The New Creditors of Developing Countries

For over half a century, Western financial institutions such as the IMF and the World Bank have played a decisive role in financing developing countries. Growing hostility to these institutions, and the structural reforms they require, have gradually enabled other states and organizations to assert themselves. In particular, after years of very strong growth, China has become a major creditor in many regions, notably in Africa. However, its economic and demographic slowdown has dampened its lofty ambitions. Now, strengthened by the power they have acquired through ever-greater public support, private creditors are playing a growing role in the financing of developing countries. Is this a sign of change?

A debt crisis is just around the corner. The effects of the health crisis, inflation, rising interest rates in the West and the global rise in the value of the dollar continue to weaken countries already facing difficulties of all kinds. Over the past three years, 18 defaults have been recorded in ten developing countries, more than in the previous two decades. The most at risk are low-income countries, almost a third of whose loans are issued at variable rates. Some 60% of these countries are considered to be over-indebted, or in the process of becoming so. According to the UN, 3.3 billion people suffer because their governments are forced to prioritize debt interest payments over essential investments. And by 2024, the overall cost of debt servicing is set to rise by more than 10% for developing countries, and by 40% for poorer countries. Faced with this situation, with its sometimes disastrous economic, political and social consequences, the current reforms of the international financial architecture provide no response.

Western institutions forced to reinvent themselves

The IMF and World Bank programs imposed over the past four decades under the Washington Consensus are increasingly being rejected. Last summer, for example, Tunisian President Kais Saied refused a $1.9 billion IMF loan. In a fragmented world, Western financial institutions are forced to reinvent themselves.

On October 9, for the first time in Africa in 50 years, the annual meetings of the IMF and World Bank opened in Marrakech. On the agenda: reform of the Bretton Woods institutions and climate finance. The aim: to tint the new loans a bright green that would almost make them look like grants. For several years now, the IMF has been offering near-zero interest loans with 20-year maturities, with the aim of "financing climate action" in the poorest countries. At a time when the contribution of the poorest countries to global carbon emissions is virtually nil, and when the countries of the North have failed to meet their commitment to provide the poorest countries with $100 billion a year for their climate policies...

At the same time, these meetings raised the fundamental question of the governance of these institutions - largely run by Western countries and yet created to stabilize the international financial system in the aftermath of the Second World War. No real changes were negotiated, with emerging countries (including the BRICS) retaining a very small, non-influential role, while sub-Saharan Africa only gained a third, insignificant seat on the IMF Board. In both institutions, the voting rights of each country depend on their quota (contribution to the capital of the institutions) calculated, arbitrarily, according to their economic and geopolitical weight in the world. The United States holds 17.4% of votes, China 6.4% (although its economy represents around 20% of global GDP) and Germany 5.6%... This enables the West to easily assemble a majority, and the United States to apply a systematic right of veto to important decisions, all of which require a minimum of 85% of votes.

Last but not least, the stated aim of these meetings was to modify the financing policy of these institutions to grant more loans. As member countries provide the bulk of financing according to their quota in each institution, a proposal to increase the quotas distributed by 50% was validated. Nevertheless, as borrowing conditions tighten in advanced countries (which distribute a significant proportion of loans) in the face of historically high levels of public debt and deteriorating public finances, the volume of their financing is likely to decline. As in previous years, this situation should theoretically benefit China, whose status as a creditor has continued to grow. But Xi Jinping's government is facing major difficulties.

China, a powerful creditor in trouble

For more than a decade, China has been concentrating particularly on its external development (to the detriment of its population). To this end, it has recycled the savings it accumulated during its boom years to lend to those in need of financing. Through a singular policy of unconditional borrowing, it sets itself apart from Western financial institutions. Repayment methods are, in theory, more flexible, as debt is often rescheduled if the debtor is close to default (in the same way, after all, as the Paris Club at the end of the 20th century), and rescue loans are introduced if the country's financial situation deteriorates (at rates of around 5%, however, i.e. twice as high as those charged by the IMF, for example). As part of its technological and military development, China has rapidly expanded into Central Asia and Africa in particular, where natural resources abound. It can count on its state-owned banks (the Development Bank and the Export-Import Bank), which have provided almost 70% of Chinese loans to emerging and developing economies over the last twenty years, as well as on its national banks. The majority of these loans (around 80%) are, however, directed towards emerging countries, in order to protect its banking sector from potential payment defaults. 

Moreover, China trades massively with these countries, becoming the main trading partner of the African continent since 2009, as well as Latin American countries (Argentina, Brazil, Chile, Peru) and many others.

But an era is coming to an end. With its economic model at the end of its breath, its status as a creditor has been weakened. China is lending far less than before. In Africa, for example, Chinese loans in 2022 amounted to just $1 billion, their lowest level since 2004. It has also found itself obliged to depart from its usual practices by agreeing to join, among others, the Western DSSI initiative created by the G20, aimed at suspending debt interest payments in certain countries.

On the whole, this situation penalizes debtor countries more than China, whose decline in lending worldwide is merely a reflection of its declining economy.

The growing influence of private creditors

The financialization of the economy has unquestionably shifted power from the public to the private sector, all the more so as public support programs (particularly from central banks) for financial players have multiplied. The bailout guarantee that the latter have obtained, whatever the cost, also enables them to lend under conditions that are sometimes risky but particularly remunerative. Unlike governments, the rates they offer are generally twice as high, and repayment terms more aggressive. These players are also spared public initiatives to cancel, suspend or restructure debts, sometimes leading to indirect public subsidies when the debt relief provided by a government benefits private players.

In recent years, the role of private creditors in financing developing countries has intensified. In particular, shadow banking players (hedge funds, private equity, etc.), retail and investment banks, and commodities managers (Glencore, for example, holds 20% of Chad's debt). According to figures from the Institute of International Finance, private financing now accounts for 27% of public debt in poor countries, compared with just 11% in 2011. In Africa, they hold over 30% of the continent's external debt. And in some middle-income countries, such as Ghana and Côte d'Ivoire, this rate reaches almost 60%.

The risks are numerous, leading to ever-increasing financing requirements. Falling budgetary and export revenues, rising interest rates, exchange rate fluctuations, capital flight, foreign exchange shortages and, last but not least, slowing growth are all challenges that exacerbate the debt burden of developing countries. Many of them also face problems of poverty or extreme poverty, a sometimes complicated political situation, and a social system in difficulty. 

Although the budgetary constraints of advanced countries may curb their ability to lend, private creditors also remain vigilant. Fear of non-repayment and weaker government support could discourage them from lending. Rising interest rates have also sharply slowed down arbitrage (and by extension financing) aimed at borrowing at low rates in advanced countries to benefit from better returns in developing countries. In 2022, for example, new loans granted by private creditors to developing countries fell by 23%, their lowest level for ten years. At the same time, they received $185 billion more in capital repayments than they lent to developing countries. The World Bank and multilateral creditors were forced to intervene.

This raises the question of the lack of financing and debt sustainability in developing countries. More and more partial, targeted and conditional debt cancellations are needed. This will give countries in desperate need room to maneuver, rather than making them pay for risks for which they are not responsible. The international financial architecture must then be rethought, through the creation of new financial institutions reflecting the new realities of today's world. A multipolar world in which many emerging countries are now emerging powers in their own right. This is the sine qua non not only for striking a balance between today's challenges, but also for preserving fragile democracies.