New CEPR Policy Insight - Averting Catastrophic Debt Crises in Developing Countries

Monday, August 3, 2020

Developing economies are facing a severe debt crisis, exacerbated by the Covid-19 pandemic. If no action is taken to avoid a debt crisis in the developing world, the long-term effects on their public spending, employment and economic development will be staggering. What has been done, and even what has been proposed, is insufficient. It is critical, both from the perspective of the debtor countries and of the international community, that there be an orderly debt restructuring. Cooperation is needed from the private sector, which has not been forthcoming. 

A new CEPR Policy Insight from Nobel Laureate Joseph Stiglitz, Chief Economist at the Roosevelt Institute and a former Senior Vice President and Chief Economist of the World Bank, and Hamid Rashid, Chief of Global Economic Monitoring at the United Nations Department of Economic and Social Affairs, provides a stark warning to the international community that left untreated, the looming debt crisis facing the developing world will have significant ramifications and truly global consequences. Developing countries can still avoid a crippling debt crisis with extraordinary measures.

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"The consequences of a debt crisis at any time are devastating. But as part of, and in the aftermath of the pandemic, the effects could be far worse. The cost of collective failure to avert the debt crisis will be too high for all"

As the pandemic hit the world economy new debt flows stopped, capital quickly flowed back to developed economies, and many developing countries are now on the verge of default. A full-blown debt crisis will inevitably force painful cuts in government spending, including on health, education and other social sectors. Such spending cuts will lead to years of low growth and high unemployment. An impending debt crisis hangs like a Damocles’ Sword over developing countries.

It will take time to establish a sovereign debt restructuring mechanism, and the pandemic is already upon us, but the process should begin now. In the meantime, the international community must do what it can within the existing institutional framework to prevent and resolve the numerous debt crises that, in the absence of international action, are likely to occur. In this CEPR Policy Insight, the authors have proposed several key policy measures to reduce the likelihood of these debt crises and the costs they impose.

There may be resistance to some of the measures proposed by creditors, and, where these creditors have sufficient influence on their governments, from their governments as well. However, lessons from the past show that such measures do not kill markets. Investors and creditors return to the market as soon as governments manage to mitigate underlying risks. It should be no different this time. 

On the other hand, the potential consequences of inaction are clear. Global collective action is needed to avert catastrophic debt crises in developing countries. Pre-emptive measures to prevent a cascading debt crisis in these economies will save the world billions of dollars in humanitarian assistance, peacekeeping and peacebuilding operations in the future.   

"We know what should be done. There should be a debt standstill, and there should be comprehensive debt restructurings. This Policy Insight provides some ideas on what can be done, in a timely way, in the midst of this pandemic"

You can also read a Vox Column here >>> 

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