Managing Debt Vulnerabilities in Low-Income Countries

Christine Lagarde, Managing Director, International Monetary Fund

September 13, 2018/IMF

By Christine Lagarde

 As prepared for delivery

Honored guests, ladies and gentlemen—it is a pleasure for me to welcome you to our conference on sovereign debt.

I would like to thank my colleagues in the Strategy, Policy and Review Department for bringing together some of the world’s leading thinkers—on a topic that lies at the heart of the IMF’s mandate.

Our principal responsibility is to maintain the stability of the international financial system—and healthy sovereign borrowers are the bedrock of that system.

We know that borrowing makes sense for all countries—rich and poor—if it finances things such as schools, hospitals, and physical and digital infrastructure. These are smart investments that can boost potential growth and improve the economic wellbeing of individuals and communities. This is especially true for low-income countries and emerging economies that tend to have a lower capital base to start with, and where global capital is likely to be the most productive.

But we also know that, over the past decade, government debt as a proportion of GDP has reached new highs.

1. What a Difference a Decade Makes

In advanced economies, public debt is at levels not seen since the Second World War. Emerging market public debt is at levels last seen during the 1980s debt crisis. And if recent trends continue, many low-income countries will face unsustainable debt burdens.

Globally, this buildup has a lot to do with the 2008 financial crisis and the post-crisis policy response. This is especially true in advanced economies, where governments used their balance sheets to rescue failing financial firms and support demand.

In emerging markets and low-income countries, the buildup shows the impact of rapid spending growth, only partly used for public investment. And let us not forget the impact of various shocks—from low export prices for commodity producers, to natural disasters, conflicts, and epidemics, which hit low-income countries especially hard.

The bottom line is that high debt burdens have left many governments more vulnerable to a sudden tightening of global financial conditions and higher interest costs. For emerging market and frontier economies, concerns about debt levels in this environment could contribute to market corrections, sharp exchange rate movements, and further weakening of capital flows.

The distinguished speakers at this conference will focus on how we can use the current global growth momentum to bolster the health of sovereign debtors.

For example: How fast should public debt be reduced? What are the best conventional and unconventional tools for debt reduction? And how can we encourage more effective debt restructuring processes?

These are some of the issues that will be discussed in an upcoming book that will build on this conference. Here I would like to thank Ken Rogoff, a former Chief Economist and long-time friend of the IMF, for co-editing the book [1] —with two Fund staff, Ali Abbas and Alex Pienkowski [2] .

Developing new policies and sharing fresh ideas can help move the sovereign debt needle in the right direction. Let me briefly talk about that approach as it applies to low-income countries.

2. Low-income Country Debt

This is about creating better prospects for the world’s poorest countries. It is about the well-being of 59 economies that make up 20 percent of the global population.

To be clear, maintaining a moderate level of borrowing is essential to lift incomes and living standards in these countries.

But rapidly growing debt burdens could jeopardize their development goals, as governments spend more on debt service and less on infrastructure, health, and education. High debt can also create uncertainty, which deters investment and innovation.

We estimate that the median debt level among low-income countries increased from 33 percent of GDP in 2013 to 47 percent. [3]

That is not that high when looking at all countries—but low-income countries often have a more limited capacity to raise public revenue and carry debt.

Again, this buildup of debt reflects a range of factors—from low commodity prices, to natural disasters and civil conflict, to high investment spending on projects that were not productive.

Of course, ample global liquidity made it easier for governments to borrow more—which brings me to the lenders.

Historically, low-income countries mostly relied on international institutions and traditional bilateral creditor countries, which can use the Paris Club to coordinate their actions on debt issues. [4]

Today, low-income countries rely much more heavily on non-traditional lenders—from bond investors, to foreign commercial banks, to commodity traders, to creditor countries outside the Paris Club.

The shift towards new borrowing sources generally means higher interest rates and shorter maturities. Borrowing from non-Paris Club lenders also means that creditor coordination will likely become more complicated.

Managing these debt vulnerabilities is critical. We estimate that 40 percent of low-income countries already face significant debt challenges.

A key challenge is preventing “debt surprises,” which can be driven by poor governance, off-balance sheet borrowing, and weak debt recording and reporting.

So, what can governments do?

3. Building Trust and Working Together

It is worth remembering that the word “credit” comes from the Latin word for “trust”—which underpins the financial system.

Building trust in sovereign debtors is the ultimate purpose of this conference and of the work that you do every day.

So, let me highlight three policy priorities that can help make a difference in low-income countries.

First—greater efforts are needed to make borrowing more sustainable . This means proceeding prudently in taking on new debt, focusing more on attracting foreign direct investment, and boosting tax revenues at home.

It means focusing on investment projects with credibly high rates of return. It also means increasing the responsibility of lenders, who need to assess the impact of new loans on the borrower’s debt position before providing the new loans.

Second—we need to ensure that all countries adhere to rigor and transparency in their borrowing and lending practices. For example, there is room to significantly strengthen the institutions that record, monitor, and report debt in individual countries.

Think about it: one third of low-income countries do not report debt guarantees for state-owned enterprises; and fewer than one in ten report debt of public enterprises. Greater transparency can help prevent these contingent liabilities from turning into massive government obligations.

In these efforts, we at the IMF work closely with all our member countries to bolster their debt recording and management capacity, and governance frameworks.

We are also using our debt sustainability analysis to shine a light on potential risks. Last year, we conducted assessments in 55 low-income countries, and we are now rolling out our new enhanced debt sustainability framework for these economies.

The new framework brings out more clearly the economic assumptions behind the analysis as well as the obligations covered, and its stress tests highlight vulnerabilities that are particularly relevant for low-income countries such as natural disasters and commodity price shocks.

Third—we need to encourage stronger collaboration between borrower countries and lenders.

For example, we have seen a sharp rise in the number of cases where debt contracts are not publicly disclosed by either the borrower or the lender. By working together, both parties can ensure better disclosure, which reduces risk and increases accountability.

We also need better collaboration to prepare for debt restructuring cases that involve non-traditional lenders. With substantial non-Paris Club debt, we need to think about new ways in which official creditor coordination — often so critical to debt crisis resolution — can take place.

Moreover, if obstacles that inhibit smooth debt restructurings now can be addressed, the IMF can more easily play its traditional role in providing financial support and acting as a catalyst for additional flows, including from the World Bank and other major lenders.

We are deeply engaged in this reform process by providing advice and a platform for dialogue. I certainly look forward to our discussions on these and many other pressing issues.

Conclusion

Let me conclude with the old adage that trust “ arrives on foot, but leaves on horseback.”

Building trust in sovereign borrowers is now more important than ever, especially in low-income counties.

I believe that, by harnessing the power of transparency and collaboration, we can help create better prospects and greater prosperity for all.

Thank you.

opan



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