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At a glance
- Developing countries in Asia have accumulated record borrowings since the pandemic.
- Both Sri Lanka and Pakistan are now in the middle of a debt crisis, and other countries in Southeast Asia are in the red as well.
- The unequal recovery from the pandemic and a fast rise in inflation are pushing Asian countries toward greater debt distress.
S
ince mid-June, unprecedented flooding from monsoon rains has left more than 1,500 people dead and millions homeless in Pakistan. The country already reeling from severe economic difficulties has taken a catastrophic turn for the worse.
Battered by runaway inflation and a dwindling currency, the predominantly Muslim country in South Asia is struggling to import food and fuel as it is. Pakistan’s import bill for necessities alone increased by 64% to US$32.32 billion this year from US$19.69 billion in 2021.
With little to no policy space to finance recovery efforts, Pakistan has been looking to its neighbors and international cooperation for monetary respite. What’s holding it back, however, is its enormous debt — a pile so huge and calling for urgent action that Pakistan is being called the next Sri Lanka if left unchecked. But it is not alone in this regard, unfortunately.
Since 2020, developing countries have accumulated huge piles of debt in a spree of record borrowings on top of their existing obligations. The International Monetary Fund (IMF) issued a warning earlier this year about the serious threat of debt defaults in Asia due to the region’s slowing economies and the worsening of global financial circumstances.
With some observers describing the region’s current predicament redolent of the 1997 Asian Financial Crisis, it’s critical to investigate the roiling debt crisis from the perspective of those who will ultimately pay for it: the people.
Debt woes
In 2020, the world’s total debt increased by 30 percentage points of GDP, reaching 263% of GDP. This was the highest annual growth in debt since at least 1970.
As the global growth rate plummeted at a rate not seen since World War II, governments had turned to debt to face the pandemic and, later, to stimulate growth. This has led to economies that are unsustainable and overleveraged, with governments increasingly turning to even more debt to get by.
Debt-to-GDP ratio (2020 and 2022)
Graph 1. As growth rates declined from the start of the pandemic, many countries increasingly relied on debt to stimulate growth, or even to just get by.
(Source: IMF Global Debt Database, various national central banks)
Debt-to-GDP ratio, one key measure of economic leverage, has soared by at least 43% on average in East, South, and Southeast Asia. Countries like Sri Lanka, Mongolia, and Laos have accumulated debt that has surpassed their respective national outputs in 2022. A huge leap in relative indebtedness can also be seen in Vietnam, Nepal, Myanmar, and the Philippines.
Indeed, the IMF warns that over half of low-income countries — 38 of 69 — are either at high risk of defaulting or have defaulted already. This list includes Sri Lanka, Pakistan, Mongolia, and Laos.
According to the World Bank, debt for low- and middle-income countries rose to US$9.1 trillion in 2021, the highest in 30 years.
The economic collapse in Sri Lanka this year also confirmed that such loans are increasingly volatile. While government mishandling of fiscal policy is generally blamed, the South Asian country’s debt-induced restructuring played a huge role in its economy’s steep decline.
The country has been running on budget deficits since 1965, buoyed mostly by loans from the IMF and elsewhere. In exchange, it has privatized and dismantled its industries and social services, increasingly relying on tourism and remittances for revenue. When these dried up as COVID-19 hit the globe, it defaulted fast and hard — subjecting its people to one of the worst crises the world has seen since World War II.
The great finance divide
Not all debts are the same, however.
Overleveraged economies aren’t exactly new. Japan and Singapore have debt-to-GDP ratios much higher than the rest of the countries in Asia, but both are still considered sustainable debtors. That’s because rich countries have access to much lower interest rates and more accommodating terms than poor nations.
In one estimate, Least Developed Countries pay an average of five percent in interest, with some paying over eight percent. Rich countries can access the same financing at one percent.
According to the United Nations, wealthier countries spend 3.5% of GDP on debt service, while less developed countries pay up to 14%. These days, the richest nations are able to support their pandemic recovery by borrowing record amounts at extremely low interest rates, while the poorest nations are spending billions of their now dwindling reserves servicing debt, preventing them from investing in sustainable development investments.
This will likely go on as economies continue to slow down and debts grow. According to the United Nations study “Financing for Sustainable Development Report: Bridging the Finance Divide,” the GDP per capita of one out of every five developing nations would not recover to 2019 levels by the end of 2023. That prediction was drawn up before the war in Ukraine broke out.
Debt distress map
Graph 2. With their reserves already running low, the world’s poorest nations continue to spend billions just for servicing their debts, making them unable to invest in sustainable development endeavors.
(Source: United Nations, Debt Justice, IMF)
The high debt servicing also means that poor countries have less to spend on social services like education, healthcare, transportation, and infrastructure. In fact, two in three countries have already cut their education spending since 2020, according to UNESCO’s Education Finance Watch.
That’s not all. Increasing interest rates in the United States to battle domestic inflation are sending shockwaves through Asia’s finance and markets. Already, major currencies in Asia are seeing high rates of depreciation, with Sri Lanka, Pakistan, Thailand, and the Philippines being hit the hardest. Depreciating currencies not only increase the price of debt servicing but also inflate the prices of imported goods and services.
Currency depreciation vs. USD in 12 months 2021-2022
Graph 3. Asia’s financial sectors are already taking a beating from the increasing interest rates in the United States. Sri Lanka, Pakistan, Thailand, and the Philippines are among the hardest hit.
(Source: Wall Street Journal Markets Database)
To stave off its depreciating rupee, Pakistan has already depleted its foreign-exchange reserves in defending the currency. Pakistan’s foreign exchange reserves dropped to less than US$9 billion in the second quarter of this year, according to a report by the country’s central bank.
This is only enough to cover imports for around six weeks. Sovereign debt levels that have risen to above US$250 billion are cause for concern for the country’s future. With annual inflation now sitting at over 38%, the nation cannot afford the next wave of looming interest rate hikes.
Selling off the future
The World Bank-International Monetary Fund established the Debt Service Suspension Initiative (DSSI) to suspend debt in the first years of the pandemic. According to World Bank data, the G20’s DSSI has already assisted nations in postponing payments totaling about US$5.7 billion till the end of 2020. Additional payments totaling US$7.3 billion are anticipated to be delayed until June this year.
But this is hardly enough, according to experts. If anything, it just kicks the can further down the road, a road that’s increasingly leading to uncertainty.
The DSSI has barely scratched the surface of the debt distress problem, however. With the end of the Initiative last December 2021, middle- and low-income countries are now required to restart payments on their debt commitments.
The DSSI has also drawn criticism for not requiring that all creditors, especially private companies, participate. Only 45 of the 73 beneficiary low-income countries have asked to suspend debt payments to official bilateral creditors. Since just a small portion of the debt service is covered, that means only US$4.6 billion in deferred debt service since July 2021.
Pre-existing debt
Yet, much like anything related to the pandemic, many of the problems relating to debt today have been looming even before 2020.
The majority of the least developed countries in Asia went into the pandemic already on the brink of a debt crisis. Not surprisingly, the situation of debt-stricken emerging markets and developing economies in Asia has already gotten worse.
In terms of interest rates, Sri Lanka had the biggest burden with 5.2% between 2009 and 2019. This was followed by India with 4.5%, and Pakistan with 4.4%, both of which had another increase by 2020. Budget vulnerabilities are highlighted by the continually significant and worsening fiscal deficits of Pakistan, the Maldives, Sri Lanka, and India.
Even in the first few months of 2020, economists of the World Bank’s Prospects Group had predicted that the debt would rise as these economies adapt to the pandemic.
External debt in millions
Graph 4. Many countries’ debt issues were already in place even before 2020. In fact, many of the least developed Asian countries were already nearing a debt crisis by the time the pandemic rolled in. (Source: International Monetary Fund, World Bank)
Sovereign bonds at an all-time high
One key characteristic of these COVID-related debts is the record number of sovereign bonds issued by governments in Asia. A debt instrument that guarantees interest, the majority of these bonds have been snapped up by large private corporations and hedge funds. Compared to bank loans, however, commercial borrowing tends to have a higher degree of exposure to financial shocks and volatility.
Many large banks and speculators — including BlackRock, JP Morgan, Hong Kong and Shanghai Bank, and UBS Group AG — now hold billions of sovereign bonds, promising up to 250% profit if paid back in full.
Indonesia, one of the most debt-distressed countries in Asia, issued over US$70 billion in sovereign bonds in 2021 alone. The top 10 bondholders, including Vanguard, BlackRock, and PIMCO, all come from the United States and collectively own 369 Indonesian bonds worth US$4.3 billion.
Home country of private firms holding Indonesian sovereign bond
Graph 5. Private firms from the United States comprise the top ten sovereign bondholders in Indonesia, one of the most debt-distressed countries in Asia.
(Source: Eurodad)
While many of these have fixed coupon rates, selling off a country’s future revenue to a private entity gives that entity unprecedented control over the bond-issuing nation’s policy space. Plus, most commercial borrowings have shorter maturity dates, meaning they need to be repaid relatively faster than institutional lenders like the IMF.
Already, some countries in Asia like Sri Lanka, Vietnam, and Mongolia have been seeing lower-than-average maturity rates among their loans in the past decade. The average maturity of Mongolia’s debts has tanked from 4.5 years in 2012 to 3.3 years by 2020. By comparison, the average maturity of Indonesia and the Philippines’ debts hovers around 12 to 14 years.
As countries bite the bullet to force a swift recovery, the mounting unsustainable debts they are incurring pose a huge threat to their people’s futures. With much uncertainty in the upcoming years, it’s a vulnerability they’re passing on to the next generation.◉