US Dollar loans to developing countries automatically become unpayable because of differences in inflation. Climate Justice demands that we stop making loans that end up crippling developing economies, and replace them with loans repayable in local currencies.
Imagine you live in a developing country and you need to take out a loan. Should you take out a loan in local currency or in US Dollars? Which is better? Does it matter?
Yes, it matters. In fact, depending on where you live, you could be risking bankruptcy if you get this wrong. Loans to developing countries must be in local currencies.
Let’s say the loan you need is the equivalent of USD $50. Or $50m, or $50bn – pick whichever is the more realistic unit to you. And let’s assume that like 95% of the world’s population you live in a country where the inflation rate is usually lower than that in the US.
In the graphs below we are assuming:
– Local average inflation rate is 8%
– US inflation rate is 2%
– you are being offered an interest rate of 3%, fixed for the duration of the loan.
The bank is willing to lend to you, and presents the following graph showing your repayments and how they reduce the amount outstanding over time:
The bank has used 2021 Dollars in its graph, which is reasonable. But it is also reasonable to ask what the graph would look like if we assume that future inflation rates in both currencies are the same as the historical averages and look at the amount outstanding in real terms.
The difference is striking. Your local currency is on average deflating against the dollar, which means that you will get fewer dollars for your local currency next year than you do this year. That means that even though the amount outstanding decreases in dollar terms, those dollars are increasing in value faster than the rate you are paying off your debt. You are never going to repay your loan. And in fact, your repayments get progressively harder to pay in real terms each year.
This could be a problem. Even if the loan repayments were initially affordable, eventual the loan will become unpayable.
According to the Jubilee Debt Campaign, there are currently 64 countries which have debt payments which are higher than the amount they spend on health care.
In some cases, debt payments are five times health care payments.
But it doesn’t have to be this way.
What would happen if the bank lent you the money in your local currency? Then, the comparatively high inflation rate is your friend; even though you are still paying off the same percentage of the loan each year, your ability to do so increases each year.
This is similar to the first graph, the one the bank used when explaining your repayments, except that the amount you will be repaying decreases steeply in real terms. In fact, we are assuming a 9% repayment rate now instead of 3%, and even so, this is clearly preferable.
The more observant of you will have noticed that the y-axis differs between these graphs. Here is a side-by-side comparison of the real terms cost of repaying both loans – the one in US Dollars and the one in local currency.
As inflation in your currency is higher than that in the US, a commitment to repay a loan taken out today becomes a smaller and smaller burden over time, with the result that it quickly becomes possible to repay the total amount outstanding. Over a period of decades, the debt evaporates. This is one of the cornerstones of Climate-Just Debt Swaps.
Doesn’t it make you question the morality of making loans to the developing world in hard currencies? Loans to developing countries must be in local currencies.