Third World Debt

Deficits, Debt and the Role of the IMF

 

Aims of the IMF
Creation of Third World Debt
Lending Practices
Criticisms of IMF Intervention
Sources

Creation of Debt

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Top Ten IMF Borrowers

 

 

 

 

 

 

 

 

 

 

 

 

 

Origins of Debt Crisis

Nature of Debt Crisis

Causes of Debt Accumulation

 

Origins of the Debt Crisis:
In the 1960s the US Government had spent more money than it earned and to make up for this decided to print more dollars. So the world's stocks of dollars fell in value.
This was bad news for the major oil-producing countries, whose oil was priced in dollars. The money they made from exports now bought less. So in 1973 they hiked their prices. They made huge sums of money and deposited it in Western banks.
Troubles fermented. Interest rates nosedived and banks were faced with an international financial crisis. They lent out the money fast, to stop the slide, and the Third World met their criteria. These economies were on the path to progress, but needed an extra nudge to maintain development and meet the rising costs of oil.
Banks lent generously, without paying much heed to the fact that the money might potentially be misused and would be unlikely to be repayed. Third World governments, for their part, were pleased to take advantage of loans at very low interest rates - below the rate of inflation.
Some countries, like Mexico and Venezuela, took out loans to repay previous debts. But for others, this was the first time they had borrowed from commercial banks. Many intended to use the money to improve standards of living in their countries.
A fraction of the money borrowed was utilized to benefit the poor. Across the range, about a fifth of it went on arms, often to shore up oppressive regimes. Many governments started large-scale development projects, some of which proved of little value. All too often the money found its way into private bank accounts.
In the mid 1970s, Third World countries, encouraged by the West to grow cash crops, suddenly found that they weren't getting the prices they were used to for the raw materials they sold, like copper, coffee, tea, cotton, cocoa. Too many countries - advised by the West - were producing the same crops, so prices fell.Consequently, interest rates began to rise, pushed further by an increase in US interest rates. Meanwhile oil prices rose again. The trap was sprung - Third World countries were earning less than ever for their exports and paying more than ever on their loans and on what they needed to import. They had to borrow more money just to pay off the interest.
In 1982 Mexico told its creditors it could not repay its debts. The International Monetary Fund (IMF) and World Bank stepped in with new loans under strict conditions, to help pay the interest. The IMF is a Western-dominated creditor, which in effect acts as a Receiver but unlike a Receiver makes short-term loans to help countries pay off other loans.
This pattern was repeated over and over in the following years as other countries found themselves in similar situations to Mexico's. But their debts continue to rise, and new loans have added to the burden.
When Mexico defaulted on its debt repayments in 1982 the whole international credit system was threatened. Mexico owed huge sums of money to banks in the US and Europe, and they didn't want to lose it. So they clubbed together and got the support of the International Monetary Fund (IMF) for a scheme to spread out or reschedule the debts. Since then the IMF and the World Bank - the two main international financial institutions - have been involved in lending money and rescheduling debt in countries which, like Mexico, cannot pay the interest on their loans.

 

Nature of Debt Crisis

The net foreign debt of developing countries as a group in relation to their Gross Domestic Product (GDP) began to rise in 1973, moving from about 15% to 22% by 1978. However, it then began to level off. This suggested that the developing countries were going to be able to bring their balance of payments positions under long-term control in time to prevent debt loads from exceeding the upper limits of credit worthiness.
This optimism did not last long and was immediately proved false after 1978. As the graphs indicate, 1978 saw a movement of interest rates to historically unheard of levels.
This crisis was compounded by the fact that 1978 witnessed a second massive hike in oil prices, placing developing countries in other precarious situation. In order to keep up with skyrocketing oil prices, many developing countries were forced to draw upon already dwindling supplies of foreign exchange. This action saw their treasuries being drained of any hope of repaying debts in the near future.
To add fuel to fire, world commodity prices saw a sharp decline. As the world commodity graph shows, the early and mid 80’s showed prices dipping below even the 100 base index established in 1977. Naturally with fewer exports, the balance of payments situation for developing economies was not favorable. This deep slash in export revenues of developing countries and accompanying recession in the Thirld world all culminated in ever increasing debt levels.
All these developments coalesced to cause the debt servicing burden of developing countries to rise in 1979. Hence, the flows of finance between the advanced and developing worlds, ideologically intended to promote economic stability, employment and improved living standards infact proved to be a perverse and dangerous anomaly. Up till the year 1982, loans had been understood to take a significant amount of time in bearing fruit. IMF and creditor countries were indifferent to the completely skewed, one-way transfer of resources, deeming time to be the only facilitator of Third World Development.
Unfortunately, since the debt crisis broke out in 1982, these flows made a one-eighty degree turn and were instead channeled back towards the IMF and the creditors. By 1985, the IMF had estimated that there was to be a resource flow from the seven largest Third World borrowers back to their creditors worth $32 billion, one-fifth of their entire earnings from the sales of exports.
Many critics claim that it was in fact high interest rates which proved to be the main stimulus for this crisis. Ignoring exorbitant rates of interest , the IMF and creditors always assumed that the financial markets would  continue to refinance old debt  and continue extending resources to catalyze the development process.

 

Causes of Debt Accumulation for Third World Countries:

1) Continuing Legacy of Colonialism:
A working paper by South Centre, a developing organization summarizes how the developing countries’ debt is partly the result of the unjust transfer to them of the debts of the colonizing States.

“The history of third world debt is the history of a massive siphoning-off by international finance of the resources of the most deprived peoples. This process is designed to perpetuate itself thanks to a diabolical mechanism whereby debt replicates itself on an ever greater scale, a cycle that can be broken only by canceling the debt.”
Third World Debt a Continuing Legacy of Colonialism, South Centre, Bulletin 85, August 2004

This is confirmed by a new Working Paper on “Effects of debt on human rights” prepared by Mr. El Hadji Guissé for current UN Sub Commission on Human Rights (E/CN.4/Sub.2/2004/27) T working paper claims that the developing countries’ debt is partly the result of the unjust transfer to them of the debts of the colonizing States. After the quick withdrawal of most colonizing powers following the Second World War, a sum of US$ 59 billion external in public debt was imposed on the newly independent States. This was compounded by the additional strain of an interest rate unilaterally set at 14 per cent. Before these nascent nations even had time to organize their economies and get them up and running, they were already saddled with a heavy burden of debt.

2) Vulnerability of developing economies:
Most Third World Countries are unable to repay debts because their crippling economies cannot muster to produce enough excess capital for them to export and generate enough foreign currency reserves.
Generally, poor countries have soft currencies that are subject to constant fluctuation. On the other hand, loans have to be paid back in hard currencies, (American Dollar, Japanese Yen) which are relatively stable. Paying off loans then implies earning foreign exchange in hard currencies. Owing to the fact that most developing countries are agro-based economies, terms of trade do not favor then and debts increasingly become an arduous burden. 
Countries are then placed in a quandary where they have to then refinance loans by taking on new debts to service the old ones.
Exacerbating this problem is the fact that structural adjustment advice in the past from the IMF and others gives impetus to cut back on important spending such as health, education, in order to help repay loans. This in turn perpetuates the downward spiral and the poverty cycle is reinforced.

3) Embezzlement and Corruption:
A significant cause of debt accumulation in Third World countries is the misappropriation of funds by traditional elites or bureaucratic officials at the helm of financial affairs in developing countries. Often the money lent to develop economies is siphoned off by corrupt institutions and channeled towards offshore private accounts. Hence, the loans never actually serve their intended purpose of facilitating and catalyzing economic development.
Many loans also come with conditions, that include preferential exports etc. In effect then, more money comes out of the developing countries than is given in. This depresses wages even further due to the spiraling circle downwards to ensure that enough exports are produced. Susan George, in her 1992 book, Debt Boomerang: How Third World Debt Harms Us All, calculated a net of $418 billion borrowed funds flowed right back north between 1982 and 1990.

 


 

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This site was created by Noor El - Edroos for Professor Vincent Ferraro's World Politics course (Spring 2009) at Mount Holyoke College.

To contact this site's creator, please email eledr20n@mtholyoke.edu