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What are the economic, political, and technological risks to future global growth and stability? This complex question was the topic of a recent CGD event, which featured a conversation between IMF's managing director Christine Lagarde and CGD’s president Masood Ahmed. This week's podcast is an edited version of their conversation.
The event took place just as the IMF revealed its latest World Economic Outlook. Its forecast for annual global growth in the coming years is relatively unchanged at around 3.5 percent—but what has changed, Lagarde said, is the “source and balancing of growth” around the world, with an upgrading of forecasts for Asia, Continental Europe and Canada, but lower projections for the US and UK. The picture for Sub-Saharan Africa is also cause for concern, as Lagarde and Ahmed discussed during the event.
They also talked about ways to address the concerns of people who have been “left behind” by development progress. For the Lagarde, that means “number one, telling the truth about what the likely consequences are of certain policies. … You have to start with that, and then allocate the resources and decide the policies that will actually help.”
Check out the podcast at the top of this page, and watch the full event on our website.
When the world’s finance ministers and central bank governors assemble in Washington later this month for their semi-annual IMF meeting, they will no doubt set aside time for yet another discussion of the lingering debt problems in the Eurozone or how impaired bank debt could impact financial stability in China. They would do well to also focus on another looming debt crisis that could hit some of the poorest countries in the world, many of whom are also struggling with problems of conflict and fragility and none of which has the institutional capacity to cope with a major debt crisis without lasting damage to their already-challenged development prospects.
Nearly two decades ago, an unprecedented international effort—the Heavily Indebted Poor Countries (HIPC) Debt initiative—resulted in writing off the unsustainable debt of poor countries to levels that they could manage without compromising their economic and social development. The hope was that a combination of responsible borrowing and lending practices and a more productive use of any new liabilities, all under the watchful eyes of the IMF and World Bank, would prevent a recurrence of excessive debt buildup.
Alas, as a just-released IMF paper points out, the situation has turned out to be much less favorable. Since the financial crisis and the more recent collapse in commodity prices, there has been a sharp buildup of debt by low-income countries, to the point that 40 percent of them (24 out of 60) are now either already in a debt crisis or highly vulnerable to one—twice as many as only five years ago. Moreover, the majority, mostly in Sub-Saharan Africa, have fallen into difficulties through relatively recent actions by themselves or their creditors. They include, predictably, commodity exporters like Chad, Congo, and Zambia who have run up debt as they adjusted (or not) to revenue loss from the collapse in oil and metals prices. But they also include a large number of diversified exporters (Ethiopia, Ghana, and the Gambia among others) where the run-up in debt is a reflection of larger-than-planned fiscal deficits, often financing overruns in current spending or, in a few cases, substantial fraud and corruption (the Gambia, Moldova, and Mozambique).
The increased appetite of sovereign borrowers has been facilitated by the willingness of commercial lenders looking for yield in a market awash with liquidity, and by credit from China and other bilateral lenders who are not part of the Paris Club. It is striking that between 2013-16, China’s share of the debt of poor countries increased by more than that held by the Paris Club, the World Bank and all the regional development banks put together.
Nor do traditional donors come out entirely blameless. Concessional funding for low-income countries from the (largely OECD) members of the DAC fell by 20 percent between 2013–16, precisely the period in which their other liabilities increased dramatically. As for the IMF and World Bank, while it may have been wishful thinking to hope they could prevent a recurrence of excessive debt, it was not unreasonable to expect that they would have been more aware as this buildup was taking place and sounded the alarm earlier for the international community. There is also a plausible argument that excessively rigid rules limiting the access of low-income countries to the non-concessional funding windows of the IMF and World Bank left no recourse but to go for more expensive commercial borrowing, with the consequences now visible.
How likely is it that these countries are heading for a debt crisis, and how difficult will it be to resolve one if it happens? The fact that there has been a near doubling in the past five years of the number of countries in debt distress or at high risk is itself not encouraging. And while debt ratios are still below the levels that led to HIPC, the risks are higher because much more of the debt is on commercial terms with higher interest rates, shorter maturities and more unpredictable lender behavior than the traditional multilaterals. More importantly, while the projections for all countries are based on improved policies for the future, the IMF itself acknowledges that this may turn out to be unrealistic. And finally, the debt numbers, worrying as they are, miss out some contingent liabilities that haven’t been recorded or disclosed as transparently as they should have been but which will need to be dealt with in any restructuring or write-off.
The changing composition of creditors also means that we can no longer rely on the traditional arrangements for dealing with low-income country debt problems. The Paris Club is now dwarfed by the six-times-larger holdings of debt by countries outside the Paris Club. Commodity traders have lent money that is collateralized by assets, making the overall resolution process more complicated. And a whole slew of new plurilateral lenders have claims that they believe need to be serviced before others, a position that has yet to be tested.
It is too late to prevent some low-income countries from falling into debt difficulties, but action now can prevent a crisis in many others. The principal responsibility lies with borrowing country governments, but their development partners and donors need to raise the profile of this issue in the conversations they will have in Washington. There is also an urgent need to work with China and other new lenders to create a fit-for-purpose framework for resolving low-income country debt problems when they occur. This is not about persuading these lenders to join the Paris Club but rather about evolution towards a new mechanism that recognizes the much larger role of the new lenders, and demonstrates why it is in their own interest to have such a mechanism for collective action.
Traditional donors also need to look at their allocation of ODA resources, which face the risk of further fragmentation under competing pressures, including for financing the costs in donor countries of hosting refugees. Finally, the assembled policymakers should urge the IMF to prioritize building a complete picture of debt and contingent liabilities as part of its country surveillance and lending programs, and to base its projections for future economic and debt outcomes on more realistic expectations. They should also commission a review to examine the scope for increased access to non-concessional IFI funding for (at least) the more creditworthy low-income borrowers.
It is the poor and vulnerable that pay the heaviest price in a national debt crisis. They have the right to demand action by global financial leaders to make such a crisis less likely.
As my colleague Sarah Rose aptly points out in a recent blog post, USAID is promoting domestic resource mobilization as a central component of USAID’s “journey to self-reliance” framework. But even for countries that are far away from graduating from foreign aid, the importance of domestic resource mobilization for maintaining macroeconomic stability and sustained economic growth is well documented. A look at the experience of countries that have received HIPC debt relief validates this point and underlines the need for attaching a high priority to tax policies and practices in international assistance programs for low income countries.
In 2008, a number of HIPC Initiative beneficiaries had yet to receive full debt relief from the initiative. Almost half were either in debt distress or were at a high risk of debt distress. By 2014, 35 of the 36 countries that have benefited from HIPC debt relief had reached the completion point of the process and had considerable amounts of debt wiped off their books. The impact with respect to reducing debt distress was impressive. However, as can be seen in the chart below, since 2014 there has been a steady increase in the risk of debt distress among HIPC beneficiaries, a rather alarming development given the billions of dollars that have gone into the initiative and the conditions attached to it.
A recently released report by the IMF entitled, “Macroeconomic Developments and Prospects in Low Income Developing Countries (LIDCs)” explains in great detail the reasons for the elevation in the risk of debt distress among low income countries, including the HIPC Initiative beneficiaries. One of the primary reasons was a decline in commodity prices that led to a drop in revenues for many commodity exporters not matched by a reduction in expenditures. But even among diversified exporters there has been a deterioration in fiscal balances leading to rising debt levels, with declining revenues the main factor in roughly one quarter of the cases.
While the IMF report shows that declining revenues are not the only reason countries face an increased risk of debt distress, a look at the record for HIPC Initiative beneficiaries shows there is clearly a strong link. The chart below shows the weighted average change in the domestic revenue to GDP ratio among three groups of HIPC beneficiaries, those currently rated at low risk of debt distress, those rated at moderate risk of debt distress, and those at a high risk of debt distress or in debt distress. The change is recorded as the difference between the revenue to GDP ratio in the year before the country received HIPC debt relief (completion point) and 2016:
Among all 36 HIPC beneficiaries, the weighted average increase in the domestic revenue to GDP ratio has been 9.8 percent, from 16.2 percent to 17.8 percent. For the five countries currently regarded as having a low risk of debt distress, the average ratio increased almost 30 percent, from 15.6 percent to 20.2 percent. For the 18 countries deemed to have a moderate risk of debt distress the average ratio increased a little over 11 percent. For the 13 countries at high risk or in debt distress, the average ratio actually fell a little over one percent (from 17.2 percent to 17.0 percent). It would have been a much greater decline absent Mozambique, which has fallen into debt distress due to malfeasance but has greatly increased its domestic revenue to GDP ratio since reaching HIPC completion point.
While countries in the high risk/in debt distress category have generally seen a decline in government revenues as a share of GDP, there are some notable exceptions. Both Afghanistan and Haiti, ranked as “high risk” due to weak institutional capacity rather than elevated debt levels, have had success in increasing tax revenues. According to the Inter-American Development Bank, tax collection in Haiti reached an average 14 percent of GDP during 2015-2016, up from 11 percent in 2008-2009 despite the devastating effects of the earthquake. In Afghanistan, revenue as a share of GDP rose from a low of 8.7 percent in 2014 to 10.3 percent in 2015 and well over 11 percent in 2016.
Much of the success in Afghanistan and Haiti is due to a concerted effort by government authorities with the support of the international donor community and international financial institutions. The embodiment of this collaborative approach is the little known Addis Tax Initiative (ATI), which was launched at the at the 3rd Financing for Development Conference in Addis Ababa in 2015. ATI is not a new international fund, but rather a pledge among like-minded countries to increase resources and attention on the basic practice of collecting taxes in a fair, efficient, and effective manner in order to fund government programs in a sustainable manner. It deserves the international community’s continued support through prominent references in communiques by the G20 and other groups. At the same time, more donors—including the United States—should fund the Revenue Mobilization Trust Fund at the IMF.
To say that John Bolton, President Trump’s latest pick for National Security advisor is a well-known UN critic would be an understatement. But it’s well worth noting that he has opinions about the IMF and the multilateral development banks too.
In a post-election opinion piece, Bolton affirmatively invoked an earlier call to shut down the IMF, made nearly twenty years ago by former US officials who had in turn been out of office for at least ten years. There’s not much value in debating the merits of the IMF today based on the institution’s performance during the Asian financial crisis circa 1998.
But I do want to focus on Bolton’s ideas about the World Bank and other multilateral development banks. Bolton argues that the development banks should be privatized, except for “the one for Africa.” (For the record, it’s called the African Development Bank). His argument is two-fold: the world is awash in private capital today, rendering the MDBs irrelevant; and, US support for the MDBs is subsidizing lending to “our competitors.”
But the panel’s conclusion was clear. We should not confuse public aims, which require public financing in some form, with the aims of private investment. This confusion also plagues President Trump’s much-touted infrastructure plan, which relies overwhelmingly on tax breaks for private firms, an approach that will likely waste public resources and not achieve its stated aims in key areas of public infrastructure like roads and bridges.
When it comes to the MDBs, the range of endeavors we call global public goods—mitigating the effects of climate change, avoiding fast-moving pandemics that can leap from poor countries to rich ones in a matter of months, working across countries to manage the flow of refugees fleeing violence in their home countries—all of these call for a response at the international level, and none can be adequately addressed by relying exclusively on private capital.
Fortunately, the MDBs have already proven themselves to be effective in these and other parts of the global development agenda. They certainly could be more effective, which is why CGD’s panel has offered a range of recommendations for reform. But removing them from the equation entirely would be devastating.
As for Bolton’s argument that the United States is subsidizing the competition by supporting the MDBs, most of the MDBs’ heavily subsidized lending and grants today go to Sub-Saharan Africa, the region that Bolton seems to be ok with supporting through the development banks.
That’s not to say that US backing, and that of other major shareholders (including China), does not act as a subsidy on the banks’ other activities. Yet, setting aside support for the very poorest countries, direct US capital contributions to the World Bank over the entire 75-year history of the institution have totaled $2.8 billion. That’s less than 10% of what the United States spends annually on foreign assistance.
Is this modest support “subsidizing” our competitors? In part, that depends on whether you see a zero-sum global economy, or one in which growth in poorer countries means new export markets for US goods and services, as well as more stable societies that are less prone to the global public “bads” that afflict the world today.
Bolton would do well to listen more closely to our military leadership, which has gone out of its way to praise the role of the MDBs in supporting the goal of avoiding military conflict. For example, as Commander of US Southern Command, Admiral James Stavridis wrote of the Inter-American Development Bank’s “tremendously positive influence” on Latin America based on what he saw on the ground in his region of operation.
US leadership at the IMF and World Bank has been essential to their strength over many decades, particularly when it comes to ensuring that they have adequate resources to do their jobs. That’s why the timing of Bolton’s pick could be particularly troubling at the World Bank, where negotiations for a capital infusion from the United States and other member countries are coming to a head. The US Treasury has already been taking a hard line with the institution, demonstrating considerable reluctance to put more money in. With Bolton at the White House, Treasury hard-liners now have a powerful ally next door.
Debt relief wiped away much of Africa's sovereign debt, but after a decade of growth, debt stocks are rising again. Here's a look at the numbers, and how we got here again.
Remember debt relief?
Twenty years ago, Bill Clinton was president, Bono was still a rock star, and the jubilee movement to forgive poor countries' debts was perhaps the central preoccupation of development policy debates. The IMF and World Bank's Heavily Indebted Poor Countries initiative (aka HIPC) got the ball rolling in 1996, but it took another two decades of Bob Geldof concerts and negotiations between the Bretton Woods institutions, Paris Club creditors, and the debtors for the process to culminate with (hypothetically) 100 percent debt relief for 36 countries—30 of which were in Africa.
Part of the reason you don't hear so much about debt relief any more is that it worked, at least for a while. Countries like Ghana saw its debt fall from 120 percent of GDP in 2000 to just 12 percent in 2006. Mozambique's fell from over 200 percent down to the mid-20s over a similar time period. While we should be careful about assigning a causal role to debt relief, economic growth rates across Africa were strong over the next decade, and the "Africa Rising" narrative took hold.
This time is different: private creditors, not the Paris Club, hold much of Africa's debt now
Fast forward to 2018, and some of those same countries are gradually accumulating fairly significant sovereign debts again, which have led to talk of a new African debt crisis.
The graphs above are based on the World Bank's International Debt Statistics, where we've pulled out numbers for the eight low- or lower-middle income African countries with the highest debt-to-GDP ratios today (ignoring a couple of small countries with total GDP below 10 billion dollars).
A few simple facts stand out:
Sudden fall: Several countries saw a dramatic decline in debt stocks after they benefited from the Multilateral Debt Relief Initiative in 2005.
Gradual rise: The countries shown were chosen precisely because they have run up debts recently. In raw numbers, the figures look more extreme—Ghana's total sovereign debt is more than double today than it was at its peak before debt relief—but Ghana's economy has grown at a steady clip, so as a proportion of GDP the figure has risen only gradually.
Commercialization: In the 2000s, most of the debt was owed to multilateral institutions like the World Bank and IMF and bilateral creditors who formed the Paris Club. Today, a much larger share of African debt is held by private banks and bondholders, so the dynamics of any hypothetical workout would be considerably different.
Did the "Africa Rising" narrative feed premature enthusiasm for commercial bond offerings?
After stepping down as director of the IMF's Africa Department last year, my colleague Antoinette Sayeh wrote an essay for CGD reflecting on what could have been done differently:
In this my first post-IMF piece, I focus on whether the volume of Fund financing for SSA frontier markets… should have been greater, and whether such financing could have helped contain the indebtedness of those countries, many of which issued sovereign bonds… Has the Fund actually adapted to the need for [non-concessional loans]to these countries as they climb up the income ladder?
Poor countries need development finance. The question is where they're going to get it.
Economic growth converted a number of major African economies from low- into lower-middle income countries, and as Antoinette notes, in the process they seem to have fallen into an awkward middle ground: not facing any imminent crisis, they were too successful for most kinds of concessional finance from the multilateral financial institutions, but still fragile enough that the cost of finance from commercial creditors was high.
One consequence is that the cost of debt service (i.e., repayment flows not debt stocks) have bounced back more quickly than debt stocks
Washington systematically underestimated African economies’ credit demand
Our analysis suggests the IMF has had a perennial bias toward optimism—and hence inaction—in the face of Africa's recent debt accumulation. Swearing "never again" after the last bout of debt relief, the World Bank and IMF agreed to periodically monitor borrowers and issue joint Debt Sustainability Analyses, which are basically forecasts of a country's economic growth, exports, government revenue, and debt levels. We downloaded the archived PDFs of these reports for the two most-heavily indebted African countries, Ghana and Mozambique, and decided to look at how well the forecasts panned out.
On economic growth, the Bank and Fund performed pretty well (though for a slightly earlier period, my former colleague Ben Leo found some evidence of over-optimism in IMF growth projections for Africa as well). Forecasts were rosy, and reality mostly lived up to expectations. Contrast this with recent European crises. There the IMF was faulted for its wildly optimistic forecasts of growth rates in Greece, Spain, Italy, and Portugal (see Figures 2-6). No debt workout was needed, was the implicit message, because Greece could tighten its belt and grow its way out of distress. Each year, Greek GDP declined, and each year the IMF said they were about to turn a corner.
While the Bank-Fund growth forecasts were much better for Ghana and Mozambique, their forecasts of the countries' debt levels have been comically wrong, year after year. As debt levels rose, the official Debt Sustainability Analyses predicted they would flatten out and soon fall. But they didn't. And this was not a one-off mistake. As the saying goes, "fool the IMF once, shame on Ghana; fool the IMF every year while your debt levels soar, maybe shame on the IMF too."
To be fair to the Fund, Ghana and Mozambique are special cases. From 2011 to 2015 the Ghanaian government, feeling flush with potential oil revenues, basically told the IMF to take a hike. And the Mozambican government engaged in secretive borrowing while keeping both its creditors and citizens in the dark.
Nevertheless, reading the Debt Sustainability Analyses and looking at these graphs, the impression is that the World Bank and IMF treated their advice as forecasts. They repeatedly cautioned both countries to restrain their borrowing and spending, and forecast that they would comply. In hindsight, neither country had any intention of doing so.
Are countries borrowing too much, or are multilateral institutions lending too little, forcing poor countries toward more expensive commercial loans? In either case, several African economies appear to be on course for a new period of debt distress and pressure for fiscal austerity. More, not less, multilateral lending in Africa might be a partial solution. Otherwise, it may soon be time for Bono and Bob Geldof to dust off their guitars.
Thanks to numerous colleagues for comments. This post emerged from discussions with Masood Ahmed, Nancy Birdsall, Alan Gelb, John Hurley, Charles Kenny, Todd Moss, Mark Plant, Vij Ramachandran, and others, but the views expressed are ours alone.