Debt sentence

A record number of countries, all of them developing nations, are now at risk of economic collapse. Sri Lanka, Lebanon, Suriname and Zambia have defaulted on their debt while Belarus is close to default and at least a dozen other countries are in the danger zone. Rising borrowing costs, inflation and debt are all coming together to push several countries to the brink of economic ruin.

According to Reuters, $400 billion of debt is in play with Argentina alone holding over $150 billion, with Ecuador and Egypt holding between $40 – $45 billion. If global markets steady in the short-term or should the International Monetary Fund (IMF) be able to provide sufficient support, some will be able to avoid default. However, for now, elevated risks remain that several countries will not be able to meet their debt servicing obligations.

Debt in and of itself is not a bad thing. Many countries borrow money to facilitate investment and economic development. While most government income comes from taxes, tax revenue alone is generally not enough to fund government programmes. Of course, governments can increase taxes to cover their spending needs. However, this is not ideal for two main reasons – one political and the other economic. Politically, higher taxes are usually unpopular with voters.

Economically, should higher taxes result in citizens having less money to spend, there can be a negative knock-on effect on economic growth and jobs.

Alarm bells usually go off when a country’s debt increases. A 2013 study by the World Bank found that if the debt-to-Gross Domestic Product (GDP) ratio exceeds 77% for an extended period, it slows economic growth. This reduction in growth keeps an economy from reaching its full potential, because each time there is a gain in economic output, that gain is reduced by debt servicing.

Notwithstanding the perils and complexities of debt, countries still need to borrow. True, countries should not borrow excessively and injudiciously. True, countries have to be careful to avoid unsustainable debt. True, high indebtedness can slow a country’s progress. However, also true is that countries equally need to focus on building strong economic foundations, strengthening their institutions and building up their resilience. Sometimes, borrowing is required to meet these objectives.

Part of building a strong economic foundation is accelerating the structural reforms which are necessary to transition economies, especially small vulnerable economies (SVEs), onto a more sustainable basis. For a long time, many SVEs have lamented their lack of economies of scale and narrow production structures. Unfortunately, this has not often been met with the responses which are necessary to engineer a change in circumstances.

The world is now in the midst of another energy crisis. The COVID-19 pandemic has also further exposed the deficiencies in many SVEs, such as an over reliance on a few sectors such as tourism. Therefore, incurring debt cannot be simply about making up for shortfalls in government revenue, but about laying the foundations for economic transformation in areas such as renewable energy, industrial growth and growing agricultural output.

Furthermore, according to Homi Kharas, Senior Fellow at The Brookings Institution, the onset of debt crises has more to do with weak institutions and low resilience than with debt indicators. Kharas makes the point that when the East Asian Crisis struck in the late 1990s, each of the East Asian countries had among their positive economic fundamentals, low public debt levels. The problem was not one of debt per say, but a lack of financial resilience.

Kharas also contends that the risks of a debt crisis in developing countries are growing not because of excessive spending by governments, but because access to financing for key projects to build resilience is shrinking. The key lesson here is that developing countries and SVEs need less, not more, investments in human capital, disaster and climate risk reduction and economic transformation.

Finally, debt does not have to be a death sentence. Rather, it can be used as a strategic tool to drive economic transformation.

Joel K Richards is a Vincentian national living and working in Europe in the field of international trade and development.
Email: joelkmrichards@gmail.com