Negative Effects of Interest Based Loans on Development


Salman Ahmed Shaikh

Most developing countries are going through a perpetual debt trap which takes away resources that could have been used on development, but instead are used to service compounded debt.

Continent of Africa seems to be most affected by the debt crisis. Africa’s debt stock in 1970 was $11 billion and Africa’s debt stock in 2008 stood at $215 billion. Furthermore, Sub Saharan Africa receives $10 billion in aid, but loses $14 billion in debt payments per year (Africa Action, 2008). It shows that on net basis, even after receiving aid, outflow is more than inflow. If this trend persists in future, one can see how it will perpetuate the debt trap.

Currently, Africa’s total external debt stands at $300 billion. Many African countries spend more on debt than either on health or education. For example, Cameroon, Ethiopia, Gambia, Guinea, Madagascar, Malawi, Mauritania, Senegal, Uganda and Zambia all spent more on debt than on health in 2002. GNP per capita in Sub-Saharan Africa is $308 while external debt per capita stands at $365. Total debt per capita which includes internal debt per capita as well would be even higher! Just to cite one example, Nigeria borrowed around $5 billion and has paid about $16 billion, but still owes $28 billion. Regrettably, 7 million children die each year as a result of the debt crisis.

Ajayi & Oke (2012) found in an empirical study for Nigeria that external debt burden had an adverse effect on the per capita income and led to devaluation of the currency, increase in unemployment, social strife and poor educational system.

Easterly (2002) presented the similar empirical evidence which shows a negative effect of indebtedness on growth. Explaining the evidence, he stated that the paradox of debt is that heavily indebted poor countries (HIPCs) became more heavily indebted after two decades of debt relief efforts. He stated that even concessional financing, a form of debt relief also failed to reduce net present value of debt. According to him, the record is not encouraging for the success of current debt relief efforts.

Cunningham (1993) collecting evidence for the period 1971-1987 from 16 HIPCs found a significant negative relationship between the growth of debt burden and economic growth in these countries.

It is not just Africa that is suffering from the debt crisis. Other developing regions are also having the same negative impacts. Malik et al. (2010) provided the empirical evidence for Pakistan’s economy which shows negative and significant relationship of external debt with economic growth. Currently, Pakistan pays around half of its tax revenues in debt servicing.

References

Africa Action (2008). “Campaign to Cancel Africa’s Debt”, Retrieved from:  http://www.africaaction.org/campaign_new/debt.php

Ajayi, L. Boboye & Oke, M. Ojo (2012). “Effect of External Debt on Economic Growth and Development of Nigeria”. International Journal of Business and Social Science, 3 (12), pp. 297-304.

Cunningham, Rosemary T. (1993). “The Effects of Debt Burden on Economic Growth in Heavily Indebted Developing Nations”. Journal of Economic Development. 18 (1), pp. 115-126.

Easterly, William (2002). “How Did Heavily Indebted Poor Countries Become Heavily Indebted? Reviewing Two Decades of Debt Relief”, World Development, 30 (10), pp. 1677-1696.

Malik, Shahnawaz, Hayat, M. Khizer & Hayat, M. Umer (2010). “External Debt and Economic Growth: Empirical Evidence from Pakistan”. International Research Journal of Finance and Economics, Issue 44, pp. 88-97.

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About Salman Ahmed Shaikh

PhD Economics. Author, Researcher, Teacher and Consultant. He can be contacted at: salman@siswa.ukm.edu.my
This entry was posted in Articles on Islamic Economics and tagged , , , , , . Bookmark the permalink.

2 Responses to Negative Effects of Interest Based Loans on Development

  1. Wassalam, it does. Islamic Banking is also there. Government these days also issue Islamic bonds, i.e. Sukuk. But, financing from Sukuk constitute not more than 2% of total public debt.

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