Debt and Financial Crises

Emerging market and developing economies have experienced recurrent episodes of
rapid debt accumulation over the past fifty years. This paper examines the
consequences of debt accumulation using a three-pronged approach: an event study of
debt accumulation episodes in 100 emerging market and developing economies since
1970; a series of econometric models examining the linkages between debt and the
probability of financial crises; and a set of case studies of rapid debt buildup that ended
in crises. The paper reports four main results. First, episodes of debt accumulation are
common, with more than 500 episodes occurring since 1970. Second, around half of
these episodes were associated with financial crises which typically had worse economic
outcomes than those without crises— after 8 years output per capita was typically 6-10
percent lower and investment 15-22 percent weaker in crisis episodes. Third, a rapid
buildup of debt, whether public or private, increased the likelihood of a financial crisis, as
did a larger share of short-term external debt, higher debt service, and lower reserves
cover. Fourth, countries that experienced financial crises frequently employed
combinations of unsustainable fiscal, monetary and financial sector policies, and often
suffered from structural and institutional weaknesses.