The Current Context
Recent International Monetary Fund statements have indicated that times are difficult due to burgeoning fiscal deficits, geo-political fragmentation, and the abrupt rise in global interest rates.1 Nowhere are these challenges causing more consternation than in Emerging Market Economies. Recent debt episodes in Sri Lanka, Ghana, and Ethiopia highlight this, and the IMF has identified as many as 40 countries facing high chances of debt distress going forward. The World Bank echoes these views in its own analysis.2 Nowhere are the financing challenges more acute than in Sub-Saharan Africa. Yet the stance of the IMF has essentially remained unchanged, resulting in a raft of repeater programs. Pakistan is now on its 26th IMF program since independence, and Ghana and Argentina trail only slightly behind. Something is radically wrong and in need of reform.
Recent Events Highlight the Problem
Kenya, one of the major success stories in Africa, was recently in the news with violent protests opposing fiscal reforms. The ostensible cause was a new fiscal program supported by the IMF that would have raised several taxes, while curtailing government spending. Government was caught between a rock and a hard place inasmuch as almost 60 percent of fiscal revenue is used to service debt, leaving little for needed social and infrastructure spending.
Total public indebtedness of $82 billion, evenly divided between national and international obligations, is a drag on the economy. Recent Eurobond refinancing of $2b. at rates above 10% adds to debt sustainability concerns. Currently, external debt service constitutes 5% of GDP, equal to Kenya’s growth rate. Ignoring exchange rates, it can be said that all of Kenya’s economic growth is going to pay its external creditors, including the IMF.
What was learned from the IMF’s failed programs in Greece, and more recently in Argentina, is that debt must be put on a sustainable footing. We unfortunately see wishful thinking in the Fund’s assurances that “Kenya’s public debt is assessed to be sustainable but subject to high risk of distress.”3 One clear lesson from both Greece in 2010 and Argentina in 2020 is that delaying debt reprofiling is a major mistake as it continues to sap economic resources and delays recovery.
A second error is to expect massive fiscal reversals to happen quickly, especially when economies are stressed. In light of events, Kenya found it necessary to pull back its fiscal program which aimed to raise the tax take from a low 15% of GDP to an eventual 25%. Again, the case of Greece is instructive. Large tax increases to fix fiscal positions are rare, yet they still dominate the advice of many IMF programs.
Is there an escape path for Kenya? The first task is to realize that the Fund’s proposed approach of “growth-friendly fiscal consolidation to preserve debt sustainability” is unlikely to work without significant revisions.4 Second, there is need for greater realism, beginning with the recognition that the amount of Fund financing on the table is insufficient to deal with the magnitude of the debt servicing challenge. The debt stock, both internal and external, needs reduction to restore any semblance of debt sustainability. A reasonable target for the debt service to tax ratio is perhaps 30%, implying a halving of current obligations.
How can this be achieved? The IMF could engage in some maturity transformation on Kenya’s debt, not debt relief, but rather a stretching out of repayments, perhaps using a new role for SDRs. This would likely need to be complemented by domestic debt transformation, as was done in Ghana, and this might trigger Chinese debt reprofiling. In parallel, the IMF should provide a more realistic set of tax proposals, while the World Bank should focus on the efficiency of government spending. Most of all, a dose of realism, informed by previous debt experiences, can help improve chances of success of IMF programs and reforms in Kenya.
Additional Lessons from Ghana and Ethiopia
Recently, Ghana also had to request IMF support to stave off default and promote an orderly restructuring of its debt. Two complications made its debt situation harder to solve. The first was the sizeable amount of debt owed to China. The basic rule for debt rescheduling is that all creditors must be treated equally, hence the problem surrounding Chinese debt, some with terms undisclosed. The second problem was the demand by external creditors that Ghanian domestic banks also engage in similar rescheduling. While perhaps reasonable, the consequence is that local banks have severely reduced ability to lend to local firms, hampering economic growth prospects.
Ethiopia was also recently in the news as it essentially exhausted its international reserves and was forced to abandon its exchange rate in favor of a depreciated floating rate. That program is also based on highly questionable assumptions concerning the adjustment path for the country, including a doubling of exports and halving of inflation in the coming year.5
Why is this another example of the IMF’s lack of realism in adjustment programs? If countries are being forced to curtail fiscal spending (and possibly raise tax revenue), while at the same time repaying internal and external debts, what will be the sources of economic growth? With consumption cut and investment reduced, the only growth-driver remaining might be expanded exports. But without credit, with higher import costs due to depreciating currencies, boosting GDP may be a herculean task. The likeliest result may well be higher debt service to GDP ratios, despite tough adjustment programs.
What Next?
The IMF has been in recent years be more concerned about delving into new areas, such as infrastructure, inequality, gender, and climate issues, while its basic functions of surveillance, balance of payments relief, and economic policy advice have weakened.6 Many IMF programs are dominated by overly optimistic growth assumptions and questionable risk analysis. The net result may be a good deal of pain, but insufficient gain for debt-ridden economies. To be fair, many have long-standing problems associated with costly state enterprises, unwise borrowing from lenient capital markets, poor tax collection, inefficient public spending and governance concerns. Yet many of these necessary reforms are overlooked in zealous efforts to deal mostly with fiscal issues and stricter monetary control to limit inflation. Efforts to move the real economy forward are often neglected, resulting in programs that face a high probability of failure. Learning from past failures should prod the IMF to design more realistic and longer-lasting policy packages.
About the Author
Danny Leipziger, Professor of International Business at George Washington University, was Vice Chair of the Spence Commission on Growth and Development and former Vice President for Poverty Reduction and Economic Management, World Bank.
References:
- See C. Pazarbasioglu, “80 Years of Bretton Woods and Future Challenges,” IMF, Finance and Development, June 2024
- See WEF/Reuters, “World Bank: Faster Growth Is Needed to Avoid Debt Restructuring in Emerging Economies,” Feb. 26, 2024
- IMF, Kenya: Article IV Consultation, January 2024
- Op.cit.
- IMF, The Federal Republic of Ethiopia, Request for an Arrangement Under the Extended Credit facility, Country Report 24/253 (July, 2024).
- See A. Posen, Geo-politics is Corroding Globalization, IMF, Finance and Development, June 2024
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Dr. Dan Steinbock
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