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The world’s financial future looks murky, as a recent report by the Institute of International Finance (IIF) stressed that the world is sinking in debt and cumulatively owes a staggering $315 trillion. To put that into context, that’s three times the size of the global Gross Domestic Product, which stands at a little over $109 trillion. Such a global debt wave is the biggest and fastest rise since World War II. This emphasises how pivotal it is to have efficient debt redressal mechanisms, which essentially are the tools and techniques used to address and manage debt repayment difficulties faced by countries across the globe in place and working.
Illustration by The Geostrata
In recent times, a number of countries like Sri Lanka faced severe financial crunches resulting in bankruptcy. To combat such a situation, the country exercised various formal and informal debt redressal tools. For instance, Colombo was offered multiple lines of credits by New Delhi. India further helped Sri Lanka secure assistance from the IMF.
It thus highlights the significance of debt-redressal mechanisms such as the likes of line of credit, restructuring of bilateral aggrements, paris club & london club- which are official syndicates of creditors to find solutions to debt problems faced by emerging economies, etc. Other financial options such as debt swaps i.e. the swap of debt with equity investment in the debtor country are more such viable options to resolve debt crises.
If we break down the global debt, it is divided into households (in the form of mortgages, credit cards, student debt, etc.), businesses (as credits taken for fueling their operations and growth), and governments (mainly debts for deficit financing).
Now, just in case you’re wondering, to whom does the world owe this much money? Then the answer is simple: such staggering sums of money are owed to private banks, central banks, non-banking financial institutions, and global financial institutions such as the IMF and the World Bank.
Further dissection tells us that, around two-thirds of the $315 trillion owed, originates from advanced economies such as the UK, Italy, France, Germany, and Canada to name a few, with Japan and the US as the top contributors to the debt pile. Meanwhile, emerging markets accounted for $105 trillion in debt, with China, India, and Mexico making it to the top. Furthermore, on the $315 trillion debt stock, household debt amounted to $59.1 trillion, whereas business debt stood at $164.5 trillion.
The IIF’s report further noted that stubborn global inflation, particularly in the US, continues to pose a significant risk of putting upward pressure on global funding costs.
Persistent inflation in the US has led people to anticipate more delays in interest rate cuts by the Federal Reserve, which will in turn pose significant challenges for countries with US dollar denominated debt. In addition, rising trade friction, geopolitical tensions, and supply chain disruptions also present substantial risk to already volatile debt markets.
The report also pointed out that as China aims to expand as a leading exporter of new clean energy technology, tighter supply chain constraints and strict industry-specific protectionist policies could maintain both inflation and interest rates above pandemic level. Consequently, the emerging markets will witness a dip in trade and foreign capital inflows, further eroding their external debt servicing capacities.
As previously mentioned, the global debt is three times as big as the global GDP, highlighting a significant economic imbalance. The rectification of such staggering levels of debt and imbalances has presented some serious concerns to policymakers and economists worldwide.
To begin with, unsustainable high debt levels could stagnate economic growth. Governments with a high burden may shift their budget priorities from economic acceleration to debt servicing, thereby hindering long-term economic output and development.
On the occasion of an inflated cost of credit, businesses may choose to refrain from making capital investments, while other small-scale industries might struggle to finance their operations. Furthermore, high household debts may lead to a reduction in spending, decreasing the demand for goods and services, which might ultimately push the economy into a deflation-like situation.
A high debt situation puts the world at serious risk of a global financial crisis. Defaults by highly indebted governments, businesses, or households can lead to severe instability in the global banking sector. A financial crisis of this size can result in a global recession, as witnessed during the 2008 financial sector crisis.
In December 2023, the IMF flagged some serious concerns about India’s sovereign debt, i.e., the total debt burden of the central and the state governments.
The institution suggested that in the next four years, India’s debt could exceed 100% of its national GDP, although such claims met stern rejection from the Government of India. New Delhi further maintained that India’s debt ratio has actually declined from 88% to 81% in the last two years and that the government is adamant about bringing down the fiscal deficit to 4.5% of its GDP.
Having said that, it is important to keep in mind that New Delhi’s debt servicing bill amounts to ₹10 lakh crores. In fact, the payment of interest alone is the largest component of the government’s expenditure, accounting for one-fifth of all its obligations.
Nevertheless, another approach to viewing debt could be that, in a developing nation like India, a deficit budget could also be favourable for the economy. For various Indian states, a high debt-to-GDP ratio arises due to excessive spending on infrastructure and public welfare. It is thereby safe to assert that as long as such debt-backed spending is sustainable, a deficit budget should not be a conundrum.
The unprecedented rise of global debt will likely heighten the conflict between meeting development goals, and debt vulnerabilities and obligations. It is therefore pivotal to offer sustainable credits. A country’s debt is perceived as ‘sustainable’ if the government is able to meet its current and future obligations without exceptional financial assistance or defaulting.
While some debt is always good, it is crucial to be aware of the line that draws the distinction between a good debt and an unsustainable one. Several factors may be used to assess a country’s debt carrying capacity, such as quality of economic policies, institutions, and macroeconomic fundamentals. Moreover, a country’s debt capacity may change over time due to an increase or decrease in its own capabilities or the influence of the global economic environment.
The colossal global debt pile highlights the prospect of global economic and financial imbalance and its implications for both mature and emerging markets.
The global debt stock, compounded with other global tensions such as the aftermath of the COVID-19 pandemic and multiple wars in Europe and West Asia, profoundly increases the risk of pushing the world into extraordinary fiscal pressure. Therefore, collaborative efforts and pragmatic economic policies will be essential in mitigating the risks associated with high debt levels. Now more than ever, there is a need to create an ecosystem that fosters a sustainable, feasible, and flexible credit system.
BY SATAKUL CHOUDHARY
TEAM GEOSTRATA
Well analyzed