By Andrea Shalal and David Lawder
WASHINGTON (Reuters) - Developing countries must quickly strengthen their financial sectors, the World Bank said on Tuesday, warning that rising inflation, interest rates and alarming levels of debt distress could trigger a global chain reaction not seen in generations.
The World Bank underscored its longstanding concerns about lack of transparency about Chinese lending and collateralized loans in the sovereign debt sector, but also called out growing private sector risks in its latest World Development Report.
The bank's surveys showed 46% of small and medium-sized businesses in developing countries expected to fall behind on debt payments within six months, but the number was twice as high in some countries, chief economist Carmen Reinhart told Reuters in an interview ahead of the report's release.
Reinhart said she was keeping a close eye on private sector debt developments in bigger emerging markets like India, South Africa, the Philippines, and Kenya, where more than 65% of small and medium-sized companies expected to be in arrears.
She told an online World Bank event that the share of countries in or at risk of debt distress was in "alarming territory," but financial sector policies were also needed to address risks posed by rising debt among households and firms.
Turkey, whose credit rating was downgraded to "BB-" by ratings agency Fitch last week, had been in crisis for several years and could "well be the straw that broke the camel's back," she told Reuters.
Massive fiscal and monetary support had helped mitigate the consequences of the economic crisis triggered by the pandemic, but forbearance policies and relaxed accounting standards could be obscuring a "hidden non-performing loan problem," she said.
"There's a huge need for better transparency on the private sector debt," Reinhart said.
"What gets you in the end is not so much what you see, but what you don't see," she said, warning against a false sense of complacency about financial health of households and firms.
Bank for International Settlements head Agustin Carstens told the World Bank event that many of the macroeconomic policies adopted by governments during the pandemic had hit their limits and new policies were now needed to enhance the resilience of private firms and support employment.
The report urged greater efforts to improve transparency about private sector debt, more proactive management of distressed loans, including out-of-court solutions, as well as accelerated work on addressing sovereign debt distress.
Many ratings agencies also failed to factor in foreign state-owned enterprises that could raise significant financial risks in low-income and some emerging market countries, it said.
World Bank President David Malpass highlighted risks of spillover effects given the interrelated nature of households, firms, financial sector institutions and governments. "Private debt could suddenly become public debt, as in many past crises," he wrote in the forward to the report.
Speaking on Tuesday, Malpass said gradual interest rate hikes by central banks and a tapering of bond purchases alone were unlikely to control inflation that is hitting the world's poorest the hardest.
Instead, he said, governments and central banks - in developing countries and advanced economies - should "use more of their tools at the same time," including steps to lengthen the maturity and transparency of all levels of outstanding government debt, and slow the growth in national debt levels.
STALLED PROGRESS ON SOVEREIGN DEBT RESTRUCTURING
Malpass said implementation of the Common Framework agreed by China, the world's largest creditor, and other Group of 20 major economies to deal with debt problems was stalled.
The pandemic-induced recession of 2020 led to the largest single-year surge in global debt in decades, and 51 countries had their sovereign debt credit rating cut, but the issue had not triggered the urgent action needed, Reinhart said.
Malpass warned that the longer such debt restructuring efforts took, the bigger the "haircut" creditors faced.
"For debtor countries, delay presents major setbacks to growth, poverty alleviation and development," he wrote, adding that negotiations about moving forward were now "stalled."
The International Monetary Fund last week said it would press G20 finance leaders meeting this week to strengthen the framework for poor countries given rising default risks.