Developing market economies face a financing dilemma; COVID-19 has placed a grave strain on countries’ health care and economic systems, increasing the need for additional public sector spending to reduce the negative economic effects of the virus. To lessen the COVID-induced economic shock, government-imposed lockdowns increased health care spending and expanded social safety nets to support households and businesses. As the COVID-19 pandemic begins to abate across these economies, additional spending must place their economies on a more sustainable trajectory. COVID-19 is predicted to plunge 420 million people into extreme poverty and risk reversing three decades worth of improving living standards under the sustainable development goals. Such an outcome can be averted if governments targeted spending towards upskilling their citizens for a more digitized world, improving physical and digital infrastructure while using targeted incentives to boost productivity across priority sectors such as information communication technology, manufacturing, healthcare, and agriculture.
Developing Markets Economies are Caught in a Debt Dilemma
It is generally expected that developing market economies that face funding constraints will use external debt in other to supplement inadequate domestic savings. The rates at which these countries borrow from abroad are determined by the link between foreign debt and domestic savings, the levels of investment in the economy, and economic growth. The most important lesson from the standard “growth with debt” literature is that countries should borrow if this debt produces a higher growth rate than the interest paid. In this case, the debtor country is increasing capacity and expanding its economy with the help of foreign savings. In the context of a post-COVID world, this means investing in smart infrastructure, upskilling the workforce, and providing incentives for high-growth sectors that will create jobs, increase the quality of exports and raise the government’s tax revenues.
In theory, one can calculate the sustainable level of borrowing based on loans, maturity, and the availability of foreign capital. In practice, such an exercise proves futile as the terms of loan agreements are usually opaque and not available to civil society. This is the case for both multilateral and well as bilateral debt. To better gauge the financial salience of foreign debt, it is imperative that such information be made available to the general public.
If additional external borrowing increases a country’s debt-service burden more than it increases the growth rate, the situation must be reversed by expanding exports. If this does not occur and conditions remain the same, more borrowing will be required in the future to meet external debt burdens, while the economy will grow at a slower pace. The negative feedback loop will result in a country that cannot service its debt.
Most countries in sub-Saharan Africa have adopted development and growth strategies heavily reliant on foreign lending from private and multilateral sources. Unfortunately, this means that the stock of external debt is rising faster even as countries contend with the same challenges. The built-up of external debt is widely viewed as unsustainable as commodity-exporting countries are beholden to changes in the global demand for commodities, while the avenues for external financing are either drying up or becoming more expensive.
According to the IMF, the external debt of sub-Saharan Africa in 1975 is estimated at $18 billion. By 1995, the stock of external debt rose to $220 billion. All standard rations of debt have exhibited this increase even as the development situation remains dire and COVID-19 threatens to reverse some of these gains. This huge build-up in debt has seen the region’s debt-to-exports ratio balloon from 51% in 1975 to about 270% in 1995. This excludes South Africa’s debt which is estimated above 300% of exports.
However, the country is taking steps to curb the accumulation of debt even as the construction of coal mines is not likely to boost long-term productivity nor ensure electricity supply. This is an example of how Africa’s natural resources are little exploited. At the same time, the rest of the world transitions away from fossil fuels at a break-neck pace. African countries continue to invest in low productivity sectors that do not create long-term jobs or boost the potential growth rate sustainably. It is imperative that additional lending prioritizes comprehensive digitization of the education system, adult reskilling programs, and subsidies/incentives for renewable energy, manufacturing, and ICT-related sectors.
It is important to note that the debt to GDP ratio was less than 150% for all developing market economies. In the same vein, the debt to Gross National Product for Africa was estimated at 14% in 1975. But by 1995, it rose to more than 74%. While debt-service ratios and interest payments have remained relatively low due to the highly concessional nature of loans provided to African countries, many countries have been unable to service their debt during the pandemic. This enabled the emergence of a debt suspension initiative to reduce the fiscal constraints imposed on domestic economies.
The Special Drawing Rights: Why They are Important
There is new evidence that the increase in Africa’s debt was accompanied by capital flight, which means that additional borrowing caused a scare for investors coming into the continent. The Special Drawing Rights are a special mechanism that could be useful as African countries attempt to navigate the post-COVID economic upheaval and place their countries on a more sustainable footing. The SDR is an international reserve asset, created in 1969 to support the Bretton Woods fixed exchange rate system. It is based on currencies, namely the Euro, British Pound, U.S. dollar, Japanese Yen, and Chinese Renminbi. The United States has 17.1% of the vote, which explains the reluctance of the IMF to issue more SDRs. However, the Biden administration judged this as an utmost necessity, designed to reduce global imbalances and ensure that developing market economies can emerge from the crisis faster.
As discussed at great length in this paper, new SDRs are necessary because developing market economies are nearing debt overhang due to higher interest rates charged on their foreign debt, poor investment choices, and a mix of domestic and governance challenges that impeded economic development. In a February letter to her colleagues in the Group of 20 blocs of nations, Janet Yellen, the head of the U.S. Treasury, said, “An allocation of new Special Drawing Rights at the IMF could enhance liquidity for low-income countries to facilitate their much-needed health and economic recovery efforts.”
Developing market economies should prioritize investment in their digital and physical infrastructure, while subsidies to manufacturing, advanced materials, and research companies should be used to support innovation and skilled employment. This will boost economic growth and the competitiveness of firms while increasing the value of exports. Commodity-exporting countries such as Cameroon, Nigeria, and Egypt should invest in refinery capacity and create a supportive environment for businesses to thrive. Lower tax revenues in the medium term and lower capital gains and dividends tax will boost investment, create employment, and enable countries to repay their debt. The Special Drawing Rights are necessary to advance SSA’s economic development in a post-COVID world, but policymakers should ensure that additional debt is used productively.