The debt crisis in low-income countries continues to fester. Meanwhile, the international policy community seems to be losing traction on the problem. Can it recover its grip, or has a developing-country debt disaster become inevitable?
The number of economies in debt distress had already risen sharply between the global financial crisis in 2008-09 and the eve of the COVID-19 pandemic, as judged by countries receiving an unfavorable grade of B3 or lower from the credit-rating agency Moody’s. Then, when the pandemic erupted, the number of distressed countries stopped rising, as global leaders resolved to address what was now a humanitarian emergency as well as a financial crisis. The G20 countries tabled a Debt Service Suspension Initiative, which temporarily relieved troubled countries’ governments of the need to repay.
But once the DSSI expired at the end of 2021, the number of distressed sovereigns began rising again, in part because higher global interest rates made it still harder to service debts. The number of countries in debt distress, as measured by Moody’s, currently exceeds 40.
At the end of 2020, the DSSI was supplemented by the Common Framework for Debt Treatments. The goal was to facilitate restructuring agreements between countries with unsustainable debts, their advanced-country creditors, and bondholders. Yet these restructuring efforts have dragged on, literally for years, without evident progress.
Last month, an agreement between Zambia and its creditors was hailed as a breakthrough. But the relief offered to Zambia was patently inadequate. And no sooner was the proposed deal announced than it collapsed. China complained that its state-owned bank creditors were being treated less favorably than the bondholders. The Common Framework, as two of its critics antiseptically observed, needed “a major reset in the new year.”
Coincidentally, 2024 marks the centennial of the Dawes Plan, under which Germany’s debts to its World War I adversaries were restructured. And therein lies a tale.
The war left a tangled financial web: some $30 billion of reparations owed by Germany to the victorious European Allies, and $10 billion of war debts owed by the Allies to the United States. It was clear that these obligations were linked – that the Allies would agree to scale down Germany’s reparations only if the US wrote off their debts.
Yet the US Congress, having taken an isolationist turn, adamantly refused to forgive the Allies’ obligations. America was new to the responsibilities of being a net creditor to the world, having been a net debtor before the war.
In 1923, the US belatedly acknowledged the severity of the post-World War I debt crisis, which the German hyperinflation made impossible to ignore. It permitted Charles G. Dawes, Chicago banker and future US vice president, to chair an international committee to review the post-war debt problem.
Dawes’s involvement was significant in that it signaled US reengagement with global affairs. But while the Dawes Plan scaled back Germany’s immediate obligations, it provided little long-term debt relief, only pushing the country’s payments into the future. Ongoing German government transfers to the Allies were then financed by a dollar loan floated in the American market by the US investment bank J.P. Morgan & Co.
These patchwork arrangements halted Germany’s hyperinflation and allowed European economic growth to resume. But everything came apart after 1929. As the global economy sank into the Great Depression, a one-year moratorium on all debt and reparation payments was agreed in 1931.
Only in 1932, when it was too late to prevent Germany’s disastrous political turn, did European governments finally agree to cancel their reparation claims. They followed up by repudiating their debts to the US, earning the lasting enmity of Congress.
Several lessons for today’s developing-country debt crisis can be gleaned from this tragic history.
First, creditors, even when inexperienced, must acknowledge their role in resolving debt crises. Today, this means all eyes are on China, which is the single most important creditor to poor countries in debt distress.
Second, simply providing credits to distressed countries, in the manner of J.P. Morgan in 1924, merely kicks the can down the road. China is currently providing renminbi swaps and credits to governments that previously took on infrastructure loans as part of China’s Belt and Road Initiative, enabling them to stay current on their payments to Chinese banks. This expedient solves nothing. It only renders troubled countries more heavily indebted.
Finally, giving debt-distressed countries just enough relief to stay afloat leaves them at risk in the event of a further shock. This was the approach taken under the Dawes Plan, and it came unstuck in the Great Depression. It is the approach taken under the Common Framework, which obliges creditors only to provide the bare minimum – just enough relief to permit the International Monetary Fund to declare the country’s debt sustainable. This leaves no margin for error. And, as events have reminded us, errors have a way of happening.
Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley, is the author, most recently, of In Defense of Public Debt (Oxford University Press, 2021).
Copyright: Project Syndicate, 2023.
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