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https://www.worldbank.org/en/news/press-release/2019/12/19/debt-surge-in-emerging-and-developing-economies-is-largest-fastest-in-50-years
Overview
Another global wave of debt underway…
The global economy has experienced four waves of broad-based debt
accumulation over the past fifty years. In the latest wave, underway since 2010,
global debt has grown to an all-time high of 230 percent of GDP in 2018. The
debt buildup was particularly fast in emerging market and developing economies
(EMDEs). Since 2010, total debt in these economies has risen by 54 percentage
points of GDP to a historic peak of about 170 percent of GDP in 2018.
Following a steep fall during 2000-10, debt has also risen in low-income
countries to 67 percent of GDP ($268 billion) in 2018, up from 48 percent of
GDP (around $137 billion) in 2010.
Why this study?
The size, speed and reach of the post-crisis debt buildup in EMDEs raises
concerns about its potential consequences for macroeconomic and financial
stability. To shed light on these consequences, this study presents the first indepth
analysis of four waves of debt accumulation, puts the current debt wave
into historical perspective, analyzes national episodes of debt accumulation,
examines the links between debt accumulation and financial crises, and draws
policy lessons. The study employs a wide range of approaches, including event
studies, econometric models, country case studies, and a detailed review of
historical episodes.
Three historical waves: All ended with crises
Prior to the current wave, EMDEs experienced three waves of broad-based debt
accumulation. The first wave spanned the 1970s and 1980s, with borrowing
primarily accounted for by governments in the Latin America and the
Caribbean region and in low-income countries, especially in Sub-Saharan Africa.
The combination of low real interest rates in much of the 1970s and a rapidly
growing syndicated loan market encouraged these governments to borrow
heavily.
The first wave culminated in a series of crises in the early 1980s. Debt relief and
restructuring were prolonged in the first wave, ending with the introduction of
the Brady Plan in the late 1980s for mostly Latin American countries. The Plan
provided debt relief through the conversion of syndicated loans into bonds,
collateralized with U.S. Treasury securities. For low-income countries,
substantial debt relief came in the mid-1990s and early 2000s with the “Highly
Indebted Poor Countries” initiative and the “Multilateral Debt Relief
Initiative”, spearheaded by the World Bank and the IMF.
The second wave ran from 1990 until the early 2000s as financial and capital
market liberalization enabled banks and corporations in the East Asia and the
Pacific region and governments in the Europe and Central Asia (ECA) region
to borrow heavily, particularly in foreign currencies. It ended with a series of
crises in these regions in 1997-2001 once investor sentiment turned
unfavorable.
The third wave was a runup in private sector borrowing in ECA from EUheadquartered
“mega-banks” after regulatory easing. This wave ended when
the global financial crisis disrupted bank financing in 2007-09 and tipped
several ECA economies into recessions.
Historical waves: Many similarities but some differences as well
The three waves of debt began during periods of low real interest rates, and
were often facilitated by financial innovations and/or changes in financial
markets that promoted borrowing. The waves ended with widespread financial
crises and coincided with global recessions (1982, 1991, and 2009) or
downturns (1998, 2001). These crises were typically triggered by shocks that
resulted in sharp increases in investor risk aversion, risk premiums, or
borrowing costs, followed by sudden stops of capital inflows and deep
recessions. The financial crises were usually followed by reforms designed to
lower vulnerabilities and strengthen policy frameworks. Many EMDEs
introduced inflation targeting, greater exchange rate flexibility, fiscal rules, or
more robust financial sector supervision in the aftermath of crises.
There are some important differences among the first three waves. The
financial instruments used for borrowing have evolved as new instruments or
financial actors have emerged. The nature of EMDE borrowers in international
financial markets has changed, with the private sector accounting for a growing
share of debt accumulation through the three waves. The severity of the
economic damage done by the financial crises that ended the waves varied
among them, and across regions. Output losses were particularly large and
protracted in the wake of the first wave, when the majority of debt
accumulation had been by governments. Meanwhile, in many EMDEs,
improvements in policy frameworks after the first two debt waves played a role
in mitigating the adverse impact of the global financial crisis that marked the
end of the third wave.
The fourth wave: Similar to previous waves but larger, faster and broader
The latest wave of debt accumulation began in 2010 and has already seen the
largest, fastest, and most broad-based increase in debt in EMDEs in the past 50
years. The average annual increase in EMDE debt since 2010 of almost 7
percentage points of GDP has been larger by some margin than in each of the
previous three waves. In addition, whereas previous waves were largely regional
in nature, the fourth wave has been widespread with total debt rising in almost
80 percent of EMDEs and rising by at least 20 percentage points of GDP in
just over one-third of these economies.
The current wave of debt accumulation bears many similarities to the previous
three waves. Global interest rates have been very low since the global financial
crisis, and the ensuing search for yield by investors has contributed to
narrowing spreads for EMDEs. Some major changes in financial markets have
again boosted borrowing, including through a rise of regional banks, growing
appetite for local currency bonds, and increased demand for EMDE debt from
the expanding non-bank financial sector. As in the earlier waves, vulnerabilities
have mounted in EMDEs as the current wave has proceeded amid slowing
economic growth.
National episodes of debt accumulation: Debt distress more likely
At the individual country level, EMDEs have historically undergone recurrent
surges of rapid debt accumulation. When these episodes took place in many
economies, they collectively formed the global waves of debt discussed above. A
closer examination of national episodes offers a more granular perspective on
the causes and consequences of debt accumulation.
Since 1970, there have been 519 national episodes of rapid debt accumulation
in 100 EMDEs, during which government debt typically rose by 30 percentage
points of GDP and private debt by 15 percentage points of GDP. The typical
episode lasted about 8 years. About half of these episodes were accompanied by
financial crises, which were particularly common in the first and second global
waves, with severe output losses compared to countries without crises. Crisis
countries typically registered larger debt buildups, especially for government
debt, and accumulated greater macroeconomic and financial vulnerabilities
than non-crisis countries.
While financial crises associated with national debt accumulation episodes were
typically triggered by external shocks such as sudden increases in global interest
rates, domestic vulnerabilities often amplified the adverse impact of these
shocks. Crises were more likely, or the economic distress they caused was more
severe, in countries with higher external debt—especially short-term—and
lower international reserves.
Unsustainable policies: A recipe for debt distress
Most EMDEs that experienced financial crises during debt accumulation
episodes employed various combinations of unsustainable macroeconomic
policies, and suffered structural and institutional weaknesses. Debt buildup had
often funded import substitution strategies, undiversified economies, or
inefficient sectors that did not raise export earnings or had poor corporate
governance. Many of these economies had severe weaknesses in their fiscal and
monetary policy frameworks, including poor revenue collection, widespread tax
evasion, public wage and pension indexing, monetary financing of fiscal
deficits, and substantial use of energy and food subsidies. In addition, crisis
countries often borrowed in foreign currency and managed their exchange
rates, while regulation and supervision of banks and other financial institutions
were frequently weak. Several EMDEs that experienced crises also suffered
from protracted political uncertainty.
End of the current wave: Will history repeat itself?
While EMDEs have gone through periods of volatility in the current wave of
debt accumulation, they have not experienced widespread financial crises.
However, the exceptional size, speed, and reach of debt accumulation in
EMDEs during the fourth wave should give policymakers in EMDEs pause.
Despite the sharp rise in debt, these economies have experienced a decade of
repeated growth disappointments and are now facing weaker growth prospects
in a fragile global economy. In addition to their rapid debt buildup, they have
accumulated other vulnerabilities, such as growing fiscal and current account
deficits and a shift toward a riskier composition of debt. Thus, despite
exceptionally low real interest rates, and prospects for continued low rates in
the near-term, the current wave of debt accumulation could follow the
historical pattern and culminate in financial crises in these economies.
A sudden global shock, such as a sharp rise in interest rates or a spike in risk
premia, could lead to financial stress in more vulnerable economies. Among
low-income countries, the rapid increase in debt and the shift from
concessional toward financial market and non-Paris Club bilateral creditors
have raised concerns about debt transparency and collateralization. Elevated
debt in large EMDEs could amplify the impact of adverse shocks and trigger a
downturn in these economies, posing risks to global and EMDE growth.
Policies matter!
While there is no magic bullet of a policy prescription to ensure that the
current debt wave proceeds smoothly, the experience of past waves of debt
points to the critical role of policy choices in determining the outcomes of
these episodes. Specific policy priorities ultimately depend on country
circumstances, but there are four broad strands of policies that can help reduce
the likelihood of the current debt wave ending in crisis and, if crises were to
take place, to alleviate their impact: policies to manage the composition of
debt, strong macroeconomic and financial policy frameworks, sound financial
sector policies, and robust business environments and institutions.
First, higher government or private debt and a riskier composition of debt (in
terms of maturity, currency denomination, and type of creditor) are associated
with a higher probability of crisis. Hence, sound debt management and debt
transparency will help reduce borrowing costs, enhance debt sustainability, and
contain fiscal risks. Creditors, including international financial institutions, can
spearhead efforts in this area by encouraging common standards, supporting
capacity building, and highlighting risks and vulnerabilities through timely
analytical and surveillance work.
Second, robust monetary, exchange rate, and fiscal policy frameworks can
safeguard EMDEs’ resilience in a fragile global economic environment. The
benefits of stability-oriented and resilient monetary policy frameworks cannot
be overstated. Flexible exchange rates can discourage a buildup of substantial
balance sheet mismatches and reduce the likelihood of large exchange rate
misalignments. Fiscal rules can help prevent fiscal slippages, ensure that
revenue windfalls during times of strong growth are prudently managed, and
manage and contain risks from contingent liabilities. Revenue and expenditure
policies can be adjusted to expand fiscal resources for priority spending.
Third, proactive financial sector regulation and supervision can help
policymakers identify and act on emerging risks. Financial market deepening
can help mobilize domestic savings, which may be a more stable source of
financing than foreign borrowing.
Fourth, in several crisis cases, it became apparent that borrowed funds had been
diverted towards purposes that did not raise export proceeds, productivity or
potential output. Apart from effective public finance management, policies that
promote good corporate governance can help ensure that debt is used for
productive purposes. Sound bankruptcy frameworks can help prevent debt
overhangs from weighing on investment for prolonged periods.