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Government debt and wealth in the Global South

9 Conclusion

One of the consequences of the different waves of decolonization has been the emergence of many new nations and states, with lower incomes, significant proportions of their populations below poverty lines, elevated levels of inequality, and the desire to develop. Government debt has been an instrument that these types of countries have used to increase the welfare levels and social cohesion of their population but also to fund infrastructure, education, and social investments that could accelerate their development process. Government debt can be a useful tool, but it also carries some inherent dangers.

Many developing countries have taken advantage of globalization. It has allowed them to deploy accelerated growth strategies centred on a rapid expansion of their exports. It has also allowed them access to international capital markets where they have funded some of the investments necessary for their modernization and expansion of exports. However, it is increasingly clear that the high volatility of global markets and the exposure to a variety of structural and systemic risks is one of the costs associated with globalization. Moreover, the possibility of structural crises that impact different aspects of the global economy (like the possibility of a pandemic accompanied by a financial meltdown) highlights the need to rethink precautionary fiscal, sovereign wealth, and debt policy. The history of debt crises in developing countries shows how debt strategies that can seem useful at one point in history can become a heavy burden when global financial and economic conditions deteriorate, and can actually make it more difficult for countries to recover.

During the COVID-19 pandemic, emerging countries with healthier fiscal accounts were able to buy and deploy vaccines at a much higher speed, reducing the effects of COVID-19 on their populations. Adequate and prudent levels of all these fiscal variables may have changed and this may be especially true for developing and emerging countries with more fragile relationships with global finance. One aspect that makes this problem particularly difficult for the Global South is the absence of a coherent system of arbitration for the private international government debt system which is increasingly dominated by government debt bonds that are held (and traded) by private investors.

One solution to this increasingly volatile world for some low- and middle-income countries is the establishment of sovereign wealth funds, where part of the excess revenues from commodity booms can be saved and used in times when international markets deteriorate. Some countries have followed this strategy and it seems increasingly likely that more and more commodity exporters will need to set up these mechanisms.

There is an enormous difference between the current world of privately held government debt with the scenario after the Second World War, when most of the government debt of developing countries was with other governments, multilateral agencies, or even large commercial banks but collateralized by these governments or agencies. After the Second World War, the Bretton Woods system established an institutionalized system for this type of arbitration based on the fact that most of developing countries’ government debt was held by multilateral institutions or world powers (such as the IMF, the World Bank, and the Paris Club). This allowed for political negotiations that considered the social and strategic consequences of different solutions. There is no such system in place, at this point, for the market of government debt bonds. Rather, the role of private banking and financial speculators has grown along with the expansion of financial globalization. To establish effective global governance of a private government debt market, we must adapt the lessons learned from Bretton Woods to modern times.

Recently, the opposite problem to government debt has developed. Many LMI nations have managed to accumulate SWFs as a result of increased commodities prices and/or expanded exports of these products. Countries have realized that the incomes from these exports can be very volatile or even transitory so they set up these funds and endow them with rules and governance to protect the long-term prospects of their management and use. SWFs have become an important feature of the fiscal policy of many LMI countries and involve many of the same economic problems and pressures of debt.

To use Sri Lanka as an example, in September 2024, Anura Kumara Dissanayake was elected as the tenth President of Sri Lanka. President Dissanayake is the first president not to be elected from Sri Lanka’s traditional political parties and is a member of the Janatha Vimukthi Peramuna (JVP or People’s Liberation Front), a traditionally Marxist–Leninist organization that was involved in two failed armed insurrections. The first, in 1971, involved the military intervention of the armed forces of India, Pakistan, the Soviet Union, and North Korea, and ended with over 1,000 casualties; the other was in the late 1980s and involved the intervention of India and ended with anything from 60,000 to 80,000 casualties. The election of President Dissanyake was an electoral upset with a shocking first-round vote that disqualified traditional parties and a surprising second-round victory. The JVP has only 3 out of 225 members of parliament and the new president has had to manoeuvre to construct a political coalition that allowed him to govern his country and keep his electoral promises of land and tax reform, economic redistribution, and anti-corruption measures.

The surprising election of President Dissanayake was a direct consequence of a huge debt crisis suffered by the country that has seen its debt increase from 11 billion USD in 2005 (20% of GNI) to over 100 billion USD during 2024 (around 120% of GNI), which means that it has been adding, on average, 4.7 billion USD per year over two decades. This is an astonishing speed of debt accumulation. The budget of the Sri Lankan government fluctuates in the range of 15–20 billion USD. This means, essentially, that a quarter of the country’s fiscal spending has been financed with debt for twenty years. There are many reasons behind the crisis. Some are related to unsustainable internal policies, others to external conditions faced by the country. What seems clear is that Sri Lanka had no margins with which to face the COVID-19 pandemic when it struck. The collapse of the economy during the pandemic, together with a severe crisis of the agricultural and energy sector, drove the government to declare a food emergency in 2021. The country essentially lost all of its central bank reserves and went into insolvency. By late 2021 both the International Monetary Fund and the World Bank had sent missions and started to negotiate relief and reform programmes with the government. A particularly important role has been played by the government of India, Sri Lanka’s northern neighbours, that provided 4 billion USD in financing, which amounts to about 5% of GDP. This allowed Sri Lanka to somewhat replenish their central banking reserves in the hope of stabilizing the economy. As this Insight is being published, the Sri Lanka crisis continues, and it is not clear how it will be resolved. It serves, however, to illustrate how debt in LMI countries, as well as its uses and dangers, continues to be a central issue of economic development today.