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A Fork in the Road for Development Financing

A majority of developing countries are facing debt distress, and their financing problems are sure to grow worse as global financial conditions continue to tighten. The moment is quickly approaching when the world will have to decide between two futures for development finance.

PARIS – For more than a decade, the US Federal Reserve and the European Central Bank, facing below-target inflation, flooded the world economy with liquidity. But now as they are hiking interest rates to bring inflation back down, the flow of funds to low- and lower-middle-income countries has dipped as more are priced out of the market. For at least 20 LICs and LMICs, the yield spread on foreign-currency bonds, relative to US Treasuries, has crossed the 10% threshold.

Meanwhile, the World Bank and the International Monetary Fund have been warning of a coming tsunami of debt crises, estimating that almost 60% of the world’s poorest countries are in debt distress or at high risk of it. To many observers, such warnings are proof that the experiment of providing capital-market access to fragile countries (those with BB-rated debt or below) is over. It was a one-off episode, reflecting a confluence of factors – including the Heavily Indebted Poor Countries Initiative, the 2000s commodity boom, the massive increase in Chinese lending, and excess liquidity in the market – that are unlikely to recur.

According to this view, today’s loss of market access is a return to the norm, and deep debt reduction makes sense. Though this could discourage future lending, that may not matter, because private-sector creditors are unlikely to return for perhaps the next decade. In the meantime, it will be up to public finance – grants, bilateral loans, and concessional lending from multilateral development banks – to support the Sustainable Development Agenda. Think of this scenario as Option A.