The urgency of global debt reform

WASHINGTON, DC — High debt levels are once again setting off alarm bells around the world. In developed countries, attention is focused on the rapid increase in public debt, while developing economies are struggling to service their external obligations amid slowing growth and stagnating exports.

Despite their current challenges, most analysts believe that developed economies will avoid a full-blown crisis, owing to their ability to issue debt in their own currencies and implement targeted fiscal and monetary measures. In the United States, for example, the fiscal deficit surpassed 6 per cent of GDP this year and is projected to rise to 8 per cent or more in 2025. Even so, declining interest rates suggest that policymakers are well-positioned to address the issue, which received little attention during the 2024 election cycle.

By contrast, the outlook for emerging and developing economies appears increasingly bleak. In 2023, developing countries spent 1.2 per cent of their gross national income on interest payments, while debt service amounted to nearly 6 per cent of export earnings in countries eligible for International Development Association (IDA) aid. The World Bank’s latest Debt Report warns that low-income countries face a “metastasizing solvency crisis.”

Several developing countries, including Zambia and Sri Lanka, have already defaulted on their external obligations, triggering a slow and painful process of debt restructuring and sweeping economic reforms. Many others are on the edge of a crisis, in Mozambique, for example, interest payments amounted to 38 per cent of export earnings in 2023. According to the World Bank, 52 per cent of low-income countries are at or near debt distress.

Since the end of World War II, the world has witnessed numerous financial crises stemming from the unique nature of sovereign borrowing. On one hand, government debt can reflect the pursuit of potentially high-return investments that cannot be financed by domestic savings alone. This was the case in the early 1960s, when South Korea borrowed up to 10 per cent of its GDP annually to enable productive investment. Those investments paid off handsomely, enabling the country to service its debt with ease and maintain stability despite sustained borrowing.

But borrowing can also finance unproductive expenditures, such as excessive public employment or private consumption, which generate little to no return. Consequently, debt service grows without any corresponding increase in governments’ ability to sustain payments. This is rarely an issue for countries that invest in high-return projects. But when resources are misallocated and debt-service costs mount without the means to cover them, a crisis becomes inevitable.

In such cases, international financial institutions (IFIs), especially the International Monetary Fund, play a critical role in helping countries restore creditworthiness by providing financing and recommending reforms. The IMF specialises in assessing indebted countries’ macroeconomic outlook, pinpointing necessary economic reforms, and steering them back toward financial stability and sustainable growth.

IMF-recommended reforms typically involve expenditure cuts, limiting future pension increases, reducing civil-service salaries, and scaling back certain investments, alongside efforts to increase tax revenue. They often also include structural adjustments, such as modifying the exchange-rate regime, removing domestic price controls, and eliminating regulations that impede economic growth. Identifying the most urgent reforms is essential, as these measures often determine a country’s ability to foster growth and improve living standards.

Economic-policy reforms become particularly important when a government lacks the resources to meet future debt-servicing payments or fund the investments needed to boost income and growth. In the absence of such reforms, heavily indebted countries risk falling back into patterns of excessive spending, undermining their growth prospects and resulting in recurring crises.

Regrettably, many well-meaning leaders and policymakers overlook the necessity of combining debt restructuring and new financing with economic reforms. Sympathy for the impoverished populations of indebted countries and acknowledgment of their overwhelming financial burdens often lead to calls for the IMF and World Bank to provide financial support without demanding structural adjustments. When international institutions succumb to such pressures, economic gains tend to be short-lived: growth stagnates, and debt-servicing difficulties return.

These challenges are compounded by the emergence of new major creditors, especially China, and the growing role of private-sector actors in sovereign lending. In recent years, China has overtaken the World Bank as the largest lender to many low-income countries. As a result, implementing economic reforms now requires the support of China and other creditors.

The protracted negotiations between creditors whenever sovereign debt must be restructured underscores the urgent need for reforms not only within heavily indebted countries but also in the international community’s approach to resolving these countries’ debt problems. Sri Lanka and Zambia were economically paralysed for years while creditors, including IFIs, struggled to reach restructuring agreements.

Traditional sovereign creditors, including the US and the European Union, must persuade emerging major lenders of the need for a faster, more effective restructuring mechanism. Without such a framework, the world’s poorest countries will remain trapped in a never-ending cycle of debt distress.

Anne O. Krueger, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is Senior Research Professor of International Economics at the Johns Hopkins University School of Advanced International Studies and Senior Fellow at the Center for International Development at Stanford University. She is the author of International Trade: What Everyone Needs to Know (Oxford University Press, 2020). Copyright: Project Syndicate, 2025. www.project-syndicate.org