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Should Timor-Leste Go Into Debt?
Lessons from Oil-Export Dependent Countries

By Kristin Sundell, 15 April 2010
Adapted from presentation at La'o Hamutuk Public Meeting

Liga ba pajina iha lingua Tetum kona ba Timor-Leste tenke debe ka la'e?
Link to page in English with analysis about Why should Timor-Leste go into debt?

I’d like to use my time to highlight some lessons from the experience of other developing countries that have taken on debt, particularly countries that have used their oil resources as collateral to access loans. These experiences can help to illustrate some of the pitfalls and dangers of borrowing based on oil and hopefully help Timor-Leste avoid the suffering and social upheaval that result from taking on unsustainable and crippling debt.

But first I want to talk more generally about why debt is so problematic. What have been the impacts of debt in other developing countries over the past 40 years?

The debt crisis that many countries experience today has its origins in the 1970s and 80s when rich governments and banks lent large sums to developing countries.

At the time, financial institutions in the global north were under a lot of pressure to lend because they had become the repositories for huge oil profits resulting from the high oil prices of the 1970s.

When oil producers deposited these profits in northern banks, they expected a return. And there was no way for the banks to pay interest to the depositors without lending the money out and collecting interest from borrowers.

So banks at this time pushed loans very aggressively and very carelessly without giving much attention to the credit worthiness of the projects or governments they were lending to or even the likelihood that these projects would actually be carried out.

They were particularly happy to lend to countries that were known to have huge untapped natural resources that could be put up as collateral because meant that repayment was virtually guaranteed.

Even when they were faced with evidence of corruption and massive theft, they continued to lend to dictatorships around the world, especially dictators who were allies of the west in the cold war. Billions were lent to Mobutu in Zaire, even after the IMF’s own staff that huge sums were being channeled into his personal bank accounts in Switzerland. Likewise, it has been demonstrated that the Suharto family stole at least 1/3 of the money lent to Indonesia by the World Bank during the Suharto regime.

As debt burdens grew due to rising interest rates and falling commodity prices, the debt of many countries spiraled out of control. Some countries found themselves in a position where they were unable to even keep up with the interest payments and began to default or to take on new loans to pay old ones.

Many countries found themselves in a desperate situation and turned to the IMF and World Bank as a last resort. The “solution” imposed by these institutions forced impoverished countries to cut their public spending in order prioritize debt repayment.

30 years later debt continues to drain countries of resources that could otherwise be spent on vital public services such as health care, education, water, sanitation, and electricity.

But debt doesn’t just soak up resources that could otherwise be spent on public services and development,

Debt has also driven privatization of services at the expense of the poorest and most vulnerable members of society

As a condition of agreeing to new loans or relief on old debts, creditors have often required countries to privatize state enterprises, such as state water and power companies.

When privatization goes into effect, it essentially creates private monopolies. And the lack of infrastructure and the lack of regulatory framework to oversee these monopolies have meant sky-rocketing prices and severe supply shortages, especially in poor areas.

When Nicaragua was required to privatize its electricity supply it lead to blackouts and prices tripled. Tanzania had to privatize the water supply of its largest city and suffered water shortages and dirtier water as a result. Eventually the situation got so bad that the government revoked the private contract and took back control of the water supply.

The lack of funding for public services and the policies and conditions placed on loans and debt relief have hit public sector workers particularly hard.

It is impossible to provide decent public education and healthcare without well-trained, well equipped doctors and teachers.

But when economic policy conditions imposed by outside financial institutions drive public sector salaries below the poverty line, doctors, nurses, teachers and other vital public sector workers are driven to find different jobs or to move to other countries. And recruiting qualified replacements becomes nearly impossible.

The problem is not only that the need to service debt limits the government’s resources, a limit on public sector wages is often a specific requirement of debt relief or new loans once a country enters a debt crisis.

For example, in 2004, the IMF required Zambia to freeze the percentage of its budget spent on public sector wages, meaning that the country was unable to employ 9,000 newly trained teachers.

This was at a time when Zambia’s debt payments to the IMF alone were more than its entire education budget in a country where more than 40% of the women could not read or write.

Nicaragua’s public sector wage cap resulted in doctor salaries so low that hundreds of doctors left to practice medicine in other Latin American countries. The staff of the public hospitals was so demoralized that they went on strike, cutting off access to affordable medical care to a huge percentage of the population.

Given Timor-Leste’s oil resources and projected future income from oil, it seems reasonable to assume that borrowing now will not be a problem. But this assumption would be wrong -- actually the more oil a country produces and the more dependent on oil exports a country is the more debt that country is likely to have. Having oil creates an incentive to borrow and borrow more simply by making more and bigger loans available. From the lenders perspective this type of a loan makes good business sense – with oil resources as collateral lenders are pretty much guaranteed eventual repayment, no matter how deeply indebted the country becomes.

Take for example Ecuador when it started borrowing heavily in the early 1970s.

Ecuador began to export oil just as the price jumped dramatically -- prices went from $2.50/barrel in 1972 to around $35/barrel in 1980. With this kind of windfall you would never expect a country to accumulate debt, but during this time Ecuador’s debt rose to from $328 million to $3.3 billion. How did this happen?

Like many developing countries in the early 1970s, Ecuador accepted foreign loans from banks that were desperate to lend. And because banks were desperate, they offered loans at extremely low interest rates – at the time it felt like free money.

Around the time Ecuador started exporting oil, the military seized power and the new leader (Rodriquez Lara) expanded the state’s role in the economy, leveraging oil money to fund an ambitious 5 year development plan.

When Lara was replaced by a new military government in 1976, oil revenues were used as collateral to increase foreign borrowing and finance even higher spending to quell domestic unrest. But by the mid-1980s the bottom dropped out.

Ecuador’s situation in the mid-1980s illustrates a major problem with borrowing against future oil revenue -- both interest rates and oil prices are very volatile and completely out of the borrowing country’s control.

Trouble comes when oil prices drop and interest rates rise at the same time. When this happens, a borrowing country can find itself unable to make payments on its debt, even to the point where it takes out new loans to pay the debt service on old ones. When interest rates rise or revenues fall to a point where a country can’t even keep up with compounding interest, debt begins to accumulate out of control. This is what happened to many developing countries in the debt crisis of the 1970s and 80s.

In Ecuador’s case, falling oil prices (from $35 a barrel in 1980 to around $13 a barrel in 1986) came on the heels of coastal floods that limited national food supplies and increased the need to import food – commodity prices for agricultural goods dropped at the same time. Meanwhile the interest rate on Ecuador’s debt rose from 6 percent to 21 percent -- by the late 1980s, Ecuador had stopped making payments on its debt and subsequently allowed arrears to accumulate for 7 years.

When Ecuador found itself in desperate circumstances in the late 1980s and asked the international community for help, it was turned down on the basis of its untapped oil reserves. A later agreement reached with the world bank required Ecuador to use 70 percent of its oil revenues for debt repayment, to save an additional 20% for later debt payments, and allowed only 10% of oil money to be used for social spending.

This illustrates a second lesson that is relevant to Timor-Leste -- when oil producing countries become heavily indebted, they are forced to rapidly exploit their oil resources with increasing oil exports being used to finance debt rather than contributing towards economic development.

A third problem with both heavy borrowing and oil money is that both allow governments to overspend and defer difficult decisions while making the government less accountable to the population.

Oil money, especially when oil prices are high, typically encourages governments to spend. The problem comes when oil prices fall again. For obvious reasons it is much harder for a government to cut back than it is for it to increase spending. So when revenues drop, governments are tempted to borrow more, using oil resources as collateral to maintain spending at the same level, despite falling national income.

Nigeria for example has been one of the largest crude oil producers in Africa for decades, and the country has regularly borrowed against its enormous untapped oil resources, running huge deficits.

In the early 1980s, the decline in oil prices and the rise in global interest rates caused a rapid increase in Nigeria’s debt while revenue from oil dropped by more than ½ -- meanwhile the loans sold to Nigeria during the boom times of the 1970s came due.

By 1983, Nigeria was struggling under crushing debt and forced to contend with the IMF which was attempting to dictate Nigeria’s fiscal policy in exchange for helping to hold the creditors at bay.

The Nigerian government found itself in a position where it was unable to deal with the financial crisis it faced. Promises to reduce spending were regularly made and then broken after the understandable popular backlash against the austerity measures grew too heated.

Even worse, oil money enabled Nigeria’s military dictatorship to rule inefficiently, corruptly, and often ineffectively without benefiting the majority of the population

From 1970 until the mid 2000’s Nigeria’s per capita GDP dropped slightly while oil revenues per capita increased ten-fold. Currently 80% of the revenue from the oil industry flows to only 1% of the population. In short, Nigeria’s oil resources permitted the government to run up an enormous debt without benefiting the people at all.

Finally, oil export dependent developing countries should view with skepticism any development “advice” that encourages the accumulation of debt and the rapid exploitation of natural resources. Borrowing and development based on the extraction of natural resources are actively supported by international financial institutions and Global North countries for many reasons that are completely unrelated to the best interests of developing countries. Among them:

  1. These resources are usually extracted by foreign companies which reap huge profits in the process.

  2. The necessary infrastructure for resource extraction is financed by lucrative loans, usually from Northern institutions that see these loans as a sure thing because Southern countries are required to put up future profits from natural resources as collateral.

  3. It is in the interest of the US and other Northern countries (most of which do not have sufficient internal oil resources) to diversify their oil supply by encouraging a greater number of countries to produce oil – this creates greater stability in supply and price and makes it harder for one country or even one group of countries to exert pressure on them.

 

The Timor-Leste Institute for Development Monitoring and Analysis (La’o Hamutuk)
Institutu Timor-Leste ba Analiza no Monitor ba Dezenvolvimentu
Rua dos Martires da Patria, Bebora, Dili, Timor-Leste
P.O. Box 340, Dili, Timor-Leste
Tel: +670-3321040 or +670-77234330
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