WASHINGTON — Developing nations are facing a catastrophic debt crisis in the coming months as rapid inflation, slowing growth, rising interest rates and a strengthening dollar coalesce into a perfect storm that could set off a wave of messy defaults and inflict economic pain on the world’s most vulnerable people.
Poor countries owe, by some calculations, as much as $200 billion to wealthy nations, multilateral development banks and private creditors. Rising interest rates have increased the value of the dollar, making it harder for foreign borrowers with debt denominated in U.S. currency to repay their loans.
Defaulting on a huge swath of loans would send borrowing costs for vulnerable nations even higher and could spawn financial crises when nearly 100 million people have already been pushed into poverty this year by the combined effects of the pandemic, inflation and Russia’s war in Ukraine.
The danger poses another headwind for a world economy that has been sputtering toward a recession. The leaders of the world’s advanced economies have been grappling privately in recent weeks with how to avert financial crises in emerging markets such as Zambia, Sri Lanka and Ghana, but they have struggled to develop a plan to accelerate debt relief as they confront their own economic woes.
As rich countries brace for a global recession and try to cope with high food and energy prices, investment flows to the developing world have been abating and big creditors, particularly China, have been slow to restructure loans.
Mass defaults in low-income countries are unlikely to spur a global financial crisis given the relatively small size of their economies. But the potential is causing policymakers to rethink debt sustainability in an era of rising interest rates and increasingly opaque loan transactions. In part, that’s because defaults can make it harder for countries like the United States to export goods to indebted nations, further slowing the world economy and possibly leading to widespread hunger and social unrest. As Sri Lanka drew closer to its default this year, its central bank was forced to arrange a barter agreement to pay for Iranian oil with tea leaves.
“Finding ways to reduce the debt is important for these countries to get to the light at the end of the tunnel,” said David Malpass, the World Bank president, in an interview at the summit for the Group of 20 nations last month in Bali, Indonesia. “This burden on the developing countries is heavy, and if it goes on, they continue to get worse, which then has impacts on advanced economies in terms of increased migration flows and lost markets.”
The urgency follows lockdowns to contain the coronavirus in China and Russia’s war in Ukraine, which have stunted global output and sent food and energy prices soaring. The Federal Reserve has been rapidly raising interest rates in the United States, bolstering the strength of the dollar and making it more expensive for developing countries to import necessities for populations already struggling with rising prices.
Economists and global financial institutions such as the World Bank and the International Monetary Fund have been raising alarm about the gravity of the crisis. The World Bank projected this year that about a dozen countries could face default in the next year, and the I.M.F. calculated that 60 percent of low-income developing countries were in debt distress or at high risk of it.
Since then, the finances of developing countries have continued to deteriorate. The Council on Foreign Relations said this past week that 12 countries now had its highest default rating, up from three 18 months ago.
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.
Brad Setser, a senior fellow at council, estimates that $200 billion of sovereign debt in emerging markets needs to be restructured.
“It is certainly a systemic problem for the countries that are affected,” Mr. Setser said. “Because an unusually large number of countries borrowed from the market and borrowed from China between 2012 and 2020, there’s an unusually large number of countries that are in default or at risk of default.”
Restructuring debt can include providing grace periods for repayment, lowering interest rates and forgiving some of the principal amount that is owed. The United States has traditionally led broad debt-relief initiatives such as the “Brady Bond” plan for Latin America in the 1990s. However, the emergence of commercial creditors that lend at high rates and prolific loans from China — which has been loath to take losses — has complicated international debt relief efforts.
Fitch, the credit rating firm, warned in a report last month that…
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