Debt Is Dragging Down the Developing World

The violent protests that began in Nairobi in June appeared to erupt suddenly, a direct response to government’s proposal of a contentious finance bill the month before. But the economic crisis that motivated the legislation, which would have raised taxes in part to pay off the country’s debt, has been years in the making. Kenya’s debt burden has forced its leaders to face a series of impossible choices. Last year, they slashed the federal budget, including health spending, to provide funds for debt servicing; the government also delayed salary payments to civil servants. In February, despite these measures, Nairobi had to issue an international bond at an eye-watering ten percent interest rate, compared with roughly six percent on bonds it issued in 2021, to refinance its existing debts and meet development needs. Kenya is now spending 75 percent of its tax revenue on debt service.

Under pressure from the protests, President William Ruto rejected the finance bill after it received parliamentary approval. But Kenya’s larger crisis remains. Like many countries in Africa and across the developing world, the economic gains Kenya made in the two decades preceding the COVID-19 pandemic are slipping away. In 38 percent of countries eligible for development assistance from the World Bank, per capita GDP is lower today than it was before the pandemic—a drop the bank has described as “a historic reversal in development.”

The heart of the problem is debt financing. Debt is not necessarily bad; nearly every country takes on external debt to fuel its economy. In normal times, most countries can sustain the burden of servicing that debt. But four years of exogenous shocks, starting with the COVID-19 pandemic, have made the task impossible in many developing economies. Unlike their wealthy counterparts, they could not shore up their economies during the pandemic by tapping domestic resources or borrowing the necessary funds. State coffers rapidly drained, and fiscal challenges piled on. When the Federal Reserve raised interest rates on U.S. Treasury securities in March 2022, low-income countries’ currencies declined in value and their governments lost access to capital markets. In sub-Saharan Africa, 19 countries are unable to make debt payments or are at high risk of reaching that point.

As governments divert more and more resources toward servicing an unmanageable debt burden, they have fewer funds available for investments that can save and improve lives. The total value of interest payments made by the world’s 75 poorest countries, more than half of which are in Africa, has quadrupled over the past decade. In 2024, these countries will have to spend more than $185 billion, which amounts to roughly 7.5 percent of their combined GDP, to service their debts. According to the World Bank, that’s more than what they spend annually on health, education, and infrastructure together.

Although low-income countries, especially in Africa, have suffered most from this shift, it is a global crisis. Stalled growth has reduced countries’ capacity to contain infectious diseases and the damaging effects of climate change. Stagnation has stoked political instability and forced people to migrate. It translates to smaller markets for global goods and services. And economic pressure throttles innovation that could benefit not only low-income countries but also the rest of the world.

To help low-income countries out of the debt crisis and to restore global growth, wealthy governments should increase their funding for the World Bank’s affordable financing programs and build on earlier debt-relief efforts, such as those coordinated by the G-20, aimed at the poorest countries. Together, world leaders have the power to write a new story—one that ends in a positive cycle of development, not in a decade of lost opportunity for the 1.5 billion people who call Africa home.

THE DEBT DILEMMA

To better understand the bind that many governments are in, consider Ethiopia. In the 1980s, it was one of the world’s poorest countries and experienced a devastating famine. Yet it went on to become one of the biggest success stories in global health and development. Foreign and domestic investments in health and agricultural systems significantly reduced child malnutrition. Between 2000 and 2019, deaths from infectious diseases halved, the mortality rate for children under five years old fell by two thirds, and the maternal mortality rate fell by three quarters. Access to sanitation and clean water improved dramatically. From 2004 to 2019, Ethiopia’s per capita GDP rose by nearly 200 percent, and its economy grew roughly ten percent per year.

But over the past few years, much of this progress has been lost. The country endured overlapping crises, including the outbreaks of COVID-19 and other diseases; a devastating civil war in Tigray, in which hundreds of thousands of civilians were killed; and natural disasters, including a drought, floods, and billions of locusts. With tax revenue faltering and international aid for basic health and development dropping to the lowest point in nearly a decade, the Ethiopian government hasn’t had the money to both respond to these shocks and serve the needs of its more than 120 million people.

Debt service has become the single largest item in the government’s budget, while investments in critical human development sectors have stagnated. The government spent $8 per capita on health in the fiscal year ending in July 2021 compared with $26 on debt service. Plans to transform the country’s health system have stalled: only half of Ethiopia’s health centers and hospitals have reliable sources of electricity and water, and construction of new facilities has slowed dramatically. Without adequate funding and consistent pay, health workers are leaving the profession. And the government, facing a $58 million shortfall in its maternal health budget, cut the types of free life-saving supplies it provides to each health center from 60 to 11. Pregnant women can no longer expect to give birth in a facility equipped with anesthetic drugs, suturing materials, or even surgical gloves.

Every Ethiopian birr or Kenyan shilling spent servicing expensive debt is money that is not available to build and staff health clinics, train teachers and equip schools, and improve agricultural productivity as the region adapts to harsher weather. A vicious cycle has developed. Investments in health care and development are impossible without financial resources, but the progress that leads to economic growth—which in turn generates those resources—is impossible without improvements in health outcomes and poverty reduction.

THE BANK OF LAST RESORT

The Gates Foundation has long advocated for reforms to the global financial system to allow cheaper financing for the countries that need it most. During the pandemic, international institutions took a few promising steps in this direction. In 2020, the G-20 launched the Common Framework, an initiative intended to help creditors collaborate on debt restructuring for borrowing countries. And in 2021, the International Monetary Fund (IMF) unlocked the equivalent of around $650 billion in special drawing rights—a type of reserve asset that recipients can exchange for currency when needed.

But these moves have proved insufficient. The IMF’s allocation provided critical temporary relief, but because of the IMF’s shareholding structure, the lion’s share of the assets it disbursed went to countries that didn’t need the assistance, such as the United States and Japan, whereas African countries received only five percent of the total. The G-20 followed the IMF allocation with its own commitment to redirect $100 billion worth of special drawing rights, but implementation has been slow, and in practice, only a tiny fraction of those resources has been accessible to the low-income countries that need them the most.

In sub-Saharan Africa, 19 countries are unable to make debt payments or are at high risk of reaching that point.

At the same time, countries entering the Common Framework experienced delays in debt restructuring as creditors struggled to agree on which loans to include and how to divide the costs. To date, four countries—Chad, Ethiopia, Ghana, and Zambia—have applied for debt treatment under the G-20’s framework. Chad was the only one to complete the process until last month, when Zambia finally managed to restructure its debts, four years after its initial application. Ghana and its creditors also finalized a deal in June that should provide some relief, but it will take time for the country’s economy to rebound. Both the IMF’s and the G-20’s efforts were well intentioned, but their limited effectiveness calls to mind global leaders’ failed commitment to equitably deliver vaccines during the COVID-19 pandemic—another in a long list of unfulfilled promises to low-income countries.

Financial decision-makers have opportunities to do better at the upcoming meetings of the United Nations, the IMF, the World Bank, and the G-20. Any solutions they consider should prioritize making low-cost capital available to those countries that cannot access money in any other way. One of the best steps would be to generously fund the World Bank’s International Development Association. IDA is the single largest source of concessional finance—below-market-rate loans, grants, and other types of funding that support development projects. It is effectively the bank of last resort for the 75 poorest countries on the planet, offering affordable financing even when these countries do not have access to global markets and when other development assistance stagnates.

With adequate funding, the World Bank has a proven track record in this kind of finance. In its six decades of operation, IDA has helped countries improve their health and education systems, create jobs, build infrastructure, and recover from disasters. By 2022, 36 countries that once relied on IDA funding—including Angola, India, and South Korea—had strengthened their economies enough to no longer need the bank’s assistance. Twenty of them now rank in the top half of all countries in measures of GDP per capita, and 19 now contribute to IDA themselves.

Every Ethiopian birr or Kenyan shilling spent servicing debt is money that is not available to build clinics or train teachers.

Donor countries, led by the United States (the single largest contributor), Japan, the United Kingdom, Germany, France, and China, pledged $23.5 billion to IDA’s most recent replenishment in 2021. Because of IDA’s triple-A credit rating, the bank was able to leverage that commitment on private markets and turn it into $93 billion that it can distribute to low-income countries. But this is still not enough to pull recipient countries out of crisis. Government contributions replenish IDA funds every three years, and ahead of the next round, later this year, World Bank President Ajay Banga has called on donors to increase their contributions by as much as 25 percent. Political leaders have echoed that call. When more than two dozen African heads of state gathered at an IDA summit in Nairobi in April, they emphasized the need for a sizable replenishment of the bank’s funds. IDA “has been and must remain a dependable development partner for Africa,” Ruto said. “We urge stronger donor contributions … so that together we can drive transformational impact.”

Asking for more money is difficult at a time when wealthy countries are facing their own fiscal constraints, but there is no better investment they can make to improve the lives of the world’s poorest people. The challenges in low-income countries are, by and large, the result not of indiscriminate borrowing but of climate-change-induced shocks, a pandemic, and far-off wars. In many cases, access to cheaper loans would be enough for these countries to restore growth, building toward a more prosperous and more stable world—an outcome that is in everyone’s interest.

That outcome also depends on trust between governments and the public. As the protests in Nairobi have demonstrated, many Kenyans have lost faith in their country’s institutions—and they are not alone. Citizens across Africa are taking leaders to task for wasteful spending and corruption. These governments need to be able to borrow, but they also must show they are accountable for the resources entrusted to them.

A SYSTEMIC SOLUTION

Even if donations to IDA increase, however, the countries that receive funds from the bank will continue to struggle without large-scale debt relief. The first step to make that relief possible is to reform the G-20’s Common Framework. Lenders have so far failed to agree on how to share the costs of debt relief, and it is time for them to recognize that procedures designed for the world of 20 years ago—the last time they dealt with debt crises in many countries at once—need to be refreshed. Some potential fixes are already on the table. A group of African finance ministers, for example, has proposed a reform that would bring private-sector creditors into the debt-restructuring process at an earlier stage and crack down on vulture funds that profit from debt distress.

International finance institutions also need to start thinking about debt crises differently. In a report published earlier this year by the Finance for Development Lab, a Paris-based think tank, the economists Ishac Diwan, Martin Kessler, and Vera Songwe suggested that at least some of these crises should be treated as problems of short-term liquidity, not of fundamental solvency. Low-income countries with young and expanding populations and opportunities for development have high potential for economic growth over the long term. Ethiopia is a great example. Despite the country’s challenges, its economic growth rate was still around six percent in 2023. Its leaders had the vision and skills to build up the country for 20 years; with the right policies and improved liquidity, they can surely do so again.

This change in mindset can lead to more tailored solutions. The Finance for Development Lab’s report goes on to recommend a “bridging program,” for instance, whereby countries facing liquidity challenges would commit to investing in a program of sustainable and inclusive growth in exchange for additional financing from multilateral development banks, including IDA, that would provide a bridge to financial stability. The specifics would need to be worked out in each case, but the collective approach in this proposal shows promise.

The challenges in low-income countries are not the result of indiscriminate borrowing.

The leaders of developing countries are not looking for free money, and they recognize that debt financing is not a one-way street. The presidents of Ghana, Kenya, and Zambia underscored this point in a March 2024 essay for The Economist. “Africa must look within for solutions,” they wrote. “We must invest our borrowing in the continent’s growth, job creation and revenue generation rather than in consumption that will not pay us back in the long run; make sure development projects are high-quality, priced correctly and finished on time; and start looking to each other as major trading partners rather than overseas.”

Before any of that can happen, however, developing countries must have access to more affordable financing. If the leaders of global financial institutions and wealthy countries fail to do their part, there is a very real possibility that dozens of countries will languish for a decade or more. But with the right reforms and investments, these countries can provide for their people and outgrow their debt, perhaps for good.

By helping African countries emerge from this crisis, Western governments and international financial institutions could unlock much more funding for African innovation and development. They could free up resources to build long-term resilience in health and food systems. And they would allow governments to support more teachers and health-care providers, ensuring that the next generation of Africans—the fastest-growing population on the planet—can realize their full potential. These are smart investments that will yield economic, health, and security benefits not just for recipient countries but for the whole world.

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