How can a country’s debt crisis affect the global economy?

A debt crisis is a situation when an organisation, a firm, an entity, or a country has debt more than its ability to pay off. Anyone can face this situation whether he is an individual or a country. However, in the case of a country, there is an edge. It is the sovereignty overprinting its currency. Individuals or firms cannot print their money by themselves.

A household faces a debt crisis when it is unable to meet its monthly payments. The household debt crisis has the following three types; credit card debt, student, furniture and auto loans, and home mortgages. The second kind of debt crisis is the business debt crisis, when a company fails to pay off its loans and bonds. Businesses face this situation mainly due to lack of capital, poor management skills, weak competitive advantage, and flawed business model. The third kind is the sovereign debt crisis.

Sovereign Account Crisis:

A sovereign debt crisis refers to the debt crisis of a country when it is unable to repay its debt or the interest on the debt. It is easier for the countries to default than households and businesses because there isn’t any international bankruptcy court to resolve lenders’ issues. Secondly, these kinds of debts are not secure by collateral, unlike household and business debt. Lastly, the country has the sovereignty to print its money to pay off loans. Unlike households and businesses, the government of a country cannot cut its expenditures to pay off liabilities. It is because if it cut costs, it would have no source to generate revenue which will make loan repayment even more difficult. Government spending is an essential part of Gross Domestic Product (GDP), and a reduction in it will slow down economic growth significantly.

Causes of the debt crisis:

A sovereign debt crisis can take place due to several reasons. Some of them mention below.

When countries take so many loans for payment for wars, they may face a debt crisis.

Although governments are sovereign in printing money, if they print so many notes, it creates a situation of inflation in the economy. This problem, if it gets worse, turns into hyperinflation, which is hazardous for the economy.

A prolonged recession can also be a reason for the debt crisis.

Federal budget deficits force a government to get loans from foreign countries or IMF. If a budget deficit prevails in the long term, it may put a country in a debt crisis. The more tax reductions are introduced in the budget; the more burden falls on debt. Moreover, additional government spending also increases the debt crisis.

The experts at nursing assignment writing service UK added that sometimes foreign investments might cause a debt crisis to increase. When they buy treasuries of the countries where they have a good market for their exported goods, their exports may increase, but the importing country faces harmful impacts.

Effects on the economy:

At the time of recessions, foreign countries buy more treasury bills from the importing country when they believe that the government is able to pay back the bills. It might also add up to the crisis.

If the debt ceiling keeps getting higher in a country, it may take unplanned or inadequately planned loans, which result in a debt crisis.

In the short run, the country and the economy may benefit from deficit financing as it increases economic stability and growth. The government spends money on infrastructure, healthcare, education, contracts with private companies, and defence. It has a pleasant effect on a country’s Gross Domestic Product (GDP), and it increases.

However, due to an increase in the GDP, debtors can claim higher interest on the debt in the long run. The lower demand for treasury bills decreases the value of the local currency because it depends on treasury securities value. Due to the decrease in local currency, foreign investors become reluctant to invest in that country and prefer local investment. In such a case, creditors will claim higher interest rates.

The quality of life declines in the debtor countries due to poor or no economic growth. The main reason for the low standard of living in those countries is the significant decline in their GDP.

Effects on the global economy:

The effects of a debt crisis in a country bore by developed countries as well as we all are a part of this world and all governments are interrelate. The increased poverty in debtor countries impacts other countries of the world. The economic growth rate of developed countries slows down. The affected country makes efforts to increase foreign exchange reserves, for which it has to decrease its imports. The foreign exchange earned is used to pay back the debt. The imports of the debtor country are actually export for a develop country and a significant source of income generation for them. As a result of the reduced imports policy, the exports of developed countries reduce significantly. In this way, they lose a significant part of their income, which impacts their economic growth.

Solutions for debt crisis:

It is clear that a crisis cannot be eliminated without paying off the debt amount once. The most efficient way of doing this is paying through the contribution of the debtor country, banks, and the developed countries. This way, the burden would not fall on any one member, and the world can get rid of the crisis effectively.

It is the foremost responsibility of debtor countries to ensure fair utilisation of money within their borders for enhanced economic growth so that they are able to pay off their liabilities as soon as possible.

The developed countries should contribute to cultivating favourable conditions for economic activities in debtor countries so that they are able to generate income. They can do this by reducing trade restrictions on these countries to flourish trade with them.

The role of the International Monetary Fund (IMF) is very crucial in this scenario. To save the world from the harsh effects of the debt crisis, it should take on its responsibility as a leader. The IMF should ease its policies for highly indebted countries. It can also help them by crafting effective plans to boost their economic growth and get rid of the debt. It should also introduce relaxation in interest rates for the highly indebted countries to provide them with some comfort.