In a worrying trend, sovereign credit ratings have deteriorated globally over the past decade. Suggesting that this trend could continue, S&P Global credit rating agency expects countries to default more frequently on their foreign currency debt over the next decade due to rising debt levels and increased borrowing costs despite earlier optimism from wealthy creditor nations that the risk of a global debt crisis was beginning to ease. 

The International Monetary Fund (IMF) has also expressed alarm over the dangerously high levels of global public debt urging governments to raise enough tax revenue to cover expenditure. As an example, in the world’s largest economy, the United States, public debt has increased sharply from below 60% of GDP in 2000 to 120% in Q2 2024. With the election drawing close, both presidential candidates, Donald Trump and Kamala Harris, are pledging tax cuts in different forms to appeal to voters, how this is exactly going to play out is somewhat uncertain. 

Election promises are very rarely fully implemented, and much of what they are promising the voters, such as Trumps replacement narrative of tariff s instead of income tax may not be practically viable and have several unintended consequences such as inflation as imported goods become more expensive. Ahead of the elections, our base case would be that the trend for the United States is a trend of higher debt levels embedded into the forecast, with the 2030 debt levels potentially exceeding 130% of GDP. 

In recent years, the CV19 pandemic negatively impacted fi nances, and it was no coincidence that during this period, seven countries defaulted on their foreign currency debt, including Belize, Sri Lanka, Zambia, Ecuador, Argentina, Lebanon, and Suriname. Once the global economy emerged from the COVID-19 pandemic, it was hit by the eff ects of Russia’s war in Ukraine, which led to a sharp increase in food and fuel prices, contributing towards eight more countries defaulting on their foreign currency debt. Highlighting the devastating impact of these events, S&P Global notes that sovereign foreign currency defaults since 2020 have accounted for more than one-third of the total that took place since 2000. 

Now, the extent to which the war in the Middle East intensifies, will determine the risk of broader regional impacts on sovereign creditworthiness through the potential impact of oil prices and trade disruptions.  

S&P Global notes that the tipping point of default for many countries is when liquidity and solvency issues become critical. A red flag for countries at risk of default includes interest payments on debt approaching or exceeding 20% of government revenue, with these countries experiencing recessions and double-digit inflation, leading to a cost-of-living crisis and worsening living conditions for their populations. Developing countries are most at risk of defaulting as they increasingly rely on government borrowing to attract foreign capital inflows while rising debt levels and fiscal deficits tend to trigger capital outflows, compounding balance-of-payment issues and the depletion of foreign reserves. At some point, further borrowing is blocked, raising the risk of default. 

Unfortunately, once in default, debt restructuring programs tend to take far too long for countries desperate for a quick resolution. 

S&P Global indicates that debt restructurings are taking much longer than they did in the 1980s, warning of severe long-term economic consequences for economic growth and exchange rates for countries that remain in default for several years while at the same time increasing the likelihood of future defaults. Ghana has recently concluded its debt restructuring after around two years, one of the quickest in recent years.  

While a country should take measures to rein in debt levels and direct revenue to areas of the economy that will lift it to a higher sustainable growth path, all is not lost for a country that has defaulted or is at risk of defaulting. As an example, teetering on the edge of failure, Egypt is now emerging from an economic crisis. Under an IMF-backed package, Egypt has started to reform its economy, including letting its currency float freely, thereby boosting competitiveness. Although the resilience of the population is being tested, the government has to stick with the debt-reducing IMF reforms, or it will lose its much-needed significant monetary support, risking its long-term sustainability. While the road to recovery is not easy or straightforward, reform is critical in countries at risk of default.  

For more information, please contact MCB Global Markets Team on [email protected]

Published in collaboration with our Financial Markets research partners, ETM Group.