Global debt rising at an alarming rate

Global debt is rising, generating pain for mostly poor countries and developing nations. Debt held by households, governments and businesses has now reached $290 trillion. Rising interest rates are pushing the world into a potential fifth wave of debt crisis as we emerge from the cheap-money era into a new expensive-money era.

Although the level of global debt has decreased from the record set last year because of the pandemic, the potential dangers are intensifying in economies and financial systems. That is because many borrowers must continually increase their interest payments as the US Federal Reserve and other central banks raise their rates at the quickest pace in decades in an effort to curb inflation.

David Malpass, president of the World Bank, is concerned about the lack of a global system that can effectively deal with debt defaults in low-income nations as well as rising debt levels in high-income countries.

The World Bank operates the International Development Association, a platform to fight extreme poverty in the world’s 74 poorest nations. Together, those countries will owe their creditors about $62 billion this year, about 35% more than in 2021.

Moreover, an analysis by the United Nations Development Programme found that the 54 developing countries it identified with severe debt problems account for over 3% of global gross domestic product (GDP), and more than half of the 600 million people living in extreme poverty globally.

Over the past decade, emerging and developing economies ran up record levels of government debt, which the International Monetary Fund (IMF) expects to reach 64.5% of GDP at the end of 2022. In 2008, government debt in the same economies was just 33.6% of GDP.

The largest problem for those nations is debt default as local currencies have lost value against the dollar and governments are facing high bills for food and fuel imports, which many governments subsidise for their citizens.

Existing sovereign debt crises are rising in several developing nations including Egypt and Pakistan, while Sri Lanka and Zambia have already defaulted. According to the IMF, more than half of low-income nations are struggling with their debt.

Rich nations can typically manage to pay higher interest rates on their government debt for a while, but investors are concerned about Italy and the UK experiencing a bond market crisis.

For developing economies, especially those that took out loans in dollars, the risk is greater. As for businesses, several regions of the global financial system are already displaying signs of a credit crisis.

Although governments in developed economies that borrow in their own currencies typically do not experience the same immediate difficulties that households or businesses do when interest rates increase, they still face threats. For example, when former British prime minister Liz Truss announced a tax-cutting scheme at a time when inflation was reaching double digits, it alarmed investors and generated fear in the money market. The result was a collapse in government bonds before the Bank of England stepped in to stabilise the market — and the UK will still face a doubling of interest costs next year.

Consumers are going to get squeezed

One of the biggest dangers in many countries is housing debt that weighs on consumers. Housing markets often have a high percentage of floating-rate mortgages, which means that increased central bank rates are quickly passed on to borrowers. As a result, households have continued to take on debt rather than cut back.

Countries in northern Europe are on the red list of housing debtors as well. In the UK, debt payments are on track to exceed 10% of all household income. Homeowners in Asian countries including South Korea, Malaysia and Thailand are also set to get squeezed too.