Developing countries are being held back by their dependence on dollar- and euro-denominated debt, which leaves them vulnerable to exchange-rate swings, capital flight and persistently high borrowing costs, according to economist Annina Kaltenbrunner.
The professor of global economics at Leeds University Business School argues that the international financial system structurally disadvantages emerging economies by forcing them to rely on foreign-currency financing, exposing them to risks that wealthier nations largely avoid.
“The concept of international financial subordination emerged from observing structural asymmetries in the international economy that disadvantage and penalize developing countries more than developed ones,” Kaltenbrunner said in an interview published in the OPEC Fund Quarterly.
According to Kaltenbrunner, countries that industrialize later often finance development in dollars or euros, leaving them exposed to abrupt changes in global financial conditions. When international investors pull back capital or local currencies depreciate, governments face rising debt burdens and higher financing costs.
“Structurally higher interest rates, greater dependence on financial flows and the fact that these flows are often determined by conditions in international monetary and financial markets” have become major constraints on economic development, she said.
Kaltenbrunner argued that multilateral development banks, while partly reinforcing the existing system through dollar-denominated lending, are also among the few institutions capable of breaking the cycle because of their ability to provide long-term financing on concessional terms.
“Currently, these structures are perpetuated because most capital going into developing countries is denominated in U.S. dollars or euros, which shifts the currency risk to the borrower,” she said. “As soon as the local currency depreciates, the debt burden increases.”
The economist called on multilateral lenders to expand local-currency financing and absorb part of the exchange-rate risk, arguing that doing so could reduce borrowing costs and improve project sustainability. Research cited in the report suggests that shielding borrowers from foreign-exchange volatility could lower default risks and encourage domestic investment.
Kaltenbrunner pointed to Uganda as an example of the challenges facing developing economies. Although the country’s central bank policy rate stands at about 10%, commercial lending rates exceed 22% because policymakers must maintain high interest rates to attract foreign capital and support the local currency.
“The macro environment feeds directly into the micro: systemic risk translates into high borrowing costs across the economy,” she said.
She also argued that climate financing presents an additional challenge for developing economies, many of which face large adaptation costs while lacking the fiscal space to fund them. Relying on private capital alone is unrealistic, she said, because many climate projects do not generate sufficient returns to attract investors.
“We need to rethink catch-up development finance and how best to mobilize funding,” Kaltenbrunner said.
The economist said regional integration could offer part of the solution, pointing to efforts in Africa and Asia to develop local-currency payment systems and regional reserve mechanisms. However, she cautioned that unless developing countries strengthen domestic financial institutions and reduce their dependence on foreign currencies, the structural imbalances embedded in the global financial system are likely to persist.
