The World Bank has raised the alarm of a new International debt crisis after citing the largest accumulation in borrowing in the last fifty years. The World Bank, which is the biggest provider of loans to developing as well as emerging economies to eliminate poverty, stated that low interest rates will not help to tackle the financial crisis although debts are becoming more manageable. World Bank official Ayhan Kose explained that low interest rates can only help in precariously protecting against financial crises. The Washington-based organisation, Global Economic Prospects (GEP) also stated, that the most recent wave of debt accumulation is bigger, faster and has more spread since that of the 1970s.
According to the report, close to five hundred twenty one national instances of swift debt growth in emerging countries have been supplemented by financial disasters that substantially diminished investments and per-capita income since the 1970s. Ultimately, these comments show that policy enhancement is a very crucial step to curtail the risks associated with the impending debt crisis.
In 2018, the total debt of emerging and developing economies was reported at 170 per cent of the gross domestic product i.e. $55 trillion or £42 trillion, a rise of 54 percentage points of their gross domestic products since the year 2010. Some of the rise in borrowing is led by country like China, whose debt-to-Gross Domestic Product ratio increased by 72 percentage points to 255 per cent from year 2010. However, the debt is still higher in emerging countries, even after a country like China is excluded among EMDE’s in the analysis.
Ceyla Pazarbasioglu, the World Bank Group’s Vice President for Finance, Institutions and Equitable Growth explained that history showed that large debt accumulation frequently correspond with financial crises in emerging countries, at a huge cost to the population. He further stated that officials should act swiftly to boost debt sustainability and decrease vulnerability to economic shocks.
Macro-Economic Policies responsible for debt crisis from an early period of time
Ineffective utilisation of debt – The public debt was utilised in a few nations such as Brazil, Chile, Argentina and Peru in the first wave of debt crisis to finance current government populist policies and spending which led to exceedingly expansionary macroeconomic policies. In other countries, speedy private-sector borrowing caused debt-fuelled domestic demand surges, including property booms in Ukraine and Thailand or ineffective production investment in Korea.
Ineffective fiscal management – Several countries exhibited serious fiscal flaws. These comprised inferior revenue collection in countries like Brazil, Argentina, Russia and Indonesia with extensive tax evasion in Argentina and Russia; public salary and pension indexing in Brazil, Mexico, Argentina and Uruguay; monetary financing of fiscal shortfalls in Argentina and Brazil and large quantum of energy and food subsidies in countries like Egypt and Venezuela.
Dangerous structure of debt – Most of the crisis nations borrowed in overseas currencies. That is why they struggled to maintain obligations of debt servicing and accumulated sharp increase in debt ratios which ensued currency depreciation in countries like Mexico, Indonesia and Thailand. For instance, for a country like Uruguay, public debt was denominated in U.S. dollars in the middle of 1990s. Several countries depended on short-term debt and encountered difficulties in rollover when investor reaction worsened in Korea, Philippines, Indonesia and Russia in the late 1990s.
In the year of 2000, Central Asian and European countries borrowed cross border from non-resident lenders and encountered a credit crisis once liquidity conditions deteriorated for international banks that were the source of this lending in countries like Hungary, Kazakhstan and Croatia in the late 2000s.
Balance sheet discrepancies - Banking disasters and a significant number of currency and most of the simultaneous currency and banking crises were linked with balance sheet discrepancies in Malaysia, Mexico, Indonesia and Russia in the late 1990s. Sovereign debt crises less frequently involved discrepancies in balance sheet, except when banking oversight was low in Indonesia and Turkey in the 1990s.
Managed exchange rates - Most, but not all, crises were linked with managed exchange rates. These tended to lead to currencies turning out to be overvalued during years of speedy growth, build-up of debt and inflows of capital but ultimately surrendered to hypothetical attacks in Brazil, Slovak Republic and Mexico.
Sound Policies facilitate protection of Emerging Nations from debt crises
Policymakers and officials should develop methods to accelerate solutions to the debt problem. There are principally four options which could be implemented in order to reduce the severity of the current debt situation and restricting it from turning into a crisis:
- Higher level of private or government debt and perilous constituents of debt, in terms of currency denomination, maturity and type of creditors, are linked to a greater possibility of crisis. Sensible debt management, as well as transparency, would support to enhance debt sustainability, bring down borrowing costs and decrease fiscal risks. Creditors, involving global financial institutions, can direct efforts in this area by helping enforce common standards, measuring exposures through timely analytical work, highlighting risks and susceptibilities.
- Strong monetary, fiscal and exchange rate policy structures could shield EMDEs’ resilience in a weak international economic situation. The advantages of stability-focused and robust monetary policy structures could not be overemphasized. Fiscal rules can assist to arrest fiscal slippages, ensure that revenues during periods of strong progress are carefully managed, and reduce risks from contingent liabilities. Expenditure and revenue rules can be modified to develop fiscal resources for spending on priority areas.
- In many crisis situations, it becomes evident that borrowed funds had been channelized in the direction of other purposes that did not raise export productivity or potential output nor result in proceeds. The rules that encourage excellent corporate culture and governance can assist to safeguard that debt is utilized for remunerative purposes as well as sensible bankruptcy structures can assist to avoid debt overhang from making fresh investments for extended periods.
- Comprehensive financial sector rules and regulations could assist policymakers and officials to discover and act on developing risks. Financial market development can help organize domestic investments, which could be a greater balanced source of funding compared to foreign borrowing.
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