Developing countries’ private debt is on the rise, and the international institutions are ill-prepared

Added 17 Jan 2013

By Bodo Ellmers

The latest statistics shed light on the new composition of developing countries’ debt. The share of private debt in developing countries’ total external debt is ever increasing and may by now have exceeded the public share. On both sides of the debt equation, private actors play an increasingly important role, as borrowers and as lenders. This new debt situation confronts a Global economic governance structure that is ill-fitted to deal with complex debt management and crisis prevention as functional debt work-out mechanisms are still not in place. While overall debt figures that are determined by a few larger middle-income countries look somewhat encouraging, many developing countries remain in serious debt distress. Debt service competes with financing development and poverty eradication for scarce public resources.

Private debt: Surging and increasingly unmanageable

According to the World Bank’s 2013 International Development Statistics that were released last week, external debt stocks of developing counties amounted to USD 4.9 trillion in 2011, up from USD 4.4 trillion in 2010. The debt stock more than doubled since 2000 when it stood at 2.1 trillion. However the most striking thing is the changing composition: the shift from the public sector to the private sector. While in 2000, long-term public sector debt stood at USD 1.3 trillion compared to USD 0.5 trillion of private sector debt, by the end of 2011 public sector debt was USD 1,761 billion compared to USD 1,708 billion of private sector debt. These trends continued, and private sector debt has already exceeded public sector debt.

Net inflows to private sector borrowers increased by 4% in 2011 and amounted to USD 363 billion, while net inflows to public and publicly guaranteed borrowers dipped  to USD 101 billion, down 31%. The true picture is actually unknown, the World Bank has to acknowledge that in particular reporting on private sector debt is patchy, a situation that is complicated by the sheer number of private actors that get into debt.  Thus, national governments and central banks and the international community are badly informed about the risks they ultimately have to manage.

While there is no legal obligation for governments to guarantee private debt, the recent experiences with the Eurocrisis proved that private creditors and debtors are often bailed out by governments and ultimately citizens and taxpayers, depending on perceived risks to the financial system, and on the private sector’s lobbying skills. Ireland’s government debt to GNI ratio rose from 48.2% in 2008 to 109.8% in 2011, largely due to bailouts of commercial banks and other private actors.

Full coverage debt work-out mechanisms that could deal comprehensively with situations of debt distress and settle them in a fair, transparent and sustainable manner are not in place. This governance gap is known - the IMF had called for new sovereign debt restructuring mechanisms more than ten years ago - but some governments’ political resistance lead to the situation that the international community has only fragmented and biased second-rate  institutions such as the official (Western) creditors’ Paris Club or the London Club for (some) commercial banks’. As the debt picture is changing, this debt management architecture becomes ever more dysfunctional as more and more actors and flows are uncovered.


Developing country debt: Sustainable for now 

Currently, developing countries’ external debt indicators appear somewhat sustainable. Most relevant indicators such as the debt to GNI ratio (21.5% in 2011), debt to exports ratio (69.3%) and debt service to export revenue (8.8%) improved. There are notable exceptions, however. Six countries even have to report debt to GNI ratios of more than 100% (Belize, Jamaica, Kyrgyz Republic, Latvia, Nicaragua, Papua New Guinea). Moreover, while some countries that profited from one-off debt relief exercises such as the HIPC and MDRI initiatives actually reduced debt levels, in many others it was mainly high economic and export growth that lead to the improvements. Progress might be fragile in particular in developing  countries where export revenue mainly come from one or a few products and commodity prices can change quickly.

Developing countries build up ever higher levels of currency reserves in order to protect themselves from such external shocks and financial crisis – in the absence of a neutral crisis prevention system and their understandable reluctance to subordinate themselves to IMF conditionality in case assistance is needed. The ratio of reserves to external debt stocks was 121% in 2011, up from 20% in 2000. The opportunity costs of reserves are high, given that they are mainly held in form of Western countries’ government bonds, and interest rates on this asset class are at historic lows.

Thus, money is missing for funding development and poverty eradication. Such self-insurance mechanisms are just second-best too, and no viable alternative to introducing fair and transparent debt work-out mechanisms that make binding decisions for all and replace the outdated global debt management architecture that is currently in place.

All data is from the World Bank’s 2013 International Development Statistics. The analysis and conclusions are Eurodad's own