The Lebanon contagion: Record debt levels are intensifying the region’s challenges
In the past decade alone, there have been repeated warnings about the cascading risks of massive borrowing across the Arab region, which have resulted in the swift accumulation of high levels of foreign debt. For a number of countries, that debt is now close to becoming unsustainable even as their economies remain overwhelmed by the quick succession of unprecedented crises and their debilitating impacts.
Combined with additional shocks in the past few years, notably the COVID-19 pandemic, volatile oil prices and the war in Ukraine, leading indicators suggest that record debt levels are further intensifying the region’s challenges, sparking fears of a “Lebanon contagion” in countries such as Tunisia, Egypt and — to a lesser extent — Morocco and Jordan.
COVID-19, in particular, left an indelible mark that saw the region’s combined GDP shrink by close to $400 billion — a consequence of reduced economic activity worsened by a sharp decline in remittances. As a result, a few of the region’s net oil importers saw public revenues and foreign reserves fall sharply, impacting exchange rates and widening budget gaps. With little fiscal space left, that necessitated turning to borrowing excessively to sustain the costs of expanding critical safety nets as well as fix balance-of-payments deficits, without resorting to austerity measures at such an inopportune time.
By the end of last year, the Arab region’s cumulative debt stood at a whopping $1.5 trillion, and given the adverse impact of the war in Ukraine as well as the shaky global economy, that figure could grow even larger still.
The sustainability of debt is one of the key anchors of credible fiscal policy given its impact on any one country’s long-term development and ability to maintain its overall competitiveness. Looking outwards for sources of finance to fuel economic growth and sustainably develop societies allows countries to invest in the prosperity of current and future generations, provided any debt is kept at sustainable levels.
However, when countries that are already fragile become unable to repay their obligations and default, as happened with Lebanon in 2020, it not only sets back development, it also ushers in additional risks that can potentially destabilize a sub-region due to spillovers from governance failures, persistent inability and even violent conflict.
Currently, countries such as Egypt, Jordan and Tunisia all owe more than 90 percent of GDP at a time when their respective governments must maintain or increase spending to, for instance, deal with rising food inflation given the Ukraine war’s impact on grain imports. Without serious interventions or commitments, Egypt and Tunisia in particular could end up like Lebanon, which not only defaulted but is yet to tackle the restructuring of a debt pile so massive it dwarfs the size of its shrinking economy.
In Egypt, food and beverage inflation reportedly stands at a staggering 62 percent as the currency devaluations mandated by the International Monetary Fund continue to wreak havoc on import costs, endangering as many as 40 million Egyptians who now require targeted cash transfers just to get by. Even that, however, may not be enough as speculation is rife about a looming devaluation in the world’s largest grain importer. Should that happen, the price of food staples will keep soaring.
The mix of massive debt combined with fiscal and current account deficits will likely unleash a flood of fiscal fatigue.
In Tunisia, on the other hand, even though headlines fixate on the disturbing crackdowns on sub-Saharan Africans, the North African country is still struggling to import basic staples. Despite securing a deal with the IMF, Tunisia’s embattled government will find it near impossible to implement wage and subsidy cuts that will likely worsen poverty rates. Furthermore, even if reforms are designed to curb public expenditures, they are fiercely opposed by the country’s most powerful trade union, the Union Generale Tunisienne du Travail. It is expected that widespread unrest will intensify in the coming months as an enraged public resists being coerced into compliance by a desperate hyper-presidency quickly running out of scapegoats.
Debt risks and the inability to solve them are not issues unique to fragile, low-income Arab states alone. The UN estimates that there are at least 52 countries around the world that are either debt-stressed or close to it, thus at risk of default. This is despite a record $185 billion in official development assistance from the developed world last year.
However, making grants and cheap loans available that often entail poorer countries slashing spending in mid-crisis to access financing that comes with predatory interest rates only worsens debt vulnerability. Worse yet, wealthier countries are still not meeting the agreed-on target of 0.7 percent of gross national income for official development assistance, despite the confluence of shocks ranging from climate change, a pandemic, a sluggish global economy and the war in Ukraine.
It is also impossible to dismiss the impact of an especially strong US dollar, which is approaching heights not seen in close to four decades as the Federal Reserve continues raising interest rates to combat inflation. Unfortunately, “the rest of the world” ends up saddled with soaring costs to service dollar-denominated debts, in addition to combatting the inflationary pressures from rising import costs, which are unavoidable among import-dependent Arab countries.
The mix of massive debt combined with fiscal and current account deficits will likely unleash a flood of fiscal fatigue — i.e., when governments approach the limits beyond which the trajectory of debt becomes unsustainable and careful adjustments become increasingly difficult to make. That recipe also creates a few more developing countries following Lebanon and Sri Lanka, defaulting on foreign debt and then muddling through in hopes of securing bailouts from the international community.
That debt will be a dominant issue this year across the region and the rest of the world is no mere hyperbole. Several countries will have to look to the IMF for relief even though that external support will not extricate debt-addicted countries from a self-imposed trap — a by-product of economic mismanagement and the fear of what some Arab countries need most — reform. This year and the next few to come will also be about unavoidable austerity to “rationalize” budgets, even amid shortages of basic commodities and intensifying hardships for tens of millions of Arabs.
• Hafed Al-Ghwell is a senior fellow and executive director of the Ibn Khaldun Strategic Initiative at the Foreign Policy Institute of the Johns Hopkins University School of Advanced International Studies in Washington, DC, and the former adviser to the dean of the board of executive directors of the World Bank Group.