Soaring global debt and hiked interest rates are creating a big issue for developing countries. Here’s why

Rising interest and depreciating exchange rates are driving capital back to developed nations—and closing doors to credit for developing countries. The situation, experts say, is forcing developing countries to borrow at higher interest rates, further exacerbating the ballooning level of global debt.

The issue was a major topic of discussion at the World Economic Forum’s Annual Meeting of the New Champions (AMNC), which was held in Tianjin, China, in June 2023.

“There is no new funding coming into the emerging markets,” M.U.M. Ali Sabry, the Minister of Foreign Affairs of Sri Lanka, said at AMNC. “As a result, emerging markets and countries like Sri Lanka, and middle-income countries, have to borrow from the local market at a very high interest rate.”

Global debt—which hit $305 trillion in recent months—has been increasing in recent years as the global economy endures compounding shocks such as COVID-19 and the war in Ukraine. Developing countries in particular saw external debt levels grow by over 15% last year compared to pre-pandemic levels, according to the United Nations. The increase has pushed up debt servicing costs, putting strain on low- and middle-income countries as well as on international financial lending institutions.

“Not all countries and people have been impacted in the same way,” a Brookings Institute report noted. “A financing divide is sharply curtailing the ability of many developing countries to respond to shocks and invest in recovery.”

The interest cost on external borrowing is on average three times more for developing countries than for developed countries, according to Brookings. The think tank’s report notes that in recent years, developed countries have borrowed at interest rates around 1% while the least developed countries have borrowed at rates ranging from 5 to 8%. The disparity results in developing countries using a far greater percentage of their domestic revenue on interest payments.

Debt servicing costs in Sri Lanka, for instance, have put a heavy burden on the government's finances, Sabry said during the meeting in Tianjin. In April 2022, Sri Lanka’s central bank suspended external debt payments, saying the government needed the money to buy essential goods like fuel.

“You can’t actually put your funding into the most important areas such as education, climate change, sustainable energy and renewable energy because you are grappling with your interest payment and your debt payment,” Sabry added.

Political and economic leaders at the event called for better coordination and communication between major world economies to help curb the global debt crisis. Moreover, experts stressed that governments, the private sector and international financial institutions like the International Monetary Fund (IMF) need to create new funding mechanisms.

“Part of the international financial architecture’s problem is that the IMF and other international institutions are insufficient to be the global emergency liquidity of last resort for developing countries,” said Keyu Jin, a professor of economics at the London School of Economics and Political Science. “It requires the Paris Club and China, and the G20 and the common framework to come out and deal with and sort out these emerging market issues.”

The Brookings report also calls on international lenders to increase access to long-term public financing as well as work to improve market borrowing terms for developing countries.

“Just like during the pandemic, nobody is safe until everybody is safe,” Sabry added while speaking about the debt crisis. “It is interconnected and intertwined all over the globe.”