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Ms. Marialuz Moreno Badia, Juliana Gamboa-Arbelaez, and Yuan Xiang
In the wake of the COVID-19 pandemic, debt levels in emerging and developing economies have surged raising concerns about fiscal sustainability. Historically, negative interest-growth differentials in these countries have played a debt-stabilizing role. But is this enough to prevent countries from falling into debt distress? Drawing from a sample of 150 emerging and developing economies going back to the 1970s, we find that interest-growth differentials have remained relatively low, dampening debt increases in the run up to a crisis. But in the face of persistent primary deficits, debt service tends to rise abruptly—particularly in emerging markets—and a fiscal crisis ensues. There is also evidence that a large part of the debt build-up around crises stems from valuation effects associated with external debt and the materialization of contingent liabilities. These findings underscore that, though not necessarily a red-herring, low interest-growth differentials cannot fully offset the deleterious effects of large fiscal deficits, forex exposures, or hidden debts.
Ms. Marialuz Moreno Badia, Juliana Gamboa-Arbelaez, and Yuan Xiang

factors behind the debt dynamics in EMDEs. To fill the gap of previous studies, we use a more comprehensive dataset covering 150 EMDEs for the period 1971–2018 and ask three interrelated questions: (1) what are the empirical regularities on the r-g and are there marked differences between EMEs and LIDCs?; (2) does the r-g play a debt stabilizing role and does it make a significant difference during the various phases of a fiscal crisis?; and (3) are other factors more important in explaining debt dynamics in EMDEs? Our starting point is the standard debt

Ms. Marialuz Moreno Badia, Juliana Gamboa-Arbelaez, and Yuan Xiang

. Abstract In the wake of the COVID-19 pandemic, debt levels in emerging and developing economies have surged raising concerns about fiscal sustainability. Historically, negative interest-growth differentials in these countries have played a debt-stabilizing role. But is this enough to prevent countries from falling into debt distress? Drawing from a sample of 150 emerging and developing economies going back to the 1970s, we find that interest-growth differentials have remained relatively low, dampening debt increases in the run up to a crisis. But in the face of

Garth P. Nicholls and Alexandra Peter

of financial development. However, even though a negative interest rate-growth differential should play a debt-stabilizing role, keeping debt stable even in the presence of persistent primary deficits, debt has increased strongly over the last years in the Caribbean region (see Chapter 2 ). This casts doubt on whether this mechanism was at play. Exceptional Fiscal Performance As a third measure, we look at a debt benchmark based on exceptional fiscal performance and compare it to the long-term debt benchmark as well as the natural debt limit. This