Global outlook c h a p t e r 1

Financial crises
The risks of financial crises are increasing owing to 
surging debt, weak activity, eroded capital buffers 
in the banking system, and elevated risk asset 
valuations (figure 1.16.A; box 1.1). These 
developments follow a decade which featured the 
largest, fastest, and most broad-based increase in 
debt on record (Kose et al. 2020a). Fiscal support 
and private sector borrowing to weather the shock 
from COVID-19 have pushed debt even higher 
(figure 1.16.B). Although low interest rates 
mitigate risks for some countries, elevated debt 
levels nonetheless increase the vulnerability to a 
shift in market conditions and make costly 
financial crises more likely—about half of all 
episodes of government and private debt 
accumulation in the last 50 years were associated 
with financial crises (figure 1.16.C). 
Many borrowers would struggle to finance fiscal 
and current account deficits if investor sentiment 
were to deteriorate suddenly. Underdeveloped 
capital markets in many EMDEs pose risks to 
banking, corporate, and government funding in 
the event of a renewed tightening in global 
financial conditions (IOSCO 2020). Higher 
funding costs could lead to forced austerity or 
disruptive defaults that result in lost access to 
international debt markets. In the past, investor 
appetite for EMDE debt has proved sensitive to 
perceptions of risk, domestic inflation pressures, 
and the return on safe assets. An increase in any of 
these could trigger a reversal of the private capital 
inflows needed to finance elevated levels of debt. 
Capital outflows would also result in currency 
depreciation pressures and a surge in external 
borrowing costs for both sovereigns and 
corporates.
Central bank easing has been successful in averting 
a liquidity crisis, but may not be able to address a 
in the face of supply bottlenecks and vaccine 
hoarding. In the downside scenario in box 1.4, 
general vaccine deployment is markedly slower, 
with widespread global coverage only achieved 
outside of the forecast horizon. 
A protracted upsurge in cases across many 
countries would interrupt the recovery in 
consumer and business confidence. News of a 
significant delay in vaccine deployment could be 
one trigger for a sudden worsening of financial 
conditions, including a sharp drop in equity 
valuations and a flight to safety that would add to 
the financial pressures on riskier borrowers. Private 
consumption would be depressed for several 
quarters and investment would soften as growth 
prospects are downgraded. Activity in sectors 
sensitive to public interactions would be hardest 
hit, with any recovery in domestic and foreign 
tourism held off until the second half of 2022. 
Some countries may be unable to provide further