According to the International Monetary Fund (IMF), there are 156 economies that could be considered "developing." Calling a country "developed" as opposed to "developing" is a charged topic: no one wants to be told that they aren't as good as someone else. Being a developing country, however, doesn't mean that the country is some backwater nation that time forgot. Quite the contrary; many developing nations are sitting on veritable goldmines of natural resources and with investments in modernizing the economy, these nations could see rapid growth in GDP.

Getting Funds from the Kitty
Countries seeking to modernize their economies face a daunting task. The projects that will push their economies forward - infrastructure, education, healthcare - don't come cheap. For example, China's Three Gorges Dam cost an estimated US$26 billion. Building roads to shuttle products and people around requires materials and engineering expertise; hospitals require expensive electronics. Developing countries often cannot afford to take on these projects without having to significantly sacrifice spending on other priorities.

There are several ways that developing countries can obtain funds from outside their borders. They can get direct loans from other countries, through funding provided by private companies or through loans provided by international lending organizations. Obtaining loans from private lenders is a difficult proposition for the poorest of countries, since they tend to be economically and politically riskier. A significant amount of developing debt comes from organizations such as the International Monetary Fund and the World Bank, which pool funds from multiple countries and use their financial clout (and good credit ratings) to obtain low interest rates.

The World Bank lends funds to countries based upon their Gross National Income (GNI). The poorest countries - those with per capita income of less than $1,195 - borrow from the International Development Agency (IDA) because they lack the ability to borrow from the World Bank's other fund, the International Bank for Reconstruction and Development (IBRD). The IDA charges little or no interest on the funds it lends out, typically allows repayments over longer-than-normal periods of time and also provides grants to countries in extreme financial distress. The amount of annual funds committed by the IDA - approximately $15 billion per year - is on par with the amount provided by the IBRD.

How Much Debt Are We Talking About?
The World Bank estimates that developing countries owed $4 trillion dollars in external debt as of the close of 2010. That number seems huge, but when compared to the debt owed by developed countries, it's fairly small. The United States and the European Union owe more than $25 trillion between the two of them.

Bleeding hearts and boisterous world leaders lament the oppressive burden that external debt (and the rules that often accompany it) has on developing countries. The evidence points to the opposite, however; debt forgiveness already exists. Debt is as much a political tool as an economic one. Leaders of developing nations, just as leaders of developed nations, want to keep their populations happy (at least happy enough to not cause trouble), and it's much easier to wag a menacing finger at foreign debt holders than it is to fess up to years of profligacy.

The World Bank, for example, operates both the Heavily Indebted Poor Countries (HIPC) Initiative and a Multilateral Debt Relief Initiative (MDRI). The MDRI was a 2005 pledge by G8 countries to cancel the IDA debt of countries that have gone through the MDRI program. The total pledge was $37 billion to an initial set of 19 countries, most of which are located in Africa. The International Monetary Fund (IMF) and Africa Development Fund (ADF) kicked in funds as well, bringing the total to $50 billion.

So what about wholesale debt forgiveness? What if the developed world and the financing institutions they run offer everyone a clean slate? It would be a disaster. It's one thing to offer the most struggling countries debt forgiveness: it's a small number of countries, it's a comparatively low amount of funds and it makes much more sense developmentally (a country in political and economic chaos could cause a humanitarian disaster at home and potentially spark lots of problems for its neighbors). It's a totally different thing to wipe the debt clean for 156 countries that the IMF considers to be "developing."

Lending countries could feel less inclined to shell out development money in the future, since there would be a precedent for not getting paid back. Debtor countries could balk at future commitments because they were allowed to start from scratch once before. The signals would be perverse. Additionally, while developing countries are net debtors - they often owe more to others than they are owed by others - many developed countries are owed money by others. If the money they are owed is suddenly wiped clean, then there would be multi-billion-dollar holes in countries' finances.

Next Time Will Be Different
The key to not getting into the debt forgiveness quagmire is to lend smart. Just as many individuals had lived beyond their means leading up to the financial maelstrom of the 2000s, so too did developing countries spend too much. The first taste of debt trouble came from the 1970s and 1980s, on the back of global commodity demand. Countries borrowed huge sums after finding natural resource bonanzas and crowded out private development. When commodity prices tumbled, those developing countries faced steep debt payments and had no funds with which to pay them. This was not totally the fault of debtors, as donors also provided expert advice that wound up not working out.

The Bottom Line
"Lending smart" entails injecting funds to develop industries outside of commodities, and to do so at a pace that won't cause a shock if the means to repay the loans falls short. After all, not all countries that receive developmental aid fall short of repayment. Some of the biggest success stories include China, Singapore, South Korea and India, all of which used funds to diversify away from reliance on volatile commodity exports. You'd be hard pressed to find a world leader who wouldn't want to be at the helm when a country makes the jump into a modern economic juggernaut.

Related Articles
  1. Economics

    Understanding the Bretton Woods Agreement

    The Bretton Woods Agreement is a famous international monetary agreement that came out of a meeting of the UN Monetary and Financial Conference.
  2. Economics

    Understanding Free Trade

    Free trade exists when nations can swap goods and services without the constraints of tariffs, duties or quotas.
  3. Mutual Funds & ETFs

    ETF Analysis: First Trust Dow Jones Global Sel Div

    Find out about the First Trust Dow Jones Global Select Dividend Index Fund, and learn detailed information about characteristics and suitability of the fund.
  4. Markets

    The 5 Biggest Chinese Natural Gas Companies

    Read about the top five Chinese natural gas companies as measured by gas production volume and learn a little more about their business operations.
  5. Markets

    The 5 Biggest Chinese Insurance Companies

    Read about the top Chinese insurance companies by market capitalization, and learn a little about their positions in the marketplace.
  6. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  7. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
  8. Investing Basics

    Explaining Trade Liberalization

    Trade liberalization is the process of removing or reducing obstacles that impede the exchange of goods and services between nations.
  9. Mutual Funds & ETFs

    ETF Analysis: SPDR EURO STOXX 50

    Learn about FEZ, the Euro Stoxx 50 ETF. FEZ tracks the 50 largest companies in Europe, making it the Dow Jones Industrial Average of Europe.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
RELATED TERMS
  1. Trade Credit

    An agreement where a customer can purchase goods on account (without ...
  2. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  3. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  4. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  5. European Monetary System - EMS

    A 1979 arrangement between several European countries which links ...
  6. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
RELATED FAQS
  1. How can I use the funds from operations to total debt ratio to assess risk?

    The funds from operations (FFO) to total debt ratio is used in fundamental analysis to determine a company's financial risk. ... Read Full Answer >>
  2. How stable are municipal bonds?

    Stability is relative in the municipal bond market. Municipal bonds tend to be safer than many other types of investments, ... Read Full Answer >>
  3. Where can I find information about corporate bond issues?

    Information about new and existing corporate bond issues is published regularly in financial newspapers, such as The Wall ... Read Full Answer >>
  4. Why are high yield bonds typically lower rated bonds?

    The term "high-yield bond" is a bit of a misnomer. It is not the case that high-yield bonds tend to be lower-rated; instead, ... Read Full Answer >>
  5. What kinds of costs are included in Free on Board (FOB) shipping?

    Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce or ICC, that indicates which ... Read Full Answer >>
  6. How do I evaluate a debt security?

    Debt securities are a form of loan from an investor to the government or a business. Among the many different types of debt ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!