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Public finance

Increasing debt problems

by Hans Dembowski

In brief

Poster criticising US court’s ruling on Argentinian debt in Buenos Aires.

Poster criticising US court’s ruling on Argentinian debt in Buenos Aires.

The international community needs a fair and transparent legal mechanism to solve sovereign debt crises. This is a core message of the Schuldenreport 2015 (Debt report 2015), which was recently published by erlassjahr.de and Kindernothilfe, two faith-based German civil-society organisations.

As the authors argue, debt crises cause massive harm and tend to drag on for very long. In his preface, Joseph Stiglitz, the economist and Nobel laureate, summarises the disappointing results of crisis management in Greece for example: “Today, the debt/GDP ratio is 50 % higher than it was at the onset of the crisis in 2010. Greece has paid a high price – 25 % unemployment, and an almost 25 % fall in GDP. Youth unemployment has been over 60 %, jeopardising the future of the country.”

Argentina is given as another example of an endless debt drama. The reason is that, while most creditors eventually accepted debt restructuring, a small minority did not. US courts have decided that Argentina must pay the hold outs in full even though many of them only bought bonds at discount rates. As a result, Argentina cannot escape its debt problems. Moreover, as Stiglitz argues, the prospect that hold outs and vulture funds will bypass any similar agreements in future crises makes debt restructuring unviable.

According to the Schuldenreport, future debt crises are becoming more likely however. The document considers several indicators, including the ratios of

  • public-sector debt to gross domestic income,
  • public-sector debt to government revenues,
  • total foreign debt to annual export revenues and
  • debt servicing to export revenues.

According to such data, only 45 of 102 countries assessed have no debt problems. At the same time, 83 have serious difficulties at least in regard to one of the indicators, and 16 have difficulties in regard to all four. Three are said to be insolvent: Zimbabwe, Sudan and Grenada.

Overall, the situation has deteriorated in 2014, with the number of troubled countries rising from 62 to 83. Particularly at risk, according to Schuldenreport, are small island states, eastern and central European countries and countries that benefitted from multilateral debt relief in the context of the G8’s Highly-Indebted Poor Countries initiative in the past one and a half decades.

Most of the report authors belong to erlassjahr.de, a German church-based network that made strong contributions to the global campaign for debt relief in the late 1990s. They discuss several reasons why debt problems are growing. One is the policy of cheap money pursued by the central banks of rich nations since the start of the global financial crisis of 2008. The idea is to reflate advanced economies, but a side effect is that some private investors are opting for high risk investments abroad in search of higher returns.

As the erlassjahr.de experts point out, governments and private-sector companies in developing countries can currently borrow money easily, even though they would not qualify for credit in normal times. The report points out that creditors are once again lending money with little concern for debtors’ long-term capacity to repay. According to the report, moreover, both public-sector debt and private-sector debt can put sovereign solvency at risk. The recent crises in Spain and Ireland proved that governments often have to bail out private-sector institutions.

Things will turn sour, the report warns, once global commodity prices drop as a response to slowing demand. The reason is that indebted parties need export revenues to service their debts. The recent oil-price decline is considered a warning sign. Another risk is that indebted parties will find it impossible to refinance their debt should interest rates rise in the rich world, as they eventually will.

In view of mounting risks, the non-governmental organisations state that it is “high time to solve the debt crisis”. They want the UN to design a mechanism for debt resolution. In their eyes, developing countries and emerging markets must keep up the pressure on those rich nations, including Germany, that object to such a reform, while civil-society organisations must campaign for the cause.

Hans Dembowski

Schuldenreport 2015
(available only in German):

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