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What happens to African countries that can't pay back their loans to the IMF?


The International Monetary Fund (IMF) is a major financial of the United Nations, and perhaps the most powerful financial institution in the world. Many people confuse sometimes the IMF for the World Bank in terms of their duties, purposes, and responsibilities vis-à-vis, the world’s financial system and countries’ monetary sovereignty. The fundamental difference between the IMF and the World Bank is that the IMF oversees the stability of the monetary system, while the World Bank focuses on actively participating in the economic development of countries by offering assistance to middle-income and low-income countries to reduce poverty. In other words, the IMF is a sort of the world’s central bank since it mainly focuses on countries’ monetary and fiscal policies while the World Bank is a sort of welfare agency that assists developing countries monetarily and socially.

It is clear that all governments in the world, in order to develop and improve their country’s infrastructure, use debt as a source of financing by issuing bonds. For example, the U.S. government sells its bonds to the Federal Reserve in exchange for liquidity. In the United Kingdom, the British government sells its bonds to the Bank of England in exchange for liquidity. The Chinese government sells its bonds to the People’s Bank of China in exchange for liquidity...etc. We see here the pattern. What about developing countries, especially African countries, for example? African countries do have their own central banks as well, and they use their central banks to fund small projects. But, for very big projects, they rely on the IMF for massive loans that their central banks cannot afford. The reason is that the various currencies of African central banks are weak. If they want to use their own currencies to fund their infrastructure projects, this will create hyperinflation. This was the case in Zimbabwe, when the Zimbabwean dollar was so weak that it triggered hyperinflation that reached the 1000s%. Thus, African governments use the IMF as the lender of last resort to fund their infrastructural projects, and these funds loaned to African governments are in U.S. dollars since the U.S. dollar is the world’s reserve currency.

The IMF loans funds to African governments knowing that the possibility that they default on their loans is pretty high. If they know that, then why do they still loan funds to African governments? First, it is essential to know the consequences when a country defaults on its loan. When a country fails to pay back its domestic or international creditors, it is called a sovereign default. The most immediate impact of sovereign default is that borrowing cost rises for the government in the domestic and international bond market. The higher interest rates will impact the entire economy of the country, including the value of its currency, banking system, stock market, corporate borrowing…etc. Furthermore, the default leads to a loss of reputation, which makes it harder for the government to borrow in the future. Hence, that country is now considered “underwater” due to its government’s inability to pay back the loan. It is also fair to say that there is a political motive behind the IMF’s willingness to loan funds to underwater governments. This political motive is to exert and retain control over these countries. Let us not forget that when the IMF loans these funds to a government, it does it under certain conditions that the government must accept in order to receive these funds. Hence, the IMF has leverage over those underwater governments.


Debt to GDP ratio of Emerging Markets and Sub-Saharan Africa

Source: International Monetary Fund


In order to determine the financial sustainability of a government to pay back its loan, the IMF measures its debt-to-GDP ratio. If the government’s debt-to-GDP ratio is above 77%, this tells the IMF that the likelihood of the government’s inability to pay back its loan becomes more and more imminent. Thus, a country whose debt-to-GDP ratio is lower than 77% shows to the IMF that it is financially healthy and it is a trustworthy debtor. Since 1960, 147 governments have defaulted on their obligations, while Sri Lanka became the latest addition to that list internationally, and Ghana and Zambia became the latest African countries to have defaulted on their international loan. In Zambia, the debt ratio was a mere 21.9% in 2007, but increased to 140.2% in 2020, when government defaulted. In Ghana, it was 22.6% in 2007, before quadrupling to 88.8% in 2022. When the debt starts to increase substantially, it means that it is perhaps time for governments to cut back on their expenditures in order to avoid defaulting and creating a long-term economic conundrum for their people.

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Guest
Apr 22, 2023
Rated 5 out of 5 stars.

Lots of information. Great Job.

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Guest
Apr 21, 2023
Rated 5 out of 5 stars.

Very thoughtful article

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