Sovereign debt levels around the world are taking a toll on macroeconomic stability, economists warn, with many noting that squeezed government finances create particular risks for developing countries.
Today, there are over 50 developing countries that spend more than 10% of total revenues on debt servicing costs, according to UN Trade and Development (UNCTAD). Moreover, UNCTAD estimates that 3.3 billion people live in countries that spend more on debt interest than on education or health.
High levels of debt are already having an impact on stability around the world. In Kenya, for instance, deadly protests erupted this summer after the government attempted to raise taxes to mitigate a debt crisis that saw interest payments swell to absorb almost 60% of total government revenues.
The World Economic Forum’s latest edition of the Chief Economists Outlook found that a majority of the chief economists surveyed believe that public debt constitutes a threat to macroeconomic stability in both advanced (53%) and developing (64%) economies. Moreover, almost 40% of chief economists expect defaults to rise in developing economies over the next year.
“Looking to the year ahead, a majority of respondents note that current debt dynamics are going to undermine government efforts to boost growth and leave countries poorly prepared for next economic downturn,” the report notes, adding that the “difficult fiscal position that many countries are in mean they are likely to struggle to prepare for numerous structural changes that are under way, including the energy transition, demographic shifts and evolving national security needs.”
In response to the debt situation, economists and policymakers are contemplating relief mechanisms – especially in times of crisis. This month, for instance, Spain called on creditors to incorporate “pause clauses” that allow developing countries to suspend debt payments during a disaster period, according to the Financial Times. The move came after Grenada became the first country in the world to use a pause clause to suspend bond payments after a hurricane hit the country in July.
To better understand the current debt dynamics, the World Economic Forum asked chief economists to provide insights into the impact of public debt trajectories and to detail how a potential fiscal squeeze is affecting governments, businesses and households.
Here’s what they had to say:
Indermit Gill, World Bank, United States
“Global economic growth appears to be stabilizing, inflation is easing, and global interest rates are finally declining. But this isn’t likely to fix a problem that has been more than a decade in the making: debt in developing economies is at levels that are depressing investment and diverting resources away from essential needs such as health and education.
“Relief isn’t likely to come anytime soon. At the end of 2023, total debt (public and private) in developing economies stood at 206% of GDP—nearly double the average in 2010. Financing costs for governments and businesses will remain higher than before the pandemic: real U.S. interest rates are expected to average 1.5% in 2025 and 2026, a huge swing from negative 1.2% between 2010 and 2019. In nearly two-thirds of developing economies today, debt is on a rising trajectory. Governments in many emerging market economies have borrowed at home, protecting public finances from currency risk but robbing the private sector of credit. The peril is greatest for the poorest economies that have to borrow abroad: for them, there is no such thing as a 'low' risk of debt distress.
“Wealthier economies should not look the other way. 4 billion people live in low and lower-middle income countries, and their economic malaise will inevitably spill over. Replenishing the World Bank’s International Development Association—which has been a crucial lifeline for the poorest economies in recent years—will be a good first step. So will multilateral efforts to speed up debt restructuring. And the G20 and the Bretton Woods institutions—the IMF, World Bank and the WTO—must soon find ways to stem the destructive downward spiral in global trade and investment relations.”
Paul Donovan, UBS Group, Switzerland
“Structural change is causing economic and social disruption that governments seek to mitigate, and insecurity necessitates an increase in defence spending. That suggests governments will play a larger role in economies in the future, with higher debt levels than in the recent past. Nonetheless, most advanced economies’ debt levels are not currently concerning – many countries experienced higher debt ratios during the 20th century.
“However, the increase in political polarisation raises challenges for fiscal sustainability. While few countries are currently threatened by disorderly markets (despite the brief turbulent episode of the UK’s Truss debacle) there will be a need to demonstrate an ability to stabilize debt ratios, even if at a higher level than historically. The difficulties of achieving the necessary political compromise to achieve this are a growing investor concern.
“Fears of crowding out private investment seem overdone. The definition of private investment needs to be reconsidered, as structural changes increase the efficiency in how a country’s capital stock is used; homeworking reduces investment in office space, for instance. The greater risk is political inertia misallocates government spending in an unsustainable way – reducing economic effectiveness during fiscal expansion, and requiring a more draconian fiscal contraction when unsustainability becomes a constraint.”
Tomas Castagnino, Accenture, Argentina
“Even though the global economic outlook has brightened with lower inflation and eased financial conditions, public debt still requires attention. Government spending is higher than pre-pandemic levels, and for many nations, getting back to strong growth is proving difficult. To keep debt-to-GDP ratios in check, governments face a tough balancing act: cutting deficits while promoting sustainable, inclusive growth.
“Consider this: all else equal, even in the best-case scenario, with AI boosting global growth by over 1 percentage point annually for the next 15 years, many developed countries would still need near-balanced budgets to bring debt ratios back to where they were before the pandemic. Some developing countries would even need to run surpluses. And all this is happening as demands on spending increase, particularly for demographic shifts and the green transition.
“With the potential to automate or augment 42% of public services' working hours, AI can help governments spend smarter and rethink how they deliver value. To keep debt sustainable, fiscal strategies could prioritize borrowing for productive investments that fuel AI-driven productivity and long-term growth. Global cooperation will be key to scaling these innovations and keeping costs down.”
Eric Parrado, Inter-American Development Bank, United States
“While Latin America and the Caribbean face significant challenges in managing public debt in the wake of the pandemic, there are reasons for cautious optimism. The region has demonstrated resilience and adaptability in the face of previous crises, and this experience can serve it well in navigating the current situation.
“The surge in public debt to more than 70% of GDP during the pandemic is certainly concerning, but it also reflects governments' commitment to supporting their citizens and economies through an unprecedented crisis. Now, as recovery takes hold, there's an opportunity to chart a course towards more sustainable debt levels.
“Bringing debt down to the estimated 'prudent' levels of 52-54% of GDP will require discipline, but it's an achievable goal. Gradual fiscal consolidation, focused on improving spending efficiency rather than drastic cuts, can help mitigate negative impacts on growth and social programs. This approach could actually enhance long-term economic prospects by creating fiscal space for productive investments.
“For businesses and households, the path forward may involve some adjustments, but it also promises greater economic stability and reduced vulnerability to future shocks. By addressing debt challenges proactively, countries can create a more robust economic foundation, potentially attracting investment and fostering sustainable growth.
“With careful policy design tailored to each country's unique circumstances, Latin America and the Caribbean have the opportunity to emerge from this challenge stronger and more resilient than before.”
Weforum