Putting debt-strapped countries on a sustainable path

A paradox is unfolding across developing economies. On the bright side, inflation is finally abating. The oppressive interest rates of the last five years are beginning to ease, suggesting that the crushing debt service burdens many countries have faced might start to shrink. For the right price, foreign bond investors are once again willing to provide financing, allowing many countries to stave off default.

But for most countries, these are small consolations—not enough to overcome the grave setbacks of this decade. The latest World Bank data show that the upheavals of the early 2020s produced a financial riptide like no other. Between 2022 and 2024, about $741 billion more flowed out of developing economies in debt repayments and interest than flowed in through new financing. This was the largest debt-related outflow in more than 50 years. And the human toll has been steep. Among the 22 most highly indebted countries, one out of every two people cannot afford the minimum daily diet necessary for lasting health. 

Policy makers must make the most of the breathing room that exists today, because it could disappear tomorrow without warning. That means putting the debt burdens of developing countries back on a sustainable path—by getting the fiscal house in order and reducing sovereign risks in ways that spur productive investment. It also means modernizing the global systems meant to avert debt distress by sounding the alarm before countries stray off the path and by helping them restructure their debts swiftly once the crisis arrives.

In 2024, the total external debt stock of low- and middle-income countries hit a new record of $8.9 trillion. This includes the $1.2 trillion—also a record—owed by the 78 most vulnerable countries eligible for grants and low-cost loans from the World Bank’s International Development Association (IDA). It’s a bad moment for this type of record-breaking, because average interest rates for developing countries haven’t been this high since just before the financial crisis of 2008–09. These countries paid a record $415 billion in interest alone, money that could have otherwise helped reduce the rising ranks of out-of-school children, improve primary health care, and electrify rural villages. 

Slow progress, more needed

There has been progress, of course, but it’s been modest, and considerably more is needed. Debt burdens are now growing more slowly. Creditors were in a forgiving mood last year, agreeing to restructure $90 billion in developing country debt—the most since 2010. Ghana, Haiti, Somalia, and Sri Lanka, for example, secured restructuring agreements that shrank their long-term external debt by between 4 and 70 percent. Thanks to the work of the Global Sovereign Debt Roundtable, led by the International Monetary Fund (IMF) and the World Bank, Ghana completed its restructuring with its official bilateral creditors in half the time it took for previous restructurings under the Group of Twenty’s Common Framework for Debt Treatments.

Yet it’s no easier for developing countries to stay clear of a debilitating debt trap today than it was a decade ago. It would be foolish to expect that the human misery caused by the next debt crisis will be milder than the most recent one. That’s because the global machinery for managing crises has not kept up with the times. It was built for an era when developing economies owed most of their external debt to the World Bank, the IMF, and a handful of high-income economies, all of which provided loans at below-market rates. But today, private creditors—bond investors mostly—hold nearly 60 percent of the long-term public and publicly guaranteed debt of developing economies. Debt owed to Paris Club creditors, the longtime overseers of the global debt-restructuring system, now accounts for only about 7 percent. 

That imbalance helps explain why restructurings in the 2020s have been so sluggish. Decision-making authority has shifted beyond the reach of the Paris Club and is now dispersed among millions of bondholders and a kaleidoscope of governments in high- and middle-income economies. As a result, debt restructurings happen through a maze of complex processes. It’s either via the Common Framework, the emergency mechanism introduced during the COVID-19 period to support debt-distressed countries, or through one-off deals with governments and bondholders. 

The early-warning system for managing the debt of low-income countries is equally overdue for an update. It was designed for an era when domestic debt markets were undeveloped and foreign private creditors were almost entirely absent. Today, the opposite is true. The system, officially the Low-Income Country Debt Sustainability Framework, is up for review this year and should be overhauled to reflect this new reality. 

Easing financial pressures

In 2024, bond investors turned on the spigots again. After retreating from developing economies only the year before, they charged back in, pumping $80 billion more in new disbursements than was repaid in debt. That inflow allowed some countries to ease their financial squeeze. Several completed multibillion-dollar bond issuances, either to finance budget deficits or pay off maturing bonds. But this was hardly low-cost borrowing: interest rates reached as high as10 percent, roughly double the pre-2020 rate. 

Not all developing countries, however, have been able to tap foreign bond markets, and other options became scarcer in 2024. Official bilateral creditors—governments and government-related entities—retreated, collecting $8.8 billion more in principal and interest than they disbursed in new financing. Most developing countries turned instead to domestic creditors. Among the 86 nations for which domestic debt data are available, more than half—50 in all—saw their domestic government debt grow faster than external government debt. This type of borrowing usually comes at a cost to the private sector: local commercial banks load up on government bonds when they should be lending to the private sector. Domestic debt also involves shorter maturities, creating greater risk when loans mature and must be refinanced at a potentially higher interest rate. 

The time has come to stop tempting fate. Mismanagement of developing-country debt is putting the brakes on economic development and pushing too many nations into a devil’s bargain: borrow at high cost from foreign bondholders or stifle the domestic private sector by soaking up the assets of domestic commercial banks. The World Bank has remained a major lifeline for the most vulnerable countries: In 2024, it provided $18.3 billion more in low-cost financing to countries eligible for IDA assistance than it received in principal repayments from them. That amount was an all-time high, but the laws of gravity cannot be defied forever.

Debt is still building in pernicious ways. Even if countries had options to climb out of the hole quickly, governments should not be risking debt distress: the long-term human costs are simply unaffordable. But such options are hardly abundant today—and there are few signs that anything will change soon. Unless it does, the easing of financial conditions today could encourage poor and vulnerable countries to sleepwalk into a larger calamity tomorrow.