Implications for the Global South
By Sasha Breger Bush | March/April 2023
This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the
March/April 2023 issue.
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You might be familiar with Karl Marx's famous notion that capitalism never really resolves its crises, rather it moves them around geographically. Up until the last couple of years, I tended to agree. To be sure, complex phenomena like financial crises have complex causes, and, further, the conditions left in the wake of prior crises often contribute to the development of the next one. But all of that said, it used to be the case that one could, more or less, roughly pinpoint a particular market in a particular country where the trouble seemed to first erupt. For example, the U.S. mortgage market in 2007 in which the Great Recession ignited, or the market for the Thai baht in which the 1997 East Asian Financial Crisis began, or the market for syndicated loans to Latin American governments that underpinned that region’s debt crisis in the 1980s.
However, in the case of today’s debt crisis, the one that has emerged over the past couple of years, things seem different. There is no single place to which one can point right now and say, “Aha!! There it is. That’s where the trouble began.” At the moment, there are very serious financial and economic problems in most of the countries I’ve researched for this article—including Egypt, Pakistan, Lebanon, El Salvador, Argentina, Sri Lanka, Ghana, Zambia, China, the United States, Japan, and the United Kingdom, among others—issues that stem from a great number of overlapping and dynamic causal factors. And there’s debt all over the place, too, one of many visible symptoms of these larger problems. It’s a Whole World Debt Crisis, and geographic release valves to vent the pressure that’s built up are scarce.Since late 2020, debt-related problems have erupted in larger, wealthier economies right alongside smaller, poorer ones. But risk always hits the poor the hardest, and the current debt crisis has been especially difficult for poor and working people and for low- and middle-income economies that rely on imported food and energy to meet domestic needs. Yet, this unfolding global tragedy also contains bright spots of hope for the future, related to the shifting geopolitical and financial terrain on which the debt crisis is playing out. The volatile landscape is complicating international debt relief and restructuring efforts while at the same time creating opportunities for debtor states that were not available in the past.
The Global Debt Landscape
At no time in history has the world economy been so thoroughly saturated in debt, across a staggering array of submarkets and product categories. For example, in the United States, household debt levels have been increasing for about 20 years, roughly doubling between 2003 and 2019, and then growing another 17% over the next two-and-a-half years of the pandemic. In late 2022, total household debt was over $16 trillion, or about $50,000 in debt for each person living in the United States in 2022, including children.
According to the consulting firm McKinsey & Company, the same rough pattern also holds for global corporate debt, with total global nonfinancial corporate bonds outstanding—i.e., debts owed by corporations, excluding banks and other financial entities, to private bondholders—increasing 250% between 2007–2017, led by China (34.4% average, annual growth in bonds outstanding) and the developing world (14% per year), and then Western Europe (8.6% per year), with the United States and other advanced economies following closely behind. The pandemic pushed corporate debts higher too, including for corporations in the United States, Korea, and Vietnam, among others.
The same pattern also holds for total global debt. The chart from the International Monetary Fund (IMF) on the previous page depicts total global debt relative to GDP—a measure of debt burdens, because debt is compared to ability to pay, i.e., income—including total public debt, total household debt, and total corporate debt (excluding financial corporations). Since the 1970s, not only have global debt levels risen precipitously, but they’ve risen far faster than our collective ability to pay them off, with total debts more than doubling relative to income over this period.
Speaking to the impact of the pandemic on global debts, the IMF notes: “In 2020, we observed the largest one-year debt surge since World War II, with global debt rising to $226 trillion as the world was hit by a global health crisis and a deep recession. Global debt rose by 28 percentage points to 256 percent of GDP, in 2020.” The climbing numbers illustrate the scope and scale of global debts: In the United States, total debt reached 282% of GDP by the third quarter of 2020, increasing by close to 30% relative to the fourth quarter of 2019. In the United Kingdom, debt rose by more than 40% over the same period to over 300% of GDP, while in Canada, total debts climbed more than 50% to over 350% of GDP. In Japan, which has long struggled with unsustainable debt levels, total debt rose over 40% to a whopping 433% of GDP between the fourth quarter of 2019 and the third quarter of 2020. China, Hong Kong, India, and Russia also posted large increases in total debt over this short period.
Where Does the Debt Come From?
While the pandemic pushed global debt levels to jaw-dropping heights, the roots of this crisis precede the Covid-19 pandemic by more than a decade, though one could also argue that the foundation for this crisis was laid even further back, in the 1970s. Taking a longer view, then, the Whole World Debt Crisis is partly a consequence of 15 years of super-low interest rates—of a whole lot of “easy” money—which resulted in massive increases in the prices of financial assets around the world, including prices of various debt instruments, but also equity prices and other non-debt financial instruments. Critics of central bank policies that kept interest rates so low for so long sometimes refer to this broad and sustained asset price hyperinflation as the “Everything Bubble.”
After the Great Recession hit, central banks around the world lowered interest rates to stimulate lending and borrowing and economic recovery, often by injecting “new” money into the system (also known as “printing money,” though some of the new money is really in the form of digital credits deposited with banks). Of course, in some countries, like the United States and Japan, interest rates were already fairly low before the 2008 crisis, and they got even lower afterward, in real terms. What was initially framed as a temporary measure to restore economic health became more permanent. Low interest rates persisted, with only minor interruptions, until 2022. Over this roughly 15-year period, individuals, households, small businesses, corporations, and governments borrowed like mad, with only minor interruptions, and debt levels soared.
Analysts had been warning for some time that the borrowing and lending frenzy driven by low interest rates would have serious consequences for economies across the global South. For example, in January 2021, American Enterprise Institute analyst Desmond Lachman warned about the scale and scope of the incoming crisis, specifically noting that this particular crisis is different, as it is fundamentally predicated on mass international insolvency (i.e., upon the broad, system-wide accumulation of unpayable debts):
Fueled by unprecedented global liquidity, emerging market asset prices have become totally dissociated from those economies’ progressively deteriorating economic fundamentals. Past bubbles of similar size in some of the same economies have demonstrated that when these bubbles inevitably pop, the shockwaves tend to be global.
U.S. policymakers should be paying close attention to the inflating asset price bubble in the emerging markets. These economies now constitute around half of the world economy, and the current bubble appears to be bigger and growing faster than those that came before it. Compared to the Asian and Latin American debt crises [in the 1990s, and 1980s, respectively], the bursting of this bubble is likely to have a much greater impact on world financial markets.
But there were other factors, too, aside from low interest rates and the Covid-19 pandemic, that conspired to drive soaring debt levels. It’s hard to overstate the impact of the Ukraine war and the Western sanctions imposed on Russia in this context, which induced a “flight to safety” in financial markets and placed upward pressure on the prices of essential raw materials (from oil and gas to fertilizer, lead, copper, and wheat), aggravating food and energy price inflation, which was already substantial before the war started. Indeed, according to the U.N. Food and Agricultural Organization (FAO), by February 2022, when Russia invaded eastern Ukraine, food prices were already 45% higher relative to their 2014–2016 average. By April 2022, they had risen another 15%. Today, food prices have fallen a bit, yet remain 20% higher than prewar levels and 35% higher than pre-pandemic levels.
Ostensibly to mitigate inflationary pressures, in March 2022 the U.S. Federal Reserve began raising interest rates. When the U.S. central bank raises rates, other central banks around the world usually follow. They have little choice in the matter because rising U.S. interest rates act as a magnet, drawing capital into the United States and away from other economies, which can lead to problems such as exchange-rate depreciation, trade imbalances, and rising debts. But keeping pace with Fed rate hikes is a Faustian bargain, since higher interest rates raise the cost of debt and debt service. It’s a Catch-22.
In June 2022, when the S&P 500 index traded 20% below its January high, an analyst wrote in the Wall Street Journal that “Monday brought the definitive evidence that the ‘Everything Bubble’ is deflating,” going on to explain how U.S. monetary policy inflated and then punctured the bubble, as interest rates were reduced and then hiked:
The policy of super-low interest rates and trillions of dollars of bond purchases created the Everything Bubble, with prices of virtually every U.S. asset hitting new highs. As the Fed reverses course, the Everything Bubble is going away. It is hard for investors to escape.
Today, as this article goes to press, many asset prices remain seriously overvalued. For example, if we assume that equity prices will eventually revert back to their mean (or long-term average), as many scholars argue they will, then the S&P 500 in the United States still has to fall by over 40% to get there.
The World Bank commented in September 2022 that most central banks were raising interest rates simultaneously, which is unusual, and predicted that hiking rates in tandem would push many economies into recession and financial (debt) crisis at roughly the same time:
[T]he world may be edging toward a global recession in 2023 and a string of financial crises in emerging market and developing economies that would do them lasting harm...Central banks around the world have been raising interest rates this year with a degree of synchronicity not seen over the past five decades—a trend that is likely to continue well into next year [emphasis added].
Sovereign Debts and Debtors
Debt in Macroeconomic Context: The Case of Sri Lanka
One measure of debtâdebt service relative to export revenuesâis important for thinking about the broader debt picture. Exports are a major source of foreign exchange, i.e., other countriesâ currencies. When a country exports to the United States, they are often paid in U.S. dollars; likewise, when a country exports to China, they are often paid in Chinese yuan. The foreign exchange reserves that accumulate over time as trade proceeds are necessary to service debts, because a lot of the foreign debts incurred by developing country governments are denominated in foreign currencies. This makes debt sales by governments in the Global South more attractive to foreign investors because it eliminates the exchange-rate risk for them, pushing the exchange-rate risk onto borrowing governments instead. For example, a lot of Sri Lankaâs sovereign debts are denominated in Chinese yuan, and service on these debts has to be paid in yuan, not in Sri Lankan rupees. Sovereign debtors who incur foreign currency-denominated debt face serious risks associated with the size of their foreign-exchange reserves. If, for example, export levels fall, then there is less foreign currency earned and less available to service debts. Or if import prices rise, perhaps because food and energy inflation is rampant, reserves may be quickly depleted because foreign currency is also used to pay for imported goods. Or, if the local currency depreciates against the currency in which that government borrowed funds, for example if the yuan rapidly appreciates against the rupee, then foreign currency becomes more costly to acquire with sales of the local currency. Sri Lanka experienced all of these problems over the last couple of years, and the government defaulted on its obligations to bondholders in April 2022. While the IMF is currently working with the government on the matter, and other major creditors such as India and China have agreed to some concessions on Sri Lankaâs debt, a formal deal remains elusive.
Sovereign debts are debts incurred by sovereigns, that is, governments. Governments borrow domestically and internationally to finance government expenditures, ranging from security and defense to education, health care, and anti-poverty programs. They even take on new debts to pay off old ones, using borrowed funds to finance debt service. Debt service refers to the regular payments a debtor has to make to a lender to stay in good standing, typically including accumulated interest and sometimes also a portion of the principal.
Not all sovereign debtors face the same risk of default in the current environment. In general, the wealthiest and most advanced countries currently struggling to manage their debts—for example, the United Kingdom, Japan, and the United States—have structural advantages that smaller, poorer economies do not, including robust central banks that coordinate with other major central banks to support domestic markets, preferential access to credit in international capital markets, relatively more stable exchange rates, and diversified economies that are more resistant to external shocks. Less wealthy and powerful countries, however, do not have the same advantages, and many have struggled mightily as the pandemic added to already-high debt levels.
The World Bank recently reported that for low-income countries eligible to borrow from the International Development Association (an arm of the World Bank that lends to the lowest-income economies), by the end of 2021, “Debt service payments on long-term external debt rose to US$78 billion ... equivalent to 18% of exports of goods and services and 3% of GNI [gross national income], compared to 5% and 1% respectively in 2010” (italics added; see sidebar). In February 2020, before the pandemic hit, more than half of low-income countries were already at “high risk of debt distress or already in debt distress,” according to the IMF. Zambia became the first African country to default on its sovereign debts during the pandemic, failing to make payments on a Eurobond commitment in November 2020.
Figure 2, from the IMF, shows rising levels of debt distress among low-income, DSSI countries, countries with some of the lowest per capita incomes in the world, such as Afghanistan, the Democratic Republic of Congo, and Haiti (DSSI countries are those eligible to participate in the Debt Service Suspension Initiative and have been designated by the G20 as having high default risk). Note that a greater proportion of DSSI countries were at high risk for debt distress or in debt distress in 2019, just before the pandemic began, than were at risk even during the Great Recession in 2009–2010.
The U.N. Committee on Trade and Development (UNCTAD) recently described how high food prices and a strong U.S. dollar (a consequence of rising interest rates) generate hunger and debt:
During past crises, the value of the U.S. dollar fell as food prices climbed...But the U.S. dollar has gotten stronger this time, climbing 24% between May 2021 and October 2022 as the Federal Reserve increased interest rates to try to curb inflation in the United States... [T]he combination of high food prices and a strong dollar is a “double burden” that many people in developing countries cannot bear, leaving them to face even harder choices to make ends meet—such as skipping meals or taking a child out of school...
Explaining that the “exchange rate effect is a significant driver of rising food import bills, contributing to inflation, loss of purchasing power and food insecurity,” UNCTAD gives the example of Egypt, the world’s largest importer of wheat, which would have paid $3 billion more in 2022 to import the same quantity of wheat that it did in 2020. In mid-January 2023, with the country already deep in debt, the Egyptian currency collapsed. Reporters with the Financial Times explained what happened:
The Arab state has been hit by the headwinds of Russia’s invasion of Ukraine, which drove energy and food prices higher. It also triggered capital flight from Egypt, with foreign investors pulling about $20bn out of local debt in February and March last year. The outflows triggered by the war resulted in the Egyptian government borrowing over $13 billion from various Gulf States and tapping the IMF for additional funds.
Zambia and Egypt are not alone. Similar debt-currency-trade-inflation dynamics—with rising interest rates and the strong U.S. dollar this past year igniting the dry tinder beneath—have underpinned a tidal wave of financial volatility, instability, and crisis since 2020. Argentina, Suriname, Lebanon, Ghana, Ecuador, Turkey, Bangladesh, Sri Lanka, and Pakistan, among many others, are now or have very recently been in similar predicaments, and all have been working with major international creditors like the IMF on new (emergency) loans and/or debt restructuring. Add to this the many dozens of countries (48 countries, to be exact, as of February 2022) that utilized the DSSI program organized by the World Bank and IMF, which temporarily suspended $12.9 billion in bilateral and multilateral debt service during the pandemic. As I mentioned earlier, we should also add in the growing likelihood that a number of wealthy, “advanced” economies are also headed for financial trouble, as recent events in British and Japanese bond markets suggest is probable.
But some economies are more insulated than others. Soaring commodities prices have been a stabilizing force for major commodity-exporting economies, such as Peru, Chile, Malaysia, Vietnam, and the oil-exporting Gulf states, helping to increase dollar reserves, stabilize currency values, and balance trade (these economies have been running trade surpluses, largely on the strength of their commodity exports). As global growth slows and credit conditions tighten, though, this balancing act will become more difficult. With a global recession now expected in 2023 (see the section above for the World Bank forecast), the financial position of commodity exporters is a hotly debated question in financial circles. Some expect commodities prices to fall as the global recession reduces income and demand for commodities, while others anticipate elevated commodity prices well into 2024 in spite of the recession, owing to demand from China, supply chain disruptions, and geopolitical risks (e.g., the widening war in Ukraine and related sanctions).
The dollar reserves accumulated through trade are critical for countries to be able to service debts and can help them avoid having to engage the IMF and other creditors for emergency loans or debt restructuring (see sidebar). The IMF typically demands substantial changes in economic policy as a condition of borrowing funds (called “structural adjustment programs”), and the changes required have in many cases radically undermined standards of living in debtor countries and in every case eroded the policy autonomy and independence of debtor governments. Today, the IMF holds almost half of DSSI country debt, with China holding 18% and another 11% in Eurobonds (Eurobonds are emerging market bonds denominated in euros).
What Happens Next?
I don’t care to make firm predictions about our economic future because, as John Kenneth Galbraith once said, “the only function of economic forecasting is to make astrology look respectable.” But I have questions and concerns about what happens next, based on my research, that I share below in lieu of a forecast, in no particular order, along with a bit of reasoning and discussion.
>When will we hit bottom? The data I’ve seen indicate that we probably have a while to go before we hit bottom, so to speak. Academic scholarship indicates a very substantial lag between the time monetary policy changes are implemented (on the one hand) and the time the impact of those changes is felt (on the other). At a minimum, the literature suggests that it usually takes at least one year for an interest-rate hike to affect inflation (central bankers like the Fed are “inflation targeting” with their hikes, so they will likely wait to see inflation abate before reversing course). As it is, we’re only about 12 months since the first hike, and debt defaults and related financial crises are starting to come in hot and heavy.
Who will be the lender of last resort? If the Whole World Debt Crisis becomes sufficiently broad, who will bail the whole world out? Given the global scope and synchronicity of rising debt levels and recent monetary policy tightening, it is likely that many or most countries will be in distress and facing liquidity shortfalls simultaneously or in rapid succession, raising questions about who will act as lender of last resort. Are the major central banks and multilateral institutions like the IMF sufficiently well capitalized to support the system as a whole? If not, from whom would they raise the necessary funds in a crisis environment? The private sector? A 2018 article in the Australian Financial Review entitled “No lender of last resort when the ‘everything bubble’ bursts” explains that the Dodd-Frank Act, which was passed in the United States in the wake of the Great Recession, prevents the central bank from “rescuing individual companies in trouble (there must be at least five, and they must be solvent) or lending to non-banks in a panic.” This suggests that central banks will, at best, only be able to support a small range of financial institutions as defaults mount.
What options do debtor nations in the Global South have to manage their debts? This is where I see real hope and promise for the future. Relative to past crises, it appears that debtors in the Global South today have more options, creating opportunities to make debt deals on better terms than in in the past, and allowing some to perhaps avoid IMF structural adjustment. A few interesting examples:
- Argentina is playing creditors off one another and leveraging recent geopolitical shifts—especially the growing competition between the United States and Europe on the one hand and the BRICS countries (Brazil, Russia, India, China, and South Africa) on the other—to its advantage. An expert quoted in the Rio Times recently explained the approach as follows: “[President] “FernÃ¡ndez will seek a mature relationship with China and the United States, seeking to get the best he can from both countries. If China wants to invest and provide funding, then great. Need will prevail over the ideology.” Argentina did a currency swap with China in 2020, and another this past January 2023, trading its local currency for Chinese yuan to hold in reserve, both of which shored up foreign exchange reserves and boosted investor sentiment. Beyond Argentina, China—which is now the largest official bilateral creditor for many of the world’s poorest countries and a major creditor for many others—has been working on debt restructuring and relief with other governments in the Global South, especially countries like Egypt and Angola that are strategically positioned within China’s Belt and Road Initiative.
- El Salvador last year defied the IMF and adopted Bitcoin as legal tender alongside the U.S. dollar in a bid to stabilize the economy and reduce the impact of the strong dollar on domestic financial stability (see Hadas Thier, “Cryptocurrency Will Not Save Us,” D&S, January/February 2022). (El Salvador is a dollarized economy, one that adopted a foreign currency as its own domestic currency.) In January 2023, the government shocked the world when it made a large payment on a large outstanding external bond obligation. Referring to the bad press to which he had been subjected and credit downgrades since the change (Fitch Ratings downgraded Salvadoran bonds to “CC” level in September 2022), Salvadoran President Nayib Bukele wrote on Twitter, “Well, we just paid in full, $800 million plus interest. But of course, almost nobody is covering the story.” El Salvador also tapped into funding from a smaller, regional development bank (the Central American Bank for Economic Integration), rather than meet the conditions set by the IMF as a condition for new loans. In the past, such defiance came at a much greater cost because there were fewer viable alternatives.
- Ghana, which suspended external debt payments in December 2022, is deploying an interesting approach to debt restructuring, in the context of a possible IMF loan. The Ghanaian government is required to restructure its public debts in order to receive a $3 billion IMF loan, which in turn requires the participation of private bondholders. (Across the developing world as a whole, in 2009, about 33% of the debt held by developing countries was private, rising to 51% by 2020, rendering private bondholders major creditors in the Whole World Debt Crisis). Instead of negotiating with creditors as a group, the approach typically deployed in the past, the government is maximizing its leverage by negotiating with smaller groups of bondholders on an individual basis. As a financial commentator recently put it, “The government’s approach has been to ‘divide and conquer.’” In the past—for example in negotiations with Western creditor governments who work together on debt issues as the “Paris Club”—it has often been the case that already-powerful creditors negotiate together as a group with individual debtor states, with all of the power and leverage lying on the creditors’ side of the table. Ghana’s approach—buoyed perhaps by elevated commodity prices, alternative sources of capital (e.g., from China), and perhaps high investor demand for “underpriced” emerging-market debt—dispenses with this old and blatantly rigged game. Perhaps Ghana’s offer to restructure debts for less than 40 cents on the dollar, one that has so far been underwhelming to investors, will seem more appealing to bondholders as the recession sets in.
The Whole World Debt Crisis is bittersweet. As in the past, the economies of the global South are shouldering an unfair share of the costs of a financial crisis that was largely manufactured elsewhere. But unlike in the past, new options to manage sovereign debts are presenting themselves, and the future may thus hold more opportunity for autonomy, independence, and better deals for debtor governments.
Sasha Breger Bush is an associate professor of political science at the University of Colorado Denver and the author of Derivatives and Development (Palgrave Macmillan, 2012). You can read more of her work at her newsletter IPEwithSBB (ipewithsbb.substack.com).
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