Special Representative and Director, External Affairs, Europe The World Bank
In this edition of The Review, Carlos Primo Braga shares his insights on the impact of the global financial crisis on debt in developing and developed nations.
Q. What role do bodies like the World Bank have in helping developed nations with debt problems when so many poorer countries require assistance?
A. The World Bank Group (WBG) is not directly involved in supporting developed nations with their debt problems. The focus of our activities is on developing countries. However, our sister institution, the International Monetary Fund (IMF), has provided financial assistance to developed countries (e.g. Iceland, Greece and Ireland) in the context of the global financial crisis. This financial assistance entails policy programs that address macro-economic problems with a view to limit economic disruption. In the case of Greece, for example, the IMF program (EUR 30 billion) complements financing from Euro area countries (for a total of EUR 110 billion), and focuses on two key problems faced by the Greek economy: high public debt and lack of international competitiveness. This type of intervention has an important role in contributing to global economic stability.
It is worth noting, however, that the WBG is involved in the debate about the implications of the sovereign debt crisis in developed nations for the world economy and for developing economies, in particular. This is done via its knowledge products, such as the recently released Global Economic Prospects, and by participating in relevant forums, including the G20.
Q. What actions need to be taken by developed nations to ensure that their own financial institutions and government policies are effective and don’t result in crises?
A. The financial crisis was “nurtured” by global macro-economic imbalances, lax monetary policies in the developed world, poor corporate governance of the financial system and regulatory failures amid growing international financial integration. The bursting of an asset price bubble associated with excess investment in real estate in several developed countries unleashed the process. It is true that we have seen this before, whereby financial cycles lead to asset bubbles with international implications, but not on this scale.
Countries around the world took measures to address the impact of the financial crisis. The most notable policy actions included easing of monetary policies, recapitalisation of financial systems, bailout of the household and corporate sectors, overhaul of financial regulatory systems and fiscal stimulus packages. With respect to monetary policies, most Central Banks significantly lowered their policy interest rates and several of them, including the US Federal Reserve Bank, the European Central Bank, the Bank of England and the Bank of Japan, approached the zero lower bound constraint. Many of them also adopted aggressive balance-sheet policies, credit policies to affect interbank and non-bank credit markets, purchase of government bonds, and purchase of foreign currency securities.
In addition to these monetary actions, governments adopted aggressive counter-cyclical fiscal policies. Fiscal deficits in advanced economies, which were around 1.1 per cent of GDP in 2007, jumped to 8.8 per cent in 2009 and are expected to remain around 8.4 per cent in 2010, according to the IMF. Similar numbers for emerging economies were 0.0 (i.e. fiscal equilibrium) in 2007 and 4.9 per cent in 2009, with a forecast of a deficit of 3.9 per cent in 2010.
In short, an economic boom fostered by growing indebtedness of the private sector came to a halt when the asset bubble burst. Governments have stepped in to avoid the collapse of the financial sector, forestall credit contraction and to sustain aggregate demand. As a consequence, public debt – particularly in advanced economies – has been growing by leaps and bounds over the last two years.
Moving forward, governments have to put special emphasis in regaining the confidence of markets while introducing regulatory reforms that clamp down, for instance, on excessive risk-taking. It is a difficult task to perform and it is further complicated by the fact that the current fiscal imbalances put policy makers in a corner. They are damned if they begin to introduce fiscal austerity, eventually impairing the nascent recovery, but they may be damned if they don’t as the growing debt burden may further impact market confidence and raise the spectre of a debt trap. There is growing consensus, however, that fiscal retrenchment will be inevitable in the years ahead not only because of the size of existing imbalances, but also because of expected increase in entitlement spending in the absence of pension and health-care reforms.
Q. Is it a viable option for countries to rely on debt restructuring packages backed by financial markets rather
than relying on the support of multilateral organisations?
A. I will focus on the experience of developing countries. Each case has to be analysed in terms of the specific situation of the country. Consideration has to be made for the currency in which the debt is issued, whether the main creditors are private or the official sector, the trigger for the debt crisis, the role of the domestic private sector and the response of the government vis-a-vis the crisis, the legal jurisdiction governing the debt issuance, etc. In the case of low-income countries that rely on concessional lending and whose debt is mainly held by bilateral and multilateral agencies, the support of multilateral organisations is always necessary since they are often key players among the creditors. The experience with debt relief efforts such as the Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI) illustrates this (for details see C.A. Primo Braga and D. Doemeland (2009), Debt Relief and Beyond: Lessons Learned and Challenges Ahead, Washington, DC: The World Bank).
But even in the case of countries with access to international capital markets, experience shows that official intervention is often important in facilitating debt restructuring packages. The role of the US Treasury in establishing a mechanism for voluntary debt and debt-service reduction operations, the Brady Plan, in 1989 comes to mind. More generally, multilateral organisations can play an important role by providing crisis lending for countries in need of temporary financing and by helping identify the resources available for the debt settlement. Multilateral programs backed by organisations, such as the IMF and the World Bank, are instrumental in creating a cooperative environment and lowering uncertainty for stakeholders, while serving as commitment devices for debtors to implement the adjustment programs required to regaining solvency.
Q. Parts of the emerging world – including Brazil and selected Asian nations - have emerged strongly from the GFC, and are finding favour among private investors. Is there a lesson in this for others, and if so, what is it?
A. The basic lesson is that countries that entered the crisis with better policy fundamentals and that had lower vulnerability to external shocks (e.g. because they had accumulated international reserves and/or improved fiscal positions) fared better during the crisis, experiencing lower output decline and a faster recovery.
These countries were able not only to adopt counter-cyclical policies in an effective manner, but also faced fewer problems in terms of negative market sentiment with respect to sovereign debt risk, as captured, for example, by increases in sovereign spreads.
In other words, the financial crisis underscored the fact that globalisation has not changed the historical experience that lending booms often end in busts. What is different this time is that places that were often identified as risky are showing a much greater resilience than was the case in the past or even when compared with advanced economies. This illustrates the positive impact of economic reforms in the developing world in the last decade, widespread recognition of the importance of macroeconomic stability, and in many cases the decision that was fostered by experiences with previous crises to invest in buffers against external shocks. Needless to say, these economies will have to remain vigilant to sustain their recovery in a global economic environment that remains quite uncertain.
Q. How serious is the scale of the national debt problems that now faces the world, and how long will it take to find lasting solutions to them?
A. Government debt-to-GDP ratio in advanced economies has risen from 73 per cent in 2007 to roughly 91 per cent at the end of 2009. The surge in gross borrowing needs of advanced economies – from US$9 trillion in 2007 to roughly US$16 trillion in 2009, with an expected similar level for 2010 – is adding to the financial stress under which public debt is being managed. This is the highest level of debt-to-GDP ratio since World War II. If general government debt ratios in advanced economies are to be brought back to the pre-crisis median of 60 per cent of GDP by 2030, this will require an 8 per cent plus upswing in the primary fiscal balance by 2020 and then maintenance of the achieved surplus for the ensuing decade. In short, a major fiscal effort is required if the aim is to reverse the trend of the last few years.
The growing level of public debt suggests that the spread between long-term and short-term interest rates is likely to increase over time, even though quantitative easing may delay such a trend. For developing countries, this is likely to imply higher borrowing costs and shortening maturities on new borrowings. Developing countries will be impacted by these developments not only through the cost of capital and reduced global economic dynamism, but also because the massive public interventions of the last two years – in the absence of an orderly unwinding – may foster asset bubbles and speculative waves. Exchange rate misalignments can further add to the tensions in the financial system.
All of these risks need to be managed on a continuous basis, and risk management should be accompanied by credible, medium-term debt management practices and financing strategies to support recovery efforts. Markets will be closely monitoring the evolution of fiscal positions around the world, and economies that are not able to implement consolidation plans will face increasing difficulties in financing their debts. In this context, international coordination and monitoring can play a positive role in helping enhance the credibility of national strategies and by giving ammunition to financial authorities to resist short-term pressures associated with political cycles.
Q. Has the MDRI enacted by the World Bank and the IMF been effective in helping to provide aid where needed and to sustain the economies of low income countries?
A. The MDRI was introduced in 2005 to reduce further the debts of HIPCs. Under the initiative, three multilateral institutions—the World Bank Group’s International Development Association (IDA), the IMF, and the African Development Bank’s African Development Fund (ADF)—agreed to provide full debt cancellation on eligible credits to countries that reached the HIPC completion point. In 2007, the Inter-American Development Bank announced the IADB-07 Initiative, which parallels the MDRI. The MDRI was intended to go further than the HIPC Initiative, by providing full debt relief in order to free up additional resources to help countries reach the Millennium Development Goals (MDGs).
Since MDRI’s inception, the participating international financial institutions have provided US$46.7 billion to the 32 countries that reached the completion point under the HIPC Initiative, of which US$31.4 billion was provided by the World Bank. This amount has been provided in addition to the US$71.8 billion delivered under the HIPC Initiative. Debt relief provided under the two Initiatives has substantially alleviated debt burdens in recipient countries. This assistance, together with relief under traditional mechanisms and additional relief from Paris Club creditors, is expected to reduce the debt burden for these countries by about 80 per cent relative to pre-decision point levels. Countries begin to benefit from debt relief at the so-called decision point when certain performance criteria are met. The overall assistance to the 36 countries that reached the decision point under the HIPC Initiative represents on average about 40 per cent of these countries’ 2009 GDP.
Debt relief has helped countries free up valuable resources to finance poverty-reducing expenditures. At the end of the 1990s, payments on debt obligations amounted to more than 20 per cent of fiscal revenues in HIPCs. In 2009, this had declined to 6 per cent. Meanwhile, the share of poverty reducing expenditure in HIPCs has increased from 44 per cent in 2001 to 56 per cent of fiscal revenues in 2009. This share is expected to further increase to 58 per cent in 2010, reaching almost 10 per cent of these countries’ GDP despite the economic crisis.
Social indicators in HIPCs have improved over the last two decades. Recent estimates of maternal mortality and under-five mortality, for instance, suggest that progress in health outcomes in HIPCs, and especially post-completion point HIPCs, has accelerated during the 2000-10 period. Still, most HIPCs will face an uphill struggle to meet the MDGs by 2015. This will require additional efforts at the country-level, improving governance and the administration of scarce resources, as well as a renewed effort by advanced economies in keeping their aid commitments.
Q. Are there any particular countries that you can cite as being successful?
A. On average in the past 10 years (1999-2008), GDP growth rates have been positive in the 32 completion point HIPCs. In fact, in 12 of completion-point HIPCs, growth rates have averaged above 5 per cent in the past 10 years. Countries like Ethiopia, Mozambique, Rwanda, Uganda, Tanzania, and Ghana have enjoyed not only high growth rates and improving living conditions, but also economic stability.
The majority of post-CP HIPCs is also on track to achieve universal primary education, promote gender equality and empower women, reduce child mortality, improve maternal health and combat HIV/AIDS, malaria and other diseases. As an example, Guyana reached the HIPC initiative’s completion point in 2003. Since then, the country has saved US$60 million annually in debt service payments and has increased social spending by over 25 per cent. Debt relief allowed Guyana to scale-up social expenditures in education, health, water and sanitation and to provide targeted social programs.
Albeit one-third of the post-completion point HIPCs are still characterised as fragile states, many HIPCs have succeeded in improving their policy and institutional environment. As an example, Liberia focused specifically on improving its governance capacity. Describing Liberia’s accomplishments under the HIPC initiative, President Ellen Johnson Sirleaf recently noted: “We concentrated on building institutions, getting laws, getting our public financial management law passed, making sure we got a general auditing commission that’s functioning, and making anti-corruption effective.”
Improved macroeconomic performance, combined with debt relief and improved institutions, has also led to increased interest by foreign investors. For example, private capital flows to Sub-Saharan Africa rose sharply before the financial crisis. Improved creditworthiness has also led some countries to explore new forms of borrowing, including on commercial terms. Ghana and the Republic of Congo issued international bonds in 2007, as did Senegal in 2009. Many HIPCs, including Uganda, Tanzania, and all countries of the CFA franc zone, have also developed domestic debt markets as an alternative for governments to raise resources to finance public investments.
These examples illustrate the impact that debt relief initiatives can have. It is worth noting, however, that unless local governments take full ownership of the associated reforms, the impact of debt-relief initiatives will fall short of expectations.
Q. What lessons have been learned as a result of the worldwide economic downturn for the debt relief initiative?
A. The financial crisis increased low-income countries’ (LICs) debt vulnerabilities. Recent debt sustainability analyses performed by the World Bank, the IMF and other international financial institutions indicate that external and fiscal financing requirements have increased. In addition, standard measures of a country’s capacity to repay debt – GDP, exports, and fiscal revenue – are expected to be lower than pre-crisis forecasts. On average, debt ratios are expected to deteriorate in the near term.
However, because of debt relief, debt vulnerabilities have been lowered sharply in post-completion-point HIPCs. Debt vulnerabilities in these countries – as measured by the risk of debt distress under the LIC debt sustainability framework – compare favourably with those LICs that did not benefit from debt relief. Almost 80 per cent of post-completion-point HIPCs are classified as either facing low or moderate risk of debt distress, compared to 70 per cent of non-HIPC LICs. Furthermore, 8 per cent of the non-HIPCs are currently assessed to be in debt distress, compared to none of the post–completion-point HIPCs.
In sum, debt relief has improved the capacity of HIPCs to cope with the global financial crisis and to avoid a new cycle of sovereign debt problems. It is important to underscore, however, that debt relief is no guarantee of future debt sustainability. In order to address debt vulnerabilities, countries need to continue to invest in their institutions, with special attention to debt management capacity, and to maintain sound macroeconomic policies.
About - Carlos A. Primo Braga
Carlos Alberto Primo Braga, a Brazilian national, was the Director, Economic Policy and Debt Department, Poverty Reduction and Economic Management Network (PREM) from January 2008 to January 2011.
In the period February-August 2010, he was the Acting Vice President and Corporate Secretary of the World Bank Group. His main roles as PREM Director were to provide integrated support to country programs in the areas of debt, macro-policy and inclusive growth; provide low-income countries with better growth diagnostics, as well as debt management policy advice; and provide institutional guidance in the areas of fiscal policy, macroeconomic management, and overall economic policy, acting as the Chairman of the Economic Policy Sector Board of the World Bank.
Before assuming this position, he was Senior Adviser of the Poverty Reduction and Economic Management Vice-Presidency, and Head, International Policy and Partnerships Group, anchoring strategic relationships with key shareholder groupings (e.g. G7/8, G20, G24, APEC, ASEM) and the dialogue between the World Bank and partners such as the IMF, OECD, and the Commonwealth Secretariat, among others.
From 2003 to 2006, he was the senior adviser of the International Trade Department, The World Bank. Based in Geneva, he was responsible for covering international trade issues of relevance to developing countries vis-à-vis European-based institutions, including the OECD, the European Commission, UNCTAD and the WTO. Previously, he was the senior manager of the Informatics Program at the Information Solutions Group of the World Bank. He was also the director of the Development Gateway initiative − a web-based initiative for sharing information on development-related topics.
From 1997 to 2001, he was the Manager of infoDev (the Information for Development Program), a multi-donor grant facility administered by the Global Information and Communication Technologies Department, The World Bank. In that capacity, he was responsible for a portfolio of more than 200 innovative projects funded by infoDev grants worldwide. He was also in charge of the Bank’s Y2K outreach activities in the period 1998-2000.
He joined the World Bank Group in 1991 as an economist in the International Trade Division of the Bank’s International Economics Department. From 1991 to 1994, he was responsible for research and projects focusing on trade in services, intellectual property rights, regional integration agreements, and trade and the environment. In 1995, he moved to the Industry & Energy Department as a Senior Economist.
Prior to joining the Bank, he served as a consultant to the Organization of American States (OAS) in 1990. He was a Fulbright Scholar (1988/89) at the Paul Nitze School of Advanced International Studies (SAIS), The Johns Hopkins University and taught there as a visiting professor (1988-98). He was an assistant professor of economics, University of São Paulo and Senior Researcher at FIPE, São Paulo, Brazil, in the 1980s. He was also a lecturer on the economics of intellectual property rights at the World Trade Institute, University of Berne, Switzerland in the 1990s.
His most recent publications include: Soveriegn Debt and the Financial Crisis: Will This Time Be Different? co-editor with Gallina A. Vincelette; Innovation and Growth: Chasing a Moving Frontier, co-editor with V. Chandra, D. Erocal, and P.C. Padoan. Paris: OECD, 2009; Debt Relief and Beyond, co-editor with D. Doemeland. Washington, DC: The World Bank, 2009; The WTO and Accession Countries, 2 vols, co-editor with O. Cattaneo. Edward Elgan Publishing, 2009; Trade Preference Erosion: Measurement and Policy Response, co-editor with B. Hoekman and W. Martin. Washington, DC: The World Bank, 2009.
Dr Braga received a degree in Mechanical Engineering (1976) from the Instituto Tecnologico de Aeronautica (Brazil), and an MSc (1980) in Economics from the University of São Paulo, Brazil. He holds a PhD (1984) in Economics from the University of Illinois, Urbana-Champaign, USA.