## Shining a Light on Debt

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**Canonical URL:** [Shining a Light on Debt](https://www.imf.org/-/media/files/publications/fandd/article/2022/march/pazarbasioglu.pdf)

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### Context and vulnerabilities
- Emerging market and developing economies entered "perilous waters" as the COVID-19 crisis lingers, with recoveries substantially lagging advanced economies.
- Tighter monetary policies in advanced economies are poised to push up international interest rates, pressuring currencies and heightening default odds.
- Many emerging market and developing economies are "debt intolerant" and "have encountered crises at lower debt levels (Chart 1) than those prevailing in 2021."
- Public sector foreign currency debt remains a vulnerability; sustained exchange rate depreciation can force governments to rescue private entities with large foreign currency liabilities, triggering a sudden rise in public borrowing needs.
- The share of sovereign domestic debt has increased sharply in the past two decades; sovereign debt held by domestic banks raises the risk that sovereign distress could spread to banks, pension funds, households, and other domestic sectors.

### Rising debt levels and external debt-servicing burdens
- Public debt buildups and historical breaking points (from Chart 1):
  - Debt buildup 1931 avg. 47.2%
  - Debt buildup 1982 avg. 45.8%
  - Deleveraging 2008 avg. 37.6%
  - Debt buildup 2019 avg. 55.9%
- Despite low global interest rates in the past decade, the external debt-servicing burden of EMDEs has been "steadily climbing," with "a sharp rise in 2020."
- Debt-servicing averages cited are for 123 EMDEs (average total external debt service, EMDEs, as a percent of goods, services, and primary income).
- Global financial conditions are set to deteriorate as advanced-economy central banks tighten policy; declining overseas lending by China is expected to reinforce this trend.
- Financing needs—and debt—"have a habit of coming in higher than expected."

### Opaque balance sheets and hidden debts
- The true extent and terms of liabilities are often not fully known to creditors or international financial institutions.
- During the pre-2014 commodity boom many EMDEs borrowed heavily—often beyond Paris Club creditors and notably from China—with a substantial share unrecorded in major databases and off the radar of credit-rating firms.
- External borrowing by state-owned or guaranteed enterprises with uneven reporting standards escalated.
- The boom in hidden debts has given way to "a rise in unrecorded debt restructuring (Chart 3) and hidden defaults."
- Debt contracts often lack transparency on key features beyond maturity, interest rates, and currency—examples: collateral, cross-default, secrecy clauses.
- Evidence suggests many of China’s bilateral infrastructure loans are collateralized.
- Pandemic-era accounting and regulatory forbearance and guarantees may have increased nonperforming loans that are not yet reflected on banks’ balance sheets, reinforcing the "so-called sovereign-bank nexus."
- Banking and sovereign debt crises have "often erupted in close succession"; the pandemic has strengthened this "doom loop" and increased opacity of private and public balance sheets.

### Detection, transparency, and resolution
- An encompassing strategy to increase transparency across public, financial, and corporate sectors is the first step to support recovery and resolve sovereign debt problems.
- The Group of Twenty’s Common Framework for Debt Treatments (introduced more than a year earlier) had, as of the document date, not achieved a single country restructuring; delays trace to both creditors and debtors.
- Suggested procedural steps include clarifying steps and timelines for the Common Framework and suspending debt-service payments until negotiations are completed.
- Transparency is essential to increase the odds of faster and orderly debt restructuring by building trust among creditor groups; disclosure must come from all creditors and debtors.
- Fiscal, monetary, and financial sector policy support during the pandemic may conceal vulnerabilities; timely action requires:
  - Improving transparency of banks’ asset quality, including exposures to the sovereign and contingent liabilities.
  - Conducting asset quality reviews and stress testing exercises to prepare contingency plans.
  - Avoiding evergreening—renewing loans indefinitely—which delays recovery.
  - Implementing credible recapitalization plans or restructuring of liabilities swiftly, in ways that do not markedly worsen sovereign debt burdens.
  - Where needed, government intervention including targeted programs to alleviate debt overhangs in the household and commercial real estate sectors.
  - Driving asset restructuring by market forces, supported by tighter regulation (loan-loss classification, provisioning, disclosure) and enhanced supervision, to avoid "zombification."

### IMF, World Bank, and transparency actions
- The IMF and the World Bank will continue to support the transparency agenda via data dissemination, capacity building, and lending policies to assist sovereign debt restructuring.
- IMF staff propose a new policy under which the IMF can lend only if countries share comprehensive information about their debt stock and debt terms (in the aggregate) with all creditors; this information sharing would be expected regardless of whether countries are already in arrears or seeking to avoid arrears.
- The World Bank’s International Debt Statistics increased debt coverage substantially in the most recent year, identifying and adding "almost $200 billion in previously unreported loans to past statistics," the single largest increase in debt coverage in the 50-year history of the World Bank’s debt report publications.
- About "60 percent of low-income countries are now at high risk of or already in debt distress, compared with fewer than 30 percent in 2015."
- Transparency gaps are particularly acute in low-income countries but are also widespread among emerging market and developing economies; the risks of not addressing these gaps promptly are "both significant and rising rapidly."

*CEYLA PAZARBASIOGLU and CARMEN M. REINHART*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/march/pazarbasioglu.pdf_