At the recent spring meetings of the IMF and the World Bank in Washington, DC, optimism cloaked the underlying crisis. Policymakers mingled and discussed as if the worst debt crisis had passed. This belief was supported by the fact that the poorest countries grew at a decent rate of 4% last year, and some, like Kenya, even started borrowing from international markets again. However, the reality is different.
It has been four years since poor countries began defaulting due to the high costs of dealing with COVID-19 and investors pulling their money out of risky markets. Two years ago, rising interest rates in rich countries made things even harder for these struggling governments. The crisis is far from over. Countries that defaulted are still stuck in complicated debt restructuring talks and have not gotten out of default. They remain in financial trouble; without real solutions, more countries could soon face similar problems. During the social events and high-level discussions at the spring meetings, the IMF introduced a bold new plan to address the crisis. This situation raises the important question: Can the IMF truly solve the poor world’s debt crisis?
The IMF was established in 1944 to promote global economic stability and growth by providing financial assistance to countries facing balance of payments problems. Over the decades, it has become the go-to institution for countries in financial distress, especially in the developing world. However, its interventions have been contentious, with critics arguing that IMF policies often exacerbate economic problems rather than alleviate them.
Every debt crisis begins with unheeded warnings and ends with severe limits on investment in education, health, and infrastructure, among other things. These crises often spark civil unrest and government collapse, delivering a lasting setback to the growth prospects of the affected country. In the wake of the COVID-19 pandemic, global debt has surged. Today, 58% of the world’s poorest countries are in debt distress or at high risk, and the danger is also spreading to some middle-income countries. High inflation, rising interest rates, and slowing growth have set the stage for financial crises like those engulfing a developing economy in the early 1980s.
But it would be a mistake to pin the blame solely on the pandemic for these crises. The seeds were sown long before COVID-19. Between 2011 and 2019, public debt in a sample of 65 developing countries increased by 18% of GDP on average—and by much more in several cases. In sub-Saharan Africa, for example, debt increased by 27% of GDP on average. What drove this pre-COVID debt accumulation? It wasn’t an economic surprise beyond the government’s ability to foresee; it was simply bad policy.
An analysis of debt sustainability in 65 developing economies suggests that those countries’ sustained primary deficits were the single-largest driver of public debt. Countries were simply spending beyond their means. Between 2011 and 2019, the median public debt increase attributable to primary deficits amounted to 14% of GDP. In sub-Saharan Africa, it was 18%. Yet, in South Asia, it was just slightly over 5%. In Africa, in particular, governments ran up primary deficits not to make productive long-term investments but to pay current bills. They took on far more debt to pay the wages of public sector workers than they did to build roads, schools, and factories. Among the 33 sub-Saharan countries in the sample, current spending outstripped capital investment by a nearly three to one-ratio. That did nothing to strengthen their ability to repay the debt. Nor did these countries opt to borrow inexpensively from multilateral lenders offering concessional financing rates. In 2010, multilateral lenders accounted for 56% of sub-Saharan countries’ public and publicly guaranteed debt; by 2019, that share was just 45%. In 2010, loans from Paris Club creditors accounted for 18% of the debt; by 2019, the share was just 8%. On the other hand, borrowing from China and commercial creditors nearly tripled over the same time: from 6% to 16% and from 8% to 24%, respectively.
So long as real economic growth remained strong, the risks were masked. Growth curbs the accumulation of public debt: from 2011 through 2019, economic growth—adjusted for inflation—reduced public debt by about 12% of GDP. Today, however, the dynamics are opposite: developing economies are expected to grow just 3.4% in 2022, barely half the rate in 2021. And as interest rates surge to tackle inflation, growth will likely remain weak for the next few years. This scenario underscores the challenges facing the IMF and the global community in addressing the debt crisis.
Despite optimistic growth figures in some regions, the reality of the situation is far from promising. Defaulting governments remain trapped in a limbo of debt restructuring negotiations, hindered by the complexities of a fragmented creditor landscape. Traditionally, debt restructuring has been a straightforward process involving Western countries and banks. However, the emergence of new creditors, notably China, along with increased lending from countries like India, has complicated matters. The lack of consensus among these diverse creditors has led to prolonged negotiations, leaving defaulting nations uncertain.
In response to this crisis, the IMF has announced a radical new approach: lending into arrears. This policy marks a significant departure from conventional practices, allowing the IMF to lend to countries in default without requiring a finalised debt restructuring agreement. By doing so, the IMF aims to break the deadlock in negotiations and provide much-needed liquidity to struggling nations. The key challenge lies in incentivising cooperation among creditors, particularly those reluctant to compromise. The IMF imposes discipline by threatening to leave non-compliant creditors empty-handed while offering an alternative funding source for debtor nations. This dynamic shifts the balance of power, potentially facilitating smoother negotiations and faster resolutions. Critics raise concerns about the potential backlash from influential creditors, especially China, whose relationship with the IMF is carefully cultivated. However, the urgency of the situation leaves little room for hesitation. With numerous countries teetering on the brink of default, decisive action is necessary to prevent a humanitarian catastrophe.
Furthermore, the IMF’s involvement may lead to more accurate debt sustainability assessments, avoiding overly optimistic projections that could exacerbate the crisis. By providing a transparent and impartial framework, the IMF can better differentiate between countries needing debt relief and those requiring short-term liquidity support.
Another critical issue is the moral hazard associated with IMF lending. Governments may engage in reckless borrowing, knowing that the IMF will provide a safety net in times of crisis. This can perpetuate a cycle of dependency and inhibit long-term economic reforms. Furthermore, the conditionalities attached to IMF loans can undermine national sovereignty, as policymakers are forced to prioritise IMF-mandated reforms over domestic considerations. Recent data suggests that while the IMF’s role remains crucial, there is a growing recognition of the need for more flexible and context-specific approaches to debt crises. The IMF has introduced initiatives such as the Debt Service Suspension Initiative (DSSI) and the Common Framework for Debt Treatments to relieve the poorest countries during the pandemic temporarily. These initiatives aim to ease the immediate debt burden and create space for countries to invest in recovery and growth. However, the implementation has been slow, and the relief is often insufficient to address the magnitude of the debt challenges.
The IMF’s traditional model of crisis intervention is increasingly being questioned in light of the evolving global economic landscape. Climate change, for example, poses a significant threat to many developing countries, particularly small island nations and countries in Sub-Saharan Africa. These countries often face higher borrowing costs due to their vulnerability to natural disasters, which can lead to a vicious cycle of debt accumulation and economic instability. The IMF has begun to recognise the need to integrate climate resilience into its lending programs, but much more needs to be done to align its policies with the realities of climate change.
Furthermore, China’s rise as a major creditor presents new challenges for the IMF. China’s lending practices often lack the transparency and conditionalities associated with IMF loans, providing an alternative funding source for many developing countries. While this can offer short-term relief, it raises concerns about debt sustainability and the strategic implications of Chinese influence. The IMF must navigate this complex landscape and find ways to coordinate with other major creditors to ensure a coherent approach to debt resolution.
In conclusion, the question of whether the IMF can solve the poor world’s debt crisis does not have a straightforward answer. The IMF is vital in providing financial stability and assistance to distressed countries, but its traditional approaches have significant limitations. The imposition of austerity measures and structural adjustments can lead to severe social and economic consequences, and there is a need for more flexible, context-specific interventions. The evolving global challenges, such as climate change and the rise of new creditors like China, require the IMF to adapt its strategies and coordinate with other international actors.
The debt crisis in the developing world is a complex issue that requires a multifaceted approach. The IMF must continue to evolve and innovate, integrating considerations of social equity, environmental sustainability, and global economic dynamics into its policies. Only then can it hope to provide meaningful and lasting solutions to the debt challenges faced by the world’s poorest nations. As the example of Indonesia in 1998 shows, IMF interventions can stabilise economies in crisis. Still, the true test lies in ensuring that these interventions lead to sustainable and inclusive economic growth.
