In contrast, loans from members of the Paris Club have declined considerably. In developing countries, the amount of public debt owed to private creditors as a share of total debt rose from around 40 percent in to 60 percent in , according to UNCTAD. Moreover, not only has foreign debt increased, but domestic debt has also risen sharply in developing countries. In order to prevent a renewed debt crisis in developing countries, it is of primary importance to establish good debt management practices.
The capacity for public debt management needs to be improved and an appropriate debt structure established which takes into account loan maturities and the ratios of domestic and foreign currency. Good debt management also provides greater transparency and more complete data on the debt situation in developing countries. Another important element is establishing a set of uniform principles for responsible lending and borrowing.
In the event of a debt crisis, it will be difficult to coordinate with such a heterogeneous group of creditors.
This is why the governments of developed economies are able to issue bonds denominated in their own currencies. The currencies of developing countries tend to have a shorter track record and might not be as stable, meaning that there will be far less demand for debt denominated in their currencies. Risk and Reputation Developing countries can be at a disadvantage when it comes to borrowing funds. Like investors with poor credit, developing countries must pay higher interest rates and issue debt in foreign stronger currencies to offset the additional risk assumed by the investor.
Most countries, however, don't run into repayment problems. Problems can arise when inexperienced governments overvalue the projects to be funded by the debt, overestimate the revenue that will be generated by economic growth , structure their debt in such a way as to make payment only feasible in the best of economic circumstances, or if exchange rates make payment in the denominated currency too difficult.
What makes a country issuing sovereign debt want to pay back its loans in the first place? After all, if it can get investors to pour money into its economy, aren't they taking on the risk? Emerging economies want to repay the debt because it creates a solid reputation that investors can use when evaluating future investment opportunities. Just as teenagers have to build solid credit in order to establish creditworthiness , countries issuing sovereign debt want to repay their debt so that investors can see that they are able to pay off any subsequent loans.
The Impact of Defaulting Defaulting on sovereign debt can be more complicated than defaults on corporate debt because domestic assets cannot be seized to pay back funds. Rather, the terms of the debt will renegotiated, often leaving the lender in an unfavorable situation, if not an entire loss.
The impact of the default can thus be significantly more far-reaching, both in terms of its impact on international markets and of its effect on the country's population. A government in default can easily become a government in chaos, which can be disastrous for other types of investment in the issuing country. The Causes of Debt Default Essentially, default will occur when a country's debt obligations surpass its capacity to pay.
There are several circumstances in which this can happen:. Debt Default Examples There have been several prominent cases in which emerging economies got in over their heads when it came to their debt. Investing in Debt Global capital markets have become increasingly integrated in recent decades, allowing emerging economies access to a more diverse pool of investors using different debt instruments.
This gives emerging economies more flexibility, but also adds uncertainty since debt is spread over so many parties. Each party can have a different goal and tolerance for risk, which makes deciding the best course of action in the face of default a complicated task. Email Print.
Tweet Share Share LinkedIn. Stumble Upon. Contacts In Washington: Mark Felsenthal For Broadcast Requests: David W. Young His figures, reproduced in Table Nonetheless, as a rough approximation, the data suggest that external factors were significantly more important than the internal causes of inefficiency and corruption. The IMF stabilization programs, with their nearly exclusive emphasis on the internal economic policies of heavily indebted countries and relative disregard for the factors that Cline identifies, have failed to encourage the very type of economic growth that might have helped the developing countries to grow out of their indebtedness.
In fact, these programs have had exactly the opposite effect: they have further impoverished many of the heavily indebted countries to a point where their future economic growth must be seriously doubted.
Many observers have come to share Jeffrey Sachs's assessment of structural adjustment programs: "The sobering point is that programs of this sort have been adopted repeatedly, and have failed repeatedly. Source : William R. This failure of traditional techniques to alleviate the debt problem suggests that perhaps the conventional interpretation of the debt crisis is incomplete or misleading.
Indeed, much evidence suggests this inference. Perhaps the most compelling evidence is the fact that periodic debt crises seem to be endemic to the modern international system.
There have been cycles of debt and default in the past, and some of the same debtors have experienced similar crises in almost regular cycles.
This explanation must be supplemented by factors that are more structural and deep-seated. There are at least two issues relatively unexplored by the conventional explanation of the debt crisis that deserve greater attention, and they both relate to the vulnerability of the developing countries to changes in the world economy over which they have little direct control: their sensitivity to monetary changes in the advanced industrialized countries, and their dependence on primary commodities as sources of their export earnings.
The first consideration is perhaps the more dramatic. It is no mere coincidence that the United States experienced its own very serious debt crisis in the same year that panic arose over the external debt of developing countries.
Interest rates in the United States had achieved very high levels in , but the inflation rates at the time were also very high. After the deep economic recession of , the inflation rate declined markedly, but the interest rates remained high.
In turn, the high interest rates inflated the value of the dollar, reducing U. The United States, however, did not experience a debt "crisis" because it was able to reassure its creditors that its promises to pay were plausible. But the high real interest rates forced upon the developing countries as their loans were turned over created a situation where no similar guarantees could be offered.
As it became obvious that the debtor countries could not meet the increased payments, the private banks tried to pull back, bringing about the very crisis they wished to avoid.
Only very persistent efforts by official governmental agencies managed to stabilize the situation enough to avoid a precipitous default. In a very real sense, however, it was the actions of the United States that created the immediate crisis, and not some event or pattern of events in the developing world itself. Similarly, this debt crisis aggravated an already bad situation with respect to the ability of the developing countries to pay back their loans. Many of the developing countries were extremely poor prior to the crisis, which was one reason why they took out such massive debts in the first place.
There was no evidence, before , that this condition of relative poverty was changing in any but a few of the developing countries, such as the newly industrializing countries of South Korea, Singapore, and Taiwan. In fact, most of the traditional measures of economic development suggest that most developing countries were falling farther behind the advanced industrialized countries at an increasingly faster rate.
The developing countries will always be relatively poorer than the advanced industrialized countries as long as they rely heavily on primary commodities, such as copper and rubber, for export earnings. Trade may be a stimulus to growth, but trade is not an effective way to overcome relative poverty if the values for primary commodities fail to keep pace with the value of manufactured products.
This relationship between the values of manufactured exports and the values of primary commodities exports the terms of trade has been carefully examined by many economists, and some of them, such as Prebisch, have argued that the international division of labor is systematically biased against the interests of countries that rely heavily on the export of primary products.
This debate, which has been extended into what has been termed a theory of dependency, is a difficult one to resolve with clear empirical evidence. Some recent evidence, however, suggests that raw materials producers have indeed suffered relative economic losses in the twentieth century.
Enzo R. Grilli and Maw Cheng Yang analyzed the terms of trade between primary commodities and manufactured goods since and found that "the prices of all primary commodities including fuels relative to those of traded manufactures declined by about 36 percent over the period, at an average annual rate of 0. Thus, the developing countries are at a structural disadvantage compared to the advanced industrialized countries. The newly industrializing countries of East Asia are the exceptions that prove this rule.
Because they have been able to expand manufactured exports, they have improved their relative economic situation tremendously in recent years. Other countries have been less successful, and the recent resurgence of protectionist measures against manufactured products from the developing world will make this type of transition only more difficult. Ultimately, the solution to the debt crisis, and the underlying poverty that spawned it, must address this terms of trade issue.
This imperative will be discussed in further detail below. Clearly, however, the solutions to the debt crisis will require a perspective that looks at the problem as more than a temporary aberration precipitated by bad luck and incompetence. This explosion of debt has had numerous consequences for the developing countries, but this section will focus on only three consequences: the decline in the quality of life within debtor countries, the political violence associated with that decline, and the effects of the decline on the developed world.
The next section of this chapter will explore separately the most publicized cost of the debt crisis, the possibility that it might have instigated a global banking crisis. The first, and most devastating, effect of the debt crisis was, and continues to be, the significant outflows of capital to finance the debt. According to the World Bank: "Before the highly indebted countries received about 2 percent of GNP a year in resources from abroad; since then they have transferred roughly 3 percent of GNP a year in the opposite direction.
This capital hemorrhage has severely limited prospects for economic growth in the developing world and seriously skewed the patterns of economic development within it. The implications for growth are summarized by Table The decline in average growth, from 6. Given the rate of population increase in these countries, a 1. In other words, the populations of these countries were significantly worse off economically during the period of the debt crisis; and this decline further jeopardizes opportunities for future economic growth given its implications for domestic demand and productive investment.
The terms of trade statistics, which reflect the relative movement of export prices to import prices, are similarly grim: developing countries are getting much less in return for their exported products when compared to their costs for imported items. In short, these countries must export even more of their products in order to maintain current levels of imports.
The total effects for the quality of life in the highly indebted countries were summarized by the United Nations Conference on Trade and Development:. Per capita consumption in the highly-indebted countries in , as measured by national accounts statistics, was no higher than in the late s; if terms of trade losses are taken into account, there was a decline. Per capita investment has also fallen drastically, by about 40 percent between and It declined steeply during , but far from recovering subsequently, it has continued to fall.
As for the debtor countries, many have fallen into the deepest economic crisis in their histories. Between and real per capita income declined in absolute terms in almost every country in South America. Many countries' living standards have fallen to levels of the s and s. Real wages in Mexico declined by about 50 percent between and A decade of development has been wiped out throughout the debtor world.
Sachs is not overstating the case. Before the debt crisis, global poverty had reached staggering proportions, as described above. One can document the extent of poverty in the world by pointing out statistics on gross national product, per capita income, or the number of telephones per thousand in a particular country. But these statistics obscure too much in their sterility. In , one billion people were considered chronically underfed. Millions of babies die every year from complications from diarrhea, a phenomenon that typically causes mild discomfort in the advanced industrialized countries.
Millions of people have no access to clean water, cannot read or write their own names, and have no adequate shelter. And this misery will only continue to spread. The debt crisis has a self-reinforcing dynamic. Money that could have been used to build schools or hospitals in developing countries is now going to the advanced industrialized countries.
As a consequence, fewer babies will survive their first year; those that do will have fewer opportunities to reach their intellectual potential. To raise foreign exchange, developing countries are forced to sell more of their resources at reduced rates, thereby depleting nonrenewable resources for use by future generations.
Capital that could have been used to build factories and provide jobs is now sent abroad; as a result, the problems of unemployment and underemployment will only get worse in poor countries. A second effect of the decline in living standards in the heavily indebted countries concerns the increased potential for political violence.
There have been over twenty violent protests in recent years specifically against the austerity measures imposed by the IMF, with over 3, people killed in those protests. Harold Lever posed the problem well in Will it be politically feasible, on a sustained basis, for the governments of the debtor countries to enforce the measures that would be required to achieve even the payment of interest?
To say, as some do, that there is no need for the capital to be repaid is no comfort because that would mean paying interest on the debt for all eternity. Can it be seriously expected that hundreds of millions of the world's poorest populations would be content to toil away in order to transfer resources to their rich rentier creditors?
Political violence will only continue in the future, but its implications are hard to predict. Political instability may make it more difficult for democratic regimes to survive, particularly in Latin America, and may lead to the establishment of authoritarian regimes.
Similarly, popular pressures may lead to regimes radically hostile to market economies, thus setting the stage for dramatic confrontations between debtor countries and the external agencies that set the terms for debt rescheduling or relief. Finally, political violence can spill over into international security issues. One can only imagine what sustained political conflict in Mexico would do to the already troubling issues of drug smuggling and immigration between Mexico and the United States.
Debt-related issues complicated political relations between the United States and the Philippines over the military bases, and the extraordinary impoverishment in Peru a decline in real GNP of between 15 to 25 percent from September to September has certainly led to an 31 increase in the drug-related activities of the Shining Path.
Debtor governments will find themselves forced to demand certain concessions on debt repayment in order to maintain their legitimacy, and these concessions will invariably be cast at least in terms of lower and more extended payments, if not reduction or outright debt forgiveness.
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