A new debt crisis? Assessing the impact of the financial crisis on developing countries

A new debt crisis? Assessing the impact of the financial crisis on developing countries

Are developing countries heading towards a new debt crisis?

The global financial crisis is already having a severe effect on the developing world. Many prominent donor countries have announced draconian cuts to their overseas aid budgets; falling global demand for goods is being felt by many producers in poorer countries; whilst much-needed foreign remittances, are, according to the IMF, falling for the first time in decades. Add in falling commodity prices and developing country prospects look bleak.

Crucially, such (negative) economic conditions could have a severe impact on developing country debt. For will ‘poorer’ governments, in the face of the global downturn, be able to meet existing commitments and stave off a spiralling debt bill? How can such nations be protected – after strides had been made in reducing (and cancelling) debt – from once again trying to manage an unsustainable level of debt?

This paper from the Jubilee Debt Campaign details the extent of what it sees as a burgeoning ‘debt crisis’. Their research asserts that:

  • with traditional sources of finance drying up, export markets collapsing and a range of other economic impacts, the threat of a renewed debt crisis is very real. Out of the 43 most vulnerable countries, 38 needed at least some debt cancellation to meet their people’s basic needs, before the crisis
  • the sudden withdrawal of foreign capital has caused dramatic falls in exchange rates. Governments with large debt burdens, which are usually denominated in foreign currencies such as the dollar, may struggle to meet the repayment requirements, and even default on their debts
  • private capital flows to developing countries could fall to around $165 billion in 2009. This is less than half the $466 billion of 2008 and down 82% on the peak year of 2007. At the same time the cost of borrowing is rising in the developing world, as investors withdraw, risk premiums and interest rates go up

So what can be done? The authors of the paper make several recommendations, including:

  • cancel more debts - at least $400 billion should be cancelled for around 100 countries if they are to be able to pay for essential services for their people without having to tax those below the poverty line
  • responsible finance - financial flows to developing countries urgently need to be increased, but must not contribute to future unsustainable, unjust debt burdens. As well as debt cancellation, additional grant-based finance should be provided to the poorest countries
  • debt tribunal - the need for an international forum, akin to a tribunal, to deal with sovereign debt work-outs. The current debt relief initiatives are inflexible, entirely creditor-controlled, and wholly inadequate to meet the challenge of the continuing debt crisis