The World Development Report 2022: Finance for an Equitable Recovery in the Context of the International Debt Crisis

World Bank Group, World Development Report 2022: Finance for an Equitable Recovery. Washington, DC: World Bank Group, 2022. xix + 248 pp. www.worldbank/org/en/publication/wdr2022

As if the climate crisis was not enough, the world's economic system is now in a full-blown development crisis, with debt distress at its core. It threatens another ‘lost decade’, with economic insecurity, political instability and further erosion of democratic institutions for much of the world's population. The International Monetary Fund (IMF) projects the weakest global medium-term growth prospects in more than 30 years. Developing countries have amassed enormous debts dealing with the COVID-19 pandemic, and face high food and energy costs, exacerbated by a high US dollar. A slowing global economy, rising interest rates and depreciating currencies have come together to tip at least 60 countries into debt distress or close to it — more than twice as many as there were in 2015. The Institute of International Finance (IIF) estimates that total developing world debt rose to a record of US$ 98 trillion at the end of 2022.

Global debt relative to global output was already at unusually high levels before the pandemic. Moreover, global growth had slowed down in 2011‒21, compared to the previous decade. In the later period, 80 per cent of developed countries experienced slower growth than in 2000–10, as did 75 per cent of developing countries. Then came the exogenous event of the global COVID-19 shock which began in early 2020. As the World Bank's World Development Report 2022: Finance for an Equitable Recovery states, ‘The COVID-19 pandemic is possibly the largest shock to the global economy in over a century’ (p. 20). In 2020, the first year of the pandemic, the global economy shrank by 3 per cent; economic activity contracted in about 90 per cent of countries. This is a higher percentage of countries experiencing negative growth in per capita GDP than in any year since 1901, when the data started — a higher proportion even than during two World Wars, the Great Depression of the 1930s, the emerging markets debt crisis of the 1980s, and the 2007‒10 North Atlantic financial crisis.

Major economies administered the largest double dose of fiscal and monetary expansion in history, and major firms exploited the uncertainty of the pandemic to mark up their prices far above the cost of labour and non-labour inputs, making a combined demand- and sellers-inflation at the highest rate in decades. Central banks are now frantically trying to rein it in. Governments and private entities were forced to borrow even more than before in order to stay afloat as business activity ground to a halt; and they deferred payments on existing debt while borrowing more.

In 2020, the average total debt burden (both public and private) of low- and middle-income countries leapt by 9 percentage points, compared with an annual increase of 1.9 per cent in the previous decade. In the same year, 51 countries, including 44 emerging economies, experienced a downgrade in their sovereign debt rating, making borrowing more expensive. Then came exogenous shock number two in the form of Russia's war on Ukraine which began in early 2022 and continues at the time of writing (mid-2023), creating upheaval in global markets for food, fuel and fertilizer. The dramatic shrinkage of supply of these essentials has caused high prices, hurting many developing countries dependent on imports of these basics even more deeply than they had already been hurt by the COVID-19 pandemic. The two shocks together compounded inflation and multiplied public and private debt. The IIF reported that government debt in 30 large low- and middle-income countries hit almost 65 per cent of GDP by the end of 2022 — an increase of 10 percentage points over pre-pandemic levels and the highest ever year-end total. From the start of 2020 to the end of 2022, the debt of more than 100 developing countries ballooned by almost US$ 2 trillion (excluding China), as social spending soared while incomes froze.

These trends caused shock number three (this one endogenous), which, like shock two, also started in early 2022, as the US Federal Reserve and other central banks raised interest rates rapidly and synchronously to curb high inflation after decades of low inflation and low interest rates; monetary tightening in the past two years has been the fastest in the past four decades. Thanks to the deep integration of both developed and developing countries’ into Western financial markets (with free capital mobility and flexible exchange rates strongly promoted by the IMF and World Bank), the rising interest rates in safe-haven US and other Western markets caused investors to pull capital from developing countries and the latters’ currencies to depreciate. Currency depreciation produced higher import prices, higher inflation and higher borrowing costs (Grynspan, 2023; Wheatley, 2023). Both changes — the rise in interest rates and the rise of the dollar — had a knock-on impact on the cost of meeting existing debt obligations and current borrowing because most international debt obligations are contracted in US dollars and at variable, rather than fixed, interest rates.

The surge in debt service costs drains resources from public goods like food subsidies, health, education, social assistance and physical infrastructure, at the same time that costs of food and other basic necessities soar. Consumers are hit by inflation especially in products of inelastic demand (including healthcare, housing, pharmaceuticals) and by the erosion of public services. It is a fair guess that the global ‘hardship index’ (number of hours it takes an unskilled male labourer to earn the equivalent of 100 kg of the basic food grain) is now higher than it has been for several decades.

Private creditors — those who lent to developing countries to get high returns justified by high risk — are faced with very low visibility in terms of the location of losses. At the same time, they are faced with demands for large-scale debt renegotiation. They have responded by rushing to their governments and to the IMF to say ‘make them pay’, as though they should get the high returns without bearing the cost of risk. This is a blatant version of the long-established game of private finance in dealing with public financiers: ‘heads I win, tails you lose’; or in other words, ‘you (public creditors) have to take the hit so we can be made whole’.

The upshot is that many developing countries and their governments today face an acute dilemma. On the one hand, they have to meet the continuing high costs of handling the pandemic and its aftermath, plus the high and rising ‘cost of living’ (amplified by Russia's invasion of Ukraine), plus the rising interest rates. On the other hand, they face the high costs of the debt they have already borrowed and the debt they now want to borrow to meet those high recurrent expenditures. Their creditors, public and private, press the governments to implement drastic rises in taxes and cuts in public spending, which implies severe cuts to investment and future growth, leading to more ‘income divergence big time’ between developing and developed countries.

The World Bank's World Development Report 2022 (hereafter WDR 2022, or the Report) provides valuable information about the economic aspects of the pandemic and economic recovery from it. It also lays out a broad-gauge set of policy priorities for governments of developing countries to pursue. What follows is a summary of these policy priorities.

The WDR 2022 identifies five broad policy priorities for governments to set their countries on a path to a more equitable and sustained economic recovery after the pandemic (see Ch. 6: ‘Policy Priorities for the Recovery’). First, the many governments with dangerously high levels of sovereign debt have to give top priority to improved debt management. Second, many governments face elevated levels of financial sector risks and must focus on resolving these risks to ensure the continued supply of credit. Third, governments have to scale back support for the more resilient households and firms first, leaving relatively more for the poor in order to counter the strongly regressive impacts of the pandemic. Fourth, governments must set national policy in the context of heightened global economic risks, especially interest rate and currency risks caused by advanced economies scaling back stimulus policies and raising interest rates to fight inflation. Fifth, recovery policies should particularly target support at green sectors and business models.

The Report elaborates by saying governments should recognize that different sectors of the economy are interconnected, such that risks can spill over from one sector to another. Therefore, it is necessary to prioritize recovery resources where the risks to the economy are greatest and where policy action is likely to be most effective at reducing economic fragilities. Well-designed fiscal, monetary and financial policies can take advantage of sector interconnectedness and generate positive outcomes in support of economic recovery (p. 250).

Governments should rapidly scale back financial support (such as debt moratoria and credit guarantee schemes) to firms and industries that have access to private finance and avoid giving support based on pre-crisis size, because that could easily cause resources to be trapped — inefficiently — in firms and sectors that are less viable due to the crisis. Likewise, they should rapidly scale back support (such as cash transfers) for financially viable households, and concentrate the remaining support on vulnerable populations that have been hardest hit by the pandemic recession.

In middle-income countries with fairly well-developed financial sectors, households and small businesses typically take on debt. Income losses due to the pandemic (as well as the later shocks) have raised the risks of a sharp rise in loan defaults once government support measures are withdrawn. That in turn means governments must establish frameworks for quick and comprehensive recognition of financial sector fragility and default, and scale back support in a targeted and predictable way in line with economic recovery, to avoid a wave of insolvencies and defaults. In the longer term, an important tool for resolving high levels of private debt is a legal insolvency framework. The Report notes, ‘Even in countries where institutional capacity is limited, small improvements in the bankruptcy code can make a difference’ (p. 254).

According to the Report, governments should mobilize new sources of revenue to pay off debts incurred for crisis recovery. Most emerging economies rely on consumption taxes and lack the institutions for raising income taxes. Consumption taxes burden the poor disproportionately, which sets a limit on their revenue potential. For example, Mexico, which relies on consumption taxes, raised only 18 per cent of its GDP in taxes in 2020, as compared with 41 per cent on average for countries of the European Union, which rely on income taxes (p. 254). The pandemic response should include building up institutions for raising income taxes as a long-term project.

Governments also have to grapple with risks from the economy's interdependencies with other economies via credit markets, international trade and foreign aid that may threaten the robust, equitable recovery in their own economies. In particular, they must shape domestic policy in the light of high and rising global interest rates as the central banks of ‘advanced economies’ act to slow inflation. Those high external interest rates raise the cost of servicing domestic public and private debt — and higher debt service costs make debt defaults more likely, potentially cumulating into a national debt crisis. Moreover, high interest rates go with additional external risks in the form of exchange rate risks. High advanced-country interest rates tend to cause currency appreciation in those countries, as investors sell other currencies and buy those of the advanced countries — depreciating the currencies of many emerging economies, raising the cost of their imports and the cost of debt service. The WDR 2022 is careful not to identify the leading role of institutions such as the US Federal Reserve in raising US domestic interest rates without regard for impacts on the rest of the world; indeed, the Fed's mandate from Congress is to focus on only two objectives: full employment and price stability.

Finally, the Report emphasizes throughout that the COVID-19 crisis should be seized as an opportunity for national governments to accelerate the transition to a sustainable world economy, above all, with fast-falling carbon emissions. Governments should introduce carbon taxes, and revise the tax code to incentivize green investment, while central banks should mandate higher risk provisioning for loans for activities that are anti-green, notably activities that use fossil fuels.

The full 267-page document is as bland as the foregoing summary of policy priorities suggests, though it is lifted by some useful statistics. It is a depoliticized technical analysis that steers clear of power and inequality, and especially steers clear of how the geo-economic structure of the world-system — and its dominance by a small set of high-income countries led by the US, which have long coordinated amongst themselves to sustain their continued dominance — affects pandemics, financial crises and financial resolutions (Wade, 2019, 2020). The remainder of this Assessment focuses on these political economy issues. The next main section puts the COVID-19 economic crisis in the context of earlier economic crises; outlines the economic effects of the pandemic; and suggests how China's bilateral rather than multilateral approach to rescheduling debts of its Belt and Road borrowers is complicating the larger project of rescheduling the debts of developing countries. The following section then focuses on directions for progressive reforms at global and national levels, especially to reduce debt distress in developing countries now and in the future. The conclusion adds the COVID-19 crisis to the other elements of the more than run-of-the-mill weirdness of today's world system.

We know that the global debt problem is a lot more acute than it was a decade ago. It bears repeating that as of early 2023, the average debt to GDP ratio across developing countries was around 65 per cent. Five years ago, it was 50 per cent. Looking five years ahead, to 2028, it is likely to be 75‒80 per cent and in several large countries, as much as 100 per cent. So, over the course of only a decade, the ratio is likely to rise by 25‒30 per cent of GDP. This magnifies financial fragility in economies which do not issue hard currencies but have to repay in hard currencies and face exchange rate depreciation, and which have shifted their production structure from smallholder agriculture and industry towards (low-skill) services and commodities.

Despite the far-reaching disruptions in the more than three years since the pandemic hit, the world has made dismayingly little progress on preparing for the next pandemic. China's refusal to cooperate with investigations into the origins of COVID-19 is a sign of a wider breakdown in inter-state cooperation to build pandemic warning systems, and deepens fears that China will again be late in alerting the world to the next virus outbreak. But the pandemic risk and the debt risk are only two ingredients of the new epoch of polycrisis facing the global community. They join risks including climate change, an ageing labour force, the wild card of artificial intelligence, dramatic slowdown in China, and geopolitical-economic tensions particularly between China and the US, with other states under pressure to take sides and separate blocs emerging. Edward Luce of the Financial Times argues, ‘The cost of Covid can also be measured in damage to global psychology, including a form of diplomatic long Covid. The world's superpower and its rising great power are now working from home and nourishing paranoia about each other. When we look back on Covid that may be its biggest cost’ (Luce, 2023).

In March 2023, the World Bank (2023) issued a report called Falling Long-term Growth Prospects. Its message can be summarized in the context of this essay by saying that not only the developing world but the whole world faces the real prospect of a ‘lost decade’. Yet in the months following the publication of that report, evidence has come to light which suggests that the 25 largest developing countries are beating growth forecasts. Their growth is less tightly linked to China's and their median inflation rate is no higher than in developed countries, which has not happened in four decades (Sharma, 2023). These are certainly ‘interesting’ times.