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Short term and long term debts

Discuss about the Debt and Developing Nations System.

Developing economies or developing nations rather find it difficult or wholly impossible to oversee its development and pay for all its expenses on its means and ensure correct management and use of its expenditures and resources without both internal and external borrowing. According to Faiez H. Seyal, the International Monetary Funds (IMF, 2006) says that the level in which the borrowing rate of these countries have gone up and at a very alarming unsustainable rate. They say that the total external debt owed by the developing nations increased by 437 billion dollars to stand at 4trillion dollars at the end of 2010, the latest period for which data is available.

The agricultural and mineral exports produced by these developing nations together with the revenue collected does not earn them enough to sustain their economies hence the massive accumulation of these debts both foreign and domestic. Public debt, which is, basically, the borrowing of capital, machinery, and technology by governments from within the country (domestic) or from foreign lenders, from private individuals or both banking and non-banking financial institutions, are classified as;

In-house or internal debt is that which is borrowed with the country while the foreign one is that which is borrowed from foreign creditors, outside a country.

Productive debts are those that are expected to enable the creation of assets that will increase the level of income earned to be able to sustain the country and pay back the debt together with the accrued interest. Non-productive loans do not generate any assets and are albatross.

Short term loans, also known as floating debts, are temporary thereby having a short maturity period and paid after a short period while long-term debts take a lot of time, maybe some years, before it is paid.

There are various causes that have led to the increase of public debts by developing nations, besides war including the following;

The high deficits in federal budgets. These arise from the need by these governments to sustain a full economic activity where they cease to expand.

Shortage of foreign exchange and an increase in the capital flight,

Excessive foreign aid and the commissioning of welfare schemes in the modern times by these states.

The increase in both corporate and house debts and the growth in war preparedness in an attempt to guard their territories against intruders and enemies.

Causes of debt increase in developing nations

It has been proved beyond doubt that extensive study and research that developing nations face a daunting challenge to achieve economic growth, even when they are producing and exporting goods, and that a “countries debt burden played a significant role in influencing the productivity of labor and capital.”  (Cunningham, 1993).  Years later, a study published in the World Bank Economic Review that linked performance in different financial sectors to rate of economic growth and distribution of income.

It became apparent that developing countries had been locked into a cycle of incurring debt to finance debt (Beck, Demirguç-Kunt, & Ross, 2010).  These findings were confirmed in another study published in 2010.  Jens Hilscher and Yves Nosbusch have also reported the phenomenon associated with varying interest rates at which emerging markets borrow and repay.  Sometimes this phenomenon could have contributed to its inability to repay debt and avoidance to incur more (Vasishtha, 2010).  IMF, the World Bank and the government aid are the major lenders to these economies and these countries have no other obligation than to enrich their creditors through their low priced supplies to get the deficits to sustain their economies.

The less developed countries (LDCs) borrow both externally, foreign debts, and internally, that is, domestic debts (Hilscher & Nosbusch, 2010). These countries have a tendency of borrowing from its commercial banks and financial institutions that give credit with little maturity period and has increased the debt volatility from 7.8 -14.4 percent of Gross Domestic Product, GDP, Traditionally, domestic borrowing was used by countries only when they did not have access to external market, unlike today, where the increase in internal financing is due to lack of access to the International capital market. (Brooks, et al., 2015), argues that borrowing funds domestically has the benefit of being given in the currency of that country hence reducing exchange incongruities, thereby, policy makers are trying to lessen the menace of free financing through reduced rate of foreign borrowing.

They actually, consider adjustments between the rate and effects of alternative financing and the available possible returns when planning and deciding the optimal structure of public debts. Krugman 2006, as quoted by Ugo Panizza, says that the kind of the original debt format a country will settle on will comprise of lots of adjustments and any flaws with the existing system only recognized after a financial crisis begins to be sensed. Hence policy makers should be aware of these vulnerabilities. 

Impact of debt on economic growth

(Ferraro, 2008), argues that borrowing considerably influences the actual economic growth of these indebted countries despite their financial value.  The role of converting the countries savings into credit has been described as one of the most serious methods they have for resource allocation. He further says that different valuations have displayed some differences on the level of debt intensification on GDP growth, hence proving it very hard to regulate the prime ratio of debt-to-GDP. The total maximization of debt-to-GDP ratios, as quoted by Ferraro (2008) lies between 200% and 220% where short-term progress drops for levels above 150%. Valuations on various government debts have shown adverse effects on both, development and progress on GDP levels.  Having access to reserved debts has resulted in a higher value of about 270% when GDP per capita levels are considered for growth maximization.

(Cranston, et al., 2010) illustrates that a country’s ability to give national bonds with extended maturity periods in its own currency, lies entirely on the presence of resources control and management which has disputed by Reynaud (2005) who say that the outcomes are not vigorous due to the difference in countries ability to borrow and capability to pay these debts in terms of export, and revenue collected.

The foreign markets have provided lots of money and aid to the developing countries, who have used them as an opportunity to increase their limited savings, thus financing public arrears without depending only on the private sector or inflationary finance for funding (Desai & Vreeland, 2011). Foreign aid has been used as an insurance to all monetary dealings made or promised to needy countries either in cash; through investments, loans and infrastructural development, or in kind through;  giving of army and war equipment at lower prices, armed pacts, military assistance during crisis, military technical assistance, advice, subversions and direct participation. (Ajay 2000, as quoted by Funso Aluko and Dare Arowolo). Third world countries resort to external loans due to their increased demand for capital and resources to enable the sustenance of its economy and development agendas. It has led to the growth of a debt crisis leading to little savings on their GDP for social, domestic services.

The overwhelming financial predicaments that affected these emerging markets in the developing countries saw to it that policymakers were well aware of the risks involved in borrowing foreign aid (Franko & Seiber, 2014). These loans are highly exploitive and are consistently given by the creditors to hold these countries as their slaves in a way that they cannot be able to repay hereafter they maintain the “master- servant/slave relationship,” because of the depth of these debts. For example, Funso Aluko and Dare Arowolo say that in Nigeria, according to CIA World Fact Book (2010), their debt profile by 2009 stood at 3.97 billion dollars where federal governments have a debt of 2.093 billion dollars while the governments are indebted with 1.85 billion dollars.

Borrowing from foreign lenders

These amounts are so high compared to Nigeria’s’ GDP, and revenues, therefore, cannot be able to pay all the debts completely and maintain the growth of its development projects at the same time, making them slaves to their debtors.  Various study cases that have been conducted have shown that debts issued by foreign lenders seem to be less expensive compared to those released by the countries internal creditors (Grimmett, 2010). Many can conclude from these results that these developing countries might contribute to reducing their interest rates of funding without risking their image through giving more securities to their creditors, without feeling like this could be the unachievable strategy. These LDCs could be able to give long-dated internal loans and debts despite currency-maturity trade-off, provided they pay the prices posed by the market for such debts. These prices, however, may not echo the right inflation or devaluation values expected, thereby becoming costly.

Aluko and Dare Arowolo illustrate that various theories have been established to try and identify or explain reasons that have fueled the development of these LDCs and the Dependency model is one of them, which is built on the notion that resources flow from poor nations to those that are established and already developed (Ximin, 2012). Some of the mentioned resources that flow include;

  • The provision of natural resources like crude oil, provision of less expensive labor, majorly through indirect slavery, a dumpsite for outdated technology and market to the industrialized nations hence their high standards of living.
  • The countries that give financial aid counter the attempts of these states to repeal their influences of economic endorsements or use of force (Todaro 2003).
  • These developed nations prolong their dependence through involving finances and banking, media control, political influences, education funding, culture, and sports together with all spheres involving human development (United Nations, 2009).

In their Nigerian experience, they also note that the causes of the country’s external debts include the following;

  • Trade and exchange rate policies that is ineffective
  • Exchange rates and interest rate movements that is very hostile to the debtors
  • Inappropriate lending trends and wasteful loan utilization by the indebted government.
  • Lack of proper debt management practices due to inadequate debt management systems that ensure the required amount of funding is raised; its costs and risks objectives are also achieved.
  • Accumulation of arrears and penalties causing a lot of burden for the nation due to an increase of lending interest in percentages and also in the growth of taxation.

Many governments have tried to make good use of the debts they borrow enable sustainability of the rate and level of growth through involvement of a public debt management docket, that ensures the required amount of funding is raised, its costs and risks objectives are also achieved and all these can be serviced under a wide range of circumstances (Gulati, 2008). The managers placed in this docket often share fiscal and monetary policy advisors, who enable them to ensure the public debt remains sustainable and maintenance of the credible strategy that reduces excess levels of debts (Beck, Demirguc-Kunt, & Levine, 2010). Without the involvement of these public debt management programs, governments tend to end up signing and receiving poorly structured debts with unclear maturity period related to the payment agreements, currency or interest rate compositions, massive unfunded contingent liabilities which have increased the economic crisis (Timothy & Nyaupane, 2009).

Wachter, Marcel argues that there is no direct evaluation of debt stages instead only modeling the effects of recurring economic policy on growth. Nonetheless, this system is not linked to the government’s debt as taxes will be required to explain their accountabilities. (Brooks, Cunha, & Mosley, 2015), find that an alternative economic policy enhances growth because many organizations have capitalized on long-term projects.

Policies to minimize financial risks

External loans have the inherent capacity to put a country on developmental plinth quickly, and if misused, will involve both societal and humanoid costs. It could also accelerate the decrease of a country’s external possessions and a drop in the level of production together with its effects on the micro economy (International Monetary Fund, 2001). For efficient sustainability of these debts, then they should be serviced by the creditor in a way that there is no exceptional financing like bailout by the donor depending on two factors; one is that how much money/ debt is owed, and two, the capacity of the lender to repay the debt that will be determined on the GDP, exports and amount of collected revenue (Jamovich & Panizza, 2010).

The need for an efficient sound capital market, has been highlighted as that of importance, and many governments have been encouraged to adopt a sound debt management system in order to reduce the governments’ debt portfolio and substantial obligations in relation to contingent liabilities that  increase the debt crisis level (Rowden, 2009) and (Santiso, 2008). Various countries have tried various means to escape from the debt crisis through adoption of the different issues as argued by Faiez H. Seyal, including; improving debt ratios through debt restructuring and reorganization that involves;

Refinancing which means getting new loans to pay old loans (Konteh, 2009). This, however, makes the country get deeper and deeper into debts, a term is known as “spiral debt.”

Rescheduling through the acquisition of longer repayment periods, which sometimes also comes with very strict conditions like cuts in spending on healthcare, education and food subsidies (Kose, et al., 2009). These even worsen the situations for the people in the indebted countries.

Buying loans from the creditor at a value of the loan with a payment an ossuary.

Giving the creditor equity in a company owned by the state in return for debt cancellation.

External debt is important for the developing nations as it enables them to fill up the differences between the expenses and profits collected that can never be sustained with national savings. It also allows them import machinery, capital goods, and technology that they need for their growth and investment purposes (Lekomola, 2010). These debts either foreign or domestic forces a country to embrace and device better methods that will enable its level of independence do not prevent or hinder the issuance of debt or the flow of fairness. Marcel, 2002, illustrates that the high levels of globalization in finances have led to the unleashing of forces that have brought about better public and corporate governance and improvement of discipline on microeconomic policies.

The LDCs also borrow to suppress their depression on the creation of employment opportunities, therefore, funding the states’ public works program (Mitton, 2008). Another advantage of this is that it enables the marketing and promotion of exports or importation of substitution industries to create employment opportunities and increase a county’s independence in economic issues (Ringland, 2010) and (Roberts & Parks, 2009). Governments also borrow money and give free loans to withdraw purchasing power of its citizens by bringing down prices of goods hence curbing the inflation rate.

On the other hand, when loans are paid with interest, a lot of wealth that has accumulated is transferred thereby causing a lot of burden for the nation due to increase of lending interest in percentages and also in the growth of taxation in order to generate additional revenue since they only operate using soft currencies (Nersisyan & Wray, 2010). The independence of a country due to dogmatic twines, changes the investment of a country, consumption rates that make the indebted country use a lot of resources to finance and complete its projects. A lot of capital used will therefore result in the increase of profits which encourages more consumption that eventually trickles down causing inflation in the country if the demands are not satisfied and cause indirect adverse effects (Panizza, 2008).

We know that debt is a liability that forces a country to work extra hard in tax collection to meet its repayments. These results in fewer savings for a nation for its development and social functions reducing the level of usage too that increases the level of inflation, saving levels and income levels (Petr, et al., 2012). Some the LDC’s have gained a lot from these countries and are working their way out of their debt situation although there are a lot of setbacks. The payment of loans has proved difficult due to the conditions that loans must be paid in the form of the hard currencies; which include the American Dollar, the Japanese Yen, and the Swiss franc.

Governments always try to repay their loans in order to maintain a good standing and strengthen the national credit between itself and their creditors by employing such tactics as; utilization of extra proceeds to pay the debts, buying its own stock in the money stock and exchange markets or borrowing at lower rates, conversion of high rated debts to lower ones when the rates of interests fall compared with the time they had borrowed and the setting aside of a certain amount of money every year from the revenue collected to repay a loan, calculated over given period (Presbitero, 2012). Public borrowing if properly managed and well planned for and skillfully operated, then can be a very powerful and straighter path to economic development and assuring the citizens of a stable continuous income that will continuously yield assets for them hence a productive form of debt (Rais & Anwar, 2012).

Conclusion

Leadership is a critical role when there is a dire need for resource mobilization in pursuit of attaining economic growth and national prosperity hence leading to the achievement of national goals. Adoption of leadership that inspire both confidence and economic restructuring, and can deviate from ineptitude and corruption to competence and moral decency will be very essential. Since, foreign debts by the developing nations cannot be entirely done away with since these countries are still far from being completely developed and industrialized, to be able to manage and sustain their economies and creation of both wealth and employment opportunities. Repayment of these debts have equally proved a challenge as some government deficits are very high, there is also reduced demand for foreign exports and reduced capital flows. These have ensured these nations remain slaves to their creditors and therefore will forever remain accountable to them. Debts and borrowing will continue into the future for all the developing countries and will continue to enslave them hence can be seen a contemporary annexation.

References

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