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  • Vinay Nair

Decoding the Global Debt Wave

Updated: Aug 24, 2020

The global economy, as it is, by now has witnessed four waves of debt accumulation over the last fifty years. The first three ended in a financial crisis, and caused massive economic downturns around the world. We are now in the middle of the fourth wave!

World Bank warned that the current wave could dwarf the first three.

According to The Institute for International Finance (IIF), Global debt hits record high of 331% of GDP in Q1 2020 (vs. 320% in Q4 2019). Mature Markets like Canada, France and Norway saw the largest increases with Total Debt reaching 392% of GDP (vs. 380% in 2019). Debt in Emerging Markets (EM) also surged to over 230% of GDP (vs. 220% in 2019), largely driven by non-financial corporates in China.


Third World debt is the external debt that the government in developing countries owe to foreign banks, institutions and governments. For most of these countries their debt started accumulating during the 60’s, 70’s and 80’s. By the end of 1990 these countries owed more than $1.2 trillion to other developed countries. Most of the debt is owed to private commercial banks and the remaining to international lending organisations like the International Monetary Fund and the World Bank along with governments and their agencies. Different regions have experienced diversified debt development since the 1970’s.

Latin American debt crisis (first wave)

The first wave was experienced between the 1970’s and 1980’s as the Latin American Countries (LAC) borrowed heavily from commercial banks in more developed markets. Post the Second World War, these countries wished to become self-reliant and adopted vast industrialisation policies. The government used external borrowing to finance these projects. The borrowing continued to increase rapidly after 1970 as banks were more than willing to lend at low interest rates. The oil price shock in 1973 led to a further increase in borrowing, especially by the public sector. Most of the debt was owed by the public sector. In 1979 there was another oil price shock which led the U.S Federal Reserve to increase the interest rates. This resulted in increased interest payments for the Latin American countries that borrowed from American banks. The rise in external debt varied among Latin American countries, with the largest increases in Argentina, Mexico, and Venezuela. The Latin American debt crisis began in 1982 after Mexico announced that it could no longer service their debt.

Crude Oil Prices, 1970 - 1981
Two Large Oil Price hikes in 1970s (Source: Muhtasim Sarowat Rayed)

Almost 16 Latin American countries fell into arrears on their debt payments. In 1989 the American government launched the "Brady Plan", where they offered debt relief and restructuring to finally resolve the Latin American debt crisis. The debt crisis resulted in a lost decade of growth in the Latin American region.

The East Asian financial crisis (second wave)

The second wave of debt growth started in the early 1990’s. This wave was different from the first one as it was driven by the private sector. Policy changes in the financial markets lead to an increased capital flow into some emerging and developing countries. A decline in global interest rates in 1990-91 led to an accumulation of short term external debt in the East Asian region. External borrowing by East Asian countries increased after 1990, growing by almost 14% every year. The build-up of debt was particularly large among the five countries which were subsequently at the centre of the Asian financial crisis — Indonesia, Korea, Malaysia, the Philippines, and Thailand. Private debt increased rapidly and was primarily financed by commercial banks, international lenders and external financial institutions. Loans were used to finance non-tradable sectors, such as real estate. By 1997 many of the East Asian countries had developed excessive reliance on external debt and their books showed large current account deficits. Inefficient policies lead to adverse shifts in investor sentiments leading to a reversal in the capital flow. Thailand was the first country to recognise a crisis as they had one of the highest external debts in the region. The government was not able to support the currency and it marked the beginning of the East Asian Financial Crisis.

The financial stress in Thailand quickly spread elsewhere, with large capital outflows leading to substantial currency pressures in Indonesia, Korea, Malaysia, and the Philippines Corporates could not service their debt payments leading to a widespread banking crisis in the region. While the East Asian financial crisis did not lead to widespread sovereign debt crises, several countries required official financial support during and after the crisis. IMF support included $23 billion for Indonesia, $58 billion for Korea, and $20 billion for Thailand 

Global Financial Crisis and Recession (third wave)

The third wave of debt resulted in a global financial crisis. Developing countries were increasingly borrowing in the international debt markets, especially from banks in America and Europe. The build-up in debt was greatest in the Eastern and Central Asia (ECA) region and was accounted for mainly by the private household sector. The defaults in the American subprime mortgage market led to a major crisis in 2008. This displayed the fragile nature of the banks. The financial crisis of 2008 led to a major recession in America, the economy contracted in three out of the four quarters. This led to a sharp reduction in lending to developing countries from American and European banks. The capital markets in these countries relied heavily on external capital flow and were finding it very difficult to maintain liquidity after the crisis. All regions dependent on external debt from America and Europe faced a recession. External debt increased rapidly in the ECA region between 2000-07, but the region also experienced rapid growth. When the crisis hit, the deterioration in financial conditions resulted in sharp recessions in ECA.

Great Recession created an Unusually Large and Long-Lasting Gap between Actual and Potential GDP

Economic contractions were particularly severe in Bulgaria, Croatia, Romania, and Ukraine. The crisis in the ECA region was short lived as the government granted robust stimulus and the major countries along with the G20 helped curb the crisis.

The Fourth Wave and Coronavirus recession.

The fourth wave is said to have begun in 2010. The current wave of debt accumulation bears many similarities to the previous three waves. Global interest rates have been very low since the global financial crisis, and the search for yield by investors has contributed to narrowing spreads for emerging markets and developing economies (EMDE). Some major changes in financial markets have again boosted borrowing, including through a rise of regional banks, growing appetite for local currency bonds, and increased demand for EMDE debt from the expanding shadow banking sector.

The outbreak of coronavirus pandemic in 2019 has further aggravated the fourth wave. The pandemic has resulted in widespread relief and stimulus within and outside the borders of every country. Many of the nations will resort to debt post the pandemic to fuel their economy and health infrastructure. Banks and Organisations will have to provide governments with the necessary funds as the pandemic is a natural disaster and not a case of mismanagement. This being said, the fourth wave is believed to be the largest, fastest, and the most broad-based accumulation of debt compared to its predecessors, as it involves a concurrent build-up of both public and private debt, it involves new type of creditors and is widespread among major economies of the world.

The average annual increase in EMDE debt since 2010 of almost 7% points of GDP has been larger by some margin than in each of the previous three waves. Whereas previous waves were largely regional in nature, the fourth wave has been very widespread. It has seen both sovereign debt rising in tandem with private sector debt, in contrast to earlier waves. But there have also been important policy improvements which may mitigate these concerns. Multiple reforms have increased the resilience of the international financial system, and global financial safety nets have been expanded and strengthened since the global financial crisis. Many EMDEs have improved their macroprudential and regulatory policy frameworks over the past two decades.

The $258 Trillion question confronting policymakers and economists are whether the fourth wave may also end in a financial crisis?

Strong institutional frameworks will play a critical role in reducing the likelihood and impact of the coronavirus-induced recession and ongoing debt situation. This includes robust financial regulation and supervision, fiscal frameworks that credibly maintain sustainability, and monetary policy frameworks and exchange rate regimes geared toward macroeconomic stability.

All of that makes the strong case for urgent rate cuts, extra public spending, or both. It is estimated that the coronavirus in itself could cost the Global Economy $2.7 Trillion!




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