What is a Debt Crisis?

A debt crisis refers to a situation where a country borrows excessively in the international debt market (typically including sovereign and private debt), exceeding its repayment capacity, resulting in an inability to repay debts or requiring debt extensions.

There are several indicators to measure a country's external debt repayment capacity, the most important of which is the debt service ratio, i.e., the ratio of a country's principal and interest payments on external debt in a year to its export earnings in the same or previous year. Under normal circumstances, this ratio should remain below 20% (Note: China's debt service ratio was 10.5% at the end of 2022). Exceeding 20% indicates an excessively high external debt burden.

I. Causes of Debt Crises

1. Excessive External Debt Scale
   A country's external borrowing should be moderate. Without corresponding domestic financial conditions, excessive external borrowing can lead to overwhelming government debt and trigger a debt crisis.

Internationally, the debt service ratio (annual debt service payments/annual export earnings) is commonly used to control the scale of external borrowing. Repayment of external debt primarily depends on a country's export earnings capacity. Strong export capabilities allow for larger borrowing scales. However, if external debt growth consistently outpaces export growth, it signals excessive external debt and increases the risk of a debt crisis. Theoretically, a country should limit its annual debt service payments to below 20% of its export income; exceeding this threshold raises the risk of a debt crisis.

2. Unreasonable External Debt Structure
   An irrational external debt structure also heightens the risk of a debt crisis. This irrationality manifests in several ways:

a) Excessive Proportion of Commercial Loans: Commercial loans typically have short maturities. If a country demonstrates strong economic growth, international banks may continue lending, allowing the country to refinance old debts. However, if the country experiences economic or political instability (e.g., large trade deficits or political turmoil), international banks may cease lending, forcing the country to repay its debts. This loss of confidence can lead to currency depreciation, massive capital outflows, and a debt crisis if foreign exchange reserves are insufficient.

b) Overconcentration of Debt Currencies: If a country's external debt is concentrated in one or two currencies, appreciation of those currencies increases the debt burden, making repayment more difficult.

c) Unreasonable Debt Maturity Structure: The maturity structure refers to the proportion of short-term versus medium- and long-term debt in a country's total external debt. An imbalance, such as excessive short-term debt with concentrated repayment periods, can strain repayment capacity and trigger a crisis.

3. Misuse of External Debt
   In the short term, debt repayment capacity depends on export earnings. In the long term, it hinges on economic growth.

Thus, after borrowing, a country should use external debt to boost economic growth and exports. Misuse—such as investing in large-scale projects with high costs, long cycles, and slow returns—can hinder short-term growth and export capacity, exacerbating debt accumulation. Alternatively, using debt to import luxuries instead of raw materials or capital goods fails to enhance growth or export capacity, weakening repayment ability. Some countries even channel short-term debt into speculative sectors (e.g., stocks, real estate), creating bubbles that, when burst, precipitate a crisis.

4. Poor Debt Management and Control
   Ineffective government oversight can lead to uncontrolled borrowing, irrational debt structures, and misuse. Chaotic debt management delays policy adjustments, allowing risks to escalate. By the time risks are recognized, a crisis may already be unfolding.

5. Deteriorating Trade Conditions
   Persistent trade deterioration reduces export earnings and repayment capacity. A widening current account deficit (imports exceeding exports) increases reliance on foreign capital. International investors, losing confidence, may halt lending or refuse extensions, overburdening the debtor and triggering a crisis.

II. Impacts/Harms of Debt Crises

1. Sharp Decline in Domestic Investment
   a) To repay debts, crisis-stricken countries slash imports to achieve trade surpluses, reducing access to vital technology, equipment, and raw materials. This contraction stifles economic development.

b) Crises damage international creditworthiness, making borrowing harder and deterring foreign investment. Reduced capital inflows starve the country of construction funds.

c) Domestic investors may withdraw capital, compounding debt burdens and shrinking investment further.

2. Escalating Inflation
   Debt repayment demands curb imports and prioritize exports. Reduced domestic investment lowers production capacity, shrinking local supply. Coupled with import cuts, this inflates prices. Governments may raise interest rates and issue bonds to fund repayments, converting local currency to foreign exchange. This excess liquidity fuels inflation.

3. Economic Slowdown or Stagnation
   Massive foreign exchange conversions devalue the local currency. Struggling firms face higher import costs, worsening operations or bankruptcy. Reduced imports and weak production capacity slow or reverse economic growth.

4. Social Unrest
   Debt crises trigger recessions, business closures, and mass unemployment. High inflation erodes wage purchasing power. Austerity measures, like cuts to public projects, worsen living conditions, fueling public discontent and potential upheaval.

5. Disruptions to the International Financial System
   Debt crises inevitably affect creditor nations. Refusing aid risks bankrupting the debtor's institutions, harming its political economy; providing aid strains creditors' finances. Major economies in crisis can destabilize global financial markets.