Global waves of debt: Economic Impact

By Victor MUJIDU

Countries’ debt crises can have significant ripple effects on the global economy due to the interconnected nature of the world financial system.

Here are some ways in which a debt crisis in one country can affect the global economy:

 

Contagion effect

When one country experiences a debt crisis, it can lead to fears among investors and lenders that other countries may also default on their debts. This can result in a flight of capital from emerging markets and other vulnerable countries, leading to widespread financial instability.

 

Decline in trade and investment

A debt crisis can lead to a decline in a country’s economic growth and a weakening of its currency. This can make it more difficult for the country to import goods and services, reducing its demand for exports from other countries. Additionally, investors may become hesitant to invest in the country, further dampening economic growth.

 

Financial market volatility

Debt crises can lead to heightened volatility in global financial markets as investors react to the uncertainties surrounding the situation. This can lead to sharp swings in asset prices, affecting the wealth and confidence of investors worldwide.

 

Weakening of global financial institutions

If a debt crisis leads to the default of a large financial institution or the collapse of a country’s banking system, it can have a cascading effect on global financial institutions. This can lead to a lack of confidence in the financial system as a whole, further exacerbating the crisis.

 

Policy responses

In response to a debt crisis, countries may implement austerity measures or seek financial assistance from international institutions like the International Monetary Fund (IMF). These measures can have spillover effects on other countries, as they may lead to reduced government spending and slower economic growth.

 

Overall, countries’ debt crises can have far-reaching effects on the global economy, highlighting the need for coordinated policy responses and mechanisms to prevent and address such crises in the future.

 

When the situation looms, individual citizens can experience debt default resulted by the rising costs of food and other goods and services due to inflation as a government prints money to support its expenditures, higher interest rates on mortgages, credit card debt, car loans, and more, as well as the loss of jobs and growing unemployment as companies and the government slash their spending.

 

Kenya for instance presently experiencing external debt with a larger portion from multilateral sources, a lot of pressure has existed, leading to an overhang on the Kenyan economy.

 

Procuring more public debt has caused the Kenyan government to use more of its tax to finance the ever-increasing loans and leave minimal economic growth. Overall, most countries rely on foreign financing to meet their development expenditures occasioned by budget deficits.

 

Overreliance on external debt has led to a steady increase in debt service costs, compelling tax agencies to raise their domestic revenue collection targets year after year. Kenya can serve as a good example of countries facing significant risk of debt distress from international loans like Eurobond’s recent issuing that helped to calm foreign investors’s heatwaves over the possibility of the country defaulting on the repayment of its debut $2 billion (Ksh291.38 billion) Eurobond that is maturing in June.

 

This has resulted in massive pressure on taxation, causing the government to spend an equivalent of two-thirds of tax revenues to service mounting obligations to domestic and external creditors.

 

“Within the budget estimates in most African countries, debt servicing is a recurrent expenditure that now competes with the provision of goods and services or other recurrent expenditure items, putting pressure on the tax agencies to increase revenue targets, especially among the corporate sector,” said Babatunde Oladapo, executive secretary of the West African Tax Administration Forum (WATAF) who generally, reflected the regional economic situation.

Scholars and economic experts reveal that the resurgence in Eurobond issuance by African countries may expose the vulnerability of local currencies on the continent.

 

IMF data shows that about 40 per cent of public debt is external in sub-Saharan Africa and over 60 per cent of that debt is in US dollars for most countries. It notes that, since the beginning of the pandemic to the end of 2022, exchange rate depreciations in Africa have contributed to the region’s rise in public debt by about 10 percentage points of GDP on average, holding all else equal.

 

This points to the arduous task ahead for African central banks in keeping their local currencies stable over the next few years as their countries take on more foreign debt.

Solutions

It is quite significant for countries experiencing debt effects to shun away from the crisis by simply tackling the thorny issue of narrowing their budget deficits.

The countries must restructure their debt so that they can continue to make payments, arrange for emergency funding, and undertake domestic reforms that can increase revenue. They must support broad and healthy economic activities to protect the financial well-being of their citizens.

Insights from the IMF reveal that countries in Sub-Saharan Africa tend to rely excessively on expenditure cuts to reduce their budget deficits.

Policy reforms are needed to boost growth and capture more revenue from that growth, for instance, through tax reforms. This will directly improve countries’ key debt metrics and ensure they can avoid a costly debt crisis.