Imagine being the finance minister of a country that has long relied on foreign aid to fund critical public services. You hear the news that your country’s most prominent donors have economic constraints and are shifting priorities. The budget you had meticulously planned, counting on aid inflows to support essential sectors, is now in question. You must quickly address funding shortfalls and reassure citizens of your country’s economic viability.
Some will view this as an opportunity for self-sufficiency; others will point out the dire socioeconomic reality that compels governments to borrow more. The retreat of global aid and programme suspensions comes when debt levels in low-income countries are already high, with fiscal space diminishing further.
The key question is not whether the decline in aid and external assistance will push these economies towards more debt – it already does – but rather what kind of debt they will incur and what long-term implications it will bring.
The link to debt accumulation
Various estimates suggest that donor aid reductions will disproportionately impact the poorest low-income countries, particularly in essential health, education and infrastructure sectors. The Center for Global Development has calculated that potential aid cuts will reduce recipient economies’ fiscal buffers by 2-4% of gross domestic product, forcing them to find alternative funding sources.
Many of the 69 low-income economies eligible for the International Monetary Fund’s concessional financing through the Poverty Reduction and Growth Trust are already burdened by unsustainable debt. As of October 2024, the IMF assessed 11 countries as being in debt distress, 24 at high risk and 25 facing moderate risk of default – a situation that has likely deteriorated further.
Recourse to borrowings and risk-laden financing
Countries with functional domestic debt markets (only a handful) may turn to local borrowing through treasury bonds, bills and central banks. While this can provide short-term relief, it risks crowding out private investment, increasing domestic interest rates and fuelling inflation.
Larger countries with deeper financial sectors may absorb this shift better than smaller economies with limited capital market depth. However, for most of the poorer, low-income nations, domestic borrowing is constrained by underdeveloped banking systems and a narrow investor base, making it an insufficient solution.
For countries with limited access to international capital markets, sovereign bond issuance – or other offshore financing – is an attractive alternative. Countries that previously relied on international bond issuances have since defaulted, rendering the issuance of Eurobonds at sustainable rates challenging without substantial risk premiums. Moreover, issuance of this kind of funding is complex due to market volatility, global interest rates, concerns over creditworthiness surrounding some categories of lenders.
Bilateral borrowing from non-traditional creditors has emerged as another option. Once a dominant lender to African economies, China has become more selective due to concerns over debt vulnerabilities and calls for greater transparency. In contrast, Gulf states and Asian lenders have shifted their focus towards commercially driven investments rather than concessional loans. The result is a financing landscape where bilateral lending is increasingly tied to infrastructure projects or resource-backed agreements. Historically, countries that seek to use commodity-backed lending structures may continue along this path, but such strategies expose them to significant volatility in global commodity prices.
Alternative financing
A likely outcome could be seeking the South-South payment platforms in INR, CNY or Brics currency swap agreements. Several PRGT-eligible countries have engaged in local currency trade mechanisms with China and India to facilitate the import and export of essential goods and energy. As of 2025, India has authorised 156 Special Rupee Vostro Accounts with banks from 30 countries – most from the global South. China has expanded renminbi use for international trade settlements, with 31 offshore clearing banks globally.
Digital money presents an untested avenue for mitigating short-term funding and liquidity challenges. Digital credit platforms provide small, short-term loans to individuals and businesses without requiring a formal credit history, while stablecoins maintain value for transactions and cross-border remittances.
Nigeria’s e-Naira and Ghana’s e-Cedi are early examples of digital money easing liquidity pressures without using expensive external borrowing. While these mechanisms will not replace traditional aid flows, they offer innovative ways to navigate financial uncertainty.
Some have suggested that philanthropies and charities could play a role in addressing some of the financing gaps. However, this channel is very different and cannot be viewed as a substitute for the scale of required financing for fiscal and financial sustainability.
Structural shifts in fiscal, financial and debt policies are vital
While the instinct might be to borrow or leverage more, this moment should spark a broader rethinking of fiscal and financial governance at the country level and the aid architecture at the international level.
Governments must strengthen debt and asset-liability management frameworks as many low-income economies borrow reactively rather than strategically. Some possess state-owned assets that, if properly managed, could contribute to the financing flows. An ALM approach could help unlock their potential, leading to better asset management strategies, stronger institutions and debt management strategies that align borrowing with macroeconomic stability.
To add, a significant share of debt obligations remains unclear. Strengthening reporting requirements and public accountability will enhance market and stakeholder confidence and reduce financing volatility and extreme dependence on donor aid.
Many poorer low-income countries also lack the legal mechanisms, human skills and capacity to adequately manage new funding agreements. Multilateral institutions can step in to provide quick, systematic help to build capacity and processes. Establishing accountability rules and requiring a parliamentary or independent review of how a country and its socioeconomic needs are financed can help prevent the accumulation of unsustainable liabilities that burden future generations.
A seismic shift for the most financially vulnerable countries
With traditional aid flows becoming increasingly conditional, the most debt-stressed low-income countries are facing an accelerated shift towards reliance on borrowing. Domestic debt issuance, international bond markets and bilateral loans have become default financing mechanisms, yet each introduces risks that could further destabilise macro-financial conditions.
Policy-makers cannot afford to rely on short-term financing fixes or the uncertain prospect of donor policy reversals. They must implement deeper structural reforms to ensure that today’s funding crisis does not create an irreversible debt spiral. Strengthening debt management, transparency and instituting legal safeguards are critical steps that can improve fiscal resilience. While none of these measures will generate immediate funding, they are necessary to prevent future crises and ensure that today’s budgetary decisions do not become tomorrow’s burdens.
These reforms are essential to breaking the cycle of reactive crisis management. The policy choices today will determine whether the most financially vulnerable economies navigate this transition towards greater resilience or fall deeper into a self-reinforcing debt spiral with long-term consequences for growth and stability.
Udaibir Das is a visiting professor at the National Council of Applied Economic Research, senior non-resident adviser at the Bank of England, senior adviser of the International Forum for Sovereign Wealth Funds, and distinguished fellow at the Observer Research Foundation America. He was previously at the Bank for International Settlements, the International Monetary Fund, and the Reserve Bank of India.
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