Q: 44. Third World Debt Crisis, Comment?

TOPIC: Third World Debt crisis

Submitted by: Sumit Mahajan

Submitted to: Prof. Mr Gurdeepak Singh

Introduction

Q.1. What is Debt Crises?

A debt crisis deals with countries and their ability to repay borrowed funds. Therefore, it deals with national economies, international loans and national budgeting. A Debt Crisis is when a national government cannot pay the debt it owes and seeks, as a result, some form of assistance. Many of the world’s poorest nations today have foreign debts that are greater then their entire national income. A significant portion of the foreign currency they earn from exports goes just to make their debts payment.

Q.2. What are First Second and Third World Countries?

First World Countries were NATO(North Atlantic Treaty Organization) and their allies, which were democratic, capitalist and industrialized. First World Countries included most of North America & West Europe, Japan and Australia

Second World Countries described as communist-socialist states and included Soviet Union, Eastern Europe and China

Third World Countries are the least developed countries(LDC). The term Third World War was originally coined in the cold war to distinguish those nations that are neither aligned with West(NATO) nor with the East(Communist). Most Third World Countries are in Africa included: Angola, Somalia, Sudan, Tanzania, Uganda and Zambia etc and in Asia including Bangladesh, Bhutan, Maldives, Myanmar and Yemen etc

Third World Debt Crises

It is a situation where a Developing/ Third World Country have very large debts and they are increasing and pay-back the debt has become a serious problem for these countries and which causes great burden for their people

It was at the end of 1970’s when many oil exporting countries had large amount of money, they put this money into Western banks. Banks then loaned a-lot of money to Third World Countries for big development projects. Reasons behind the rise of debts mainly are “rise in world interest rates”, “global recession” “and low commodity prices”. These countries then owe money to commercial banks and organizations like World Bank, International Monetary Fund(IMF) and to the First World Government. The amount of money owed by developing countries has increased dramatically since the early 1980's.

DISCUSSION:

CAUSES OF THE DEBT CRISES:

1. Legacy of Colonialism- For example, the developing country’s debt is partly the result of the transfer to them of the debts of the colonizing states, in billion of dollars at very high interest rates
2. Odious debt, whereby debt is incurred as rich countries loaned dictators or other corrupt leaders when it was known that the money would be wasted
3. Mismanaged spending and lending by the West in the 1960’s and 70’s

DEBT KEEP GROWING, WHY?

It is difficult for developing loans to repay loans

1. Loans must almost always be paid in Hard Currency -> Most Loans to the Third World have to be repaid in Hard Currency -> Hard Currency are stable currencies which means their value does not change very much. Just like The Japanese YEN, The American DOLLAR and the Swiss FRANC are examples of Hard Currencies.

Developing Countries have soft currencies -> they go down in value. Therefore when the value of the Developing country's money goes down(as it often does) the cost of its debt rises. It takes most of the country's own currency to pay back the same amount in Hard Currency.

2. The Value of the Country's Exports goes down - The value of the commodities that at Third World Country exports can go down by large amounts. This makes it more difficult for the country to repay its loans. For ex. In Latin America debt is growing faster than earning from exports.

Refinancing Loans means invitation to trouble:

Refinancing is when more money is borrowed to pay off earlier loans. Refinancing is a measure to help Developing Countries with their debt problems. However it doesn't make good sense to take a new debt in order to servicing older debts. If this happens, the result is that countries get deeper and deeper into debts(a DEBT Spiral)

Secondly many of the loans to developing countries are made by governments or organizations like IMF. These loans often carry strict conditions with them like cuts in spending on health care, education and food subsidies

Conclusion:

Third World Debt Relief: Indebtedness just a symptom of Poverty

1. Reschedule the Debt: This is when terms of repaying the loan are changed and more time is allowed to repay the loan.

2. Debt swaps: Some countries have thought of clever ways to help developing countries with debt problems-

UNICEF's Debt for Child Relief is an example of how an organization helped some countries with debt problems. In this program, UNICEF and International Banks made a deal. Some of the money that poor countries owed the banks was not paid to the bank but was paid to UNICEF. Instead of the money, the banks received tax deductions. UNICEF collected the debt repayments in local currency and then spent this money for programmes to help children inside the country.

3. Cancel the Debt: Quite simply the debt would no longer exist. The Developing Countries would not have to repay the loans and they would not have to pay the interest.

After all, what what do the developing countries really owe the developed world? They have repaid their loans many times over in interest payments. In addition, in many cases, developing countries have paid the First World more(in-debt servicing) than the Northern countries have given-in aid, loans and investment.

From 1983-1989 a surplus of $165 million went FROM countries aid TO the countries who were 'giving' in . Again in 1994, the less developing countries paid out $112 billion more then they received

Of-course, Cancelling Third World Debts now will not solve the problem in future. To do that we must change the present financial system, which is based on debt and interest payments; a system that keeps control in the hands of those who are rich and powerful

Spending on poverty reduction in these countries had increased to 8 percent of

A way had to be found to ease the burden on these countries and to give their economies the breathing room to grow again. In 1996, the World Bank and IMF launched a debt relief program called the Indebted Poor Countries Initiative. Since that time, 27 countries-- representing two-third's of the world's most heavily indebted poor nations --- have qualified for debt relief worth $53 billion over the next 20 years.

Spending on poverty reduction in these countries has increased to 8 percent of national income in 2003 from 6 percent to 1999. At about $9 billion, this additional spending on poverty reduction represents about three-and-a-half-times the amount spent on debt service about these countries.

This is a good start, and much more is yet to be done, but it must be recognized that debt relief is not a cure -all for poor countries.

The reduction of debt in low-income countries, on its own, will neither guarantee debt sustainability, nor ensure growth and poverty reduction. Debt: relief must be a part of more comprehensive development strategy.

Strong economic growth and effective public institutions remain essential to cutting poverty to developing countries. A High Debt burden is, in many cases, really a symtom of deeper development problem confronting low-income countries, rather than a actual disease

Several nongovernmental organizations have called for 100 percent debt forgiveness for the world's poorest countries, with the belief that this in itself is the key to poverty reduction. But unless complete debt relief for the poorest nations is matched with an equivalent injections of funds by wealthier nations into the international financial institutions, such a step will in effect only shrink the pool of resources available for other developing countries that are home to the majority of world's poor.

In addition, total debt forgiveness for a small group of poor countries also would be unfair to those developing countries that have managed their finances prudently

Developing countries need to improve governance, stamp out corruption, enhance the capacity of public institutions and boost economic growth. At the same time the rich nations need to support them by delivering more and better aid, by opening their own markets, and by boosting their economic growth. Together these are the most critical steps towards reducing poverty and preventing future debt crises

Source:

Vikram Nehru is the manager of the Heavily Indebted Poor Countries initiative at

the World Bank.