Growing debt burdens are putting increasing pressure on governments worldwide, leaving developing countries with less fiscal space for development and strengthening calls for a fundamental overhaul of the global financial system.
The United Nations’ Fourth International Conference on Financing for Development (FfD4), held in Seville in July 2025, delivered a clear warning about the global financial architecture’s inability to cope with mounting debt distress. The issue received renewed attention at the 2026 annual meetings of the International Monetary Fund (IMF) and World Bank, which concluded in Bangkok last month.
Pakistan’s Planning Minister Ahsan Iqbal also highlighted the need for fundamental reforms at the Sustainable Development Policy Institute’s (SDPI) 29th Sustainable Development Conference. He stressed that the global financial architecture required a comprehensive overhaul, arguing that limited or partial reforms would not be sufficient.
Global Debt at Record Levels
Debt is increasing across regions and income groups faster than many countries can manage it, steadily reducing the resources available for development.
According to the Institute of International Finance (IIF), global debt reached a record $348 trillion at the end of 2025. Average global debt per person exceeded $42,000, almost three times the world’s average per capita income of approximately $14,400 in 2025, according to World Bank figures.
Higher global interest rates and the dominance of the US dollar have placed additional pressure on developing economies. Countries with lower debt levels can face greater difficulties servicing their obligations than wealthier nations because of their limited revenue-generating capacity.
World Bank data highlights this imbalance. Low-income countries generate government revenue equivalent to just 12% of their gross domestic product (GDP), compared with 26% in wealthy economies. This leaves poorer nations with fewer resources to meet debt payments while funding essential public services and development projects.
External shocks, including recent increases in Middle Eastern oil prices, can make the situation worse, particularly for low-income countries that depend heavily on imported energy.
Developing Countries Face Debt Risks
The IMF’s debt sustainability assessments, published as of September 2025, indicate that nearly half of low-income countries are either already experiencing debt distress or face a high risk of it.
Since 2020, several countries, including Zambia, Ghana, Sri Lanka and Ethiopia, have defaulted on their debt obligations.
The World Bank estimates that more than 837 million people remain in extreme poverty, many of them living in countries facing severe fiscal pressures.
The author argues that these conditions make fundamental changes to the international financial system increasingly urgent. Pakistan is also in a position to contribute to the debate, as it is scheduled to chair the IMF-World Bank Boards of Governors in 2027.
Pakistan’s own experience demonstrates how quickly economic vulnerabilities can intensify under difficult international conditions. During its near-default episode in 2023, the country’s foreign exchange reserves held by the State Bank of Pakistan fell to approximately $3 billion, covering less than three weeks of imports.
Inflation reached 38% in May 2023, according to the Pakistan Bureau of Statistics, while the central bank’s policy rate increased to 22%.
Six Reforms to Address Debt Distress
The international response to rising debt distress has so far remained temporary, fragmented and largely reactive.
The G20’s Common Framework, which was introduced to facilitate deeper debt restructuring, has faced lengthy negotiations, slow implementation and limited results.
The situation has become more complicated as the creditor base has expanded beyond traditional Paris Club lenders. Private bondholders, non-traditional bilateral creditors and lenders providing loans against collateral now play a larger role, making coordination more difficult and reducing incentives for timely debt resolution.
The author identifies six major reforms needed to address the crisis.
1. Establish a Debt Workout Mechanism
A predictable, rules-based mechanism for restructuring sovereign debt is essential to ensure that countries facing unsustainable obligations can negotiate solutions without prolonged uncertainty.
The author argues that legislation in New York and London could give such a mechanism legal force, as the laws of these two financial centres govern nearly all international sovereign bonds.
2. Make Debt Restructuring Preventive
The second reform, which the author considers particularly important, is to shift debt restructuring from a reactive process to a preventive one.
Governments often delay acknowledging debt distress because formally announcing a default carries significant political and economic costs. In an effort to avoid that stigma, they may impose strict fiscal measures even when economic conditions require additional public spending and support.
Such policies can deepen economic contractions and reverse development gains.
The author proposes automatic debt standstill provisions that would temporarily suspend debt repayments when predefined and transparent conditions are met, such as a specified level of damage caused by a natural disaster.
The World Bank’s climate-resilient debt clauses already allow eligible countries to defer repayments for up to two years following a natural disaster.
At the Seville conference, the Debt Pause Clause Alliance, comprising bilateral and multilateral creditors, also committed to promoting similar provisions.
The next step, according to the author, should be to extend these arrangements to all lenders and bondholders.
Pakistan could have benefited significantly from such a mechanism after the devastating 2022 floods, which caused more than $30 billion in damage and economic losses. A temporary suspension of debt payments could have released resources when the country needed them most.
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3. Bring Private Creditors Into Restructuring
The third priority is to develop a more effective approach to involving private lenders in debt restructuring.
Countries can face higher borrowing costs as soon as they signal financial difficulties, even when they are considering early solutions such as debt-for-nature swaps. This discourages governments from seeking assistance before the situation becomes critical.
Although collective action clauses have become standard in most newly issued bonds, the author argues that they are not sufficient on their own.
Comparable treatment of official bilateral and private creditors should be enforced. Laws restricting litigation by creditors that refuse to participate in restructuring agreements could also prevent a small number of lenders from blocking broader settlements.
4. Strengthen Multilateral Development Banks
The fourth reform involves increasing the capital bases of multilateral development banks and expanding their concessional lending facilities.
The author also recommends introducing counter-cyclical financing instruments that automatically increase lending during global economic downturns.
Such support could help developing countries maintain essential spending and protect development programmes when economic conditions deteriorate.
5. Improve Public Debt Transparency
The fifth priority is greater transparency in public borrowing.
Governments and lenders should publish detailed, loan-level information to make debt obligations easier to track and assess.
The author proposes establishing a comprehensive global debt registry that would be publicly accessible and regularly updated.
Greater transparency would reduce information gaps, improve accountability and help countries and creditors make better-informed decisions.
6. Reform Debt Sustainability Assessments
The final reform is to move beyond Debt Sustainability Analyses (DSAs) that focus primarily on financial and economic indicators.
The IMF and World Bank are reviewing their debt sustainability framework for low-income countries, with a revised version expected in 2027.
The author argues that climate risks should be incorporated directly into baseline projections rather than considered mainly through stress tests. The potential economic growth benefits of climate-related investment and spending on Sustainable Development Goals (SDGs) should also be reflected in these assessments.
Pakistan’s Role in Global Reform
The author acknowledges that debtor countries must also take responsibility for improving their financial positions.
Given that low-income economies generate government revenue equivalent to only 12% of GDP, broadening tax bases and strengthening public debt management are essential steps towards improving fiscal stability.
Pakistan, which faces both climate-related risks and a heavy debt-servicing burden, should use its 2027 chairmanship of the IMF-World Bank Boards of Governors to advocate for debt pause clauses across its creditors.
The country could also help build a coalition of debtor nations to push for more effective and coordinated international reforms.
The global financial architecture was designed for a different economic era. Without decisive and coordinated changes, it risks continuing to respond too slowly and inadequately to the growing debt challenges facing developing countries.
About the Writer: The writer is Deputy Executive Director at the Sustainable Development Policy Institute (SDPI) and writes on macroeconomic policy and economic governance.
