Global debt in the wake of ME conflict

The conflict has made matters worse

Around a year before the start of the middle east conflict, a March 17, 2025 article ‘Debt crisis: developing countries’ external debt hits record $11.4 trillion’ published by UNCTAD, pointed with regard to the difficult global debt situation ‘Developing countries are sinking deeper into a debt-driven development crisis. Their external debt– money owed to foreign creditors– has quadrupled in two decades to a record $11.4 trillion in 2023, equivalent to 99percent of their export earnings. A mix of factors has fuelled this surge, including increased borrowing for development projects, volatile commodity prices, and widening public deficits. The COVID-19 pandemic worsened the situation, as countries borrowed heavily to offset the economic fallout and fund public health measures.’

Having said that, the article does not indicate an otherwise important cause of rise in debt overall globally, which is the significant increase in interest payments on debt, which has been because of over-board use of monetary austerity policies. At the same time, debt burden has increased proportionate to exports, revenues, and growth, due primarily to over-emphasis on squeezing aggregate demand side to curb inflationary pressures whose origin has been primarily aggregate supply shock, especially during the recent years in the wake of Covid-19 pandemic, Ukraine War, and the ongoing Middle East conflict. Hence, the extensive use of monetary austerity– raising the policy rate– and fiscal austerity policies– targeting a primary surplus– at best provided short-term macroeconomic stability, and at an unnecessarily high cost of economic growth sacrifice. 

Therefore, lack of investment to boost aggregate supply side, negatively impacted domestic production, and exports, which also meant likely diminishing impact on revenues. This, in turn, likely enhanced poverty, and unemployment, and also reduced capacity to repay both domestic and external debt. The same UNCTAD-published article pointed out in this regard ‘While debt can be a vital tool for economic growth and development, it becomes a problem when repayment costs outpace a country’s capacity to pay. That is now the case for two thirds of developing countries. Debt distress now looms over more than half of the 68 low-income countries eligible for the International Monetary Fund’s Poverty Reduction and Growth Trust – more than double the number in 2015.’ 

For instance, in Pakistan in recent years, both poverty, and unemployment have increased, while the debt distress in terms of capacity to repay interest payment has been negatively impacted because of the country being stuck in low-growth equilibrium over the medium-term, which overlaps the time of application of heavy austerity policies regime. Having said that, macroeconomic stability also remains on fragile grounds due to weak aggregate supply fundamentals, especially in terms of resilience to shocks, like being faced in the shape of ongoing deep level of aggregate supply shock due to the ME conflict.

Moreover, an 11 May PS-published article ‘How Africa can escape the debt trap’ pointed out that a significant reason why Africa is facing a very difficult debt situation, is not because of the debt stock, but because of an unsupportive global financial architecture, which has played a significant role in diminishing the capacity of a country to grow appropriately, and in turn, enhance its capacity to repay debt. The article indicated in this regard ‘The narrative that Africa faces a persistent debt crisis has become entrenched. In fact, despite representing nearly one-fifth of the world’s population, the continent accounts for less than three percent of global sovereign debt. By contrast, the European Union and the United States account for a much larger share (nearly 16 percent and more than 34 percent, respectively). Moreover, Africa’s average debt-to-GDP ratio, at 67 percent, is markedly lower than those of Europe (88.5 percent), the US (122.6 percent), and Japan (236.7 percent). …On May 12–13, Senegal will host an international conference to address the country’s escalating debt crisis and, crucially, one of its main drivers: the structural asymmetries embedded in the global financial system. This flawed architecture has obstructed Africa’s access to affordable, long-term capital and prevented the continent from diversifying its sources of economic growth and trade, transforming debt from a manageable development instrument into a self-perpetuating cycle of vulnerability.’

Pakistan faces a high level of gross financing needs over the medium-term. The projected ‘gross external financing requirements’ facing Pakistan stood on average during the next five fiscal years, that is during 2026/27-2030/31, at a high level of $24.6 billion.

Having said that, while the global financial structure needs to be made more supportive of developing countries– including Pakistan– in terms of meaningfully financing developing countries towards inclusive, resilient, green growth objectives, including improving global sovereign debt restructuring framework, developing countries also need to be more purpose-driven in terms of pursuing the development agenda, and need to move away from neoliberal, and austerity policies, which unwarrantedly keep an otherwise much-needed role of public sector limited, increase interest payments to an unjustifiably high level, and overall diminish growth prospects.

Years of overboard use of austerity policies, in general globally, and the recent severe commodity shock due to the ME conflict, the situation of global debt has all the more worsened. A 4 June PS-published article ‘The Iran War is fuelling a global debt shock’ indicated ‘As everyone knows, the war in the Middle East has caused a sharp spike in oil, gas, and food prices, creating severe economic hardship worldwide, and especially in developing countries. But less well understood is the war’s effect on government borrowing costs. Across the Global South, what began as a price shock has morphed into a debt shock. The seeds of the current crisis were sown during the period of low interest rates in the 2010s, when low- and lower-middle-income countries borrowed heavily in dollars. Many invested these funds productively and reaped the rewards of stronger economic growth. But after the COVID-19 pandemic, global interest rates rose and the US dollar strengthened, making borrowing significantly more expensive. … Last year, UN Trade and Development (UNCTAD) calculated that 3.3 billion people were living in countries that spent more on debt payments than on basic services such as health or education, and the situation has only grown worse since then. …The energy shock triggered by the Iran war has further increased borrowing costs, particularly for energy-importing countries, and this trend may persist if current geopolitical tensions continue. Making matters worse, there have been broader structural shifts in the global debt landscape, owing to the changing composition of creditors and upcoming repayment peaks for certain types of debt, notably bilateral lending. These trends have left countries with large near-term refinancing needs especially vulnerable.’ 

Here, it needs to be mentioned that Pakistan faces a high level of gross financing needs over the medium-term. The ‘IMF Country Report No. 26/101’ for Pakistan, and released in May pointed out in this regard ‘Medium-term risks remain high, reflecting Pakistan’s large gross financing needs and challenges in obtaining external financing (including high-quality foreign investment).’ Moreover, based on ‘Table 3b. Pakistan external gross financing requirements and source 2023/24-2030/31’ the projected ‘gross external financing requirements’ facing Pakistan stood on average during the next five fiscal years, that is during 2026/27-2030-31, at a high level of US$24.6 billion.