Getting debt sustainability right in developing countries

The current international financial system needs a major overhaul.

This is especially true for its approach to developing-country debt. A new strategy is essential for these countries to attract investment. This investment is crucial for long-term growth.

The International Monetary Fund (IMF) and World Bank influence the concept of debt sustainability. However, many economists recognize the Debt Sustainability Framework (DSF) has serious flaws.

The DSF aims to balance development financing with debt sustainability. Unfortunately, it often promotes low levels of government spending and investment. This can lead to future economic problems in developing nations.

Additionally, the DSF does not adequately consider necessary investment scales. It also lacks sensitivity to economic shocks and external factors. Historically, it has overestimated how fiscal consolidation boosts growth, leading to forecast errors.

One major issue is that it overlooks the long-term benefits of debt-financed investments. This includes investments in areas like green transitions. The framework must shift from focusing solely on reducing debt to encouraging growth-oriented investments.

Some advanced economies are already changing their approach. For example, Germany is increasing public spending beyond its debt limits for urgent needs. Policymakers understand that borrowing for consumption differs from strategic infrastructure investments.

Lending decisions for low- and middle-income countries (LMICs) should rely on long-term models of sustainability. Simple rules like debt-to-GDP ratios are insufficient.

Debt sustainability improves when adjustment programs support high investment levels. Effective management of investment-driven borrowing can reduce sovereign debt risks.

Currently, many LMICs face significant debt burdens. Past interventions show that options like debt relief and interest payment suspensions can help.

However, addressing long-term financing needs requires broader reforms as well. There must be an increase in long-term, low-cost financing options.

Multilateral development banks should play a key role in providing affordable loans during crises or downturns in private financing.

We need more initiatives similar to the African Development Bank’s African Development Fund, which offers concessional funding and grants.

Establishing a permanent mechanism for sovereign-debt restructuring is also vital. Ideally, this would operate through the United Nations or an independent agency within the IMF.

Such a body could create a fair process for renegotiating debts through structured stages: voluntary negotiation, mediation, and arbitration with deadlines.

The current view of debt sustainability hinders global growth and sustainable development. We must broaden our understanding beyond just reducing debt to include long-term investment-driven growth.

By rethinking this concept, we can empower LMICs toward sustained economic development.

A bold reimagining of international finance is necessary to prevent ongoing crises and ensure stability worldwide.

The Fourth UN International Conference on Financing for Development will occur in Seville this July. This event will allow developing countries to unite their voices against existing financial structures.

These institutions hold the key to alleviating unsustainable debts faced by developing nations and enabling systemic changes in finance.

Kevin P. Gallagher is a Professor at Boston University’s Global Development Policy Center.
José Antonio Ocampo is a professor at Columbia University and former UN under-secretary-general.
Kunal Sen directs UNU-WIDER at the University of Manchester.