As many low- and middle-income countries (LMICs) grapple with a sharp rise in payments on their sovereign debt in the wake of the COVID-19 pandemic and the war in Ukraine, leaders across the world are calling for urgent debt restructuring and reforms to the development financing system. Their calls are often framed in humanitarian and ethical terms.
An August 2023 UN report described the global debt crisis as a product of “inequalities in the international financial architecture” and argued that the provision of debt relief from high-income countries is an essential step toward creating a more just world economy. Two months later, U.S. Assistant Secretary of the Treasury for International Finance Brent Neiman cited the example of Sri Lanka’s debt default in 2022, which led to the rationing of fuel and medicine, a deterioration of public services, and ultimately emergency assistance from the United States and others
These ethical arguments are compelling. However, reducing the burden of loan servicing and expanding development financing for LMICs are not just ethical responsibilities for wealthy Western nations—they are also strategic imperatives. The impacts of debt distress are not confined to the borders of indebted nations. High debt servicing costs increase poverty and fragility in developing countries, contributing to political instability. They also reduce those countries’ capacity to combat climate change, the effects of which are felt globally, including in the form of mass migration to Europe and North America.
More generally, alleviating global debt burdens is in the economic interests of wealthy nations, particularly those in the West. Higher income growth in LMICs is likely to increase their imports and reduce demand for development aid, eventually driving growth in wealthy nations and freeing tax dollars to be spent domestically. Debt forgiveness could act as a transfer within creditor nations—from wealthy savers to farmers, manufacturers, and producers—by stimulating import demand from debtor nations, rather than act as a transfer from creditor nations to debtor nations. Poverty reduction through debt reform could thus lead to mutual benefits for wealthy nations and LMICs. Finally, debt reform could pay geopolitical dividends for Western countries, such as stronger diplomatic ties with LMICs and diminished Chinese and Russian influence.
How Effects of the Debt Crisis Spread Globally: Poverty, Fragility, and Climate Resilience
Sixty percent of low-income countries and 25 percent of middle-income countries are now either in debt distress or at high risk of debt distress. Overall, 3.3 billion people now live in countries that spend more on interest payments than on either health or education. Thanks to the COVID-19 pandemic, the economic fallout from the war in Ukraine, and the deepening climate crisis, the cost of servicing debt has risen precipitously for many governments that are struggling to meet their debt obligations. Public expenditure on interest payments in LMICs is growing faster than spending on public services like education, health, infrastructure, and sanitation. It is also crowding out investments aimed at growing incomes, driving growth, and addressing climate change.
This shift away from public service spending has already had serious consequences for LMICs. High indebtedness is exacerbating poverty; impeding progress toward the first Sustainable Development Goal (SDG), which calls for an end to poverty; and endangering progress on other SDGs, including improved access to education, healthcare, energy, and sanitation. Alleviating the burden of rising debt service could thus result in huge dividends for LMICs. According to the UN Development Programme, just 4 percent of what LMICs spent on external public debt servicing in 2022 would be sufficient to undo the pandemic-precipitated rise in poverty in those countries—in effect, lifting 165 million people out of poverty. Greater debt relief could do the same for hundreds of millions more.
Poverty precipitated by high levels of LMIC indebtedness generates negative spillovers for wealthy nations beyond simply a reduction in global economic growth. For instance, poverty contributes to state fragility and political instability, which can make countries more susceptible to violence and extremism. It also undermines the capacity of LMICs to respond to climate change and spurs mass irregular migration. Although the causal linkages in these cases are indirect, wealthy countries cannot afford to ignore the knock-on cross-border impacts of unsustainable debt burdens.
Data published by the International Monetary Fund (IMF), the Fund for Peace, and the Notre Dame Global Adaptation Initiative show that many countries with high debt burdens are also fragile states or are particularly vulnerable to climate risks (see table 1). The Fund for Peace’s Fragile States Index defines state fragility as the risk of state collapse and aims to capture a state’s capacity to respond to and withstand crises.1 The Notre Dame Global Adaptation Initiative’s Country Index measures both a country’s vulnerability to climate change and its readiness to improve climate resilience.2 As shown by the correlation between debt risk, political risk, and climate risk, the debt crisis has the potential to substantially exacerbate national security risks.
| Table 1. The Conflict and Climate Risks of Countries With Significant Debt Burdens | |||||
| Country | Risk of External Debt Distress (2023) | Fragile States Index Score (2023) | Fragile States Index Rank (2023) | Climate Vulnerability and Readiness Index Score (2021) | Climate Index Rank (2021) |
| Afghanistan | High | 106.6 | 6 | 32.8 | 179 |
| Burundi | High | 94.2 | 20 | 35.5 | 169 |
| Cameroon | High | 94 | 21 | 40 | 145 |
| Central African Republic | High | 105.7 | 8 | 27.7 | 184 |
| Chad | High | 104.6 | 9 | 27 | 185 |
| Comoros | High | 82.2 | 45 | 38.1 | 157 |
| Republic of the Congo | In Debt Distress | 90.7 | 28 | 35 | 174 |
| Djibouti | High | 82.2 | 45 | 42.6 | 130 |
| Dominica | High | Not Available | Not Available | 53.5 | 64 |
| Ethiopia | In Debt Distress | 100.4 | 11 | 37.5 | 163 |
| The Gambia | High | 76.1 | 67 | 39.8 | 148 |
| Ghana | In Debt Distress | 62.3 | 107 | 44.9 | 114 |
| Grenada | In Debt Distress | 53.7 | 127 | 54.8 | 57 |
| Guinea-Bissau | High | 89.9 | 31 | 32.5 | 181 |
| Haiti | High | 102.9 | 10 | 35.5 | 169 |
| Kiribati | High | Not Available | Not Available | Not Available | Not Available |
| Laos | In Debt Distress | 74.7 | 70 | 43.8 | 121 |
| Malawi | In Debt Distress | 83.2 | 43 | 37.6 | 161 |
| Maldives | High | 62.9 | 106 | 45.8 | 109 |
| Marshall Islands | High | Not Available | Not Available | 39.6 | 150 |
| Micronesia | High | 69.3 | 88 | 37.2 | 165 |
| Mozambique | In Debt Distress | 94 | 21 | 38.5 | 154 |
| Papua New Guinea | High | 78.1 | 59 | 36.8 | 167 |
| Samoa | High | 65.1 | 101 | 46.6 | 104 |
| Sao Tome and Principe | In Debt Distress | 69.7 | 86 | 42.7 | 129 |
| Sierra Leone | High | 81.4 | 51 | 37 | 166 |
| South Sudan | High | 108.5 | 3 | Not Available | Not Available |
| Saint Vincent and the Grenadines | High | Not Available | Not Available | Not Available | Not Available |
| Sudan | In Debt Distress | 106.2 | 7 | 32.8 | 179 |
| Tajikistan | High | 74.2 | 72 | 47.6 | 98 |
| Tonga | High | Not Available | Not Available | 41.1 | 140 |
| Tuvalu | High | Not Available | Not Available | Not Available | Not Available |
| Zambia | In Debt Distress | 81.8 | 48 | 42.4 | 132 |
| Zimbabwe | In Debt Distress | 69.6 | 16 | 35.6 | 168 |
| Note: The numbers in the table are color coded to indicate relative risk along the relevant indices. Along a color spectrum ranging from red to blue, red indicates the greatest risk, followed by orange, yellow, and green, and blue indicates the least risk. Sources: “List of LIC DSAs for PRGT-Eligible Countries,” International Monetary Fund, November 30, 2023, https://www.imf.org/external/pubs/ft/dsa/dsalist.pdf; “Fragile States Index: Country Dashboard,” Fund for Peace, https://fragilestatesindex.org/country-data; and “ND-GAIN Country Index,” University of Notre Dame, https://gain.nd.edu/our-work/country-index/rankings. |
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Researchers have established a connection between poverty and violence, albeit a tangled one mediated by intervening variables. High levels of poverty exacerbate fragility by undermining already weak governing institutions. Fragile states have a diminished capacity to provide essential services, including public order, as well as reduced popular legitimacy, making them more vulnerable to political instability and violent challenges from insurgents. Rising levels of poverty have also been shown to reduce the opportunity costs for individuals to engage in violence and, at the same time, reduce the capacity of states to respond to security threats.
Worldwide, poverty is increasingly concentrated in around forty fragile states. The deepening debt crisis, if unresolved, will increase both the number of the world’s poor states and the number of fragile states. The crisis is likely to aggravate political grievances and reduce state capacity and legitimacy, including in countries that are already home to active, anti-Western insurgencies. As table 1 indicates, among the countries that are either already debt distressed or at high risk of it are Afghanistan, Mali, Mozambique, and Ethiopia, where militant groups such as al-Qaeda, Boko Haram, the self-proclaimed Islamic State, and al-Shabab, respectively, are active and pose plausible threats to U.S. and European interests. Sustainable debt relief, by helping to improve livelihoods, could reduce the appeal of extremism, as well as individual incentives to resort to violence to achieve political and economic changes. It could also help ensure that fragile states are not further weakened due to a lack of financial resources.
Beyond exacerbating fragility and instability, the debt crisis could undermine the interests of wealthy nations by weakening LMICs’ capacity to mitigate and adapt to climate change. Table 1 shows that some of the countries least able to mitigate the effects of climate change are also among the world’s most debt burdened. The small island developing states of Comoros, Dominica, Grenada, Haiti, Kiribati, Maldives, Marshall Islands, Micronesia, Papua New Guinea, Samoa, Sao Tome and Principe, Saint Vincent and the Grenadines, Tonga, and Tuvalu—which all face an existential threat from climate change–induced sea-level rise—are either debt distressed or at high risk of it. As Kenyan President William Ruto and other high-level officials pointed out in October 2023, debt service burdens are diverting scarce funds away from developing countries’ efforts to build climate resilient infrastructure, hasten the transition to clean energy, and reduce carbon emissions that harm the entire planet. These dynamics will slow the decarbonization of the world economy, to the detriment of global prosperity and security.
A U.S. National Intelligence Council report, released in October 2021, identifies three likely flash points in which climate change could precipitate national security risks for the United States in particular: growing geopolitical tensions resulting from disagreement over the measures necessary to adapt to climate change, how these shifts will be financed, and how resources will be allocated; growing cross-border tensions, resulting from competition for natural resources like water; and growing instability within individual countries that increases demand for humanitarian relief, strains food and energy systems, exacerbates internal conflict, and undermines public security. The global debt crisis is likely to intensify all three climate change–induced security risks.
Finally, the debt crisis, if unaddressed, will likely add to already high levels of irregular migration by deepening poverty and undermining efforts at climate adaptation and resilience in highly indebted countries. According to the International Organization for Migration, climate change is already displacing millions from their homes. The World Bank and other organizations estimate that, by 2050, hundreds of millions could be at risk of displacement. Afghanistan, Ethiopia, Kenya, and Sudan are among those countries projected to produce the most climate migrants; they are also either debt distressed or at high risk of debt distress.
Across Africa, South and Southeast Asia, the Pacific, and the Middle East, LMICs experiencing debt distress will disproportionately bear the consequences of climate change. Their inability to invest in climate resiliency due to the burden of debt servicing, and the resulting loss of livelihoods, will surely push more of their residents to make perilous journeys to wealthy countries in search of better opportunities. Australia, Europe, and the United States are already struggling to manage significant influxes of irregular migrants. The debt crisis will only increase migration, contributing to economic strains and further political polarization in destination countries.
How Debt Restructuring Provides Economic Benefits to Wealthy Countries
Debt reform will not just stave off significant costs for creditor nations; it will also open new avenues of economic growth for wealthy countries. Intuitively, it is easy to view debt forgiveness or restructuring as being harmful to creditor countries, since it requires a reduction in the value of assets on creditor balance sheets. However, the “loss” to the creditor needs to be kept in perspective, because in the absence of debt relief, there is no probable scenario in which the debt-distressed country would be able to repay the full liability. Moreover, because debt relief will likely encourage economic growth, thereby increasing debtors’ capacity for repayment, debt restructuring could ultimately result in greater profits for creditors. It could also create opportunities for mutually beneficial trade and investment and reduce the demand for publicly funded development assistance, leaving more of creditor nations’ resources available for domestic consumption.
Michael Pettis, a professor at Peking University and a nonresident senior fellow at the Carnegie Endowment for International Peace, has outlined why forgiveness of sovereign debt is often in the best interests of creditors. Countries that are severely debt burdened enter a negative feedback loop: high debt servicing costs stifle domestic investment within debtor countries, slowing economic growth and reducing the ability of debtors to service existing debt. This makes debt servicing even costlier, as the debtor’s ability to service their debt comes into question. Creditors can break this cycle by reducing a country’s debt burden enough to ensure that it retains the ability to invest in growth-driving activities. In doing so, creditors trade larger nominal amounts of debt that are unlikely to be serviced in exchange for smaller nominal amounts of debt that are likely to be serviced. Thus, although debt forgiveness results in a nominal loss, in reality, creditors are likely to recoup a larger value in taking this approach.
In fact, debt relief could actually add value to creditor nations’ economies. When the cost of debt servicing rises, debtor nations are forced to cut back on imports. Foreign currency reserves generated via exports must be spent on debt servicing rather than on purchasing goods from abroad, and reduced economic activity caused by the decline in public services and subsequent economic contraction dampens consumer demand for imports. Providing debt relief could thus increase demand for exports from creditor nations. In this way, debt forgiveness could result in a transfer of wealth from unproductive savers within creditor nations to farmers, manufacturers, and other producers within creditor nations, rather than in a transfer from the creditor nation to the debtor nation. Debt forgiveness acts as an economic stimulus for both debtor and creditor nations.
In addition, well-structured debt relief could reduce the demand for humanitarian and development assistance from abroad, enabling wealthy nations to use those resources for other purposes. Research from the IMF has shown that previous restructurings of LMICs’ debt substantially reduced public and external debt burdens and sparked sharp growth in productivity and output for debtor nations. The economic growth that results from debt forgiveness can reduce poverty in LMICs and free up public funds, thereby decreasing LMIC reliance on financing from abroad.
How Debt Reform Pays Geopolitical Dividends
Finally, debt relief could reap geopolitical dividends. Both Europe and the United States are engaged in diplomatic pushes to improve relations with LMICs, in part to counter Chinese and Russian influence within the Global South. The administration of U.S. President Joe Biden and the European Union have embraced language supporting a “fairer” global economic order that meets the needs of and creates lasting benefits for partner countries. Many LMICs, however, remain “fence-sitters,” continuing to engage strategically with China and Russia and impeding Western countries’ diplomatic aims in the process.
Western countries frequently invoke the issue of debt in asserting that China’s engagement with LMICs is exploitative, arguing that the latter would be better served by partnering with the West. The Biden administration has expressed concern that China’s development policies are unethical and predatory, leaving LMICs trapped in unsustainable debt. In a speech at the 2023 Global Gateway Forum, an event seemingly focused on countering China’s Belt and Road Initiative, European Commission President Ursula von der Leyen billed the Global Gateway as offering LMICs a better option, stating that “no country should be faced with a situation in which the only option to finance its essential infrastructure is to sell its future.”
However, private creditors—many of whom are based in Western cities like Frankfurt, London, New York, and Paris—are perhaps more significant contributors to the debt crisis that is currently forcing LMIC governments to spend more on debt repayments than public services. In 2021, private creditors held 62 percent of developing countries’ external public debt. In 2022, private creditors received 59 percent of African governments’ external interest payments. Moreover, private creditors can use litigation (grounded in American, British, and European financial law) to force large payouts amid sovereign debt crises. Although Belgium and the United Kingdom have taken some legislative steps to force private creditors to provide debt relief, these steps remain insufficient. Zambia’s debt-restructuring process, which has been ongoing for over three years, recently stalled once more due to official creditors’ concerns that private creditors were receiving a more generous deal than official lenders, including the IMF and China. Because the vast majority of international sovereign debt is issued under New York State or British financial law, the United States and the United Kingdom are uniquely positioned to drive or impede progress on restructuring debt held by private creditors. Until Western countries bring private investors to the table on debt restructuring, in the eyes of LMICs they will be doing exactly what von der Leyen accuses the Chinese of doing.
Given its own complicity in the current debt crisis, the West’s debt-trap rhetoric about China and its calls for a fairer global economy are proving unpersuasive. Deeper engagement by Western countries on debt reform for LMICs, particularly stronger efforts to bring private debt holders to the table, could reduce the perception that Western governments are hypocritical and out of touch. The Common Framework for Debt Treatments, established by the G20, has helped to resolve problems with the traditional sovereign debt restructuring process by bringing non–Paris Club creditors like China into the fold and stipulating that private creditors must provide debt relief comparable to that provided by public creditors. However, there is no clear enforcement mechanism to ensure that private lenders actually comply with the framework.
A variety of innovative solutions have been proposed to ensure that private creditors based in wealthy nations participate in debt relief. Politicians in New York State and the United Kingdom, for instance, have called for legislation capping what private creditors can recover in sovereign debt restructurings, codifying norms and mechanisms around the participation of private creditors in the restructuring process, and revising the “champerty” doctrine, which prohibits pursuing lawsuits motivated by a financial interest in the outcome. Listening to LMICs’ concerns and delivering tangible debt relief could persuade developing nations that they stand to benefit from deeper engagement with the West. Debt relief thus offers a prime opportunity for the West to counter Chinese and Russian influence by backing its diplomatic rhetoric with practical policies rooted in shared interests with the Global South. Such policies are likely to be more persuasive than pious invocations of the rules-based international order.
Further, greater participation in debt forgiveness also provides an opportunity for Western lawmakers to ensure that producers at home, rather than Chinese manufacturers, benefit from the globalized economy. Chinese lenders’ unwillingness to move forward with a restructuring of the debt they own without greater concessions from other creditors is currently preventing Zambia from exiting default and threatens other debt restructurings. As noted earlier, producers in creditor nations are major beneficiaries of debt restructuring. By accepting a generous restructuring with or without equivalent Chinese concessions, Western countries have the opportunity to (1) secure significant economic benefits for their farmers and manufacturers, (2) lift the burden of debt servicing from highly indebted nations, and (3) show LMICs that Western nations are, in fact, better partners in financing development than China.
Conclusion
Although it is tempting to conceptualize debt relief as an act of charity or a purely humanitarian concern, it should also be seen as a source of mutual benefit for creditor nations and LMICs alike. Neither the costs of the debt crisis nor the benefits of resolution are limited to the borders of LMICs. And debt restructuring need not be costly. It could be a boon both economically and geopolitically. Wealthy nations, especially in the West, should add enthusiastic support for debt relief to their current engagement efforts with LMICs, particularly by bringing private creditors to the negotiating table.
However, there is a deeper structural problem that the West must address, beyond the demand for debt relief: namely, the inaccessibility of public financing that can meet the needs of LMICs. From an economic perspective, debt per se is not a problem. Indeed, when it is structured so that debtors can sustainably meet the terms of the debt agreement, it can benefit both the creditor and the debtor—and serve as a transformative source of development financing. In fact, hundreds of billions of dollars of additional debt issued to LMICs is likely necessary to finance the climate transition. The unsustainable debt burden borne by LMICs, and the wave of defaults triggered as a result, are symptoms of the lack of public financing for LMICs’ needs.
To unlock the potential mutual benefits to debtor and creditor nations through debt reform and ensure that debt crises do not recur among LMICs, the world needs to shift beyond largely employing debt forgiveness to more aggressively reforming the development financing landscape. LMICs must be able to finance urgently needed public projects without assuming very expensive debt. Wealthy Western nations, particularly the United States, should move quickly to better support this reform so that countries that have been forced into austerity to service their debts or have defaulted can obtain generous debt restructurings. There are a number of ways to do this: for example, through amending current finance laws; buying out Chinese debt; reallocating IMF Special Drawing Rights (international reserve assets); and reforming the Bretton Woods institutions, particularly by expanding the availability and flexibility of concessional loans.
Delaying meaningful reform will likely result in greater national security and climate risks (exacerbated by the debt crisis) and worsen the economic damage incurred by nations drowning in debt. Alternatively, moving faster on debt forgiveness and structural changes that increase access to public financing could result in more economic and geopolitical dividends for the West and ensure that the West—rather than China—leads international public financing.
Notes
1 The Fragile States Index aims to capture a country’s risk of state failure. The index compiles assessments of twelve indicators of state fragility: the condition of the state security apparatus; fragmentation and conflict within state institutions and the ruling elite; the existence and salience of social divisions; economic decline; uneven economic development; human flight and brain drain; state legitimacy; public services; human rights and rule of law; demographic pressures from population growth, distribution, and density as well as availability of essential resources; the presence of refugees and internally displaced persons; and the influence of external actors in state functioning. Index values range from 0 to 120, and a higher index value indicates greater risk. The index ranking compares index values for countries within the dataset, with a ranking of 1 indicating the greatest relative fragility.
2 The Notre Dame Global Adaptation Initiative Country Index measures a country’s vulnerability to climate change in combination with its readiness to improve resilience. The index uses over forty indicators to evaluate how exposed a country’s “life-supporting sectors” (food, water, health, ecosystem services, human habitat, and infrastructure) are to climate risks, how sensitive they are to climate-induced changes, and their capacity to adapt to climate risks. The index also evaluates the country’s capacity to mobilize capital for climate investments, provide a stable governance environment, and efficiently and equitably make use of climate investments. Index values range from 0 to 100, and a higher index value indicates that a country is less vulnerable to climate change and more able to respond to climate threats. The index ranking compares index values for countries within the dataset, with a ranking of 1 indicating that the country is least exposed to climate risk and most prepared to adapt to climate change.
