Nations need to evade the debt trap

debt crisis

The existence of debt has both social and financial costs.

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It takes years for a tree to grow but moments to be felled, likewise, debt and economic crises can obstruct and reverse decades of gains in per capita incomes and thwart efforts of poverty reduction in developing countries. The existence of debt has both social and financial costs.

According to UN Development Programme, “heavily indebted poor countries have higher rates of infant mortality, disease, illiteracy, and malnutrition than other countries in the developing world”. Japan, a very wealthy nation with the third largest financial assets in the world also happens to have the greatest debt, however, they have avoided a situation of debt crisis as they can manage their borrowings.

Over the recent past, many economies have fallen prey to the debt crisis. Going back to 2008, the collapse of Iceland's banking system caused a financial emergency and its impact spread across to Portugal, Italy, Ireland, Greece, and Spain as well as other neighbouring countries. The crisis led to the collapse of their economic and financial wellbeing. This year we witnessed the Sri Lankan debt crisis.

Great success

Once considered a great success in the developing world for meeting basic human needs as a low-income country in the late 1970s, Sri Lanka is in the epicentre of the worst debt and economic emergency since the country’s independence in 1948 and the nation is on the brink of bankruptcy. This situation was brought on by a cycle of ever-increasing foreign debt, changes in weather patterns that negatively affected the crop harvests and exports, the onset of Covid-19 leading to a series of lockdowns, soaring inflation, shortages in fuel supply, an enormous deficit in the economy’s balance of payment, and drastic depletion of foreign currency reserves and progressive devaluation of the currency.

As per the 2021 World Economic Forum Global Risk report, “147 governments have defaulted on debts since 1960”. As per the IMF reports, there have been increased disbursements of loans to nations, particularly across Africa and Asia as Covid-19 has raised debt distress predominantly in low-income nations and emerging market economies. Is it a rare occurrence that the rising of sovereign debts to all-time highs causes bankruptcy status? Zambia borrowed $12 billion from international creditors and has defaulted on debt repayment. Other noteworthy countries which have defaulted or restructured debt after non-payment since the year 2020 besides Zambia and Sri Lanka include Lebanon, Belize, Argentina, Suriname and many others. Lebanon was once referred to as “Switzerland of Middle East” for its economic power in the region, and today it is on the brink of bankruptcy.

What has caused the debt crisis to be so prevalent now? Many countries have suffered due to the economic downturn brought on by Covid-19, thereafter the continued impact on supply chains has led to a shortage of essentials leading to escalating costs of goods. Geopolitics has damaged the situation even further, from the Russia-Ukraine war, down to regional politics. Several countries across Africa have a debt totalling more than 70 percent of their Gross Domestic Product. This was confirmed by an IMF report indicating countries including South Africa, Ghana, Kenya, Eritrea, Congo, Angola, Mozambique, and others are on the watch list for being heavily indebted. Kenya is faring well compared to some African counterparts, however, we have our challenges too.

The government of Kenya defaulted on debt repayment of three loans amounting to Sh5.1 billion from an international bank in the financial year ending June 2021. The loans defaulted on were secured for the construction of Arror, Itare, and Kimwarer dams. This was revealed by the auditor general in an audit report on the country’s public debt. Kenya’s public debt currently stands at Sh8.4 trillion. The government maintained that the country’s debt is sustainable and there is no cause for alarm. General public debt has been a subject of intense debate even as the National Treasury has maintained that at the debt level being 69 percent of the country’s gross domestic product the economy and public remain in a safe space. Nancy Gathungu, Auditor General of Kenya stated “taxpayer is bearing the burden of incurring commitment fees for loans that National Treasury is yet to disburse”. These revelations by the auditor general are at a time when the National Treasury has proposed through the 2022 finance bill a revision of the Kenyan debt ceiling from the present Sh9 trillion to 55 percent of the country’s Gross Domestic Product. The proposal is currently being deliberated by the National Assembly’s financial planning committee.

Larger picture

Looking at the larger picture, the global economy continues to face challenges. Kenya is not unique with its ever-rising fuel costs, increasing inflation, impacted growth, and tightened financial conditions. This is the predicament faced by many nations. It is no surprise that the world’s poorer nations have taken on an increasing amount of variable rate debt as a share of their total debt increasing their vulnerability to rate hikes. A high and rising stock of government debt risks leading to higher taxes in the future. The ever-rising mountain of debt is expensive to service and has a potentially significant opportunity cost for the government.

High taxes and interest rates can crowd out the private sector as well. Supporters of small governments believe a lot of states' spending on borrowing and servicing loans is wasteful and showcases allocative inefficiency. Cutting national debt allows for lower taxes which can increase both aggregate demand and aggregate supply in the long run.

Is a high level of national debt a concern? This depends in part on the root cause of the debt, both cyclical and structural. It also depends in part on the cost of annual interest payments and repayment terms for new and existing debt. The ability of the government to attract investors to buy new debt is an important factor. What is most important and required is a careful and realistic forecast of the impact of inflation on the real value of unpaid debt and value judgments about how best to fund public services and welfare and which generation should bear the cost of paying this debt. Thomas Jefferson famously quoted “to preserve our independence, we must not let our rulers load us with perpetual debt.” Countries must aim at reducing debt and evade the debt trap.

Ritesh Barot is a business and financial analyst, humanitarian, conservationist, occasional artist, recipient of OGW honor. [email protected]

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