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06 Oct 2022  (768 Views) 
International economy

Borrowings by poor countries
Poor countries need to borrow money from rich countries to fund their infrastructure and economic development. They have to pay interest on the borrowings and return the capital at the end of the term. 

Ideally, the borrowings should be denominated in their local currency, but it is not accepted by the international lenders. 

They have to borrow in an internationally accepted currency. The US dollar is used in most cases, as it is the reserve currency. 

This borrowing carries a large risk. In past years, the US dollar has appreciated strongly against the local currency of the borrowing country due to many factors. The sharp increase made it difficult for the borrowing countries to repay the debts. It has led to the economic collapse of the poor country.

When the poor countries goes into default, they are required to restructure their economy and allow the lenders to buy their assets at depressed prices. 

In 2022, the US dollar has appreciated sharply due to the increase in interest rate in America (that is required to fight inflation). This increase has increased the repayment burden of many poor economies, who has borrowed in US dollar.

There must be a better way for poor countries to receive international capital for their development. 

The borrowing may be denominated in another currency, instead of US dollar. This does not eliminate the underlying problem, because the selected currency may also appreciate sharply.

A better approach is to split the borrowing in several international currencies, such as US dollar, Euro and Chinese yuan. If one currency appreciates, it may be offset by the depreciation in another currency. The average cost of the borrowing, based on several currencies, may be more moderate.

An alternative is to allow the international investor to bring capital into the poor country and own the infrastructure or factory that is developed. This will reduce the risk of borrowing.

Poor countries need a better approach towards managing their international borrowings.

Tan Kin Lian

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