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Higher interest rates could also expose risks in countries with high debt levels

In addition to the longer-term effects that a return to higher capital costs would have, there is also the risk that the transition to higher rates occurs in an abrupt and disruptive fashion (IMF 2013d). In such a scenario, rather than a gradual increase in long-term rates as monetary stimulus eases, markets react preemptively, causing rates to jump quickly, potentially trapping some participants in vulnerable positions that appeared manageable under low interest rates but proved not to be under suddenly higher interest rates.

Developing countries that have run up private and public sector debt during the low-interest period could be particularly vulnerable. So too would be countries with relatively weak domestic financial sectors and elevated current account or government deficits that might make them vulnerable to either a sharp increase in capital costs or a reduction in flows.

Although the majority of developing countries appear to be in good condition in this regard, public debt levels are high and proving difficult to manage in countries such as Cape Verde, Egypt, Eritrea, Jamaica, Jordan, Lebanon, Pakistan, and Sudan. IMF statistics suggest that gross general government debt exceeds 50 percent of GDP in 36 low- and middle-income countries and increased in 12 of these by 10 or more percentage points of GDP between 2007 and 2012 (figure 19).

Figure 19
Several developing countries combining high and rapidly rising government debt are at risk
Figure 19
Source: IMF

Individual country exposure is not limited to general government debt. In several economies, private sector debt has been increasing rapidly as well. And private debt can rapidly become a public­sector problem as the recent financial crisis illustrated for high-income countries and the East Asia crisis for developing countries. In this respect, 18 developing countries have private external debt exposures in excess of 30 percent of GDP. Three-quarters of these are in developing Europe and Central Asia reflecting strong banking and inter-company linkages with high-income Europe. In the case of Seychelles and Papua New Guinea, the gross private sector debt reflects a thriving offshore-banking system (figure 20). While that changes the nature of the associated risk, it does not eliminate it, as the recent experiences of Cyprus, Iceland, and Ireland illustrate.

While external debt is sometimes more problematic, because exchange rate movements can affect domestic agents’ ability to service loans, local currency debt can also problematic — especially if problems with domestic debt provoke a local banking crisis.

Data on domestic banking claims on the private sector (such data exclude debt associated with local bond markets) suggest a number of countries where debt levels are especially high (second panel of figure 20.) However, interpreting the data is difficult, because while debt to GDP levels can reflect vulnerability, they also reflect the extent of intermediation — which is generally associated with stronger growth and higher incomes.

Figure 20
Private sector debt levels, as well, are elevated in some developing countries
Figure 20A
Figure 20B
Source: World Bank, International Debt Statistics, World Development Indicators, IMF IFS
1. External private debt include private nonguranted external debt with short- and long-term maturity.
2. Domestic credit to private sector refers to financial resources provided to the private sector, such as through loans, purchases of nonequity securities, and trade credits and other accounts receivable, that establish a claim for repayment. For some countries these claims include credit to public enterprises.
3. Orange bars indicate low income countries.

Countries where debt levels are high, and have been rising rapidly, may represent the greatest risk. In East Asia for example, combined nonfinancial corporate and household debt has increased in several countries, reaching 130 percent of GDP in China and Malaysia in 2012. For the East Asia region as a whole, private debt has increased by 19 percentage points of GDP since 2007, while in Latin America it has increased by 9 percentage points. Household debt (only by deposit-taking corporations) in Thailand has risen 15 percentage points since 2007 and now stands at 63.4 percent of GDP (see World Bank 2013 for more). Total household debt is estimated to be about 77 percent of GDP in Thailand and almost 80 percent of GDP in Malaysia.

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