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Illustrated by Rohan Joseph Sabu

Too Little, Too late: External Debt Crisis in the Making

What happens when a state can not pay back their debt to another state? Sorry to say, but we are about to find out.

From the neighborhood shopkeeper to central governments and global economic forums, debt is the talk of the town. The Institute of International Finance reports that global debt passed USD 300 trillion in 2021. In October 2022, the UNDP reported that “54 developing economies accounting for more than half of the world’s poorest people need urgent debt relief as a result of cascading global crises”.
At the end of 2021, the external debt of these economies, the debt owed to foreign parties, totaled USD 9 trillion. Whilst sovereign debt as a whole is indeed an interesting case to be managed, the complexity of external debt repayments is a test for the international finance and political system, and thus the focus of this article. Since a sovereign government, by definition, controls its own affairs, it cannot be obliged to pay back its debt. Today, a government that defaults may, for example, be widely excluded from further credit; and some of its overseas assets may even be seized. What is the current status of global external debt, what makes 2023 different, and where do we go from here?
But first, how did we even get here?
Two important facts must be kept in mind before delving into the impending debt crisis. Firstly, since 1970, three debt waves have ended in financial crises for emerging and developing economies. Debt crises, then, are nothing new. Secondly, the current crisis was in the making over the past decade as debt levels were unable to keep up with GDP growth. This discrepancy was further aggravated during the last two years by supply chain shocks from the Covid-19 pandemic and the Russia-Ukraine war. GDP growth plummeted, while spending increased. Amid these economic challenges, the forecast predicts continued worsening of the debt crisis during 2023, based on a mounting number of indicators and factors expected to directly affect the debt landscape.
What affects external debt in 2023?
One of the key factors complicating probable debt repayments is the increasingly strong dollar and parallel sharp depreciation of the borrower’s local currencies. This is helped by increasing interest rates as governments try to control inflation rates arising from pandemic-induced supply shocks. Such currency fluctuations inevitably increase the real repayment of external debt by borrowers to their lenders, as many countries have borrowed in dollars. The effects of such circumstances are worsened for poorer countries due to degrading credit ratings and resulting loss of investors, making it harder for these countries to borrow any further and thus leaving them no choice but to default. By some accounts, poor countries owe USD 200 billion to wealthy countries, multilateral development banks, and private-sector creditors. Thus a combination of rapid inflation, slow growth, high interest rates, and the strong dollar will further intensify debt. Despite such difficulties, something must be done by someone. Question is, who will it be and what can they do?
Relief, please?
The parties with the largest capacity to stop or lessen the effects of the debt crisis are those in the developed world, though there are other supportive measures as well. Developing countries could, for example, use text-book strategies such as reducing government expenditure to lower the budget deficit and maintain the debt-to-GDP ratio through actions like tax increases or cuts to social programs. Countries with relatively lower sovereign credit ratings, which may face difficulty attracting investors, may offer higher interest rates. If they are still unable to attract a sufficient number of investors, they may incur sovereign debt by borrowing money from entities like the World Bank or the IMF. In this context, there is also potential for these international organizations to further improve their own support mechanisms and be more adaptable to overcome the current crisis. For example, some suggest reducing IMF surcharges or recycling SDRs. In the case of acute insolvency crises, where countries are unable to meet their debt obligations, it can be advisable for regulators and supranational lenders to preemptively restructure a nation's public debt — also called "orderly default" or "controlled default".
Blaming lenders for unwise or fraudulent lending, although it may very well be the case, is not the way forward, especially as the solution seems plausible only with sweeter rather than sour international relations. Taking initiative in providing relief is a responsibility of the developed world and is also in their interest as the global financial system remains at stake. As UNDP administrator Achim Steiner says, “debt relief would be a small pill for wealthy countries to swallow, yet the cost of inaction is brutal for the world’s poorest. We cannot afford to repeat the mistake of providing too little relief, too late, in managing the developing economy's debt burden.”
Sachinta Pilapitiya is Deputy Columns Editor. Email him at
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