Multilateral development banks (MDBs) could offer low-income countries (LICs) a short-term solution through sovereign local currency loan offerings to help them deal with issues resulting from the discrepancy between local currency revenues and debt repayments denominated in foreign currencies, according to a recent report by AfriCatalyst.
This mismatch has placed immense pressure on low-income countries (LICs), as fluctuating exchange rates intensify the local currency cost of external debt, worsening their debt burdens.
TitledLocal Currency Financing and Multilateral Development Banks: A Case for IDA Leadership, the report highlights that fluctuating exchange rates significantly increase the local currency value of debt owed to external lenders, placing huge pressure on governments in low-income countries (LICs) that primarily collect revenues in their domestic currencies
The analysis illustrates how this condition exacerbates the debt load for low-income countries (LICs), who frequently lack the resources and capability to adequately handle such risks, using Ethiopia as a case study.
With a focus on the International Development Association (IDA) of the World Bank, the research assesses the prospects and difficulties of local currency funding as a multilateral endeavour.
In order to help low-income countries (LICs) avoid getting into severe debt situations, it emphasises the necessity for IDA to take the lead in providing local currency loans.
Among the Key findings from the report include:-
According to the paper, IDA is in a unique position to spearhead efforts to “develop a practical offer for local currency lending,” particularly for public sector projects, in response to the increasing calls from around the world for MDBs to do so.
Being one of the biggest multilateral lenders to LICs, IDA’s participation in sovereign local currency loans may offer these nations a more stable and controllable method of repaying their debts.
It highlights how crucial it is for LIC governments to provide asset-liability management-friendly regulations so that MDBs can increase their efforts.
“MDBs should shift their portfolios towards more local currency loans while acknowledging the risks this entails.
Potential avenues for mitigating these risks include offering loans on a project-by-project basis, creating liquidity pools, and engaging in cross-currency swaps.
The public policy mandate to support LICs’ development aspirations should compel MDBs to assume more of the currency risk, as these countries already have limited capacity to manage it, the report outlines.
“We need to reduce Africa’s reliance on foreign currency debt, as it exposes many countries to significant risks, such as exchange rate volatility,” Jean-Claude Tchatchouang, Senior Advisor at AfriCatalyst, remarked.
While acknowledging the risks, the study suggests strategies to reduce them, such as project-specific loans, liquidity pools, and cross-currency swaps. It also makes the case that MDBs should change their lending portfolios to include more local currency loans.”concluded Jean Claude
AfriCatalyst CEO Daouda Sembene echoed this sentiment, highlighting IDA’s critical role. “This report highlights the critical role IDA could and should play in mitigating foreign exchange risks for eligible borrowers,” he stated.
