Time for the developed world to rein in the debt crisis

It's already here, from Africa to America, from Morocco to Mexico; the unthinkable, the unimaginable, and the unprecedented debt crisis that is eating up the fruits of development.

The current state of the global debt crisis paints a frightening picture and makes an alarming forecast about the future of the economy. This time around, however, the issue is not confined to affecting the economy of a single nation or area; rather, it is affecting the economy of the whole world. A growing number of nations are struggling to pay their debts in this frightening period, and the breaking point is drawing near. 

Around 25% of developing economies and 60% of low-income nations are already experiencing or are at high risk of a debt crisis. A major debt crisis is also now affecting around 54 emerging economies. Although they account for just more than 3% of the global economy, they make up 18% of the world's population and more than 50% are living in conditions of severe 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. 

What caused the crisis? 

One of the most significant developments in global finance over the past ten years and a major risk factor for the economic slowdown, financial market volatility, and global financial instability in borrowing countries has been the worsening scale of external debt, particularly in emerging and developing market economies and poor countries. 

The Covid-19 pandemic's economic effects and the outbreak of the Ukraine war have exacerbated this situation. Based on the growing number of indicators and events anticipated to have a direct impact on the debt landscape, projections anticipate that the debt problem will continue to deteriorate throughout 2023, notwithstanding the present economic constraints. 

In 2022, the world experienced a cascade of extraordinary occurrences, the majority of which triggered a domino effect. 

Around 25% of developing economies and 60% of low-income nations are already experiencing or are at high risk of a debt crisis. A major debt crisis is also now affecting around 54 emerging economies. Although they account for just more than 3% of the global economy, they make up 18% of the world's population and more than 50% are living in conditions of severe poverty. 

Firstly, the world economy is undergoing a broad-based slump that has been more severe than anticipated. Inflation is at its highest level in many years and cost-of-living has made financial circumstances more difficult in most areas. This makes it more challenging for governments and enterprises to pay their debts.

Secondly, the year 2022 witnessed several political upheavals, and the reappearance of these crises that undermined investor confidence has made it more difficult for a government to handle its debts. Along with the Taiwan issue, coups in Africa, and political unrest in Latin America, the Ukraine conflict in particular caused a huge structural upheaval that impacted the overall economic situation.

Thirdly, there have been a number of currency changes in 2022, with the most significant currencies suffering abrupt depreciations. It is more costly for certain nations to pay back debts with foreign currency 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. As a consequence, currency devaluation and rising bank rates have had a big impact on the debt crisis.

Finally, a lot of emerging nations are 'over-investing' and spending a lot of their money on these over-investments. These nations are now facing a shortage of the resources needed to pay down their debt.

2023 Debt Crisis: What will happen? 

The current political and economic climate might result in worsening global debt rates in the next year, especially in poor and emerging nations. 

Firstly, developed countries, multilateral development institutions, and creditors in the private sector are owed $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, fast inflation, weak growth, and a strong currency. 

So if the economic problems in borrowing nations worsen, attempts to reduce debt will be difficult. 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. They are projected to create a much more challenging scenario because they will slow economic growth in borrowing countries and decreased production capacity will decrease those countries' ability to repay debt. Governments may also be compelled to curtail expenditure to pay off debt, which might result in cuts to crucial initiatives like healthcare and education.

Thirdly, recessions are frequently accompanied by a string of financial crises in emerging markets and developing economies, which results in slower GDP growth, and less foreign cash and cash liquidity in those nations. As a consequence, this leads to a reduction in their capacity to pay back debts, leading to an increase in payment defaults. This is the root of the global debt problem.

The 2023 debt crisis may also cause a decline in economic confidence, which may deter foreign investors from making investments in those nations.

Fourthly, given the current interest rate hike and the inability to return global inflation to pre-pandemic levels, investors anticipate central banks will raise interest rates to roughly 4% in 2023, which is more than a two-point rise above the 2021 average. This would cause national currency exchange rates to become unstable, particularly for developing economies with large debt levels. This could further lead to a devaluation of those countries' currencies as they would be 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. In extreme cases, these protests may even lead to a collapse in government.

Sixthly, given the anticipated economic unrest in 2023, many individuals may be compelled to leave their home countries in search of a better quality of life and financial opportunities. However, increasing migratory flows to affluent nations may have a detrimental effect on those economies.

Lastly, businesses may fire employees as they try to stay afloat, which would raise unemployment. On the other side, banks and other financial institutions would start to exercise greater caution when disbursing loans, which might make it difficult for companies and people to get credit.

How can we stop the disaster?

The parties with the capacity to stop or lessen the effects of the debt crisis are those in the developed world, while there are many other options as well. If we want to find a solution to the economic crisis and the debt issue, we should start by ending the war in Ukraine.

Since the beginning of the Ukraine War, all economic indices have been increasing oddly. Some other textbook strategies may be used, such as reducing government expenditure to lower the budget deficit and maintain the debt-to-GDP ratio. This can include actions like tax increases or social program cuts.

Secondly, we can rework a country's debt agreement with its creditors to make it more manageable. This could also mean lowering the interest rate 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.

Fourthly, to help it satisfy its debt commitments, a nation may get financial aid from other nations or international institutions like the International Monetary Fund (IMF).

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

To conclude, 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 unfavourable outlook in global economic trends. In such a complicated global debt crisis, emerging and impoverished nations are most at risk because those economies are minor in comparison to the global economy.

There are, nevertheless, a few possible alternatives or remedies that may shorten the time period during which disaster would occur, yet, once again, the choice to take action is completely up to the developed world. Therefore, the moment has come for the developed world to demonstrate that they are responsible and sane in order to put an end to the insane, unfathomable and disastrous destiny that lies ahead for humankind.

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

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.