High interest rate causing debt distress in emerging economies

The combination of aggressive interest-rate hikes in developed countries, lack of sufficient affordable capital from the World Bank and a failure to consider and address the spillover effects are creating costly spillback economic consequences on low-and low-middle income countries already at high risk of debt distress, a new analysis from One Campaign says. 

The international, non-profit advocacy and campaigning organisation that fights extreme poverty, particularly in developing countries, finds that ‘rich countries’ actions to control domestic inflation through rises in interest rates are creating unsustainable economic realities for  low-and low-middle income countries. The high interest rates, it explained, is gradually locking  emerging economies out of low-cost financing options and creating an increasingly divergent global economy and exacerbating an already dangerous debt crisis. 

One Campaign, in a new report titled, “The collateral damage of rising interest rates”, said the rises in rates will make borrowing and debt increasingly unsustainable for many countries. 

“That lack of financing is felt hardest by the people living in low-and low-middle income countries. But it has serious long-term consequences globally as well: it prevents much-needed investment in the climate, economic, and development solutions of the future,” the report noted. 

Analysis by the global movement campaign organisation finds that borrowing from capital markets is costing African governments 500 percent more of what they could pay if G20 leaders had delivered swiftly on financial reforms through the World Bank. 

The implication of this, it explained, is that in the coming years, African countries will be forced to pay an additional $56 billion in the repayment costs on new debts raised from capital markets between 2017 and 2021.

Further analysis on the affordable debt crisis showed that  all middle-income countries globally are facing a $74 billion hurdle in additional unnecessary costs for new bonds issued just in 2021.

 “If average interest rates on bonds increase by 1% more, interest would cost an additional $2.5 billion for African countries and $27 billion for middle-income countries from debt taken in 2021 alone,” says the report. 

One Campaign noted that the situation  is generating real-time costs that could worsen the debt crisis and increase poverty with serious long-term consequences globally as well. In addition, it is  creating opportunity costs as low-and low-middle income countries are unable to finance investment in the climate, economic and development solutions of the future that they  and the rest of the world desperately need.

On how unprecedented interest rate hikes risk driving a big divergence in the global economy, the report explained that the Covid-19 pandemic shut down economies in previously unimaginable ways. In response, G20 countries including the United States spent an estimated $14 trillion in massive stimulus packages. Though this was able to stabilise the global economy from the brink of recession, it fired up inflation which peaked globally at 10.4 percent in September 2022 and in Africa at 18.6 percent as at March 2023. 

In response, central banks have implemented what is termed ‘the fastest tightening of monetary policy’ since the 1980s, trying to catch up on an initially slow response. 

Critically, this includes the US Federal Reserve which drives global rates. This is as the U.S rate hikes have consequently dealt a heavy blow on emerging economies who will be paying higher for their debt for years.

According to One Campaign, higher US interest rates strengthens the US dollar, which causes many other currencies to depreciate. 

“From January 2022 to March 2023, African currencies lost 8% of their value, increasing their debt by 10% of GDP and pushing up the cost of imports. 80% of external debt in low- and middle-income countries is held in US dollars. So recent interest rate hikes have served as a one-two punch for lower-income countries, triggering inflation and currency depreciation, which has compounded budget and inflationary problems,” the report showed. 

Gayle Smith, chief executive of  ONE Campaign, argued that it makes no political or economic sense that low- and low-middle income countries are being forced to pay premium prices for capital at the very moment they are trying to recover from the pandemic, deal with the fallout from Russia’s invasion of Ukraine, and respond to the growing threat from climate change.

“It’s even more stunning to consider that solutions are at hand, if the world’s wealthy and most powerful countries choose to pursue them – solutions that would enable developing economies to recover and grow and would also deliver big-time to a global green energy future,” said Smith. 

One Campaign’s analysis showed that lack of affordable capital will impact the whole world. The report further noted that Africa alone possesses vast renewable energy resources and carbon capture potential that could fuel its economic growth and transform global efforts to tackle climate change, but this potential cannot be realised without access to affordable capital.

The report also indicated that since 2000, governments in  low-and low-middle income countries have faced huge financing needs and  until recently, historically low interest rates, which led them to borrowing as it appeared a logical move.  

Unfortunately, in the decade to 2021, Africa debt stocks grew by 250 percent to $645 billion with more and more of that debt in the form of market bonds as countries took finance where it was available. This came with an unpleasant price, leading to greater exposure to market changes, biassed risk assessments, and higher costs.

These high costs, One Campaign stressed, mean that African countries cannot invest for the future. It also pointed out that in addition to decreased health and social spending, they cannot harness their considerable resources to deliver climate solutions.

“Countries currently have little choice but to absorb the extra cost and make painful tradeoffs with social spending and transformational investments. If capital were more affordable, they would not have to make these impossible choices,” One Campaign emphasised.  

According to the report, multilateral development banks (MDBs) such as the World Bank were established to provide transformational finance/capital at much affordable rates to needy economies but haven’t done enough to salvage the situation. 

One Campaign maintained that MDBs offer much lower  interest rates compared to the bond markets and the low-income, noting that low- and middle-income countries wouldn’t have fallen so deeply into the current debt crisis had the MDBs risen to the occasion. 

It said, “That matters because MDBs, including the World Bank, are much cheaper than the markets. A significant share of the World Bank’s lending through its concessional arm, the International Development Association (IDA), carries an interest rate of 0.75%. Even the Bank’s non-concessional arm offers much cheaper lending to African countries.

While the World Bank is the largest MDB, regional banks also offer preferential loan rates. The African Development Bank, for example, lent to African countries at a rate of 1.2% in 2021—nearly five times cheaper than government bonds.”

On how affordable investment opportunities and financing can be made available for low and low-middle income countries, One Campaign advised G20 leaders to implement proactive measures in providing countries with much needed low-cost financing. This, it explained, means reforming out of date global financing institutions so they are better, bigger, and more responsive to countries’ needs. 

The advocacy and campaigning organisation called on the G20 leaders to increase the multilateral development bank system, accelerate efforts to reform the World Bank in commitment to tripling World Bank loans and grants in order to significantly improve the volume of affordable investment available to low-and low-middle income countries. 

Among other recommendations, the World Bank was advised to make bolder investments and more efficient use of IBRD’s existing capital. This includes optimising its balance sheet, known as capital adequacy framework reform which is expected to maximise potential financing while preserving its financial stability and AAA credit rating.

One Campaign also charged G20 leaders and World Bank shareholders to commit to triple the World Bank IDA through increasing donor contributions and implementing reforms to further leverage its resources.

G20 leaders and MDB shareholders were also advised to implement the G20 Independent Expert Group recommendations to improve the MDB system and ensure that MDBs move faster, more efficiently, and are driven by country needs.