One of the puzzles of international macroeconomics is that if capital has diminishing returns, then it seems plausible that capital should flow from capital-rich high-income countries to capital-poor low-income countries. After all, the potential returns to capital investment should presumably be high in a capital-poor environment.
However, for some decades now, net capital inflows have been coming into the US economy. Moreover, as the World Bank International Debt Report 2024 points out, since 2022, the interest payments that low- and middle-income countries are making on their external (that is, outside their own country) debts are greater than the amount of new debt capital flowing in. Indermit Gill describes it this way in the “Foreward” of the report:
Since 2022, foreign private creditors have extracted nearly US$141 billion more in debt service payments from public sector borrowers in developing economies than they disbursed in new financing. As this report documents, that withdrawal has upended the financing landscape for development. For two years in a row now, the external creditors of developing economies have been pulling out more than they have been putting in—with one striking exception. The World Bank and other multilateral institutions pumped in nearly US$85 billion more in 2022 and 2023 than they collected in debt service payments.
That has thrust some multilateral institutions into a role they were never designed
to play—as lenders of last resort, deploying scarce long-term development finance
to compensate for the exit of other creditors. Last year, multilateral institutions
accounted for about 20 percent of the long-term external debt stock of developing
economies, five points higher than in 2019. … In 2023, the World Bank accounted for fully a third of the overall net debt inflows going into IDA-eligible countries—US$16.7 billion, more than three times the volume a decade ago.That reflects a broken financing system. Capital—both public and private—is
essential for development. Long-term progress will depend to an important degree
on restarting the capital flows that most developing countries enjoyed in the first
decade of this century. But the risk-reward balance cannot be allowed to remain
as lopsided as it is today, with multilateral institutions and government creditors
bearing nearly all the risk and private creditors reaping nearly all the rewards.
The report provides a wealth of underlying detail, but here’s one point that stuck with me. If one looks at the ratio of external debt to gross national income, it’s not rising a lot for these low- and middle-income countries in the last couple of years. (IDA refers to International Development Association: it’s the part of the World Bank focused on lending to the lowest-income countries.)
Instead, there was a gradual but substantial run-up of debt for these countries over the last decade or so. A key fact here is that low-income countries typically cannot borrow in their own currency: instead, they commonly borrow in US dollars or sometimes in euros. In addition, they often borrow at adjustable interest rates, while a large developed economy like the United States can typically borrow at fixed nominal interest rates. Thus, when it comes to repaying external debt, low-income countries are vulnerable to higher interest rates and to accompanying shifts in exchange rates. The report notes:
Total debt servicing costs (principal plus interest payments) of LMICs [low-and middle-income countries] reached an all-time high of US$1.4 trillion in 2023. For LMICs excluding China, debt servicing costs climbed to a record of US$971.1 billion in 2023, an increase of 19.7 percent over the previous year and almost double the amounts seen a decade ago. In 2023, LMICs faced historically challenging debt service burdens due to high debt levels, interest rates that hit a two-decade high, and depreciation of local currencies against a strong US dollar. The tightening of monetary policy in the United States in 2022 affected exchange rate movements and drove an increase in the value of the US dollar relative to other currencies, which persisted in 2023 and made repayment of non–local currency debt more costly for LMICs as their local currencies depreciated.
In short, interest payments for the US government are rising as new borrowing at higher interest rates plays a greater role compared to earlier debt accumulated at lower interest rates. But low- and middle-income countries face a double-whammy of their currencies being less valuable on exchange rate markets and also a share of their debts adjusting automatically to higher global interest rates. When those factors hit on top of the greater debt accumulated in the last decade, difficulties can arise. Some countries have already managed to reschedule their debts, but I suspect those are the easy cases–and the hard cases will be coming in the next few years.
