A strong dollar worsens debt cycles for poor countries

Federal Reserve Chairman Jerome Powell’s stern warning from Jackson Hole, Wyo., that the bank will continue raising interest rates until “the job is done” firmed up the dollar’s decades-high value, worsening the vicious and unsustainable debt cycle of developing and emerging market countries.  

As the dollar rose in value, these economies found it harder and harder to repay their dollar-denominated debts, because they had to exchange more local currency and draw down their central banks’ hard-currency reserves, a safety cushion protecting a currency’s liquidity.

The crippling debt compounds countries’ chances for economic collapse, with scenes of social unrest, as we saw in Sri Lanka in June, likely becoming more common nightmares for wealthy nations.

Distressed debt has reached one-quarter of a trillion dollars, according to Bloomberg. Lebanon, Sri Lanka, Russia, Suriname and Zambia are already in default. Of some 73 highly indebted nations tracked by the International Monetary Fund (IMF), roughly 40 are in the danger zone.

The COVID-19 shutdown worldwide had already increased countries’ debt burdens, and with the global economy now suffering from inflation fever, food shortages, supply-chain bottlenecks and Russia’s chokehold on energy supplies, low-income countries have failed to recover. Bad decisionmaking by these governments’ leaders, too, has played a role.

Judging from press reports, little has been said in public by either Powell or Treasury Secretary Janet Yellen about the high dollar’s impact on poor countries’ sovereign debt.

In July, Powell used a Fed-sponsored conference on the dollar’s global role to tout the currency’s advantages and unrivaled status. His justifications for the Fed’s inflation-cutting strategy are repeatedly domestic in focus. To use Powell’s words, is this “rational inattention”?

Yellen’s focus at G-20 meetings has been on an oil price cap, shoring up Ukraine’s economy and pressuring China to both reveal more about its lending arrangements and restructure low-income countries’ debt.

Little has been said, too, by President Biden or other key administration staff about the defaults ahead.

Elevating the situation to a top priority, with Powell and Yellen being more expansive in their remarks about the sovereign debt crisis, is a necessary and urgent step to begin managing the outcomes. They should also establish U.S. leadership, particularly in building support from the richest nations to use their collective leverage in negotiations with private creditors.

First on the agenda should be the immediate suspension of interest payments for the time being to give countries “breathing room,” as some experts have proposed.

A baseline assessment is urgently needed from the World Bank and the IMF, one that uses realistic projections of economic outlooks to better understand each country’s likelihood for servicing debt. Their effort should include obtaining information from China about the size and terms of its lending, which accounts for 18 percent of credit owed by 68 countries.

Debt restructuring must be pursued, but coordination is tougher given the diversity of creditors and their terms. The G20 Common Framework is a starting place for addressing insolvency and prolonged liquidity problems. Negotiations must start now regarding the volume, speed and terms of new money.

One roadmap for solutions is the one offered by the Center for Global Development. It advocates for clearer steps and detailed timelines while strengthening incentives for private creditors to rework loan terms. Better integrating IMF’s financing programs, such as its “lend into arrears,” into the framework could address the recalcitrance of private and public creditors.

Restructuring, too, should utilize conjunctural mechanisms, as Brookings suggests. Brady bonds are one such tool. By converting sovereign debt into securities denominated in U.S. dollars backed by U.S. Treasury bonds, commercial banks could replace nonperforming debt from their balance sheets with tradable securities. Tying these notes to commitments for economic reforms was also involved.

In panic mode, securities markets exaggerate the risks, exponentially increasing the costs to end a debt crisis. Efforts now to initiate immediate responses and reach agreement on medium and long-term responses could ease investors’ angst. With the wake-up call sounded repeatedly by the World Bank and the IMF, the United States must start working on approaches to contain and reduce the debt crisis.

James David Spellman is principal of Strategic Communications LLC after working in the securities industry.