How to Tackle Soaring Public Debt

IMF Blog, April 10, 2023

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Public debt soared to a record during the pandemic, topping global gross domestic product.
With government debt still elevated, the rise in interest rates and the strong US dollar are adding to interest costs, in turn weighing on growth and fueling financial stability risks.
The analysis summarized here draws on Chapter 3 of the April 2023 World Economic Outlook and uses two decades of data to identify what policies durably reduce public debt ratios (debt to GDP).

An adequately tailored fiscal contraction of about 0.4 percentage point of GDP—the average size in the sample—lowers the debt ratio by 0.7 percentage point in the first year and up to 2.1 percentage points after five years.
The probability of reducing debt ratios through consolidation improves from the baseline (average) of about half to three-quarters when undertaken during a domestic and global boom or periods during which financial conditions are loose and uncertainty is low.
Design matters: in advanced economies, spending cuts are more likely to lower debt ratios than increasing revenues.
Odds of success improve when fiscal consolidation is reinforced by growth enhancing structural reforms and strong institutional frameworks.
Fiscal consolidation alone often failed to reduce debt ratios historically because:
- First, fiscal consolidation tends to slow GDP growth.
- Second, exchange rate fluctuations and transfers to state-owned enterprises or contingent liabilities can offset debt reduction efforts via “below-the-line” operations that increase debt despite improvements in the primary balance.

Debt restructuring may be necessary for countries in debt distress or facing increased rollover risks; it is typically used as a last resort.
When combined with fiscal consolidation, restructuring can significantly reduce debt ratios—on average, up to 8 percentage points or more after 5 years in emerging markets and low-income countries.
The depth and timing of restructuring matter:
- Early but shallow treatment may leave debt elevated (example: Belize experienced elevated debt despite two sequential restructurings).
- Early and deep restructurings that focus on maturity extension and coupon reduction (rather than face-value haircuts) can significantly reduce debt ratios and create fiscal space that can be saved (example: Jamaica).

Seychelles: public debt over 180 percent in 2008; after restructurings with official Paris Club and private external creditors involving a large reduction in face value of debt, the debt ratio declined to 84 percent in 2010. Prudent fiscal policy combined with high GDP growth helped sustain the reduction.
Belize: debt remained elevated despite two sequential restructurings, illustrating that insufficiently deep treatment can fail to reduce debt ratios.
Jamaica: early and deep restructuring through extension of maturity and reduction in coupon payments significantly reduced debt ratios and supported strong fiscal consolidation.

For countries that can afford moderate and gradual reduction in debt ratios:
- Undertake fiscal consolidation when conditions are favorable (domestic and global booms; loose financial conditions; low uncertainty).
- Pair consolidation with growth-promoting structural reforms.
- Strengthen institutional frameworks to prevent “below-the-line” operations and ensure buffers are built during good times.
For countries facing increased funding pressures or in debt distress:
- Substantial or rapid debt reduction may be unavoidable.
- Fiscal consolidation will likely be needed to regain market confidence and recover macroeconomic stability.
- Consider timely debt restructuring; restructurings need to be deep to materially reduce debt ratios.
Global policymaking actions to support successful restructurings:
- Promote mechanisms to enhance coordination and confidence among creditors and debtors.
- Improve the Group of Twenty Common Framework to bring greater predictability, earlier engagement, a payment standstill, and further clarification on comparability of treatment.

Based on Chapter 3 of the April 2023 World Economic Outlook, “How to Tackle Soaring Public Debt.”