It is being accused that the policies of the IMF and other world financial institutions could bring states into a debt trap. Similarly, it is also accused that China’s hegemonic practices could also lead states into a debt trap. So, now the question is, what does it mean by a debt trap? When did it start? And who is responsible for taking states into a debt trap?
The answers to these apparently simple questions are not simple as these questions are intertwined in a way that we cannot examine them separately. So, to investigate the real reason behind the debt trap, we have to take the help of history.
In the case of Pakistan, from 1947 to up till 1973, our external loan was only $425 million (whose current worth is about $2.5 to $3.0 billion), which has been taken from the IMF. Currently, our external loan has exceeded the figure of $120 billion, which has been aggrandized in terms of debt servicing. Here, if we talk about the loan taken in the 80s, it was $425 million, which has accumulated in terms of inflation, interest, and repayment of debt, etc., and reached $120 billion. So, why are these loans constantly increasing?
The policies of the IMF and other financial institutions, as well as China’s hegemonic practices, are accused of leading states into a debt trap.
Some scholars opine that the fiscal deficit – low income and high expense, trade deficit – high imports and fewer exports, and current account deficit – less inflows of dollars and more outflows of dollars are the reasons that require more loans. So, all of these problems are related to the country’s domestic economy. They argue that no country could become a victim of a debt trap only due to domestic economic problems. If it were so, then the journey of the debt trap should have started from 1947.
The real problem ignited in 1973 where not only Pakistan but all the other third world countries got trapped in debt when the Organization of the Petroleum Exporting Countries (OPEC) had increased oil prices without the problem of demand and supply. In the 1970s, they increased oil prices twice. So, if a country needed oil of $1 million, then they had to pay $1.5 million for the same quantity. It became difficult for the countries to purchase oil. Then, western banks came to help and offered loans at low markup. They had offered low markup loans to neutralize the import bill, but in the late 1970s, countries in Eastern Europe and third-world countries misused this opportunity and took huge sums of loans with the expectation of stable interest rates and low markup rates. They made calculations based on the time value of money – one million dollars at a 2% markup in the 1970s were worth more than one million dollars in the 1980s. Ignoring other factors, they took more loans, but when the repayment decade started in the 1980s, all the calculations proved wrong. Instead of an increase in inflation, it decreased in the 1980s, and markup rates increased, and states had to repay loans at an increased markup.
These countries did not focus on increasing exports and economic development; they had just an opportunity to take a loan at a low markup in the 1970s on the proposition that the worth of the dollar would decrease in the 1980s. Eventually, every country became trapped in the 1980s because they had to repay the loan amount with a new interest rate. Domestic economy issues, i.e., fiscal deficit, trade deficit, and current account deficit, etc., were also present. It became difficult for the countries to repay loans, and they decided to take more loans for debt servicing. In this way, in the 1990s, the whole world became a victim of this debt trap. As we discussed in the beginning, the domestic economy is not the only reason. The whole trap, which was developed, is set by the western countries.
The real problem started in 1973 when OPEC increased oil prices twice without a problem of demand and supply, causing difficulties for countries to purchase oil.
From 1982-1990, the repayment decade, western banks provided $927 billion more loans to the world, which were provided to the poor states. On the contrary, in these 8 years, $1345 billion was received on account of debt servicing and installment of 1970s loans. Now, the lenders got worried about the default of the countries that received loans. If they became a defaulter, then how would they recover? Some countries asked to forgive the loan, but the World Bank refused. It could become a practice if today World Bank forgave loans, then these poor countries would take courage and take more loans with the expectation that their debts would be forgiven, and they would never come on track.
To get them on track, in the late 1980s, IMF and World Bank launched a program called the Structural Adjustment Program (SAP), in which all the countries that received debt had to comply with the program. The purpose of this program was to keep all countries that received debt on debt sustainability or make them able to repay their debt installment. From this, domestic interference has started, which was something new for the loan-trapped countries. Then, international financial institutions started to interfere in domestic policies, and the purpose was to make them able to repay loans and could take more loans. Now they had started regulating loans and the domestic market. States were trapped, so they had to follow the SAP.
Similarly, Pakistan has also adopted SAP but did not comply with any structural adjustment program completely. Eventually, in the 21st century, the SAP strategy exposed that it cannot sustain the debt. Then another strategy was introduced from the forum of IMF, called Extended Fund Facility (EFF). Pakistan also started to get loans under the Extended Fund Facility, which is provided in installments to develop debt sustainability.
This is the journey that started from the price hike of oil and did not end at EFF, and miscalculations of developing countries to take short-term benefits lead them to enchain into the debt trap. Here it is very difficult to determine who is responsible for this trap. But, it is clear that to come out of this debt cage, we have to take hard decisions; otherwise, it would be catastrophic if we did not take necessary measures.