## CAUGHT by the cresting DEBT WAVE

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### Debt buildup and the fourth wave
- Since 2010, total debt in emerging market and developing economies rose by 60 percentage points of GDP to a historic peak of more than 170 percent of GDP in 2019.
- Although China accounted for the bulk of this increase, debt was higher in 2018 than in 2010 in about 80 percent of these economies.
- Even excluding China, debt rose by 20 percentage points of GDP, to 108 percent, in 2019.
- The current wave (begun in 2010) featured:
  - An average annual increase in debt since 2010 of almost 7 percentage points of GDP—significantly larger than during each of the previous three waves.
  - Total debt rising in almost 80 percent of these economies and by at least 20 percentage points of GDP in more than 45 percent.
  - Debt in low-income countries rising to 65 percent of GDP in 2019, up from 47 percent of GDP in 2010.
  - A rise in foreign-currency-denominated corporate debt from 19 percent of GDP in 2010 to 26 percent of GDP in 2018.
  - The share of government debt held by nonresident investors climbing to 43 percent in 2018.
- Debt has also risen in the nonbank financial system, which appears to be more lightly supervised and less resilient than the banking system.

### Historical waves and common features
- Three prior broad-based debt accumulation waves (1970–89, 1990–2001, 2002–09) featured:
  - Beginnings during periods of low real interest rates.
  - Facilitation by financial innovations or changes in financial markets.
  - Endings with widespread financial crises coinciding with global recessions (1982, 1991, 2009) or downturns (1998, 2001).
  - Triggers typically being shocks that sharply increased investor risk aversion, risk premiums, or borrowing costs, leading to sudden stops of capital inflows and deep recessions.
  - Follow-up reforms designed to lower vulnerabilities (including greater reserve accumulation), stronger policy frameworks, inflation targeting, greater exchange rate flexibility, fiscal rules, and more robust financial sector supervision.

- Differences across waves:
  - First wave (1970–89): Rapid debt accumulation by sovereigns; led to a series of financial crises in the early 1980s and a prolonged period of debt relief and restructuring.
  - Second wave (1990–2001): Heavy borrowing by banks and businesses and foreign-currency borrowing; crises during 1997–2001 required large-scale bank and corporate bailouts.
  - Third wave (2002–09): Private sector borrowing run-up in Europe and central Asia from EU-headquartered megabanks; global financial crisis required pan-European efforts and bank bailouts.
  - Fourth wave: More broad-based, faster, and larger in magnitude—with greater private sector borrowing and nonbank financial sector involvement.

### Vulnerabilities and the pandemic’s impact
- The COVID-19 pandemic has abruptly ended market tranquility and is testing resilience amid:
  - A decade of repeated growth disappointment accompanying mounting and riskier debt composition.
  - Growing fiscal and current account deficits and a shift toward riskier debt.
  - The exceptional severity of the current recession, reaching into every corner of the global economy.
  - Poorer prospects for a robust rebound amid possible repeat outbreaks and mounting backlash against globalization.
- Fiscal deficits in these economies are expected to widen by about 5 percentage points of GDP, on average, in 2020 (IMF 2020).
- Recent developments risk tipping some economies into widespread debt distress similar to previous waves’ conclusions.

### Policy priorities (“Surfing the wave”)
- Overarching principle: Tackling the health crisis is paramount, whatever the fiscal cost; but restoring fiscal sustainability during recovery requires mechanisms and institutions that encourage investor confidence.
- Four broad policy strands to help weather the global recession despite high debt:
  - Sound debt management and transparency:
    - Ensure today’s debt can be repaid tomorrow, keep borrowing costs in check, restore debt sustainability, and contain fiscal risks.
    - If central banks contribute to fiscal financing, establish frameworks ensuring a return to pre-pandemic monetary policy.
    - Creditors, including international financial institutions, can promote common standards.
  - Good governance:
    - Spend borrowed funds wisely to support export proceeds, productivity, and potential output.
    - Strengthen bankruptcy frameworks to prevent debt overhangs from weighing on investment for prolonged periods.
  - Effective regulation and supervision:
    - While temporary regulatory easing is appropriate, proactive regulation and supervision can identify and act on emerging risks.
    - As recovery proceeds, deeper financial markets can mobilize domestic saving, a potentially more stable financing source than foreign borrowing.
  - Robust macroeconomic policies:
    - Maintain robust monetary, exchange rate, and fiscal policy frameworks to safeguard resilience.
    - Flexible exchange rates can soften short-term domestic blows and discourage long-term balance sheet mismatches.
    - Adjust revenue and expenditure policies to expand fiscal resources for priority health spending and support for vulnerable groups.
    - Invoking escape clauses to fiscal rules during the crisis may be necessary, but fiscal rules are essential to restore fiscal sustainability when recovery begins; frameworks ensuring the eventual unwinding of stimulus are important.

### Key statistics and indicators (as presented)
- Total debt rose by 60 percentage points of GDP since 2010 to more than 170 percent of GDP in 2019.
- Debt was higher in 2018 than in 2010 in about 80 percent of these economies.
- Excluding China, debt rose by 20 percentage points of GDP, to 108 percent, in 2019.
- Average annual increase in debt since 2010: almost 7 percentage points of GDP.
- Total debt rose in almost 80 percent of these economies and by at least 20 percentage points of GDP in more than 45 percent.
- Low-income countries: debt rose to 65 percent of GDP in 2019, up from 47 percent of GDP in 2010.
- Government debt held by nonresident investors: 43 percent in 2018.
- Foreign-currency-denominated corporate debt: rose from 19 percent of GDP in 2010 to 26 percent of GDP in 2018.
- Fiscal deficits expected to widen by about 5 percentage points of GDP, on average, in 2020.

*Source: M. Ayhan Kose, Franziska Ohnsorge, Peter Nagle, and Naotaka Sugawara, Finance & Development, June 2020.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2020/june/covid19-and-debt-in-developing-economies-kose.pdf_