Definitions

debt-issue

Developing countries' debt

Developing countries' debt is external debt incurred by the governments of Third World countries, generally in quantities beyond the governments' political ability to repay. "Unpayable debt" is a term used to describe external debt when the interest on the debt exceeds what the country's politicians think they can collect from taxpayers, based on the nation's Gross domestic product, thus preventing the debt from ever being repaid.

Much of the current levels of debt were amassed following the 1973 oil crisis. Increases in oil prices forced many poorer nations' governments to borrow heavily to purchase politically essential supplies. At the same time, OPEC funds deposited in western banks provided a ready source of funds for loans. While a proportion of borrowed funds went towards infrastructure and economic development financed by central governments, a proportion was lost to corruption and about one-fifth was spent on arms.

Historical background

Most present-day states in Africa and the majority of Asia did not have an independent financial existence as recently as World War II. However, not all external debts of these countries were acquired after independence. As a condition of independence in 1949, Indonesia was required to assume the Dutch colonial government's debt, much of which had been acquired fighting pro-independence rebels the previous four years. In order to receive independence from France, Haiti was required to pay France 150 million francs.

Egypt, which had not been formally colonized, but had been effectively governed as first an Anglo-French and later British protectorate, did not have control over the lucrative Suez Canal, which links the Mediterranean Sea with the Red Sea (and therefore the Indian Ocean). Denied credit to build the Aswan Dam, Egypt's government moved to nationalize the canal, formally owned by a European corporation but built (at tremendous human cost) by Egyptian labor, in 1956, sparking the Suez Crisis.

In the first decades following decolonization, first world and multilateral creditors such as the World Bank and International Monetary Fund lent massively to third world governments. Money was frequently directed towards massive infrastructure projects such as dams and highways. Additional funds focused on an import substitution model of development, creating a capacity to replace imports from industrialized countries. Such policies emerged in a convergence of ideologies towards the concept of industrial development, shared by capitalists, communists and Third World nationalists.

Additionally, a number of dictatorships and arguably neocolonial governments imposed and/or backed by foreign powers received extensive debt-based financing to conduct civil wars or repression against their own population. In Central and South America, these policies fell under the rubric of the national security state, civil wars accumulated substantial debts in Guatemala, El Salvador and Colombia. In Haiti, the father-son dictatorship of François and Jean-Claude Duvalier accumulated massive debts, which the United States pressured then-exiled President Jean Bertrand Aristide to recognize as a condition of his return to power in 1995. Foreign military operations, such as the invasions of East Timor by Indonesia; of Angola and Namibia by South Africa; and of Iran and Kuwait by Iraq also led to massive indebtedness.

Massive lending was followed by the threat of major defaults, such as that of Mexico, in the early 1980s, precipitating what became known as a debt crisis. Faced with the possibility of losing their investments lenders proposed a variety of structural adjustment programs (SAPs) to fundamentally reorient Southern economies. Most called for the drastic reduction in public welfare spending, focusing economic output on direct export and resource extraction, providing an attractive investment climate to multinational investors, increasing the fluidity of investment flows (by replacing foreign direct investment with the opening of stock markets) and generally enhancing the rights of foreign investors vis-à-vis national laws.

As these programs became a prerequisite of lending and other development assistance from all major multilateral creditors, and as Soviet economic assistance evaporated in the late 1980s, SAPs became the dominant economic plan for much of the world's population. Saddled with massive debts, and unable to collectively alter unfavorable terms of trade, many Third World governments were pushed from the role of legislating economic policy to negotiating it. Many of them, such as Jamaica's Michael Manley, have argued they were even pushed into the job of managing an enforced economic transition against the wishes of their populations.

Arguments about Third World Debt

There is much debate about whether the poorest countries should be liable for debt. The legitimacy of such liability is little doubt in terms of international and contractual law, but many arguments in the debate have to do with the fairness or practicality of the system currently in place.

There is currently little political will to write off the debts of third world countries.

Critics of the practical point in this argument might question whether or not unpayable debt truly exists, since governments can refinance their debt via the IMF or World Bank, or come to a negotiated settlement with their creditors. However, this is not an argument that can withstand a glance at the state of the essential services supposedly being provided by many of the heavily indebted countries. There is overwhelming evidence that governments have financed their debts through instigation of austerity policies directed at essential services and subsidies for essential goods. The history of Mali, for example, from 1968 onwards, provides a clear illustration of this. In fact, the requirement that governments should service debts at the expense of their populations is integral to the strategies adopted by the Washington institutions in 1982 to solve the banking crisis triggered by the Mexican Weekend in August that year. Austerity was one of the ways in which interest payments could continue to be serviced, preventing liquidity problems in the US money-centre banks. The same principle is evident in the design of the Heavily Indebted Poor Countries Initiative. While refinancing has taken place (particulalry to lessen private creditor exposure subsequent to 1982) this has come with conditions which have cause a crisis of development. Stuart Corbridge has described the 1982 debt crisis as a banking crisis which was transformed into a development crisis, brokered by the Washington Institutions.

Consequences of debt abolition

Some economists argue against forgiving debt on the basis that it would motivate countries to default on their debts, or to deliberately borrow more than they can afford, and that it would not prevent a recurrence of the problem. Economists often refer to this as a "moral hazard". But some critics and debt relief activists say the problem is not necessarily with borrowers, but with lenders, and thus the moral hazard is not necessarily immoral borrowing, but immoral lending.

Debt relief in response to emergencies

The 2004 Indian Ocean earthquake

When the 2004 Indian Ocean earthquake and tsunami hit, the G7 announced a moratorium on debts of twelve affected nations and the Paris Club suspended loan payments of three more. By the time the Paris Club met in January 2005, its 19 member-countries had pledged a total of $3.4 billion in aid to the countries affected by the tsunami.

The debt relief for tsunami-affected nations was not universal. Sri Lanka was left with a debt of more than $8 billion and an annual debt service bill of $493 million. Indonesia retained a foreign debt of more than $132 billion (PDF) and debt service payments to the World Bank amounted to $1.9 billion in 2006.

G8 Summit 2005: Aid to Africa & Debt Cancellation

The traditional meeting of G8 finance ministers before the summit took place in London on 10 and 11 June 2005, hosted by former Chancellor Gordon Brown. On 11 June, agreement was reached to write off the entire US$40 billion debt owed by 18 Highly Indebted Poor Countries to the World Bank, the International Monetary Fund and the African Development Fund. The annual saving in debt payments amounts to just over US$1 billion. War on Want estimates that US$45.7 billion would be required for 62 countries to meet the Millennium Development Goals. The ministers stated that twenty more countries, with an additional US$15 billion in debt, would be eligible for debt relief if they met targets on fighting corruption and continue to fulfill structural adjustment conditionalities that eliminate impediments to private investment and calls for countries to privatize industries, liberalize their economies, eliminate subsidies, and reduce budgetary expenditures. The agreement came into force in July 2006 and has been called the "Multilateral Debt Reduction Initiative", MDRI. It can be thought of as an extension of the Heavily Indebted Poor Countries (HIPC) initiative.

While negotiations have essentially taken place between the G8 member states, some of which are reluctant to endorse debt cancellation and aid increases, African governments, advocacy organizations and their allies have criticised the Blair-Brown plan as inadequate and argued that the continuation of structural adjustment policies outweighs the benefits of debt cancellation, while also pointing out that only a small proportion of the Third World debt will be affected by the proposal. Structural adjustments have been criticized for years for devastating poor countries. For example, in Zambia, structural adjustment reforms of the 1980s and early 1990s included massive cuts to health and education budgets, the introduction of user fees for many basic health services and for primary education, and the cutting of crucial programs such as child immunization initiatives.

Besides the small number of countries included in the deal and the required structural adjustment reforms, the agreement has also been criticized as being inadequate for its failure to include all creditors. While countries that qualify for the HIPC process would have their debts cancelled to the World Bank, IMF, and African Development Bank, Asian and Latin American countries will still have to pay debt service to the Asian Development Bank and Inter-American Development Bank. The Latin American countries that qualify for the G8 debt deal – Bolivia, Guyana, Honduras and Nicaragua – will pay almost $1.4 billion in debt service over the next five years to the Inter-American Development Bank (IDB).

Impact of Debt Relief

A number of impoverished countries have recently received partial or full cancellation of loans from foreign governments and international financial institutions, such as the IMF and World Bank.

Under the Jubilee 2000 banner, a diverse coalition of groups joined together to demand debt cancellation at the G7 meeting in Cologne, Germany. As a result, finance ministers of the world's wealthiest nations agreed to debt relief on loans owed by qualifying countries.

A 2004 World Bank/IMF study found that in countries receiving debt relief, poverty reduction initiatives doubled between 1999 and 2004. Tanzania used savings to eliminate school fees, hire more teachers, and build more schools. Burkina Faso drastically reduced the cost of life-saving drugs and increased access to clean water. Uganda more than doubled school enrollment.

In 2005, the Make Poverty History campaign, mounted in the run-up to the G8 Summit in Scotland, brought the issue of debt once again to the attention of the media and world leaders. Some have claimed that it was the Live 8 concerts which were instrumental in raising the profile of the debt issue at the G8, but these were announced after the Summit pre-negotiations had essentially agreed the terms of the debt announcement made at the Summit, and so can only have been of marginal utility. Make Poverty History, in contrast, had been running for five months prior to the Live 8 announcement and, in form of the Jubilee 2000 campaign (of which Make Poverty History was essentially a re-branding) for ten years. Debt cancellation for the 18 countries qualifying under this new initiative has also brought impressive results on paper. For example, it has been reported that Zambia used savings to drastically increase its investment in health, education, and rural infrastructure. The fungibility of savings from debt service makes such claims difficult to establish. Under the terms of the G8 debt proposal, the funding sources available to HIPC countries are also curtailed; some researchers have argued that the net financial benefit of the G8 proposals is negligible, even though on paper the debt burden seems temporarily alleviated.

The 2005 HIPC agreement did not wipe all debt from HIPC countries, as is stated in the article. The total debt has been reduced by two-thirds, so that their debt service obligations fall to less than 2 million in one year. While celebrating the successes of these individual countries, debt campaigners continue to advocate for the extension of the benefits of debt cancellation to all countries that require cancellation to meet basic human needs and as a matter of justice.

To assist in the reinvestment of released capital, most International Financial Institutions provide guidelines indicating probable shocks, programs to reduce a country’s vulnerability through export diversification, food buffer stocks, enhanced climate prediction methods, more flexible and reliable aid disbursement mechanisms by donors, and much higher and more rapid contingency financing.

Debt as a mechanism in economic crisis

An example of debt playing a role in economic crisis was the Argentine economic crisis. During the 1980s, Argentina, like many Latin American economies, experienced hyperinflation. As a part of the process put in place to bring inflation under control, a fixed exchange rate was put into place between Argentina's new currency and the US Dollar. This guaranteed that inflation would not restart, since for every new unit of currency issued by the Argentine Central Bank, the Central Bank had to hold a US Dollar against this - therefore in order to print more Argentine currency, the government required additional US Dollars. Before this currency regime was in place, if the government had needed money to finance a budget deficit, it could simply print more money (thus creating inflation). Under the new system, if the government spent more than it earned through taxation in a given year, it needed to cover the gap with US Dollars, rather than by simply printing more money. The only way the Government could get these US Dollars to finance the gap was through higher tax of exporters' earnings or through borrowing the needed US Dollars. Of course a fixed exchange rate was incompatible with a structural (i.e. recurrent) budget deficit, as the government needed to borrow more US Dollars every year to finance its budget deficit; eventually leading to an unsustainable amount of US Dollar debt.

Argentina's debt grew continuously during the 1990s, climbing above $120 billion USD. As a structural budget deficit continued, the government kept borrowing more, creditors continued to lend money, while the IMF suggested less state spending to stop the government's ongoing need to keep borrowing more and more. As the debt pile grew, it became increasingly obvious the government's structural budget deficit was simply not compatible with a low inflation fixed exchange rate - either the government had to start earning as much as it spent, or it had to start (inflationary) printing of money (and thus abandoning the fixed exchange rate as it would not be able to borrow the needed amounts of US Dollars to keep the exchange rate stable). Investors started to speculate that the government would never stop spending more than it earned, and so there was only one path for the government - inflation and the abandonment of the fixed exchange rate. In a similar fashion to Black Wednesday, investors began to sell the Argentine currency, betting it would become worthless against the US Dollar when the inevitable inflation started. This became a self-fulfilling prophesy, quickly leading to the government's US Dollar reserves being exhausted. The crisis exploded in December 2001. In 2002, a default on about $93 billion of the debt was declared. Investment fled the country, and capital flow towards Argentina ceased almost completely.

The Argentine government met severe challenges trying to refinance the debt. Some creditors denounced the default as sheer robbery. Vulture funds who had acquired debt bonds during the crisis, at very low prices, asked to be repaid immediately. For four years, Argentina was effectively shut out of the international financial markets.

Argentina finally got a deal by which 76% of the defaulted bonds were exchanged by others, of a much lower nominal value and at longer terms. The exchange was not accepted by the rest of the private debt holders, who continue to a challenge the government to repay them a greater percentage of the money they originally lent. The holdouts have formed groups such as American Task Force Argentina to lobby the Argentine government, in addition to seeking redress by attempting to seize Argentine foreign reserves.

Borrowing through bond markets

Historically, developing countries sought to borrow either from other sovereign governments, institutions such as the IMF and banks. Since the creation of the Brady Plan, however, the issuance of bonds by developing countries, known as Emerging Market Debt has increased sharply, leading to its development as a security.

References

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