Who Owns that Developing Country's Debt?

A peek to why countries borrow and where are they borrowing from

Reading/Speaking time: 13 min read or 19 minute listen at 1x speed.

The City of London - which is one of London’s most primer financial centers where governments first went to get Eurobonds - a debt instrument not denominated in the borrowing country’s currency

Each December, the World Bank publishes the World Bank’s International Debt Report, a database covering external debts in low, lower-middle, and upper-middle-income countries. (Basically if your average citizen in that country makes less than $14K a year in 2022 dollars, then your country is considered Low or Middle Income Country). While not flawless since there are some countries that are not fully transparent in releasing all their debt obligations or who they lend to (i.e. we have no data on North Korea), this database is the best compendium we have.

When I say external debt I should define that and separate that from internal debt. External debt, or foreign debt, encompasses a country's total obligations to foreign creditors, including loans, bonds, and financial commitments to entities outside its borders. The World Bank reports this debt, often denominated in US dollars due to its relative stability for now (As of Q3 2023, 59% of reserves is denominated in US dollars).

Internal debt, or domestic debt, is the money a government owes to creditors within its country, often involving bonds issued to domestic investors in the local currency.

Why are countries going into debt??

Debt gets a lot of bad media but in truth it is a crucial financial tool for governments, providing support during economic downturns or funding essential infrastructure projects. Countries borrow to fund roads, dams, or ports that the country may not be able to finance through taxes alone.

Unfortunately some countries misuse their borrowing funds.

• Borrow to win elections: In some countries the incumbent party will spend like a drunken sailor on poor people to secure votes a few weeks before an election.

• Construction Corruption: Another form of corruption is lying about the price of a construction project. The country inflates the price of construction, and the difference between the stated cost and actual cost is pocketed away in United Bank of Switzerland (UBS) or in properties in the City of London.

• Government Ministers using government owned firms to steal: Some countries pretend to be socialist to loot funds. In Angola or Mozambique, enterprises owned by the state (SOEs) have been used by government ministers as a black box to loot funds meant to be spent on increasing productive capacity for those SOEs.

Low and middle-income countries often need to borrow externally in foreign currency due to being capital poor. This occurs when there's insufficient development in domestic capital markets, including limited presence of pension funds, insurance funds, mutual funds, hedge funds, and individual bond buyers. Additionally, countries may lack enough domestic savings derived from households (bank deposits, investments, retirement accounts), corporate savings, and government savings (budget surpluses).

In many poorer countries, a substantial portion of employment lies in the informal sector, where capital markets don’t really exist. Also, individuals prefer investing in their businesses over saving in banks. The absence of long-term investment entities, like pensions and endowments, constrains domestic borrowing capacity for the government. Analyzing the World Bank Database provides insights into countries' borrowing patterns.

General Trends & Myth Debunking

1. Low and middle-income countries predominantly borrow from private investors, using eurobonds or syndicated loans. This trend is notable in East Asia, Developing Europe, the Middle East, North Africa, Sub-Saharan Africa, and Latin America.

2. In contrast, South Asian countries show a preference for multilateral financing, relying on institutions like the World Bank, IMF, or Asian Development Bank.

3. China is currently the largest lender to 6 African countries (11% of the African continent). Maybe the proportion will continue in more years to come, but no nation on earth has increased its speed of lending like China has over these two decades.

4. Contrary to a common belief, France is not the primary lender to any of its former African colonies.

Bilateral Lending

Bilateral lending involves official agencies of one country providing loans to another government.

Countries where America is the Largest Lender

The U.S. government, through entities like the Export-Import Bank, International Development Finance Corporation, and the Overseas Private Investment Corporation lend to other governments. Even the Pentagon can lend! The only developing country where America is the largest creditor is Somalia.

However, as of December 2023, the U.S. Department of Treasury, IMF, and World Bank is going to relieve Somalia of $4.5B under the “Heavily Indebted Poor Countries” Initiative, a program that most African countries received debt relief from in the late 1990s, early 2000s.

Countries where China is the Largest Lender

There’s a copious amount of fearmongering about Chinese lending to poor countries. While it is true that China is one of the biggest lenders to the developing world, China is only the largest lender in 15 developing countries.

In the year 2000, President Jiang Zemin, had a “go out” strategy to seek greater global engagement and partnership. While the West was giving debt relief, China was scaling up its lending with Africa. The Chinese government owned banks like the China Export Import Bank, China Development Bank, Commercial Bank of China, China Construction Bank or Industrial Bank of China would make loans that funded infrastructure contracts awarded to Chinese firms to build infrastructure to countries that entered its Belt and Road Initiative.

Notably, with Chinese lending, capital flowed from the Chinese bank to the Chinese firm, instead of the African government which actually reduces the chance of corruption. This is the opposite of Western lending where infamously, corrupt idiots like Mobutu Sese Seko of Democratic Republic of Congo stole over $5B, a luxury yacht, over 20 palaces and properties in Morocco, Belgium and Switzerland.

China typically requires a 10% to 20% down-payment before commencing projects. The developing country will borrow from private markets to finance the Chinese project.

China engages in infrastructure-for-commodity deals (copper, oil, gold, &cobalt), distinct from the IMF's policy-conditioned loans that may require reforms like liberal democratic reforms, privatization of state owned enterprises, currency floating, or removal of costly food & fuel subsidies. Contrary to Western perceptions, Chinese loans are often concessional (below market rate). Here’s the list of countries where China is the main financier:

Africa: Cameroon, Comoros, Democratic Republic of Congo, Djibouti, Guinea, Zimbabwe
South East Asia: Cambodia, Laos
South Asia: Pakistan
East Asia & Pacific: Mongolia, Samoa, Tonga, and Vanuatu
Central Asia: Kyrgyzstan, Tajikistan

Areas where Japan is the Largest Lender

Former Prime Minister, Shinzo Abe, meeting with African leaders in 2016 to discuss Japan’s “Quality Infrastructure” Plan to Counter China’s Belt and Road Initiative

Myanmar, Turkmenistan, Vietnam, and surprisingly Iraq mainly borrow from Japan.

One interesting aspect about Japan is that China borrows a significant amount of policy prescriptions from Japan. A good rule of thumb is that anything China is doing, Japan did a few decades ago — Complaints of “window guidance monetary policy”? Japan did it first. Complaints of “purposely undervalued currency?” Japan did it first. Economic cooperation through loans and public-private investments in developing countries? Japan did it first.

Right after WW2, Japan paid reparations to the countries it occupied for killing 10M Asians and provided energy & transportation infrastructure to Asia to seek forgiveness and further cooperation from its former vassals. In contemporary context, Japan, under deceased Prime Minister Shinzo Abe, is trying to counter China, by pursuing its own “Belt & Road Initiative” by backhandedly insulting China’s Infrastructure projects by calling its initiative “Partnership for Quality Infrastructure”.

Areas where India is the Largest Lender

India is also trying to extend regional cooperation in its own home-turf. However, right now India’s pockets aren’t as deep as China or even Japan (yet). Right now, India is the largest lender to Bhutan.

Areas where Russia is the Largest Lender

Russia also has influence in its region. Although in Europe, it competes with the EU, which has vastly deeper pockets.

Russia is the largest bilateral lender to Belarus and Afghanistan.

Areas where Saudi Arabia is the Largest Lender

Saudi Arabia is the regional power in the middle east. Yemen’s biggest lender is Saudi Arabia.

Areas where Venezuela is the Largest Lender

Haiti is currently, Venezuela’s largest lender. A quick history of Haiti, during the Haitian revolution, Haitian rebels slaughtered the 5000 French slave owners. For slaughtering Europeans, the America and Europe embargoed Haiti and Haiti had to pay reparations for massacring the French. Haiti was basically 19th century North Korea-fully isolated, hated by the West, no trade or aid. France initially forced Haiti to pay massive compensations or become re-enslaved. That French debt was paid off 1947. Haiti was then run by idiots “Papa Doc” and “Baby Doc” propped up by America because they opposed Communist Cuba which was propped up by Soviet Union. Haiti increased its debt massively without proportional living standard increases since most of the money was stolen anyway. The World Bank and IMF forgave half of Haiti’s debt ($1.2B) in 2009.

Haiti’s debt from Venezuela largely comes from Haiti borrowing to buy Venezuela’s oil and financing its projects through a line of credit called “Petrocaribe”. Haiti’s High Court of Auditors accuses most of these projects to be fraudulent and mainly an embezzlement scheme done by continuous corrupt Haitian officials.

Areas where Angola is the Largest Lender

Angola, an African petro-state, was temporarily upper-middle income African country when oil prices were high. (Now that oil prices aren’t triple digits, Angola is a lower-middle income country). Angola’s government owned oil company Sonagol, invested and lent money to its neighbor Sao Tome & Principe to develop ports. Angola is also one of the main suppliers of oil and gas to Sao Tome.

Multilateral lending

Multilateral lenders, such as the International Monetary Fund, World Bank, African Development Bank, and Asian Development Bank, are official agencies governed by multiple countries. They provide loans with longer terms and friendlier interest rates compared to traditional bank loans or bond issuances.

African Development Bank Lending

The African Development Bank was founded in 1964. It was part of the Pan-Africanist vision of leaders like Ghanaian President Kwame Nkrumah to make a continental development bank. The headquarters of the bank is in Abidjan (“Ah-Be-Jawn”), Ivory Coast and funds projects at concessional (below market rates). The voting powers of the bank is 59% African and 41% non-African with America, United Kingdom, European Union, Switzerland, Canada, and Sweden also possessing large voting rights. This is largely due to the fact that these non-African member countries are also significant funders of the bank.

The African Development Bank has worked on hydropower projects in Uganda, water management projects in Egypt, and irrigation systems in Morocco.

For some countries in Africa, like Algeria, Eswatini, & Botswana, the African Development Bank is its the largest lender.

Arab Fund for Economic and Social Development Lending (AFESD)

The AFESD is a development bank based in Kuwait. All members of the Arab League have access to this bank.

For Mauritania, their loans largely come from this institution.

Asian Development Bank Lending

In the Philippines, there is the Asian Development Bank (ADB). The Asian Development Bank, was concocted by Japan. In fact, Japan has had the idea of a Pan-Asian bank since the days of Japanese imperialism. This Asian Development Bank was made in Philippines as a way of Japan showing Asia that this bank isn’t a scheme for Japanese Supremacy again. However, the bank’s Presidents has always been Japanese and Japan & America are the biggest funders and have the most voting power in the bank.

For Fiji, Solomon Islands, East Timor, and Papua New Guinea, their loans largely come from the ADB.

China made an alternative development Bank called Asian Infrastructure Bank. United States, Japan, and Taiwan are non-members and have zero voting shares in the Asian Infrastructure Bank.

Inter-American Development Bank Lending

Obama with Usain Bolt, after pledging $70M to Latin American & Caribbean Youth

America made this bank in 1959. It’s located in Washington D.C. and it serves as a development financing arm to Latin America and the Caribbean. This bank was part of a cold war strategy to prevent the Soviet Union from creating more allies in the region like Cuba & Nicaragua. America holds 30% of the voting power, followed by Brazil & Argentina (11% each), European Union (9%), Mexico (7.3%), Japan (5%), and etc.

For Bolivia, Guyana, & Honduras, their loans largely come from this bank.

International Monetary Fund & World Bank Lending

I've previously discussed the World Bank and IMF. If interested, you read the articles below. The IMF, acting as the lender of last resort, imposes conditions that developing countries often dislike in order to secure loan.

Then there’s the World Bank which is really five organizations put in one. To learn more click here:

These institutions are known as the “Bretton Woods Institutions” and developing countries try their best to borrow from any institution except these due to their conditions for fiscal prudence. The pros to the World Bank is that their loans are long term (35 years) and the rates are concessionary (below market).

These countries have most of their loan portfolio taken up by these institutions:

South Asia: Bangladesh, Nepal
Africa: Burkina Faso, Cabo Verde, Central African Republic, Eritrea, Ethiopia, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mozambique, Niger, Rwanda, Sierra Leone, Tanzania, Uganda
Caribbean & Latin America: Dominica, Grenada, Nicaragua, St. Vincent

Private Lending

Private lending includes bank loans and purchases of a country's bonds by private lenders.

Eurobonds: Eurobonds, despite the name, are often denominated in U.S. dollars. Typically, they have a 5 to 10-year term with market-based interest rates, benchmarked against the 10-year U.S. Treasury bond. If U.S. Treasury yields are low, as seen post-2008 and during COVID, borrowing for low and middle-income countries becomes cheaper. However, when U.S. Treasury yields rise, as during the U.S. Federal Reserve's actions against inflation (2022-present), eurobonds become more expensive. Borrowing from the Eurobond market, while less generous than multilateral financing, can enhance a country's credit rating and credibility among investors. This positive feedback loop allows countries with prudent financial management to secure loans at more favorable rates, fostering economic development. As the country’s credibility increases, a developing country like Ivory Coast which has a “BB-” rating can borrow at cheaper rates than a country with a terrible credit rating like Burkina Faso which has “CCC+”.

The issue with Eurobond financing is that its denominated in US dollars. Chances are no one wants to borrow in that home country’s currency. Why? Let’s say I’m Morgan Stanley(MS) and I buy a cedi bond from Ghana in 2019. I buy a 1M cedi bond from Ghana, giving Ghana 1M cedis, and Ghana has to pay me, MS 10% each year. In 2019, the exchange rate is 4.89 cedis to 1 dollar (If you do the exchange rate math, I lent $204.5K). Afterwards, Ghana continues paying its 10% each year until the final year, Ghana pays the principal. From 2019-2024, Ghana’s currency has depreciated significantly, It’s no longer 4.89 cedis to a 1 dollar but 12.38 cedis to 1 dollar (as of Jan 27, 2024). Because the cedi is depreciating, Ghana is paying me less money when you convert cedis to dollars each year. By the end of the 5th year, Ghana paid me back my principal- 1M Ghana cedis. But now that the exchange rate is weaker, Ghana paid a principal of roughly $81K….

In short, I lent Ghana $200K, Ghana over time increasingly paid me less interest payments due to their currency weakening, and by the 5th year I got $81K back…. I lost roughly half my money when I borrowed from Ghana’s local currency after converting cedis to dollars. Do you understand why lenders lend in US dollars instead of local currencies now? Lenders don’t want to lose money!!! Instead banks lend in US dollars or another stable currency, charging a higher interest rate premium due to the risk of the country defaulting due to foreign currency risk.

If home country’s the currency depreciates to the US dollar, then its debt is ballooning, increasing the likelihood of default. For countries like Ivory Coast or Gabon which is on the CFA franc which is anchored to the euro, they like borrowing eurobonds in Euro since the CFA franc is fixed to the euro, eliminating the foreign currency risk that non -CFA franc countries have.

This is why some African countries like Ivory Coast like the CFA franc. As President Ouattara said “The fact that we are pegged to the euro, if we borrow euros, by the time to repay them in five or 10 years, the rate is fixed. Member nations of the West African Monetary Union do not have big debt problems and “it is thanks to this fixed parity.”

Another form is syndicated lending. That’s a form of private lending where a group of lenders give a loan to a single borrower. Think of Goldman Sachs, Citi, Barclays and etc. working together to provide a large sum of money to a borrowing country. These rates are usually quite high for a developing country.

These are the developing Countries that borrow mainly from the private debt markets:

North Africa & Middle East: Egypt, Iran, Jordan, Lebanon, Morocco, Turkey
Sub-Saharan Africa: Angola, Benin, Chad, Congo-Brazzaville, Ivory Coast, Gabon, Ghana, Guinea-Bissau, Mauritius, Nigeria, Senegal, South Africa, Sudan, Zambia
Latin America & Caribbean: Brazil, Argentina, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Jamaica, Mexico, Paraguay, Peru, St. Lucia
South Asia: India, Maldives, Sri Lanka
East Asia: Indonesia, Philippines, Thailand, China
Eastern Europe: Bulgaria, Montenegro, North Macedonia, Serbia, Ukraine
Eurasia & Caucuses: Russia, Azerbaijan, Kazakhstan, Uzbekistan

Sources:

World Bank’s International Debt Report.

Where Credit is Due: How Africa's Debt Can Be a Benefit, Not a Burden