krueger67_Pradeep DambarageNurphoto_sri lanka debt Pradeep Dambarage/Nurphoto

The Great Debt Conundrum

When debt levels are high and rising, as they are today across the developing world, crises can erupt suddenly and worsen quickly. To prevent a global catastrophe, the international community must establish mechanisms to ensure timely and fair burden-sharing among sovereign creditors.

WASHINGTON, DC – The exponential growth of international capital flows, predominantly in the form of debt, has been one of the great development successes of the past 50 years. But while foreign lending has played a pivotal role for developing economies, loans are a two-edged sword. When used judiciously, they can generate high returns, boost GDP growth, and improve the well-being of borrower countries. But if debts accumulate and the debt-servicing burden increases without a commensurate increase in repayment capacity, the consequences can be severe and even disastrous.

During the COVID-19 pandemic, for example, many countries grappled with a dramatic increase in fiscal demands, driven by rising public-health expenditures and a drop in revenues due to reduced economic activity. Highly indebted countries edged closer to the brink of default, and even those with previously sustainable public finances experienced a dangerous surge in their debt burdens.

When debt levels are high and rising, crises can emerge suddenly and worsen quickly. While several governments have taken steps to reduce their elevated debt levels and introduced reforms to avert potential crises, some countries’ debt-servicing costs are so high that meaningful adjustments are politically or economically unfeasible. Under such conditions, skeptical private creditors sell these countries’ sovereign bonds at reduced prices and refuse to extend further credit. Once this happens and governments default on their obligations, they find themselves shut out of capital markets. The subsequent economic crisis typically persists until these countries can restructure their existing debts, implement policy reforms, and restore confidence in their creditworthiness.

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