Urgent Debt Relief Measures Needed to Accelerate Low Income Countries’ Pandemic Recovery

A stark divide has emerged between the more developed world and the less developed world in the economic recovery from the Covid-19 pandemic. Wealthier nations have secured most of the global vaccine supply and have had the capacity to deliver massive economic stimulus packages. In poorer nations, vaccination rates remain dismally low, and the impact of the pandemic is compounded by a looming debt crisis. As revenues have crashed and the strain on healthcare and social assistance systems has soared, many less developed countries face crippling debt burdens which hinder their ability to fight the pandemic and invest in sustainable development, and which threaten to increase inequality and depress global economic output for years to come. Short-term relief measures from the International Monetary Fund (IMF) and the World Bank have begun to address the challenge, but they have some major limitations. The global recession due to Covid-19 has caused widespread suffering, but it also provides an opportunity to fundamentally rethink the future of the world economy, reduce inequality, and drive a new leap forward in fighting the climate crisis. But global crises require global solutions, and without international and private sector cooperation to reduce and restructure the debt of less developed countries beyond the timeline of the pandemic, a just, inclusive, and sustainable global recovery will remain out of reach.

In 2020, the world’s total debt-to-GDP ratio jumped 35 percentage points to hit 365%, according to the Institute of International Finance. The pandemic caused economies across the globe to grind to a halt as factories, workplaces, and businesses closed, trade slowed, and currencies weakened. At the same time, the need for government spending on healthcare and social services increased dramatically. For countries with high levels of public debt, especially for emerging market and developing economies, this has been disastrous. Even before the pandemic, many poor countries had high levels of debt. According to IMF data, the external debt of poor countries was 29% of GDP in 2012; by 2019, it had reached 43% of GDP. According to the Jubilee Debt Campaign, in 2019, 64 countries were already paying more to service their debt than they were spending on healthcare. A UNICEF study found that 25 countries spent more on debt service than on healthcare, education, and social protection combined in 2019. Less developed countries consistently pay higher interest rates, sometimes upwards of 10%, compared to more developed countries with longer histories of borrowing on foreign markets, which sometimes pay rates below 1%.

The debt of the less developed world, both external and domestic, has been accumulating since the 1970s, when low interest rates and favourable market conditions encouraged high levels of lending to Latin American and low-income sub-Saharan African countries. At the end of the decade, slow growth and two oil price shocks caused a recession in the West. International trade declined and interest rates in many Western countries were raised in order to control inflation, increasing debt service costs to their debtors. The result was a debt crisis in the early 1980s often called the Third World Debt Crisis, the Latin American Debt Crisis, or La Década Perdida (The Lost Decade). In order to prevent widespread defaulting, in the 1980s, the IMF and the World Bank began issuing large loans to the affected countries as investments in their economic development. These loans were conditional; through so-called structural-adjustment programs, poor countries came under pressure to adopt free-market policies, privatizations, and austerity measures that reduced deficits by decreasing social spending. Despite fluctuations over the next decade, the debt burdens of poor countries remained generally high. This problem led to the formation of the Paris Club and significant debt and debt service cancellations. It also spurred the creation of various new debt relief initiatives, including the Heavily Indebted Poor Countries (HIPC) Initiative in 1996 and the Multilateral Debt Relief Initiative (MDRI) in 2005. How the debt of the less developed world should be managed continues to be a subject of debate.

It should be noted that at least according to current economic thought, high levels of public debt are not inherently bad. As long as interest rates remain low and a country’s economy grows faster than interest accumulates on its debt, borrowing can be an effective strategy for governments to finance development and invest in further growth. However, when an event like a global pandemic paralyzes economic growth, a debt crisis may occur when countries suddenly struggle to make repayments. In 2020, low- and middle-income countries spent an estimated $130 billion servicing their debt. The number of poor countries eligible for assistance from the International Development Association (IDA) classified as being in debt distress or at high risk of debt distress rose to 54% in 2020 (up from 24% in 2013). Low- and middle-income countries owing billions in debt service had an impaired ability to mobilize their resources to respond to the pandemic. Comprehensive debt relief and restructuring programs for less developed countries are, therefore, a crucial component of efforts to accelerate the pace of pandemic recovery.

Several initiatives have been launched to address the debt burdens of the less developed world exacerbated by Covid-19. The IMF has recently advanced a proposal for an allocation of Special Drawing Rights (SDRs) worth $650 billion to boost liquidity and quickly give countries the resources to pay for vaccines and other pandemic relief measures. The allocation is expected to take effect in August 2021. SDRs are essentially reserve assets, which may be exchanged for currency by the country to which they are credited. One of the major issues with SDRs is that they are allocated according to countries’ respective financial contribution shares in the IMF. This means that the majority of the reserves would go to wealthy nations; according to a United Nations Development Program analysis, only around 8% of the total allocation would go to the 82 countries classified as “highly debt-vulnerable.” This would cover only about 5% of the total external debt of these countries. Therefore, in order for the new reserves to really benefit the most vulnerable nations, wealthy North American and European governments would have to voluntarily transfer a share of their SDRs to those in need, either through recycling mechanisms, on-lending, or direct donation. IMF officials are currently developing a plan for how such transfers could be organized, including possibly through the Poverty Reduction and Growth Trust (PRGT).

Another program is the World Bank’s Debt Service Suspension Initiative (DSSI), which was established on May 1st, 2020 with the endorsement of the Group of 20 Finance Ministers. In 2020, the DSSI temporarily suspended $5.7 billion in debt service payments owed by 43 countries, on the condition that the borrowers commit to direct the money to social, health, and economic pandemic relief. In total, 73 countries are eligible for the DSSI; the group comprises every IDA-eligible country and every country classified as “least developed” by the U.N. The suspension period has been extended until December 2021, but the DSSI still only provides immediate respite and not a long-term solution to debt. The G20 Finance Ministers have also endorsed a Common Framework for Debt Treatments beyond the DSSI to provide solvency support to countries on a case-by-case basis. The DSSI is a step in the right direction, but it suffers from limited scale. It makes only a small dent in the debt of the less developed world, considering that the IMF estimates that low-income countries will need some $200 billion over five years for immediate pandemic relief, $250 billion more to close the gap between rich and poor countries in pandemic recovery, and potentially another $100 billion in certain risk scenarios. Some countries have also been hesitant to join the DSSI for fear that doing so would cause downgrades in their credit rating, scaring off potential investors and threatening to increase the cost of future debt. This fear is well founded, and such rating downgrades pose a challenge to most debt relief and liquidity support initiatives.

Another key limitation of the DSSI and similar programs is that they fail to bring all of the relevant players to the table. Since the Latin American Debt Crisis, the global debt architecture has changed significantly. In the 1980s, most of the creditors lending to poor countries were foreign governments and groups from the commercial banking sector; today, the IMF, the World Bank, and multilateral development banks are among the major lenders, and private investment firms make up a far greater proportion of creditors. Today, around 27% of the total external debt of the 73 DSSI-eligible countries is owned by private investors, such as hedge funds and pension funds. Additionally, China has rapidly become the biggest bilateral lender in the world. These shifts have important implications for modern debt relief programs. Private investors have little incentive to adhere to the same sort of concessional, standardized terms to which official lenders adhere. This makes it more difficult to secure favourable repayment terms, like lower interest rates and longer maturities, on privately-held debt. Private lenders are also reluctant to suspend debt service payments, because suspending payments on bonds causes defaults; this in turn forces rating downgrades which reduce market access to the debtor countries. Whereas China has signed on as one of the major DSSI lenders, private creditors have declined to participate.

Debt relief initiatives launched in response to the pandemic require a significant increase in scale and scope, as well as incentives for increased private sector participation. Any debt standstill that fails to include private creditors will have limited success, effectively putting money into the pockets of private creditors at the cost of taxpayers in the official creditor countries agreeing to debt relief measures. The main priority of the short-term crisis response must be increasing vaccination rates in the less developed world. The COVAX program is not expected to procure more than 20% of the vaccines needed by low-income countries, and without a rapid increase in vaccination rates, hundreds of thousands more lives will be lost. Beyond immediate relief and macroeconomic stabilization, international cooperation on long-term debt restructuring is required to decrease the global gap between the rich and poor and to put poor countries back on track to achieving their 2030 Sustainable Development targets. Some have called for long-term expansions of broad-based debt relief programs like the HIPC and the MDRI, and for wholesale debt cancellations in certain cases. The scope of some debt relief and restructuring programs could also be widened to include middle-income countries under fiscal strain, rather than focusing exclusively on low-income countries. Others have proposed sovereign-debt buybacks as a tool for reducing debt; buybacks have helped to resolve past debt crises in Latin America and Greece. Another idea, explored in more detail in a recent report from the New Climate Institute, is “debt-for-climate swaps,” similar to the debt-for-nature swaps pioneered as a response to the Latin American Debt Crisis. Such swaps would help to address indebtedness while incentivizing ambitious climate action in the poor countries most vulnerable to the effects of climate change. It has also been suggested that climate and environmental vulnerability should be taken into account in the criteria for a range of debt relief and restructuring programs, considering that climate change is increasing the cost of borrowing for many less developed countries.

Whereas the world’s wealthier nations are now well on the way to rapid recoveries from Covid-19, poorer countries are seeing dangerous surges in the Delta variant and facing the prospect of vaccine rollouts that may take years. In addition to the human cost of slow vaccine rollouts, experts worry that until the whole world is vaccinated, new variants will continue to emerge, creating new waves of infections across the globe and potentially costing trillions of dollars. The inequality already deeply entrenched in the global economy threatens to become more extreme, and this will have implications for development far beyond the end of the pandemic. In a recent blog post, IMF Managing Director Kristalina Georgieva wrote: “Poorer nations are facing a devastating double-blow: they are at risk of losing the race against the virus; and they could lose the opportunity to join a historic transformation to a new global economy built on green and digital foundations.” Even before the pandemic struck, high debt burdens in the less developed world were already undermining investment in green industry, sustainable infrastructure, and climate resilience. Covid-19 has exacerbated these challenges, threatening to derail progress for years to come. The global economy is changing rapidly, and many see this decade as a crucial tipping point in the planet’s future. There is great potential now for a just, inclusive, and sustainable economic recovery; there is also a very real possibility that many of the world’s poorer nations will be left behind. An urgent push for international solidarity and private sector accountability in relieving struggling countries from debt and investing in development may make all the difference.