Background

Debt is a major cause of poverty and hardship for millions of people in the developing world.

In the most heavily indebted poor countries (HIPCs) of the world:

• 50% of the population live on less than $1 per day
  
• 1 in 6 children die before the age of 5
  
• Almost 50 million children are out of school
  

A brief History of the Debt Crisis

During the course of the 20th Century, the world became increasingly dependent on crude oil for industrial development, transport and energy. In the early 1970s the price of oil increased dramatically. Oil has traditionally been priced in US dollars and in the 1970s, economic policies in the United States decreased the value of the dollar, which in turn diminished the profits made from the sale of oil. In response to this, the oil-producing countries of the world raised the price of oil and deposited their profits in commercial banks in the West.

Role of the Banks

These banks sought every opportunity to invest this money profitably. Essentially they were under pressure to find borrowers, and since most western countries were going through a recession, in part due to the oil price rise, the banks turned their attention to developing countries. These countries were eager to promote their own development and cheap loans seemed a very reasonable way to achieve their aims.

However, rather than improve life for those in developing countries, the loans spiralled out of control and instead created an enormous debt that has dominated them ever since. Some of the money was spent on badly designed development projects, or on projects that produced very low rates of return, thereby making repayment difficult. However, substantial amounts of money either went to purchase arms, or into the private bank accounts of corrupt dictators. It is important to remember that the banks were eager to lend and therefore, not enough attention was paid to the final destination of the money. With the cold war dominating international politics, Western leaders were keen to befriend right wing dictators like Ferdinand Marcos of the Philippines or Mobutu of Zaire (see Illigitimate debt).

Increasing Interest Rates and Declining Terms of Trade

Most of the loans had been borrowed at variable interest rates, pitched at approximately one per cent above the US prime rate. In 1981 this peaked at 21.5 per cent. Economic policy makers in the US opted to increase interest rates in an effort to attract foreign investment so as to fuel growth in their own economy. An increase in interest rates meant an increase in costs to developing countries. This proved disastrous as it conincided with a serious decline in their income. Developing countries exported commodities like copper, tin, sugar and so on and they were dependent on the foreign exchange to pay their debts. During the late 1970s and on into the early 1980s, commodity prices fell continually. Meanwhile, the interest on the loans was mounting and so the vicious cycle of debt began.

The International Monetary Fund and World Bank Step in

In 1982, Mexico declared that it was unable to repay its debts. Mexico owed vast sums of mney to commercial banks in the west and default posed a serious threat to the stability of the international financial system. The commercial banks, in conjunction with the International Monetary Fund (IMF), worked out a system whereby indebted countries could spread out or reschedule their debts rather than default. It was during this time that the IMF and World Bank began to take over much of the debt owed to commercial banks. The IMF and World Bank offered developing countries new loans with strict conditions attached.

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