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Three Steps to Avoid a Debt Crisis

The sustainability of the debt of some high-risk countries has been the subject of wide debate. However, the burden of public debt is a growing problem worldwide.

In advanced countries, public debt stands at levels that have not been recorded since World War II, although it has decreased more recently. Public debt in emerging market countries is at levels last seen during the debt crisis of the 1980s. Furthermore, 40% of low-income countries —that is, 24 of 60 countries— are at high risk of a critical situation caused by indebtedness, that is, the inability to service public debt, which could considerably alter economic activity and employment. Therefore, it is not surprising that, as the country that chairs the G-20, Japan has considered debt sustainability as a priority item on the G-20 agenda.

High levels of unprecedented debt are not necessarily a problem when real interest rates are very low, as is the case today in many advanced economies. However, high levels of debt can leave governments much more vulnerable to the tightening of global financial conditions and rising interest rate costs. This could lead to market corrections, strong exchange rate movements and further weakening of capital flows.

Not all debt is bad

In fact, loans can unlock vital resources for investment in infrastructure, health, education, and other public goods. Investment in productive capacity, when done correctly, generates an increase in income that can offset the cost of debt service. In addition, part of the increase in debt, especially in advanced economies, helped prop up growth after the global financial crisis and prevent a worse outcome.

Problems arise when the debt is already high and the resources from new loans are not spent wisely (due to corruption, weak institutions or other reasons), or when a country is affected by natural disasters or economic shocks, such as the sudden reversal of capital flows that affects your ability to repay debt. Currently, some emerging market countries face this latest challenge.

But it is usually low-income countries that face the most difficult debt challenges and are also often less prepared to respond to these challenges.

Many of these countries have a great need to generate additional resources for development, and end up increasingly turning to external financing through sovereign bond issues, loans from new official lenders, and credit from foreign commercial creditors. Sovereign bonds and commercial loans tend to have higher interest rates and shorter maturities, which increases the cost of debt service and complicates the task of managing it.

Although diversification of financing sources has advantages, it also creates new challenges for managing debt and, if necessary, addressing its restructuring, since we do not have established mechanisms for the coordination of creditors that include new creditors.

What can lenders and borrowers do?

Three policy priorities can help change the situation.

Redouble efforts to ensure that sovereign debt is financially sustainable

Borrowers should carefully define their public spending and fiscal deficit plans to keep public debt on a sustainable path. They should also carefully consider the potential return on their projects and their ability to repay through increased tax revenue before taking on new debt. Lenders should evaluate the impact of new loans on the borrower’s debt position before making new loans. This will protect both the lender and the borrower from entering into agreements that will cause them financial difficulties in the future.

Ensure that all countries declare comprehensive and transparent information on public debt

In many developing countries, there is scope to significantly strengthen the institutions that are responsible for recording, supervising and declaring debt. For example, one third of low-income countries do not report information on guarantees provided by the public sector, and less than one in ten countries report information on public company debt. Debtors have scope to allow more complete disclosure of the terms and conditions of their loans. Greater transparency in relation to public debt liabilities can help to avoid the accumulation of large “hidden” liabilities that end up turning into explicit government debt.

Promote collaboration among official creditors

in order to prepare for debt restructuring cases involving non-traditional lenders. Given the high level of debt maintained by new creditors, we must think about what we can do to make coordination between official creditors effective, as it is often essential for the resolution of debt crises.

As for the IMF, together with our institutional partners, we are working closely with member countries to strengthen their ability to record and manage debt, as well as to ensure their transparency. We are strengthening our methodologies to assess debt sustainability and training officials in member countries to use them. In addition, we are actively working with new lenders, in particular to strengthen their ability to participate in multilateral debt restructuring, should the need arise. .