Roy Culpeper is senior fellow at the University of Ottawa's school of international development and global studies and adjunct research professor at Carleton University. Nihal Kappagoda is an Ottawa-based international debt-management expert.
For years, international debt problems were associated primarily with developing countries. However, the fallout from the 2007-08 financial crisis demonstrates that debt has also become a serious problem of rich, developed countries.
If developing countries fared relatively better in the crisis, it was because they have already been forced to address their debt problems over the past three decades. Also, they have not yet fallen prey to the highly risk-prone financial markets that precipitated the current crisis in developed countries. The poorest countries also benefited from significant debt relief during the late 1990s and early 2000s.
But the total stock of developing-country debt outstanding subsequently rose from $2.4-trillion (U.S.) in 2005 to $5.5-trillion at the end of 2013. And while the World Bank claims the risk of another debt crisis in the developing countries is not high, there is little room for complacency, for a number of reasons.
First, the share in overall debt of public and publicly guaranteed external debt declined from 53 to 36 per cent over the 2005-2013 period. The share of private and short-term debt increased from 45 to 62 per cent over the same period and is estimated by the World Bank to have amounted to $3.4-trillion at the end of 2013. What's worrisome is the notion that private and most short-term debt are not risks for developing country governments. Unfortunately, from the Asian financial crisis to the current European debt crisis, governments have been pressured to assume the liabilities of private debtors. It can and will happen again, leading to difficult austerity programs.
The monitoring of private debt has received much less attention than it deserves. Notwithstanding the World Bank's estimate, there is no comprehensive data series on the external obligations of the private sector in developing countries. The numbers are weakest in low-income countries, which are often unaware of the true extent of their exposure.
Second, there has been rapid growth in developing countries' local currency bond markets since 2000. The good news is that this has reduced their exposure to exchange-rate fluctuations. In some countries, local bond markets have become suitable for financing long-term investments such as infrastructure and mobilization of domestic savings through institutional investors. Unfortunately, it is usually very costly to borrow money in domestic markets, with double-digit interest rates being common, so this also leads to higher debt-servicing costs. As with private debt, there is often a lack of consistent data on domestic debt levels.
Third, the world's poorest countries are now borrowing from international bond markets. In 2013, about $4.6-billion worth of sovereign bonds were issued by African countries. One of the main advantages is that interest rates tend to be lower than in domestic markets. However, international bonds expose developing countries to a number of risks – for example, if the borrower is faced with a depreciating currency, leading to effective servicing costs that are even higher than in domestic markets.
Fourth, there is a huge institutional gap facing any country in distress when it needs to restructure its international bond debt. Collective action clauses in bond contracts, introduced after the Asian financial crisis, allow a majority of bondholders to agree to reduced debt payments. However, a few recalcitrant bondholders can disrupt these deals. They can give rise to "vulture funds" that buy up debt at deep discounts and pursue litigation to press for much better terms, undermining the possibility of a settlement, as in Argentina.
What's clearly missing from the global architecture, as the current problems with Greece also demonstrate, is the equivalent of a bankruptcy court to help resolve problems between debtors and creditors fairly and expeditiously. After 15 years of discussion, an international debt restructuring mechanism is long overdue.