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The Looming Global Debt Disaster

3 weeks ago
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The Looming Global Debt Disaster

Despite a succession of shocks since 2020, the global economy has held up remarkably well—so far. But the margin for error is dwindling. Total global debt is now nearly 25 percent higher than it was on the eve of the COVID-19 pandemic, when it already was at an all-time high. This overhang could undercut all economies’ ability to shield themselves against the latest shock: higher trade tariffs.

Although debt is crucial for driving economic growth, it should be understood as a form of deferred taxation. By borrowing rather than taxing, governments can make long-term investments that will benefit future taxpayers without burdening the current generation; or they can prop up national growth and incomes during an economic emergency, when hiking taxes would only deepen the downturn.

Eventually, however, the piper must be paid, and if national income does not grow faster than the cost of borrowing, taxes must be raised to repay the debt. Persistently high debt thus becomes a barrier to economic progress.

That barrier has seldom been higher. Over the last 15 years, developing countries got hooked on debt, which they amassed at a record-setting clip: six percentage points of gross domestic product (GDP) per year, on average. Such rapid debt build-ups often end in tears. Indeed, the odds that they will trigger a financial crisis are roughly 50-50.

Moreover, this particular surge has been punctuated by the fastest increase in interest rates in four decades. Borrowing costs doubled for half of all developing economies, with net interest costs as a share of government revenues rising from less than 9 percent in 2007 to about 20 percent in 2024. That alone constitutes a crisis.

Although the world has so far managed to dodge a “systemic” financial meltdown of the 2008-09 variety, too many developing economies are now in a doom loop. To service their debts, many of these countries are cutting the investments—in education, health care, and infrastructure—that they need to assure future growth.

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This is especially true of the 78 poor countries that are eligible to borrow from the World Bank’s International Development Association. These countries are home to one-quarter of humanity, representing a large slice of the 1.2 billion young people who will enter the global workforce in the next 10-15 years. Yet policymakers around the world have opted to tempt fate. In another triumph of hope over experience, they are betting that global growth will accelerate, and that interest rates will fall, by just enough to defuse the debt bomb.

Such passivity is understandable. It has been extremely difficult to devise a 21st-century system capable of ensuring global debt sustainability and swift debt restructuring for countries that need it. In the absence of such a system, the progress that has occurred has been too slow to avoid rising debt dangers.

But the world cannot afford yet another decade of drift and denial where debt is concerned. Under current policies, global growth will not speed up anytime soon, which means that sovereign debt-to-GDP ratios are likely to climb for the remainder of this decade.

Today’s trade wars and record-breaking levels of policy uncertainty have only made the outlook worse. At the start of 2025, the consensus forecast among economists was predicted 2.6 percent global growth this year. That number is now down to 2.2 percent, nearly a third lower than the average that prevailed in the 2010s.

Nor will interest rates fall. In advanced economies, interest rates set by central banks are expected to average 3.4 percent this year and next, more than five times the annual average between 2010 and 2019. This will compound developing economies’ difficulties. In an era of scarce public resources, it will take an all-out mobilization of private capital to boost growth and development over the next five years.

But foreign private capital is unlikely to flow into highly indebted economies with weak growth prospects. Private investors will correctly assume that any gains from economic growth will simply be taxed to pay off the debt. Thus, reducing debt should be the top priority for developing economies with persistently high debt-to-GDP ratios.

But we also need a clear-eyed view of the broader problem: the global apparatus for assessing the sustainability of a country’s debt urgently needs to be upgraded. The current system is too quick to decide that countries merely need loans to tide them over, when most low-income countries today are in fact insolvent and will need debt write-offs. Governments also need to ditch the habit of borrowing from domestic creditors; the rise in domestic debt is strangling domestic private-sector initiative.

After reducing debt, the next priority is to accelerate growth. It is foolish to pretend that growth will magically return. Policies that impede trade and investment, like tariffs and non-tariff barriers, should be rolled back as soon and as much as possible. For many developing economies, cutting tariffs equally with respect to all trading partners could be the fastest way to restore growth. Developing economies also have much to gain by fostering a more investment-friendly regulatory environment. And those gains can be used to shift the national focus back to development, particularly by ratcheting up investments in health, education, and infrastructure.

As the saying goes, when you’re in a hole, it is wise to stop digging. An era of extraordinarily low interest rates encouraged too many countries to spend far beyond their means. A string of catastrophes, both natural and man-made, made it impossible for them to do anything else in the last five years. But prudence is now essential. Governments should revert to previous norms on what constitutes excessive sovereign debt. Call it the 40-60 maximum: 40 percent of GDP for low-income economies, 60 percent for high-income economies, with everyone else in between.

Source: World Bank
Via: norvanreports
Tags: Debt disasterThe Looming Global Debt DisasterWorld Bank

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