In What Ways And in What Circumstances is Debt a Problem for Developing Countries - Research Paper Example

In what ways and in what circumstances is debt a problem for developing countries? Introduction: Over the years, plans of economic expansion and economic liberalization , extreme rises in the availability of loans combined with other factors have lead to the current state of financial crisis that the world is going through. Even though the current onslaught of the crisis was brought on by the impact of the bursting of the US housing Bubble (Rapp, 2009), but this financial crisis has been an event whose imminent arrival could be seen from far off. However what is of relevance here is the fact that these debt crises, even though it had their roots in the ‘mis conceived aid policies’ of the so called world leaders (Emery, 2000) ; it is in fact the poor countries who bear the worst brunt of the ordeal. According to Erikson & de Soysa (2009), although the World Bank, IMF and other such agencies provides loans to the poorest countries on concessionary terms, they bulk of the loans provided by such agencies are non-concessional. These loans which have been provided on concessionary terms come with conditions which hurt the public in these poor and/or developing countries (Oatley, 2004), but being in a crisis these countries have no choice but to accept the loans on these harsh conditions. According to Abouharb & Cingranelli, (2007) the conditions which are tied to these loans hurt the poor and lead to severe debt crises and repression in these developing countries. This paper aims to provide an in-depth analysis of the circumstances and conditions due to which debt can become a severe problem for the developing countries of the world and the reason that this problem can cripple the economic and political stability of these countries. When Debt Becomes a Problem : The Circumstances 1. The sensitivity of Developing Economies to the Global Financial situations: The lesser economies of the world, those that are till going through the process of learning to stand up on their own two feet without the guidance of the world economic leaders are generally more sensitive to all sorts of credit shocks and boom. Eichengreen & Lindert (1989) have observed that every time there is a great lending boom, each past lending wave combined with some political-economic shock create a debt crisis. This statement gives proof to the fact that debt crises are indeed one of the major perpetrators of global instability and when that happens, the poor and the developing countries are the first ones to get hit. These episodes may occur due to a number of reasons among which the major could be political disruption, or any calamity but Reuveny & Thomson (2004), believe that although these random ‘shocks’ do play a large role in the destabilizing of an economy and a country, it is still much better to view these crises as periods during which the world economy goes from a phase of expansion to a phase of contraction. This serves one to analyze the implication of the situation much better in the context of a developing country, because although this period of contraction will effect the more advanced countries as well, it would still have a far worse impact on the economies of the less developed countries of the world. Dornbusch & Fischer (1986) point out that due to any such situation of global or local financial crisis, when a developing country is brought to the point that it accrues a current account deficit, the interest which is to be paid on the debt taken from foreign sources starts to accumulate, hence feeding off itself and creating a situation where the debtor country cannot meet its debt liabilities because it does not have the required money which is to be given in the form of interest on the loan. Unstable financial conditions, are therefore among many others, the major reason due to which the debt starts accruing and starts to become an issue for developing countries. According to Hajivassilio (1994), inability to repay the debt is the biggest problem that could arise for a borrowing country, and which in turn can result in extreme financial difficulties for the country in question, and as the preceding discussion has implied before, the biggest reason for this inability to pay principle interest rates is the fluctuation of the international financial markets and economies. 2. Debt Crises & Macro Economic abilities of Debtor Countries: As the previous analysis has pointed out before, debt becomes a major problem when the debtor country faces difficulties in trying to return it. However, global financial booms and shocks are of course not the only things that can go wrong with the economy of a state, there always being the possibility of an unwise or corrupt government that might use the money obtained through loans for its own end. However, whatever the case may be, it was pointed out by Dornbusch & Fischer (1986), that when the governments of developing states reach the conclusion that they have begun to accrue debts, they start planning and devising strategies through which they could save up enough money next year to pay off the accrued interest. This is done by cutting spending and trying to free the resources which can be traded in turn of for money that can be given off to the creditors in lieu of the interest on the loan. These savings are accumulated through a number of way and activities such as the import of goods from abroad is reduced as a means to save foreign exchange (Dornbusch & Fischer, 1986). However the authors also note that just by cutting expenditure governments are not able to improve their trade balances and they have to adjust their entire economy to accommodate this saving mission. Prices of goods have to be increased so that a trade surplus can be achieved and at the same time, the wages of the public have to be handled in a way that they remain stagnant at the place where they were. Due to this, the buying power of the general public of the debtor country falls down and the general conditions of any such country deteriorates. Melbourne (1995) notes about the indebted developing countries who try to accumulate funds for debt service deficits that “in most of these countries, investment and the domestic capital stock also fell dramatically“. Even though saving plans like these have been successful, there are a lot of hazards associated with it, because it mainly involves policies that harm the common man in general. Bradshaw & Huang (1991) note that plans to get out of indebtedness by the developing countries “leads to inflation and reduced individual purchasing power, thereby harming economic development and quality of life“. Among the biggest consequence is the lack of economic activity in the country and the fact that the living standards of the general public decline to the point that most countries are never able to get out of the situation that they have created with their own hands. An example of the following scenario is the country Mexico, as pointed out by Dornbusch & Fischer (1986), when the government of the country implemented this form of savings plan so that they could create funds for the debt services deficit that they had accrued when the prices of oil fell in the 70’s. The Country’s government raised taxes and cut their expenditure so that funds could be saved. There was a drastic decrease in the per capita income and the real wage level dropped by 40 %. In short, the common man in Mexico was the one who was effected in the extreme sense. 3. Debt Management with Fluctuating Exchange Rates: Laurent et al (2003) have provided a detailed analysis of the volatility associated with the exchange rates and how this effects the developing countries who have taken foreign debts. The authors point out that developing countries are constantly going through periods where they have to finance their savings deficit by borrowing money from abroad. The authors point out that taking a hard-currency debt is extremely beneficial for the developing countries because of it, they can attract foreign investors. This debt in foreign currency also carries less interest rate and is ‘more plentifull’ (Laurent et al, 2003). Having said all that, it is also crucial to remember that hard-currency loans carry the risks associated with fluctuating exchange rates. According to Artus (2000), the volatility in the exchange rates of the foreign currencies has mostly been aggravated by the establishment of the Euro currency market, which has overtaken the USD and is now the safest hard currency to borrow. Although the prices of the Euro are relatively stable and even USD are though to have more stability than the currencies of a developing economy, there are still considerable risks associated with borrowing hard-money. Hajivassiliou (1989), studied the implication that varying levels of exchange rates had on the general indebtedness of a developing economy. His study has concluded that in the coming times turbulent political and economical conditions will make debt repayments a difficult task for countries who have borrowed in the currency of an economic leader. Yilmaz (2008) also noticed that a volatile exchange rate effects the economies of developing countries to a great extent and that fluctuations in exchange rates stagnate the economic expansion of developing countries to a very great extent. Although it may be argued that the depreciation of an emerging economy’s own currency is far worse a problem for a country which has borrowed in its own currency. This increased risk is due to the fact that although the situation will remain the same i.e. the country will have to pay back a larger sum of money if either the Foreign currency in which money has been borrowed appreciated remarkably or the countries own currency depreciated , there is still a lesser chance of the former happening. Having said this, the point that has to be reinstated again is that fluctuating exchange rates provide a challenge to developing countries, for which a debt can become a nuisance if the hard currency that they have borrowed in appreciates startlingly because then the country will face difficulties in saving up enough money to pay off the loan. 4. Concessional Debt and Lending Agency terms: According to Griffith-Jones & Ocampo (2009), the fact that the debt crises have occurred so repeatedly over the course of the last century, show the incompetence of the International Financial Architecture. The fact that so many of the loans that are given to developing countries over the years have shown a tendency to go into default has lead to many researchers claiming that the international lending agencies such as the IMF and the world bank should devise proper strategies that reduce the scenarios where the debtor countries are rendered unable to pay back their loans due to the impact that the global financial conditions have had on their economies. (Rogoff, 1999). Instead of trying to help the debtor countries fend for themselves and try to strengthen their economies in a true sense, what the international lending agencies such as the IMF do is that they attach conditions to the loans that they give out to developing countries of the world. These conditions are negotiated with the borrower country by the IMF’s professional economists who prepare the loan proposal before it reaches the Executive Board for the final decision. Martin (2006), points out that it is principally these agents who negotiate the term of the loans and who are essentially the power players doing the bidding of the bosses above them, who very rarely reject a staff proposal. The terms which are negotiated with the borrower countries usually include a huge level of discretion given to the ‘Big People’ at the lending agency, through which they can exercise a lot of control over the economical and social decision making of the country. The reason that I believe that this is a major problem associated with debt is that it takes away a lot of authority from the governments of these developing countries. Though Skolnikoff (2003) argues that the ultimate priority of a national government is the maximization of the national welfare, the same is not the case for any lending agency. Hence it can easily be understood that although the major lending agencies in the world try to pretend that they are ‘helping’ out the borrowing country by trying to inject some sort of ‘semblance of normality’ into the way that their governments run the country, what they are actually doing is controlling aspects of the governments activities which they believe might endanger their chances of getting the loan repaid. The control that these lending agencies exercise over the decisions made by these debtor countries effects the performance of these nations on the whole. The loss of complete control over the proceeding effects the decision making abilities of the governments as they have to put the interest of their people at par with the interests of the bosses at the lending agency. This is a fact that in my opinion is one of the biggest problems associated with foreign debts and loans which can cause serious problems for a developing economy. 5. Debt Accrual & Human Rights Issues: According to Poe & Tate (1994), when the integrity rights of the people are violated at the most basic level, it can be rightly be considered ‘a crime against humanity’. The accrual of debt and the inability to pay back loans. According to Erikson & de Soysa (2009) is one of the biggest issues that give rise to abuse of the human rights of the people of these borrower countries. This ‘crime again humanity’ has been carried out over and over again over the last centuries. Reinhart et al (2003) have pointed out that the emerging market economies with external debt to GNP ratios above 150 percent run a huge chance on loan defaults. When lending agencies -unable to get their interest rates due on time have been forced to discontinue the allocation of any further loans to the defaulting country, there has been seen an unusual fall in the living conditions of the general public of such countries. Most of the countries who are going through a current account deficit, take up more loans so that they can keep their economies running, a process through which they manage to pile up huge loans that even the coming generation will not be able to totally pay back (Emery, 2000). The reason that debt accrual effects the human rights conditions of the general public in all such developing countries is because being unable to pay back interests on a loan will mean that the lending agency will give them nothing more in the name of aid again. As pointed out before, the only alternative is borrowing even more on top of the one which is currently not paid; something which is mostly avoided by national policy makers and is an option used when the worst comes to worse. Therefore, to avoid what Reuveny & Thompson call the ‘Debt Inertia’, most countries employ extreme versions of saving plans which leave the middle and lower income group to suffer the consequences. Due to this there arises a social and economical development crisis of an extreme level in these countries, because as I have elaborated before, the governments of these countries try to save money by cutting down on expenses, by cutting down investments in the development of the country, by increasing taxes and by decreasing the wages of the people. This leads to extreme violations of the rights of the general public (Neumayer, 2005) who are brought to the point where there are no new jobs on the market due to the cut back on investments which effect trade, no resources and almost no purchasing power. This is the reason which in my opinion makes debt a really big issue for developing countries because instead of helping, this debt becomes a necklace of stones for these countries who slowly go down under water dragged by their weight. Conclusion: This report tries to trace some of the root causes behind the statement that ‘there is no fate worse than debt’ (Erikson & de Soysa, 2009). For developing countries who have labor rich but capital poor economies, debt seems to be the only option when faced with fiscal & budgetary deficits. But taking foreign help comes with added strings. The borrowers are buried under conditions which are implied upon them from the side of the lenders whose major interest is in making sure that they get back the money that they lent. Not only this, still in the process of development, these countries are extremely vulnerable to global financial and economic conditions and shocks which may have little impact in the countries were they originated may have huge financial implications for these countries. Due to this vulnerability these developing countries are also effected the worst when any such condition arises and have to battle internal economic crises. Due to this they face deficits and are unable to pay interests on the loans that they have taken over time. From there, as my essay has pointed out there is a trail of mishaps that effect these countries and their economies to the point that some are eventually brought to insolvency. Hence, it would be safe to conclude that debt can cause a lot of problems for developing economies , and is a big factor contributing to the current global financial crisis which is being felt at its worst in the less developed regions of the world. References Abouharb, Rodwan M. and David L. Cingranelli,2006. The Human Rights Effects of WorldBank Structural Adjustment, 1981–2000, International Studies Quarterly 50(2): 233–262 Artus, P. (2000), Leurose condem onnaied e rdservein ternationaleet le dollar,s eule monnaie de transaction, Document de travail (Working Paper) no. 2000-39, CDC, May. Dornbusch, Rudiger and Stanley Fischer. 1986. Third World Debt . Science, New Series, Vol. 234, No. 4778 (Nov. 14, 1986), pp. 836-841. Eichengreen, Barry and Peter H. Lindert, 1989. 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