and its single-year increase being unprecedented in the past four decades—as monetary stimulus supported credit extension while revenues fell sharply in the pandemic-induced output collapse. As a result, total debt—consisting of government and private debt—in EMDEs rose to 206 percent of GDP, on average, in 2020, from 118 percent of GDP in 2010 and its highest level in five decades (Figure 2, Table 2; Aldosoro, Hardy, and Tarashev 2021; Avdjiev, McGuire, and von Peter 2020; Borensztein and Ye 2018).<sup>4</sup> Much of that increase reflected soaring corporate debt in China. However, even in EMDEs excluding China, total debt rose to 137 percent of GDP in 2020, from 96 percent of GDP in 2010. In 2020, private debt accounted for more than half of total debt in EMDEs excluding China and around 17 percent of total debt in LICs.

# 3. Potential benefits and costs of debt

Fiscal support programs during the 2020 global recession were a critical policy response to avoid worse economic outcomes. They supported household incomes, kept businesses afloat, and helped stabilize financial markets. Until the recovery from the recession is firmly entrenched, fiscal support needed to be maintained, to varying degrees, in many countries, implying that debt accumulation may continue to finance support programs. However, the rapid increase in government debt, its shift toward a more fragile composition, and the rise of potential contingent liabilities from private debt over the past decade raise concerns that are now magnified by record increases in debt levels to finance such fiscal support.

Beyond its role during the recent global recession, debt accumulation has benefits as well as costs. Potential benefits of debt accumulation include funding growth-enhancing projects (e.g., infrastructure, health, and education) and programs to protect vulnerable groups; stabilizing short-term macroeconomic fluctuations by supporting activity; and serving as a safe asset. Potential costs of debt accumulation are servicing the cost of debt (the interest to be paid to creditors); rollover costs (the costs of refinancing when debt matures); limiting the magnitude and effectiveness of fiscal policy; and crowding out private investment.

As the recovery from the pandemic-induced recession gives way to a new normal, the balance of benefits and costs is likely to increasingly tilt toward costs. As the global economy strengthens, financial conditions are likely to tighten, whether because central banks begin to normalize monetary policy or because investors expect higher inflation. In EMDEs, this may be accompanied by depreciations that put pressure on debt sustainability in those countries with a large share of foreign currency-denominated debt. Even where foreign currencydenominated debt is limited, rising borrowing cost may erode debt sustainability, especially if growth fails to rebound strongly. Record-high EMDE debt makes countries vulnerable to financial market stress. Meanwhile, a recovery in domestic demand and closing output gaps may make additional fiscal stimulus unhelpful.

We now provide a brief discussion of these potential benefits and costs of debt and put them into the current context.

> 4 Total EMDE debt is defined as the sum of EMDE government debt (the GDP-weighted average for 152 EMDEs in 2020) and EMDE private debt (the GDP-weighted average for 128 EMDEs in 2020—private debt data are available on a quarterly basis, and in some countries, data as of Q3 are used).

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