Today at TILE we talked about lending on an international level. The devastating earthquake in Haiti raised two clear questions in our office. First, what can we do to help? But also, what was the economic situation in Haiti before the earthquake even hit? We know that Haiti was wracked with debt, but what does that mean? What is the difference between lending to a country and lending to an individual? What happens when a country defaults, or backs out, of its fiscal commitments? Are all countries able to raise money and attract investments equally, and if not, why not?
For the most part, countries go about getting a loan (or raising debt) the same way individual borrowers do. They decide how much they need, make a case to the potential lender, an outside agency assesses the risk, and terms are decided. Clearly, there are differences in the size of the loans (how much a country needs versus a local business), the types of lenders (a bank or credit union versus The World Bank, institutional investors, and other countries), the magnitude of risk, and the terms of the loan (such as the life span of the loan and amount of interest paid).
When a country doesn’t pay back its financial commitments, they don’t have to file for bankruptcy, but they will most likely find themselves in a legal battle on the international stage – and with a damaged reputation. Often it is in the interest of the country and the lenders to renegotiate the terms of, or restructure, the loan. For the country, it is better to say, “I can’t pay you right now, but I will pay you over a longer time frame.” For the lender, it is often better to accept a lower return on investment (or profit on the loan) by extending the time frame and/or accepting a lower interest rate. For example, if you lent a friend $1,000 and then found out they couldn’t pay, what would you do? Would you prefer to “restructure” that loan so that you received $800 or just accept that the money is gone? It’s better to get most of your money back rather than none. But regardless of the outcome of the restructuring, you probably won’t lend any more money to that person in the near future!
Key components of lending are motives and risks. Motives relate to understanding the need to raise money as well as the interest of the lenders to lend. What is the money going to be used for? Building bridges? Investing in new industries? Or something else? Why might it be a good decision to lend money? Most likely it is financial gain – the lender sees the potential to make money on the interest or the investment. Risk is the cornerstone of any financial transaction – it is a metric for the likelihood that everything will go according to plan. That is why each country (like companies and individuals) receives a credit rating (similar to a personal credit score) – the lower the risk, the higher the score. In addition, the terms of the loan represent the market’s view of that risk. Greater perceived risk usually means a higher interest rate (getting paid for taking a higher risk) and more stringent conditions. The same concepts apply when lending to individuals (how you are perceived/assessed if you go to take out a loan or apply for a credit card).
While attracting lenders is important to a country that is seeking to grow, so too is the ability to attract companies that want to build their businesses abroad. Most countries want businesses to invest in them – it is good for the economy – but if there is too much uncertainty when it comes to doing business in a country, companies will most likely find another place to go. Google’s recent announcement that it may stop doing business in China fits into this category. Google’s motives were to expand the brand and reach of the company. Its risks, like many international companies that expand globally, related to the expectation that international law and privacy protections would apply. Understanding all the risks, and costs, they still chose to move ahead. Kind of like finding themselves in the position of dealing with a borrower that is “defaulting” on their loan, Google is calculating the costs (time, money, and people) if it gives up and moves on. Should they restructure? Go to court? Or do they just walk away – and send a really big signal to other companies who are considering investing in China?
So how does this relate to Haiti and what does it mean for the TILE Community? While a natural catastrophe is much different than other uncertainties, like government instability, the treatment of debt and prospect of investment is similar. First, it is very likely that Haiti’s debts will be forgiven and/or restructured. Second, it will need sustained investments and capital to rebuild its infrastructure. Admittedly, though the current outpouring of humanitarian aid is critical in the short-term, the long-term health of any country is long-term investment – something Haiti didn’t have much of even before the earthquake hit. In terms of the TILE community, we encourage you to consider our Causes when looking for ways to help the victims Both charity:water and ACCION have earthquake response efforts in Haiti. In addition, think about the difference between short-term and long-term investments. Are your financial actions, whether in Spending, Growing, or Giving, more like applying a band-aid, or are they really addressing the long-term roots of the problems you face?
- Amy