A global debt crisis with geopolitical and geo-economic effekt is looming, according to the World Bank. Global debt has steadily increased over the past decades. GDP growth is however declining in many regions, such as Latin America (Latam) and the Middle East and North Africa (MENA). Consequently, when interest rates are high as they are now, government expenditures for servicing debt multiply. This pushes many countries closer to a debt crisis.
- Today, 3.3 billion people live in countries where the government spends more on servicing its debt than on schools and healthcare systems.
- These countries cannot achieve budget balance without, for instance, compromising public health. Therefore, debt can only move in one direction here: Upward.
- In Pakistan, for example, the government spends eight times more on debt servicing than on the healthcare system.
Demand for international funding rises while supply diminishes
At the end of last year, China’s 3rd Belt and Road Initiative (BRI) forum revised its scope. Going forward, BRI will focus on Central Asia and a few resource-critical countries in Africa and South America. Sector wise, scope is also revised to medium-sized projects such as digital infrastructure. No more mega-projects on physical infrastructure. This will often leave the Partnership for Global Infrastructure and Investment (PGII) or the IMF/World Bank as the only remaining sources of funding. However, the West and Bretton Woods institutions have traditionally been less willing to take risks compared to China’s BRI. Additionally, Western countries approach funding and risk diversification differently than BRI did. They e.g. limit their credit to scopes defined in advance. BRI had the opposite approach. Countries approached it with their loan requests, to which BRI then agreed, and, on rare occasions, declined.
- When Giorgia Meloni launched Italy’s “Africa Plan” in early February, top EU officials and several African leaders from countries like Tunisia, Senegal, Kenya, DR Congo, Zimbabwe, and Somalia participated. The plan includes €5.5 billion in loans and grants for education, agriculture, water, health, and energy.
- However, enthusiasm among potential borrowers was limited. African Union chairman Moussa Faki Mahamat stated e.g. “African leaders wish they had been heard before Italy presented its plan. Africa does not want to reach out. We are not beggars.”
Thus, the need for haircuts and debt relief increases
Debt spirals from existing loans, predominantly from BRI, will need haircuts and restructurings. BRI believes the IMF should pick up the bill here. However, as three-quarters of the IMF’s guarantee capital is signed by the EU and USA/Canada, the IMF believes that China itself should take the lead in providing relief. This disagreement has persisted, and in the meantime, the number of countries nearing default has increased.
At the end of February, the US and China agreed to resume discussions on principles for debt restructuring. A concrete breakthrough will likely take time. It may be useful to consider historical lessons when guessing what form these principles might take. April 9th of this year marked the 100th anniversary of the Dawes Plan. This was the first major international debt plan.
- A few years after the Treaty of Versailles (1919), Germany in 1923 defaulted on its war reparations to France and Britain. This prompted France and Belgium to seize the Ruhr as collateral.
- Germany urged its population to passively resist the occupation. This led to minimal activity in the Ruhr, which became unprofitable for the lienholders. Consequently, France and Britain were unable to service their loans from the USA.
- In 1924, the USA appointed Chicago banker Charles Dawes to find a solution. Dawes was appointed as a private individual. This allowed him to act freely without considering US domestic politics.
- The Dawes Committee created an agreement that did not solve the underlying war reparations issue. It however restructured the debt service profile by deferring the principal amounts. It also made payment schedule progressive, i.e. increase over time. In effect, it thus presumed that Germany economic growth would accelerate substantially.
- Charles Dawes received great praise for the agreement and was appointed Vice President in 1925 (serving until 1929). He also received the Nobel Peace Prize in 1925.
- In 1932, Germany went bankrupt as a result of the global depression combined with its rising loan payments.
The solution must however be long-term
A sustainable debt plan for distressed EMDEs thus should include elements of relief, haircuts, to address the real issues.
- This would allow China to distance itself from the accusation of “debt trap diplomacy”. This however requires sensitive communication inside China. Both Xi Jinping’s and He Lifeng’s personal success is closely tied to the success of BRI.
- The same applies to many developing countries' prospects. They generally depend on continued funding from BRI.
- Janet Yellen has long argued for expanding the World Bank’s balance sheet multiple times. Originally this was to ensure financing for climate transitions regardless of who is US president.
- This could also serve as a natural extension for the World Bank, to take over the restructuring of developing countries' debt.
- The problem is that the World Bank is a Bretton Woods institution. If China agrees to increase the World Bank’s role, they indirectly support the global influence of the USD. This is is contrary to China’s ambitions and the goals of initiatives like BRICS+.