A Global Debt Explosion?

Debt is vital to the functioning of the world economy. But, after soaring in the aftermath of the 2008 global financial crisis and the COVID-19 pandemic of recent years, it has reached unprecedented levels: as of last June, total debt amounted to $300 trillion, or 349% of world GDP. With negative supply shocks persisting, and the world’s major central banks scrambling to rein in inflation, debt risks are becoming increasingly alarming.

As New York University’s Nouriel Roubini explains, “The explosion of unsustainable debt ratios [in recent decades] implied that many borrowers – households, corporations, banks, shadow banks, governments, and even entire countries – were insolvent ‘zombies’ that were being propped up by low interest rates (which kept their debt-servicing costs manageable).” Inflation’s return ended this “financial Dawn of the Dead,” and together with low growth, is propelling us toward “the mother of all stagflationary debt crises.”

Harvard’s Kenneth Rogoff highlights another risk: a real-estate slump could severely affect private-equity firms that borrowed heavily to buy up property during the period of ultra-low interest rates. “With housing and commercial real estate on the cusp of a sharp, sustained drop, some of those firms will most likely go bust.” Such developments could trigger a crisis in an advanced economy – for example, Japan or Italy – that “would be difficult to contain.”

But it is poor countries that face the most immediate risks, points out Colombia’s Finance Minister José Antonio Ocampo. “Hammered by tightening financial conditions and steep currency depreciations, dozens of developing countries are either teetering on the edge of a debt crisis or have already defaulted.” And the international community’s efforts to deliver relief have been far from inadequate. More ambitious action – such as an independent panel for sovereign-debt negotiations and another large issuance of special drawing rights by the International Monetary Fund – is needed.

Anne O. Krueger of Johns Hopkins University echoes that sentiment. In her view, the “most promising route” would be to grant the IMF – which plays a crucial role in supporting macroeconomic policy reforms – greater authority to deem debt unsustainable. But, for any effort to have an impact, the international community must bring China and major private creditors on board.

One way to do that, suggest Harvard’s Dani Rodrik, former State Bank of Pakistan Governor Reza Baqir, and Ishac Diwan of the Finance for Development Lab, is to design debt deals in ways that unlock growth opportunities. This would make debt deals “more compelling” to all parties, potentially helping to stave off devastating financial crises.