World Bank says private debts pose hidden risk to emerging economies, can spill over to public debt

• Bank faults slow progress on sovereign restructuring

• Over 65% of small and medium-sized businesses to default on loan repayments in India, South Africa, the Philippines, and Kenya

World Bank on Tuesday warned that emerging economies must quickly strengthen their financial sectors as mounting inflation interest rates and lack of transparency about sovereign and private debts are rising risks.

In the World Development Report, the international financial institution highlighted its longstanding concerns about the lack of transparency around Chinese lending and collateralized loans in the sovereign debt sector.

The report also called out the growing risks in the private sector. One of the surveys showed 46% of small and medium-sized businesses in emerging economies are expected to fall behind on debt payments within six months.

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However, World Bank's chief economist Carmen Reinhart, in an interview with Reuters told that the number was twice as high in some bigger emerging markets like India, South Africa, the Philippines, and Kenya, where more than 65% of small and medium-sized businesses expected to be in arrears.

Hidden risks around private debt

Reinhart told Reuters that massive fiscal and monetary support, coupled with moratoriums on bank loans and generous forbearance policies, had eased the economic crisis triggered by the COVID-19 pandemic, but households now face adverse consequences.

Non-performing loans, or the loan in which the borrower is in default, had remained below what was feared at the start of the pandemic, but Reinhart expected forbearance policies and relaxed accounting standards could be obscuring a "hidden non-performing loan problem."

"What gets you, in the end, is not so much what you see, but what you don't see," she warned against complacency about the financial health of households and firms. "I'm afraid that in many countries, we're not even at the recognition stage."

Concerns around sovereign debt and growth setback

In 2020, the pandemic-induced economic recession led to an enormous single-year surge in global debt in decades, with IMF saying it jumped to $226 trillion, and rating firms slashed sovereign debt credit rating of 51 countries.

Last week, the International Monetary Fund (IMF) said it would press the G20 finance leaders in the February meeting, which is scheduled for this week, to adopt changes to strengthen the framework for developing countries given rising default risks.

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"For debtor countries, delay presents major setbacks to growth, poverty alleviation, and development. Unfortunately, negotiations on debt restructuring for the poorest countries under the G20 Common Framework are currently stalled," World Bank President David Malpass wrote in the forward to the report.

Last month, the IMF downgraded its global fiscal growth forecast for 2022, citing more significant slowdowns in the U.S. and, more importantly, China, which is one of the world's largest single creditor nations, are expected to drag down the output on every continent.

Spillover effect

The World Bank report urged nations to put greater efforts to improve transparency in private sector debt, more proactive management of distressed loans, and accelerated addressing of sovereign debt distress.

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The report also mentioned that many rating agencies failed to factor in investments by foreign state-owned enterprises that could raise financial risks significantly in low-income and some emerging market countries.

"Private debt could suddenly become public debt, as in many past crises," Malpass wrote, highlighting the risk of spillover effects, given the interrelated nature of households, firms, financial sector institutions, and governments.

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