World Bank warns current debt wave could lead to major financial crisis

The growing wave of debt in developing nations could end with another financial crisis and major output loss, the World Bank warned in a report. The 'Global Waves of Debt' report said that the current global wave of debt, which started in 2010, has seen the “largest, fastest and most broad-based increase” in debt in emerging market and developing economies (EMDEs) in the past 50 years. 

The report analysed the past three waves of debt accumulation, 1970-89, 1990-2001, and 2002-09, did not follow a linear path. The first wave of debt was primarily due to borrowing by governments in Latin American countries and low-income countries, especially the low-income countries in sub-Saharan Africa. “The combination of low real interest rates in much of the 1970s and a rapidly growing syndicated loan market encouraged EMDE governments to borrow heavily,” the report read.

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The second wave of debt occurred after the financial and capital market liberalisation enabled banks and corporations in East Asia and Pacific and governments in Europe and Central Asia to borrow heavily. It was followed by a series of crises in 1997-2001. During the third wave, private sector borrowing from U.S. and EU-headquartered “mega-banks” shot up after regulatory easing. “This wave ended when the global financial crisis disrupted bank financing in 2008-09 and tipped several ECA economies into deep (albeit shortlived) recessions,” read the report.

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Ripple or Tsunami?

In the latest wave, the annual increase in debt in the emerging market and developing economies showed an annual increase of almost 7% of the Gross Domestic Product (GDP). “Whereas previous waves were largely regional in nature, the fourth wave has been very widespread with total debt rising in almost 80 per cent of EMDEs,” the report claimed. However, the World Bank said that the current wave is different from the past three waves in terms of magnitude, policy frameworks, and financial regulatory reforms. It said that the study suggests that there has been unprecedented debt buildup, precarious safety of low-interest rates and significant room for improvement on macroeconomic, financial, and structural policies.

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