Do poor countries systematically over-borrow, leading to cyclical debt crises, or are the current debt difficulties caused by unusually large external shocks?
To answer this question, we focus on the debt situation in 2019, before a series of negative shocks started hitting developing countries.
We dispute the cynical view that for poor countries, debt crisis is destiny. We show that in the recent period, there is a much greater heterogeneity of cases that suggested by this deterministic pessimism. Our findings suggest that while some countries’ current debt difficulties mirror past patterns, others face challenges that are distinct and influenced by external shocks.
Drawing on correlations between macroeconomic trends and indebtedness assessments, we find that among countries that have borrowed extensively after the latest massive debt reduction schemes of the 2000s, we observe a diversity of experiences – not all countries borrowed, and among those that did, some but not all invested the funds sufficiently, and finally, among these that invested, some but not all were hit by negative external shocks.
To illustrate, Figure 1 shows the evolution of public debt between 2012-2019. Besides a group that did not borrow a lot (blue), two distinct and about equally populated groups of countries are apparent:
- A group that borrowed a lot and whose debt became at high risk of distress (red dots) over 2012-2019. These countries are distributed almost everywhere to the right of the 45o line – some have borrowed a little and some a whole lot. This shows that their problems are not linked directly to the volume of borrowings, and that instead it must be connected to how efficiency these loans were used, or to the extent of shocks that hit them subsequently.
- Another group that also borrowed a lot but whose debt remained low/moderate (green). Green (and blue) green dots are to the right of the 45o line, and therefore that most countries have borrowed during the period, even though only the red countries have become at risk of debt distress.
We then look for identifiable common structural factors among the countries of each group. Our method follows Easterly (2002) to assess whether the economic and governance structure in over-indebted countries diverges significantly from those in nations with low or moderate risk of debt distress. We estimate simple econometric models designed to capture differences in averages across various macroeconomic indicators, including structural imbalances, creditor heterogeneity, and exposure to international commodity price shocks, and the return on public capital investments. While our findings are descriptive, they do help describe the different ways in which some, but not all the countries that borrowed heavily ended in a debt crisis.
Figure 1: High and low borrowers, and high and low debt
Notes: The figure plots ratio of public debt as of 2019 expressed in percentage of 2012 GDP against public debt-to-GDP ratio as of 2012. A deviation on the right from the 45° line indicate an increase in the stock of public debt as compared to 2012. Countries are classified according to their risk of debt sustainability as of 2019. Countries experiencing a debt distress situation or a high risk of debt distress are grouped together, while those with low or moderate risk of debt distress form another category. This last category is then divided between countries that recorded the above median increase in public debt between 2012-2019 (i.e. the “large borrower” group), or below median increase in public debt (i.e. the “small borrower” group).