LECTURE SEVEN

Developing countries do not only borrow from donor countries and multilateral agencies but also commercially from the international banking system. All borrowing, whether official or private involves repayment obligations, unless the loans are gifts or written off. The loan has to be repaid over a certain number of years (amortization repayments) Interest payments will be charged on the loan.

Amortization and interest payments constitute debt-service payment. All loans that have to be repaid with interest are debt-creating flows. Debt burden are measured by various indicators: Debt to export ratio Debt to national income ratio Debt-service ratio (the ratio of debt service payments to export earnings

The accumulation of external debt is a common phenomenon of developing countries at the early stage of economic development where: -The supply of domestic savings is low -Current account payments deficits are high -Imports of capital are needed to augment domestic resources. Prior to the early 1970s, the external debt of developing countries was relatively low and small.

Foreign borrowing can be highly beneficial providing the resources necessary to promote economic growth and development, when poorly managed, it can be very costly. In recent years, these costs have greatly outweighed the benefits for many developing countries. The main cost associated with the accumulation of a large external debt is debt service. Debt service is the payment of amortization and accumulated interest; it is a contractually fixed charged on domestic real income and savings.

As the size of the debt grows or as interest rises, debt service charges increase. Debt service charge must be made with foreign exchange. Therefore debt service obligations can be met only through export earnings, curtailed imports or further external borrowing. In most LDCs, debt service obligations are met by export earnings.

The basic transfer of a country is defined as the net foreign-exchange inflow or outflow related to its international borrowing. It is measured as the difference b/n the net capital inflows and interest payments on the existing accumulated debt. The net capital inflow is the difference b/n the gross inflow and the amortization on past debt. The basic transfer is important because it represents the amount of foreign exchange that a particular LDC is gaining or losing each year from international capital flows.

Let the net capital inflow, Fn be expressed as the rate of increase of total debt. D is the total accumulated foreign debt and d is the % rate increase in the total debt. then Fn = dD Because interest must be paid each year on the accumulated debt, let r =the average rate of interest so that rD measures total annual interest payments. BT is simply the net capital inflows minus interest payments BT = dD rD = (d-r)D

BT will be positive if d>r and the country will be gaining more foreign exchange. If r>d the basic transfer turns negative and the country losses foreign exchange. Any prospects and challenges for LDC debt crisis requires an examination of the various factors that cause d and r to rise and fall. In the early stage of debt accumulation, when LDC has a relatively small total debt, D, the rate of increase in d is likely to be high.

Because most first stage debt accumulation comes from official sources in the form of bilateral foreign aid and WB lending, most of the debt is incurred on concessional terms. r is therefore quite low and in any event less than

d.

As long as this accumulating debt is being used for productive development projects with rates of return in excess of r, the additional foreign exchange and rising foreign debts represented by the positive basic transfers pose no problem for recipient countries.

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When the accumulated debt becomes very large so that its rate of increase, d naturally begins to decline as amortization rises relative to rates of new gross inflows The sources of foreign capital switch from long-term official flows on fixed concessional terms to short-term, variable-rate private bank loans at market rates that cause r to rise. The country begins to experience severe BOPs problems as commodity prices suddenly fall and the TOT rapidly deteriorate.

4. A global recession or some external shock, such as a jump in oil prices, sudden change in the value of the dollar in which must debts are denominated, a steep rise in U.S. interest rates on which loans are based. 5. A loss in confidence in an LDCs ability to repay resulting of the preceding factors. 6. A substantial flight of capital is precipitated by local residents who for political or economic reasons.

All these six factors can combine to lower d and raise r in the basic-transfer equation, with the net result that the overall basic transfer becomes highly negative and the capital flows from the underdeveloped to the developed world. The debt crisis then becomes a self-reinforcing phenomenon and heavily indebted developing countries are forced into a downward spiral of negative basic transfer dwindling foreign reserves and stalled development prospects.

Any solution to the debt problem must resolve around concerted efforts by: The debtor countries International organisations Official creditors The commercial banks, To help restore economic growth in the debtor countries.

Policy changes have been introduced to improve public sector performance, reorganise or close loss-making SOEs through privatisation and commercialization exercises, provide adequate incentives for productive sectors and encourage small and medium-scale enterprises with the view to increasing the role of the private sector in economic development. Efforts have also been geared towards the promotion of exports while liberalization of imports and price system now operates in many African countries.

UNCTAD as far back as 1978 proposed the cancellation or conversion into grants of loans to LDCs. G8 also agreed on measures to reduce the bilateral debt-service obligations of LDCs and also convert their ODA loans to grant Also actions by the DCN of the UK comprising more than 40 churches, charities, campaign groups has declared war against international financial institutions to force them to cancel Africa's debt and offer the continent a fresh start.

The various initiatives taken by the international community should be made applicable to all African debtor countries. A debt-ridden country is a debtor country, therefore classification of African debtor countries into middle-and lowincome countries seems unnecessary and should be discontinued. Disbursement of funds under SAF should be accelerated. Establishment of large-scale debt-forgiveness programmes among bilateral donors

HIPC initiative is the first international response to provide comprehensive debt relief to the worlds poorest, heavily indebted countries. It was launched by the WB and IMF in 1996. It aims at: 1. Removing the debt overhang for countries that pursue economic and social reform targeted at measurable poverty reduction 2. Reducing multilateral debt 3. Helping countries exit from endless debt restructuring to lasting debt relief.

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Deeper and broader debt relief under which external debt servicing will be out by about 50b dollars more than twice the initial framework Fast debt relief where most participating creditors including IMF,WB provide debt relief beginning immediately or soon after the decision point Strange link b/n debt relief and poverty reduction-freed-up resources will be used to support poverty reduction strategies developed with civil society participation