More than 40 nations could default on loans, affecting everyone

Sri Lanka might be only the beginning. The South Asian country, once an economic darling hailed as a “hidden jewel,” has been sucked into a financial black hole this year as an unsustainable pile of debt crushed sector after sector. The debt crisis has triggered widespread unrest and political upheaval.

But the small island nation isn’t alone, experts warn, as a range of countries worldwide — from Tunisia to Egypt, Kenya to Argentina, and beyond — groan under their own giant piles of debt.

Put aside the economic jargon, and the story is a straightforward one. As global prices and interest rates rise, putting pressure on the finances of these countries, they are struggling to pay the interest they owe on all the loans that they have taken out in recent years. That in turn is affecting their ability to keep their economies running — to feed their people, to provide fuel — even as they try to get things back on an even keel after the blows of the covid-19 pandemic.

The consequences now, as the debt crises gather pace and an already fragile global economy struggles with the fallout from the war in Ukraine, could extend far beyond these individual nations’ borders. The world faces the possibility of a series of collapses that could destabilize the lives of millions of people.

In the worst-case scenario, “we could head into a complete dystopia,” an “apocalypse” for some of the world’s poorest countries, Jayati Ghosh, an economics professor at the University of Massachusetts Amherst, told Grid.

Ghosh said she fears a tide of “terrible economic devastation in many countries … a kind of descent into a combination of warlordism, extreme inequality, extreme material suffering. Just bad stuff. And lots of instability.”

The debt bombs — waiting to explode

A recent Bloomberg Economics analysis identified 19 countries that are at the extreme end of this struggle; traders in financial markets see a distinct possibility that these countries might be unable to make interest payments on their debts. That in turn could force them to go to institutions such as the International Monetary Fund for a bailout.

Depending on the country, the debt ranges — in U.S. dollars — from tens of millions to billions; some countries may get a bailout — others probably won’t. The IMF’s financial lifelines, for example, come with strict — and often painful — conditions, necessitating what are often politically unpopular choices to cut public spending. No bailout, and a country’s economy may collapse; getting a bailout, meanwhile, could mean widespread economic pain for the more than 900 million people who live in these nations as governments are forced to cut back public spending to bring their finances under control.

For economists, this means that the scenes we saw recently in Sri Lanka — where angry citizens, robbed of their livelihoods and even their ability to access basics such as fuel and food, stormed the presidential palace — could prove to be Act 1 in a whole new post-pandemic global nightmare.

Already, debt-related pressures have pushed Pakistan to secure an IMF loan as stretched finances sparked widespread unrest, threatening the stability of a nuclear-armed nation that sits in one of the most strategically important corners of the planet. The IMF has agreed to help in principle — but the money has yet to arrive, held up because of worries at the IMF about Pakistan’s compliance with a prior bailout under former prime minister Imran Khan. A clue as to how important the deal is for Pakistan’s stability came last month, when the country’s army chief was reported to be seeking U.S. help in trying to get the funds released.

In Africa, Kenya’s economy has grown to become the continent’s sixth biggest — but at the same time, the country has amassed giant debts; interest payments on the debt have soared to roughly 30 percent of the government’s GDP. All this as the country faces higher food and fuel prices as a result of the war in Ukraine. Analysts warn that debt has driven Kenya perilously close to the brink.

The story is being repeated across the globe. In many cases, the pressures have been worsened by bad decision-making at the highest levels. In Sri Lanka, a decision last year to ban chemical fertilizer imports depressed the country’s all-important farm sector. On the other side of the world, El Salvador embraced Bitcoin last year, accepting it as legal tender as a hedge against rampant inflation. But as Grid has reported, the move has backfired as the cryptocurrency tumbled in value. That has added to pressure on what is already a debt-laden economy — and another nation that could end up defaulting on its interest payments.

“There are many more Sri Lankas on the way,” the World Bank’s Chief Economist Carmen Reinhart warned recently in an interview with Reuters. “There are lots of countries in precarious situations.”

Such is the worry in the corridors of global finance that, back in April, not long before Sri Lanka was swallowed up by its debt-fueled inferno, the heads of the World Bank and IMF came together to issue a joint warning about what they called the “huge buildup of debt, especially in the poorest countries” of the world.

The makings of a crisis

To understand how the world ended up at this potentially catastrophic juncture, experts say it’s worth looking back to the 2007-2008 global economic crisis, which led to a slashing of interest rates in major economies, including the U.S. That made borrowing money cheap both for ordinary customers and governments around the world.

There was a lot of easy money “sloshing around,” Ghosh, from the University of Massachusetts, told Grid. For commercial investors, low interest rates in the U.S. and Europe meant it didn’t make much sense to park their capital in the West; instead, they sought investments in low- and middle-income countries.

“So lots of countries took out loans,” Ghosh explained. “And what’s different from the past is that they took out these loans not from bilateral or multilateral creditors [richer countries or big international institutions], it was from private creditors.” These creditors borrowed from banks, she said, and issued high-interest bonds that were then snapped up by financial firms.

Now, as the world sees record levels of inflation and central banks raise interest rates, poorer countries are facing higher bills to service the debt they’ve amassed. This is at a time when they are also facing higher prices for food and fuel and — as Ghosh reminded — “their economies have also not recovered from the pandemic.”

The IMF has been tracking some 73 highly indebted nations and estimates that roughly 40 of these are at high risk of what it calls debt distress: In other words, they are either actively trying to restructure their debts, preparing to do so or already falling behind on their interest payments.

China’s role

The debt that has piled up on the balance sheets of poor nations was borrowed from a range of sources; lenders have included private banks and hedge funds that invest in government bonds, as well as multilateral institutions like the World Bank. When it comes to nations lending to other nations, China tops the charts.

China has been lending to poor nations for decades — to the tune of $843 billion in international development finance from 2000 to 2017. It’s one reason why Western officials including German Chancellor Olaf Scholz, U.S. Treasury Secretary Janet Yellen and USAID head Samantha Power have recently pointed fingers at Beijing for fueling the debt crisis.

During a speech in New Delhi last month, Power cited China’s involvement in Sri Lanka; as Grid has reported, Chinese loans helped drive the country’s boom over the past two decades.

China, Power said, had been “an increasingly eager creditor of Sri Lankan governments since the mid-2000s.” She added: “Now that economic conditions have soured, Beijing has promised lines of credit and emergency loans … but calls to provide more significant relief have gone unanswered, and the biggest question of all is whether Beijing will restructure debt to the same extent as other bilateral creditors.”

And it’s not just Sri Lanka. According to a 2021 report from the College of William and Mary, 44 countries owed debt to China equivalent to 10 percent or more of GDP, with some owing more than a quarter of GDP. China is the largest lender to Zambia, which defaulted on its sovereign debt in 2020 and is currently undergoing debt relief negotiations.

Some have questioned China’s motivations, labeling its lending “debt trap diplomacy.” The idea is that China has extended loans to countries knowing those countries wouldn’t be able to pay off the debt — at which point China is able to extract strategic concessions in exchange. The most commonly cited case is the Hambantota Port project in Sri Lanka, where a Chinese state-owned company secured a 99-year lease of the port once Sri Lanka started hitting financial trouble.

Many China scholars have pushed back against the “debt trap” charge — in Sri Lanka and elsewhere. Deborah Bräutigam, a political economist at Johns Hopkins University, said the arguments are driven largely by a negative bias toward China and its role in global development. “So far, in Africa, we have not seen any examples where we would say the Chinese deliberately entangled another country in debt, and then used that debt to extract unfair or strategic advantages of some kind in Africa, including ‘asset seizures,’” she wrote in a 2019 study.

Matthew Mingey, a senior analyst of Chinese overseas finance at Rhodium Group, said that responsibility for the debt issues in these cases lies with both sides. Some nations lack the necessary capacity to monitor their debt; at the same time, China was less experienced in emerging markets when its banks started making these big loans. “Certainly, China’s banks were probably optimistic,” he said, “especially in the early going and made loans that they probably should not have.”

How to dig out

With the debt mountain looming over so many nations and the lives of millions of people, the urgent question is a simple one: What to do about it?

Perhaps the quickest way of ensuring that the world doesn’t witness a series of Sri Lanka-style collapses would be to turn the dial back on a major source of pressure on all these low-income economies: sky-high prices for food and fuel. Food consumption alone accounts for up to 60 percent of household consumption in poorer countries.

Of course, no policymakers or global financial institutions can snap their fingers and send prices falling. A current hope is that this week’s first shipments of Ukrainian grain may begin to ease what the U.N. has called a war-driven “perfect storm” for poorer nations.

Meanwhile, economists are calling for concerted global action by the world’s richest countries to help poorer nations manage or restructure their debt burdens. Put simply: to work out ways for them to cut down their monthly credit card bills.

In a report under the heading “The world isn’t ready for the looming emerging-market debt crisis,” the Atlantic Council called on the world’s richest nations to at least temporarily suspend interest payments, to “give countries breathing room.” It also recommended the introduction of “bridge financing” — essentially, temporary, short-term infusions of funds to help cover interest payments — to aid countries that cannot secure the IMF’s help in a timely manner.

There is precedent here: The arrival of the pandemic spurred the creation of an international initiative that saw bilateral lenders — that is, richer governments — temporarily suspend billions of dollars in interest payments from poorer nations as everyone dealt with the challenges posed by covid-19. Known as the debt service suspension initiative, it saw the suspension of almost $13 billion in interest payments between May 2020 and December 2021.

That said, the Atlantic Council also noted an absence of will, among nations of the G-20 in particular: “The international community doesn’t seem prepared to do much about it.”

The IMF and the Paris Club of 22 wealthier nations typically take the lead in such negotiations, but China’s increasingly large lending role has complicated that dynamic. Although China has stepped in to help — by suspending interest payments and restructuring loans for some of its debtors — Beijing has been reluctant to join other nations in collaborative efforts toward debt relief. Such collaborations are essential in complex debt negotiations, in which delays on the part of one creditor can drive indebted countries to default.

Case in point: Zambia, which defaulted on its debt two years ago. China agreed to join multilateral talks about Zambia’s debt crisis only last month.

What is clear — to analysts and policymakers alike — is that something needs to be done about the debt crises across the low-income world. Inaction, as Kristalina Georgieva, the head of the IMF, warned recently, could trigger an array of international disasters. Richer countries must help poorer counterparts, she said — in particular, by supporting initiatives to help restructure unsustainable debt piles before they spark defaults.

Failure to move ahead with such initiatives, Georgieva said, would create problems for the entire world. “This is a topic we cannot have complacency on,” she told Reuters. “You don’t know where it would end.”

Thanks to Lillian Barkley for copy editing this article.