External Debt Crisis in Developing Countries: Causes and Solutions

Introduction to External Debt

Past studies on external debt have been conducted for two primary reasons. First, while borrowing from external sources can increase a nation's access to funding, borrowing from internal sources merely transfers existing resources within a country from one party to another. Thus, only external borrowing can result in a transfer problem (Keynes, 1929). Second, because financial regulatory authorities cannot simply print the hard currency required to repay externally sourced debt, only external borrowing is associated with the vulnerabilities that may precipitate debt crises.

In terms of external debt, most countries do not know precisely who holds their debt obligations, and so they categorize all debts from the international market as external and all debts from domestic markets as internal (ECESAUN, 1999). As a result, so-called external debt is, at best, a poor proxy for the actual transfer of financial resources between nations.

Foreign Debt Management

At a consultative meeting held by ESCWA in 2008, a World Bank consultant and the Executive Director of the Centre for Project Evaluation and Macroeconomic Analysis of the Ministry of International Cooperation of Egypt stated that the member countries of the organization had benefited greatly from Official Development Assistance (ODA) over the preceding three decades, which had helped to raise living standards and promote economic growth. He also noted that ESCWA members were confronting a number of significant challenges, including high unemployment rates and gaps in technology. He emphasized the need for stronger institutions and more skilled human resources at various levels in order to increase the effectiveness of ODA (ESCWA, 2008).

The Islamic Development Bank, the Qatar Development Bank, and other financial institutions were represented at the meeting and offered perspectives on the debt crisis. A professor from the Lebanese American University made a particularly notable contribution with a detailed report on the external debt situation among the community's member countries. His report revealed that many ESCWA nations continued to suffer from external debt crises despite the financial reforms initiated by their respective governments. According to his findings, to reduce external debt, countries should:

a) Continue with the privatization of government corporations and use the proceeds to pay off external debts.

b) Improve their investment climates to decrease reliance on borrowing in international markets.

c) Join together to form a single institution to evaluate the foreign debt situation and develop a long-term strategy to reduce it (ESCWA, 2008).

Another report presented during the meeting by the Public Debt Bureau of Lebanon's Finance Ministry revealed that, among the ESCWA member countries, the ratio of external borrowings to Gross Domestic Product (GDP) was increasing among net oil-importing members such as Lebanon and Jordan, while decreasing among net oil-exporting members. The report further stated that to manage public debt effectively, its growth should not exceed the average growth rate of GDP (ESCWA, 2008).

Reasons for Internal and External Indebtedness

Debt in developing countries has long been identified as a major challenge to human development. Many additional difficulties have emerged as a direct consequence of the large external debts that developing nations owe to developed ones. Debt has been cited as an obstacle to security, economic and political stability, and sustainable development (Shah, 2007).

Neocolonialism: According to a working paper released by the development institution South Centre (2004), the debt burden of third world countries was, to some extent, caused by the transfer of debt from colonizing states to their former colonies. The paper argues that this cycle is likely to continue and grow unless the debt is cancelled outright. A paper released by El Hadji Guisse for the UN Sub-Commission on Human Rights (E/CN.4/Sub.2/2004/27), titled "Effects of Debt on Human Rights," supports this argument. According to Guisse, debt in developing countries can be partly attributed to the unjust transfer of obligations from colonizing states; he estimates this at approximately $59 billion in external debts transferred to newly independent states during the 1960s (Shah, 2007).

Odious Debt: According to Jubilee USA (2003), odious debts are unjust obligations arising from loans extended to dictatorial or illegitimate governments that subsequently used the funds for personal gain or to suppress opposition. In cases where loans were used contrary to the interests of citizens and the lenders were aware of this, the lender may be considered to have committed an act of hostility against the borrowing country. Such loans are therefore regarded as illegal, and the countries involved are not obligated to repay them — for example, loans taken by the apartheid government in South Africa, which used the funds to oppress its own citizens (Shah, 2007).

Conclusion and Recommendations

With regard to coordination efforts to resolve debt crises, there is a clear need for such cooperation, particularly in the areas of debt management and debt conversion. In terms of debt conversion, institutions have shown a willingness to channel resources released through debt relief initiatives toward human and social development programs. However, as discussed above, several considerations — especially the absorption capacities of debtor countries — must be taken into account before initiating debt conversion plans.

It is important for international banking agencies to first assist debtor nations in formulating national strategies for human and social development before designing debt relief plans. Debt conversions, in turn, can help generate additional relief and free up resources for development purposes. The costs of such initiatives should, however, be carefully assessed to ensure that they do not inadvertently result in higher debt burdens for the countries they are meant to help (ECESAUN, 1999).

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