MIT - Massachusetts Institute of Technology

Debt Crisis In Developing Countries

Debt crisis in developing countries:

INTRODUCTION:

In the 1980’s the debt problem emerged whereby Argentina defaulted to pay for its international debt, this led to the emergence of a debt facilitating plan introduced by the World Bank and the international monetary fund (IMF). The paper focuses on the problem faced by these countries, the causes of high debt levels and the solutions to the debt problem in developing countries.

Developing countries are faced with low standards of living, underdevelopment, and high poverty levels, weak and unstable currencies, low capital levels and low GDP. All the above problems faced by developing countries are caused by debts which affect not only those who acquire loans but also generations that follow.

However despite the many problems associated with developing countries it is still possible to solve the debt problem and to attain high levels of development, this can be done through well laid strategies that involves all the sectors in an economy and this will be analyzed in this paper.

Debt problem in developing countries:

Debts in developing countries have increased over the years, many factors have caused this increase in debts including unfavorable terms of trade, rising international interest rates, increasing protectionism in the international market, irresponsible lending by international finance organizations and the rescheduling of punitive terms where countries delay payment.

The above mentioned factors are external factors and that there exist internal factors that have led to the increased problem of debts include economic mismanagement, unsustainable government deficits and the maintenance of unrealistic exchange rates. All the above factors have led to the increased debt problem in developed countries.

Factors that have led to the debt problem:

Terms of trade:

As a result of unfavorable terms of trade countries are faced with the problem of balance of payment, developing countries mainly export agricultural goods and in turn import machinery and electric goods, the value of imports in most cases exceeds the value of exports and as a result the increasing debt problem, countries are faced with an increasing balance of payment which lead to rising debts.

Rising international interest rates:

Most international finance institutions will raise their interest rates which in most cases affect developing countries, for example a country may obtain funds from a financial institution but the country may face increasing interest rates on the loan which will increase the pay back value where in most cases the country may end up paying more than double it acquired from the institution, therefore this has added to the problem of debts in developing countries.

Increased protectionism in the international market:

Increasing protectionism in the international markets has led to an increase in the debt problem in the developing countries, most of the products produced in developing countries are exported to developed countries, when the products are faced with high levels of protectionism in the developed countries the developing countries will experience a reduction in exports leading to unfavorable balance of payment, this means that the country will experience debt problems.

Irresponsible lending by finance institutions:

Financial institutions will lend money to countries without taking into consideration the current state of an economy, a country may receive a lot of funds which will end up not being used for their intended purpose, finance institutions will lend the developed countries large sums of money and also they lend money even before previous payments are not yet complete leading to the increased debt problem in the developing countries.

Rescheduling of payment terms:

Financial institutions will change payment terms over time and this may end up increasing the debt problem in developing countries, such terms include the increase in interest rates, the delay of payments has also led to the increasing debt problem in developing countries where countries will not pay up debts on time and therefore increasing the debt problem to other generations who may have not been present when the funds were given.

Unstable government deficit:

Most developing countries will at many times have deficit budgets, this is caused by budgets that have high planed government spending which is higher than government revenue, this deficit in most cases is funded through international funds which are in terms of loans, this countries failure to balance spending and revenue lead to the increasing debt levels which in turn increases the debt problem in developing countries. The increased deficits over the years have led to accumulation of debts which are unsustainable.

Maintenance of unrealistic exchange rates:

Developing countries will in most cases maintain unrealistic exchange which in turn affects their trade balances, when a country is offered funds there are usually some conditions that are set, such conditions include devaluing of the currency before the funds are given, this heavily affects the developed countries in that after devaluing their currency the country receives the funds but the value of the funds in most cases is not equal to the expected value, when a country is asked to devalue its currency this means that the value of the currency will be lower than normal and it will be very weak to the hard currency, the country ends up receiving lower value of the funds given resulting to more and more debt problem.

Oil hike

The rise in oil prices over the decades has resulted to the rise in the debt problem in developing countries, developing countries are importers of crude oil and oil products and a rise in the price of oil will lender them to have unfavorable balance of trade and this results to the rise in the debt problem due to increased balance of trade.

US monetary Policy and rise of neo-liberal policies

US is one of the major importers of goods from developing countries, the monetary policies and the rise of the neo-liberal policies have greatly contributed to the rise in debt problem in developing countries, the introduction of free market has led to countries to import more and export les resulting to an increase in balance of trade and this has led to an increase in debts.

Embezzlement and capital flight

The rising debt problem in the developing countries may also be as a result of the rise in embezzlement of funds, the loans offered to these countries are not used for their intended purposes and as result the funds end up in the wrong hands through increased corruption, due to embezzlement of funds there is an increase in capital freight.

OECD protectionism

The OECD was formed to monitor trade activities among member countries, as a result it has caused a reduction in the imports from developing countries who are not members of the union, its objectives are to reduce inflationary pressure, reduce unemployment and monitor trade activities among member countries, as a result of protectionism the imports from developing countries have drastically reduced resulting to the increasing debt problem in developing countries.

Impacts of debts in developing countries:

Underdevelopment:

The reason why the developing countries are underdeveloped is because they have to repay debts, the debt problem has forced countries to channel a high percentage of their GDP to paying debts and as a result the country cannot develop due to high debt levels. High interest rates on debt have also led to the high amounts of debts which are a negative force to development due to high spending on servicing debts.

Poor living standards and increased poverty:

Developing countries are faced with poor living standards that are caused by very low government spending on social amenities, governments have very little to spend after servicing debts and this has led to the poor living standards of its citizens. The developing countries will also experience high poverty levels due to the debt burdens, this burden is shifted to generations to come and this means that they will also be poor because they will also be forced to pay debts, this causes what is known as the poverty vicious cycle which is diagrammatically demonstrated below:

Low capital stock:

Due to high payment levels of the debts developing countries have experienced a reduction in capital stock; a large proportion of a country’s GDP is spent on debt repayment, low capital stock in a country means that the level of investment is low leading to underdevelopment in these countries. High levels of capital stock promotes investment and development, therefore if a country has low capital stock it will experience low investment levels and also underdevelopment and high unemployment levels because the higher the levels of investment the higher is the level of employment.

Weak currencies:

As the developing countries repay their debts they experience a devaluation of their currency against the other hard currencies, this will result to an increase in the cost of imports which may lead to an unfavorable balance of payment and contribute to the increase in debts, therefore weak currencies will lead to an increase in the value of the debts the developing countries and therefore contribute to the debt problem.

Credit worthiness:

A country will be faced with the problem of creditworthiness whereby it may be denied funds by international finance organizations because of its solvency level, the solvency level is a measure of whether a country has the capacity to repay debts, therefore according to the solvency index a country may be denied funds which may have helped the country to develop and this is caused by high debt levels.

Inflation:

Developing countries are faced with high inflation levels which are caused by the high liquidity levels caused by the funds, the amount of money that is in supply in the economy is usually very high when the country receives the funds and this triggers inflation for a long period in the developing country.

Solutions to the debt problem:

Budget deficit:

Developing countries will reduce debt problems through maintenance of a balanced budget, in this case governments should always make sure that taxation which the source of revenue for government spending does not exceed the planned government spending, therefore governments should stop including international funding in their budgets and stop over relying on loans to finance their activity.

Maintaining realistic exchange rates:

Overvaluing of a currency will tend to reduce the price of imports but at the same time because the exports tend to more expensive then the less a country will export. Overvalued currency will also raise expectations for devaluation and this will lead to capital freight, on the other hand if currency depreciates it raises the value of external debts, increases the level of exports and at the same time reduces imports because imports become more expensive, therefore a country should at all times maintain proper and realistic exchange rates in order to solve the problem of debts.

Better terms of trade:

Countries should join regional integrations that offer favorable terms of trade, this will lead to increased export value and quantity leading to sustainable development which will enable them to pay up their debt, and favorable terms of trade will offer favorable balance of payment which will lead to reduced debts. Countries should also aim at reducing balance of payment through import substitution strategies and also export producing strategies, the import substitution strategies will involve the initiation of industries that produce goods that were previously imported while the export producing strategy will involve the production of goods for exports.

Through research and discovery:

Many developing countries have not involved themselves in research and discovery, these countries have not tapped all the resources in their countries and bearing in mind that resources are not they become then the countries should explore and discover new resources which will help them to come out of their miserable state, many developing countries are importers of crude oil but they have done very little to discovering crude oil deposits in their countries due to lack of research and discovery. Research will also help them to discover better crops and ways of farming because these countries mostly depend on agriculture for sustainability.

The Paris Club

The Paris club was formed by 19 member countries and its objectives is to provide financial support to indebted countries, their activities include such efforts as restructuring of debts, debt relief and debt cancellation, this efforts are aimed at reducing the debt problem and can act as a resolution to the debt problems.

The Baker plan

This was a plan by the treasury secretary of the United States in 1985, this plan by James baker was known as the bakers plan and was aimed at resolving the issue of international debts, this plan was inspired by Japan when it used its trade surpluses to help indebted countries, therefore the bakers plan can be termed as a solution to the debt problem in developing countries.

Conclusion:

Developing countries are faced with the debt problem, however these problem can be solved through international trade, high levels of export will lead to reduced reliance on international aid and loans, the high levels of exports can be achieved through the import substitution strategy and the export production strategy, this two strategies will improve the balance of payment leading to a reduction of debt burden and also the country will use the gains from trade to service the debts.

Governments should also avoid deficit budgets and the reliance on foreign aid, governments should therefore collect enough revenue through taxation that will finance its spending and that the spending side should always be equal or less than the revenue side of the budget.

Countries should also look forward in engaging themselves in research and discovery which will help them discover new resources that will help them to develop and discover better crop breeds that yield more, also new ways of farming that will help them yield more, most developed countries are well known for their research and discovery of new resources and that is why they developed, because they are highly mechanized and have the resources to finance research and discovery.

The international finance institutions could also aid the developing countries through debt relief, this would involve the writing off all debt owed to by the developing countries, this will assist the countries in terms of development bearing in mind that most countries will spend a high percentage level of GDP to service debts.

However despite the assistance through debt relief developing countries should formulate good and sound governance whereby policy makers and top government officials make good decisions that aid them to develop and solve the debt problem.

References:

Willem H. and Richard M. (1985) International Economic Policy Coordination, Cambridge University press, UK

Matthew B. and D. Henderson (1991) Monetary Policy in Interdependent Economy, MIT press, UK

Brian Snow (1997) Macroeconomics: introduction to macroeconomics, Rout ledge publishers, UK

Stratton (1999) Economics: A New Introduction, McGraw Hill Publishers, US

Wikipedia the free encyclopedia (2007) developing countries, retrieved on 21st May, available at www.en.wikipedia.org

Todaro M.P (2004) Economics for a Developing World, McGraw Hill Publishers, US

Todaro M. P (2002) Economics for Development, McGraw Hill Publishers, US

Philip Hardwick Et Al (2004) Introduction to Modern Economics, Pearson Education Press, UK

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