Debt servicing in the developing world

The debt servicing problem of developing countries has been a matter of continuing concern since the early 1980s. What are the factors that contributed to this problem? What were the domestic effects of rising external debts? What measures have been undertaken to alleviate this problem? What kinds of policies would you recommend for alleviating the balance of payments difficulties of affected countries?

The developing world was caught up in a global paradigm shift in the late 70s and early 80s when the price of oil spiked due to collusion among OPEC members and international banks were flooded with oil proceeds (the so-called petrodollars) from oil-producing nations. Banks lent the excess petrodollars to developing countries based on over-optimistic expectations of future growth, a sustained high price for oil, and ability and willingness of the recipient nations to pay back. Once the domestic governments realised that their expectations were unlikely to materialise, it was too late in some cases, and balance-of-payments crises ensued, along with high inflation and eventual default on loans. In most cases, these government's myopic profligacy and out-of-control spending was to blame for much of the suffering that followed the end of the petro-fuelled boom. Fiscal restraint, along with sound macroeconomic policies of a countercyclical nature, remain the best preventive against future crises such as this.

The formation and eventual supremacy of OPEC in the world oil markets was largely the beginning of the future balance-of-payments crises of the 1980s. Flooded with foreign currency, host countries deposited their extra proceeds in large multinational banks, who in turn lent several times the amount to developing nations at high interest rates. The governments of developing countries, perpetually strapped for investment, were eager to receive these investments, which were often backed by the international community. Putting aside the issue of corruption or misuse of these now public funds, many times the investments were improperly accounted for in governmental budgets. This was especially true in oil-producing developing nations that were also receiving loans, because budgets were constructed with the expectation of a high oil price built into the equation. Finally, not all governments spent the loan funds efficiently: many were run in a populist fashion that precluded long-term planning and emphasized short-term gain for government agents in office. This continued to be a problem when the crisis unfolded and countries were unable to easily repay: populist governments were likelier to default on loans rather than risk losing political support from their political base, which were often composed of the same people that had benefited from the boom.

As rising external debts mounted during the 1980s, a twofold process took place. Firstly, the global economy slumped and import proceeds fell, constraining the inflow of tax funds. This was combined with a reduction in foreign direct investment and in loans from banks, and it sharply constricted domestic government's purses. Secondly, as national debt matured and was paid with further debt issuance, while at the same time income fell, sovereign debt-income ratios became less and less attractive, to the point where the banks and investors most strapped for cash began refusing new debt issuance and demanded repayment. These two effects combined led to balance-of-payments crises in several countries, e.g. Mexico and Brazil. Deep recessions followed when governments, in an effort to stymie a recession, began to repay debt by simply printing more money without having sufficient foreign reserves to back up the new issues. This worsened the situation further by causing massive inflation as both foreign and domestic consumers lost confidence in these particular currencies. Eventually, the situation became unsustainable and the affected countries suffered deep recessions as debt and imports income dried up, while debt payments due ballooned.

In the years since, contingency plans to prevent similar future crises have been created, and a set of fiscal and monetary guidelines, known as the Washington Consensus, has been promoted among liberal governments to minimize the danger of a repeat. Fiscal restraint and planning is the most obvious of the bunch. To achieve this, the independence of the central bank is encouraged as not just a way to ensure that monetary policy is not politically motivated, but also to project an image of fiscal responsibility to outside investors. Also encouraged is the creation of a countercyclical policy, such as Chile's copper fund. Such policies are tasked with achieving budgetary balance during recessionary periods and with saving and safe investing in boom periods. Finally, to promote openness and transparency, governments are encouraged to disclose the necessary financial and accounting information to international bodies and potential investors.

What if a balance-of-payments crisis is already underway, despite all these safeguards? Assuming an outside "rescue package", such as what Mexico received during the Tequilazo of 1998, is out of the question, there are a few steps domestic governments can take to minimise the pain. One of the first priorities of the government is to ensure the outflow of money is stopped and reversed. The Central Bank will play a crucial role in raising interest rates and properly managing the amount of domestic currency issued to minimize inflation and attract savings. Debt relief or renegotiation with creditors is another top priority in times of balance-of-payments crises. Economies inevitably contract during these crises; therefore, governments have the important job of offering the right stimuli to domestic and foreign businesses not only by maintaining sound macroeconomic policies but also by creating business incentives in the form of lowered or cancelled tariffs, preferred tax regimes, and streamlined legal processes for registering and maintaining businesses.

Time: 1hr 6min