Debt, Development and Dependence: Financial Stability and Debt for Economic Development in Emerging Markets

Borrowing, both public and private, has increased significantly in emerging markets (EMs) in recent years. These developments have given new impetus to the debate about the potential detrimental effects of indebtedness in developing countries, which range from sluggish growth and financial instability to alleged political subversion. Yet, many emerging economies have grown at extraordinary rates in the past decades, sometimes on the back of debt-driven investment. What to make of these seemingly contradictory statements? Is debt for growth a viable strategy? The common theme of the wide-ranging possible drawbacks of indebtedness is dependence. Debt can increase a country's dependence on both monetary and other economic policies of other countries, as well as on political and regulatory developments in those countries, and sometimes even on the good faith of private creditors in other jurisdictions. This article discusses how this dependence can either be exacerbated or mitigated depending on the nature of the debt. Because of the costliness of financial crises, it focuses in particular on financial stability risks, offering some lessons from the LDC debt crisis and the East Asian crisis that can help provide an idea of how the current situation may develop if monetary policy in advanced economies begins returning to more “normal” conditions. A number of possible measures (besides domestic policy in emerging economies) to avoid the severity of future crises are also discussed.