Low- and middle-income countries’ external debt cycle and global economic prospect

Abstract

The rapid growth of peripheral countries has brought significant changes to the global economic and financial system, making it crucial to examine the relationship between their cyclical debt fluctuations and the world economy. Using the Bayesian dynamic factor model, this paper documents the presence of a set of common factors, known as global debt cycles, in the external debt accumulation of the low- and middle-income countries (LMICs). The interesting finding is that this debt cycles differ from well-known factors for global financial cycles in capital flows, such as U.S. monetary policy and global risk aversion. Even after controlling the factors for global financial cycles, our results reveal a significantly negative predictive effect of estimated debt cycles on global economic growth. Moreover, we demonstrate that this negative effect is primarily dominated by LMICs occupying prominent positions in international debt market networks, especially during the post-2008 financial crisis period. These findings emphasize the increasing importance of peripheral countries in the world system, which has been largely ignored in existing literature.