Since its inception, the Heavily Indebted Poor Countries debt relief initiative has slashed debt servicing costs by US$76 billion, supporting increased poverty reducing expenditure and more stable debt dynamics. Debt relief, coupled with strong growth and high demand for commodities, improved debt-to-GDP ratios, lowering the average from 66% in 2006 to around 48% at end-2014 (see Figure 1). The exception to this positive trend was the group of small countries who saw a significant rise in debt ratios, reflecting consistently weak growth and the fiscal impact of natural disasters over the past decade.
Figure 1. Total public debt (in percent of GDP)
Source: LIC DSF Database , and IMF staff calculations.
Between 2007 and 2013, there was a significant decline in countries’ debt vulnerabilities, as measured by the IMF/World Bank Debt Sustainability Framework, which categorises countries into three risk groups: low, moderate, and high (or in debt distress). During this time, there was a decrease in the number of countries at high risk of distress, and a corresponding increase in those at low risk (Figure 2). Despite the Global Crisis, low-income countries were reducing debt, improving revenue collection, and generating strong growth.
However, the more recent fall in commodity prices and weakening of global growth ended this positive run and the last two years have seen low-income countries increasingly exposed to heightened vulnerabilities. In fact, since 2013, 11 countries have experienced a deterioration in their risk rating, while only seven have seen an improvement. Perhaps not surprisingly, the countries that have experienced this deterioration tended to be commodity exporters, which suffered from a collapse in export revenues.
Figure 2. Evolution of the risk of external debt distress (in percent of total)
Sources: LIC DSF database and staff calculations.
A new financing landscape
The past decade has been characterised by a significant shift in the sources of debt financing. Two clear trends were identified. First, credit from large emerging market economies has steadily replaced bilateral debt owed to Paris Club creditors (Figure 3). This has likely helped low-income countries maintain investment spending without having to resort to higher levels of domestic or external market borrowing, potentially on less concessional terms. Financing from these sources will likely become increasingly important.
Figure 3. Official bilateral debt stock (in percent of GDP)
Source: Calculations based on 2015 Survey of IMF country teams.
The second key trend that has emerged is the rise of the frontier low-income countries whose debt portfolios increasingly resemble those of emerging markets (Figure 4). Access to international capital markets for these countries increased significantly in the years following the Global Crisis, as the search for higher yields and good economic performance in low-income countries led investors to these less traditional markets. Frontier low-income countries’ borrowing from domestic markets also increased from 14 to 19% of GDP from 2007 to 2014; and there is some evidence of an increase in non-resident participation in these markets. Analyses suggest that both the increase in international market access and financial deepening at home are associated with economic growth and financial development. There is also preliminary evidence that eurobond issuances help relax countries’ financing constraints without a near-term loosening of fiscal policy.
Figure 4. External commercial borrowing: Frontier low-income countries (in US$ million)
Sources: Dealogic, Bloomberg.
The wider financing options available for low-income countries have presented both opportunities and risks. More diverse financing sources allow greater flexibility for countries to conduct discretionary fiscal and debt management policies. However, the nature of risks that they face has also accordingly changed. For example, increased market access could mean greater volatility in borrowing costs and rapid changes in capital flows, both relatively uncharted territories for most low-income countries.
Despite improved economic fundamentals and financing opportunities, many low-income countries will face policy challenges in coming years to ensure that debt remains sustainable. The weaker growth outlook in key advanced and emerging market economies is likely to impact low-income countries through lower demand for traded goods. Prospects for tighter global liquidity conditions could raise the cost of borrowing for countries with increased reliance on market-based financing. Lower commodity prices have already forced fiscal adjustments for many commodity exporters, and more will likely be necessary given that commodity prices are forecast to remain subdued for the foreseeable future.
Looking ahead, low-income countries’ fiscal and financing decisions are vital to countering the worsening global outlook. In this regard, fiscal prudence, as well as improvement in institutional capacity to manage fiscal policy, debt, and the budgets is a priority for safeguarding countries against vulnerabilities that have emerged with the new financial landscape.
Disclaimer: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.
IMF (2015) “Public debt vulnerabilities in low-income countries: The evolving landscape”, Washington.