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Borrowers' blues


Monetary policy tightening in the US and EU is becoming a nightmare for high-debt developing countries

Over the past decade, the debt burden of emerging and developing countries has risen significantly.

This year, with the Russia-Ukraine conflict and the US monetary policy tightening, many developing countries are driven to the edge of debt crisis and some of them have already fallen off the cliff. In early April, Lebanon and Sri Lanka announced that they were in debt distress. According to the International Monetary Fund and the World Bank, 38 of the 69 low-income countries are already in or at high risk of debt distress. It is also warned that the number of countries in crisis is very much likely to rise in the near future.

Three groups of countries deserve close attention. The first group is emerging market economies with a high dependence on external debt, a poor historical record of sovereign credit and weak economic recoveries, such as Argentina, Turkey, Brazil, and Mexico. Since the beginning of 2022, these countries have experienced severe inflation and currency depreciation. To cope with these problems, their central banks have already raised the policy interest rate. However, even if their central banks tighten the monetary policy more aggressively, the pressures of capital outflows and currency depreciation are still high, because of their weak fundamentals and poor sovereign credibility. In general, these countries struggle with the dilemma that there are few appropriate policy tools and inadequate space for both policy expansion and tightening.

The second group is the high-debt countries that have been hit hard by the Russia-Ukraine conflict. On the one hand, some Russian and Ukrainian entities have defaulted on their debts due to the conflict and sanctions, causing asset losses to financial institutions that hold their debts, especially those in Europe. On the other hand, rises in commodity prices and refugee problems caused by the conflict have added to the fiscal burdens of many governments neighboring to Russia and Ukraine or having close economic and trade ties with them. European countries including Hungary, Moldova, Romania and Slovakia, and Asian countries, including Mongolia, Tajikistan and Kazakhstan, fit into this category.

The third group is countries with severe debt and poverty problems and strong dependency on food imports, such as Lebanon, Yemen and Syria. These countries may experience multiple crises such as capital outflows, food crises and political unrest. Since the outburst of the Russia-Ukraine conflict, global food prices have risen sharply and many countries have announced restrictions or bans on food exports. The UN has warned that 325 million people worldwide are currently suffering from food shortages, and about 43 countries are expecting famine to knock at their doors.

At the global governance level, the top priority is further expanding and improving debt restructuring and relief programs under multilateral mechanisms. As a first step in tackling the debt crisis, the G20 has postponed debt repayments for 73 poorest countries through the Debt Service Suspension Initiative. The bloc also rolled out a Common Framework aiming to promote wide-ranging, quick and orderly debt restructuring. However, the influence of the DSSI and the CF is still relatively limited. Among the countries eligible for application, many countries choose to continue borrowing from the private sector at high interest rates rather than participating in debt restructuring at an early date, because the DSSI and the CF provide insufficient discounts, but are expected to require lengthy negotiation and induce downgrades of sovereign credit ratings. Such a slow response to debt crisis will eventually lead to the snowballing of debt problems and higher debt relief costs in the future.

In order to prevent a debt spiral, it is necessary to develop a multilateral consensus with long-lasting and broad influences. The key to achieve this goal is to create more incentives for borrowers and creditors to participate in debt resolution as soon as possible. It is especially important to provide more incentives, pressure and platforms for the private sector to participate in debt relief. For example, eligible debtor countries can be encouraged to combine debt resolution with other sustainable development goals, through the use of debt-for-nature swaps, debt-for-climate swaps, and other sustainable financing tools. These instruments are able to hit two birds in one shot: reduce debt burden and channel funds to support sustainable development.

The combination of debt resolution with sustainable development goals like climate mitigation can help attract funds from NGOs, international organizations and ESG investors. Through its cooperation with The Nature Conservancy, a non-profit organization, Seychelles not only completed a debt restructuring of $21.6 million, but also established 410,000 square kilometers of ocean protection area. In 2021, Belize also secured a debt restructuring of $364 million and finance the protection of 30 percent of its waters through a similar debt swap program.

As an emerging creditor, China should also be prepared for the upcoming wave of debt crises in developing countries. It should further improve its external lending standards and debt management institutions, and provide more diversified debt resolution options for debtor countries, especially market-based debt restructuring options. For example, more swaps from loan to bonds can be encouraged. These loan-for-bond swaps can largely increase debt transparency, because the information disclosure requirements of bonds are much more stringent than loans. Meanwhile, it is also important for China to adhere to multilateral frameworks and strengthen its coordination and cooperation with other creditors. For example, China can better monitor the debt sustainability of relevant countries by cooperating with the IMF and the World Bank. In-depth cooperation among all parties will help formulate more influential and more efficient international rules for debt governance, laying a better global foundation for the prevention of future crises.

Xiong Wanting is an assistant researcher of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. Xu Qiyuan is a researcher and deputy director of the IWEP at the CASS. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn