The International Monetary Fund and the World Bank have established a new approach to what they view as a pervasive liquidity crisis in many low-income countries and some emerging markets. According to this assessment, many countries are simply facing a short-term liquidity problem led by a concentration of debt service payments at a moment when creditors are not willing to extend additional lending.
The proposed approach has three pillars: first, an IMF reform programme; second, supplementing this with concessional financing from development banks and donors; and third, hoping that the private sector will return to the country – potentially with some incentives.
However, injecting more liquidity into LICs and EMs may pile on debt and lead to unsustainable debt overhangs. That is likely to result in a need for continued ‘extend and pretend’ refinancings, creating greater hardships for the poorest and sowing the seeds for massive debt relief in the future. The inconvenient truth is that the IMF should lead on new initiatives for debt relief for low- and lower-middle-income countries.
IMF estimates are off the mark
According to the IMF’s debt sustainability analyses, 35 out of the 68 LICs on the list are currently in debt distress or at high risk of debt distress, and another 25 countries are in moderate risk of distress. The IMF no longer makes such predictions for market access countries but Suriname, Sri Lanka, Ecuador and Argentina have all fallen into debt distress and Pakistan, Nigeria and Egypt are on the lists watched by market participants and experts.
This is an alarming number of countries and is likely to be a significant underestimate as the DSAs are a subject of major controversy from governments, market participants and economists alike. A core concern is the large forecasting errors on debt to gross domestic product ratios.
IMF economists published an analysis of 174 countries from 1995 to 2020 and found that realised debt ratios are significantly larger than forecasted ratios and increase over time to upwards of 10% of GDP after a five-year time horizon. In a more recent analysis of the post-Covid-19 period by Sheryln Raga, research fellow at ODI Global, IMF forecasting errors were found to have significantly widened, with overly optimistic debt forecasts across the board and especially in hard hit countries like Chad, Ethiopia, Ghana, Sri Lanka and Zambia.
In addition, the baseline scenario for IMF DSAs often maintains a suboptimal level of spending and investment that in part leads to eventual distress in the first place, not the level of spending and investment needed to restore robust growth, exports and tax revenue. Further, according to the G20 Independent Expert Group, LICs and LMICs need to mobilise upwards of $2tn annually by 2030 from domestic and external sources in order to meet the United Nations sustainable development goals and Paris climate agreements and avoid the costs of inaction, which far outweigh the size of the initial investments.
Poorest bear the biggest burden
Because of the lack of strong initiatives on debt relief, many LICs and LMICs are self-imposing fiscal consolidation and defaulting on their climate and development goals rather than their loans. According to the UN, 3.3bn people are living in countries now spending more on interest payments than education and health – two core ingredients for long-run growth (and tax revenue).
The UN also sees that the number of countries spending more than 20% of government revenue on debt service is at the same level as during the debt crisis of the 1990s. The World Bank finds that the share of developing countries with sovereign spreads greater than 10 percentage points – when new bond issuance is unattainable – is at the same level as the last debt crisis as well.
Filling financing gaps with more liquidity and new debt can increase debt service and amortisation costs, and ultimately the burden of economic adjustment, making the poor pay more of the costs and putting a drag on global growth. That isn’t fair. There is no doubt that domestic reforms are needed across the developing world, but the current distress has been magnified by the pandemic, war and geopolitical tension, climate change and interest rate hikes.
Time for new initiatives
There are countries that simply face liquidity problems, and the Fund’s approach may have promise there. But the IMF needs to call for a major debt relief initiative akin to the Heavily Indebted Poor Countries programme for those LICS and LMICs where debt payments are squeezing government revenues, making debt service unsustainable and choking the growth prospects of billions of people. The costs of the IMF misdiagnosing debt ratios by 10% of GDP under the IMF’s new liquidity approach could backfire.
Nearly 20 years ago, the major official bilateral creditors built on the HIPC and eliminated their debts under the Multilateral Debt Relief Initiative. The freed up fiscal space was not managed well and was then gobbled up by bond markets and non-traditional official creditors.
It is better to be safe than sorry. Many countries simply need much deeper relief from private and official creditors in the net present value of their debt. The World Bank to its credit has been warning of a silent debt crisis but the Fund’s new three-part approach pays too little attention to debt relief.
Next year the G20 is in Africa, where much of the debt distress resides. It should be the year for a new debt initiative.
Kevin Gallagher is Professor and Director of the Boston University Global Development Policy Center. Mark Sobel is US Chair of OMFIF.
