WASHINGTON, CMC—When considering the economic and development challenges of developing economies in the face of the climate crisis, most people view debt as a complicating factor and, at worst, a source of many of our problems.
There are good reasons for this. Rising public debt across the developing world and the surging interest bills accompanying it are diverting public funds from already underfunded health and education programs. It threatens to push more countries into outright distress and more people back into poverty.
Yet there is no escaping the fact that debt will continue to be a critical component of the funding developing economies need to meet their sustainable development goals—particularly climate resilience—and fulfill their economic development potential more generally. The challenge, therefore, is to both lend and borrow “better.” What does this mean?
It means ensuring that public borrowing is anchored in sustained fiscal discipline. However, it also means avoiding debt that is likely to prove unsustainable. While multiple factors determine overall debt sustainability, experience teaches us that the rate of economic growth is the most critical driver of debt dynamics.
There is a simple rule to help determine when the terms of new borrowing are unlikely to prove sustainable over time, at least when it comes to cost: put, rates of interest that are likely to exceed the rate of future nominal growth cannot be considered sustainable. The more such rates feature across a public debt portfolio, the greater the likelihood of sovereign debt distress in the future.
Flawed framework
Although much focus has been on the very high interest rates paid by some developing economies on their Eurobond issuances since the start of 2024, the problem of unsustainably high borrowing costs is also evident in lending by the official sector.
The recent rise in global interest rates has revealed a flawed IMF lending framework for middle-income countries that no longer support debt sustainability. It is in desperate need of reform.
Let’s start with the central issue of cost. At the start of the millennium, surcharges were introduced on all IMF lending to middle-income countries through the General Resources Account (GRA), which includes Stand-by Arrangements (SBAs), Extended Fund Facilities (EFFs), and Rapid Financing Instruments (RFIs).
The surcharge structure comprises a level-based surcharge of 2 percent on GRA borrowing that exceeds 187.5 percent of quota and an additional one percent “time-based” surcharge on the portion of GRA credit above this threshold that is outstanding for more than 36 months (or 51 months in the case of the EFFs).
The IMF introduced these surcharges when it was trying to extinguish the flames of the first emerging market debt crises, including by burning through its capital. The underlying objective of the new surcharges was to dissuade extensive and prolonged borrowing from depleting the IMF’s resources, particularly among higher-rated emerging market sovereign borrowers.
The surcharges worked well, and these countries quickly regained investment-grade ratings after the crisis. Years later, the approach worked well again: Organisation for Economic Co-operation and Development countries that had been forced to borrow from the Fund during the global financial crisis were able to prepay their IMF liabilities once the worst of the instability problems had subsided, thanks to deep domestic capital markets.
But the world has changed radically over the past 25 years. The IMF has gone from having precautionary balances of US$6.2 billion as of April 1999 to approximately $33 billion as of April 2024.
It has also succeeded in making a much-needed pivot, gradually expanding its role as a lender of last resort to become a partner of some of the poorer and most fragile countries in the world at a time when their access to liquidity has been severely compromised.
The scale of IMF lending has also increased. 187.5 percent of the quota is no longer a big deal: as of April this year, 21 middle-income countries had borrowed above this level from the Fund. Compared with a decade ago, the average per capita income of countries with active EFFs has fallen by a factor of 4.
Yet the Fund’s surcharge regime remains unchanged, exposing fragile sovereign borrowers to rising world interest rates. This is even though the IMF is now well-capitalized and does not rely on market borrowing to fund its lending arrangements.
Surcharge regime
As of June this year, the minimum all-in interest rate payable on GRA disbursements (this covers SBA, EFF, and RFI disbursements) had surged to 5.1 percent a year, with sovereigns paying 7.1 percent on the portion of their drawings that exceeds 187.5 percent of quota.
GRA liabilities outstanding for three years or more (or four in the case of the EFF- less than halfway to final maturity) now have a record interest rate of 8.1 percent.
The IMF cannot argue that its lending programs are based on debt sustainability when its own lending to middle-income countries is not sustainable.
This is a problem the IMF must address. Incentivizing sovereign borrowers to repay the IMF is correct in itself. Still, it could be better in a world where most GRA borrowers cannot access alternative sustainable financing sources.
The IMF’s surcharge regime needs to be reformed urgently, either through a radical overhaul that includes caps that consider the interest rate cycle or by scrapping it outright.
However, costs are only one area of IMF lending that needs urgent reform. Tenor matters, too. Take the EFF- an instrument designed to address balance of payments imbalances caused by structural weaknesses in the economy. It is widely accepted that structural reform is a complex task that takes time to implement and years to bear fruit.
Yet, in the EFF, we have a lending instrument that disburses over only three or four years and has to be repaid in seven (on a weighted average basis). A facility that is so constrained is not fit to support structural reform at a time of “poly-crisis” and in light of the increasingly devastating effects of the climate crisis.
Perpetual programmes
Therefore, it should come as no surprise that so many middle-income countries are locked into perpetual programs, borrowing from the IMF to repay the IMF. This is not good for sovereign borrowers, is unsuitable for the IMF, and could be better for the people the IMF serves.
Forty-five years have passed since the EFF was last reformed in 1979. Fresh thinking on IMF support for middle-income countries, based on what we know to be dedicated and capable management and shareholders, is long overdue.
Therefore, it is fortunate that the IMF, under its current leadership, has, in recent years, already demonstrated a capacity for fresh and innovative thinking, often moving before others. This was evident in the quick rollout of the RFI and the Rapid Credit Facility soon after the pandemic broke out and the subsequent allocation of a record US$650 billion equivalent in SDRs.
More recently, we have seen the introduction of the Resilience and Sustainability Facility – a facility funded by rechanneling a portion of the new SDRs designed to help finance climate resilience and adaptation for countries with an IMF upper-credit-tranche arrangement. Critically, this new facility has a final maturity of 20 years and carries no surcharges.
As they confront the multiple crises of the early 21st century, middle-income countries need lending arrangements that are fit for purpose. It’s time for the IMF to switch its attention to fundamental reform of its existing lending arrangements for middle-income countries.
*Mia Mottley is the Prime Minister of Barbados. Her article is among those written in a special publication marking the 80th anniversary of the IMF by world leaders such as Kenyan President William Ruto, Pablo Garcia-Silva, a former vice-governor of Chile’s central bank, and IMF Managing Director Kristalina Georgieva.
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