Debt relief in developing countries

It is time to give highly indebted countries a fresh start

By Rachid Bouhia, Economist, and Patrick Kacmarczyk, Consultant, UNCTAD[1]

Fast deterioration of financial conditions in the Global South

Sustained investments are a prerequisite for attaining the Sustainable Development Goals (SDGs). Without stable financial conditions, however, these investments are not possible. Roller coaster capital markets prevent investors in the real economy from predicting their rate of return, leaving only financial speculators in the game.   

Regarding capital market stability, analysis of financial conditions in emerging and developing economies provides us with a very grim picture. For instance, new UNCTAD Financial Condition Indicators (FCIs) not only show stable financial market conditions to be largely absent in the Global South, but that they are also continuing to deteriorate. The indicators combine about 25 financial variables referring to both external and domestic factors. The former include net capital flows, foreign exchange rates, and computed spreads between United States 10-year Treasury notes and domestic 10-year government bonds. The latter comprise domestic interest rates (prime rate etc.), returns to government bonds, yield curve indicators, debt service ratios for the private sector, stock exchange indices, financial sector indices, real estate sector indices, residential property prices, and volatility indices (Figure 1).

Figure 1: Financial Conditions in 76 emerging and developing countries (Jan 2005 to Mar 2022)


Against a historic background of large swings in financial conditions over the past 15 years, the last three years were marked by particularly difficult conditions. Coming out of the emerging market jitters in 2018 caused by a strong appreciation of the US dollar and in the context a slowing global economy, the COVID-19 shock in early 2020 had a very significant negative impact on financial conditions. Following the downturn, emerging and developing countries experienced a short period of relief between December 2020 and August 2021, mostly due to the interventions by advanced economies’ central banks, which helped to maintain global liquidity and thus mitigated the fallout of the pandemic.

Since the fall of 2021, however, emerging inflationary pressures, largely driven by energy prices and still broken supply chains, have pushed central banks to revert their monetary policy support. Widespread monetary tightening, most aggressively pursued by the US Federal Reserve, accelerated the downward trend in December 2021. As the Federal Reserve doubled its speed of tapering, financial conditions continued to deteriorate. The situation was exacerbated from February 2022, as the war in Ukraine put pressure on commodity prices, which are another major external driver of financial conditions in the South. The latest data shows that between August 2021 and March 2022, financial conditions dropped by 1.4 points, equal to around one third of the spectacular collapse recorded between May 2008 and April 2009 during the global financial crisis.

Developing countries with protracting debt sustainability issues are more vulnerable

Faced with numerous recurring shocks since the 2008 financial crisis, countries have shown different degrees of resilience, with domestic factors playing an important role. Many middle-income countries (MICs) are among those that have exhibited the most significant deterioration in financial conditions since the first signs of monetary tightening in the North. Many of them have been struggling with debt sustainability issues over the last decade, such as Egypt, Ghana, Pakistan, Sudan, Tunisia, and Zimbabwe. When COVID-19 hit, these countries were still grappling with the fallout from past periods of financial stress. The adverse compounding effects of galloping inflation, shrinking global liquidity, and ballooning commodity prices emerged faster and stronger in this group of developing countries (Figure 2).

Figure 2: Financial Conditions in Egypt, Ghana and Pakistan (Jan 2005 to Mar 2022)

In recent years, these countries have significantly expanded their presence in global financial markets to mobilise new resources and strengthen their financial sustainability. This greatly increased their exposure to the vagaries of private capital flows. However, these economies are often not well shielded to cope with massive capital flows, sudden currency depreciations and intense strain on debt servicing. At the same time, they are ineligible to financial aid from international financial institutions, usually capped by GDP per capita.

Some low-income countries (LICs), which have also been affected by similarly severe sovereign debt issues, such as Chad and Ethiopia, share a common fate. In other LICs, financial conditions proved more resilient as of March 2022, not only due to less exposure to private financial markets but also because rising commodity prices and currency depreciations have improved the terms of trade. However, this does not rule out slower, yet substantial erosion in the longer term.

A fair and feasible fresh start for highly indebted developing countries

In many developing countries, the prolonged debt burden has been the major cause of financial stress and obstacle to further mobilising financial resources for the SDGs. For more than a decade, those economies have been trapped in a spiral of high public indebtedness with disadvantageous economic and social outcomes, hampering structural transformation and Agenda 2030. All these countries have periodically sought assistance from the IMF, with a new unsurprising wave in the summer of 2022, but never managed to get out of the red despite implementing macroeconomic policies and reforms that came with the financial assistance. With little reason to assume that public debt will stabilise soon, especially post-pandemic and with the ongoing war in Ukraine, financial vulnerabilities and hindrance to financing for development are likely to persist.

Under the exceptional global circumstances, these countries would benefit from a significant round of debt cancellation targeting low- and middle-income countries that request it. The last debt cancellation initiative of this kind occurred in the 1990s and was successful in putting highly indebted countries back on the right track.

Such a debt cancellation programme should be coordinated at the international level to curb adverse effects on recipient countries’ ability to access private financial markets. It could be financed by taxes on speculative capital flows, which could also curb the adverse “roller-coaster” nature of financial conditions. Since the 1990s, financial speculation, via carry-trade operations or speculation on commodity prices among other activities, has drained incalculable amounts of resources out of developing countries, which could have instead served development and structural transformation.

In the long run, overcoming these dysfunctional systemic factors through reforms to the global financial and monetary system will be paramount for sustainable development. For the moment, however, the urgency to contain the dangerous social and economic fallout from debt crises and financial instability must be the top priority. This requires providing the Global South with sufficient “breathing space” to clamp down looming sovereign risks and social unrest. A vast debt cancellation campaign for LICs and MICs is therefore not only doable, fair and desirable, but would also give many distressed economies a fresh start, reviving glimmers of hope for Agenda 2030 and the SDGs.  

[1] The views expressed herein are those of the authors and do not necessarily reflect the views of the United Nations.