Mapping debt vulnerabilities: an update

Published on: 04/12/23

By: Martin Kessler,  Charles Albinet

The liquidity double-bind

Many developing countries are facing a difficult situation due to their deteriorating debt dynamics. A majority of them are caught in a double-bind where they have to deal with peaking debt service, which will come due between 2023 and 2026 for most of them, while also experiencing a collapse in new funding flows from global markets.

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Rising interest rates

In a new policy note, Charles Albinet, Marco Brancher and myself updated last year's analysis on "The Coming Debt Crisis". We used a DSA-lite approach to study 104 countries, taking into account IMF projections for GDP growth, government revenues and primary deficits, as well as World Bank data on external debt. We made assumptions on future borrowing conditions with three scenarios. The pessimistic scenario, where interest rates remain high and above nominal growth rates in most developing countries, would lead to risks of long-term unsustainability. While low-income economies are protected thanks to access to concessional funds, those tend to be limited. In the baseline scenario, interest rates remain high but moderate.

Chart 1: Average nominal interest rate and GDP (denominated in USD) growth rates

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Sources: IMF World Economic Outlook, World Bank IDS, FDL

External pressures caused by debt service could lead to concerns about debt solvency

Our analysis shows that debt service will put significant pressure on revenues, reaching its peak in 2024, and then gradually decreasing (assuming interest rates remain high, but lower than in 2023) or remaining constant (in a pessimistic scenario). Under the baseline scenario, debt stocks will remain stable, but there is a risk of them exploding as countries refinance new obligations at very high rates.

Lower-middle-income countries, which are exposed to market forces but have less deep investor pools and worse credit ratings, are more vulnerable to these risks than other groups.

Chart 2: External public debt service to government revenues

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Sources: IMF World Economic Outlook, World Bank IDS, FDL

New loans from markets and China are declining

One of the major risks faced by countries is the reduced availability of financing, which may force them to default even if they are not insolvent. The gap is quite significant, with an estimated $30 to $42 billion required annually to refinance debt service in the next five years for IDA/Blend countries alone. If international financial institutions were to cover these amounts, they would need to more than double their commitments, which were around $27 billion in 2021. About 24 to 30 countries are at high risk, as they have large debt service payments due in the next few years and face difficulties in refinancing.

Chart 3: New lending flows under baseline and a financing shock scenario where lower-rated sovereigns see sharp declines in their market borrowings, as well as lending from China

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Sources: IMF World Economic Outlook, World Bank IDS, Moody's for ratings, FDL

A way out?

The Lab is working on a proposal to smooth those maturities and push them back, to a time where growth can be reignited and markets revert to lower risk spreads. This plan will require considerable coordination from all stakeholders, including rescheduling of existing debt by private and bilateral creditors, refinancing through new flows from the IMF and MDBs, and implementing reforms to promote sustainable growth. Such a deal could assist countries that are currently solvent but illiquid, and who would not benefit from applying to the Common Framework.