The threat of a lost decade in development

The shocks of the past three years have hit all countries, but they have particularly affected emerging and developing countries. As a result, according to the “Global Economic Prospects 2023” just released by the World Bank, the convergence of average incomes between poor and rich countries has stalled. Even worse, it may not return soon, given the damage already done and likely to continue in years to come.

By the end of 2024, GDP levels in emerging and developing economies are expected to be 6 percent lower than levels projected before the pandemic. The cumulative loss in GDP for these countries between 2020 and 2024 is projected to be 30 percent of the 2019 GDP. In fragile and conflict-affected areas, real per capita income is expected to decline directly by 2024. If it slows The global economy is more than expected now, as a result of tight monetary policy and possibly other shocks, these outcomes could easily be worse.

These losses, with all their meaning for the plight of the world’s most vulnerable people, show the impact of the pandemic, the war in Ukraine, soaring energy and food prices, skyrocketing inflation, and sharp tightening of monetary policy on the rise. Income countries, especially the United States, and the consequent rise in the value of the dollar. The obvious danger now is waves of defaults in heavily indebted developing countries. Combined, these shocks will have long-lasting effects, possibly lost decades, in many of the vulnerable places.

It has happened before. Indeed, this is what happened in Latin America after the debt crisis of 1982. It should be noted that this crisis also came on the heels of a boom in private lending to developing countries, later called “recycling” of the surpluses of oil-exporting countries. Unfortunately, this surge in debt was followed by Iraq’s invasion of Iran, a second “oil shock” (the first was in 1973), a rise in inflation, a sharp tightening of US monetary policy and a stronger dollar. Disaster followed – a decade-long debt crisis.

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Worryingly, the recent tightening of monetary policy by central banks in the seven leading economies has been more similar to that of the 1970s and early 1980s than to any tightening since then, both in speed and scale. On current market implied interest expectations, the cumulative rise will be close to 400 basis points over a 17-month period. The rise from May 1979 was ultimately bigger, but it also took longer. It is true that prices start from a much lower level this time around. But this may not make much difference if people are counting on such low rates. Moreover, the appreciation of the US dollar has been particularly strong. For countries with large external debt denominated in the US currency, this will also sharply increase debt servicing costs.

Bar chart of price appreciation and dollar appreciation during periods of monetary tightening showing the latest hike in US interest rates and the dollar was large by previous standards

It helps that this time the borrowing was not so much from banks at variable rates, but in bonds, which have longer maturities and fixed rates. However, the sudden interruption in the flow of credit will create ruthless pressure. The World Bank showed a 17-percentage-point rise in foreign-currency sovereign borrowing margins for commodity-importing countries with weak credit ratings in 2022. In effect, these countries are locked out of markets. Moreover, sub-Saharan Africa’s external debt is also high, exceeding 40 percent of GDP. Not surprisingly, there has been a significant decline in public and private bond issuances in emerging and developing countries since February 2022 compared to the previous year.

Bar chart of changes in sovereign spreads in emerging market and developing economies in 2022, by credit rating and energy source status (% points) showing how the cost of credit for vulnerable borrowers has exploded

Inevitably, heavily indebted countries that have already experienced the Covid shock and a sharp deterioration in terms of trade, with food and energy prices soaring, will now face more serious and enduring problems. This will also include a large number of low-income countries, many of which are already on the margins of survival. According to the Bank, the number of people “food insecure” (that is, on the verge of starvation) in low-income countries jumped from 56 million in 2019 to 105 million in 2022. When might this reverse?

The bar graph of external debt of emerging and developing economies as a percentage of GDP shows that the external debt of developing countries has reached high levels

We know, in addition, that many children lost their parents during the pandemic and that their education was seriously disrupted. Moreover, material investment has fallen sharply. Thus, for emerging and developing countries as a whole, the Bank projects that total investment in 2024 will be 8 percent lower than expected in 2020. If one adds the possibility of long-term debt problems and consequently the cessation of capital outflows, then the possibility of losing a decade of Convergence is definitely becoming very possible for many countries. Needless to say, this also isn’t going to be an environment in which a lot of progress will be made with energy going in many places.

Covid was not the fault of these countries. The lack of global cooperation in addressing it was not their fault. The lack of external official funding was not their fault. Global inflation was not their fault. The war is not their fault. But if high-income countries don’t provide the help they clearly need now, it will be unequivocally their fault.

Bar chart of change in bond issuance in emerging market and developing economies* ($ billion) showing that 2022 saw a significant decline in bond issuance in emerging and developing countries

High-income democracies want to wage a war of values ​​with China. Well, that’s one fight. A way must be found to effectively solve the debt problems that are emerging now and not, as happened in the case of Latin America, after nearly a decade of pretending. A way must be found to escape the vicious circle in which lower creditworthiness leads to unsustainable spreads, which generate debt crises and then lower creditworthiness.

This is not only in the interest of poor countries. It is also in the interest of the rich. The problems of fragile and poor countries will also become their problems. It’s time to do things differently. Next week, I plan to think about how to do that.

martin.wolf@ft.com

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