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Global Debt Crisis: Economic Precipice Ahead



  Sep 25, 2023

Global Debt Crisis



Why is Global Debt Rising?

Pandemic Impact: The COVID-19 pandemic led to economic downturns, requiring governments to spend heavily on healthcare and fiscal stimulus. This increased both public and private debt levels.

Ukraine War: Geopolitical conflicts like the Ukraine war require large military and humanitarian expenditures, thus contributing to debt. Additionally, wars disrupt global trade, affecting the economy.

Economic Investments: Countries borrow to invest in infrastructure, education, and other developmental projects, hoping future growth will offset the current debt.

Low Interest Rates: Central banks have kept interest rates low to encourage borrowing and stimulate economic activity.

Currency Inflation: Governments sometimes intentionally allow inflation to erode the real value of their debt, making it easier to manage.

Effects?

Interest Rate Pressure: When central banks raise interest rates to fight inflation or stabilize the economy, the cost of servicing new and existing debt rises, putting pressure on governments.US interest rate hikes are hurting the developing countries

Economic Instability: High debt levels, if unsustainable, can lead to defaults and economic crises. This risks the stability of both the country in question and its trading partners.

Inflation: Allowing inflation to reduce the real value of debt can backfire, as it might harm the economy by increasing the cost of living.

Global Financial Risk: Unsustainable debt levels across countries can risk the stability of the global financial system.

What is Being Done?

Interest Rate Adjustments: Central banks may increase interest rates to curb borrowing, even though this makes existing debt more expensive to service.

Debt Restructuring: Countries might renegotiate the terms of their debt with creditors, extending payment periods or reducing interest rates.

Austerity Measures: Governments may reduce public spending to balance their budgets, though this often comes at a political cost.
 

Who Can Bail Out?

IMF and World Bank: These international organizations often step in with financial aid packages to help countries in debt crises.

Bilateral Agreements: Some countries might enter into agreements with wealthier nations to secure financial support.

Private Sector: Large institutions or even crowdsourcing could help in some instances.

Reasons for Debt Growth in Emerging Economies
 
Developmental Needs: These economies are still building essential infrastructure and social services, requiring significant investment.

Global Trade: Emerging economies often borrow to invest in industries and technologies that will make them more competitive globally.

Pandemic Recovery: Like developed countries, emerging economies have also spent heavily on stimulus packages to revive their economies.

Sri Lanka Debt Crisis:Case Study
 
Causes: Sri Lanka's debt crisis primarily stems from heavy external borrowing for infrastructure projects that didn't yield expected economic gains.
High interest rates and foreign-denominated debts magnified repayment burdens.
Exacerbated by the COVID-19 pandemic and declining exports, the situation led to dwindling forex reserves.
 
Effects: The crisis resulted in devalued currency, increasing the cost of imports.
Social services and development projects are being cut.
A forex crisis has severely impacted daily life, causing shortages of essential goods like fuel and medicines.
 
Solutions:Securing a bailout from IMF, restructuring existing debts, and adopting austerity measures.
Boosting exports and encouraging foreign investments can provide more sustainable long-term solutions.


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