A Template for Understanding Big Debt Crises

by Ray Dalio

Here is what we typically see when the country reaches the bottom: The collapse in imports improves the current account a lot (on average by about 8 percent of GDP). Capital inflows stop declining and stabilize. Capital flight abates. Frequently, the country turns to the IMF or other international entities for support and a stable source of capital, especially when its reserves are limited. Short rates start to come down after about a year, but long rates continue to stay relatively elevated. After peaking, short rates fall back to their pre-crisis levels in around two years. The decline in short rates is stimulative. As interest rates come down, the forward currency price rallies relative to the spot. As the currency stabilizes, inflation comes down. Usually it takes nearly two years after the bottom for inflation to reach pre-crisis levels.