The question of debt sustainability has been of relevance for some years, as debt remains a continuing concern for developing countries. Much of the focus in recent discussions has been on the various international initiatives to reduce the debt burden of the Heavily Indebted Poor Countries (HIPC). In implementing the HIPC initiative, the IMF and World Bank have introduced debt sustainability analysis, on the basis of which debt relief is given to selected debtor countries. Some indicators used to determine the sustainable level of debt have aroused much controversy, especially as many HIPCs have not completely overcome their debt problems despite exhausting debt relief, often at great cost. Debt relief alone will not generate sufficient resources in heavily indebted countries to achieve the Millennium Development Goals (MDGs), though it can help. Five years after the Millennium Summit, it is clear that while we may expect progress towards some MDGs at the global level, this may well obscure significant setbacks in many of the poorest countries.
There now seem to be two main approaches to debt sustainability analysis. The first defines sustainable debt indicators in terms of an ostensibly optimal debt level, beyond which debtors will not be able to service their debt. A country is then said to achieve debt sustainability if it can meet its current and future external debt service obligations in full without rescheduling debt or accumulating arrears. Traditional debt sustainability analysis does not pay sufficient attention to the long term development prospects and strategies of debtor countries, but focuses instead on controlling existing levels of debt. A more developmental approach must conceive of a sustainable debt strategy as part and parcel of a broader growth and sustainable development strategy.
Financial flows to developing countries have also changed after the sovereign debt crises of the 1980s. Official flows have become much less important than private flows. Many middle-income developing countries (and transition economies) now have access to private finance and have been dubbed ‘emerging markets’. Such access has given rise to new problems. A major new concern has been how to manage the inflows and outflows of external capital, and how to handle their inevitably destabilizing effects on the national economy. Recurrent financial crises since the 1990s have taught us some major lessons for managing capital flows.
Greater capital flows, due to financial liberalization, have not resulted in sustained net flows of funds from the capital-rich to the capital-poor, or even to the emerging markets, except for brief unsustainable episodes. The converse has, in fact, been the case, with capital actually flowing out over the long term, even from Africa. Also, the cost of capital has not fallen, as was supposed to happen.
Meanwhile, the volatility of the international financial system has grown, due to — rather than despite — financial deepening, while, the frequency and severity of currency and financial crises have increased over the last decade. Although some new financial derivatives have reduced some old sources of volatility (due to exchange or interest rate fluctuations, for example), new sources of volatility have been introduced by greater ‘financialization’.
Financial liberalization has made financial interests much more influential, if not dominant. As a consequence, deflationary pressures have been exerted on macroeconomic policy throughout the world, which has reduced growth in the last quarter century except in parts of Asia that have had greater control of their own growth processes. Perhaps worse, from a development perspective, financial liberalization has undermined earlier financial policies, institutions and instruments to pro-actively promote growth of desired firms and industries, including small and medium enterprises. All this has been confirmed by IMF research in the last couple of years, which also notes that both capital flows and macro-economic policies have generally been pro-cyclical, thus further undermining emerging markets’ ability to avoid as well as manage crises.
Drawing from recent experience, six major issues come to mind in thinking about sovereign debt sustainability to sustain development in emerging markets.
First, existing mechanisms and institutions for financial crisis prevention are grossly inadequate. Recent trends in financial liberalization have increased the likelihood, frequency and severity of currency and financial crises. Too little has been done to discourage short-term capital flows, while there are unrealistic expectations of protection from international adherence to codes and standards. Here, we should not forget then IMF Deputy Managing Director Stanley Fisher’s 1998 support for controls on capital inflows to avert crises.
As noted earlier, financial liberalization has also reduced the macroeconomic instruments available to government for crisis aversion, and instead left governments with little choice but to react pro-cyclically, which tends to exacerbate economic downturns. National macroeconomic policy autonomy needs to be assured to enable governments to be able to intervene counter-cyclically to avoid – and mange — crises, which have generally had much more devastating consequences in developing countries than elsewhere. The exaggerated effects of currency adjustments on emerging markets also require greater coordination among the three major international currency issuers.
Second, existing mechanisms and institutions for financial crisis management are also grossly inadequate. The greater likelihood, frequency and severity of currency and financial crises in middle-income developing countries from the mid-1990s – with devastating consequences for the real economy and also for “innocent bystanders”, as in the East Asian and Latin American crises – makes speedy crisis resolution imperative. There is an urgent need to increase emergency financing during crises and to establish adequate new procedures for timely and orderly debt standstills and workouts. The international financial institutions, including regional institutions, should be able to provide adequate counter-cyclical financing during crises, while the policy and institutional ‘space’ for regional monetary cooperation initiatives should be expanded. In 2003, then IMF Managing Director Helmut Kohler endorsed capital controls on outflows as a sovereign government’s right, especially as an emergency measure in the face of likely distress. Instead of current arrangements which tend to privilege foreign creditors, new procedures and mechanisms are needed to ensure that they too share responsibility for the consequences of their lending practices. Much of the recent sovereign debt accumulated in crisis-affected economies has been taken over from the private sector, under considerable pressure from the IFIs and other stakeholders, and it is telling to note recent efforts to ‘pre-pay’ existing debt obligations by governments with the means to do so.
Third, the availability and provision of development finance has declined drastically. Unfortunately, most multilateral development banks have either abandoned or sharply reduced industrial financing, thus limiting the likelihood of developing countries securing funding to develop new manufacturing capacities and capabilities so necessary for sustainable development.
Fourth, the governance of existing IFIs to ensure greater and more equitable developing country participation and decision-making – and hence, ownership – in operations, research and decision-making deserves urgent consideration. The concentration of power in some peak institutions may also need reform, e.g., by delegating authority to other, even new agencies, as well as by encouraging decentralization, devolution, complementarity and competition (with other IFIs, including regional IFIs). Developing countries and others need to be more seriously and systematically consulted by the G7 and other existing coordination institutions in matters of international economic governance to avoid insensitive and potentially disastrous oversights as well as loss of policy legitimacy.
Fifth, national economic authority and autonomy essential for more effective macroeconomic management and sustainable development need to be restored and ensured. Policy conditionalities accompanying financing must be minimized and necessary to address the problems at hand. It is clear that “one size does not fit all”, and recently imposed policies have not contributed much to either economic recovery or growth, let alone sustained development. Such reforms will ensure greater legitimacy for public policies and should include regulation of the capital account as well as choice of exchange rate regime. Since it is unlikely that reforms in the foreseeable future will adequately provide the “global public goods” and international financial services needed by most developing countries, it is imperative that while reforming the international system to better serve sustainable development, national policy sovereignty is also ensured to better address regulatory and interventionist functions beyond global and regional purview.
Finally, there is growing appreciation of the desirability of regional monetary cooperation in the face of growing capital mobility and the increasing frequency of currency and related financial crises, often with devastating consequences for the real economy. It has been recognized, for instance, that growing European monetary integration in recent decades arose out of governments’ recognition of their declining sovereignty in the face of growing capital mobility, especially as their capital accounts were liberalized. Instead of trying to assert greater national control, with limited efficacy likely, cooperation among governments in a region is more likely to be effective than going it alone in the face of the larger magnitude and velocity of capital flows. The existence of such regional arrangements also offers an intermediate alternative between national and global levels of action and intervention, and reduces the likely monopolistic powers of global authorities. To be successful and effective, such regional arrangements must be flexible, but credible, and capable of effective counter-cyclical initiatives for crisis prevention as well as management. With the growing reluctance to allow the IMF to serve as a “lender of last resort”, there should be growing acceptance of regional cooperative arrangements as alternatives.