Three Steps to Avert a Debt Crisis

Debt

January 18, 2019//-There has been much public discussion of the debt sustainability of a handful of high-risk countries. 

However, the burden of public debt is a growing problem across the globe.

In advanced countries, public debt is at levels not seen since the Second World War, despite some declines recently. Emerging market public debt has accumulated to levels last seen during the 1980s debt crisis.

And forty percent of low-income countries—that is, 24 of 60 countries—are in or at high risk of debt distress—the inability to service public debt, which could produce significant disruption of economic activity and employment.  It is therefore not surprising that as chair of the G20, Japan has made debt sustainability a priority issue for its G20 agenda.

There is room to significantly strengthen the institutions that record, monitor, and report debt in many developing countries.

Unprecedentedly high debt levels are not necessarily a problem when real interest rates are very low, as they are at present in many advanced economies. However, high levels of debt can leave governments much more vulnerable to a tightening of global financial conditions and higher interest costs.

This could contribute to market corrections, sharp exchange rate movements, and further weakening of capital flows, potentially exacerbating debt sustainability concerns.

Of course, not all debt is bad. Actually, borrowing can finance vital investments in infrastructure, health, education, and other public goods. Investment in productive capacity, when done right, leads to higher income that can offset the cost of debt service, when you have bad credit a company like arcct has unique programs that may help. And some of the increase in debt, especially in advanced economies, helped to support growth in the wake of the Global Financial Crisis and avoid a worse outcome.

Problems arise when debt is already high and resources from new borrowing are not spent wisely (including because of corruption and weak institutions), or when a country is hit by natural disasters or economic shocks, such as exchange rate movements or sudden reversals of capital flows, that impair its ability to pay back the debt. Some emerging market countries are currently grappling with the latter.

But it is typically low-income countries that face the most difficult debt challenges and are also usually the least well-equipped to respond.

Many of these countries need substantial additional resources for development, and for external funding have relied increasingly on sovereign bond issuances, loans from new official lenders, and foreign commercial creditors. Sovereign bonds and commercial credits often come with higher interest rates and shorter maturities, increasing the cost of servicing debt and complicating the task of managing it.

And while diversification of financing sources has benefits, it also creates new challenges in managing debt and tackling debt restructuring, if needed, since we do not have in place established mechanisms for creditor coordination that would include new creditors.

What can lenders and borrowers do? Three policy priorities can help make a difference.

First, greater efforts are needed to ensure that sovereign borrowing is financially sustainable. Borrowers should carefully set their fiscal spending and deficit plans to keep public debt on a sustainable path.

They should also consider closely potential returns on their projects and their ability to repay through higher tax revenues before taking on new debt.

Lenders need to assess the impact of new loans on the borrower’s debt position before extending fresh credit. This will protect both lender and borrower from entering into agreements that will cause both financial difficulties in the future.

Second, we need to ensure that all countries adhere to comprehensive and transparent reporting of public debts. There is room to significantly strengthen the institutions that record, monitor, and report debt in many developing countries.

For instance, one-third of low-income countries do not report on guarantees extended by the public sector, while fewer than one in ten report on the debt of public enterprises.

Creditors have room to allow more full disclosure of the terms and conditions of their borrowing. Greater transparency regarding public debt liabilities can help prevent the build-up of large “hidden” liabilities that in due course turn into explicit government debt.

Third, we need to promote collaboration among official creditors to prepare for debt restructuring cases that involve non-traditional lenders.

Given the high level of debt held by new creditors, we need to think about how to make official creditor coordination work—since it is often so critical to resolution of debt crises.

As for the IMF, we along with partner institutions, are working closely with our member countries to bolster their capacity to record and manage debt and ensure transparency.

We are strengthening our methodologies for assessing debt sustainability and training country officials in using them. And we are actively engaging with new lenders, including to enhance their capacity to participate in multilateral debt restructurings, should they be necessary.

Starting in the 1980s, it took decades of grinding negotiations to create mechanisms to resolve the debt crises in Latin America and then in heavily indebted poor countries.

And research and events have highlighted how debt overhangs affect economic recoveries in advanced economies. We need to anticipate the risks inherent in the present debt build-up, and take the right steps to mitigate them.

By Martin Mühleisen and Mark Flanagan, IMF blog

IMFBlog is a forum for the views of the International Monetary Fund (IMF) staff and officials on pressing economic and policy issues of the day.

The views expressed are those of the author(s) and do not necessarily represent the views of the IMF and its Executive Board.

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