The poorest countries facing the sovereign debt crisis
The move by the US Federal Reserve and other major central banks to raise interest rates in response to rising inflation threatens to trigger a sovereign debt crisis for many so-called emerging economies and low-income countries .
Many warnings to this effect have been issued since the beginning of the year, as it became clear that the Fed was planning a “take-off” in rates, perhaps as early as March.
Economists William Rhodes and John Lipsky, who lead the Sovereign Debt Task Force of the Bretton Woods Committee, a semi-official US economic think tank, wrote in the the wall street journal this week on the growing “challenges” in the sovereign debt market.
“The warning signs of a crisis are already clear,” they said. “According to figures from the International Monetary Fund, interest payments on public debt as a percentage of government revenue are four times higher in low-income countries than in advanced economies, while the same ratio in emerging economies is twice as high.”
Ten years ago, this ratio was similar in all countries, but today, according to the World Bank, some “60% of low-income countries suffer from debt distress or are at high risk of suffering from it”.
Rhodes and Lipsky noted that debt restructuring mechanisms through the so-called Paris Club, an informal grouping of official lenders to debtor countries, had “become confused and inefficient” and that the lack of a restructuring process of debt created “market volatility and risk, detrimental to a wide range of financial market participants.
In other words, a sovereign debt crisis, in the absence of “restructuring” arrangements, could have an impact on the global financial system.
Last week, Argentina reached a “restructuring” deal with the International Monetary Fund on a $57 billion loan to avoid a default. In the FinancialTimes (FT), Gillian Tett wrote that the deal should be a “wake-up call” not only about Argentina’s problems, but because it raises the broader question of “what what will happen to the troubled sovereign debt of the rest of the world”. This year.”
A report by the FT last month noted that the world’s poorest countries face a $10.9 billion increase in debt repayments this year. They must repay about $35 billion to public and private lenders in 2022, a 45% increase from 2020.
One of the most vulnerable countries is Sri Lanka. Rating agency S&P Global warned last month that the country faces a possible default this year by downgrading its sovereign bonds.
In an interview with the FT in late January, Sri Lankan Finance Minister Basil Rajapakse said the government was “negotiating with everyone” and “trying all our options” to avoid a default.
Sri Lanka has nearly $7 billion in debt repayments due this year, but less than $3 billion in foreign exchange reserves. More than a third of debt is owed to international bondholders and the crisis has already led to power cuts and shortages of imported goods, such as fuel and powdered milk. Long-term government bonds are already trading at half face value.
In Sri Lanka, as in all highly indebted countries, “restructuring” or outright default will inevitably be accompanied by mounting attacks on the working class, as international finance capital demands that the flow of money into its chests continues.
Officials from major international institutions have warned of a growing crisis. World Bank President David Malpass said creditor demands mean “the risk of disorderly defaults is increasing.
“Countries are facing a resumption of debt payments at the precise moment when they do not have the resources to repay them.”
With many countries having to take on more debt to cope with the effects of the pandemic, debt repayments were suspended in 2020. But that period has now come to an end with an initiative supposedly aimed at easing the burden of debt that s turns out, in the words of the FT, to be a “wet squib”.
A debt suspension plan, aimed at deferring around $23 billion in debt owed by 73 countries, launched in April 2020 and extended until the end of last year, saw only 42 countries get relief totaling just $12.7 billion.
Rebeca Grynspan, Secretary General of the United Nations Conference on Trade and Development, told the FT: “Debt problems are getting worse and the developing world’s fiscal space will continue to shrink. We really run the risk of another lost decade for developing countries.
In 2020 and 2021, when the world was awash with money due to the ultra-accommodative monetary policies of major central banks, developing countries were able to access international capital markets for funds. But the situation is now changing rapidly as inflation rises around the world.
According to Ayhan Kose, head of the World Bank’s forecasting unit: “Market access is a wonderful thing to have when there is cheap money, but there might be a different view as conditions are getting tighter.
The poorest countries are caught in a dilemma. They can seek relief through an arrangement with the IMF and bilateral creditors to secure new terms, and then try to secure the same arrangement from private creditors. But, as Grynspan noted, if a country publicly admits it has debt repayment problems, “the private sector will punish it.”
Turmoil in the financial markets, especially the violent fluctuations in the value of bitcoin, also cause major problems.
In an interview with the FT this week, Tobias Adrian, head of the IMF’s Monetary and Capital Markets Department, said fluctuations in cryptocurrency prices are “destabilizing” capital flows in emerging markets.
“Crypto is used to withdraw money from countries considered unstable [by some external investors],” he said. This posed “a big challenge for policy makers in some countries.”
Adrian said some emerging and developing economies face “immediate and acute risks” due to the replacement of their established currencies with crypto assets.
There was also a risk that cryptocurrency sales would fuel stock markets and vice versa, creating turbulence that increased financial risks for highly indebted economies.