China and the sovereign debt bomb

INTERNATIONAL capital flows have long been a major source of economic growth. Savings in higher-income countries have financed high-yielding investments in low-income countries, generating benefits for all. After World War II, capital flows under the Marshall Plan drove the rapid reconstruction of Europe, and after those countries recovered, they extended their own foreign aid and other official financial flows to the developing world. Private financing also increased substantially; by the 1990s, it accounted for over half of total capital flows to developing countries.

Some of these flows led to spectacular results. South Korea was one of the poorest countries in the world in the 1950s, with a savings rate of only 3 per cent of gross domestic product (GDP). But after implementing major policy reforms, it was able to avail itself of large capital inflows to finance investments with very high rates of return. It has since become an advanced economy. High savings and investment rates mean it has no difficulty servicing its debt.

But not all low-income countries have pursued macroeconomic and other policies that are conducive to growth. Many have borrowed to cover balance-of-payments deficits and other problems, depleting their foreign-exchange reserves and jeopardising their access to private capital markets.