Countries across the world are drifting towards a debt crisis. Economic slowdowns and rising inflation have increased demands on spending, making it almost impossible for many governments to pay back the money they owe.
In normal times, those countries could simply take on new debt to replace the old debt. But international conditions have made it much more difficult to do this.
As a result, some of those approaching repayment deadlines will simply not be able to meet them. Sri Lanka and Zambia have already missed payments, throwing both countries into an economic tailspin, and offering perhaps a preview of impending global problems.
One of the main reasons for this worrying scenario is that countries across the world are essentially compelled to borrow money in US dollars or Euros, and keep foreign currency reserves for future debt payments.
But those reserves face other vital demands. They are needed to purchase oil and other imports, and well as maintaining the credible value of their domestic currency.
Unfortunately for many emerging economies, the reserves they hold are simply not enough to cover all of these demands – especially after energy prices soared when Russia invaded Ukraine.
At the same time, foreign currencies have become more expensive to buy because the US Federal Reserve and the European Central Bank are raising interest rates. Sri Lanka reportedly has no reserves left, while Pakistan is said to be operating on a month-to-month basis.
Countries usually issue new bonds (think of them as tradeable IOUs) to roll over old debt, a process that works just fine – until it doesn’t. In July 2022, no emerging countries issued any new bonds, indicating that investors are alarmed by the risk of low currency reserves, and are no longer interested in lending to them.
China too has scaled back its lending since the beginning of the pandemic to limit its exposure to global risk. So without bond markets or China, countries are turning to alternative sources of credit.
Kenya and Ghana for example, recently took out bank loans to alleviate budget shortfalls. And while the precise terms of these loans are not known, banks usually demand higher interest rates and shorter repayment periods, which may only add to a country’s financial stress levels.
Other countries are turning to some of the oil-rich gulf states currently profiting from high energy prices. Egypt and Pakistan have received loans from Saudi Arabia, the United Arab Emirates (UAE) and Qatar, while Turkey has also borrowed from the UAE. These loans may be welcome lifelines, but they also create opportunities for richer countries to effectively buy influence and generate dependency.
Overall then, a multitude of factors are working against some of the world’s poorest and indebted countries. If a global debt crisis does ensue, expect political turmoil to follow.
Sri Lanka’s default prompted wide spread protests, forcing the president to resign. And research shows that extremist parties perform better after a financial crisis.