World’s Poorest Nations Face ‘COVID-19 Debt Trap’
WASHINGTON—The world averted a systemic debt crisis amid the pandemic. However, the poorest developing countries continue to face significant debt problems, raising global worries over multiplying debt traps by creditors like China.
Addressing the rising risk of a systemic debt crisis in developing countries is one of the key themes at this week’s virtual spring meeting of the International Monetary Fund (IMF) and the World Bank.
Economists believe tackling debt vulnerabilities in poor nations is critical to prevent divergent recoveries around the world. Hence, IMF and World Bank officials are calling for extending debt relief for the most vulnerable countries to help them address challenges caused by the pandemic.
“The poorer countries don’t have a way out of these very heavy debt burdens,” David Malpass, World Bank president said during a press conference on April 7.
He said these countries face inequality in terms of access to credit markets and have growing fiscal deficits that are becoming problematic.
In addition, Malpass referred to China’s controversial lending practices without naming it and said opaque debt contracts and an unbalanced relationship between creditors and debtors complicate debt relief efforts.
Speaking at a seminar titled “Averting a COVID-19 Debt Trap,” IMF Managing Director Kristalina Georgieva said that many countries entered the pandemic with elevated debt levels. And during the pandemic, economic activities collapsed, causing public debt to reach 100 percent of the global economy.
According to Georgieva, “56 percent of low-income countries are either at a high risk of debt distress or already in debt distress.”
Many of these highly indebted countries “fall in a debt trap,” she said because “they cannot generate enough growth to bring down debt levels and these debt levels hold them back.”
And if the interest rates go higher globally, the situation for these countries in terms of debt burden “is going to be incredibly difficult,” she added.
Since the start of the pandemic, both the World Bank and the IMF have been urging the world’s 20 wealthiest economies (G20) including China to provide temporary suspension of debt service payments to the world’s poorest countries to avert a debt crisis.
There have been calls for the private sector creditors to participate in these debt relief efforts as well.
Finance ministers of the G20 nations agreed on April 7 to increase reserves at the IMF by $650 billion and further extend a freeze on developing countries’ debt servicing so that these countries can redirect funds toward vaccines and stimulus. The debt service suspension will run through the end of 2021.
China is the world’s largest creditor, accounting for almost 65 percent of official bilateral debt. China’s lending practices, however, complicate relief efforts in countries that are in financial distress.
Beijing’s Secretive Lending Program
A new study led by AidData, a U.S. research lab at the College of William & Mary showed that China’s loan contracts with emerging countries “have unusual secrecy provisions, collateral requirements, and debt renegotiation restrictions.”
Researchers analyzed the legal terms of 100 Chinese loan contracts to 24 developing countries, many of which have participated in the Belt and Road Initiative (BRI).
AidData conducted an in-depth review over a 36-month period and found that China’s loan contracts contained unusual confidentiality clauses, which prevented borrowing nations from disclosing the terms or sometimes even the existence of the loans.
Researchers also found that contracts also contained provisions that placed Chinese state-owned banks as senior creditors whose loans should be repaid on a priority basis. Informal collateral arrangements put Chinese creditors at the top of the repayment line.
In addition, Chinese lenders were given the freedom to cancel loans or accelerate repayment if they disagree with a borrower’s policies.
According to Malpass, these unusual lending practices make it very hard to restructure debt in emerging countries.
In recent years, China has lured many countries into a debt trap through the BRI, which is one of the world’s most ambitious and controversial development programs. Since its launch in 2013, the BRI has poured billions of dollars into infrastructure projects across Africa, Latin America, Eastern Europe, and Asia.
Washington has repeatedly criticized Beijing for exploiting the pandemic to further expand its geopolitical influence through predatory lending practices. Most of the BRI projects are financed through Chinese state-controlled lenders with a lack of transparency, leaving borrowing nations distressed by massive debt burdens. Beijing has also come under fire for implementing a “debt-trap diplomacy” to seize control of strategic assets in emerging countries.
China was a signatory to the debt service suspension initiative agreed to by the G-20 nations last year. The initiative provided a freeze of debt repayments for the poorest nations upon request. However, China has been less cooperative than other G-20 members expected.
The Trump administration officials criticized Beijing for dragging its feet by putting conditions on debt forgiveness and restructuring.
Economists believe debt vulnerabilities in poor countries will be a drag on the global recovery.
According to the IMF’s latest projections, global growth will be 6 percent in 2021, and 4.4 percent next year. The growth is stronger than in the January economic outlook report due to the additional fiscal support in a few developed countries and vaccine rollouts that bolster the economic recovery.
The IMF, however, warned that emerging economies would lag developed nations, which could perpetuate the growing gap between societies of rich and poor countries. Uneven access to vaccines would also be a drag on the recovery of poor nations, which underlines the urgency of providing debt relief to these countries, according to the IMF.