The Debt Trap: How Global Lending Institutions Shape the Fate of Developing Nations

Content:

• Challenges Faced by Developing Nations

• The Role of Loans and Investments in Economic Growth

• The Hidden Risks of IMF & World Bank Policies

• The Consequences of Unsustainable Debt

• Strategies to Break Free from the Debt Trap

 Let us begin with a simple question,

 Sri Lanka, Zambia, Pakistan, Djibouti and Maldives -

What do these nations have in common?

There are two similarities the first being that they are Developing Nations and the second being that they are stuck in a Debt Trap.

 

1.   Situation of Developing Nations

A Developing Nation is a nation which has a low income or middle-income population they are often under a slow or rapid process of industrialization and economic growth but have not yet reached a level of wealth, infrastructure and living standards and living standards. For example: India, Pakistan, South Africa, etc.

Now comes the question, why do these nations require loans and who or what gives them these loans?

The IMF (International Monetary Fund) and the World Bank are international organizations which provide loans to nations in distress. Developing countries require loans for the following reasons:

Economic Stability: Countries in financial recession and crisis often choose to take loans from IMF to stabilize their economies as the IMF provides a stepwise plan and a set of instructions to aid their economies.

Infrastructure: Countries which lack a standard of living and do not have a satisfactory infrastructure like roads, schools, hospitals, and water systems often approach the World Bank to borrow funds for a long-term growth and future plans to lay a stable foundation for the country.

Poverty Alleviations: Developing countries often suffer from problems like poverty, healthcare, and education, choose to borrow funds to resolve these problems.

Technical Expertise: Organizations like the IMF and World Bank are considered as highly expert and experienced and are thus approached by developing nations for advice and funds.

Disaster Recovery: Developing Countries which face extreme weather and are prone to disasters often take loans to quickly rebuild and rehabilitate the victims and cities.

Foreign Investment Attraction: By having a stable capital and trust of these reputable organizations these countries become an attractive place for foreign investments.

2. Importance of loans and investments towards developing nations

Loans and investments are indispensable for developing nations as they support growth reduce poverty, improve education system, improve sanitation, refine public transports, encourage use of renewable energy resources, etc. They help in social progress and urbanization of rural areas. Additionally, foreign investments often bring advanced technologies and create jobs, strengthening these economies for long-term success.

3. IMF & World Bank and their traps and policies

The IMF and The World Bank are two of the most reputed monetary organizations throughout the world. They were established in 1944 to provide funds and assistance to countries suffering from the second world war, its economic consequences and the development of newly formed nations which had suffered from years of colonialization.

While mostly provided from a purely financial perspective, it has been observed that some countries that are not in a critical economic situation still face a crisis after taking loans from these organizations. This is due to several reasons:

1.     Structural Adjustment Programs: These are basically policies to reduce government spending and to promote foreign trade and relations with companies and other countries. Though they seam normal it has been observed that this leads to increased unemployment and public resentment, reduced domestic production, and increased dependency on IMF and World Bank.

2.     Debt Dependency: Huge loans from the IMF and The World Bank result in the borrowing country’s economy being exhausted in repaying the installments and the interest thus schemes of public and national welfare are halted for a long period of time leading to the decay of the internal economy of the nation.

3.     Loss of Sovereignty: These loans often require the borrowing country to mortgage their land and assets. These organizations indirectly gain control of government policies and allegedly use them for favoring multinational companies.

4. Consequences and Traps involved in taking loans

For this Sub topic we will dive into a case study:

Case Study: Sri Lanka's Debt Trap and Hambantota Port

The Government of Sri Lanka wanted to boost Sri Lanka’s economy so they agreed to take loans from China, despite ongoing discussions about Debt Diplomacy.

Sri Lanka’s blunder: Sri Lanka took huge loans at insane interest rates for the development of the Hambantota Port but in 2017 Sri Lanka started struggling to pay installments thus they had to give the Hambantota Port on a lease for 99 years to China. The limited returns from a major port further strained the already stagnated Sri Lankan economy.

5. How to Overcome the Debt Trap?

Though every nation requires loans the best example being the world’s largest economy, the United States, but the difference between taking loans and getting trapped by them is only what time and mathematics can tell. There are certain concepts which developing nations should take care of while taking loans from another country or the IMF and the World Bank:

How to take the loan: The country must be aware of its growth rate, future schemes and the emotions of its citizens, further, while taking a loan it should negotiate for longer payment periods and lower interest rates.

Diversified investments and promotion of local economy also help in stabilizing the economy and also creates a positive image of the government thus encouraging local entrepreneurship.