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A silent debt crisis is engulfing developing economies with weak credit ratings

Some developing economies are finally seeing light at the end of the tunnel. Global inflation is receding and global interest rates appear to have peaked, prompting a bond-issuance rush by these economies to refinance their debt before the opportunity vanishes. In early January, Mexico, Indonesia, and several other developing economies easily raised more than USD 50 billion from bond investors. 

Yet 28 developing economies—those with the weakest credit ratings— remain stuck in a debt trap with no hope of escape anytime soon. Their average debt-to-GDP ratio was nearly 75 percent at the end of 2023—20 points greater than the typical developing economy. They account for a quarter of all developing economies with credit ratings and 16 percent of the global population. But their collective economic activity constitutes a mere 5 percent of global output, which makes it easy for the rest of the world to ignore their predicament. Their debt crisis, as a result, is silent—and it could intensify. 

Over the past two years, real U.S. interest rates—a benchmark of the real cost of borrowing globally—increased at the fastest pace in four decades. Rapid tightening of the U.S. monetary policy has historically spelled financial trouble for many developing economies, as it did in the 1980s. This time, developing economies with good credit ratings have escaped that fate. But the peril has not passed for economies with weak credit ratings. Their cost of borrowing has increased sharply over the past two years: they now face interest rates roughly 20 points above the global benchmark rate and more than nine times that for other developing economies. 

These economies, in short, have now been locked out of global capital markets for more than two years. They have issued almost no international bonds during that time, a barren spell of the kind not seen since the global financial crisis. Not surprisingly, 11 of them have defaulted since 2020, approaching the total of the previous two decades.  

The economic effects have been severe: by the end of 2024, people in nearly half of developing economies with weak credit ratings will be poorer on average than they were in 2019, on the eve of the COVID-19 pandemic. For developing economies with better credit ratings, the comparable share is just 8 percent. Prospects are unlikely to improve anytime soon: developing economies with weak ratings will grow nearly a full percentage point more slowly over 2024-25 than they did in the decade before the pandemic. 

These economies need immediate help from abroad—both in the form of debt relief for some of them and an overall upgrade in the global framework for restructuring debt, which has so far delivered little relief to countries that need it most. But there is also much they can do to help themselves.  

A good start would be to build the fiscal space necessary for economic growth and resilience. Overlapping crises of the past five years deepened the debt challenges, but fiscal imprudence was often the original cause of their troubles. Before they lost access to capital markets, their governments had borrowed too much, especially in foreign currencies—the equivalent of nearly 30 percent of their GDP on average. That exposed many of them to a familiar vicious cycle: as local currencies weakened, debt costs rose, pushing yields on dollar-denominated bonds as much as seven percentage points above the growth rates of their economies.

Building fiscal space means broadening government revenue bases and prioritizing public spending. Distortive and wasteful subsidies can be jettisoned, for example. On the monetary side, these economies can help themselves by putting in place credible exchange-rate systems and nurturing central-bank independence. These reforms will need to be complemented by improvements in the quality of domestic institutions, so that a more investment-friendly environment can be established. These policy interventions will not be easy to implement. But they are indispensable to restoring economic stability, attracting much-needed investment, and promoting growth.  

Beyond these 28 developing economies, another 31 mostly low-income countries with no credit rating are already in debt distress or high risk of it. That implies roughly one out of every three developing economies is struggling with high debt in an environment of weak growth, steep borrowing costs, and a multitude of downside risks. An additional shock could easily push more of them over the edge. Should that happen, the silent debt crisis would become an increasingly loud one. 

(Philip Kenworthy is an Economist in the World Bank Group’s Prospects Group. Ayhan Kose is the Deputy Chief Economist of the World Bank Group and Director of the Prospects

Group. Nikita Perevalov is a senior economist in the Prospects Group of the World Bank.)

By Philip Kenworthy, M. Ayhan Kose & Nikita Perevalov

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