The high cost of debt is crippling developing nations: How can we overcome the fiscal divide? TOU

The high cost of debt is crippling developing nations: How can we overcome the fiscal divide?


The high cost of debt is crippling developing nations: How can we overcome the fiscal divide?

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Rainy days in camps under COVID-19 lock-down, Maina IDP camp, Kachin, Myanmar. Credit: UNICEF / UNI358777 / Oo.

United Nations, April 18, 2022 (IPS) – As the world shakes with the confluence of crises, the global economic outlook for 2022 is becoming increasingly uncertain and fragile. The prospects for sustainable development for all and the achievement of the Sustainable Development Goals (SDGs) by 2030 are unclear, especially for developing countries.

The war in Ukraine is adding to the strain on the world economy, which is still reeling under increasing stress from the COVID-19 epidemic and climate change. This cascading crisis affects all countries, but the effect is not the same for all.

While some, mostly developed countries, had access to cheap credit to offset the socio-economic effects of the epidemic and to invest in recovery, many others did not.

Large-scale recovery packages in rich countries are sharply contrasted with those in poor countries, which had to bear the necessary costs. For many, the education and development budget had to be slashed in response to COVID-19.

Of the UN system Credit for 2022 Sustainable Development Report: Bridge to the Finance DivideFinds that the ‘finance divide’ between rich and poor countries has become a sustainable development divide.

Naveed Hanif

Growth prospects in the developing world are severely blocked – even before the war in Ukraine and its aftermath, 1 in 5 developing countries are not expected to return to pre-COVID income levels by 2023.
This situation is likely to get worse as the consequences of the war increase the challenges faced by developing countries. Food and fuel prices are reaching record highs. This puts a strain on the external and financial balance of import-dependent countries.

Disruptions in the supply chain increase inflationary pressures, creating a very challenging environment for central banks – with rising prices and deteriorating growth prospects. Tight financial conditions and rising global interest rates will make it increasingly difficult and impossible for some to roll over their existing commercial debt.

Many vulnerable countries will not be able to absorb the combined shock of disrupted recovery, rising inflation and sharply rising borrowing costs. Sri Lanka has just defaulted, and the wider debt crisis could be on the horizon – which is likely to push the Sustainable Development Goals out of reach.

The lack of adequate and affordable financing for developing countries makes it increasingly difficult to realize the 2030 agenda on time. Due to the underdeveloped local financial markets, their governments have very few ways to raise funds locally. But borrowing from abroad is both risky and expensive, with some African countries paying more than 8% on their Eurobond issue in 2021.

As Lending for 2022 Sustainable Development Report Note, the only way to achieve a more equitable recovery is to overcome these financial divisions. It will take definite action on many fronts.

First, developing countries will need additional concessional public financing. Bilateral providers and international financial institutions have stepped in to respond to the COVID-19 epidemic, but additional funding was not enough to prevent these various recoveries. The consequences of the Ukraine war are widening the credit gap and countries will need additional support.

Credit: UN Photo / Cia Pak

The first key test of international unity will be the Official Development Assistance (ODA). Additional assistance for conflict refugees in Ukraine, while important, should not come at the expense of cross-border ODA flows to other countries in need.

Development banks should provide more long-term countersycle finance at affordable rates by easing lending pressures during a crisis. Donors should ensure that multilateral development banks increase their capital and that the relief window is generously replenished.

One immediate step development banks and official bilateral creditors themselves can take is to use state-contingency clauses more systematically in their own lending. This means that automatic debt payments will stop, giving countries a place to breathe in a crisis.

Development banks and development finance institutions at all levels can also work to strengthen the ‘development bank system’. In the poorest countries, national institutions are smaller and smaller. They will benefit greatly from capacity and financial support.

Multilateral and regional development banks can in turn benefit from the detailed knowledge of local markets of national banks.

Second, we need to improve borrowing costs and other conditions by developing countries in the international financial markets. Additional returns for investors indicate market inefficiency. We must close the gap in the international financial architecture – the lack of a sovereign debt restructuring mechanism adds uncertainty – and improves transparency by both debtors and creditors.

Transparency and good information for investors can help reduce costs. Short-term credit ratings are also an issue. Rating agencies assess a country’s creditworthiness on a very short horizon, often three years. Meanwhile, many public investments in sustainable development – in infrastructure, education or innovation – only pay off in the long run.

Credit valuations are systematically biased against long-term investments. Thus, they poorly serve investors who have long investment horizons, such as pension funds. Long-term sovereign ratings that take into account such investments, as well as long-term risks such as climate change, should complement existing assessments. Scenario analysis can help eliminate the underlying difficulties of such long-term evaluations.

Countries can also exploit the growing interest of investors in sustainable development and climate action. Sovereign green bonds, which can sometimes be issued at a lower price (“greenium”), are a fast growing market segment. The commitment to maritime defense has recently helped Belize to achieve more favorable terms with private creditors for debt restructuring.

Development finance institutions can also help sovereign borrowers by providing partial guarantees, reducing interest rates in return for investments in SDGs and climate measures.

Third, many countries will need debt relief to avoid a long and costly debt crisis. Once the debt reaches unsustainable levels, providing additional financing, even at a concessional rate, will only delay the calculation.

Current methods are clearly inadequate to deal with debt-ridden countries. The general framework established by the G20 in the fall of 2020 was a step in the right direction, but its shortcomings have become very clear.

No restructuring has been completed yet; There is no better answer for commercial debt treatment; And many of the heavily indebted developing countries do not qualify for access to the Common Framework.

The G20 should step up efforts to implement and deliver the Common Framework more effectively. But as the wider debt crisis becomes a frightening prospect, even more fundamental reforms in the sovereign debt architecture should be on the table.

The United Nations can provide a neutral venue that brings creditors and debtors together on an equal footing to advance such discussions.

We at the UN believe that SDG can still be found. But now without taking bold action on all fronts, the road ahead looks very rough. Timely and bold policy choices will get us there.

Naveed Hanif Director of Financing for the Sustainable Development Office of the United Nations, Department of Economic and Social Affairs (UNDESA). He is also the UN Soos Sherpa for G20 Finance and the main track. He joined UNDESA in 2001. He was a Senior Policy Adviser in the Department of Sustainable Development and a member of the team for the World Summit on Sustainable Development held in Johannesburg in 2002. He served as head of the policy coordination branch and later as director in the office. Economic and Social Council (ECOSOC) for support. He was the first head of the DESA Strategic Planning Unit, established in 2010.

IPS UN Office

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