Debt and Global Economy: the challenges and the way-out Belayneh Zelelew Negash, Addis Ababa, Ethiopia, October 2020 Many developing countries cannot service their external debt as scheduled. Piecemeal attempts to rearrange their debt profiles have not worked. New lending has not been forthcoming. Developing countries are now paying back to their creditors more in interest and principal than they receive in new loans. Countries which are already very poor are suffering, imports are being curtailed and world recovery undermined (Overseas Development Institute, 1987). Ten years after the global financial crisis, UNCTAD estimates that the ratio of global debt to gross domestic product (GDP) was a third higher at the beginning of 2018 than at the start of the crisis in 2007/2008, and roughly four times global GDP. While rising indebtedness is a general and global phenomenon, it is the debt levels of developing countries that have highlighted future debt sustainability vulnerabilities (United Nation, 2017). There is serious unemployment in many developed countries and increasing poverty in the developing countries, many of which have huge debts to the countries suffering unemployment which, struggle as they may, they cannot pay. The cause of these crises and therefore our ultimate concern, is the poor performance of the world economy, but the immense burden of debt over a trillion ('000 billion) dollars is now itself a major obstacle to a solution. Unless the debt- ridden countries receive more investment in wealth-creating activity, their poverty will intensify to the point in some countries of near starvation. It is argued that if they do not pay their debt, many important private banks and international financial institutions will be in financial difficulty, causing greater unemployment and contraction (Overseas Development Institute, 1987). In recent years, developing countries have faced renewed financial stress in a context of increased (and, in many cases, premature) connectivity to international financial markets. It could be argued that the constraints imposed by a world with policy parameters shaped by unregulated international financial markets are particularly binding on developing countries. This point of departure acknowledges that developing countries‘ vulnerabilities are not due to their ~2~
failure to organize themselves and to create policy space for themselves; they are largely influenced by global trends over which they have little control (Dymski, 2018). The majority of countries in Africa still have sustainable debt ratios, but since 2012, public debts in Africa have increased from a national average of around 36 per cent of GDP to close to 56 per cent. According to the IMF, eight African countries are classified as being in debt distress and another eleven are in high risk of moving into debt distress. Some of these countries are already facing debt default or debt restructuring by replacing short-term loans with long-term loans. A combination of factors explains developments in debt-distressed countries. Many countries have been running large fiscal deficits, and interest payments have increased due to the depreciation of their currencies. Exchange rate movements have caused dramatic changes in debt levels in countries such as Senegal, Zambia, Mozambique and Malawi (Jörgen Levin, 2019). This paper tried to deals mainly with debt and global economy challenges and way out. Contemporarily concept and scale of debt Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. But, when it is used imprudently and in excess, the result can be disaster. For individual households and firms, over-borrowing leads to bankruptcy and financial ruin. For a country, too much debt impairs the government‘s ability to deliver essential services to its citizens(African Development Bank, 2018). On the turn of twentieth century, the global scale of external debt of developing countries has been the greatest so far. The debt crisis proved to be an unprecedented phenomenon to the world economy. The direct cause of occurrence of the global debt was the increase in commodity exchange between well developed countries and the countries still considered as developing ones. To a great extent, that phenomenon occurred due to the loans given by the richer countries to the countries that were worse developed- though- it should be noted that also well-developed countries ran into debt. Debt has strong and significant impacts on real GDP growth in Africa. There is a strong and positive correlation between public investments and debt, particularly in highly indebted African countries. Although correlation does not imply causation, these results suggest that increased ~3~
debt accumulation in some African countries may have promoted economic growth (African Development Bank, 2018). Many countries find it difficult to find the means to finance the infrastructure development projects they need to boost economic growth and improve living standards. In recent years, this challenge has been made more difficult by the decline in concessional financing that has occurred as major donor countries continue to experience tight budget constraints. The ratio of total government revenue to GDP remained flat while the ratio of expenditure to GDP ratio increased between 2008 and 2015, leaving African governments with no option but to rely on deficit financing through borrowing (African Development Bank, 2018). The outlook for China‘s financial and economic health matters a great deal. Over the past decade it has accounted for around one-third of global growth and has emerged as the world‘s top merchandise trader, second largest economy and third biggest creditor nation. It also has the world‘s largest banking sector, second largest stock market and third largest bond market. One factor potentially impacting upon China‘s growth prospects is an apparent debt challenge. In recent years, there have been considerable market concerns about whether China‘s rising leverage is sustainable (Huang and Bosler, 2014; IMF, 2016; Li, 2016). This debate has gained significance for two additional reasons. First, it is set against a global backdrop of rising leverage since the global financial crisis (GFC), which in itself was borne out of excessive indebtedness. Second, there is controversy about the role of debt in the context of unconventional and highly accommodative monetary policy being pursued by major central banks around the world since the crisis. Concessional financing has gradually declined since the financial and economic crisis of 2008/09, although there was a small increase in 2015. To bridge the revenue gap, some African countries have turned to international capital markets as an alternative source of financing. This practice has resulted in rising debt levels, renewing concerns about the debt burden. In Ghana, for instance, where external debt increased by 41 percent in 2016 alone, 92 percent of the debt was non-concessional. Sovereign euro bond borrowing accounted for 70 percent of total non- concessional borrowing in 2016. Loans from multilateral and bilateral donors accounted for 24 ~4~
percent of African debt and loans from non–Paris Club members for 71 percent (African Development Bank, 2018). Following a long period of decline, supported in part by the Heavily Indebted Poor Countries HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI), public debt ratios are again rising. The upturn reflects increased macroeconomic stress across the continent, increased development financing needs, and greater access to international commercial capital markets (African Development Bank, 2018). The IMF and the World Bank use a four-step scale for rating the risk of external public debt distress: Low risk, generally when all the debt burden indicators are below the thresholds in both baseline and stress tests. Moderate risk, generally when debt burden indicators are below the thresholds in the baseline scenario, but stress tests indicate that thresholds could be breached if there are external shocks or abrupt changes in macroeconomic policies. High risk, generally when one or more thresholds are breached under the baseline scenario, but the country does not currently face any repayment difficulties. In debt distress, when the country is already experiencing difficulties in servicing its debt, as evidenced, for example, by the existence of arrears, ongoing or impending debt restructuring, or indications of a high probability of future debt distress (IMF, 2019). The Global Economy Growth Key developments such as the creation of the post World War Two Bretton Woods institutions (mainly the World Bank [WB] and the International Monetary Fund [IMF]), the oil crises of the 1970s, the decline of American hegemony, developing country debt from the 1980s onwards, the East Asian financial crisis in the 1990s, and the rise of the Chinese and Indian economies in the 2000s, provide evidence of the high stakes involved in international economic relations as well as their political and social importance. Such developments can change our understanding of the way the world works and force major intellectual shifts in IR such as the emergence of theories of interdependence, hegemonic decline, development, economic and political transition, regionalization, and globalization. Within each of these intellectual shifts we see a significant ~5~
movement away from the narrow focus on states and security issues towards analysis of the interdependence of economic, social and political issues as well as the interconnectedness of state and non-state actors in the international system(Lee, Donna and Brian ,2010 ). The world economy grew by 2.6 percent a year to almost double in size between 1990 and 2014. During that period, global economic growth was driven mainly by low- and middle-income countries, whose gross domestic product (GDP) grew by some 5.1 percent annually. China‘s GDP grew at double that rate, by more than 10 percent a year, and in 2014 the country accounted for 9 percent of global GDP, compared to just 2 percent in 1990 (UN, 2016). World financial markets have been enjoying unprecedented breath and strength over the past decades. The total value of the world‘s financial assets, including bank deposits, public and private debt securities as well as equity securities, has been multiplied by 10 over the past quarter of century, jumping from $12 trillion in 1980 to $136 trillion by the end of 2004. During that period global financial depth has been steadily increasing, the value of global financial assets growing from an amount roughly equaling the global GDP to more than three times its size (Mishkin , 2006). China is the single biggest—and to many the single—issue on the U.S. trade and competitiveness agenda today. When a U.S. lawmaker talks about unfair trade or exchange rates, it is a good bet that China is on their mind. Any discussion on the state of U.S. manufacturing quickly finds its way to China‘s growing prowess (BGED, 2007). Because China is successfully pursuing—at a scale never seen before—a growth strategy that is export led and foreign direct investment fed, its rise is sending tsunami-like waves to the farthest reaches of the global economy, posing tough challenges to some and enticing opportunities to others. China‘s enormous appetite for energy and raw materials has strengthened commodity prices and put many resource-rich countries back on the map. But in manufacturing, where China is now deeply embedded in global supply chains, the story is more complicated. Higher wage economies competing in the same manufacturing export segments where China has established an edge are faced with the difficult choice of moving up the value chain or lowering costs. ~6~
India‘s concurrent economic emergence has multiplied the challenges and opportunities manifold. Integration of the combined low-wage labor forces of India and China into global labor markets means an expansion of roughly 70 percent— highly concentrated at the lower end of the wage scale. Just about any economic model would predict a squeeze on wage earners until capital and technology investments adjust. Indeed, the data suggests that inequality is once again on the rise in many of the world‘s richer economies. In the United States, profits are capturing a much larger share of national income, while wages command a lower share than at any time in the last 50 years (UN, 2016). Though India is pursuing a growth strategy more reliant on domestic consumption and investment than China, nonetheless its success in building export strength in higher skilled ―knowledge‖ industries such as software programming has elicited concern among U.S. white- collar workers facing the prospect of low-wage foreign competition for the first time, as well as causing excitement among similarly placed developing countries looking to move up the value chain. Debt Trap Diplomacy The debt-trap diplomacy concept was first used by Brahma Chellaney, an Indian academic, to refer to a deliberate strategy where one country excessively loans another with the intention of gaining economic or political concessions when the borrowing country defaults on repayment (Patrick and Nyongesa, 2019). The emergence of China as a global economic power introduces new opportunities and challenges to the developing world. Sri lanka has been cited numerously as perfect example where China is suspected to have designed the aid package through the Belt and Road Initiative (BRI) in order trap gain both financially and to attain its broader grand strategy objective. When Sri Lanka failed to repay Chinese loans that were used to building facilities at Hambantota port, it signed a 99 year lease of the port to the Peoples‘ Republic of China in 2017(Maender, 2018). Parker and Chefitz(2018) argue that China extended the debt book diplomacy to create influence in Southeast Asia, and that as a result, Laos and Cambodia ,Who rely on Chinese funding, no ~7~
longer condemn its behaviour. Other nations suggested to be influenced by China as a result of excessive lending, or are at risk of ―debt trap Diplomacy‘ include Vanuatu (Parker&Chefitz, 2018), Djibouti, Tajikistan, Kyrgyzstan, Lao, Maldives, Mongolia, Pakistan, and Montenegro(Fernholz,2018). The increase in public debt in Africa has been a subject of scrutiny in recent years. This policy insight examines the rise of sovereign debt in Africa, with a focus on Chinese lending. It seeks to understand why African debt is growing, taking into account the geopolitical context of China– Africa relations that informs the uptake of, response to, and implications of rising public debt in Africa. After a period of manageable public debt in Africa, debt is on the rise once more. To understand why this is raising concern, one should look back to the impact debt has had on Africa in the past. During the 1980s, African economies had substantial sovereign debts that they were unable to repay, and by the mid-1990s much of the continent was frozen out of the global financial system (The Economist, 2018). This was followed by attempts to address the debt problem through structural adjustment programmes (SAPs). As will be explored in more detail below, these were largely destructive failures. The solution, reached in 2005, was for lenders to write off loans to heavily indebted poor countries (HIPCs), 30 of which were in Africa. With fresh credit and better economic policies, many of these countries turned their fortunes around. By 2012 the median debt level in sub-Saharan Africa (as defined by the International Monetary Fund, or IMF) had fallen to just 30% of gross domestic product (GDP). The IMF believes that the threshold for low-income countries is an external debt ratio of about 40%. For countries with debt ratios below this level, the probability of a debt crisis or ‗correction‘ is around 2–5%; for countries with debt ratios above this level, the probability rises to about 15–20%(IMF, 2002). Today, however, the median debt to- GDP ratio in the region is back over 50% (The Economist, 2018). Africa‘s debt-to-GDP ratio had been trending downward until it picked up in 2012, with an increase from 37 to 56% of GDP between 2012 and 2016(Sow, 2018). The U.S. government is beginning to acknowledge the power of debt book diplomacy as a new instrument in China’s geo-economic arsenal. In March 2018, then-Secretary of State Rex Tillerson warned that Chinese economic diplomacy “encourages dependency using opaque ~8~
contracts, predatory loan practices, and corrupt deals that mire nations in debt and undercut their sovereignty, denying them their long-term, self-sustaining growth‖( Tillerson, 2018). The Challenges and the Way-out International debt has been increasing since 2011, after falling from 2008-2011. The total net debts to owed by debtor countries, both by their public and private sectors, which are not covered by corresponding assets owned by those countries, have risen from $11.3 trillion in 2011 to $13.8 trillion in 2014. We predict that in 2015 they will increase further to $14.7 trillion. Overall, net debts owed by debtor countries will therefore have increased by 30% – $3.4 trillion – in four years (Tim, 2015). The beginning of 2007 offers a conflicting picture of the global economy for those trying to discern trends, challenges and opportunities. Although American multinationals and consumers are benefiting from new global opportunities, some American workers now face challenges in both manufacturing, where productivity is outpacing wage growth, and services, where off- shoring is on the rise. Concern runs across political and demographic lines, with discussion of the ―anxious middle‖ who seek safe harbor from the forces of globalization. How effectively the United States responds to this new competition will help to determine future living standards for the American middle class. It will also influence America‘s capacity to reassert leadership in the international arena and to address the needs of the world‘s poorest people (BGED, 2007). Rising cost of debt service, as debt loads have grown and become less concessional, interest payments have absorbed a growing share of government revenues. Drivers of rising debt, countries with the fastest rise in debt were often fragile and affected by a combination of conflict, weak governance, or commodity-dependence (World Bank 2018c). Countries relying on capital inflows to finance a large and persistent current account can be more vulnerable to currency crises, as weaker investor confidence can result in a slowdown in capital inflows, leading to higher borrowing costs, downward currency pressures, difficulties in rolling over debt, and possible macroeconomic and financial market stress (Roubini and Wachtel 1999). ~9~
Companies have spent the years since the global financial crisis binging on debt. Now, as the corona virus (Covid-19) pandemic threatens to push the world into recession, the bill could come due exacerbating damage to the economy and feeding a meltdown in financial markets. To respond successfully will require that political leaders reject both the hollow cheerleading for a benign globalization that spreads benefits evenly, as well as the false comfort that they can shield their constituents from the forces of globalization and technological advance. It will require a proactive and sustained strategy that not only addresses trade rules but also vigorously implements the requisite domestic policies to ensure that a large majority of countries thrive in the global economy. Poorer regions should be assisted in investing more in developing finished products for export and extending local value chains instead of relying on commodities and ―leapfrogging‖ to more advanced technology. Many African countries economies must be more resilient and better placed to cope with harsh external conditions than they were in the past. African governments need to present their countries with plans on how they intend to manage debt going forward and address citizens‘ concerns about spiraling debt. They should present a clear breakdown of the national debt by creditor and how it will be managed responsibly. Countries should work to strengthen their comparative advantage in high-value-added, innovation-intensive industries and empower our citizenry through appropriate training and incentives to take on new high-skill jobs. This will require expanding the quality and accessibility of education and training, strengthening science and technology, and investing in infrastructure. Do no harm while economists can argue whether the nation as a whole benefits from the current episode of globalization, most would predict that some workers pay the costs disproportionately. Indeed, current data suggests that gains are increasingly concentrated at the upper end of the income spectrum with earnings at the middle falling behind. Politicians can hardly expect support for a policy of continued openness if they insist on pursuing tax cut policies that ~ 10 ~
exacerbate these distributive trends and providing health and other benefits through the tax system in a manner that favors the already advantaged. The debt on the debt trap diplomacy narrative has elicited valid issues for consideration. That African nation should be wary of Chinese lending by practicing debt trap diplomacy, but like any form of investment, professional and honest feasibility studies should be carried out on the projects to be funded by China to establish beforehand whether or not profits will be made. The feasibility should accurately estimate the actual costs involved, repayment terms, and the short and long term financial gains expected from the investments. Furthermore, African governments should reduce or eliminate leakages of funds meant for the projects through corruption. Conclusion There is serious unemployment in many developed countries and increasing poverty in the developing countries, many of which have huge debts to the countries suffering unemployment which, struggle as they may, they cannot pay. Africa‘s growing public debt has sparked a renewed global debate about debt sustainability on the continent. This is largely owing to the emergence of China as a major financier of African infrastructure, resulting in a narrative that China is using debt to gain geopolitical leverage by trapping poor countries in unsustainable loans. Rising cost of debt service, as debt loads have grown and become less concessional, interest payments have absorbed a growing share of government revenues. Countries should work to strengthen their comparative advantage in high-value-added, innovation-intensive industries and empower our citizenry through appropriate training and incentives to take on new high-skill jobs. The debt on the debt trap diplomacy narrative has elicited valid issues for consideration. That African nation should be wary of Chinese lending by practicing debt trap diplomacy, but like any form of investment, professional and honest feasibility studies should be carried out on the projects to be funded by China to establish beforehand whether or not profits will be made. ~ 11 ~
Reference African Development Bank, (2018).African Economic Outlook 2018,Macroeconomic Developments and Structural change. African Development Bank Group.2018.p.22-24 Brookings Global Economy and Development(BGED),(2007).Top 10:Global Economic Challenges, An Assessment of Global risks and Priorities.Brookings Global Economy and Development .February 2007. P.8-9 DYMSKI G, (2018). Developing economies, international financial integration and sustainable development. Presented at the second session of the Intergovernmental Group of Experts on Financing for Development. UNCTAD. Geneva. 7–9 November, UNCTAD, Geneva. Available at https://unctad.org/meetings/en/Contribution/DYMSKI%20Developing%20Economiespaper. Pdf Fernholz,T. (2018). Eight countries in danger of falling into China‘s ―debt trap‖. Quartz. Retrieved from http://qz.com/1223768/china-debt-trap-these-eight-countries-are-in-danger-of- debt-overload-from-chinas-belt-and-road-plans/ Huang, Yukon and Canyon Bosler (2014): ―China‘s Debt Dilemma: Deleveraging While Generating Growth‖, Carnegie Endowment for International Peace, September, http://carnegieendowment.org/files/china_debt_dilemma.pdf. IMF, (2019). Risk levels of debt distress, per latest DSA (Debt Sustainability Analysis) as of August 31, 2019. IMF (International Monetary Fund), ‗Assessing Sustainability‘, 28 May 2002, https://www.imf.org/external/np/pdr/sus/2002/eng/052802.pdf, accessed 23 July 2018. Lee, Donna and Brian Hocking (2010) ‗Economic Diplomacy‘ in Robert A. Denemark (ed.) The International Studies Encyclopedia, Vol. II, pp 1216-1227. Wiley Blackwell. ~ 12 ~
Maender,R.(2018). The belt and road initiative:assessing China‘s new grand stragegy.(Civilian research project, Syracuse University, new York, United States of America). Retrieved from http://insct.syr.edu/wp-content/uploads/2018/06/Army_War_College_Reports_Maender- mwedit061518_2.pdf Overseas Development Institute,(1987).MANAGING THIRD WORLD DEBT. All Party Parliamentary Group on Overseas Development. Published for the All Party Parliamentary Group on Overseas Development by the Overseas Development Institute, Regent's College, Inner Circle, Regent's Park, London NW1 4NS. 1987. P5.p9 Patrick Maluka(Ph.D) and Nyongesa Lemmy, (2019).Is China‘s Development Diplomacy in horn of Africa transforming into Debt-Trap Diplomacy? An Evaluation.Debt Trap diplomacy narrative . 27 June 2019. P.1 Parker,S./& Chefitz,G.(2018). Debtbook Diplomacy: China‘s strategic leveraging of its newfound economic influence and the consequences for U.S foreign policy. http://belfercenter.org/sites/default/files/files/publication/debtbook%20diplomacy%20PDF.PDF Sow M, ‗Figures of the week: Africa‘s changing debt structure‘, Brookings Institution Blog, 26 April 2018, https://www.brookings.edu/blog/africa-in-focus/2018/04/26/ figures-of-the-week-africas-changing-debt-structure, accessed 15 August 2018. The Economist, ‗Debt is creeping back up in sub-Saharan Africa‘, 13 March 2018, https://www.economist.com/graphic-detail/2018/03/13/debt-is-creeping-back-up-insub- saharan-africa, accessed 2 August 2018. UN. 2016. National accounts data (available at http://unstats.un.org/ unsd/nationalaccount/data.asp). Accessed 9 February 2016 ~ 13 ~
United Nation,(2017). CURRENT CHALLENGES TO DEVELOPING COUNTRY DEBT SUSTAINABILITY. United Nations. Geneva, 2019.p.9 Jörgen Levin, (2019).Risks and Challenges of Debt-Financed Development ;Roots and causes of the rising debt levels in Africa. Policy notes no 7:2019. The Nordic Africa Institute, October 2019.P.3 World Bank, (2018). ―Are Poor Countries Headed Towards Another External Debt Crisis?‖ Internal note. Roubini, N., and P. Wachtel. 1999. \"Current-Account Sustainability in Transition Economies.\" In Balance of Payments, Exchange Rates, and Competitiveness in Transition Economies, edited by M. I. Blejer and M. Skreb, 19-93. Boston, MA: Springer. Tillerson, Rex W. (2018). ―U.S.-Africa Relations: A New Framework.‖ 6 March 2018, George Mason University, Fairfax, VA. Tim Jones,(2015). The new debt trap: How the response to the last global financial crisis has laid the ground for the next. Jubilee Debt Campaign. Printed by: Kolorco, July 2015 ~ 14 ~
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