The external debt of developing countries has reached unprecedented levels, having surpassed $11 trillion in 2023. The growing burden of debt servicing, exacerbated by high global interest rates and economic slowdowns, is putting pressure on national budgets and threatening developmental progress. With debt distress deepening in low-income nations, the conversation around reform and financial sustainability has become more urgent than ever. In many cases, debt obligations have outpaced economic growth, placing entire regions at risk of stagnation.
The evolution of third-world debt
Developing nations have experienced a rapid escalation in external debt over the past decade. Although exact growth rates vary by region, the World Bank estimates that the total debt in 131 low- and middle-income countries has risen by over 5% annually in recent years.
This surge has been fueled by multiple factors:
- Higher global interest rates following the COVID-19 pandemic
- Significant currency depreciation in emerging markets
- Slower economic recovery that hinders fiscal consolidation
The key elements of this debt include sovereign borrowing, multilateral loans, and private external credit. As borrowing costs rise, many governments are being forced to allocate an increasing percentage of a country’s income to debt repayment — often over 20% of tax revenues — leaving limited fiscal space for development.
Debt burdens are not evenly distributed across the developing world. Sub-Saharan Africa and parts of Latin America face particularly severe constraints. In Africa, over 20 countries are currently experiencing debt distress or are at high risk of this.
Figure 1: Evolution of the external debt of developing countries, 2012 – 2023
Source: UNCTAD
These regions rely heavily on external financing and are very much exposed to global market fluctuations. Lending sources include multilateral institutions such as the IMF and the World Bank, bilateral creditors such as China and Western countries, and, increasingly, influential private bondholders.
While external credit is essential to bridge fiscal gaps, it creates a web of obligations that complicate negotiations during restructuring. Moreover, this dependency can result in creditor nations exerting undue influence over the domestic policies of the borrowing countries.
Top 10 developing countries by general government gross debt as percent of GDP (2023) from the World Economic Outlook Dataset.
Source: IMF
The consequences of growing debt in developing countries
The potential outcome of growing debt levels is already apparent in poor countries, with debt servicing now accounting for an alarming share of government budgets. For example, in Ghana, debt service expenditure accounted for nearly 70% of government revenue in 2022.
Several countries, such as Zambia, Sri Lanka, and Lebanon, have entered default status and are undergoing restructuring negotiations.
Credit downgrades by international rating agencies further worsen borrowing conditions and are compounding existing financial fragility. These dynamics could lead to reduced investor confidence and capital flight, thereby increasing volatility and weakening domestic currencies.
If borrowing nations fail to sustain debt payments, the consequences can be serious and far-reaching, both for the affected countries and the global financial system. Here’s a breakdown of the potential outcomes of and reactions to the failure to meet debt repayments that could be encountered within the borrowing country:
- Sovereign default. A country unable to meet its debt obligations may default, meaning it stops repaying part or all of its debt. This leads to an immediate loss of access to international credit markets and an increase in the cost of future borrowing.
- Economic and social crisis. Defaults often result in austerity measures, currency devaluation, inflation, and recession. Essential public services such as healthcare, education, and infrastructure could be cut. Furthermore, unemployment may rise, and poverty increase sharply, as seen in past crises in Argentina, Lebanon, and Sri Lanka.
- Political instability. Economic hardship often triggers civil unrest, protests, or changes in government. Trust in institutions could erode, leading to authoritarian shifts or weakened democracy.
- Contagion effects. Multiple defaults can spark financial contagion, particularly if major economies or several countries in a region default simultaneously. This can shake global investor confidence and increase risk premiums for other developing countries.
- Credit rating downgrades. Countries that default typically suffer downgrades by credit rating agencies (e.g., Moody’s, S&P), which worsens their financial position and deters future investment.
On the other side, lenders are likely to react to the failure to repay debt in the following ways:
- Multilateral Institutions (IMF, World Bank) may step in to bail a country out or offer emergency funding, but usually demand stringent economic reforms in return (fiscal discipline, structural adjustments).
- Private creditors often initiate debt renegotiations or lawsuits to recover funds. A lack of coordination among creditors can stall effective resolution.
- Bilateral creditors (e.g., China, G20 nations) could push for restructuring agreements or offer conditional relief through frameworks such as the G20’s Common Framework.
- Markets – investors could pull capital from risky regions, thereby increasing exchange rate volatility and destabilizing financial systems across the Global South.
Third world debt short-term perspectives
Looking ahead, the picture framing of third-world debt remains troubling. The debt levels of developing nations are expected to continue to rise in the short to medium term due to a combination of high interest rates, slow economic recovery, and increasing borrowing needs to meet the costs of climate adaptation, infrastructure, and social programs.
Low-income countries are particularly vulnerable, with over 60% at risk of or already in debt distress. If current trends persist, debt servicing will become unsustainable for many developing nations by 2030. The failure to meet repayment obligations could trigger a chain of sovereign defaults, weakening investor confidence and potentially creating systemic risks. Such defaults would also reduce access to emergency financing, exacerbate poverty, and heighten political instability. International creditors could tighten lending conditions or withdraw altogether, leaving the affected nations with no viable alternatives. The resulting fiscal crisis could roll back years of development progress.
To avoid the negative scenarios, coordinated reforms are essential. Debt relief mechanisms such as the G20’s Common Framework must be restructured for greater efficiency. Transparency initiatives should be strengthened to promote trust and prevent hidden debt accumulation. Introducing state-contingent instruments, like GDP-linked bonds or climate-resilient debt clauses, could help countries to manage shocks. Mobilizing domestic resources, refining tax systems, curbing capital flight, and improving governance would all help to reduce dependency on external debt and help to build fiscal resilience.
Final thoughts
The external debt of developing countries has reached unprecedented levels and is expected to continue to rise. Coordinated efforts by both lenders and borrowers will be required to lessen the negative consequences of the eventual failure to make repayments.
