Global Debt Market Outlook 2024

Rapid Increase in Debt Post-Covid-19: There has been a substantial and rapid increase in global debt following the Covid-19 pandemic. This surge is notable both in advanced economies and emerging market and developing economies (EMDEs).
Historically Low Interest Rates: Until recently, historically low interest rates in advanced economies helped manage the increased debt burden. However, EMDEs faced higher interest rates, leading to greater debt service costs.
Shift in Interest Rates: The era of ultra-low interest rates has ended, with central banks globally increasing rates to combat post-pandemic inflationary pressures. This has resulted in higher borrowing costs and debt servicing challenges for both advanced economies and EMDEs.
Changing Lender Landscape: There has been a shift in the composition of bilateral lenders, with China emerging as a major creditor. Chinese loans are often larger in size and carry higher interest rates compared to those from traditional sources like the IMF.
Increased Default Rates: The volume of debt in default has escalated, indicating broader credit risks. The proportion of Chinese loans in default has particularly risen, as noted in the Bank of Canada - Bank of England Sovereign Default database.
Debt Sustainability Concerns: The synchronous rise in debt levels across various economies has raised concerns about debt sustainability, especially under the pressure of higher interest rates.
Challenges in Debt Management: Managing the increased debt burden amid a fragile economic recovery poses significant challenges. It requires a mix of fiscal prudence, productivity enhancement, and policy reforms.
In summary, the global debt outlook presents a complex scenario of heightened debt levels, rising interest rates, and evolving creditor dynamics, all of which contribute to increased financial vulnerabilities and challenges in debt management.

The rise in worldwide debt levels has become a major point of concern following the Covid-19 pandemic. Governments from both developed and emerging nations have introduced various direct and indirect fiscal measures to counteract the harsh economic effects. In our approach to Sovereign Rating, the burden and affordability of debt are pivotal elements, greatly affecting a nation's capacity to meet its credit obligations. This report is designed to analyze different debt cycles after 2008, focusing on how the current situation differs from past patterns and considering the consequences of the recent global debt increase post-Covid-19.

Data from the International Monetary Fund’s (IMF) World Economic Outlook (WEO) Database, as of October 2023, indicates a significant rise in global public debt, which soared to USD 92 trillion in 2022. This figure represents about 92% of the world’s GDP. Of this amount, nearly USD 19 trillion, or roughly 20%, was incurred since early 2020. While the pandemic greatly intensified the debt situation, it’s noteworthy that public debt had been steadily climbing even before Covid-19 struck. To put this into perspective, the Global Debt to GDP ratio was approximately 63.9% in 2008 and had escalated to 84% by 2019.

Even though debt was already high before the pandemic, the Covid-19 crisis triggered the largest annual increase in global debt witnessed since the Second World War. This escalation in debt occurred simultaneously in both emerging market and developing economies (EMDEs) and advanced economies. In advanced economies, public debt rose to 123% of GDP in 2020, while in EMDEs, it climbed to 65% of GDP, causing widespread concerns over debt sustainability. Numerous nations implemented stimulus packages in response to COVID-19, financed through means outside the regular budget. As a result, approximately 43 EMDEs and 5 advanced economies faced credit rating downgrades in 2020.

Three years after the pandemic, the debt levels in advanced economies have slightly decreased from their 2020 highs to 112% of GDP by 2022. The IMF’s World Economic Outlook from October 2023 projects that debt levels for advanced economies will increase to 116% of GDP by 2028. In EMDEs, the debt level experienced a slight rise to 64.2% of GDP in 2022, roughly equivalent to the levels in 2020, and is anticipated to grow to 75% of GDP by 2028

Consequently, by 2028, it is forecasted that Global Public Debt will reach USD 132 trillion. Of this amount, EMDEs’ debt is expected to be around USD 44.4 trillion, with China accounting for USD 24.6 trillion and other countries contributing USD 19.8 trillion, approximately 33% of the total.

The current debt cycle is distinguished by several unique characteristics compared to previous episodes of debt accumulation. Firstly, the rate and magnitude of the increase in debt levels following the Covid-19 pandemic are unprecedented. While high debt levels have been a persistent issue, the rapid escalation in debt since Covid has been particularly startling.

In the initial phases (Phase 1 and Phase 2), despite these elevated debt levels, lower global interest rates helped maintain manageable debt servicing costs for both advanced economies and emerging market and developing economies (EMDEs). However, this situation has changed recently with the global rise in interest rates over the past year. This increase is placing additional pressure on economies as they now face heightened interest burdens in the latest debt cycle.

Secondly, the extent of debt that is considered in distress or problematic is greater in the current cycle. This implies that a larger portion of the global debt is at risk of default or restructuring, making the financial stability of several countries more precarious.

Thirdly, there has been a notable shift in the composition of bilateral lenders. Previously, countries from the Organisation for Economic Co-operation and Development (OECD) were the primary bilateral lenders. However, there has been a rise in other official creditors, notably China, which has become a significant lender in this cycle. This change in the lender landscape impacts the overall debt dynamics, including the sovereign debt repayment capabilities of borrowing countries in the current cycle.

These factors combined suggest that the current debt cycle presents unique challenges and risks, distinguishing it significantly from past debt accumulation episodes.

Elevated interest rates in recent times have significantly impacted government finances. Post-Global Financial Crisis, advanced economies witnessed a steady decline in interest rates. The US Federal Reserve (Fed) slashed the Fed Funds rate by about 400 basis points (bps) from 4.25% in December 2007 to 0.15% by December 2008. Other major central banks like the European Central Bank (ECB) and the Bank of England (BoE) also reduced rates, cutting them by 150 bps and 350 bps, respectively, between 2007 and 2008, with further cuts in 2009 to near-zero levels. By 2014, some countries, including Sweden, Denmark, Switzerland, Japan, and the Euro Area, had entered negative interest rate zones. Most advanced economies maintained these ultra-low rates until 2021, except the US Fed and BoE, which started gradual increases in 2016. By 2019, rates were 1.6% in the US and 0.75% in the UK. However, during Covid-19, both reverted to near-zero levels, aiding these economies in managing debt interest payments effectively.

In contrast, EMDEs typically had higher interest rates, leading to a greater interest burden. Post-Covid, inflationary pressures from supply chain disruptions and the Russia-Ukraine conflict led central banks to hike interest rates. Since 2021, rates have increased by an average of 400 basis points in advanced economies and about 650 basis points in EMDEs. In 2023, the US policy rate reached around 5.3%, the highest in 22 years. Ongoing core inflation in major economies, particularly the US and parts of Europe, has set the stage for sustained high interest rates, posing challenges for governments in managing rising interest payments and servicing costs. Heavily indebted advanced economies, such as the UK, USA, Italy, France, and Spain, have seen increasing interest payments on public debt as a percentage of GDP . These higher interest payments limit the fiscal space for other critical expenditures like health and education.

Moreover, advanced economies often issue inflation-indexed bonds, adding to the interest burden with payouts tied to inflation. On average, less than 10% of debt in advanced economies is inflation-indexed, but the UK and Italy have higher proportions, at 25% and 12% of their total public debt, respectively. For example, the UK's interest payments in 2022 were USD 138 billion, much higher than expected, mainly due to high inflation. Additionally, the cost of new borrowings has increased, as shown by wider yields. The OECD Sovereign Borrowing Outlook 2023 reports that the coupon rate on new debt issuances for advanced economies jumped from 1.1% in 2021 to 3.3% in 2022.

EMDEs inherently face higher interest burdens and borrowing costs due to increased credit risks. Leveraged EMDEs like China, India, and Malaysia are expected to experience rising interest burdens. Low-income EMDEs with large public debts, such as Sri Lanka, Ghana, Zambia, and Pakistan, are especially vulnerable to the growing interest rate burden. As per the OECD Sovereign Borrowing Outlook 2023, coupon rates on new debt issuances for most EMDEs rose from 3-5% in 2021 to 5-8% in 2022.

In the third phase of the current debt cycle, the level of debt distress has reached an unprecedented peak. The swift escalation in debt levels has been paralleled by a steady increase in debt distress. Since 2020, approximately 19 economies have either defaulted on their debt or undergone debt restructuring, with 7 of these incidents occurring in 2022 alone. This figure is striking when contrasted with the 11 instances of sovereign defaults or debt restructurings that took place between 2008 and 2019.

Data from the Bank of Canada-Bank of England database on sovereign defaults further illustrates this trend. In 2022, the total value of sovereign debt in default reached USD 554 billion, marking a significant 34% increase compared to 2021. This figure represents 0.6% of the World's GDP in 2022, the highest ratio observed since 2014.

This surge in defaults and restructurings highlights the heightened financial challenges nations are facing in the current economic climate. The increased frequency and magnitude of these debt crises indicate a more severe and widespread issue of debt distress compared to previous years, underlining the unique and challenging nature of the current global debt cycle.

In the last decade, there has been a notable shift in the composition of bilateral lenders, with loans from China, India, and the Gulf States increasing significantly. China's lending activities, in particular, have attracted considerable attention. According to World Bank data, Chinese loans surged from USD 333 billion in 2012 to USD 952 billion in 2022, representing a Compound Annual Growth Rate (CAGR) of 11%. These loans were primarily directed to low-income developing countries, oil-exporting nations such as Ghana, countries involved in the Belt and Road Initiative (BRI) like Sri Lanka and Pakistan, as well as smaller economies in close proximity to China, including Laos and Cambodia, and some smaller European countries.

Due to the limited availability of loans from the International Monetary Fund (IMF) for high-value infrastructure projects, emerging and particularly low-income economies have increasingly relied on China as an alternate source of funding. China's investment in crucial infrastructure projects has enhanced trade links and established the country as a key global economic player. The IMF indicates that China’s contribution to the external debt of low-income countries grew from 2% in 2006 to 18% in 2020. Meanwhile, the share held by multilateral organizations such as the IMF and the World Bank declined from 55% to 48% during the same period.

However, loans from China have also increased the debt vulnerabilities of recipient nations, owing to their large size and relatively higher interest rates. The World Bank points out that Chinese loans to low-income nations typically have an interest rate premium of about 3-4% above the federal funds rate. In contrast, loans from the IMF and other multilateral organizations are often concessional and come with more favorable terms. There are also concerns about the transparency of Chinese loans, as there is limited information available regarding their terms and conditions.

According to the Bank of Canada - Bank of England Sovereign Default database, the total Chinese loans in default as a percentage of total sovereign debt in default stood at 6.1% in recent times, a figure that was almost negligible before 2008. This trend highlights the growing influence of China in the global debt landscape and the potential risks associated with its lending practices.

The recent significant escalation in global debt is characterized by its swift rise and immense volume. Post-global financial crisis, debt levels in advanced economies surged, while emerging market and developing economies (EMDEs) initially showed resilience. Nevertheless, the stability of EMDEs in maintaining steady debt levels was disrupted after 2015, largely due to shocks in commodity prices and a substantial rise in China's debt. During this period, debt levels in advanced economies, while high, remained relatively constant. However, the landscape altered after 2020, with both advanced economies and EMDEs witnessing a concurrent increase in debt levels, intensifying concerns over debt sustainability.

The current phase of prolonged high-interest rates has resulted in greater borrowing costs for governments, leading to an increase in debt service costs. In 2022, the amount of debt in default swelled to USD 554 billion, a 34% hike from the previous year, signaling a widening of credit risks.

A notable shift has also occurred in the makeup of bilateral lenders, with China emerging as a key official creditor. Although Chinese loans have often been beneficial for both lenders and borrowers, they have simultaneously increased the external debt vulnerabilities of the receiving nations.

Addressing a debt crisis usually requires a diverse set of policies, including fiscal discipline, boosting productivity, and implementing policy reforms. However, the fragile state of economic recovery currently makes the process of reducing debt levels more prolonged and complex than expected. This situation is compounded by the increased size and relatively higher interest rates of Chinese loans, as noted by the World Bank, which typically carry a premium of around 3-4% over the federal funds rate. In contrast, loans from the IMF and other multilateral organizations are often more concessional.

Concerns have also been raised about the transparency of Chinese loans, with limited information available on their terms and conditions. The Bank of Canada - Bank of England Sovereign Default database reveals that the proportion of Chinese loans in default has increased to 6.1% of total sovereign debt in default, a figure that was negligible before 2008 

In summary, the current global debt scenario presents a challenging landscape, with increased borrowing costs, changing creditor dynamics, and heightened vulnerabilities, especially for EMDEs. The path to resolving these debt issues will likely be a complex and extended endeavor.

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