The total debt of Latin America and the Caribbean increased to US$5.8 trillion, equivalent to 117% of regional GDP, from less than US$3 trillion in 2008, revealed the Inter-American Development Bank. (IDB), which considers this trend worrying.
In the study “Dealing with debt, less risk for more growth in Latin America and the Caribbean”, the IDB adds that public debt in particular went from representing 58% in 2019 to 72% in 2020 “due to related fiscal packages with the covid, lower income and the recession”.
“Debt is not bad per se”, it can be used to create jobs or build infrastructure, for example, but “if it is used in an imprudent way, it has its problemscan represent a burden” for economies, companies and also for people, IDB President Ilan Goldfajn said during the presentation.
High debt levels drive investors to demand higher returns. Therefore, they force governments to allocate resources to pay higher interest rates, instead of using that money to invest in infrastructure and public services. The situation reduces the ability to respond to future economic shocks, as well as increasing the risk of a crisis occurring.
For this reason, governments should aim to reduce the percentage of public debt in relation to Gross Domestic Product (GDP), from an average of 70% to a range of 46%-55%, a level that the IDB considers “prudent.” Countries “dependent on volatile commodity income” should lower it further, the study says.
“Sustainable debt has benefits that clearly outweigh the costs,” Eric Parrado, chief economist at the IDB, said at the launch of the report, convinced that debt can become a driving force.
Óscar Valencia, one of the authors of the report, stated that the latest statistics show that “countries are acting” with a tendency to lower debt in the medium term, but it is insufficient.
The report proposes to strengthen fiscal institutions, to prevent overspending in good times and create a cushion to deal with bad times.
The fiscal rules, which set limits on public spending, are useful, but the countries of the region “complied with only 57% of the objectives” that were outlined in this matter.
“The best way to reduce debt is through higher growth combined with efficient public spending and adequate public revenue,” the report concludes.
“A Regional Forum”
It also recommends reducing labor informality and actively managing debt repayment schedules.
“More than half of the countries in the region face a debt service (ndlr: payments) of more than 2.5% of GDP, and a quarter of them more than 5%, an amount similar to spending on education” , exemplifies the financial institution.
Latin America and the Caribbean should take advantage of multilateral development banks and other lenders that provide lower rates and longer terms than private markets.
The report advises “creating a regional forum to improve the coordination of debt restructuring processes” and complementing international initiatives focused mainly on low-income countries.
Private debt also increased before and during the pandemic.
A quarter of the countries have internal credit that reaches at least 100% of GDP, but for another quarter the figure is less than 50% of GDP.
Access to credit “remains scarce, especially for households, small and medium-sized enterprises (SMEs) and companies run by women,” says the IDB.
Estimates “point to a $1.8 trillion gap between the demand and supply of funds available to SMEs,” for example.
According to the IDB, the level of household indebtedness in the region “continues to be relatively low compared to international standards, standing at an average of 22% of GDP, well below other emerging economies (35%) and the developed countries (77%)”.
The IDB maintains that high levels of debt can hinder development, because they push investors to demand higher returns, displacing private investment and forcing governments to divert scarce resources to pay interest, instead of investing in infrastructure and public services. .
Furthermore, this situation reduces the ability of countries to respond to future economic shocks to support households and businesses., and increase the risk of a crisis. The pandemic, the Russian invasion of Ukraine, high inflation, rising interest rates and low global growth, combined with high debt, increase the region’s vulnerability.
“Well-managed and sustainable debt can help unlock the abundant growth potential of Latin America and the Caribbean,” said Eric Parrado, chief economist at the Inter-American Development Bank. “Our new flagship report presents a pro-growth agenda, in which debt becomes an engine rather than a drag on growth. It offers governments in the region comprehensive policy recommendations to strengthen institutions macrofiscal measures, reduce public debt and guarantee a favorable financing environment for companies”.
The study highlights that the best way to reduce debt is through higher growth combined with efficient public spending and public revenue that is adequate and collected in a way that does not sacrifice growth.
In general, countries, especially those with high levels of spending and taxes as a percentage of GDP, should focus on improving the efficiency of both revenue collection and spending. The quality of public investment can be improved at all stages of the project cycle, transfer payments should be targeted to those who really need them, and tax monitoring should be improved. In countries where revenues and spending are a smaller percentage of national income, broadening the tax base and increasing public sector revenues would allow for greater public investment with a positive impact on growth.
Other opportunities include reforms to reduce labor informality, such as reducing tax incentives for companies to hire informal labor and shifting the financing of labor tax benefits to more general taxation.
Debt Management Strategies
The report also concludes that countries need to pay close attention to debt management strategies. Efficient institutions, such as well-functioning debt management offices and innovative debt instruments, are vital to managing the composition of debt. Pre-pandemic progress in improving that composition has stalled and countries must actively manage repayment schedules. More than half of the nations in the region face a debt service that exceeds 2.5% of GDP, and a quarter of them more than 5%, an amount similar to spending on education.
Countries should take full advantage of multilateral development banks and other official lenders that provide competitive long-term financing. In addition to offering loans at lower rates and longer terms than private markets, development banks offer technical expertise and other tools to help countries manage risk.
The study considers that the general level of household indebtedness in the region continues to be relatively low compared to international standards, standing at an average of 22% of GDP, well below other emerging economies (35%) and the developed countries (77%). The report provides comprehensive new data on credit to households, and recommends that governments continue their efforts to improve access to credit, both for families and for SMEs.
The report also recommends that governments tailor interventions to precisely target promising companies that need support, but offer them a broader set of instruments, including equity or quasi-equity, so as not to increase their debt burden.