Serious Debt Crisis Unfolding in the Poorest Part of the World: A Way Forward

Since the start of the year, a severe debt crisis is intensifying across the developing low and middle-income countries. According to United Nation Development Programme’s report on international debt relief, nearly 54 countries are now facing serious debt problems with rise in interest rates increasing borrowing costs, decline in fiscal space which are pushing the countries into more debt burden. The warning has came amid the rising global recession tensions as well as the debt scenarios of Sri Lanka and Pakistan to Chad, Ethiopia and Zambia.

Too Little Too Late

In a recent research based on credit ratings, debt sustainability ratings, and sovereign bond spreads, UNDP has identified that the poorest countries are the world is at a risk of severe debt burden. At least 54 developing economies are experiencing debt burden. Although they represent only 3% of global economy and 18% of population altogether, it is home to more that 50% of people live in extreme poverty. Furthermore, it includes 28 of the world’s top 50 most climate vulnerable countries who are in need of urgent debt relief as a result of cascading global crises.

The developing economies were struggling with debt distress long before the Covid-19. Though major debt relief initiatives were taken in response to pandemic such as the Brady Plan, Highly Indebted Poor Countries (HIPC) and Debt Service Suspension Initiative (DSSI) contributed significantly to reduce debt-burdens and improve development prospects, these were not adequate to avert the resurgence of debt trouble. For instance, the G20 in May 2020 initiated the Debt Service Suspension Initiative (DSSI) and offered 73 poorest countries debt relief by allowing them to postpone debt service payments on official bilateral debt and urged the private creditors to join in the mission. However, the DSSI not only failed to reach the expected level of relief due to limited take up but also called for an end at a time when many countries are experiencing shrinking foreign reserves and large gross financing needs.

Currently, more than one third of developing economies issuing dollar debt in international markets with 19 countries paying more than 1,000 basis points over US Treasury bonds. Similarly, close to one third of all developing economies with a credit rating at are now either ‘substantial risk, extremely speculative or in default’. Among the 54 countries, 25 countries are from Sub-Saharan Africa, followed by Latin America and the Caribbean.

According to a major credit rating agency called S&P stated that the impact of Ukraine war might continue exert downwards pressure on credit rating across the developing and poorer countries which could last beyond 2024. Along with this, since the majority of debt vulnerable countries are also climate vulnerable, a change in climate conditions could adversely affect the sovereign credit ratings. In this circumstances, if these countries do not get access to effective debt restructuring immediately, poverty will rise and desperately needed investments in climate adaptation and mitigation will not happen. To avoid this, the working paper has suggesteda number of policies for debt restructuring which could contribute to manage the developing economy debt distress and help countries improve their future fiscal and economic resilience.

From Debt Rescheduling to Restructuring

To avert the prolonged debt crisis, as per UNDP, the focus must be shifted from debt rescheduling to comprehensive restructuring involving write-offs allowing countries to make progress on sustainable development. New sources of funding are needed for developing countries to undertake investments in climate adaptation and mitigation. A structurally different future of tighter funding conditions and higher frequency of climate disasters will require a re-think and ramp-up of official sector concessional lending to vulnerable developing economies.

Since effective debt restructuring is only one solution of ensuring that developing economies have the finances they need, the international community should not wait until interest rates drop or a global recession kicks in to take action. All Creditors, debtors, and guarantors must act fast and decisively to avoid past mistakes of providing ‘too little too late’ debt relief & improve their future fiscal and economic resilience.

Tahmina Haque
Tahmina Haque
PhD candidate at MacCormack Graduate School. Research interest: South Asia, Governance and Development, Security and Gender Issue