Debt crisis in the world
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The Looming Global Debt Crisis: Developing Nations at the Extreme Risk

Sri Lanka: The First Domino to Fall?

Following weeks of protests and a worsening crisis, Sri Lanka’s prime minister, Mahinda Rajapaksa, announced his resignation. There is no state bankruptcy system, but if one existed, the South Asian country, which is down to its last $50 million (£40 million) in reserves, would be the first to utilize it.

Related Article: Explained: Why is Sri Lanka on the Verge of Bankruptcy?

A delegation from the International Monetary Fund (IMF) met with authorities in Colombo this week to discuss a rescue that will include a rigorous reform plan and financial assistance. But, as the IMF and its partner organizations, the World Bank, are well aware, this is about more than a single country’s mismanagement. Sri Lanka, they believe, is the canary in the coalmine.

Despite various local factors in play, including mismanaged finances, higher spending, deep tax cuts, and excess debt, the role of the global factors can’t be undermined. Global factors including the pandemic-induced slowdown, Russia-Ukraine crisis, and growing cost of borrowing also led Sri Lanka to its most significant financial crisis since independence.

But, now, international financial institutions fear that the Lankan crisis could mutate, and more countries are heading in the same way. As a result, low- and middle-income nations worldwide are dealing with a three-pronged crisis: the epidemic, the growing cost of their debt, and the rise in food and gasoline costs brought on by Russia’s invasion of Ukraine.

Developing countries across the globe are suffering from the sovereign debt crisis, one of which has already taken the fall. And, now the world is now expected to face a debt turmoil that is projected to erode the economies of low and middle-income countries.

Global Debt Crisis: Is History Repeating Itself?

Financial turmoils defined the 80s in Latin America. First, a debt typhoon eroded the economies of major Latin American nations. The skyrocketing oil price disrupted the finances, created significant deficits and surpluses, took their foreign debt to unprecedented highs, and pushed their economies to collapse.

Mexico was the first to fall, followed by sovereign bankruptcies in Latin America. One country after another was engulfed in the debt crisis, falling like dominoes. A deep recession, high inflation, unemployment, slow economic growth, and massive debt led the countries to the most profound financial crisis of the century.

Three decades later, is history about to repeat itself?

The Looming Global Debt Crisis

On the fifth of February, ten days before Russia stated its “special military operation” in Ukraine, the world bank issued a report warning of the looming danger of a debt crisis. Focused on seventy low and middle-income countries facing debtor payments worth $11 billion, the report highlighted the dear of crushing economies.

Nine days later, the global economy threw the financial market into disarray, disrupted the supply chain, and sparked a global oil crisis.

Following the shrinking economies, the US released a report stating that 107 economies, homing 1.7 billion people are on the radars of at least one of the following three risks:

  • Rising food prices
  • Tougher Financial Conditions
  • Rising Energy Prices

Furthermore, 69 of the above countries face all three risks, thus heading on Sri Lanka’s footpath, including Egypt, Tunisia, Lebanon, Argentina, Peru, Ghana, Kenya, and more.

Debt crisis in Africa
Source: DW

Most of the crisis-engulfed countries are running out of basic necessities, and many are on the verge of civil unrest. In South Asia, the debt crisis is choking the economies of Pakistan and Maldives, with China playing the role of the largest bilateral creditor.

Related Article: Africa: How China’s Huge Investments Are Sinking The Continent Into Debt

World Bank’s latest statement warns as many as a dozen developing economies may not be able to service their debt before twelve months. This can trigger the largest debt crisis in generations.

Today, the entire world is in debt distress, national budgets are at breaking point, and many governments are forced to cut spending, whereas others are borrowing more to stay afloat. But, what can be done to stop this?

Finding the Solutions

First, multilateral banks and financial institutions must considerably enhance their lending capacity with shareholder backing. They just lack the firepower to satisfy the needs of the current global economy. Current capacity is roughly a quarter of a trillion dollars, but analysts anticipate that they will need to be able to lend at least $1.3 trillion each year in the future.

Second, more resources necessitate increased responsibility. Unfortunately, global financial giants have failed to adapt properly since they were founded by a small group of wealthy Western countries, who remain the dominant owners today.

These banks’ credibility and capacity to assist the nations who need them the most are harmed by such undemocratic control. More prosperous nations should agree to a dual voting system that combines today’s ownership structure with more democratically managed institutions’ one-country, one-vote approach.

By extending Special Drawing Rights, a line of credit, the IMF could have a significant influence in stabilizing the current looming debt crisis. The IMF provided $650 billion in Special Drawing Rights last year in response to the pandemic. However, most of this credit allowed went to its principal shareholders—rich countries that didn’t need it.

We need to see the IMF offer credit on this scale every year, but we also need to see richer countries relinquish their rights to claim these debts to low-income countries in severe need of low-cost loans that cannot be secured from private creditors.

Global Debt Crisis: No End in Sight

For far too long, the world has turned a blind eye. Debt crises in emerging nations are also a security concern; relief comes too late and too little, which must alter to build more crisis-resistant global economies. We require a proactive response, one that averts a disaster.

The worldwide pandemic has shown us that every crisis has the potential to become huge. Sri Lanka might be the start of an irreversible chain reaction triggered by a bit of occurrence in a faraway nation. It’s still too early to predict where it all ends.