Debt bubbles “popping” in emerging economies

New debt crises feared as China economy slows

19 February 2016 by Bretton Woods Project

Global economic instability has highlighted the vulnerability of developing countries to renewed economic turbulence and even the potential for new debt crises in developing countries, in particular Sub-Saharan Africa. During the summer of 2015 China’s stock market began to falter; in January these problems recurred. Adding to the challenges for developing economies, the United States began to raise its interest rates in December, signaling the end of its period of so-called ‘extraordinary accommodative monetary policy’, including quantitative easing (see Bulletin Feb 2014), increasing pressures on developing countries by triggering capital flows out of emerging markets at record rates. According to economist Martin Wolf writing in The Financial Times in January, “another set of credit bubbles … in emerging economies is loudly popping”.

Gloomy forecasts, but no change to Fund’s policy advice despite fears of “domino effect” in developing countries

International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
and World Bank World Bank
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

issued January economic analyses which significantly downgraded their previous expectations. The World Bank’s Global Economic Prospects report emphasised the risk of a “synchronized” slowdown in the biggest emerging markets. It found growth in developing countries reached a post-crisis low of 4.2 per cent in 2015, and that in Sub-Saharan Africa it slowed to 3.4 per cent in 2015. Over $52 billion was removed from developing countries’ financial markets in the third quarter of 2015, the largest quarterly outflow on record. The IMF released its update to the World Economic Outlook (WEO), downgrading its own previous forecasts for economic growth. IMF managing director Christine Lagarde told German business daily Handelsblatt in December that growth prospects were “disappointing and uneven”. Lagarde cautioned that an interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rate rise in the US would also lead to higher debt costs for many developing countries, but Lagarde warned against any debt defaults because they would risk “infecting” banking systems and governments.

The WEO update identified the risk of its forecast being wrong as “to the downside”, e.g. that the Fund may still have been over-optimistic, due to the possibility of a “generalized slowdown in emerging market economies, China’s rebalancing” and US’ rising interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
. The Fund added that global growth could be “derailed” if these risks are not “successfully managed”. The update reiterated that “policy priorities” for emerging and developing economies are varied but cautioned that policymakers “need to manage vulnerabilities and rebuild resilience”, often seen as a coded way of indicating further fiscal caution. The IMF advocated that “policymakers in emerging market and developing economies need to press on with structural reforms [and] facilitate an …. innovation-friendly business environment”. It also encouraged further “deepening local capital markets”. ­­ The Fund concluded that for “a number of commodity exporters, reducing public expenditures” is necessary, also advocating for “exchange rate flexibility” to cushion the impact of further shocks.

However, an October policy brief by the International Labour Organisation (ILO) contradicted the Fund’s policy advice. It had warned that the “new adjustment shock” to come in 2016 was not simply driven by inevitable global economic dynamics, but by policy choices to cut budgets and spending “excessively”. They warned that such policies in this climate would mean that developing countries would be “most severely affected”, with sub-Saharan Africa and the Middle East and North Africa regions to be “hardest hit”. This vulnerability would come from premature reductions in subsidies on “fuel, electricity, food and agriculture” that were going to predominantly would impact the poorest and most vulnerable. The ILO argued that protection via targeted schemes and social protection “takes time to be fully functional”. Moreover, trying to offset the impact on the most vulnerable by targeting assistance to the very poorest “risks excluding large segments of the vulnerable and low income households” while it will “only increase the vulnerability of middle classes”. Instead, in times of crisis, policy should prioritise “scaling up … and building social protection floors for all”.

“Increasing debt vulnerability” in developing countries, following “boom in lending to most impoverished”

A December IMF policy paper, Public Debt Vulnerabilities in low-income countries: the evolving landscape acknowledged that developing countries “faced increasing debt vulnerability in the last 2 years”. The report examined the evolving public debt of 74 LICs, arguing that changes were due to “debt relief, strong growth and high demand for commodities Commodities The goods exchanged on the commodities market, traditionally raw materials such as metals and fuels, and cereals. ”. Despite the changing circumstances and the concerns set out by the ILO over excessively cautious policies, two of the paper’s authors advocated in a January blog for “fiscal prudence [and] improved debt management.” They argued that to address “challenging debt conditions”, countries should still focus upon the “need to strengthen their fiscal frameworks … and reduce their debt”.

The UK’s Guardian newspaper reported in September that the IMF’s September Global Financial Stability Report (GFSR) had also identified the risk of “a new credit crunch”, due to growth fuelled by a “10-year corporate borrowing binge”. The IMF report found risks of banking sector distress and increasing corporate bankruptcy, in particular when US interest rates would rise, as subsequently occurred in December. The Fund itself warned: “shocks to the corporate sector could quickly spill over to the financial sector and generate a vicious cycle as banks curtail lending”.

The January economic turbulence in China occurred as the world’s economic and political leaders gathered in Switzerland for the World Economic Forum (WEF). The Trade Union Advisory Committee to the OECD OECD
Organisation for Economic Co-operation and Development
OECD: the Organisation for Economic Co-operation and Development, created in 1960. It includes the major industrialized countries and has 34 members as of January 2016.
(TUAC) published a briefing to coincide with the January World Economic Forum questioning whether the gathered global policymakers appreciated the risk of global stagnation, despite their own studies’ findings. The briefing warned of a potential “domino effect” in developing countries in 2016, starting with China then affecting other leading emerging markets. It pointed out that China’s corporate debt increased “from around 100% to 150% of GDP GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
” since 2008.

UK NGO Jubilee Debt Campaign (JDC) had warned in a July report that global debt levels were rising and that 22 LICs were “already in debt crisis” and a further 71 were at risk (see Observer Autumn 2015) due to “boom in lending to the most impoverished countries”, in particular to low-income countries (LICs) where lending which tripled from 2008 to 2013. As the Chinese economy slows, the period of high commodity prices has ended, driving growing debt risks of many commodity exporting countries, such as Ghana who turned to the IMF for a loan in late 2015. Crude oil has fallen from a price of $100 per barrel in September 2014 to below $30 in January. JDC also highlighted the important role played by new forms of investment, in particular Public-Private Partnerships (PPPs), in adding to debt risks by masking the amount of debt government may have to eventually repay and concealing the actual degree of vulnerability to new debt crisis. A follow-up blog by JDC in December pointed out that developing countries’ increased borrowing was primarily from new loans, of which 60 per cent had come from multilateral institutions (half of which was from the World Bank alone).

Financial newspaper the Wall Street Journal highlighted the risks to African commodity exporting countries in a January report. It pointed out that South Africa’s rand had lost 26 per cent of its value against the US dollar in six months from June 2015, and reached a new record low in January. Though Nigeria had “ratcheted up efforts” to sustain a currency peg, Lagarde – visiting the country at the time – advised against, saying “exchange rate flexibility … can help soften the impact of external shocks”. However, the article revealed that “accelerating currency declines across Africa are starting to feed through to the real economy”, citing the fact that “mining companies in Zambia have laid off thousands of workers”.

The Guardian reported in January that Africa’s oil-producing and metal-rich giants now find themselves facing a dangerous mix of lower export revenues, depreciating currencies, declining financial flows from China, falling domestic demand and higher debt costs following December’s US interest rate rise. Kenya-based commodity trader, Aly Khan Satchu, told the Guardian that “in Zambia, the currency has pretty much collapsed” adding that many commodity producing states in Africa “have tipped over the edge because they are going to find it very expensive to borrow international money”.

Source: Bretton Woods Project



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