Global Debt Distress: States and Central Banks

13 mins read

The world is simultaneously experiencing elevated inflation, highest debt levels, and supply chain bottlenecks. While to save their economies from recession, politicians aim to expansionary fiscal policies, CBs counterattack inflation with restrictive monetary policies to preserve their credibility. 


In a recent analysis, I discussed the importance of global debt and the danger that we all face due to its expansion that incapacitates the continuation of expansionary fiscal policies necessary in many countries after the pandemic and the global supply chain disruption. In the same analysis, I investigated the role of international organizations, like the International Monetary Fund (IMF) and the World Bank, in supporting and financing most developing countries currently in foreign debt distress.

Indeed, the IMF calculated that global public debt will increase 11 points from the pre-pandemic level, arriving at 95% of world GDP, with more than 20 million people now risking entering extreme poverty  and 41% of African countries downgraded by rating agencies due to their elevated financial and investment risks. Many countries may not recover from the pandemic crisis and further sinking into debt and economic recession. 

What Are States Doing and What Should They Do?

During the pandemic, countries implemented countercyclical, expansionary fiscal policies to contrast the detrimental effect of lockdowns and interruptions in the supply chains. These strategies protected many individuals from losing their jobs and maintained small and big businesses as financially healthy as possible despite all their losses. Indeed, global debt reached a record €290 trillion in 2021, an increase of €74 trillion from the previous year and the most significant one-year debt surge since World War II.

These schemes also fostered the economic recovery, portrayed as quarterly GDP growth, experienced globally in 2021, especially during its last trimesters. However, the spill-over effects from the war in Ukraine are hindering all the benefits and advantages generated, undermining the recovery efforts in many developing countries. Indeed, the International Monetary Fund projected that around 100 countries, most low-income, will have to decrease social spending on health or education to fulfill their debt obligations.  

It is crucial to remember that all crises have different effects based on countries’ demographic and economic structures. Indeed, distributional effects during recessions can expand economic grievances and social unrest among the poor population. For this reason, the IMF requested governments to protect vulnerable people from the global inflation in the food and energy sectors since it can create a new wave of extreme poverty.

However, without the necessary fundingfrom international institutions and donors, authorities in developing countries cannot implement the required policies without risking a jeopardizing increase in their debt level. Although the G20 creditors discussed the possibility of providing debt relief to some problematic countries, the solution can still be distant since it requires time and assurances. Indeed, many emerging economies are reluctant to request it due to the concern that it will jeopardize their possibilities to access financial markets in the future since it will trigger extensive downgrading by rating agencies which will convert their bonds into junk investments.

Furthermore, private creditors are reluctant to renegotiate debt and seek to profit from the international monetary assistance provided by various institutions since the pandemic outbreak. Despite these difficulties, a more cooperative approach toward indebted countries could promote global debt sustainability while safeguarding the interests of both debtors and creditors. In the meantime, highly-indebted countries can improve their status and ratings by improving how they communicate their debt level, the transparency of their accounts and balance of payments while strengthening their domestic debt management policies. 

For instance, countries with short-term difficulties with their obligations’ repayment could reprofile their debt, swapping it into new debt with different currency and/or maturity profiles. Similarly, the same countries can negotiate debt restructuration with creditors, including a plan for a series of reforms to increase short- and long-term debt sustainability. Otherwise, countries can develop innovative tax policies seeking to upgrade the administration structure and revenue system in the long run. This way, governments can reduce the risks allocated to their countries and convince foreign creditors of the soundness of their finances. 

Fortunately, there are some escape routes in the food sector to prevent the global rise in prices generating socio-economic instabilities around the globe. Indeed, the two biggest world economies, China and the US can step up and reduce world pressures on the food supply chain by avoiding protectionism, as in the Indian case. Indeed, Delhi decided to reduce its food exports to safeguard domestic supplies, banning wheat outflows and capping sugar.

By contrast, the US produces significant quantities of corn which can be redistributed to indebted countries, while China could release some of its food reserves, the biggest in the world and holding more than half of global wheat and corn, to reduce the inflationary pressure. Nonetheless, governments can overcome these challenges by smartly allotting their revenues, prioritizing the most economically disadvantaged groups and subnational areas, and trying to normalize their fiscal policies.

These strategies will decrease the overall spending, reducing the pressures and perceived risks on their foreign debt. Furthermore, governments should control selected sections of their national economies to tackle any possible vulnerability, like food imports and house price growth, while ensuring the integrity of their financial and banking system, especially against the expansion of digital currencies.

At the same time, policymakers should also redistribute labor and capital toward the most productive and competitive firms to foster trade and preserve domestic supplies, together with medium-term policies of product diversification to reduce losses from regional supply disruptions and investments in infrastructure digitalization. 

What Are Central Banks Doing and What Should They Do?

Most central banks (CBs) also supported the governmental effort to stabilize domestic economic systems and reduce the losses on their balance sheets. Indeed, CBs closely followed the economic development and tried to adjust their monetary policies following the most evident trends. Therefore, CBs provided an enormous amount of liquidity that increased the aggregate demand and avoided deflationary pressures that could have drastically harmed the global economy.

For instance, the European Central Bank (ECB) announced a new asset purchase program of private and public sector securities in March 2020 to tackle the detrimental effects of the pandemic, for a total value of €750 billion. A month later, the ECB decided to reduce the interest rates for commercial banks to support the provision of credit to households and firms. Finally, it provided new refinancing operations to stabilize the Euro area financial system, maintaining functional regional money markets. Currently, the ECB is reducing its expansionary policies due to the increasing concerns regarding inflationary pressures, normalizing its policies by ending the exceptional asset purchase programs and gradually raising its interest rates.

The Bank of England (BoE) implemented similar strategies, cutting its interest rates to 0.1% in March 2020 and providing long-term funding to banks and building societies to expand their lending services. The combined balance sheets of CBs in the US, the Eurozone, Japan, the UK, and Canada in 2020 inflated faster with record velocity, but now they are reversing their expansionary policies. For instance, Michael Saunders, a high-rank official of the BoE, stated last month that “most MPC members judged that, based on our updated assessment of the economic outlook, some degree of further tightening in monetary policy may still be appropriate in the coming months” through increasing interest rates and selling government bonds. 

However, CBs must implement additional and more decisive actions to decrease the substantial inflationary pressures that are now rising due to the war in Ukraine. Indeed, CBs, especially in emerging countries, risk losing their credibilityif they do not remain watchful and take decisive measures whenever required. Some experts argue that “many CBs may have to move further and faster than what is currently priced in markets to contain inflation.”

This assertion means that monetary authorities should restrict their interventions, reduce their quantitative easing schemes, and slowly increase their interest rates. Although these policies will further tighten global financial conditions, restricting international flows of capital and overall trade, they are necessary to undermine users’ expectations of entrenched and long-term inflation, which could be far more deleterious.

 Advanced economies have fewer limitations and more room for maneuver and can avoid excessively rising interest rates with transparent and clear communication hedging uncertainties in markets. By contrast, CBs in emerging economies must maintain or implement stricter monetary policies to convince investors of the credibility of their mandate against high inflation by reliably anchoring expectations. Nevertheless, CBs “will need to weigh the benefits against potential negative impacts on their own transparency and credibility,” especially for individuals with variable-rate mortgages and small and medium-sized enterprises.  


Governments should consider the impact of restrictive fiscal and monetary policies on the most financially stretched consumers and businesses when managing the exit strategy from the previous extraordinary support policies implemented during the pandemic. Indeed, domestic and international institutions must minimize vulnerabilities with long-term policies that “include reducing balance sheet mismatches; developing money and foreign currency markets; and reducing exchange rate passthrough by building monetary policy credibility.”

There are alternative strategies that governments and central banks can pursue to reduce the economic damages that the normalization of their fiscal and monetary policies will have on the real economy. Policymakers and economists perfectly know that worse than an economy in recession is an economy where inflation is out of control. Politicians and CBs’ governors must answer one simple question: how will they distribute the economic losses?

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