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Cross-Cutting Issues: Debt and Financial Fragility


Debt issues are much more pronounced during the COVID-19 pandemic and the subsequent economic downturn, but it remains an understudied area. While debt financing is an essential tool for development, rising debt levels and increased debt service in many IDA countries could impact priority social spending and/or public investments that promote growth. The pandemic and the near-global lockdowns that came with it have created the most precarious environment for emerging economies since the 1980s. Once again, general debt management, debt transparency, sovereign defaults, debt restructuring, and debt relief have resurfaced as a major policy focus and demand more research and data efforts. In this context, the research topics the KCP would support include but are not limited to the role of official creditors throughout history, analyses of international capital flows, debt crises and their resolution, legal and regulatory aspects of sovereign debt restructuring, debt transparency, financial sector distress, crises and credit crunches, as well as the social and economic effects of the Great Lockdown during the COVID-19 pandemic.

For example, contrary to the vast amount of literature on private cross-border capital flows, the field of official (bilateral and multilateral) lending remains largely underexplored. Most existing studies zero in on a single institution, and existing data sets are often narrowly focused or span a short time horizon. How can the World Bank and other official multilateral and bilateral lenders better provide debt relief? How can the private sector be catalyzed to join in debt relief efforts? The KCP would support more studies on how official lending is shaping the dynamics of international capital flows, and help surface new knowledge related to the features, determinants, and consequences of official lending around the world and the implications for the future of the international financial architecture. In addition, analyses have shown that lengthy and messy debt defaults have historically ended with great losses to creditors. More research is needed to develop an analytical framework and supporting data to assess the current landscape of debt crises and their resolutions, better understand the determinants and consequences of past and current debt crises, and further discover patterns of debt restructuring.

Emerging and developing economies are facing increasing financial fragility in the context of the pandemic. Scholars and policy makers are calling for more analyses of international capital flow partners and more realistic growth forecasts to detect whether the liquidity challenges may turn into insolvency problems.[1] In-depth analyses of a global capital flow database spanning more than 200 years (1815–2018) reveal several important features of international capital flows. For instance, there is a global cycle in capital flows, with co-movements across countries, but there are important differences between the cycles of advanced economies and those of emerging economies; the global cycle in real commodity prices also influences capital flows, but commodity cycles are more frequent, although major cycles are rarer; and the influence of global financial factors is significant, but the relationships are time-varying. When the initial shock of the COVID-19 pandemic hit in March-April 2020, capital flows from emerging and developing economies far outpaced the worst days of the global financial crisis in 2008.[2] Such drastic flight to safety led to a sharp tightening of the financing conditions of these countries and widened the spreads on higher-risk debt. Conditions may be worse for countries that had limited fiscal buffers, rising debt levels, and financial vulnerabilities prior to the start of the crisis. There are stark differences and disturbing similarities between the COVID-19 pandemic and past episodes of global crises. More research in this area, as well as examinations into the relationships between COVID-19, crises, and capital flows in historical perspective, would be beneficial for evidence-based policy making as countries ponder ways to work toward a more resilient recovery.

Considering the novelty of the global economy’s current situation, there is also a need to revisit and expand our understanding of the issues presented in these situations – in particular, what are the channels currently generating financial distress and potential channels for contagion? A large literature has explored the causes, dynamics, and mechanisms of financial and currency crises. Contingent liabilities in the form of corporate, banking, and household debt are potentially a significant threat to recovery from the major dislocations associated with the pandemic in many countries with elevated private debt levels. More studies are needed to expand the current understanding of these phenomena and propose how best to support policies aimed at mitigating their usually severe and adverse effects.

More research on the legal and regulatory instruments that support orderly sovereign debt restructuring is also desired. At the international level, for example, legal steps that govern international bonds could promote a level playing field between sovereign debtors and creditors. New research would spell out the implications for the future of the international financial architecture and the design of debt contracts and surface more insights on the roles of the Paris Club, other sovereign bilateral creditors, and multilateral institutions.

In addition, the effectiveness of debt transparency may be an area to be further explored. A new line of research initiated by DEC’s research group examines the effects of recently adopted laws in Mexico that regulate and make transparent the public debt acquired by states and municipalities. Using high-quality, loan-level data from administrative sources, a key early finding is that bank lending to states that were highly indebted declined substantially after borrowing limits were imposed on them. The decline was driven largely by a reduction in investment loans to state governments. Consistent with the existence of crowding-out, banks reallocated their lending from local governments to local firms in the private sector, with positive effects on state economic activity.

Lastly, the Great Lockdown during the pandemic has affected the global economy in transformational ways that are not yet understood. The dynamics and structures that sustain global value chains, dense cities, and modern economies in general may change in the years to come. Some of those changes may well influence existing development strategies. The KCP will support research that studies the effects of this systemic shock on economies at different levels of development and the policy implications.

Working Papers

The Social Impact of Financial Crises: Evidence from the Global Financial Crisis (2013)

The financial crisis that hit the world economy in 2008–09 transformed the lives of many individuals and families. The challenge for policy makers is to incorporate the lessons from the failures to take into consideration the complex linkages between financial, fiscal, real, and social risks and ensure effective risk management at all levels of society.

Weathering a Storm: Survey-Based Perspectives on Employment in China in the Aftermath of the Global Financial Crisis (2012)

Evidence from a range of sources suggests that Chinese workers lost 20 million to 36 million jobs because of the global financial crisis. The paper reviews several available sources of evidence for the effects of the crisis and notes the biases associated with alternative ex post efforts to measure the employment effects of the crisis.

Fiscal Multipliers in Recessions and Expansions: Does It Matter Whether Government Spending Is Increasing or Decreasing? (2014)

Using nonlinear methods, this paper finds that existing estimates of government spending multipliers in expansions and recessions may yield biased results by ignoring whether government spending is increasing or decreasing.

More Working Papers »




[1] J. Bulow, C. Reinhart, K. Rogoff, and C. Trebesch, “The Debt Pandemic,” Finance and Development, fall 2020,

[2] “Saving Lives, Scaling-up Impact and Getting Back on Track,” COVID-19 Crisis Response Approach Paper, World Bank Group, Washington, DC, June 2020.