Global debt challenges ahead

With higher interest rates increasing the debt-servicing burden of nations, the scope of productive expenditure will shrink further

The global economy has been going through a rough phase, marked by slowing growth and rising uncertainties. According to the International Monetary Fund (IMF), global gross domestic product (GDP) growth is projected to slow from 3.5 per cent in 2022 to 3 per cent in 2023 and further to 2.9 per cent in 2024, falling below the historical average of 3.8 per cent between 2000 and 2019.

While inflation has eased significantly from the peaks seen post-Covid, it remains above the target for many economies. Globally, interest rates have broadly peaked, but they are expected to remain higher for longer in economies like the US and the European Union, which will have further repercussions on growth. Amid falling growth and high interest rates, a significant cause for concern is the rising global public debt. Global public debt has skyrocketed to 92 per cent of GDP in 2022 from 84 per cent in 2019 and 61 per cent in 2007 (source: IMF). While global public debt to GDP had been rising since the global financial crisis (GFC) in 2008, the pandemic sharply exacerbated the debt scenario.

The sharp rise in global public debt after Covid-19 is more menacing than any previous debt waves. The speed and the quantum of rise in debt levels post-Covid have been alarming. Of the total global debt of $92 trillion (2022), around 20 per cent has been accumulated since 2020. The debt levels have increased across both emerging and advanced economies. Unfortunately, currently, the high debt levels are accompanied by high interest rates, implying that many economies are going to face the brunt of high debt-servicing costs.

Following GFC, advanced economies had very low interest rates for a long period. Hence, even highly indebted economies like the US, Italy, France, Spain, and the UK enjoyed a low debt-servicing burden. But over the past two years, interest rates have risen sharply in many of these economies and are expected to remain higher for longer, impacting debt servicing. For instance, for the US, even with government debt to GDP at a high of 123 per cent, the net interest to revenue is at a relatively low level of 10 per cent. On the other hand, emerging economies have had relatively high interest rates, resulting in a higher debt-servicing cost. For India, the general government debt to GDP is at 83 per cent, but the interest-to-revenue is at a high of around 27 per cent.  Looking ahead, with interest rates in the US likely to remain higher for longer, the debt-servicing cost will go up sharply. The net interest/revenue for the US is projected to rise to 20 per cent by 2033.

Furthermore, some advanced economies also issue inflation-indexed bonds, which exacerbate the interest burden due to payouts linked to inflation. For instance, the UK has a high proportion of inflation-indexed bonds, accounting for 25 per cent of its total public debt. The UK’s interest payments reached $138 billion in 2022, significantly higher than the initial government forecasts, primarily driven by high inflation.

Emerging economies will also face some heat with high interest rates. For India, the interest burden (interest payment to GDP) is projected to rise to 5.7 per cent by 2025 (source: IMF), up from 5.3 per cent in 2022, but the quantum of the increase will be relatively low. Low-income emerging economies, with substantial public debt, such as Sri Lanka, Ghana, Zambia, and Pakistan, are particularly severely affected by the increasing interest rate burden.

With sharp rise in debt levels, the quantum of debt distress has also been rising steadily. Since 2020, about 19 economies, including Ukraine, Russia, Sri Lanka, Pakistan, and Ghana, have either defaulted on their debt obligations or restructured debt, with seven of them doing so in 2022 alone. These numbers seem very high when compared to the 11 sovereign defaults or debt-restructuring events across countries between 2008 and 2019. The total sovereign debt in default amounted to $554 billion in 2022, marking approximately a 34 per cent jump compared to 2021 (Bank of Canada-Bank of England database on sovereign defaults).

The other factor that has aggravated global debt distress is the increased sovereign lending by China. Loans from China have risen sharply, increasing from $333 billion in 2012 to $952 billion in 2022, reflecting a compound annual growth rate of 11 per cent (World Bank data). Given the limited access to IMF loans for high-value infrastructure projects, many of the low-income economies have increasingly turned to China as an alternative funding source. Predominantly, these loans were extended to low-income economies; oil-exporting nations like Ghana; countries involved in the Belt and Road Initiative (BRI) such as Sri Lanka and Pakistan; small economies in close geographical proximity to China, like Laos and Cambodia; and some smaller European economies.

China’s share in the external debt of low-income economies has risen from 2 per cent in 2006 to 18 per cent in 2020 (IMF data). These loans come at a relatively high interest rate, in contrast to loans from the IMF and other multilateral organisations, which are generally concessional. Additionally, there have been concerns regarding the transparency of Chinese loans, as limited information is available about their terms and conditions. According to the Bank of Canada-Bank of England Sovereign Default database, the total Chinese loans in default, as a percentage of total sovereign debt default, stand at 6.1 per cent, a figure that was negligible before 2008.

Addressing a debt crisis requires fiscal prudence. However, given the current fragile state of global economic recovery, the process of debt deleveraging is likely to be protracted and more challenging. Slowing growth and high interest rates will make the path towards debt sustainability difficult for many economies. The high debt-servicing burden will also limit the scope of productive expenditure, which, in turn, will have repercussions on future growth potential. As we enter 2024, the global economy needs to brace for a challenging public debt scenario amidst low growth.

The writer is chief economist, CareEdge. Shobana Krishnan contributed to the piece