This article first appeared in Forum, The Edge Malaysia Weekly on July 15, 2024 - July 21, 2024

For some time, most multilateral financial institutions have urged developing countries to borrow commercially, but not from China. Now, borrowers are stuck in debt traps with little prospect of escape.

The last decade and a half has seen protracted worldwide stagnation, with some economies and people faring much worse than others.

The 2008 global financial crisis and Great Recession have recently been worsened by the Covid-19 pandemic, US Federal Reserve-led interest rate hikes and escalating geopolitical economic warfare.

Following Reagan-inspired tax cuts, ostensibly to induce more private investments, budget deficits have loomed larger. Instead of enabling rapid recovery, greater fiscal austerity is now demanded, as in the 1980s.

After fiscal expansion averted the worst in 2009, unconventional monetary policies, mainly “quantitative easing” (QE), took over. The European Central Bank (ECB) followed the US Fed’s QE lead for over a decade.

QE’s lower interest rates encouraged more borrowing as more credit became available and affordable. With rich nations offering less concessional finance, developing countries had little choice but to turn to markets for loans.

Spending counter-cyclically in a downturn requires government borrowing, which QE made more accessible and cheaper. The resulting borrowing surge has returned to haunt these economies since 2022-23, when interest rates spiked.

World Bank slogans, such as “from billions to trillions”, urged developing-country governments to borrow more on market terms to meet their funding needs for the Sustainable Development Goals (SDG), climate and pandemic.

With capital accounts open, many private investors have long sought “safety” abroad. But when lucrative direct investment opportunities beckoned, for example, in India, some “capital flight” returned as foreign investments, typically privileged and protected by host governments and international treaties.

Easier credit availability on almost concessional terms, thanks to QE, enabled more, often innovative, financialisation. Blended finance and other such innovations promised to “de-risk” private investments, especially from abroad.

Despite less bank borrowing than in the 1970s, indebtedness increased with more market-based debt. However, such indebtedness did not grow the real economy much despite much private technological innovation.

The US Fed started raising interest rates from early 2022, blaming inflation on the tight labour market. As interest rates rose sharply, debt became more burdensome.

As such, government borrowing worldwide became more constrained when more needed. The raising of interest rates has dampened demand, including private and government spending for investment and consumption.

But recent economic contractions have been mainly due to supply-side disruptions. The second Cold War, the Covid-19 pandemic, and geopolitical economic aggression have disrupted supply lines and logistics.

Raising interest rates dampens demand but does not address supply-side disruptions. Inappropriate policies have not helped, as such anti-inflationary measures have cut jobs, incomes, spending and demand worldwide.

Following the 2008 global financial crisis, successive US presidents have successfully maintained full employment. All central banks are committed to ensuring financial stability, but the US Fed also has an almost unique second mandate to maintain full employment.

Developing countries now face many more constraints on what they can do. Most are heavily indebted, with little policy space to manoeuvre. With more financing from markets, the pro-cyclical bias is more pronounced.

Vulnerable developing countries believe they have little choice but to surrender to the market. Poverty in the poorest countries has not declined for almost a decade, while food security has not improved for even longer.

Worse, geopolitical developments have put much pressure on the Global South to spend more on the military. But most recent food price increases were due to speculation and “artificial”, rather than real, shortages.

The likelihood of distress increases with debt burdens. Debt stress has grown tremendously in the last two years, especially for developing countries that are borrowing heavily in major Western currencies.

Although the apparent reasons for central banks raising interest rates are rarely cited anymore, interest rates have not fallen, and funds have not flowed back to developing countries.

For at least a decade, the US has increasingly warned developing countries against borrowing from China despite its low interest rates compared with most other credit sources except Japan.

Consequently, China’s lending to developing countries, particularly in Sub-Saharan Africa, has fallen since 2016. By 2022, poorer countries had borrowed much more from commercial sources. But such private capital has since fled to the US and other Western markets offering high returns with more security.

Capital flight from developing countries, especially the poorest, followed as much less money went to the poorest developing countries via markets. With fewer funding options, the poorest countries have been the most vulnerable.

Negotiating with varied private creditors in markets, rather than via intergovernmental arrangements, has proved much more difficult. With much more private market funding, such financiers will not take instructions from governments unless compelled to do so.

Hence, little on the horizon offers any real hope of significant debt relief, let alone strong recovery and improved prospects for sustainable development in the Global South.

Jomo Kwame Sundaram is currently senior adviser at Khazanah Research Institute. A former economics professor, he was United Nations assistant secretary-general for economic development. He is a recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

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