Enormous doses of stimulus spending are offering relief from COVID-19 damage, but their lifelong legacy of debt could seed future crises by hobbling economic growth and worsening poverty, especially in developing countries.
Central banks and governments worldwide have unleashed at least US$15 trillion of stimulus via bond buying and budget spending to cushion the blow of a global recession tipped to be the worst since the 1930s.
However, these steps will pile even more debt on countries already struggling with the aftermath of the 2008-2009 financial crisis — total global debt has risen US$87 trillion since 2007, and governments, with US$70 trillion, accounted for the lion’s share of that increase, the Institute of International Finance estimates.
This year alone may see the global debt to GDP ratio rise by 20 percentage points to 342 percent, based on 3 percent economic contraction and a doubling in government borrowing from last year, the institute said.
Taking on that kind of debt does not go unpunished. The most pain will be in highly indebted states, whether relatively wealthy ones such as Italy, or those such as Zambia which were already under strain before the virus hit and are now careering towards default.
Not even the richest will be spared. Rising debt could lose Germany and the United States their “AAA” credit ratings, while governments will increasingly rely on central banks to keep borrowing costs in check or even directly finance spending for years to come.
“Historically, whenever countries step up debt levels, things change,” said Mike Kelly, global head of multi-asset at PineBridge Investments.
“This crisis ... has taken us back to the slow-growth trap that we had just started to shake off in 2016-2019,” Kelly said.
The challenge for policymakers in coming years will be to find a way to “grow into this massive debt-GDP structure we have found ourselves in almost overnight,” he added.
For now, with the world economy staring at a 5 to 6 percent contraction this year, the additional borrowing and spending is a lifeline. The IMF estimates public deficits will jump to almost 10 percent of national income this year from just under 4 percent last year.
Even European powerhouse Germany is taking on new debt for the first time since 2013, while the US Treasury’s second quarter borrowing will amount to almost US$3 trillion — more than five times the previous record.
US federal debt held by the public, a gauge tracked by the Congressional Budget Office, will rise to 100 percent of GDP this year — levels last seen in the 1940s — and approach 125 percent by 2030, Deutsche Bank calculates. It was 79 percent in the last fiscal year.
Eventually though, debt can drag on economic growth if countries start to spend more and more of their annual income on paying creditors, a position developing countries have endured time and time again.
Accelerating economic growth under those circumstances is like “trying to fly when we were already carrying a lot of debt and now we are adding more,” Secretary-General of the Organisation for Economic Co-operation and Development Angel Gurria said.
Low interest rates will allow some countries to live with higher debt. Japan’s debt for instance exceeds 200 percent of its GDP, but it prints money to issue debt which the central bank then buys.
“The ability to control interest rates and keep rates low is a key parameter for keeping debt servicing costs low and we expect that to continue,” said Eric Brard, head of fixed income at Amundi.
The trend will gather pace in the United States and Europe too, with central banks soaking up much of the excess debt.
However, in some countries, average GDP growth has crawled along well below interest rates for years, meaning debt ratios were rising relentlessly even before the COVID-19 pandemic hit.
Italy, for instance, has not benefited from five years of low interest rates, said Kevin Thozet, a member of the investment committee at asset management firm Carmignac.
“Italy’s debt, at around 135 percent of GDP, is likely to rise to around 170 percent — those levels are not sustainable, so it either needs rapid growth or debt mutualization,” he said.
He was referring to the idea of pooling European risk across all member states, something wealthier countries are resisting.
According to Pictet Asset Management, Greece had the worst debt sustainability at the end of last year among developed countries, followed by Italy, Japan, Belgium and Britain.
However, Italy and other southern European states have the might of the European Central Bank backstopping their borrowing, a luxury most developing countries lack.
Central banks in about a dozen emerging economies have started their own quantitative easing programs. Yet without big domestic savings pools, most rely on foreign investors to cover balance of payment deficits and underpin currencies.
That, along with inflation risks, constrain how much money they can print to support growth. Bond-buying programs in Brazil or South Africa could see real interest rates at the back end of the yield curve push up sharply, said Manik Narain, a strategist at UBS.
“How can South Africa service debt at 10 percent? This debt becomes unsustainable and creates a crisis — at best it will pull GDP growth down,” he added.
The dynamics could put some developing economies on track for another devaluation and inflation cycle.
“Worryingly, some large developing economies — Turkey, Brazil, South Africa — are heading in this direction,” said Andres Sanchez Balcazar, head of global bonds at Pictet Asset Management.
Some countries such as Brazil and South Africa have for years grappled with annual growth below 2 percent, while interest rates were as high as 14.25 percent and 7 percent respectively.
Bank of America calculates public debt could hit 77.2 percent of GDP by the end of the year in Brazil and 64.9 percent in South Africa. A decade ago, they were around 61 percent and 35 percent respectively, IMF data showed.
Rising debt levels in turn raise borrowing costs for such issuers, said Edith Siermann, head of fixed income solutions at NN Investment Partners.
“The long-term worry is — who is going to pay for this?” she added.
Additional reporting by Sujata Rao
This year marks the 75th anniversary of the end of World War II. In that war’s aftermath, novelist George Orwell produced two prophetic works. The first, Animal Farm, was published in August 1945; the second, Nineteen Eighty-Four, came out in June 1949. Both still ring true and cover a wide range of messages, including even how the mid-sized nation of Taiwan achieved its democracy and why it still maintains an outlier status in a COVID-19 world. With its full planetary scope, WWII left untold millions dead and injured, cities were destroyed and the future path of most nations was altered. New
Israel-based geo-intelligence data provider ImageSat International on May 13 released a satellite photograph of the Chinese-controlled Fiery Cross Reef (Yongshu Reef, 永暑礁) on Twitter. The image gave a clear view of Chinese People’s Liberation Army (PLA) Air Force Shaanxi KJ-500 airborne early-warning aircraft, KQ-200 anti-submarine maritime patrol aircraft and a suspected Changhe Z-18 anti-submarine helicopter, showing that the PLA has advanced its deployment in the South China Sea. Only last month, China established Xisha District (西沙) on Woody Island (Yongxing Island, 永興島) and Nansha District (南沙) on the reef, both of which fall under Sansha, a prefecture-level city established in
In Japan, as in Taiwan, interest in President Tsai Ing-wen’s (蔡英文) inaugural address on Wednesday last week for her second term was widespread. In her speech, which I listened to online, Tsai talked about how the COVID-19 pandemic has changed the global political economic order and altered global supply chains. This is an issue that Japan must also face, so I would like to present an idea for the people of Taiwan to consider. In the wake of the pandemic, Japan and Taiwan must consider the risks arising from supply chains’ dependence on China, as well as the risks that arise from
China took advantage of the vacuum left behind when US carriers stayed out of the western Pacific Ocean due to COVID-19 outbreaks on several US Navy warships. The Chinese government is solidifying its hold on artificial islands in the South China Sea by moving in missiles and surveillance equipment, and formalizing its occupation by creating two municipal districts in the region under Hainan Island’s Sansha — Xisha District on Woody Island (Yongxing Island, 永興島) to administer the Paracel Islands (Xisha Islands, 西沙群島) and Nansha District on Fiery Cross Reef (Yongshu Reef, 永暑島) to administer the Spratly Islands (Nansha Islands, 南沙群島) —