Problems associated with sovereign debt are acute in low-income countries due to various factors.
High levels of indebtedness, debt servicing challenges, vulnerability to external shocks, currency depreciation, limited access to capital markets, and dependency on aid, corruption and lack of infrastructure investment exacerbate liquidity squeeze, particularly in low-income countries.
According to IMF, low-income countries have significant debt repayments falling due in the next two years. They need to refinance about $60bn of external debt each year, about three times the average in the decade through 2020.
But with many competing demands for financing, including from advanced and emerging market economies that are also trying to adapt to climate change, there’s a significant risk of a liquidity crunch — failure to raise sufficient financing at an affordable cost. That could in turn lead to a destabilising debt crisis.
One major factor for rising debts was higher government borrowing and deficits to mitigate the impact of the pandemic and other external economic shocks. This has increased the level of debt and consequently the cost of servicing it.
However, IMF recently noted it is encouraging that this trend is reversing as countries bring primary deficits back in line with pre-pandemic levels.
In addition, central banks have significantly raised borrowing costs to tame inflation. That makes it costlier for governments to raise new debt or refinance existing debt.
While central banks may be done raising rates, it is not clear when they will start to cut, and this uncertainty may be reflected in volatile financial market conditions.
Low-income countries have also increasingly borrowed from the private sector — with about one third of financing coming from private creditors in the last decade compared with about one fifth in the previous decade.
This reflected a slowdown in financing from multilateral development banks (MDBs) and through official development assistance (ODA) agencies. This shift has increased both financing costs and vulnerability to global financial shocks.
Building resilience in the face of these trends requires countries to act. Some countries have made progress and have taken steps to implement significant energy subsidy reforms to create space for development spending.
But many are lagging behind, especially in efforts to increase revenues, such as broadening the tax base, reducing tax exemptions, and increasing the efficiency of tax administration.
For instance, the typical Sub-Saharan African country raised only 13% of gross domestic product in revenues in 2022, compared with 18% in other emerging economies and developing countries and 27% in advanced economies.
Policy reforms are needed to boost growth and capture more revenue from that growth, for instance, through tax reforms. This will directly improve countries’ key debt metrics and ensure they can avoid a costly debt crisis.
However, reforms take time to deliver results, so countries should also proactively work on mobilising funding at lower costs, in particular grants. For some, this might mean turning to the IMF for help.
Addressing sovereign debt issues in low-income countries often requires a combination of measures, including improved governance, debt restructuring, increased transparency, and international assistance to create a more sustainable and inclusive path for economic development.