The Debt Crisis

Justin Frewen

Between 1970 and 2002, the Continent of Africa received some US$540 billion in loans.
Despite repaying some US$550 billion in principal and interest over the same period,
there was still some US$295 billion outstanding. In 2005, as a result of its outstanding
debt, Kenya was obliged to spend as much on the servicing of its debt as it allocated to
health, water, roads, agriculture, transport and finance combined. Indonesia, whose debt
was largely run up by previous dictators, used up almost 25% of its budget on debt
service, some four times its combined spending on health and education.

So, how did this debt crisis arise and what if anything can be done to tackle it?

The origins of the current debt crisis can be traced back to the 1970s. In 1973, the
Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of oil in
response to the North’s (Northern Hemisphere) backing for Israel. Given the relatively
inelastic demand for oil, particularly in the North, OPEC accumulated vast profits,
generally stored in US dollars, commonly known as petro-dollars. Large banks in the
North were inundated with these petro-dollars and were faced with the dilemma of
where and how to invest them at a profit. Given the slackening growth in the North,
states in the South were actively encouraged by these banks to take out loans.

The effects of this policy can be seen in the massive rise in borrowing by states in the
South that led to a twelve-fold rise in their debt burden between 1968 and 1980.
However, as long as the interest rates on the loans contracted remained low and the
debtor countries earned sufficient export-based revenues to cover their repayments, the
debt incurred remained sustainable.

Initially, the interest rates were relatively low in the region of 4-5% but at the turn of
the 1980s this all changed as the interest rates began to soar upwards. Within a
relatively short period, they went as high as 16-18% and debtor states found themselves
having to allocate three times as much to cover their debt. Most importantly, this
imposition of higher rates was completely one-sided. It was imposed by the North on the
loans the South had taken out. The South had no input or chance to challenge this
massive increase in their debt burden.

This situation was aggravated by the fact that the loans were denominated in ‘hard’
currencies, such as the US dollar, Japanese yen and Swiss franc. These currencies tend
to remain relatively stable over time. On the other hand, the borrower countries had
‘soft’ currencies, which frequently depreciate in value. As a result, they had to devote
ever increasing quantities of their currency to purchase the hard currency necessary to
repay the same amount of debt.

The difficulty in meeting debt repayment obligations, provoked by these interest

increases, was compounded by the decline in the value of the South’s raw materials and
agricultural exports. Debtor countries now had to radically increase their exports of
primary produce and raw materials. However, as demand in the North remained
relatively stable, this led to a flooding of the international market in a range of
commodities. The resulting glut and over-supply led to a severe fall in their prices. To
take just a few examples, between 1980 and 2001 the price of coffee fell from 411.7
cents/kg to 63.3 cents/kg, sugar from 80.17cents/kg to 19.9 cents/kg, lead from 115
cents/kg to 49.6 cents/kg, and palm oil from 740.9 cents/kg to 297.8 cents/kg. As a
result, the South was left unable to access sufficient foreign currency to repay their
loans.
Unable to cover their debt repayments, states in the South frequently found themselves
obliged to resort to the tender mercies of the International Financial Institutions (IFI).
The best known and most powerful of these IFI are the International Monetary Fund
(IMF) and the World Bank (WB).

However, in order to access IMF and WB funds, borrowing states had to introduce and
adhere to a range of neo-liberal economic measures, commonly known as the
Washington Consensus. These conditions included limiting state involvement in the
economy, removing protection from local industries and companies, opening their
domestic market to foreign competition and facilitating the free movement of goods and
investment.

With the removal of state protection, local industries and companies found themselves
faced with competition from large-scale transnational corporations with which they were
unable to compete. This frequently led to foreign companies owning and controlling
crucial industries in ‘developing’ economies, effectively preventing the creation of a
sustainable, indigenous commercial sector. In addition, public sector expenditure
cutbacks were demanded. These cuts usually targeted areas such as education and
health and therefore had the greatest negative impact on the more vulnerable members
of the population.

Such policies led to the South accusing the IFI as being primarily concerned with
protecting the interests of the lenders to the detriment of the debtor countries’ citizens.

Given the growing international criticism of their operations, the IFI reacted by
introducing a number of initiatives aimed at relieving the debt burdens of heavily
indebted poorer countries. The latest of these programmes is the Multilateral Debt Relief
Initiative (MDRI), launched at the G8 meeting in July 2005. Unlike preceding schemes,
MDRI provided relief to multilateral debt – debt to multi-state membership institutions
such as the WB and IMF – in addition to bilateral debt – debt owing to individual states.
Specifically, the MDRI would cancel all debts owed to the WB, the IMF and the African
Development Bank (AfDB) to states that satisfied certain conditions.

While this deal was obviously an extremely positive development for many countries, it
fails to prove a solution to the overall problem. Although, participating states will benefit
to the tune of billions of dollars, many other heavily indebted countries have been
excluded.

The MDRI’s limitations become clear when one compares its estimated US$50 billion
debt relief with the total estimated low-income country debt of some US$500 billion.
Furthermore, debt owing to multilateral institutions apart from the IMF, WB and AfDB
was not cancelled. This is a particularly critical issue for Latin American countries who
have significant debts outstanding to banks such as the Inter-American Development
Bank (IADB).

Moreover, the MDRI imposes a range of conditions on the debtor countries to be

approved for debt relief. In the case of the IMF, eligibility to the MDRI initiative requires
debtor countries to be ‘up to date’ on their IMF obligations. Furthermore, they are
required to implement ‘satisfactory’ macroeconomic policies, a poverty reduction
strategy and public expenditure management.

Similar to previous initiatives, the MDRI does not take illegitimate debts, otherwise
known as odious debts, into consideration. Odious debts refer to debts, which should be
regarded as illegitimate given they were lent to oppressive regimes and corrupt
administrations who were well known to be misappropriating the funds borrowed.
Creditors are refusing to assume responsibility for their lending practices while still
expecting repayment from the poor. In the case of South Africa, the citizens were
expected to repay debts incurred by the previous apartheid government that had
oppressed them.

Of course, there are many who would argue that debt cancelation would only result in
corrupt regimes having more money to pilfer and squander. While corruption is
undoubtedly a problem in many countries, not just in the South, this should not obscure
the fact that much of the debt contracted was odious debt or that punitive debt
repayments are preventing the successful tackling of poverty.

Furthermore, research has shown that debt relief has led to a significant rise in
allocations for health and education.

Prior to its debt cancellation, Zambia was obliged to spend twice as much on repaying
debt as on health care in 2003. Following its debt relief, user fees were abolished at rural
clinics to that all citizens could access free basic medical services. The government also
committed to providing anti-retroviral drugs for 100,000 citizens. The removal of
primary school fees in Uganda, following debt relief, saw enrolments double over the
next four years, with a further 50% increase in the subsequent four-year period.

In addition, there is a danger that the debt crisis could re-emerge in the near future,
even amongst those states that have already received debt relief. Countries more open
to financial investment, often as a result of IFI persuasion, now find themselves
extremely vulnerable to capital flight, as institutions in the North withdraw funds as a
result of the current recession. Furthermore, the continued slide in commodity prices has
meant that countries such as Zambia, which did receive debt relief, are now in danger of
seeing their debt appreciate to twice the level deemed sustainable by the IMF and WB.

It is clear, therefore, that if we are to be serious about changing the debt crisis cycle,
cancelling international debt, although essential, will not be sufficient on its own. There
is an urgent need to change the whole structure of our current financial framework if a
sustainable solution is ever to be realised. We need to move away from a monetary
system based on debt and interest payments that enables control to be kept in the
hands of a small and prosperous elite.

Above all, if there is to be any real hope for global development and an end to poverty, it
is imperative that developing countries regain their sovereignty and dignity, free from
the crippling dependency the burden of debt has placed on them.