very likely to increase in the near future.

Three groups of countries deserve particular attention. The first group is made up of emerging market economies with high external debt dependence, poor historical sovereign credit records and weak economic recoveries, such as Argentina, Turkey, Brazil and Mexico. Since the beginning of 2022, these countries have experienced high inflation and currency depreciation. To deal with these problems, their central banks have already raised the key interest rate. However, even if their central banks are tightening their monetary policy more aggressively, the pressures from capital outflows and currency depreciation are still high, due to weak fundamentals and weak sovereign credibility. In general, these countries face the dilemma that there are few appropriate policy tools and insufficient space for policy expansion and tightening.

The second group includes highly indebted countries that have been hard hit by the Russian-Ukrainian conflict. On the one hand, some Russian and Ukrainian entities have defaulted on their debts due to the conflict and sanctions, leading to asset losses for the financial institutions that hold their debts, especially those in Europe. On the other hand, rising commodity prices and refugee problems caused by the conflict have increased the fiscal burden of many governments neighboring Russia and Ukraine or having close economic and trade ties with them. European countries, including Hungary, Moldova, Romania and Slovakia, and Asian countries, including Mongolia, Tajikistan and Kazakhstan, fall into this category.

The third group includes countries with serious debt and poverty problems and high dependence on food imports, such as Lebanon, Yemen and Syria. These countries may experience multiple crises such as capital outflows, food crises and political unrest. Since the outbreak of the Russian-Ukrainian conflict, world food prices have risen sharply and many countries have announced food export restrictions or bans. The UN has warned that 325 million people worldwide are currently suffering from food shortages, and around 43 countries expect famine to knock on their doorsteps.

At the level of global governance, the top priority is to expand and improve debt restructuring and relief programs within the framework of multilateral mechanisms. As a first step in tackling the debt crisis, the G20 has postponed debt repayment for 73 of the poorest countries through the Debt Service Suspension Initiative. The bloc has also rolled out a common framework aimed at promoting large-scale, speedy and orderly debt restructuring. However, the influence of the DSSI and the CF is still relatively limited. Among the countries eligible to apply, many countries choose to continue to borrow from the private sector at high interest rates rather than participate in debt restructuring at an early date, because the DSSI and the CF offer insufficient discounts, but should require lengthy negotiations and induce downgrades of sovereign ratings. Such a slow response to the debt crisis will eventually snowball into debt problems and higher debt relief costs in the future.

In order to avoid a spiral of debt, it is necessary to develop a multilateral consensus with long-lasting and broad influences. The key to achieving this goal is to create more incentives for borrowers and creditors to participate in debt settlement as soon as possible. It is particularly important to provide more incentives, pressures and platforms for the private sector to participate in debt relief. For example, eligible debtor countries can be encouraged to combine debt settlement with other sustainable development goals, through the use of debt-for-nature swaps, debt-for-climate swaps and other debt settlement tools. sustainable funding. These instruments are capable of hitting two birds at once: reducing the debt burden and channeling funds to support sustainable development.

Combining debt resolution with sustainable development goals like climate change mitigation can help attract funds from NGOs, international organizations and ESG investors. Through its cooperation with The Nature Conservancy, a non-profit organization, Seychelles not only completed a $21.6 million debt restructuring, but also established 410,000 square kilometers of ocean protection zone. In 2021, Belize also secured a $364 million debt restructuring and funded the protection of 30% of its waters through a similar debt swap program.

As an emerging creditor, China should also be prepared for the next wave of debt crises in developing countries. It should further improve its external lending standards and debt management institutions, and provide more diversified debt settlement options to debtor countries, especially market-based debt restructuring options. For example, more loan-to-bond conversions can be encouraged. These loan-for-bond swaps can greatly increase debt transparency, as the disclosure requirements of bonds are much stricter than those of loans. At the same time, it is also important for China to adhere to multilateral frameworks and strengthen its coordination and cooperation with other creditors. For example, China can better monitor the debt sustainability of the countries concerned by cooperating with the IMF and the World Bank. Deeper cooperation between all parties will help formulate more influential and effective international rules for debt governance, thereby laying a better global foundation for the prevention of future crises.

Xiong Wanting is a research assistant at the Institute of Global Economics and Politics, Chinese Academy of Social Sciences. Xu Qiyuan is a researcher and deputy director of IWEP at CASS. The authors contributed this article to China Watch, a think tank powered by China Daily. Opinions do not necessarily reflect those of China Daily.

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