The question of debt sustainability has
been of relevance for some years, as debt remains a continuing concern
for developing countries. Much of the focus in recent discussions has
been on the various international initiatives to reduce the debt burden
of the Heavily Indebted Poor Countries (HIPC). In implementing the HIPC
initiative, the IMF and World Bank have introduced debt sustainability
analysis, on the basis of which debt relief is given to selected debtor
countries. Some indicators used to determine the sustainable level of
debt have aroused much controversy, especially as many HIPCs have not
completely overcome their debt problems despite exhausting debt relief,
often at great cost. Debt relief alone will not generate sufficient resources
in heavily indebted countries to achieve the Millennium Development Goals
(MDGs), though it can help. Five years after the Millennium Summit, it
is clear that while we may expect progress towards some MDGs at the global
level, this may well obscure significant setbacks in many of the poorest
countries.
There now seem to be two main approaches to debt sustainability analysis.
The first defines sustainable debt indicators in terms of an ostensibly
optimal debt level, beyond which debtors will not be able to service their
debt. A country is then said to achieve debt sustainability if it can
meet its current and future external debt service obligations in full
without rescheduling debt or accumulating arrears. Traditional debt sustainability
analysis does not pay sufficient attention to the long term development
prospects and strategies of debtor countries, but focuses instead on controlling
existing levels of debt. A more developmental approach must conceive of
a sustainable debt strategy as part and parcel of a broader growth and
sustainable development strategy.
Financial flows to developing countries have also changed after the sovereign
debt crises of the 1980s. Official flows have become much less important
than private flows. Many middle-income developing countries (and transition
economies) now have access to private finance and have been dubbed 'emerging
markets'. Such access has given rise to new problems. A major new concern
has been how to manage the inflows and outflows of external capital, and
how to handle their inevitably destabilizing effects on the national economy.
Recurrent financial crises since the 1990s have taught us some major lessons
for managing capital flows.
Greater capital flows, due to financial liberalization, have not resulted
in sustained net flows of funds from the capital-rich to the capital-poor,
or even to the emerging markets, except for brief unsustainable episodes.
The converse has, in fact, been the case, with capital actually flowing
out over the long term, even from Africa. Also, the cost of capital has
not fallen, as was supposed to happen.
Meanwhile, the volatility of the international financial system has grown,
due to -- rather than despite -- financial deepening, while, the frequency
and severity of currency and financial crises have increased over the
last decade. Although some new financial derivatives have reduced some
old sources of volatility (due to exchange or interest rate fluctuations,
for example), new sources of volatility have been introduced by greater
'financialization'.
Financial liberalization has made financial interests much more influential,
if not dominant. As a consequence, deflationary pressures have been exerted
on macroeconomic policy throughout the world, which has reduced growth
in the last quarter century except in parts of Asia that have had greater
control of their own growth processes. Perhaps worse, from a development
perspective, financial liberalization has undermined earlier financial
policies, institutions and instruments to pro-actively promote growth
of desired firms and industries, including small and medium enterprises.
All this has been confirmed by IMF research in the last couple of years,
which also notes that both capital flows and macro-economic policies have
generally been pro-cyclical, thus further undermining emerging markets'
ability to avoid as well as manage crises.
Drawing from recent experience, six major issues come to mind in thinking
about sovereign debt sustainability to sustain development in emerging
markets.
First, existing mechanisms and institutions for financial crisis prevention
are grossly inadequate. Recent trends in financial liberalization have
increased the likelihood, frequency and severity of currency and financial
crises. Too little has been done to discourage short-term capital flows,
while there are unrealistic expectations of protection from international
adherence to codes and standards. Here, we should not forget then IMF
Deputy Managing Director Stanley Fisher's 1998 support for controls on
capital inflows to avert crises.
As noted earlier, financial liberalization has also reduced the macroeconomic
instruments available to government for crisis aversion, and instead left
governments with little choice but to react pro-cyclically, which tends
to exacerbate economic downturns. National macroeconomic policy autonomy
needs to be assured to enable governments to be able to intervene counter-cyclically
to avoid - and mange -- crises, which have generally had much more devastating
consequences in developing countries than elsewhere. The exaggerated effects
of currency adjustments on emerging markets also require greater coordination
among the three major international currency issuers.
Second, existing mechanisms and institutions for financial crisis management
are also grossly inadequate. The greater likelihood, frequency and severity
of currency and financial crises in middle-income developing countries
from the mid-1990s - with devastating consequences for the real economy
and also for "innocent bystanders", as in the East Asian and
Latin American crises - makes speedy crisis resolution imperative. There
is an urgent need to increase emergency financing during crises and to
establish adequate new procedures for timely and orderly debt standstills
and workouts. The international financial institutions, including regional
institutions, should be able to provide adequate counter-cyclical financing
during crises, while the policy and institutional 'space' for regional
monetary cooperation initiatives should be expanded. In 2003, then IMF
Managing Director Helmut Kohler endorsed capital controls on outflows
as a sovereign government's right, especially as an emergency measure
in the face of likely distress. Instead of current arrangements which
tend to privilege foreign creditors, new procedures and mechanisms are
needed to ensure that they too share responsibility for the consequences
of their lending practices. Much of the recent sovereign debt accumulated
in crisis-affected economies has been taken over from the private sector,
under considerable pressure from the IFIs and other stakeholders, and
it is telling to note recent efforts to 'pre-pay' existing debt obligations
by governments with the means to do so.
Third, the availability and provision of development finance has declined
drastically. Unfortunately, most multilateral development banks have either
abandoned or sharply reduced industrial financing, thus limiting the likelihood
of developing countries securing funding to develop new manufacturing
capacities and capabilities so necessary for sustainable development.
Fourth, the governance of existing IFIs to ensure greater and more equitable
developing country participation and decision-making - and hence, ownership
- in operations, research and decision-making deserves urgent consideration.
The concentration of power in some peak institutions may also need reform,
e.g., by delegating authority to other, even new agencies, as well as
by encouraging decentralization, devolution, complementarity and competition
(with other IFIs, including regional IFIs). Developing countries and others
need to be more seriously and systematically consulted by the G7 and other
existing coordination institutions in matters of international economic
governance to avoid insensitive and potentially disastrous oversights
as well as loss of policy legitimacy.
Fifth, national economic authority and autonomy essential for more effective
macroeconomic management and sustainable development need to be restored
and ensured. Policy conditionalities accompanying financing must be minimized
and necessary to address the problems at hand. It is clear that "one
size does not fit all", and recently imposed policies have not contributed
much to either economic recovery or growth, let alone sustained development.
Such reforms will ensure greater legitimacy for public policies and should
include regulation of the capital account as well as choice of exchange
rate regime. Since it is unlikely that reforms in the foreseeable future
will adequately provide the "global public goods" and international
financial services needed by most developing countries, it is imperative
that while reforming the international system to better serve sustainable
development, national policy sovereignty is also ensured to better address
regulatory and interventionist functions beyond global and regional purview.
Finally, there is growing appreciation of the desirability of regional
monetary cooperation in the face of growing capital mobility and the increasing
frequency of currency and related financial crises, often with devastating
consequences for the real economy. It has been recognized, for instance,
that growing European monetary integration in recent decades arose out
of governments' recognition of their declining sovereignty in the face
of growing capital mobility, especially as their capital accounts were
liberalized. Instead of trying to assert greater national control, with
limited efficacy likely, cooperation among governments in a region is
more likely to be effective than going it alone in the face of the larger
magnitude and velocity of capital flows. The existence of such regional
arrangements also offers an intermediate alternative between national
and global levels of action and intervention, and reduces the likely monopolistic
powers of global authorities. To be successful and effective, such regional
arrangements must be flexible, but credible, and capable of effective
counter-cyclical initiatives for crisis prevention as well as management.
With the growing reluctance to allow the IMF to serve as a "lender
of last resort", there should be growing acceptance of regional cooperative
arrangements as alternatives.