This is a bad year for the developing world. More and more countries are on the brink of a debt crisis. Some have already had to suspend debt repayment (Lebanon, Sri Lanka, Russia, Surinam and Zambia), and more and more will need help to avoid economic collapse and further impoverishment of the population.
Common solutions to debt crises involve complicated negotiations on aid packages between indebted countries, international financial institutions and foreign creditors. Owners of domestic state shares, trade unions and other interested parties also participate in the negotiations, as they have their own interests to protect. Reaching an agreement between all involved parties is a long and difficult process, in which domestic and global actors routinely try to adapt the outcome to their wishes and shift as much of the burden of losses to other participants as possible. During that time, the economic situation in the indebted country further deteriorates.
The rise of several developing countries that have since become important bilateral creditors further complicates this already very complex process. China, India and countries of the Middle East, as well as some other countries, have so far not participated in the preparation of the usual arrangements for resolving debt crises. In addition to making coordination difficult, the new heterogeneity on the side of lenders can initiate very destructive processes as a result of self-fulfilling forecasts and expectations, for example, a sudden reversal of the direction of capital movements or a crisis in banking systems.
In order to make an agreement on solving the debt crisis attractive to all interested parties, an arrangement that opens up room for growth is needed. The prospect of making a profit motivates the participants to sit down at the negotiating table, hoping to benefit from the agreed package.
Solutions that promote development imply the agreement of three interested parties. Governments of indebted countries can invest in sectors with the best prospects for growth and eliminate unproductive and inefficient costs only if they are granted additional funds. International financial institutions can provide additional funds only if existing creditors agree to reduce debt (and repayment obligations). Existing creditors will agree to debt reduction only if international financial institutions are in a position to effectively apply conditions that guarantee that indebted countries will consistently implement the necessary development policies. Before the expected new wave of negotiations between debtors and creditors, some of the elements of these arrangements must be updated and adapted to the new global reality.
One of the key questions concerns the very nature of the possibility of achieving growth. Recent events, such as deglobalization, the implementation of measures to prevent climate change and the collapse of the export-oriented development model, certainly limit the development potential of low-income countries. This means that new debt relief arrangements must not exaggerate the role of future growth and that the loss of growth opportunities must bring greater relief to debtor countries. In any case, in the absence of new investments that adjust the development path to the new reality, that future growth would be even lower.
If new opportunities for growth are supported by new investments and if they prove to be profitable, this will reduce the need for further debt reduction, as it will at least partially neutralize the effects of the loss of growth due to the reduction in trade volume. Such opportunities and financing needs are most obvious and important in the field of green transition. Climate change affects growth in low-income countries the hardest, partly because of their geographical position, and partly because of greater exposure and less prospect of the population to control climate risks. Green growth aims to implement public policies that will neutralize these negative forces. But he should also open up some new possibilities.
Investments in adaptation to climate change include projects that should provide defense against rising sea levels, reduce food salinity, strengthen road infrastructure and protect water resources. Since greater food price fluctuations are expected in the near future, the adjustment must also include food security. Crisis mitigation, on the other hand, is focused on the production of clean solar and wind energy using technologies that must be invested in in advance.
All this requires a change in the approach of international financial institutions. Their business must adapt to new development challenges. These institutions should adopt a new development agenda and shift the focus from emphasizing macroeconomic goals to socially acceptable policies that support the imperative of green development. Since it takes a lot of time to achieve the results of such development, conditioning by those institutions must be applied gradually, in stages.
Also, international financial institutions must play a more important role in financing, both directly and by creating conditions for engaging private capital. More than it would be the case in the past, these institutions need to provide new sources of financing in the early stages of aid, until the indebted countries recover their credit rating and restore access to markets thanks to the transition to a new path of development. The investment needs of the green transition are much greater than the needs of the reforms implemented in the 80s, when resources were simply diverted from the public to the private sector to concentrate on a smaller set of public expenditures.
Bearing in mind the solid prospects for development, a negative correlation between the amount of loans from international financial institutions and the amount of debt reduction is possible. An ambitious lending program to finance an ambitious reform program should increase growth rates and thus reduce the need for further debt reduction.
Finally, these institutions must adapt to changes in the creditor profile. The distribution of the burden is increasingly complex, both due to the growth of the share of private market debt and the rise of new creditor countries (especially China, India, Russia and several other countries). If we expect the new creditors to significantly reduce their claims, they will expect to be allowed more influence on the formulation of debt restructuring principles. In the short term, these principles must be flexibly applied to ensure progress. In the long run, changes are needed in the composition of the management boards of international financial institutions in accordance with the new reality.
Economic growth is an important element of any successful debt management arrangement. But even under the most favorable circumstances, growth in developing countries will be slower and mainly focused on domestic markets, which is why we need to reduce debts in larger amounts and place development on a longer time horizon. We need an understanding that new investment opportunities require additional investments and new forms of conditioning. Funds for this must be provided for the most part in advance by international financial institutions, at least until developing countries regain credibility on new growth paths.
(Project Syndicate; Peščanik.net; translation: Đ. Tomić)
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