The government debt crisis in developing countries becomes even more serious — a global issue

• opinion Written by Jomo Kwame Sundaram and Ndongo Samba Sira (accra, ghana)
• Wednesday, April 3, 2024
• interpress service

Progress towards sustainable development is often reversed, and external debt repayments are now impeding progress. Many governments are cutting spending in accordance with conditions and advice from powerful foreign economic institutions.

Current account story
Many still believe that every national economy should have a trade or current account surplus with other countries, typically citing the postwar economic booms of Germany and Japan. But of course, not all countries can achieve a surplus at the same time.

If a country's trade and current account balances remain in deficit for an extended period of time, the purchasing power of its currency is often under downward pressure. At least that's true in developing countries. The situation is different in countries such as the US, UK and Japan.

The Bretton Woods Agreement of 1944 created “extraordinary privileges'' for the United States by making the dollar the world's reserve currency. This privilege continued even after the United States refused to comply with its Bretton Woods obligations starting in August 1971.

Central banks in creditor countries have long purchased low-risk U.S. Treasuries. In fact, their current account surpluses make them net exporters of capital, repaying foreign debts and making other payments abroad without incurring external debt.

In contrast, developing countries with chronic current account deficits are often forced to borrow money, incurring the higher costs of accessing foreign currency financing.

Developing countries are thus seen as “creditors of safe assets (U.S. Treasuries)'' offering low returns, but “debtors of risky assets'' promising higher returns.

Pandora's box of foreign capital
Foreign capital is usually considered necessary to compensate for insufficient domestic investment. For example, very high interest rates in developing countries may encourage foreign borrowing and investment. However, there are further problems with the country's high dependence on foreign finance.

Repayment of foreign debt depletes foreign exchange resources and ultimately causes the depreciation of the domestic currency. More foreign borrowing may be required to address external debt, including returns on foreign investments and external debt repayments.

Reducing foreign debt by selling domestic assets to foreigners further denationalizes postcolonial economies and reduces national wealth. The repatriation of proceeds from foreign investments, both direct and portfolio investments, is likely to increase external debt in the medium to long term.

If the exchange rate is undervalued but stable (which is rarely the case), rapid economic transformation may be possible, discouraging imports and encouraging exports. However, some imported goods, such as food and medicine, are essential goods and cannot be easily replaced with domestically produced alternatives.

Macroeconomic stabilizer?
Credit to households and government deficits increase purchasing power, making spending possible, at least temporarily. When domestic production capacity meets such demand, a nation's economic output increases.

When private credit and spending fell during the 2008 global financial crisis, government deficits revived many rich economies, averting a sharper economic contraction and restoring production. Government and private spending and investment therefore increase, and growth is stimulated through the use of debt and revenue.

As budget deficits have increased in recent decades, recessions have become less frequent and severe. Consistently counter-cyclical fiscal policy can therefore shorten business cycles and stabilize growth and employment in rich countries.

With public debt and spending, the economy will prosper more often. Government debt is less of a problem in rich countries. Unlike developing countries, government debt is usually denominated in the local currency and interest rates are under the control of the central bank.

interest rate yoyo
Interest rates on government bonds issued by prosperous economies have been reduced since 2008. “Unconventional monetary policies”, especially “quantitative easing”, were widely adopted and went against orthodox monetary theory.

These rates are part of the Federal Reserve's response to the tightening of the U.S. labor market after three consecutive presidents, Obama, Trump, and Biden, maintained full employment in the wake of the 2008 global financial crisis and subsequent Great Recession. It remained at a low level until early 2022, when the government took measures.

For two years, the US Federal Reserve and the European Central Bank have been raising interest rates, fully aware that governments in developing countries will have to borrow large sums of money on far more difficult terms.

The US Federal Reserve (Fed) has halted interest rate hikes but has refused to cut them, while the ECB has maintained its position of not raising interest rates. Meanwhile, central banks in developing countries are maintaining high interest rates, fearing further hemorrhage overseas.

Developing countries facing government debt crises are increasingly demanding fiscal austerity. However, it is unlikely that austerity measures will be able to deal with external debt and debt. In other words, there is no analytical basis for typical policy prescriptions for developing country governments facing external debt stress.

Dr. Ndongo Samba Sira He is the Africa Research and Policy Director at IDEAS, which hosted the International Conference on the African Debt Crisis in Accra, Ghana, from March 27-29, 2024.

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© Inter Press Service (2024) — All rights reservedSource: Interpress Service

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