Lender of everyone’s resort

Sri Lanka defaulted on its sovereign debts in April 2022. In July 2022, the International Monetary Fund (IMF) warned that 53 more low-and-middle-income countries, including Pakistan, were either experiencing debt trouble or were at high risk of doing so with few options to ward off crises. What are those options? Before answering that, we need to understand why these countries are in debt crises.

Let us start with Sri Lanka. Amidst plummeting revenue collection and a widened budget deficit, (former) president Rajapaksa came into power in 2019 with populist claims of reducing inflation and providing relief to his people. He reduced the value-added tax from 15 per cent to 7.0 per cent and increased the annual taxable income limit from SLR0.5 million to SLR3 million. Things worsened when tourism, the primary source of foreign exchange, got hit by Covid-19. Multiyear high-trade imbalance and a growing current account deficit increased the demand for dollars, putting pressure on the SLR. However, the government resisted a depreciation of SLR to save its popularity. It spent the scarce foreign currency reserves to fix the exchange rate to SLR200 a dollar.

Dwindling foreign currency reserves eroded its capacity to pay for imports. Curtailed import of oil and gas affected electricity generation, severely affecting businesses and manufacturing. Shy of taking ‘unpopular’ measures, the government did not engage the IMF in time. With no dollars in reserves, Sri Lanka went dry on essential items like food and medicines; the president resigned amidst people’s protests, and the country defaulted on its sovereign debts. As of today, after 80 per cent depreciation, SLR is 360 a dollar; inflation is 70 per cent, and the interest rate is 30 per cent.

Argentina, the largest borrower of the IMF, has defaulted on its international sovereign debt nine times, including three times during the past two decades. In 2001, Argentina defaulted on more than $132 billion of federal sovereign debt. The underlying reasons behind its default are similar to what we observed in Sri Lanka. Its politicians prefer politics over the economy. They take populist decisions, overspend through borrowing, are shy of carrying out structural reforms, and rely on regressive indirect taxation.

Successive governments in Argentina have been granting special exemptions and favouring their cronies and interest groups. Its utility subsidies are regressive (amounting to 1.5 per cent of GDP for electricity alone). At the same time, its public-sector enterprises are inefficient and cross-subsidized. Over-reliance on external borrowing, inflation, currency depreciation, corruption, and political instability are some chronic problems facing the Argentinian economy.

Egypt is the second largest borrower of the IMF after Argentina. The Egyptian government has consistently run large budget deficits (partly due to less revenue collection and partly due to the concessions and exemptions given to —mainly military-owned— business ventures), which have been financed through borrowing. Public debt has reached almost a hundred per cent of Egypt’s GDP, and half of its revenue is spent on debt servicing. Central and commercial banks lost foreign currency reserves due to the president’s love for a heavily managed exchange rate.

The Ukraine war resulted in the outflow of $22 billion of portfolio investments from Egypt within a few months, worsening the shortages of foreign exchange reserves. Egypt turned to old friends Kuwait, Saudi Arabia, and the UAE, which had deposited $18 billion in its central bank between October 2021 and March 2022. However, these friends seem to be losing faith in countries unwilling to implement economic reforms. The World Bank also withheld a separate package of support. To conserve dollars, the Egyptian government restricted imports. In December 2022, $9.5 billion worth of goods were stuck at Egyptian ports as there were no dollars to clear these shipments. The pound has been devalued thrice during the last 13 months to secure an IMF loan. Having lost 50 per cent of the pound’s value last year, inflation, already at 21 per cent, has increased further.

Zambia defaulted on its Eurobonds in 2020 and is still stuck in a debt crisis. Chronic economic mismanagement, non-targeted subsidies, overvalued domestic currency, and inefficient government spending resulted in large fiscal and external imbalances in Zambia. It is heavily reliant on copper exports, and a sharp decline in copper prices in the global market during Covid-19 hit the country’s economy hard. This led to a trade imbalance, reducing the country’s revenue and ability to pay its debts. Besides defaulting on Eurobonds, it has accumulated arrears to other creditors.

The spending addiction of Ghanaian politicians, despite Ghana’s fiscal deficit, has once again led it to a debt crisis. Currently, its public debt is above 100 per cent of the GDP. It consumes 70-100 per cent of its revenue on local and foreign interest payments. To control inflation which is running at 54 per cent, the central bank has raised the interest rate to 27 per cent. In 2022, its currency depreciated by 58 per cent against the US dollar. Dwindling foreign exchange reserves have made it difficult for Ghana to pay its debts.

As far as Pakistan is concerned, replace the name of any country mentioned above with Pakistan, and one would be able to relate to the underlying reasons for our debt unsustainability. The underlying reasons for debt crises in low and low-middle-income countries are common. These countries, including Pakistan, suffer from self-inflicted policy wounds that are rotting to cause economic septicaemia. They are trapped in a vicious cycle of ‘borrowing, overspending, currency depreciation, inflation, and further borrowing’.

For many of them, China, Saudi Arabia, UAE, Qatar, etc, are lenders of first resort. Till lately, the debt diplomacy of China and oil-exporting gulf countries have been masking the economic mismanagement in many debt-ridden countries. However, these lenders have also started pressing for structural and policy reforms before doling out their money. The lukewarm response of bilateral creditors reinforces the IMF’s role as the lender of last resort.

Hence, all the above-mentioned debt-troubled countries approach the IMF to get out of their debt problems. Argentina and Egypt have already got their loans approved by the IMF Executive Board. Whereas Sri Lanka, Zambia, and Ghana have only managed staff-level approval. Their final approval from the IMF Executives Board is conditional on debt restructuring with the bilateral creditors and additional financing from multilateral partners. On the other hand, Pakistan is struggling to get its ongoing IMF programme resumed.

IMF support would be contingent on reforms that politicians not only in Pakistan but across continents have talked about for decades but failed to implement. They will have to implement policies to reduce fiscal deficits, tackle persistent high inflation through tight monetary policies, improve foreign exchange reserve coverage through market-based exchange rates, and set the basis for sustained and inclusive economic growth by bringing transparency and efficiency in government spending (including subsidies).

The governments of low and low-middle-income countries are in a chicken-egg situation. The bilateral and multilateral creditors will only reschedule their debts once the borrowing country is under IMF discipline (IMF programme). In contrast, the IMF Executive Board will only approve a programme for a country once its other creditors ensure debt restructuring. Despite defaulting, Sri Lanka and Zambia are still waiting for IMF support as they lack assurances from other creditors.

People in debt-affected countries are suffering not only due to the follies of their governments but also due to the lopsided approach of the international financial system. The good news is that a ‘global sovereign roundtable’ of all (multilateral and bilateral) creditors is being planned this month to move away from the case-by-case approach of the G20 framework for debt restructuring toward a more systemic approach. Let us hope this roundtable yields results.

The bad news is that politicians in debt-ridden countries (including Pakistan) don’t seem to learn from their mistakes or from each other. They oppose economic reforms and fiscal discipline in the name of the poor when in opposition and shy away from reforms to lure their voters and shower favours on their cronies when in government.

The writer heads the Sustainable Development Policy Institute.

He tweets @abidsuleri