Interview: Western financial institutions endanger developing countries with "debt trap"

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by Xinhua writer Tai Beiping

BEIJING, Aug. 18 (Xinhua) -- Reckless operations of large European and American investment institutions are undermining the debt sustainability of some developing countries and putting their economic stability at risk, a Chinese scholar has warned.

In a recent interview with Xinhua, Professor Tang Xiaoyang of China's Tsinghua University said the U.S. subprime mortgage crisis in 2008, coupled with the European debt crisis, have led to the diversion of large amounts of private financial capital from the West to developing countries. Such funds, when the economies are facing downward pressure, could prove to be troublesome.

"At that time, capital that did not find a growth point in Western countries hoped to grow from developing countries, so they greatly encouraged developing countries to issue bonds and profited from them," he said.

In a report released earlier this month by a team led by Tang, researchers found out that in just 12 years after 2008, the stock of sovereign bonds (mainly Eurobonds) of all low- and middle-income countries rose by nearly 400 percent to reach 1,737.2 billion U.S. dollars in 2020, accounting for over 50 percent of these countries' external debt.

"This is the first time they have issued bonds, so they are inexperienced, and under such circumstances, they feel that everything is very good when the economy is going up. I borrow more debt, but I did not expect when the economy is down, the prices of resources and commodities also drop," Tang said.

Issuing bonds helped them solve some short-term problems, however, for some developing countries that have vulnerable economic structures and lack financial risk management experience, it might be difficult to deal with the adverse impacts of a global economic downturn.

Currently, many countries have already been forced to issue new bonds with higher interest rates in order to repay old debt, forming a vicious cycle in the medium and long term, according to Tang's report, which was titled "The trap of financial capital: The impact of international bonds on the debt sustainability of developing countries."

With bond interest rates far higher than traditional bilateral and multilateral debts, interest payments to the Western financial institutions now account for more than 63 percent of the total interest expenses of those bond-issuing countries.

To make things worse, as international bonds are mainly denominated in currencies such as the U.S. dollar or the euro, the actual debt repayment burden has greatly increased as the U.S. Federal Reserve raises interest rates and the dollar gets stronger on the foreign exchange market.

Tang also explained that for bilateral and multilateral sovereign debts under the G20 framework, there are agreements on debt reduction or debt mitigation, but private bonds are not under such a framework and are considered by Western countries to be fully market-oriented.

These institutions might justify themselves by saying that they conduct market-oriented conventions and market-oriented operations, "and this is precisely the crux of the problem," Tang said.

The so-called market rules mentioned here are based on market conditions in developed countries or the characteristics of their developed markets, but not developing countries, he argued.

"We can see that, especially in the economic crisis in recent years, such as the Sri Lanka example, such a bond issuance in the capital market actually further amplifies market volatility," Tang said.

If the indebted countries cannot make repayments, they will face a chain reaction of default, rating downgrade, foreign exchange shortage, and currency depreciation, leading to further economic recessions and even political stability.

Western financial institutions encourage developing countries to issue international bonds, with a major feature being that there are no restrictions on the use of these bonds, Tang said. Some may take money just for payroll or non-productive contingency purposes, but do not see the long-term burden that such an approach might have.

The severe impact of cyclical bond repayment has led to many developing countries to fall into a vicious cycle of unsustainable economic growth in modern history. Western media and governments have seriously neglected the impact of international bonds on national sovereign debt, Tang said. Enditem

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