ByCaroline Hlatywayo

The causes and effects of debt crisis in developing

countries

“All that we had borrowed up to 1985 or 1986 was around $5 billion and we have paid about $16 billion yet we are still being told that we owe about $28 billion. That $28 billion came about because of the injustice in the foreign creditors' interest rates. If you ask me what is the worst thing in the world, I will say it is compound interest.”

President Olusuge Obasanjo of Nigeria, Jubilee 2000 news update, August 2000

Dely (2001) indicates that each year African countries pay the West nine times more in debt repayments than they receive in grants.

Of the 32 countries classified as severely indebted low-income countries, 25 are in sub-Saharan Africa.

Africa spends four times as much on debt repayment as she does on healthcare. Sub-Saharan Africa owes more than £140 billion (83 per cent of its total GNP).

This enormous debt means that repayments to Western Creditors take priority and ordinary people suffer in poor health, restricted access to education, lack of employment and limited ability to trade and provide for themselves. 

Causes of debt on developing countriesDebt crisis is the result of unprecedented borrowing, rising interest rates, falling commodity prices, inadequate investment of borrowed funds, and the domestic and international management of the resulting crisis (Adams, 1999)

The legacy of colonialismOdious debtThe development of developing countries over reliance on external debt

Improper debt structureImproper use of debtThe deterioration of foreign trade caused a sharp cut-off in export income

A continuing legacy of colonialism The developing countries’ debt is partly the result of the unjust transfer to them of the debts of the colonizing States:

The history of third world debt is the history of a massive siphoning-off by international finance of the resources of the most deprived peoples. This process is designed to perpetuate itself thanks to a diabolical mechanism whereby debt replicates itself on an ever greater scale, a cycle that can be broken only by cancelling the debt. According to a report on “Effects of debt on human rights” prepared by Mr. El HadjiGuissé for current UN Sub Commission on Human Rights (E/CN.4/Sub.2/2004/27), the developing countries’ debt is partly the result of the unjust transfer to them of the debts of the colonizing States.

A sum of US$ 59 billion external in public debt was imposed on the newly independent States in 1960. With the additional strain of an interest rate unilaterally set at 14 per cent, this debt increased rapidly. Before they had even had time to organize their economies and get them up and running, the new debtors were already saddled with a heavy burden of debt.

— Third World Debt a Continuing Legacy of Colonialism, South Centre, Bulletin 85, August 2004

Odious debtOdious debt is unfair debt resulting from illegitimate loans.

Odious debt is an established legal principle.

Legally, odious debt is debt that resulted from loans to an illegitimate or dictatorial government that used the money to oppress the people or for personal purposes. Moreover, in cases where borrowed money was used in ways contrary to the people’s interest, with the knowledge of the creditors, the creditors may be said to have committed a hostile act against the people. They cannot legitimately expect repayment of such debts.

Improper Debt StructureGeorge (1996) states that the causes of the debt crisis are a result of mismanaged spending and lending,

Most loans to the third world have to be paid back in hard currencies (which do not usually change too much in value, e.g. the Japanese Yen, the American Dollar, etc.)

Poor countries have soft currencies (values which can fluctuate).

Debt crises can also occur just by the value of the developing country’s money going down, which can be due to a variety of other inter-related factors.

Paying off loans implies earning foreign exchange in hard currencies.

Combined with falling export prices for many poor countries, debts become even harder to pay off.

Refinancing loans implies taking on new debts to service the old ones.

Structural adjustment advice in the past from the IMF and others, has led to the cut back on important spending such as health, education, in order to help repay loans. This has implied a downward spiral and further poverty.

Improper use of debtSome debtors lent a great deal of money but did not make the repayment strategy by considering their amount of investment, term of repayment or the development rate of macroeconomic.

Some debts are not used in production or to import capital goods but used instead to import durable goods and luxury

These loans were used to pay for current consumption, but not for productive investments

Why do the debts keep growing?

Loans must almost always be paid in hard currency. Most loans to the Third World have to be repaid in hard currencies.

The value of a country's exports goes down. The value of the commodities that a Third World country exports can go down by large amounts. This makes it much more difficult for the country to repay its loans. In Latin America, for example, debt is growing faster than earnings from exports.

Continued.....Refinancing loans can get countries into even more trouble. Refinancing is when more money is borrowed to pay off earlier loans. In theory, refinancing is a measure to help developing countries with their debt problems and sometimes it does this. However, it does not make good sense to take on new debts in order to service existing debts. If this happens, the result is that countries get deeper and deeper into debt. (This is called a 'debt spiral.') In addition, many of the loans to developing countries are made by governments or organisations like the IMF. These loans often carry strict conditions with them, like cuts in spending on health care, education and food subsidies. This makes life even worse for people in the indebted countries. E.g. ESAP in Zimbabwe

Effects of debt crisisSignificant outflows of capital to finance the debt. Six out of seven heavily indebted poor countries in Africa pay more in debt service (i.e., interest and principal repayments) than the total amount of money needed to achieve major progress against malnutrition, preventable disease, illiteracy, and child mortality. The UNDP estimates that sub-Saharan African governments transfer to Northern creditors four times what they spend on the health of their people (Human Development Report, 1997)

On the financial side, heavy indebtedness is a signal to the world financial community that the country is an investment risk, that it is unwilling or unable to pay its debt. As a result, impoverished countries are either cut off from the international financial markets or pay more for credit e.g. Argentina

Absence of infrastructure such as roads, schools, or health facilities that could both fight poverty and create the conditions for more economic growth. A different type of cost is associated with the time governments spend negotiating debt repayments. Oxfam International estimates there have been over 8,000 debt negotiations for Africa since 1980.

Heavily indebted countries face enormous pressure to generate foreign exchange in order to pay their debt service and purchase essential imports

The international financial institutions often offer financial assistance to countries in this situation and use their leverage to compel the countries to accept structural adjustment and stabilization policies.(SAPs)

SAPs are designed to: I ) Stabilize faltering economies by reducing inflation and correcting the balance of payments; and, 2) Increase growth by making economies more productive and efficient and by opening them to market forces.

Although SAPs may help a country become more competitive in the global arena, they can severely harm the poor

SAPs can also create an environment that values global competition above all else, resulting in lower wages and worsening labour conditions for workers.

Governments are then forced to decide which public sectors to cut and which to save. Unfortunately, the poor and the vulnerable are the ones least able to protect themselves in this process.

The IMF conditions also made sure that any trade protection for the country's agricultural goods was lifted. So African export crops now compete with those from the western countries, which are highly subsidized and protected, using all available techniques to improve their quality .

Debt and structural adjustment policies can harm the environment

Developing countries depend on exports such as logging, mining, or a single agricultural crop, there is a serious risk that they will exploit these resources in a way that will cause major damage to the environment. CIDSE (International Cooperation for Development and Solidarity)

Debt Relief Under the Heavily Indebted Poor Countries (HIPC) InitiativeLaunched in 1996 by the IMF and World Bank, with the aim of ensuring that no poor country faces a debt burden it cannot manage.

To be considered for HIPC Initiative assistance, a country must fulfil the following four conditions:

Be eligible to borrow from the World Bank’s International Development Agency, which provides interest-free loans and grants to the world’s poorest countries, and from the IMF’s Poverty Reduction and Growth Trust, which provides loans to low-income countries at subsidized rates;

Face an unsustainable debt burden that cannot be addressed through traditional debt relief mechanisms;

Have established a track record of reform and sound policies through IMF-and World Bank–supported programs; and

Have developed a Poverty Reduction Strategy Paper (PRSP) through a broad-based participatory process in the country.

List of Countries That Have Qualified for, are Eligible or Potentially Eligible and May Wish to Receive HIPC Initiative Assistance (as of September 2014)Post-Completion-Point Countries

Post-Completion-Point Countries(35)Afghanistan Ghana Mozambique Benin Guinea Nicaragua Bolivia Guinea-Bissau Niger Burkina Faso Guyana Rwanda Burundi Haiti São tomé & Principe Cameroon Honduras Senegal Central African republic Liberia Sierra Leone Comoros Madagascar Tanzania Republic of Congo Malawi Togo Democratic republic of Congo Mali Uganda Côte D’ivoire Mauritania Zambia Ethiopia  The Gambia

Interim Countries (Between Decision and Completion Point) (1)Chad

 Pre-Decision-Point Countries (3)EritreaSomaliaSudan

The Debt Crisis and The Human Development FactorPortes (1992) argues that debt sustainability cannot be captured solely by reference to financial indicators.

Basic human needs must also be taken into account, especially in the highly indebted poor countries (HIPCs) in Africa.

For the HIPCs, the scale of unmet social need is too vast, and the rate of progress in human development too slow to leave any doubt about the need for increased budget resources for poverty reduction.

Debt relief is one mechanism through which these resources could be provided.

There are forty-one heavily indebted countries covered by the HIPC initiative, most of them in sub-Saharan Africa.

They have some of the world’s worst human development indicators. These indicators are improving at an abysmally slow rate, leaving the majority of HIPCs well ‘off track’ for achieving the 2015 human development goals.

Increasing rural and urban nutritional gaps in the Southern African countries have also been identified as partly due to the debt crisis

Sen (1995) adds that even non-emergency food aid, which seems a noble cause, is destructive, as it under-sells local farmers (mostly women) and can ultimately affect the entire economy of a poor country. If the poor African countries are not given the sufficient means to produce their own food and are not allowed to use the tools of production for themselves then poverty and dependency will continue.

Conclusions and RecommendationsBasic human needs in Southern Africa have been jeopardized by the debt crisis, especially with regard to women and children

In spite of the fact that the debt crisis is not the only factor responsible for poverty, HIV/AIDS escalation and environmental degradation in these countries, it is part of the problem.

The following measures are recommended to alleviate the plight of these countries and the developing world at large:

These countries should be free to pursue policies designed to emphasize building up of their local economies and maintaining the government's role in guaranteeing health care and other essential social services 

Debt relief will be effective if it is integrated into comprehensive poverty reduction strategies. It should be geared towards the creation of conditions for broad-based economic growth and improved access to basic services.

The debt payment burden should be cancelled because it is draining much-needed foreign exchange in these countries that could otherwise be used for the provision of basic services. Encouragingly, in July 2009, the IMF announced the provision of interest payments relief to low-income countries in the form of zero payments for concessional lending facilities until the end of 2011.

Need to interrupt the cycle of debt payments and new debt that links the interests of Western and developing countries' elites. This should involve imposing conditions on African countries' elites, such as the democratization and redistribution of wealth downward

Thank You!