Will External Debt Uplift or Submerge Emerging Regions?

World Bank data shows an increasing trend of indebtedness in the world’s emerging regions since 2012. Will this debt be a precursor to higher development, or instead to a decline?

The trends of debt owed to foreign lenders by four emerging world regions (Latin America and the Caribbean, South Asia, Sub-Saharan Africa and Middle East and North Africa), show both positive and worrisome signals.

The price of debt incurred by emerging regions of the world has heavily depended on the sources of debt, and the resources the borrower can offer to the lender or its allies. Cost of borrowing can be assessed by yearly payment rates and debt yields.

Long-term interest payments made by Middle Eastern and North African countries have been increasing year-by-year from 2012. Public and publicly guaranteed interest payment decreased in 2015, but saw a sharp increase in 2017.

Latin America and the Caribbean countries (3.8 – 5.8 per cent from multilateral development banks) follow the lead with significantly smaller borrowing costs. For all but two Latin American countries, borrowing from multilateral development banks is a cheaper alternative to the release of sovereign bonds.

The amount of the debt carried by Latin America and the Caribbean, South Asia, Sub-Saharan Africa and MENA has been growing since 2012. A slight ($13B) decrease in 2016 for South Asia, is the only decrease in the amount of debt taken on by these emerging regions since 2008.

The increases in the amount of debt carried by these four regions, along with high borrowing costs, point to the conclusion that external debt stocks should be very well thought out steps. Mostly, because of their large downside.

The amount of debt taken on by these four emerging regions has created an interesting relationship between them and some financial indicators. The relative strength index (RSI) for the Emerging Markets Bonds Index is particularly interesting. By charting the iShares JP Morgan fund for EMBI from 2012 to 2019, it is possible to see that its RSI frequently trends to values close to 70. With the amount of indebtedness growing in the emerging regions, these RSI values can mean that the perception of the debt’s value is decreasing.

Fundamental analysis of the emerging regions taking on debt in the Americas, Africa and Asia, shows a complex picture of debt and its management.

The increasing debt, when not used to re-finance older and unpaid debt (like 73% of new debt in 2018), fundamentally looks to be a precursor to higher development.

By using debt, MENA and Latin America and the Caribbean regions, have built energy infrastructure and invested into industry, trade and services – all necessary for higher development.

Receiving development assistance, and using it successfully, also comes with its costs. Latin America and the Caribbean and MENA, are regions that could eventually see a re-classification of their financial state into a more developed one. And with a re-classification to one of higher development, less developed regions will become competitors for cheaper assistance from multilateral development banks.

The success of debt taken on by emerging regions, can be measured by the growth in GNI, decreases in unemployment, and increases in wealth. Increases in unemployment are a particularly worrying trend for countries in emerging regions – as forecasted by the IMF. It could mean that the rising indebtedness has not translated into spending related to a better life quality.

The most basic indicators of a country’s financial state and their ties to external debt should also not be forgotten. Not improving debt to GDP ratios; and the still present divergence of debt growth in different industries, in contrast to mature markets, are basic factors that have shown mixed performance since 2012. Along with growing debt, this means that the trend of growing indebtedness could turn for the worse.

The effects of increasing debt in Latin America and the Caribbean, South Asia, Sub-Saharan Africa and MENA will be positive for all regions using accountable spending and fiscal responsibility.

The percentage increase of external debt stocks of South Asia (25.3% from 2012-2017) and Latin America and the Caribbean (20.1% during the same period) is the smallest out of all these four emerging regions. Yet, potentially, this increasing debt for the Asian and American regions, carries the most risk.

South Asia’s environmental problems have the power to decrease the development potential of this region. Having both too much, and not enough aquatic resources, remains a problem for some South Asian countries. Moreover, the still unpredictable impacts from recycling operations in South Asian countries like Sri Lanka, will very likely increase healthcare costs and spending in a country with an already high debt to GDP ratio.

Growing debt should not present a problem if the debt to GDP ratio remains stable. That is, if the economy will follow the same growth trend. In Latin America and the Caribbean, the effect of growing debt could turn negative, if the negative and uncertain growth prognoses will come true.

A growing external loan portfolio along with the underdeveloped finances sector could start to become a political issue in countries of MENA. Simon Neaime of American University of Beirut argues that “[…] MENA policy-makers will need to introduce macroeconomic policy measures […]” and “[…] financial policies aimed at increasing MENA countries’ savings […]”. All that to decrease the impact of the growing debt and its negative effects.

Increasing external debt can also affect the debt released by the borrowing government. Sub-Saharan Africa is the emerging region which saw the highest percentage increase in external debt stocks from 2012 to 2017. This increase has been recorded at 34%. The increase by over a third, if higher debt to GDP will continue to be a positive influence on debt yields, could lead to even higher indebtedness or difficulties in repaying debt.

Countries in different continents of emerging regions have used external debt for vastly different projects.

In emerging regions of Asia and Africa (MENA, South Asia, Sub-Saharan Africa), debt is mostly used to finance energy and extraction and public administration (World Bank 2019 Annual Report) projects.

In MENA and Sub-Saharan Africa, borrowing from external borrowers is done mostly for the financing of the energy and extraction sectors.

South Asian countries, in a similar manner, have received over a tenth of development loans for their energy sector in 2019.

Contrarily, in an emerging region of Americas (Latin America and the Caribbean), external debt is a more complex tool. In contrast to spending on energy and extraction, development loans are used to finance social protection and industry, trade and services (World Bank 2019 Annual Report).

The country which has taken on the highest proportional share of external debt to GDP in this region is Jamaica. Jamaica has used the debt to combat the negative effects of a financial crisis. Although non-infrastructure spending is harder to assess, but the second-highest interest payment to GDP figure in the region (6.9% of GDP), looks to have been a necessary step to take.

The lowest share of external debt taken on by a country in Latin America and the Caribbean belongs to Paraguay. Most recently, Paraguay’s 15% debt to GDP ratio has been taken on to finance its budget.

Without any financing, even in the form of external debt stocks, world’s emerging regions would have had a much harder and longer path to development. Loans for development or financing of necessary operations, can uplift emerging regions if used properly and with accountability. Latin American countries are the best examples of debt used for development without going into too much indebtedness. However, in regions where corruption perception is higher, and governmental accountability may be lower, the once good solution to both financial and developmental problems can easily submerge the already struggling countries.