With aid cuts of more than 20%, developing countries will struggle to manage debt
For the last few years, developing countries have been spending more money on debt repayments to official and private lenders than they are receiving in new loans. Investments in official development assistance have kept most countries above water.
With countries like the US, France, Germany, and the UK announcing drastic cuts to development assistance – at least 23% by 2027 – low- and middle-income countries will struggle to access the affordable capital needed to stay afloat.
The world is in the midst of a debt crisis. 35 countries are in or at high risk of debt distress. Debt servicing puts a significant burden on low- and middle-income countries, where borrowing rates are 2 to 4 times higher than those of the United States and 6 to 12 times higher than those of Germany. This strains countries’ abilities to provide essential services for their people to thrive; in fact, 3.3 billion people live in countries that spend more on debt payments than on education or health.
Many countries are already walking a financial tightrope. And it’s likely to get worse, fast. Massive cuts to investments in developing countries. Rising interest rates. Lack of access to capital. And new tariffs which threaten trade revenues and economic growth. All of this makes existing and future debt more expensive, pushes countries to the brink, and threatens progress. Low- and middle-income country governments face an unjust choice: default on loans and invest in their people’s future, incurring devastating economic backlash, or make staggeringly high debt repayments and underfund essential services for their people.
Both are bad options, but the good news is that practical and innovative solutions exist to scale up financing and reduce the cost of capital to meet low- and middle-income countries’ needs. What’s missing—and urgently needed—is political action.
What’s been happening?
Net debt flows turned negative in 2022, but aid and concessional finance have kept global flows in the black.
From the turn of the century, net flows to developing countries dramatically increased. Investors seized opportunities in emerging markets. G7 donors scaled up aid. The Paris Club cancelled illegitimate debt through the Highly Indebted Poor Country and the Multilateral Debt Relief Initiatives.
Meanwhile, low- and middle-income countries took advantage of historically low interest rates and took on new debt, including from China and private creditors. They sought to address massive infrastructure and development needs as their populations grew rapidly.
The pandemic, Russia’s invasion of Ukraine, and other geopolitical challenges, however, put an end to cheap borrowing. Interest rates and energy costs have soared, local currencies have lost value against the dollar, and investors are withdrawing their money from low- and middle-income countries.
A financing decline
Net debt flows have been negative since 2022 – meaning overall, low- and middle-income countries are sending more money to creditors than they are receiving in new loans. Net transfers on external debt owed by low- and middle-income countries to bondholders have been negative since 2020, and net external transfers to commercial banks and other private creditors turned negative in 2021.
The chart above shows how net financing flows have managed to remain positive due to aid and other concessional financing, although they have significantly declined over the last decade. In 2023, five African countries had negative net financing flows (Angola, Botswana, Gabon, Republic of Congo, and South Africa). If you exclude concessional financing flows, 22 African countries were in the red in 2023.
Flows slow, debt grows
The massive decline in net financing is primarily due to two trends:
First, inflows to developing countries are on the decline. While multilateral development banks have made considerable efforts to increase their funding since the start of the pandemic, other sources of finance are in decline.
- Chinese lending to Africa dropped 70% from a peak of US$41.8 billion in 2018 to US$12.3 billion in 2023 as countries struggled to repay debt.
- Private lending flows to developing countries have declined 40% from a high of US$252 billion in 2017 to US$152 billion in 2023. Higher interest rates are keeping many countries from accessing new private finance.
Second, developing country debt levels have more than doubled since 2009, and the cost of servicing that debt has skyrocketed.
Developing countries (excluding China, Russia, and Ukraine) paid US$311 billion in debt service in 2023. That figure was expected to balloon to US$414 billion in 2024. Lending from China and private bondholders and banks typically carries higher interest rates than public debt from donor countries and multilateral development banks. In recent years, those rates have been four times higher than the average loan from the World Bank’s International Bank for Reconstruction and Development.
Developing countries tend to have lower debt-to-GDP levels than most G7 countries. But because they are considered riskier, the cost of servicing their debt tends to be more expensive.
These trends have particularly affected middle-income countries, which have access to capital markets and are paying high premiums on private loans and bonds. See chart below. When excluding concessional finance, many low-income countries also end up in negative net flows.
Aid cuts bite
With more than half of G7 donors announcing significant cuts to aid budgets in the coming years, it’s about to get even worse. As concessional finance decreases, access to capital will be even more constrained for low- and middle-income countries.
In 2024, global aid levels dropped by 7%, and are projected to drop even further as more than nine donors have announced significant cuts over the coming years, including the US, UK, France and Germany. The OECD-DAC estimates that aid could decline between 9% and 17% in 2025. Our own projections, based on data from SEEK, project cuts of at least 23% by 2027.
Foreign aid accounted for over 5% of gross national income in 44 countries in 2022, the most recent year for which we have data. The recent aid cuts are likely to hit hard, especially in countries with few short-term options to fill the aid gap. Many governments will face serious challenges given their fiscal constraints.
Twenty-four low- and middle-income countries are estimated to be spending more than 20% of government revenue on debt. That’s the highest in over 20 years, when high debt levels led to massive debt relief programs. Debt indicators in many developing countries are blinking red. Some countries are hitting debt thresholds “highly associated with default risk,” warns the IMF. And sovereign defaults are on the rise: one-third of all defaults since 2000 have happened in the last five years. Cuts in aid will exacerbate the risk of default.
Modelling future net flows
We estimate that global net flows went negative in 2024, primarily due to a peak in debt service payments. Despite net flows potentially bouncing back in 2025, due to lower debt payments, more countries may be pushed into negative flows as aid cuts start to take effect.
To explore the impact of future aid cuts combined with other trends, ONE looked at three future scenarios. In each, only concessional finance projections change. Other inflows are held constant from 2023, and outflows are based on official projections from the International Debt Statistics database.
- Scenario one – optimistic: models how net flows might recover from 2025 if donors’ aid levels stayed constant (in nominal terms) and debt service declines slightly as projected.
- Scenario two – realistic: models potential net flows if concessional finance flows decrease by 23% by 2027 based on announced donor by donor decreases.
- Scenario three – pessimistic: models potential net flows if concessional finance flows from major donors decrease by 36% by 2027 (based on announced donor by donor decreases, with an additional 10% decrease by 2027, and including an 80% cut to US aid by 2027), plus an additional 10% decline for all other donors.
While the aid cuts are significant, other net flows changes (such as declining debt service) appear large enough to mitigate a drop into negative flows for many countries. Unfortunately, there is not enough data to craft projections for all inflows including non-concessional loans. But what the data do show is that it’s extremely likely that net flows will remain depressed, far below their peak from the last decade.
As ever, it’s important to look beyond global aggregates. Upper-middle-income countries which are less dependent on aid and have the most exposure to private debt are more likely to stay in negative net flows. Low-income countries will likely see continued decline in net flows, but their higher level of concessional flows will likely keep them out of the red. Lower-middle-income countries are teetering on the brink of negative flows and susceptible to even small changes in trends.
The likely impacts of US tariffs
The recently announced US tariffs could severely impact low- and middle-income countries and further reduce their fiscal head space.
African countries with significant trade exposure to the US could see their export earnings decline, and their import bills increase. Should the tariffs slow global economic growth and negatively impact commodity prices, countries reliant on commodity exports will be hit the hardest. That’s bad news for the many African countries that rely on commodities to generate export revenues.
The market uncertainty unleashed by the tariffs has devalued the currencies of many low- and middle-income countries, further increasing the cost of their debt. Exacerbating the problem, the tariffs have motivated investors to move money into perceived safe assets in high income countries and away from countries perceived to be risky. That has driven up the cost of future borrowing for many developing countries.
The impact on people’s lives
The governments of low- and middle-income countries are being forced to choose between servicing their debts or investing in the health and prosperity of their people. 40% of the world’s population lives in countries that spend more on debt service than health or education. And there’s a negative correlation between external debt service and government spending on agriculture and environmental protection.
Rising debt payments and reduced inflows from trade and aid will exacerbate the problem. That will make people less secure and the global system less stable, to the detriment of all.
Global leaders must find new ways to reduce the cost of capital for low- and middle-income countries and mitigate the fiscal pressures of declining aid.
For replication code, please visit this report’s GitHub repository.