World debt is borrowing by governments, businesses and people (households), and the IMF warns that it is at dangerously high levels.

Global debt rose to a record high of more than US$305 trillion in the first quarter of 2022, driven by rising debt in the US and China, the Institute of International Finance's (IIF) latest Global Debt Monitor shows.

The quarterly debt monitor reported that China's debt increased by $2.5 trillion over the first quarter, and the United States added $1.5 trillion, while total debt in the eurozone declined for a third consecutive quarter.

The historically high debt surpassing $300 trillion is a further jump from soaring global debt in 2020 of $226 trillion, which marked the biggest one-year debt surge since World War II, as reported by the International Monetary Fund (IMF) in its Global Debt Database.

First, the pandemic triggered unprecedented borrowing, and now inflation, interest rate hikes and ripple effects of the Russia-Ukraine conflict are pushing global debt even higher.

The current debt wave is the world’s fourth since 1970 and appears to be the biggest one yet, the World Bank says.

Corporate debt (excluding banks and government borrowing) increased slightly, with debt outside the financial sector rising above US$236 trillion, about $40 million higher since the onset of the COVID-19 pandemic, as per the IIF. Government debt is up 14 percentage points, or US$17.4 trillion, to 103% of Gross Domestic Product (GDP) since the start of the pandemic.

The IMF cautions that ballooning government debt is putting sovereign balance sheets under pressure. As food and fuel prices soar, governments may need to give more grants to households in need to help them cover costs, particularly in low-income countries.

In 2021, the countries with the highest global debt levels compared to GDP were Japan (257%), Sudan (210%), Greece (207%), Eritrea (175%) and Cape Verde (161%), as per data published by Visual Capitalist.

Interest rate hikes make borrowing expensive

Inflation and interest rates are dependent on each other. Rising commodity prices not only stoked the already burdensome inflation, but also pushed a number of major central banks to tighten monetary policy by raising interest rates at regular intervals this year. Interest rate hikes in turn meant higher borrowing costs for corporations, governments and households.

The IIF report also noted evidence of rising debt service costs caused by interest rate increases, even as governments continue to borrow to meet fiscal demands, companies (smaller ones in particular) borrow to ward off bankruptcy, and households do so to cope with surges in food and fuel costs.

Furthermore, the interest rate climbs have made it more expensive for corporations to refinance or raise capital to invest in mergers and acquisitions (M&A) or capital expenditure.

Soaring debt: emerging markets and low-income countries

The raised interest rates and soaring debt are poised to burst the global debt bubble. Debt accumulation is accelerating across all economic sectors, particularly in emerging markets and low-income countries.

To meet debt payments, at least 100 countries will have to reduce spending on health, education and social protection, the IMF estimates.

Emerging market debt is now approaching a record US$100 trillion, reports the IIF.

"While levels of debt and debt tolerance differ significantly across emerging market countries and sectors, the sharp rise in emerging market government debt levels has put debt transparency in the spotlight. The lack of timely disclosure of public debt obligations, very limited coverage of contingent liabilities, including SOE liabilities, and the extensive use of confidentiality clauses are the major impediments causing information asymmetries between creditors and debtors," the IIF states.

Rising debt in Asia a cause of concern

The IMF warns that rising debt in Asia puts the region at risk. Debt in the region has risen from 25% before the pandemic to 38% now.

“There are many countries in the region which are facing high debt numbers. And some of these countries are in debt distress territory. And so that’s something which we have to watch out for,” Krishna Srinivasan, the director of the Asia and Pacific Department at the IMF, told CNBC’s “Squawk Box Asia” last month.

The IIF also believes Asia is a cause for concern. Corporate debt reached 140 percent of gross domestic product in Vietnam and 116 percent in South Korea, while household debt has climbed to 104 percent of GDP in South Korea, 89 percent in Thailand and 72 percent in Malaysia in the first quarter of the year, as per the IIF.

Advanced economies at risk from emerging markets exposure

Risk is by no means confined to Asia or emerging markets. As the IMF noted in April, “the number of advanced economies with debt ratios larger than the size of their economy has increased significantly.”

Advanced economies’ (a term used by the IMF) banks have a significant exposure to emerging markets in the case of the eurozone and the US, while Japanese banks have also increased their lending to emerging markets. These banks cannot easily disregard or shrug off the exposed emerging markets debt and consequences of a debt default.

Debt distress and ramifications for governments and corporations

The IMF and World Bank believe 60% of low-income countries are at or near the point where they will be unable to service their debt or fulfil their financial obligations. That would constitute a debt distress, which is likely to be widespread.

If countries default on their debts, it can trigger a panic in global financial markets and a wider economic meltdown.

For corporations, higher debt service (higher borrowing costs) can mean a higher likelihood of default, more financial pressure to stay afloat, difficulty in raising new debt, and reduced possibility of business expansion or job creation because of the inability to access affordable capital. Higher costs of capital and the corporate debt hangover from last year could lead to an increase in bankruptcies and other signs of distress. And if recession sets in, trouble could mount.  

The debt surge and rising interest expenses are becoming an increasing burden for corporations, governments and households, amplifying vulnerabilities and propelling the inevitability of the advancing global debt crisis that will constrain growth, particularly as monetary policy tightens.

Conclusion

The most highly indebted governments, households and firms will be hardest hit by significant interest rate rises, so countries have to be careful to strike the “right balance”, the IMF advises. Countries need to work together to tackle this debt mountain in order to safeguard global stability and prosperity, recommends the IMF.

As the biggest global debt crisis in history is upon us, it may be a good idea to heed the advice of Marcello Estevão, Global Director for the Macroeconomics, Trade & Investment Global Practice at the World Bank: “For too long, the world has taken a tragically languorous approach to resolving debt crises in developing economies, delivering relief that is either too little or too late. It’s high time for a 21st century approach—one that involves pre-emption rather than reaction, one that prevents the crisis from erupting in the first place.”