Development Beyond Debt

Cairo, Egypt. Photo by Jack Krier via Unsplash.

The Bretton Woods system, established 80 years ago in July 1944, is in need of an update. Even though numerous countries in the Global South have demanded reforms to make the system fit-for-purpose in the 21^st century, progress has so far been slow.  

A case in point is the Debt Sustainability Analysis (DSA) framework used by the International Monetary Fund (IMF) and the World Bank to guide the borrowing decisions of low-income countries. A critical fiscal stability monitoring tool, the DSA has been criticized for being misleading and inflexible, with governments and economists from the Global South raising concerns about the DSA framework for decades. Among the concerns, the calculation of "debt" does not differentiate between debt used for investment and debt used for consumption (salaries and pensions), which creates an anti-investment bias and is related to the neoliberal belief that government should play a minimal role in economic growth and development. This bias is outdated, especially in the current global environment where investment in public assets, consisting of public infrastructure, financial assets and natural resource reserves, is crucial for low-income countries. Additionally, the one-sided focus on public sector balance sheets with little regard for the value of the resulting public assets has hampered much needed public investment for combating climate change, including in utility-scale renewable energy, grid modernization, clean public transportation, building decarbonization and more. Given these deep inadequacies, the DSA framework should be reformed to serve as a holistic analysis of public sector balance sheets using 'net worth' as an indicator of debt sustainability. 

To promote sustainable development, the international community must look beyond debt to prevent underinvestment in public assets. Under the existing DSA framework, if low-income countries fail to meet certain benchmarks, they will be classified as being in "debt distress" and, therefore, have limited access to global capital markets. This will further hinder their ability to mobilize foreign capital, resulting in a "sudden stop" in financing for development. The conventional IMF prescription for a debt-distressed country is fiscal austerity, which hurts a country's potential for growth and, in current circumstances, can perpetuate a credit crunch. 

Rather, the DSA framework should be reformed to support a country's accumulation of 'productive' debt that is being used to support public asset development and management. Novel financial instruments like China's renminbi-denominated panda bonds can be used to issue loans at affordable rates.

Economists have long stressed the potential externalities of public investment, but such positive spillover effects have been neglected by the DSA. For example, our joint empirical work found that development finance would be more effective if the infrastructure bottlenecks in the sectors of power, transportation, telecommunications, water and wastewater are first addressed. Our analysis shows that Chinese infrastructure projects increase economic activities, measured by nighttime lights, in the second sub-national level regions in sub-Saharan Africa through both direct impacts and spatial spillovers. Previous studies that failed to include the spatial factors in their empirical estimation models may have underestimated the total impacts.

Ignoring the spillover effects in the DSA and underinvesting in public infrastructure and services can have severe consequences. Nobel Prize-winning economist Joseph E. Stiglitz argues that "Not to make essential public investments is to leave a country impoverished," and that "debt is a financial liability, not a real liability." He further asserts that, “by contrast, environmental degradation is a real liability for future generations; it imposes real burden, with real consequences, such as climate change, which will damage health, lives, and our physical infrastructure." That is, austerity in the current circumstance can have severe and long-lasting consequences. 

The Beijing Action Plan formulated at the recent 2024 Summit of the Forum on China-Africa Cooperation (FOCAC) represents a commitment to "development beyond debt," prioritizing a comprehensive development framework over concerns on debt alone. As part of the Plan, China pledged to invest more than $50 billion in financing for African countries. The Plan is based on the firm belief that if African countries borrow for productive investment, promoting employment and growth, future generations will be better off than if the essential debt had not been incurred. China also pledged to work with Africa to deepen China-Africa cooperation and spearhead "modernization" in the Global South in areas of sustainable development, trade and investment, education and health, culture and social issues, people's well-being, food security and energy security.

In addition to pledged financial support, China has expressed its commitment to opening its expansive financial market to African nations, inviting them to issue so-called panda bonds. This move offers an alternative for many African countries borrowing at exorbitant interest rates in the Eurobond market. Instead, they can secure loans at comparatively lower interest rates from the Chinese bond market. This initiative aims to enhance the connectivity between China and Africa's financial markets, while also deepening cooperation in local currency settlement, financial technology and other relevant fields. Nevertheless, both borrowers and lenders need to be cautious about the potential currency risks of the global financial markets. 

China's bond market has experienced increasing demand in recent decades as the country has witnessed rapid economic growth. According to the Bank for International Settlements (BIS), by the end of 2023, China's bond market had become the world's second largest, with an outstanding total of around $22 trillion. As seen in Figure 1, the outstanding bond market in China is lower than that of the United States, but is more than twice that of Japan and larger than the combined outstanding of France, Germany and the United Kingdom.

Source: Bank for International Settlements. Accessed in September 2024.

In recent years, China's financial market has experienced a notable increase in internationalization. By the end of July 2024, over 1,100 institutions from more than 70 countries and regions had invested in China's interbank bond market, with foreign capital holdings totaling RMB 4.3 trillion yuan ($592.88 billion). Figure 2 provides a quick look at international issuers' involvement in this market. Additionally, the renminbi-denominated panda bond market serves as an important gateway and symbol of opening China's financial market to the world. The cumulative issuance of panda bonds has surpassed RMB 800 billion yuan, attracting top international issuers and investors and enhancing the openness of China's bond market.

Source: Wind Information Co., accessed in September 2024.

China's panda bonds can potentially provide a reliable financing option for Africa. In October 2023, Egypt was the first African country to issue a panda bond. The 3.5-billion-yuan bond is backed by the African Development Bank and Asian Infrastructure Investment Bank (AIIB) and has a term of three years and a coupon rate of 3.51 percent. Other countries or regions that have issued panda bonds include Hungary, Poland, Portugal, the Philippines, Sharjah (UAE), South Korea and British Columbia (Canada) while international financial institutions with panda bonds include the New Development Bank, the AIIB, the Asian Development Bank, the International Bank for Reconstruction and Development and the International Finance Corporation. Panda bonds could potentially offer a mutually beneficial arrangement for all parties, as they can provide a reliable and predictable source of funds for African countries, while also advancing the internationalization of the renminbi.

As shown in Table 1, African countries have been increasingly turning to Eurobonds as the instrument of choice at a time of high interest rates in 2023 and 2024, which might further tighten their fiscal space. By providing access to the Chinese bond market at more affordable rates, China will help expand financing for green development in Africa alongside greater accessibility of finance for low-income countries. In the long run, more financial instruments like the China-Africa Development Fund and Africa Growing Together Fund, and more equity funds, should be created and replenished. These efforts will enhance the quality of financial services in African countries, promote the development of market tools and mechanisms, strengthen governance and supervision capabilities, and nurture the potential of ultra-long-term or patient capital.

Source: S&P Capital IQ, accessed in September 2024.

Justin Lin is the dean of the Institute of New Structural Economics (INSE), honorary dean of the School of National Development in Peking University, and former World Bank Chief Economist.

Yinyin Xu is a recent graduate of the Cornell Program in Regional Science.