Debt crisis of developing world in wake of corona

Subject: Economy

Context:

Nearly half of all low-income countries are living with high debt levels and have been since before the coronavirus crisis struck, according to estimates by the International Monetary Fund (IMF) and the World Bank.

Concept:

• The health crisis, sharp downturn in activity, and turmoil in global financial markets caught emerging market and developing economies at a bad moment.

• The past decade has seen the largest, fastest, and most broad-based increase in debt in these economies in the past 50 years.
• Since 2010, their total debt rose by 60 percentage points of GDP to a historic peak of more than 170 percent of GDP in 2019

Before the current pandemic period, emerging market and developing economies experienced the following three waves of broad-based debt accumulation between 1970 and 2009:

• 1970–89: A combination of low real interest rates and a rapidly growing syndicated loan market through much of the 1970s encouraged governments in Latin America and low-income countries, especially in sub-Saharan Africa, to borrow heavily culminating in a series of financial crises in the early 1980s.
• 1990 – 2001: Financial and capital market liberalization enabled banks and businesses in east Asia and the Pacific and governments in Europe and central Asia to borrow heavily, particularly in foreign currencies ending with a series of crises during 1997–2001 once investor sentiment soured.
• 2002–09: A run-up in private sector borrowing in Europe and central Asia from EU-headquartered megabanks followed regulatory easing when the global financial crisis disrupted bank financing during 2007–09 and tipped several of these economies into recession.
• The three historical waves of debt had several things in common.
• They all began during periods of low real interest rates and were often facilitated by financial innovations or changes in financial markets that promoted borrowing.
• The waves ended with widespread financial crises and coincided with global recessions (1982, 1991, 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 (including greater reserve accumulation) and strengthen policy frameworks.
• Many emerging economies introduced inflation targeting, greater exchange rate flexibility, fiscal rules, or more robust financial sector supervision following financial crises.