An analysis done by the World Bank, published earlier this year before the COVID-19 virus started spreading, shows that the fourth wave of debt in developing countries and in the private sector has accumulated since 2010, reaching $55 trillion as of late 2018.
Many countries have rushed to raise billions in the international market to prepare for massive spending following the COVID-19 crisis. Demand was several times higher than supply, but many countries in the world cannot raise money because they have a low credit rating.
70 out of 190 countries in the world are not ranked at all. So, if they had a rating at all, it would be D, which means bankruptcy. Most of them concentrated in Africa and Central Asia. However, many developing countries have recently accumulated considerable debt due to low-interest rates. International lenders took risks they have not taken in the past.
Since 1970 four waves of debt have been created. The first three waves ended in major financial crises: the Latin American debt crisis of the 1980s, the Asian financial crisis of the late 1990s and the global economic crisis of 2008-2009. Much of the debt was forgiving.
The World Bank published another report this year which shows that the fourth wave of government and private sector debt in developing countries has accumulated since 2010 and reached about $55 trillion as of late 2018. This makes it the largest wave of debt among the four. Almost 40% of the debt accumulated in China.
Debt creation can help meet urgent development needs like basic infrastructure, but a lot of the current debt wave takes a riskier form in many countries. Countries with lower growth experience significantly more weight than before in rising debt.
China, both geopolitically and economically, is now the largest lender to many developing countries. China not only has $20 trillion in debt, but has also become a massive lender to countries with extremely shaky economies.
Even before the COVID-19 crisis, serious concerns were raised that many governments in developing countries were not efficient enough to invest in physical and human capital. In fact, in many developing countries, public investment falls lower than their debts. Even worse, their economic growth is slower than the accumulation of debt when compared to the conditions preceding the crisis of 2008. Slow growth means weaker development results and slower poverty reduction.
Developing economies are already vulnerable on a variety of fronts:
- 1. About 75% of them are in budget deficits
- 2. Their external corporate debt is very high
- 3. Current account deficits are four times greater than they were in 2007, before the previous crisis
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In these circumstances, a sudden increase in risk premiums demanded by lenders can precipitate a financial crisis, as has happened many times before. The COVID-19 crisis brings the fragile to fragility, meaning fragile countries that are heavily affected are likely to go bankrupt.
This time, the cavalry will not come to their aid. Unlike the previous crises that focused on specific geographical parts of the globe - Latin America for the first time, Southeast Asia for the second time, and the US and Europe for the third time - the current crisis is global. The most unfortunate outcome of all - increasing poverty and human suffering.
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The risk focuses on two areas: geopolitical and economic. There is a geopolitical risk because many countries are already in bankrupt stages or are on their way to bankruptcy. The social unrest is increasing like the rest of the world, including the United States.
The economic risk is on exporters to developing countries. Credit risks will hold exports back. The exporter, being in such a position in a private or government sector in a "fragile state", should try to collect the debt even while relinquishing part of it.
In any case, collateral for future sales is a must. The most fragile countries are found mainly in Africa, South and Central America, and Central Asia, and few in Eastern Europe and Southeast Asia.