Debt is back: World Bank report unveils trend reversal for developing countries

28 February 2014 by Bodo Ellmers

The World Bank’s 2014 International Debt Statistics report, released on February 12, unveiled a worrying new trend. In 2012, the last year covered by the report, all relevant debt indicators worsened – reversing the essentially uninterrupted trend of improvement since the early 2000s. Although developing country debt levels remain low when compared with their historical levels and with crisis struck countries in the global north, in the absence of sufficient other sources of income, developing country governments increasingly turned to issuing large volumes of sovereign bonds to be sold on private capital markets. The boom in sovereign bond issuance poses severe challenges for the international financial architecture, which is not well equipped to restructure this category of debt if needed.

Developing country debt is rising again

The debt stock Debt stock The total amount of debt of developing countries grew by almost 400 billion USD in 2012 to reach 4.8 trillion. The 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.

analysts highlight that the accumulation of new debt actually slowed from 11% of the debt stock in 2011 to 9% in 2012. But, because gross national income (GNI) and export growth could not keep track, all key debt indicators are deteriorating. The external debt stock to GNI ratio reached 22.1% (up from 21.4%), to exports it reached 71.9% (up from 69.3%). The currency reserves to debt stock have shrunk to 117.6% in 2012 (down from 122.3%).

Thus, 2012 was the first year since the early 2000s (with the exception of the financial crisis year 2009) in which the debt situation of developing countries worsened significantly. Their debt situation has improved continuously when the debt relief initiatives finally started to show results and the economic environment for developing countries became more favourable. How effective this debt relief was is proven by the fact that the debt service Debt service The sum of the interests and the amortization of the capital borrowed. ratio fell to 10% of export revenue in 2011, less than half the 21.1% that it was at the start of 2000s decade. In 2012, it fell further to 9.8%. This slight improvement is however not due to less debt, it is due to exceptionally low 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.
on a rapidly increasing debt stock.

As Eurodad has argued before, developing countries tend to turn to borrowing mainly as a second-best strategy, due to lack of alternatives. Endemic tax evasion and harmful tax competition combined with donors’ persistent inability to scale up official development assistance ODA
Official Development Assistance
Official Development Assistance is the name given to loans granted in financially favourable conditions by the public bodies of the industrialized countries. A loan has only to be agreed at a lower rate of interest than going market rates (a concessionary loan) to be considered as aid, even if it is then repaid to the last cent by the borrowing country. Tied bilateral loans (which oblige the borrowing country to buy products or services from the lending country) and debt cancellation are also counted as part of ODA. Apart from food aid, there are three main ways of using these funds: rural development, infrastructures and non-project aid (financing budget deficits or the balance of payments). The latter increases continually. This aid is made “conditional” upon reduction of the public deficit, privatization, environmental “good behaviour”, care of the very poor, democratization, etc. These conditions are laid down by the main governments of the North, the World Bank and the IMF. The aid goes through three channels: multilateral aid, bilateral aid and the NGOs.
to 0.7% of their GNI, as promised, often leave no other choice than borrowing money to finance the most urgent development needs.

Volatile capital flows

The new World Bank data points at the volatility of different forms of external finance. Unfortunately, the finance that developing countries receive belongs to the more volatile types: foreign direct investment fell in 2012, while the share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. of private finance that was portfolio flows was increasing. Moreover, there are significant country differences. The surge in developing country debt would have been much larger if China had not essentially stopped net lending. While net debt inflows to all developing countries fell slightly in 2012, they increased by 20% in 2012 when China is excluded.

While some countries showed net debt outflows (meaning they repaid more debt than they received as new loans), others - in particular Turkey and South Africa - saw their debt-creating capital inflows more than double in 2012. Newer information than those in the World Bank report (which covers data only to end-2012) proves that private capital is not a loyal friend and one might be better to avoid receiving too much of it. In particular, Turkey and South Africa witnessed massive capital outflows since 2013, as private investors withdrew their money again. They joined a country group of struggling emerging economies which also includes Brazil, India and Indonesia - and is now called the fragile five.

A sovereign bonds boom

A significant new development of 2012 was the aforementioned boom in new sovereign bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. issues. Developing country governments increasingly tap private capital from financial markets. Sovereign bond issuance by developing country borrowers rose by 30% over the 2011 level. More and more countries issue bonds for the first time, replacing credits from commercial banks which used to be the more prominent form of private external finance for developing countries.

In consequence, private creditors provided 90% of new net debt for developing countries in 2012. Net official lending such as those provided by the World Bank itself becomes increasingly irrelevant. This was, however, also because several countries paid back larger IMF IMF
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.
rescue loans than they had received at the peak of the global financial crisis.

Many observers see the turn towards private external finance as positive because official creditors such as the World Bank tend to attach intrusive conditions to loans and thus undermine sovereignty and democratic decision-making processes of borrower countries. However, as Eurodad pointed out, sovereign bonds have their downsides too when compared with concessional loans that the multi- and bilateral development banks provide. They are more costly, they come with higher than average 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. rates and are thus in the long run a drain on the public resources of developing countries. Moreover, they create new debt vulnerabilities. The bonds were issued in an environment where lots of ‘easy money’ in search of investment opportunities was available on global financial markets, due to the lax monetary policies of the central banks of the USA, EU and Japan. This may no longer be the case when the bonds mature and need to be refinanced in five or 10 years, which puts a question mark on the sustainability of the debt that has been piled up.

More debt falls into a governance hole

The sovereign bonds boom does not necessarily increase developing countries’ resilience to crises either. One could argue that the trend towards sovereign bonds – which usually fall in the category of long-term debt due to their multi-annual maturities – increases financial stability and debt sustainability for developing countries. However, this could be misleading because, when debt becomes unsustainable, bonds turn out to be the category of debt that is the most difficult, most costly and most time-consuming to restructure.

While the existing processes to restructure official debt (through the Paris Club) and commercial bank credit (through the London Club London Club The members are the private banks that lend to Third World states and companies.

During the 70s, deposit banks had become the main source of credit for countries in difficulty. By the end of the decade, these countries were receiving over 50 per cent of total credit allocated, from all lenders combined. At the time of the debt crisis in 1982, the London Club had an interest in working with the IMF to manage the crisis.

The groups of deposit banks meet to co-ordinate debt rescheduling for borrower countries. Such groups are known as advisory commissions. The meetings, unlike those of the Paris Club that always meets in Paris, are held in New York, London, Paris, Frankfurt or elsewhere at the convenience of the country concerned and the banks. The advisory commissions, which started in the 80s, have always advised debtor countries immediately to adopt a policy of stabilisation and to ask for IMF support before applying for rescheduling or fresh loans from the deposit banks. Only on rare occasions do commissions pass a project without IMF approval, if the banks are convinced that the country’s policies are adequate.
) already have severe short-comings - primarily that the debtor side has no say in them - the situation is even worse when the restructuring of bonds is attempted. There is no such thing as an orderly process for bond restructuring. Restructurings of bonded debts usually depend on voluntarily participation by bondholders. But, given the recent events at US courts that strengthened the rights of holdout creditors or vulture funds, voluntary restructurings with broad participation will no longer be possible. The sovereign bonds booms therefore puts additional pressure on the international community to reform the debt restructuring regime as ever larger shares of debt remain uncovered by the existing institutions.




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