The World Bank has warned that solvent governments may default if they lack the liquidity to make interest payments and refinance maturing obligations, which is more likely to be the case when the global financial conditions are unfavorable.
In its June 2026 Global Economic Prospects report, it said liquidity and rollover risks render interest rates more sensitive to additional debt, adding, high inflation is associated with a stronger linkage between spreads and debt, whereas weaker governance increases the estimated sensitivity of domestic-currency bond yields to debt.
“To examine the role of liquidity, the interaction between debt levels and two indicators of liquidity—holdings of foreign exchange reserves and the share of short-term debt—is examined. Larger foreign exchange reserves are associated with a slightly smaller sensitivity of both spreads and domestic-currency yields to debt. Conversely, higher shares of short-term debt are associated with substantial and statistically significant increases in debt sensitivity”, it said.
Inflation
In Emerging Markets and Developing Economies, the World Bank said capital flight and currency depreciation have often stemmed from inflationary financing, which has contributed to concerns about policy credibility, repayment risk, and financial stability.
To capture this effect, it pointed out that the analysis interacts public debt with the inflation rate. “Pe estimates show that higher inflation is associated with a greater sensitivity of sovereign spreads to debt, but no difference in the sensitivity of domestic-currency yields, perhaps because these yields already fully discount expected inflation”.
Governance and Institutional Quality
The World Bank said strong institutions enhance commitment to debt service and repayment, improve debt management, and reduce policy uncertainty.
It warned that weak governance, by contrast, will tend to amplify concerns about fiscal indiscipline, fiscal dominance, and discretionary and destabilising policy shifts, tending to steepen the debt–yield relationship.
This is proxied by interacting public debt with the International Country Risk Guide’s Bureaucratic Quality index.
It stated that per the estimates, the sensitivity of domestic-currency yields to debt is significantly larger in countries with weaker governance, but that the debt-spreads relationship is unaffected.
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