The looming public debt crisis

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Already strained due to the COVID pandemic, public finances in many countries of the Global South might not be able to cope with the consequences of the war in Ukraine, leading to the possibility of sovereign defaults.

On Tuesday (12 April), Sri Lanka announced that it would not service its debts anymore.

“We need to focus on essential imports and not have to worry about servicing external debt,” the Governor of the Central Bank of Sri Lanka, P. Nandalal Weerasinghe.

The pandemic still raging in many countries has led to supply chain disruptions, shortages, and rising prices. Many governments also took on new debts to shield companies and households from the consequences of the pandemic.

This was not much of a problem for developed countries when interest rates were low. But economically weak countries that are deemed riskier to lend to have to pay higher interest rates and take on debt in a currency other than their own. Doing so exposes them to higher risks if economic circumstances change for the worse.

And changed for the worse they have.

“Now the war in Ukraine is adding risks to unprecedented levels of public borrowing while the pandemic is still straining many government budgets,” the International Monetary Fund (IMF) wrote in a blog post on Monday (11 April).

Higher debt, higher prices, higher interest rates

The war further increases food and energy prices, which increases the burden for poor households, and governments that want to shield their populations from these prices. For example, many Middle Eastern and African countries are highly dependent on grain imports from Russia and Ukraine.

According to the campaigning group ONE, 20 million additional people are at risk of falling into extreme poverty if Africa’s 16 riskiest countries fall into debt distress. The group also warned that a debt default could “wipe out a decade of economic and social progress.”

A list compiled by the IMF shows that more than 30 countries are at a high risk of debt distress.

As central banks grapple with rising inflation, they consider raising interest rates earlier and faster. This raises the cost of borrowing for all countries. Still, countries of the Global South are likely to feel the pinch earlier than others, as their public debt usually has shorter maturities and thus needs to be rolled over faster.

According to David McNair of the ONE campaigning group, indebted countries and their creditors will have to agree so that not all of the borrowed money will have to be repaid.

What about the Russian default?

Not only Sri Lanka but also Russia missed payments on its foreign debts in the past days. Moscow failed to pay several hundred million dollars that were due in early April, according to the credit rating agency S&P.

However, the reasons for this default are different from the ones looming in the Global South.

“Unlike most defaults, this is not a default linked to the fact that the country doesn’t have the resources to pay,” Ugo Panizza, professor of economics at the Graduate Institute in Geneva, told EURACTIV, pointing to the large amount of foreign currency inflows the Russian energy exports generate.

According to Panizza, it would be easy for Russia to divert some of this income toward servicing the public debt. “It’s mostly politics in the end,” he said.

Commodities might also be one of the ways by which highly indebted countries try to lower their burden. The ONE campaign group writes: “Countries are resorting to increasing natural resource extraction to finance their recovery from the pandemic.”

For example, Sri Lanka is considering tapping new oil and gas fields to get out of its debt. Therefore, the debt crisis might also be bad news for the environment.


Chart of the Week

Amidst geopolitical tensions and the crisis of multilateral trade, there is a lot of talk of the “decoupling” of world markets into more regional markets dominated by regional hegemons.

While this trend might influence trade in the medium and long term, it is not yet visible in much of the data.

The chart below shows how trade between the EU and China has expanded over the past years.

Politically, 2021 was arguably the worst year for EU-China relations due to China’s sanctions against EU lawmakers and academics, who criticised the persecution of Uighur people in China’s east and the ensuing blockade of the EU-China investment agreement.

But even in this politically difficult year, EU imports from China increased strongly.

Chart by Esther Snippe

EU imports from China also increased markedly compared to EU imports from other countries, as the second chart below shows. While imports of goods from other Non-EU countries increased by roughly 20% from January 2020 to December 2021, imports from China increased by more than half in the same period.

For now, the political tensions between the EU and China have not yet translated into economic facts on the ground. However, China’s seeming support for Russia in the Russian war against Ukraine and a renewed awareness of how trade relations can make the EU dependent on a potentially hostile power might change this pattern.

Moreover, China is battling its own economic challenges at home with a large but inefficient real estate market. Furthermore, its iron-fisted clampdown on the COVID pandemic might lead to more supply chain disruptions. Let’s look at these figures again next year to see whether all the talk of “decoupling” also shows up in the statistics or whether it remains just a phrase.

Chart by Esther Snippe


Literature Corner

Are Managers Paid for Market Power? This paper argues that a large part of the pay managers receive is for increasing the market power of a firm and that this part has increased over the past three decades.

Employment and Social developments in Europe Quarterly Review: This publication by the Directorate-General for Employment, Social Affairs, and Inclusion of the EU Commission is packed with statistics and interesting graphs on the economic developments in the EU, especially regarding employment issues.

China’s overseas lending and the war in Ukraine: This blogpost argues that the war in Ukraine might make Chinese state-owned banks more cautious in lending money to other countries. In times of distress for public finances in many countries, this might come as quite a shock.

A blueprint for the reconstruction of Ukraine: Many talk of the need for a “Marshall Plan” to rebuild Ukraine after the war. But what would such a plan look like? Well, this blog post presents a first draft.

[Edited by Alice Taylor]

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