Problem

Burden of servicing foreign public debt

Other Names:
External debt-servicing difficulties
Inadequate public debt relief for developing countries
Unsustainable debt-servicing obligations
Acute debt-servicing problems
Foreign debt trap
Indebtedness of developing countries
Third world debt
Public debt overhang
Nature:

Countries may accumulate an external public debt with servicing obligations which cannot readily be met at the time when they fall due. Money may then be borrowed on less favourable terms just to pay the interest on prior debts. Under some circumstances, and there is no clear definition, the debt burden may be considered 'oppressive' and some form of debt relief is called for.

Large debt service obligations discourage foreign investment and divert budgetary allocations away from essential investments in health and education. They also yield most economic decision-making to the hands of international creditors, undermining fragile democratic processes.

Frequent rescheduling of debt over the years at commercial interest rates has led to a rapid and insupportable growth in some countries' debt problems. When interest rates rise relative to export prices, real debt burden will increase and import capacity will decrease. Rescheduling of debt service and debt principle payments is widely criticized as aggravating the public debt burden of these countries and drawing attention away from solutions to their economic problems. Few alternatives are forthcoming, however.

Background:

The Lester Pearson Commission had already estimated that, by 1977, debt-servicing, i.e. annual repayment of principle and payment of interest, would alone exceed the gross amount of new lending by 20 per cent in Africa and 30 per cent in Latin America. In other words, the new loans which a developing country felt obliged to enter into for development purposes could not be used for development and would not even be enough to cover the servicing of existing debt. In the future, developing countries will have to regularly take on new debt, not for investment, but for repayment.

In this way, debt which increases as it is repaid becomes a further bond of dependency. For many countries, it is an intolerable burden. This situation has led to debt crises in almost every developing country, necessitating alleviation or renegotiation of their debt without any lasting solutions being found. This situation gives rise to economic and social crises which often culminate in very serious social disturbances, leading to political instability that often prevents any economic development. The debt crises of the 1980s caused the debtor countries to accept Draconian conditions for the reorganization of their economies. They had then not only to export more to repay their debt but also to restructure their economies according to neo-liberalist principles, i.e. to deregulate economic activity, privatize public companies and greatly cut back State expenditure.

While public debt is increasing steadily at a rapid rate, with the grave consequences described, official aid to the developing countries is declining. The "developed" countries, which perpetuate this situation, and the international institutions (World Bank and International Monetary Fund) which act as their collection agencies, should revise their policies so as to ensure an international transfer of resources to the developing countries, sufficient to spare them the difficulties caused by indebtedness. The primary mission of the international financial institutions is precisely that of assisting such transfers.

In 1944, the Bretton Woods Conference decided to set up the World Bank and International Monetary Fund (IMF) for the purpose of helping to improve world trade relations. Article 1 of the IMF Articles of Agreement sets out six objectives for the Fund, one of them being to facilitate the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of productive resources. IMF recommendations and guidelines, which are especially hard on countries wishing to renegotiate their debts, are in flagrant contradiction with the aims set out in article 1 of its statutes. It is worth noting that the loans granted to developing countries have actually been merely a series of fictitious operations bringing no benefit to the populations concerned, which are nevertheless called on to repay them. The loans granted in fact take different directions, none of which leads to the really needy segments of the population. They are partly used to service debt and partly misappropriated by those responsible for managing them, to be redeposited in the banks of the creditor countries or reinvested in companies in those same countries.

The main consequences of such practices are to multiply and exacerbate the problems of the developing countries. The main victims are, of course, the deprived segments of society who have less to live on, and nothing seems able to halt their slide towards absolute poverty. All the evidence suggests that perpetuating the debt of the developing countries is the result of a deliberate political decision designed solely to frustrate any attempt by the developing countries and their peoples to achieve economic and social progress.

It is certain that international financial imbalances will strike directly at the already frail economies of the developing countries. Such imbalances will continue to worsen as long as world economic structures are marked by unequal terms of trade. Moreover, there is also every indication that the perpetuation of indebtedness means that it can be used as a powerful weapon to bring developing countries to their knees, while providing their governing classes with the means to cushion themselves and to be the advocates of an economic policy which is catastrophic for the vast majority of the world's poor.

The Paris Club of Industrial Country Creditors (Paris Club), which reschedules official bilateral debts, was created in the late 1950s to deal with the liquidity problems of mainly Latin American countries. The emergence of serious and widespread debt-servicing difficulties for many other (particularly low-income) countries began in 1982. The response of the international financial community protected it from serious disruption but has often proven to be insufficient for the purpose of restoring moderate growth -- or often even maintaining positive growth -- in the heavily indebted countries. In the initial phase, the international approach to debt problems involved three steps. The debtor country would agree to an economic adjustment programme endorsed and supported by the international community. The International Monetary Fund (IMF) would assist the debtor country in negotiating with commercial banks a partial rescheduling of principal payments falling due during a 1-2 year period coinciding with the adjustment programme, combined with new loans to assist the debtor in making its interest payments. Finally, official bilateral creditors would reschedule, on a cost-of-funds basis, a portion of debt-service payments in the Paris Club, on a pari passu basis with commercial banks and other official creditors. This meant that, typically, a portion of scheduled interest payments would be capitalized in lieu of new loans.

The principal drawbacks to this approach were twofold. Debt continue to accumulate, with debt on commercial terms increasing its weight in the total. Yet new loans were insufficient to offset debt-service payments after rescheduling, resulting in a negative net transfer of resources and inadequate import capacity to sustain growth-oriented investment.

The Baker Plan of 1985 ushering in the second phase. It sought to reduce or reverse the negative net transfer of resources by urging the international institutions to step up their lending efforts in concert with commercial banks. The adjustment programmes were supposed to be situated in a medium-term context, to emphasize increasing the production of exportable, and to support a higher level of GDP growth. Although this initiative provided a framework for settling claims in an orderly way and contributed to the improved creditworthiness of nations as a result of domestic economic reforms, it also failed due to inadequate lending by commercial banks, persistence of high interest rates in the international capital markets and difficulties in increasing export revenues at a pace sufficiently rapid to reduce the relative burden of interest payments. Most deals were not generous enough to trigger by themselves the shift in investor sentiment that has taken place, and up-front costs have outweighed cash flow savings in the short and medium terms.

The experience gained through this period of "muddling on" and recognition of the high human and political cost of a continuation of the status quo led, by April 1989, to the emergence of anew implicit international consensus on the need for debt relief, which might be said to include the following elements: (a) acceptance of a tripartite responsibility by the Governments of debtor countries, the Governments of creditor countries, and the commercial banks involved in international lending to sovereign States; (b) Insistence by the Governments of creditor countries that a further strengthening of debtor-county adjustment policies is necessary; (c) Centrality of the case-by-case approach -- i.e. country-specific determination of the adjustment programme and its financial requirements; (d) agreement that debt reduction belongs on the menu of financial packages for debt-distressed countries; (e) Desirability of a market-based approach for commercial-bank debt reduction. The new procedures permitted, for low-income countries, write-downs of up to one third the value of the relevant debt and rescheduling of official and officially guaranteed debt-service repayments over a longer period than before and at concessional interest rates. In the case of low-income sub-Saharan African countries, debt relief on official debt was to have been accompanied by increased official development assistance flows from bilateral and multilateral sources. There is, as yet, little sign that the requisite amounts will be forthcoming.

Agreement on the need for selective debt reduction vis-à-vis commercial banks and on appropriate mechanism has been more elusive. However, a number of market-based approaches have evolved for enabling voluntary commercial-bank debt reduction to take place. They include debt-equity swaps, donor-financed debt buy-back schemes (sometimes accompanied by commitments to enhance environmental safeguards), exchange of discounted debt for bonds, and exchange of discounted debt for "exit" bonds. In some cases the international financial institutions would guarantee the interest payments on bonds exchanged for discounted debt. In other cases, they would lend money for the purpose of acquiring debt on the secondary market or for purchasing a zero-coupon long-term bond to serve as collateral for a national bond exchanged for debt.

Incidence:

The negative impact of unsustainable external debt-servicing extends around the world. Total outstanding debts for developing countries soared from US$68.4 billion in 1970 to $835 billion in 1985, with interest payments alone totaling $60 billion annually (draining the bulk of economic surplus of many countries). In 1993, over 20 developing countries were in arrears with the registered international financial institutions and the regional development banks. In 1982 and 1983, official creditors and banks had to reschedule over $100 billion in loan repayments owed, while in 1983 alone, non-oil exporting countries paid $50 billion just for debt-servicing interest.

Since the early 1980s, sub-Saharan Africa's debt has tripled to $180 billion, and the annual cost of servicing it is $10 billion, draining the region's limited capital resources. Moreover, despite allocating almost a third of their foreign exchange earnings to debt repayments, most countries are building up arrears at a frightening rate. Collectively these amount to almost $11 billion, compare with $220 million in 1980. In 1992, the newly elected government in Zambia was faced a bill for $123 billion in IMF arrears, along with a list of conditions likely to hamper recovery efforts, leading the deputy finance minister to comment that "democracy is a damned expensive thing". Every Zambian citizen now owes the country's creditors $1,000 -- three times what they earn in a year.

The human costs of Africa's debt crisis have been immense, with governments squeezing public sector wages and health and education budgets to meat their financial obligations. Debt repayments are also undermining efforts to introduce successful market reforms. Cuts in spending have destroyed the infrastructures on which efficient market depend, deterring foreign investment in the process. At the same time, the squeeze on imports and high interest rates needed to maintain debt transfers has deprived potentially competitive industries of access to the capital equipment they need to expand their market, at home and overseas. Living standards, which fell by a third in the 1980s, investment is hovering around mid-1970s levels, infrastructure is collapsing, inflation is rampant and hunger a spreading threat.

A specific example is Mozambique. The World Bank claims that it is "sustainable" for countries like Mozambique to pay a quarter of their export earnings on debt service. Yet after World War II, Germany was not required to pay more than 3.5% of its export earnings on debt service. Poor countries today need a ceiling on debt service similar to the one Germany had. According to UN statistics, if Mozambique were allowed to spend half of the money on health care and education which it is now spending on debt service, it would save the lives of 100,000 children per year.

The pressure of debt servicing also manifests itself in relation to workers salaries. In Brazil, approximately 20 million of the 60 million economically active citizens receive up to the minimum wage -- roughly $50 a month. The consequences of this salary squeeze is a lowered life expectancy for non-specialized workers (on average 44 years in states like Paraiba compared with 60 for Brazil as a whole). The economy has been oriented toward exports as opposed to the internal market. One reason for salary reduction is that the prices of exported commodities were lowered in order to compete in international markets. Moreover, to diminish domestic consumption and generate an exportable surplus, it was necessary for domestic prices to rise. There is also threat to the protection and sustainable management of ecosystems due to the combination of pressure to increase exports, insufficient funding for environmental agencies, and the necessities of millions of people living in absolute poverty.

Taking exclusively into account the situation of the sub-Saharan African countries, the Secretary-General of the United Nations launched, on 15 March 1996, what is said to be an unprecedented programme to mobilize all the organizations of the United Nations system and funds in an amount of $25 billion to put the economies of these countries back on their feet. The resources will not be new ones but rather a reorientation of resources already existing at the national and international levels. The international financial institutions are considering a series of measures to lighten the burden on the most heavily indebted countries. According to the World Bank, it is impossible to break the vicious debt circle with the existing financial instruments and new ones will have to be created. The Bank proposes, in the first instance, to establish a ceiling for debt-servicing which should not exceed 20 to 25 per cent of the export earnings of the country concerned. As for the debt itself, its weight must not be greater than two and a half times the value of exports. In practice, these alleviating mechanisms would intervene only as a last resort, once all the present conventional remedies had been exhausted. In view of the fact that the multilateral debt cannot be rescheduled, still less cancelled, the measures proposed seem to be simple stopgap devices designed to ensure repayment of the debt. We all remember the promises made in the context of the structural adjustment programmes which very rapidly turned into a resounding failure in all the countries that applied them.

The manner in which the debt is managed at present also enables transnational corporations to frustrate any attempt by the developing countries to assert their sovereignty or chart the course of their own development. Because of the role it plays today, debt is a formidable instrument for domination which the transnational corporations wield effectively against the developing countries. Reference must be made here to the failure of the Bretton Woods institutions to carry out their primary mission - that of creating and maintaining a balance between the various actors of international economic life in the best interests of humanity. This failure, combined with the activities of the transnational corporations and the selfishness of the developed countries, has led to the establishment of two harmful and destructive practices in the form of structural adjustment programmes and, more recently, devaluation of the currencies of the developing countries.

Related Problems:
Ecological debt
Related UN Sustainable Development Goals:
GOAL 1: No PovertyGOAL 2: Zero HungerGOAL 3: Good Health and Well-beingGOAL 4: Quality EducationGOAL 5: Gender EqualityGOAL 6: Clean Water and SanitationGOAL 7: Affordable and Clean EnergyGOAL 8: Decent Work and Economic GrowthGOAL 9: Industry, Innovation and InfrastructureGOAL 10: Reduced InequalityGOAL 11: Sustainable Cities and CommunitiesGOAL 12: Responsible Consumption and ProductionGOAL 13: Climate ActionGOAL 14: Life Below WaterGOAL 15: Life on LandGOAL 16: Peace and Justice Strong InstitutionsGOAL 17: Partnerships to achieve the Goal
Problem Type:
D: Detailed problems
Date of last update
29.04.2020 – 17:17 CEST