The World is Facing an Unsustainable Debt Crisis

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From poor to rich countries, the unprecedented debt crisis risks sinking the global economy. Moreover, the current state of global debt paints frightening images and makes alarming forecasts about the future state of the global economy.

This time around, however, the issue is not confined to affecting the economy of a single nation or area; rather, it is having an effect on the global economy. A growing number of nations are struggling to pay their debts, and the breaking point is drawing near.

Around 25% of developing economies and 60% of low-income nations are already experiencing a debt crisis or are at high risk of it. A major debt crisis is now affecting around 54 emerging economies. In spite of the fact that they account for around 3% of the global economy, they make up 18% of the world’s population and more than 50% of those who are facing staggering levels of poverty. In addition, these nations have an annual debt payment obligation of $62 billion to official bilateral creditors, a 35% rise from 2021, raising concerns about the likelihood of rising debt loads.

Why is there a crisis?

One of the most significant developments in global finance over the past ten years has been the worsening scale of external debt, particularly in developing market economies and poor countries. The pandemic’s economic effects and the outbreak of the war in Ukraine have fueled this.

Based on a growing number of indicators and events anticipated to have a direct impact on the debt landscape, the debt problem will continue to deteriorate throughout 2023. In 2022, the world experienced a cascade of extraordinary occurrences, the majority of which will trigger a domino effect.

First, the global economy is undergoing a broad-based, more severe than an anticipated slump, and inflation is at its highest level in years. Additionally, the cost-of-living issue has made financial circumstances more difficult for many trying to survive.

Second, 2022 witnessed a number of political upheavals and made it more difficult for governments to take on more debts. Along with tensions over Taiwan, coups in Africa, and political unrest in several Latin American countries, the Ukraine conflict created a huge structural upheaval that dented many economies.

Third, 2022 witnessed a number of currency changes, with most suffering abrupt depreciations. It has become more costly for certain nations to pay back their debts with foreign currencies due to the direct effects of currency depreciation. Furthermore, the majority of the nations that amassed significant debt compared to their GDP are having trouble repaying it as a result of their governments’ recent increases in bank rates.

Fourth, a lot of emerging nations are “overinvesting” and spending a lot of their money on these overinvestments. These nations now lack the resources necessary to pay down their debt as a consequence.

What’s going to happen in 2023?

Several unfavorable political and economic consequences might result from worsening global debt rates in 2023, especially in poor and emerging nations. Firstly, developed countries, multilateral development institutions, and creditors in the private sector are owed around $200 billion by developing nations. A catastrophic debt crisis for developing nations is predicted for 2023, which will be made worse by a confluence of high-interest rates, inflation, weak growth, and a strong currency. This implies that even if the economic problems in borrowing nations worsen, attempts to reduce debt will be a steep climb for many. This will probably result in a fresh wave of defaults. An economic slowdown will become more evident in 2023 as companies and individuals reduce spending and investment.

Secondly, negative supply shocks and stagflation are anticipated to persist in 2023, and they will create a much more challenging scenario than excessive demand for goods because this will slow economic growth in borrowing countries, and decreased production capacity will decrease those countries’ ability to repay their debt. Governments may also be compelled to curtail expenditure in order to pay off their debt, which might result in cuts to healthcare and education.

Thirdly, the root of the global debt problem is that recessions are frequently accompanied by a string of financial crises in emerging markets and developing economies, which would result in slower GDP growth, less foreign cash and cash liquidity in those nations, and a consequent reduction in their capacity to pay back debts, leading to an increase in payment defaults. The 2023 debt crisis may also result in a decline in economic confidence, which may deter foreign investors from making investments.

Fourthly, investors anticipate central banks to raise interest rates to roughly 4% in 2023, which is more than a two-point rise above the 2021 average, given the inability of current interest rate hikes to return global inflation to pre-pandemic levels. This would cause national currency exchange rates to become unstable, particularly for developing economies with large debt levels. This would be followed by a devaluation of those countries’ currencies as they were compelled to make repayments in hard currency.

Fifthly, in developing or impoverished nations, the inability to pay debts and engagement in additional obligations may cause public resentment and outrage, or, at the very least, may allow for greater criticism of the actions of such governments and undermine their political stability. Street protests and rallies against challenging economic circumstances may develop as a result, and in certain nations, governments may collapse.

Sixthly, given the anticipated economic unrest in 2023, many individuals may be compelled to leave their home countries for employment elsewhere. Increased numbers of migrants into affluent nations may have a detrimental effect on those economies.

Lastly, businesses may hold off on hiring more people or what is more likely, trim their payroll numbers as they try to shore up their bottom lines, which would raise unemployment. On the other side, banks and other financial institutions would start to exercise greater caution when making loans, which might make it difficult for companies and people to get credit. Google has already trimmed its workforce by thousands of employees aside from cuts at Meta and Twitter.

How can we prevent the debt crisis?

The parties with the capacity to stop or lessen the effects of the debt crisis are those in the developed world. Therefore, the world should start by ending the war in Ukraine. Since the beginning of the war, all economic indices have been increasing in an odd manner.

There are some sound economic strategies that could be deployed, such as reducing government expenditures to lower the budget deficit and maintain the debt-to-GDP ratio. This could include tax increases or social safety cuts which are always unpopular. France’s Emanual Macron has learned this lesson over the years.

Second, reworking a country’s debt agreement with its creditors to make it more manageable could also mean lowering interest rates or delaying the debt’s maturity. Thirdly, central banks may conduct monetary policies like decreasing interest rates to boost economic development and make it simpler for borrowers to pay back their obligations. Fourth, to help it satisfy its debt commitments, a nation may get financial aid from external sources or from institutions like the International Monetary Fund. However, because of a number of factors, developing or emerging economies are reluctant to do so.

Last but not least, enacting fundamental economic changes, such as labor market reforms may aid in boosting growth and raising a country’s economic output. Additionally, in rare circumstances, a substantial percentage of debt may be wiped off by creditors in order to increase the debt’s viability.

Is it all bad?

The impending debt crisis has been a long-brewing issue that has taken more than ten years to develop. The ultimate shock emerged shortly after the Ukraine conflict, which served as a catalyst. There are rising concerns of a fresh wave of debt defaults given the unfavorable outlook for global economic trends, especially the more complicated global debt crisis, particularly for emerging and impoverished nations.

There are, nevertheless, a few possible alternatives or remedies that may stave off an economic crisis. Yet, once again, the choice is completely up to wealther economies. Therefore, the moment has come for the developed world, also known as the “guardians of humanity”, to demonstrate that they are responsible and sane in order to put an end to the insane, unfathomable, and disastrous destiny of humankind!

– S. M. Saifee Islam is a Research Associate at the KRF Center for Bangladesh and Global Affairs (CBGA).

Published in International Policy Digest [Link]