Meanwhile, rising inflation and interest rate increases place greater pressure on the recovery path in these countries, according to the report.
“Risks may be hidden because the balance sheets of households, businesses, banks, and governments are tightly interrelated. Today, high levels of non-performing loans and hidden debt impair access to credit, and disproportionately reduce access to finance for low-income households and small businesses,” said the report.
The president of the World Bank David Malpass stated that the risk is that the economic crisis of inflation and higher interest rates will spread owing to the financial fragility.
Malpass added that tighter global financial conditions and shallow domestic debt markets in many developing countries are crowding out private investment and eroding the recovery process in them.
“It is critical to work toward broad-based access to credit and growth-oriented capital allocation. This would enable smaller and more dynamic firms – and sectors with higher growth potential – to invest and create jobs,” Malpass assured.
The report underpinned a number of priority areas for action in developing countries, including early detection of financial risks.
“Since few countries have the fiscal space and capacity to address all challenges simultaneously, it outlines how countries can prioritize resources depending on their context,” the report said.
In this respect, the report noted that surveys conducted among businesses in developing countries during the pandemic showed that 46 percent of these businesses are predicted to fall into arrears.
“Loan defaults could now sharply increase, and private debt could quickly become public debt, as governments provide support. Despite the severe contraction in incomes and business revenues resulting from the crisis, the share of non-performing loans remains largely unimpacted and below expectations. However, this may be due to forbearance policies and relaxed accounting standards that are masking significant hidden risks that will become apparent only as support policies are withdrawn,” the report explains.
The report urged policymakers in these economies to adopt a proactive management of distressed loans, as many households and companies are facing unsustainable levels of debt because of the lower income and revenue.
It also proposed adopting effective insolvency mechanisms in order to avoid the risk of long-term debt distress and lending to the affected companies that undercut economic recovery.
“Improving insolvency mechanisms, facilitating out-of-court workouts, especially for small businesses, and promoting debt forgiveness can help enable the orderly reduction of private debts,” the report illustrated.
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