Global debt is dangerously rising with each clock tick. But what’s more alarming is that, such reckless has borrowing pushed the world over a barrel and into a potential ‘fifth wave of debt crisis.’ About 30% of Emerging Markets (EMs) and 60% of low-income countries are now in, or at high risk of debt distress, according to the IMF. Debt default is the biggest challenge confronting countries, who are spending more on interest payments than on welfare, halting their fight against poverty.
In 2021, global debt reached a historic peak of $303 trillion, higher than the 2020 record of $226 trillion, according to the Institute of International Finance. But none can blame the pandemic for this endless debt buffet. Even though Covid-19 led to the largest one-year debt increase in 2020 since World War II, a massive debt build-up had been underway for a decade before.
According to the World Bank’s debt sustainability analysis, between 2011 and 2019, public debt in 65 developing countries shot up by 18% of GDP on average. These countries have high primary deficits, and the consensus view is that a serious global debt crisis is unfolding. Unlike last decade, countries cannot simply take new debt to replace old debt, and could force them with imminent defaults. And as we have seen during the 1990s Asian financial crises, and the more recent 2010 Eurozone debt crises, debt defaults are often contagious.
Worryingly, the anticipated defaults are not confined to low-income countries. With EM debt about to touch a record $100 trillion, fears about middle-income countries struggling with dues is mounting. Total EM debt is at a record high of 207% of GDP, while government debt at 64% of GDP, too is at its highest level in three decades. And here in lies the problem. The lethal combination of rising interest rates and strengthening dollar could once again trigger a sovereign debt distress.
Typically, countries borrow in US dollars or euros, and hold forex reserves to meet import payments, and sustain currency value. Unfortunately, these reserves are falling short especially with energy prices soaring. Foreign currencies, particularly the greenback, have become expensive with the US Federal Reserve and the European Central Bank raising rates.
Since 90% of the emerging market debt is dollar denominated, a stronger US currency makes repayments punitively expensive. This is precisely what has happened in Sri Lanka, whose first sovereign debt default since independence in 1948 of $35 billion launched the nation into an economic tailspin. If there were three main peaks in debt defaults prior to World War I -- 1830s, 1880s and 1930s -- the past 50 years alone saw four more debt waves since 1970. Of these, the first three episodes ended with financial crises in emerging and developing economies.
The last one that began in 2010, has alreadywitnessed the largest, fastest and most broad-based increase in debt among economies. In 2012, Greece, which became the first advanced nation since the 1960s to undergo a deep debt restructuring, isn’t fully out of the woods.