Many low-income countries are diverting scarce resources from development to service costly debt. But what’s driving current debt vulnerabilities—and what can be done about it? While some see a short-term liquidity squeeze, others warn of a deeper debt sustainability crisis masked by quiet cuts to development and climate spending. In response, the Debt for Resilience initiative proposes to restore long-term external debt sustainability and enable investment in development.
African nations alone are collectively set to spend USD 89 billion toward servicing external debt this year, according to the G20. This financial commitment is forcing the most vulnerable countries to dedicate limited resources to paying their creditors instead of investing in development, climate adaptation, and mitigation.
Shrinking global liquidity, net capital outflows, and an increased reliance on higher-interest, shorter-term external private debt are eroding external debt sustainability, gradually limiting countries’ ability to service their debt obligations without affecting broader economic resilience or going into default. The mounting pressure is not just a short-term liquidity issue–it is a looming threat to long-term economic stability and growth prospects. The need for comprehensive, transformative debt relief is urgent.
What is behind the worsening debt situation in low-income countries?
Eight former African prime ministers have recently called for a comprehensive debt-relief initiative, claiming that “Africa is trapped in a crippling debt crisis, the worst in 80 years.” Statements like these make it clear that developing countries are struggling with the challenges associated with heightened debt vulnerabilities—what exactly their malaise consists of, however, is less clear. To use a medical analogy: the patient is in pain, but what is causing it?
On paper, the debt levels of many low-income countries (LICs) do not look alarming. Compared to previous periods of heightened debt vulnerabilities—such as the 1990s—countries’ overall debt-to-GDP ratios remain broadly manageable.
This has led some observers to argue that what we are seeing is primarily a liquidity crunch: LICs are temporarily short on cash due to shrinking global liquidity and capital outflows. According to this view, although we are seeing increased fragility and isolated defaults, there is no systemic debt crisis.
Others challenge this perspective, contending that many developing countries are not just facing a liquidity squeeze but grappling with debt sustainability issues, stuck in a pattern where debt repayments are eating up future growth. In their view, the absence of widespread defaults reflects not financial resilience but rather a choice to default on development instead of debt. As the World Bank’s Chief Economist Indermit Gill puts it, “These facts imply a metastasizing solvency crisis that continues to be misdiagnosed as a liquidity problem in many of the poorest countries.”
Why is debt relief urgent?
The International Institute for Sustainable Development’s new report, Debt for Resilience: Ending the Debt Crisis in Low-Income Countries, finds that many countries today face debt challenges as acute as those seen in past global crises, though the underlying causes differ.
Today’s problems are not limited to public debt—they are also rooted in balance-of-payments (BOP) pressures. In other words, a country’s negative cash flows can become a fiscal problem.
Adding to the strain is a shifting credit composition landscape. Many LICs are now more heavily indebted to external, high-interest private lenders, including commercial banks and bondholders. The same applies to their private sectors (e.g., companies operating in the country). This places immense pressure on central banks, which must not only have enough reserves to service public debt but also ensure access to foreign exchange for domestic firms to meet their own external obligations. In conjunction with high debt-servicing costs, LICs not only face a sovereign debt problem but also a potential BOP problem that affects the entire economy.
These BOP constraints directly undermine external debt sustainability. Total external debt service is now reaching levels comparable to the 1990s, which led to the launch of the Heavily Indebted Poor Countries (HIPC) Initiative, one of the most ambitious debt-relief efforts in history. Back then, it was only public debt placing a burden on state coffers in LICs; however, today, fiscal pressures are driven by high debt-servicing payments pertaining to both public and private obligations.
The risks posed by these acute BOP pressures and resulting external debt problems are systemic and compounded by two further systemic challenges—declining official development assistance and the global fragmentation of trade linked to escalating geo-economic tensions. Together, these trends signal a need for urgent and comprehensive responses.
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What solutions have been advanced in the past?
Designing a debt-relief initiative inevitably involves making difficult judgment calls. Some are practical; others are inherently political and normative, such as determining which countries or groups to prioritize and how to justify the exclusion of others. HIPC, for instance, was designed to address a debt overhang in LICs and entailed the implementation of reform programs supported by the International Monetary Fund (IMF) and the World Bank.
The international community’s response to the current debt crisis consisted of a two-step approach. First, a temporary debt suspension was adopted by the G20 through the Debt Service Suspension Initiative, which concluded in December 2021. Once it became apparent that some LICs’ debt vulnerabilities ran deeper and required full-blown restructuring, the G20 Common Framework was approved. The Common Framework seeks to offer a “one-stop solution” for LICs that owe to traditional bilateral creditors, who have historically organized themselves via the so-called Paris Club, and new bilateral creditors, such as China or Saudi Arabia, who are members of the G20 but are not part of the Paris Club.
IISD’s new report analyzes past and present debt-relief initiatives, revealing several shared features. All begin with a specific diagnosis and have differing objectives, designs, and policy responses. These often reflect broader differences in perspectives, values, and interests. The report also discusses initiatives currently being proposed, noting that these initiatives continue to rely on a flawed binary between illiquid and insolvent countries, overlook the heterogeneity of credit composition among LICs, and are not attractive enough for debtor countries to make them want to apply.
What is the Debt for Resilience initiative?
The Debt for Resilience initiative offers a new framework for debt relief—one that shifts the focus from short-term liquidity fixes to restoring long-term external debt sustainability and BOP stability. It does so through substantial official external debt reductions, combined with measures to prevent these debt reductions from being used to pay off private creditors. Crucially, it avoids the contractionary effects often associated with traditional adjustment programs.
The Debt for Resilience initiative is designed to address the challenges that countries currently face:
| Objective of the initiative | Safeguarding long-term economic stability and investment capacity by creating economic conditions that prevent external adjustment. |
| Eligible countries | The world’s 75 poorest countries eligible for the World Bank’s International Development Association that are in external debt distress have automatic access. All other countries can apply for relief. The IMF and World Bank boards base their decision on an assessment drawn from an external debt sustainability analysis. |
| Debt relief features | A 50% reduction in official external debt and targeted treatments to avoid these debt reductions being used to pay off private creditors. |
| Commitments by the debtor countries | A national development plan with financing strategy policies to prevent financial flows from placing a burden on external accounts that could dilute international support or lead to leakage from relief programs toward public or private creditors, thereby risking external debt sustainability issues. |
| Monitoring mechanism | Participation in the program is contingent upon the establishment of a formal agreement with the IMF. Countries will be excluded if they fail to comply with the terms of the program, resulting in the loss of the debt reduction provided. |
For the initiative to succeed, endorsement from the G20 and formal approval by the IMF and World Bank are essential. The United Nations would also play a key role by supporting debtors in developing national development plans. By tackling structural vulnerabilities and providing a predictable, rules-based approach to debt resolution, the Debt for Resilience initiative charts a path toward sustained economic recovery and resilience for debt-distressed countries.
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This article was originally published by the International Institute for Sustainable Development (IISD) and is republished here as part of an editorial collaboration with the IISD. It was authored by Anahí Wiedenbrüg and Yanne Horas.
