Is there a way out of the global debt crisis?

The writing is on the wall. The world faces the threat of a global debt crisis. According to the World Bank recession will be hard to avoid for many countries due to high borrowing, inflation and rising energy prices. Marcello Estevão, Global Director, Macroeconomics, Trade, and Investment at The World Bank tells us how this will impact us and whether there is a way out. Listen in.

 

 

What is the unique feature of the current global debt crisis? How is it different from crises in the past?

Marcello: The debt landscape is much more diverse now, with different types of creditors with different types of incentives. It is somewhat peculiar that the very large emerging market countries haven't had a debt crisis.

We don't have a case of contagion like you saw, for instance, when Mexico stopped paying its debt in 1982. There was a contagion from that action to other Latin American countries, and then to other countries in the world, which was quite serious.

I see the crisis right now being more of a common shock. We had COVID and the invasion of Ukraine at a time when countries were already borrowing too much. Therefore, there are a bunch of countries in trouble, but not one huge country in trouble.

Recently, IMF and the World Bank have significantly lowered their global growth forecasts. The president of the World Bank has stated that for many countries, the recession will be hard to avoid. How will slower or even negative growth impact global debt?

Marcello: Everybody in the world is already facing high inflation. Part of the shock is an inflationary shock because of the war and the impact that it caused on supply chains and the price of food and fuel. Through reduced growth, you have reduced trade. If you're a more open economy, you are going to suffer, somewhat. But for countries that are more developed, this is kind of a ‘survivable’ shock.

I'm much more concerned about relatively poor countries, like Afghanistan, Eritrea, Mauritania, Somalia, Sudan, Tajikistan and Yemen that are quite sensitive to what's happening with food prices and they have a debt issue. Over the next year, the imports of wheat, rice and maize in these countries is expected to rise by the equivalent of more than 1% of GDP. That was the calculation in July. It may be a bit less now, but it is concerning because that's more than twice the size of the 2021-2022 increase!

What does a global debt crisis mean for individuals on the very grassroots? There's so much less for them in terms of critical infrastructure such as the health care education and building of the society.

Marcello: It is a big problem. Coupled with the lack of financing for key development policies, it is a big deal for development. That's why we are particularly concerned about the debt situation around the world.

I'm quite concerned about countries that have a high risk of debt distress. Those countries need special attention and our teams working hard with the authorities to help them survive this particular moment. There are also some emerging markets that are also quite vulnerable. For instance, the crisis in Lebanon is that Canada has had an economic crisis for the last three years. 

There are also countries in the common framework that are not paying their dues like Chad, Ethiopia, and Zambia. There was just some breakthrough in the case of Zambia, because it has some private sector collateral debt. But there are issues with countries that are in trouble that cannot participate in such negotiated set of agreements and solutions for their problems.

You have been a strong advocate of more transparency in government debt. Why is that one of the pillars of that new system that should be built on?

Marcello: Sometimes countries have many obstacles to be forthcoming about their data. For instance, they have secrecy clauses. While some information such as proprietary financial calculations or formulas may indeed need to be protected. There's no reason to hide the deal as a whole. 

To be very blunt, I think more often than not confidentiality clauses are the result of more unsavoury motivations - either political considerations or simply corruption. 

Policymakers need to create a better way for borrowers and lenders alike. First, they need to refrain from using such confidentiality clauses. Secrecy may be very tempting in the short run, but over the long run, transparency can bolster a borrower's reputation, which in turn, will improve investor confidence and lower borrowing costs. 

And by the way, should market conditions deteriorate and credit relief become necessary, transparency also facilitates effective debt assessments by avoiding hidden and surprised debt and fosters efficient restructuring.

Do you think that governments and central banks are acting speedily and responsibly to avert a crisis? Can you share some examples?

Marcello: Yes, I think we do not have a worst crisis because policymakers in many large countries acted decisively. It can be argued that the fiscal spending of the US has been too large and some of the inflation pressure that we see right now is because of this big fiscal impulse. 

In emerging markets, Brazil is a case in point for having the right policies. The Brazilian central bank began raising rates rapidly and way before most banks in the world. And rightly so, considering that the inflation shock within the country and the world, was more serious (than anticipated), and needed a more active response. Because of that, capital was flowing into Brazil and when it was flowing out to many countries. Of course, there was some capital flowing out as well, because every country was affected, but it was much lesser from Brazil. 

The issue now for all countries in the world is how to adjust fiscal policy when the situation demands but to rebuild the capacity to fight a crisis when needed.

So there is hope that we can still avoid the worst of it all. Are there any opportunities that can come out of this adversity and crisis, perhaps, a silver lining?

To know the answer to this question and more, please tune into the podcast.

This conversation is abridged. To hear the complete conversation please tune into the podcast.

In this episode

Atte Palomäki
Atte Palomäki
Executive Vice President Communications & Branding