During the COVID-19 pandemic, nations around the world ran big budget deficits, as counties went into deep recessions and tax revenue fell short of government spending.
In 2020, Zambia become the first African country to default on its sovereign debt. Its biggest lenders, such as China, France, and Britain, agreed to write off or delay repayment of $6.3 billion in loans they had made to Zambia.
Many additional nations are now seeking similar debt restructuring. The majority of low-income developing countries are today either already in or near debt distress. Meanwhile, the world’s two biggest economies, America and China, are expected to see dramatic growth in their public debt over the coming decade.
Ghana and Sri Lanka defaulted on their debts to foreign countries in 2022, two years after Zambia. Pakistan and Egypt are on the verge of a default. Restrictions on fertilizer use cut crop yields in Sri Lanka and made its economy collapse in 2022, after Sri Lanka adopted foolish organic farming policies promoted by foreign green groups, destroying its agricultural sector. Last week, Pakistan obtained a $3 billion subsidized loan from the International Monetary Fund (IMF), to enable it to avoid an immediate default.
On average, counties around the world now have enormous levels of debt — 92 percent of gross domestic product (GDP) at the end of 2022. Despite economic growth in 2021 and 2022, debt is not much smaller compared to GDP than in 2020, at the end of the sharp recession caused by the COVID-19 pandemic, when debt levels briefly reached 100 percent of GDP at the end of 2020. By contrast, debt was less than 84% of GDP in 2019, before the pandemic.
Under the Trump administration, the U.S. performed very well relative to other nations during the pandemic, economically. The U.S. economy shrank only 3.5% in 2020. Economies shrank much more in Europe: 7.9% in France, and 8.9% in Italy. Japan’s economy shrank 4.8%. Mexico’s economy shrank much faster than America’s during the pandemic. Latin American economies typically shrank by percentages two or three times larger than the U.S. economy in 2020, due to the coronavirus: Venezuela’s economy shrank 10%, El Salvador’s 9%, and Honduras’s 6.6%.
The net result of most countries going into a deep recession is that even though most other nations borrowed much less compared to the size of their economy than the U.S., they are often in even worse financial condition.
About three-fifths of low-income developing countries are now either high risk or in debt distress and have either had, or are about to launch, a debt restructuring process. This figure was less than two-fifths before the pandemic.
The debt crisis is aggravated by Russia’s invasion of Ukraine in February 2022, which caused a a global spike in commodity and food prices.
“Now, the resurgence of inflation means major central banks have increased interest rates, making the cost of debt servicing costly and this is a problem for both low-income and middle-income countries,” says Ugo Panizza, an economics professor in Geneva.
52 least-developed nations – home to half the world’s population living in extreme poverty – are facing severe debt problems and high borrowing costs.
The depreciation of Third World currencies has aggravated the problem. The U.S. dollar strengthened over 2022 compared with most developing currencies as investors’ demand grew for the US currency, viewed as a safe asset. This, in turn, has made it even costlier for lower- and middle-income nations to pay principal and interest on their debts, because most cross-border loans and international debt is denominated in U.S. dollars.
“A lot of global liquidity coming up for refinancing is in dollars and if your currency deteriorates, as it happened in the case of Ghana, where the cedi collapsed, your ability to meet the debt payments is hugely damaging,” says development expert Judith Tyson. “There’s probably going to be some more years of high levels of dollar and interest rates and that’s a significant problem. ”
Ghana’s currency, the cedi, lost more than half of its value between January and October of last year, causing Ghana’s debt burden to rise by $6 billion. Ghana defaulted on most external debt in December and now seeks to cut its external debt repayments of $20 billion in half over the next three years, and only wants to pay even that if it gets a $3 billion loan from the IMF as a part of its debt restructuring.
Despite its debt crisis, Ghana still has a substantially higher per capita income than most African countries, with longer life expectancy and lower infant mortality. If it can’t handle its debts, that is a very bad omen for poorer African counties where a sizable fraction of the population does not even have enough to eat. Ghana’s oil revenue may eventually make it possible for it pay all of its debts, if the oil revenue keeps growing, and Ghana develops fiscal responsibility.
The financial crises facing nations like Ghana, Sri Lanka, and Zambia echo the debt crisis of the early 1980s. It followed the oil price shocks of the 1970s, which contributed to spikes in inflation. Central banks then raised interest rates to quell inflation, driving the economy into a recession in most of the world in 1981.
As many as 16 Latin American countries, led by Mexico, and 11 other less-developed countries in Africa or Asia, had to reschedule their debts, prompting the first global debt crisis in the early 190s.
The period of the 1980s is sometimes referred to as the “lost decade” as many less-developed nations agreed to spending cuts on infrastructure, health and education in exchange for debt restructuring, with several countries ending the decade with income levels that were lower than in 1980.
Three dozen cases of unsustainable debt from poor countries, especially in sub-Saharan Africa, led to the creation of a joint debt-relief measure by the IMF and the World Bank, known as the Heavily Indebted Poor Countries Initiative, in 1996. Nations had to meet certain criteria and commit to policy changes to reduce poverty to receive 100 percent relief on eligible debts from the IMF, the World Bank and the African Development Fund.
Jeromin Zettelmeyer, the director of a think-tank in Belgium, says there are similarities and differences between the present debt situation and past shocks. “Most sovereign debt crises are preceded by periods of higher (budget) deficits, built up of debt, and some are triggered by higher real interest rates. So, these ingredients of a sovereign debt crisis are present right now.”
Yet, other “ingredients” are missing, he said, and this crisis is not just a repeat of what the world has seen previously. Many previous crises were triggered by lower commodity prices. But several poorer nations now are major producers of oil, gas and minerals. A decline in commodity prices hurts their incomes. “But the commodity prices are relatively high right now,” Zettelmeyer says.
Looking at Sri Lanka and Zambia, Zettelmeyer said their defaults were the result of poor domestic economic management, with the coronavirus pandemic worsening the situation.
But in both instances, reaching a deal to address their debt crises has been complicated by the emergence of a major new player: China.
Historically, poorer nations mostly borrowed from the so-called Paris Club of creditors, most of them richer countries like America, England, Australia and Germany, as well as multilateral institutions like the World Bank, the IMF or the African Development Bank.
However, over the last two decades, China and private bondholders have become major lenders to these nations.
The fraction of external debt owed by low- and middle-income countries to Paris Club creditors dropped from 28 percent in 2006 to 11 percent in 2020. Over the same era, the share owed to China increased sharply, from 2 percent to 18 percent, while the share of Eurobonds – international bonds denominated in a currency other than that of the issuing country – sold to private lenders increased from 3 percent to 11 percent.
China holds more than half of Zambia’s external debt, and a significant minority of Sri Lanka’s debt. For about three-quarters of the 73 counries that are part of the G-20 Debt Service Suspension Initiative – under which debt payments to creditors were suspended due to the coronavirus pandemic from May 2020 to December 2021 – China is now the biggest bilateral creditor.
The G20 set up a “common framework” in 2020 to coordinate debt restructuring for low-income countries between the Paris Club and other major creditors like China, India and Saudi Arabia. But this common framework has not been much of a success. Only Zambia, Chad, Ethiopia and Ghana have even sought to use it, with Zambia becoming the first country to reach an agreement with its creditors committee.
And in case after case – such as in regard to Sri Lanka or Zambia – negotiations have been afflicted by a blame game, with Western nations accusing China of dragging its feet in agreeing to restructuring plans and thereby delaying the process. Beijing denies that.
