Getting sustainable debt right

A slowing global economy, rising trade tensions, and increased risks of recession could mean a perfect storm for lowand middle-income countries (LMICs) burdened by high sovereign debt. Faced with exorbitant borrowing costs and an increasingly jittery international environment, these countries' potential for economic growth and development will be severely curtailed.

- KEVIN P. GALLAGHER JOSÉ ANTONIO OCAMPO KUNAL SEN

Given the circumstances, the current international financial architecture, particularly its approach to debt sustainability, needs to be overhauled. Only by embracing a new approach to developing-country debt will these countries be able to generate the investment flows they so desperately need to kickstart long-term growth.

The concept of debt sustainability remains heavily influenced by the International Monetary Fund-World Bank Debt Sustainability Framework, even though economists within both institutions have long recognised the DSF’s inadequacies. It is supposed to balance the need for development financing with debt sustainability, but it often advocates suboptimal levels of government spending and investment, inadvertently contributing to future economic distress in developing countries. It also frequently fails to account for the scale of investment required, and it is insufficiently sensitive to economic and external shocks.

Moreover, the DSF has historically overstated the potential of fiscal consolidation to spur economic growth, leading to persistent forecast errors and higher-than-anticipated debt ratios. One critical flaw is its limited consideration of the long-term benefits of debt-financed investments, particularly in areas like the green transition. The framework needs to evolve from a tool focused on debt reduction at all costs to one that incentivises investments designed to drive future growth and long-term fiscal sustainability.