11th Dec 2023

What does the global debt crisis mean for the EU Global Gateway?

  • EU Commission president Ursula von der Leyen sought to woo Senegalese president Macky Sall with Eurpe's Global Gateway investment plan last year
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With 60 percent of African countries spending more on debt repayment than on national healthcare, the EU should use Global Gateway financing to address structural issues rather than conversations about finance.

While the EU debates what constitutes acceptable debt ratios among member states, questions arise about unsustainable debt in developing countries and what it might mean for the EU's Global Gateway project.

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The details of the new fiscal rules for the EU are undecided, but the Member States do seem to agree that debt of more than 60% of GDP triggers a mandatory debt reduction clause. If the same rules would be applied to loans to Africa, the international monetary system would come to a grinding stop.

In 2022, public debt in Africa reached 65% of GDP doubling since 2010. Currently, seven African countries face debt distress and 13 are at high risk of debt distress per the latest Debt Sustainability Analysis from the International Monetary Fund (IMF) and the World Bank dated 28 February 2023. In acute distress are the Republic of Congo, Malawi, Mozambique, Somalia, Sudan, Zambia and Zimbabwe.

Overall, a staggering 60% of all low-income countries face high risks of debt distress or are already there. And the numbers continue to grow.

At the same time, the COVID-19 pandemic and economic downturn following the war in Ukraine have only increased the need for finance. Ahead of the World Bank and IMF annual spring meetings, the UN Secretary-General called for an extra stimulus of at least $500 billion per year or risk missing the Sustainable Development Goals by 2030.

The dichotomy of debt and development is clearly shown in government spending in developing countries. In 2019, 60% of African countries were spending more on debt repayment than on national healthcare.

IMF vs. World Bank

The debt versus development battle creates tension between the IMF and World Bank. In November, the IMF reached an agreement with Chad which was facing a debt crisis. While IMF Managing Director Kristalina Georgieva lauded the deal saying, "[w]e have been waiting for this day," the World Bank was less optimistic.

The IMF deal consists of lenience in the repayment schedule but did not reduce the total size of the debt. World Bank President David Malpass said he "remained deeply concerned about Chad's longer-term ability to pay its $3 billion in external debts, given the absence of actual debt reduction."

This brings up an important point about how to address a debt crisis in a country like Chad with 42% of the population living below the poverty line in 2018 and hosting over 450,000 refugees from neighbouring countries.

Unfortunately, data on the effectiveness of debt reduction approaches is lacking. "A vast literature studies the effects of fiscal consolidation on GDP, but far less work has been done on understanding the impact of fiscal policies on debt ratios, particularly in emerging market economies and low-income countries," the IMF notes in its 2023 World Economic Outlook report.

To right this wrong, the authors analysed debt crises in 55 low-income countries from 1985 to 2021. They found that cutting public spending and raising more domestic resources contributed very little to reduce the debt levels in low-income countries. The so-called fiscal consolidation approach is a lot more effective in advanced economies.

In low-income countries specifically, fiscal consolidation can have negative consequences for poverty reduction and development. For example, cutting down on public services like education and healthcare, or raising the Value Added Tax both disproportionately hurt the poor.

In low-income countries, the actions with the best chance of success to decline the debt ratio are GDP growth and inflation, the IMF notes in the 2023 World Economic Outlook report.

"Although high inflation can decrease debt ratios, it is not recommended as a policy tool," Adrian Peralta, Deputy Division Chief in the Research Department at the IMF tells EUobserver in a written response. This leaves GDP growth as the preferred method to reduce debt in low-income countries.

Debt conversations ignore structural issues

In addition, Celine Tan, Professor of International Economic Law at the University of Warwick shares with EUobserver the need for more evidence-based policy prescriptions by the IMF and coordination with local governments. "Countries often don't have the expertise or the space to direct policy as they are beholden to the IMF, other lenders and the market."

She adds that the underlying causes of the current debt crisis have not been addressed either. "There are all sorts of structural issues including issues of trade barriers, asymmetries in international investment law, in terms of tax evasion. These questions are so prominent and I don't see that being addressed in these kinds of financial conversations about debt."

For example, every year $88.6 billion leaves Africa due to illicit financial flows including tax evasion by multinational companies and high net-worth individuals, trade smuggling, organised crime or corruption by government officials. That is almost as much as Overseas Development Aid and Foreign Direct Investment combined, the UN Conference on Trade and Development reported in 2020.

Without solving the leakage, any increase in funding risks being diverted or misused, and not contributing to economic growth in the long run.

Problematic Chinese loans

Besides these underlying causes, there are also immediate obstacles to solving the debt crisis, as shown in Zambia which already rang the alarm on its debt almost two years ago.

The new Global Sovereign Debt Roundtable which convened for the first time in February and again on 12 April, was founded to "accelerate debt restructuring processes and make them more efficient". The participants included the IMF and World Bank, bilateral creditors including China, the world's largest bilateral creditor, private sector lenders and debtor countries (Ecuador, Ethiopia, Ghana, Sri Lanka, Suriname, Zambia).

Prior to the roundtable, tension had been building with China which usually doesn't cancel its debt, and only extends the repayment term. Typically Chinese loans are more expensive and must be repaid sooner, researchers note. "A typical loan from China has a 4.2% interest rate and a repayment period of less than 10 years. By comparison, a typical loan from an OECD-DAC lender like Germany, France or Japan carries a 1.1% interest rate and a repayment period of 28 years," research lab AidData finds.

The roundtable participants agreed to improve data sharing in an early stage among all stakeholders and increase concessional finance from the International Development Association to countries in debt distress. It did not mention commitments from China.

World Bank's Malpass said afterwards he hoped Zambia's debt restructuring agreement would be signed soon, including by China, but noted there are still disagreements within the country.

Opaque debt

Faced with declining GDP growth rates and lower commodity prices, China significantly decreased the loans it provides to other countries since the heydays of the Belt and Road Initiative peaking at $28.4 billion to African countries in 2016. In 2019, China provided $8.2 billion in loans and in 2020 during the pandemic only $1.9 billion to Africa.

In some countries, we're not even sure how troublesome the debt is as non-disclosure clauses in private lending prevent transparency of the debt load. Private lending has "surged" since 2000 and now makes up the largest group of creditors to low-income countries.

Chad and Zambia were both affected by transparency issues the World Bank noted. "Chad and Zambia's debt restructuring negotiations were delayed when their respective debt offices couldn't produce current and complete records of what was owed (and to whom)."

In 2022, up to 40% of low-income countries had not published sovereign debt data "for more than two years". If they do publish debt data, there can be large discrepancies between what countries themselves report and what multilateral banks state. In some cases, the debt discrepancy is as much as 30% of GDP.

With China retreating, it might be left to the EU and others to fill the financing gap.

Enter the Global Gateway

EU President Ursula von der Leyen did not hold back when sharing the intention to counter China when launching the Global Gateway in September 2021. "We will build Global Gateway partnerships with countries around the world. […] But it does not make sense for Europe to build a perfect road between a Chinese-owned copper mine and a Chinese-owned harbour," Von der Leyen said.

The EU will shell out €150 billion for investment projects in Africa over the next years. A considerable part of that is intended to come from the private sector instead of EU institutions. Of the total €300 billion estimated to make up the Global Gateway, €135 billion is intended to come from private lenders.

While "good governance and transparency" is one of six core principles of the Global Gateway, this should also extend to private lenders benefiting from Global Gateway guarantees. That means the EU should work actively to prevent non-disclosure clauses of private funding that could muddle the debt picture but also increase transparency of grants, loans and blended finance provided by EU institutions.

According to the European Network on Debt and Development (Eurodad), "[c]alls for further debt transparency have China and borrowing countries in mind, although neither the Paris Club bilateral creditors nor the private sector or even multilateral institutions are being fully transparent in their lending." The Paris Club's permanent members include EU member states like France and Germany.

With a more prominent focus on projects that will only see a return on investment in the long run like infrastructure projects, debt sustainability is more important than ever. To have an accurate picture of the outstanding debt of recipients and know exactly when and how much must be repaid, the EU should double down on debt transparency and analysis.

Financial leakage

On 14 June 2022, the European Parliament held a discussion on debt distress in developing countries. MEP Charles Goerens, rapporteur of the 2018 Resolution on 'Enhancing developing countries' debt sustainability' stressed the need of guarding the debt viability of public-private partnerships for the entire duration of the project.

Eurodad noted in its report 'The Emperor's New Clothes: What's new about the EU's Global Gateway?' from September 2022 the high risk associated with infrastructure public-private partnerships. "Privately financed infrastructure projects that suit the domestic private sector with the support of international capital are extremely capital-intensive and therefore a lucrative source of potential profit for the private sector. They incur long-term repayment cycles, which are a source of country indebtedness and a high burden to citizens of developing countries."

Considering the current debt stress levels of low-income countries and the considerable financing needs to meet the climate and SDG crises, the EU should work closely with the G20 Common Framework to anticipate debt distress before it arises and actively work to prevent this from happening together with the recipient. Essentially, this should also include private lenders and China.

The conditionality of loans should focus on economic growth instead of fiscal consolidation as this might have adverse effects, as the IMF reported. And no matter the source of the loan — EU, China or private — addressing illicit financial flows should be a main priority to fix the leaking bucket of financing once and for all.

Author bio

Anrike Visser is an illicit finance policy advisor and financial crime investigator.


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