How external debt can transform fortunes and boost wealth

Often described as a burden, external debt can be an effective tool for economic development if it is carefully managed

Shutterstock

Debt is often described as a burden and linked with times of crisis. And it can be damaging. But if spent wisely, it can help transform economic fortunes and boost wealth.

How external debt can transform fortunes and boost wealth

Amer Ziab Al-Tamimi

last update on 08 Aug 2023

Every country in the world has external debt in one form or another and to varying degrees. Borrowing is a sound option for any nation, as long as the funds raised are spent wisely.

External debt can cause unease. It has been at the centre of high-profile and serious international financial problems. In the 1980s, there were financial and social crises stoked by debt in Mexico, Brazil, Argentina and several Eastern European countries, including the former Yugoslavia and Romania.

There were difficulties of a bigger magnitude around the 2008 global financial crisis, centred on Greece and Italy but also reaching Spain and Ireland.

But in all these cases, the world’s financial system — skillfully managed by major central banks — was able to absorb and address the problems.

Mena rescue operations

Arab countries are no strangers to borrowing from abroad, via banks, the World Bank, or the International Monetary Fund, to solve their financial and economic problems. Sometimes the level of debt taken on by some nations has risen too high, and Gulf states have stepped in to ease the pressure.

Such rescue operations have helped countries including Egypt, Tunisia, Lebanon, and Sudan. The Gulf states have exempted Egypt and other indebted Arab countries from repaying some debts, and have sometimes rescheduled payments over longer periods.

But this approach can itself be a problem or can lead to more problems later if revised arrangements in debtor nations do not include the kind of economic and financial reform that is needed. Such change can come at a high political cost and can be resisted.

Shutterstock — The demise of debt talks with the IMF made the country's finances into a national talking point. A Saudi package has provided wriggle room, but political action is needed for proper progress.

Sometimes the level of debt taken on by some nations has risen too high, and Gulf states have stepped in to ease the pressure. But this approach can itself be a problem if economic reforms are not implemented.

Borrowing to fund development projects can be an effective way of achieving economic growth. But care needs to be taken to make sure that the funds raised via debt markets are invested in rational or prudent ways, with adequate measures taken to ensure economic and social value flows from the spending.

What not to do

Some uses of debt are inappropriate.

There are Arab countries that have borrowed to pay down a balance of payments deficit, a government general budget deficit, or to support the exchange rate of the national currency and maintain a high level of the exchange rate.

Some countries refused to float their currency exchange rate, borrowed funds from abroad, and employed those funds to irrationally support the exchange rate. These governments rejected the advice of the International Monetary Fund.

They did not take measures to rationalise public spending, float the exchange rate of the national currency, or implement economic reforms that would control public expenditure on wages or subsidies on basic commodities like food and electricity. This creates perpetual costs, which become a permanent and significant drain on public resources.

Some countries refused to float their currency exchange rate, borrowed funds from abroad, and employed those funds to irrationally support the exchange rate, against the advice of the IMF. This is an inappropriate use of debt.

Arab countries have also spent borrowed money on one of the least sustainable choices: weapons and the military, or other ways of financing the war effort during regional crises.

Iraq is an important example, especially during the Iran-Iraq war. Using external debt in this way is irrational and there is no economic benefit that can justify the cost of the debt.

Even spending that is capable of doing that needs to be carefully considered and controlled and limited to a specific time period. This applies to infrastructure that can open the way for development, including utilities, education, and healthcare facilities.

Tunisian health workers demonstrate to demand higher salaries and government support.

Debt should go toward funding wealth-generating capabilities

The ongoing funding of these services should come from within established national financial resources after the investment has set them up and supported them for an initial phase.

This approach also works in the private sector.

Debt funding can be used to build factories and develop farms that contribute to national production processes and create export capabilities that help generate national wealth.

The management of external debt requires an element of creativity to help spur the production process and to ensure repayments do not become a burden on the national economy, via unsustainable obligations to international financial institutions or creditor countries.

This has been a major challenge for many nations, not just in the Arab world. Badly spent debt has stoked financial and economic crises that affect living standards and social obligations globally to this day.

Debt funding can be used to build factories and develop farms that contribute to national production processes and create export capabilities that help generate national wealth.

Chronic debt problems

A recent study conducted by the United Nations Economic and Social Commission for Western Asia (ESCWA) found that the Arab region's debts exceeded $1.4tn, accounting for 60% of the Arab countries' total gross domestic product.

These debts have grown rapidly over the past decade.

Egypt, for instance, suffers from huge external debts that amounted to around $163bn at the end of 2022, according to the Ministry of Planning and Economic Development.

Since 2014, the Egyptian government has developed its infrastructure, including the Suez Canal, and embarked on the construction of New Cairo, its administrative capital. These developments are undoubtedly important for economic growth.

But some financial observers have raised concerns about Egypt's ability to meet its debt service obligations given the country's limited sovereign resources and insufficient development of productive capacity to meet increased obligations.

Jamie Wignall

Nonetheless, others argue that these infrastructure developments and improved facilities and institutions are necessary to attract foreign investments and to encourage the business sector to invest.

They may well boost manufacturing industries, agriculture, tourism and other useful service sectors. The increased production creates job opportunities for the millions who join the labour market every year.

Tunisia is among the Arab countries that are struggling to meet its external debt obligations. Currently, it is engaged in talks and dialogue with the International Monetary Fund to resolve repayment problems and reschedule payment dates.

At the same time, the country is trying to enhance its ability to improve government revenues. The IMF has called for significant adjustments in the fiscal policy, via rationalisation of subsidies, and optimisation of the public-sector workforce.

But due to the tense political situation in the country and strong disagreements, the government is refusing to reform public finances.

In addition, the revenues of the tourism sector are still below expectations. After revenue of around $2.5bn in 2010, before the revolution, tourism revenues fell to around $836mn in 2021.

While there are hopes for tourism receipts to improve this year, they are unlikely to meet external debt service requirements. The World Bank has criticised the slow pace of economic reforms in Tunisia and does not expect the growth rate to exceed 2.3% this year.

Due to the tense political situation in Tunisia, the government is refusing to reform public finances, leading the World Bank to criticise the slow pace of its economic reforms.

Debt is not the problem

There are crises among Arab countries which can be traced back to high debts and the insufficient revenues that service them, further exacerbated by faltering growth in key sectors.

Such crises are exacerbated by ongoing delays in structural reforms and the lack of ability to take effective political decisions regarding government employment, fuel and food subsidies.

The situation in Egypt and Tunisia serves as two troubled models, and other Arab countries are not far from the challenges of external debt crises.

Among them is Algeria.

While Algeria might be able to withstand the pressures due to its oil wealth, the growing demands of its people could limit that ability. The country's population has reached 45 million and the number of young people looking for job opportunities is increasing.

Countries facing such factors should remember that debt in itself is not the problem. The dilemma is how to ensure that spending is targeted on ways to help lift revenue to make repayment affordable, via the reform of unfavourable or inefficient economic structures.

+ / -