Click on the green icon on the right
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 of developing countries grew by almost 400 billion USD in 2012 to reach 4.8 trillion. The World Bank 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 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 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 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 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 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 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 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) 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.