More from UNDESAVol 25 No. 10 - October 2020

COVID-19 legacy: a high-debt, low-growth trap

Governments around the world have taken extraordinary steps to halt the spread of COVID-19 and limit the economic and social fallout from the crisis. While their interventions may have reduced the immediate economic damage, they have left governments with record debt burdens and major fiscal challenges.

The situation is especially precarious for many developing countries where the pandemic has created a perfect storm for public finances at a time when fiscal positions were already strained. In many cases, the COVID-19 crisis constitutes the third major shock to public finances in just over 10 years. Fiscal balances deteriorated sharply in the wake of the 2008-09 global financial crisis, during the 2014-16 commodity price downturn, and now again in 2020.

As a result, public debt levels have drastically increased. At 58 per cent, the median government-debt-to-GDP ratio of developing countries is almost twice as high as in 2007 and at the highest level since the multilateral debt relief programs of the early 2000s.

With fiscal vulnerabilities building for over a decade, it comes as little surprise that the COVID-19 pandemic and the ensuing economic crisis are pushing more and more countries to the brink of default. In June, 36 low-income countries were either already in debt distress or were at high of it. At the same time, sovereign debt downgrades by major credit rating agencies have soared.

Even if the worst-case scenario of widespread debt distress and disorderly defaults does not materialize, many developing countries could become trapped in a vicious cycle of high debt and low growth. Persistent fiscal consolidation pressures could trigger large cuts to public investment and social spending, jeopardizing countries’ prospects of achieving the Sustainable Development Goals by 2030.

This vicious cycle can only be broken if countries manage to return to a more robust and sustained economic growth. Premature moves to fiscal austerity would further weaken the economies and hinder repayment capacity. Current initiatives by the international community are a first step, but bolder, more comprehensive and more forward-looking measures are needed to avoid protracted fiscal paralysis.

Learn more from the World Economic Situation and Prospects Monthly Briefing for October.

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