Debt Sustainability and Growth Prospects: Constraints, Composition, and the New Normal

The post-pandemic macroeconomic environment has reconstituted the determinants of sovereign debt sustainability in two important ways. First, elevated debt-to-GDP ratios—amplified by 2020–21 fiscal interventions—now coexist with structurally higher real interest-rate risk and slower potential growth in many economies; second, heterogeneity in debt composition (currency of denomination, maturity, and creditor type) matters materially for how debt interacts with growth potential. Recent empirical and institutional work demonstrates that sustainability is not a simple function of the headline debt ratio alone but an outcome determined jointly by primary fiscal balances, real growth, real interest rates, and the profile of liabilities. Policy emphasis must therefore shift from static debt targets to dynamic interactions among these factors.

Empirical analyses reinforce classical mechanics: when the real effective interest rate persistently exceeds real GDP growth, debt ratios tend to rise absent offsetting primary surpluses, and the fiscal cost of servicing debt crowds out public investment that supports long-run productivity. Institutional evidence—synthesised in recent OECD and World Bank diagnostics—finds that elevated debt-service burdens compress space for capital spending and social programmes in many middle- and low-income countries, with direct implications for medium-term growth trajectories and the Sustainable Development Goals. Importantly, the displacement effect is conditional on the quality and efficiency of public spending: borrowing that finances high-return public investment (R&D, human capital, public infrastructure) is associated with weaker negative or even positive growth effects relative to borrowing that finances recurrent, low-multiplier outlays.

The literature on “debt overhang” provides a longer-run perspective: historically, sustained episodes in which public debt exceeds critical thresholds have tended to coincide with output levels materially below potential. Cross-country historical work shows that prolonged debt overhangs are associated with multi-year growth shortfalls, both through direct crowding-out of private investment and by elevating sovereign risk premia that raise financing costs. However, the precise threshold is not universal; institutional quality, exchange-rate flexibility, and domestic financial depth mediate the threshold at which debt becomes growth-inhibiting. Hence, country-specific diagnostics are essential rather than reliance on one-size-fits-all ratios.

Policy implications derived from peer-reviewed and institutional research converge on three actionable priorities. (i) Rebalance fiscal strategy toward improving primary balances in a manner that preserves high-return investment; sequencing matters—consolidation that disproportionately cuts productive investment will exacerbate growth losses. (ii) Improve liability management: lengthen maturities, reduce foreign-currency exposure where feasible, and diversify creditor bases to lower rollover and currency risks. (iii) Strengthen institutions and public-investment management to raise the growth yield of borrowing; better project selection and governance materially alter the growth–debt trade-off. These measures, when combined with credible medium-term fiscal frameworks, reduce sovereign risk premia and ease the real burden of debt over time.

In short, contemporary debt sustainability is an exercise in dynamic trade-offs: preserving growth requires simultaneously managing interest-rate risks, improving the composition and use of debt finance, and enhancing institutional capacity. Countries that treat debt only as an accounting ratio—and not as a vector of financing composition, governance quality, and growth impact—risk policy errors that deepen, rather than resolve, medium-term fiscal vulnerabilities.

International Monetary Fund, 2024. The fiscal and financial risks of a high-debt, slow-growth world, IMF Blog, 28 March 2024.

Organisation for Economic Co-operation and Development (OECD), 2024. Global Debt Report 2024. OECD Publishing, Paris.

World Bank, 2024. International Debt Report 2024. World Bank Group, Washington, DC.

Reinhart, C.M. & Rogoff, K.S., 2012. Debt Overhangs: Past and Present. NBER Working Paper No. 18015. National Bureau of Economic Research.

United Nations Department of Economic and Social Affairs (UN DESA), 2024. Financing for Sustainable Development Report 2024: Debt and debt sustainability in numbers. UN DESA, New York