Recent aggressive interest rate hikes have not solved the persistent inflation that economies have been experiencing. Indeed, the actual causes of inflation—supply chain disruptions and spikes in commodity prices—have currently lessened, and while speculation trading, which has exacerbated issues like global food insecurity, has waned, the Global South is facing the effects of the Western-led response, suffocating it with a debt crisis.
Due the Covid-19 pandemic, the Global South has seen its debt grow 8% from 2020 to 2021—from $ 8.6 trillion to over $9 trillion—growing more than gross national income and exports. Likewise, its external short-term debt, which grew likely due to the purchase of vaccines, testing materials, and other pandemic measures, also rose. In many countries, debt grew by double-digit figures. Due to sharp drops in exports, tourism, and remittances, as well as rising food and fuel prices, many Global South expenditures surged as foreign exchange profits rapidly dropped as a result of the pandemic. The developing world has been marred with capital flight that has resulted in its currencies depreciating, higher import costs, and contraction in household consumption—all of which has created an implosion of developing nations’ debt burdens and even led to debt default in some countries.
Furthermore, in 2022, “greedflation” or “stagflation” caused soaring inflation across the global economy, which then proceeded to be dealt with with aggressive interest rate hikes across the world, primarily led by the U.S. Federal Reserve. This has had calamitous costs for much of the developing world. Given that developing countries are already experiencing constraint on their domestic macroeconomic policies due to recent external shocks such as speculative commodity prices and the pandemic, aggressive interest rates have subsequently been threatening economic growth in the developing world. This alarming situation means that the developing world is facing a major economic recession amid a looming debt crisis.
The United Nations Conference on Trade and Development (UNCTAD) forecasts that the aggressive interest rate pressures initiated by the rich countries will cause serious debt distress in the Global South, assessing that the cost of paying off its debts will burden the developing world with at least $800 billion as debt servicing expenditures rise at the expense of investment and public spending, extending what U.N. Deputy Secretary-General Amina Mohammed called “a trade-off between investments in debt and investments in people.” The World Bank cautions that the impeding Global South debt crisis is “intensifying,” which is in particular “devastating for many of the poorest economies, where poverty reduction has already ground to a halt.” Significantly, the International Monetary Fund’s latest assessments of debt stress indicate that 10 countries were in debt distress (meaning in debt default or on the verge of default) while 52 countries were in severe to moderate debt stress.
A recent paper by INET clarifies the gravity of the situation that the West’s money-tightening policies have brought about. Developing countries are going to face serious collateral damage, likely to incur more debt and defaults and see higher unemployment and poverty rates, creating economic instability and a hit to economic growth. Central banks in these countries face the option of hiking their interest rates, but, as the paper argues, this would do considerable damage to their gross domestic products and their domestic economies—therefore, a soft landing is an “impossibility.” Importantly, if this current “monetary tightening in the U.S. during 2022-23 triggers a worse global recession than the one occurring during the early 1980s, the potential growth rate in the developing economies will take a hit—and the permanent damage to economic development in these countries will be large.” This includes “scarring” of future economic growth, which would only make their debt impossible to pay off.
Moreover, there is danger of another lost decade in development, which would have severe consequences for the global economy due to its spillover consequences and, even more importantly, for everyday life in the Global South. Indeed, UNCTAD estimates that U.S. interest-rate increases could shrink future incomes for the Global South (barring China) by at least $360 billion. In many of these debt-ridden countries, interest rate payments amount to nearly 5% of export revenue.
The West’s response has been derisory and farcical. Their payment pause program during the pandemic was wholly insufficient— as the initiative only deferred countries’ long-term external debt repayment briefly and opted not to cancel any debt. The debt “still has to be repaid in full during 2022-24, as interest payments due continued to grow,” but, more importantly, the initiative’s focus has been on bilateral debt—debt that has been made by agencies on behalf of a country’s government. This does not cover commercial lenders that have seen their share of external debt rise during the last decade.
This shift in the debt composition to riskier commercial borrowing, which comes with higher interest rates and shorter maturities, is a main source of debt unsustainability, especially since it is considerably more challenging to restructure. Many countries like Sri Lanka, which has recently defaulted on its debt, have faced this exact issue. Two decades ago, most of its foreign debt was held by multilateral and bilateral development agencies, i.e., the World Bank and the Japan International Cooperation Agency—with extensive payback periods (25 to 40 years) that included substantial grace periods and, more importantly, significantly lower interest rates (in certain cases, even under 1%). Yet, Sri Lanka’s recent foreign debt crisis paints a different picture. Today, its commercial debt composition has gone from around 2% in the mid-2000s to 60% today. To make matters worse, its long-term debt maturities amount to zero.
This has been the case for most of the developing world during the last two decades. The Global South has significantly increased its market borrowings on more onerous conditions, such as shorter maturities, higher interest rates, and reduced prospects for refinancing or restructuring. This has only been aggravated by falling foreign exchange earnings and rising interest rates seen across the world.
Another pandemic-relief approach included the International Monetary Fund’s (IMF) Special Drawing Rights (SDRs), which are meant to supply reserves to countries in need. In August 2021, the IMF set forth a $650 billion injection of SDRs in response to the financial shock of the Covid-19 pandemic. Shortly thereafter, at least 80 developing countries utilized this chance to purchase much-needed foreign currency and domestic fiscal expenditure. More importantly, unlike previous IMF allocations to the Global South, this did not come with neoliberal conditionalities. However, the allocation was wholly insufficient compared with the degree of countries’ needs, as SDRs are based on IMF quotas, reflecting one’s economic size. This meant that the countries that needed the most assistance received the least. Despite commitments from Western countries to channel their shares of SDRs to the Global South, meagerly, major Western countries such as the United Kingdom and the United States only redirected about 20% of their shares, and around $400 billion of the newly allocated SDRs remain unused.
Since the elimination of capital controls, one of the hallmarks of the Bretton Woods system that occurred during the “Golden Age of Capitalism,” developing countries have had to rely on international financial markets to raise funds for imperative needs, yet they have been increasing exposed to the unregulated financial market. This has exposed them to “hot money,” or capital flows, alongside global shocks such as pandemics and other unstable realities, leaving them with higher and riskier debt exposures and unsustainable debt burdens.
Indeed, the countries of the Global South have been increasingly vulnerable to repeated external shocks, such as commodity price fluctuations, affecting their ability to attain foreign exchange to be able to service their debts, since these countries often borrow in foreign currencies. This leaves them with a shortage of fiscal space to address economic crises. More importantly, these entrenched high debt burdens, known as the “vicious cycle,” are a direct obstacle to building climate resilience and achieving progress towards the Sustainable Development Goals. Climate change has been eroding around one-fourth of the Global South’s total GDP since the last decade. Even worse, since loans make up around 80% of all public spending for climate change, nations have been borrowing to confront these severe problems.
Undeniably, this current situation is reminiscent of the dawn of neoliberalism when the U.S. ushered in neoliberalism through its interest rate hikes, which saw a ripple effect throughout the developing world. During this time, leading international institutions such as the World Bank and the IMF, along with the West, imposed conditions such as monetary liberalization, deregulation, and privatization on much-needed assistance—leading to a strong jump in inequality and poverty and lost decades in development.
In a recently released report, Oxfam emphasized the major crisis facing the Global South, noting that “more than half (57%) of the world’s poorest countries, home to 2.4 billion people, are having to cut public spending by a combined $229 billion over the next five years.” The report highlighted that the Global South “will be forced to pay nearly half a billion dollars every day in interest and debt repayments between now and 2029.” In today’s economic background, these devastating realities are at the core of the climate crisis, which is a major threat for all. Another repeat of a lost decade must not happen, especially when real and credible options are available.
Rajko Kolundzic is a Balkan PhD candidate at SOAS University of London.
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