Record high of global debt: how much debt is too much?

From the December 2020 IAFEI Quarterly Bulletin

By Anastassios Rodopoulos

If you ask people which word in the English language is most associated with business, 99 out of 100 people will answer the same way.

You: What’s the one word you most associated with the business world?

Anyone: Money!

Every business deals with money. That’s what makes it a business! Businesses sell goods and services for money. Money is not only the basic molecule of business, it’s also what makes a business a business rather than a hobby.

Money is at the center of every conversation about how to succeed in business, how to start a business and how to keep it business thriving. And where we find the money we borrow money!

The pandemic prompted a sweeping array of relief measures, growing debt levels to near record levels of Debt-to-GDP ratios near their post World War Two highs. While economists are less concerned about these skyrocketing debt figures than in years past [the cost of borrowing is remarkably low], there is nevertheless an upper limit on how much data central bank can issue: investor confidence in present and future net tax revenues. If the government doesn’t make enough to meet its obligations, it won’t be able to roll over maturing debt by issuing new debt as investors doubt its ability to pay off its future obligations.

Assuming it cannot generate additional tax revenues, the only feasible option is for an advanced economy government [other than default] is higher inflation.

Have such a response would still cap borrowing as investors demand premiums for inflation risks, raising interest rates. While this is not a call for immediate austerity [targeted pandemic investment in households and firms will translate to future revenues], public spending must acknowledge its limits and not rely on magical monetary thinking.

The IMF, the World Bank, and other multilaterals acted quickly to provide much needed funding amid the pandemic as government revenues collapsed alongside economic activity, while private capital flows came to a sudden stop. In addition to new loans from multilaterals, Group of 20 [G20] creditors granted a debt moratorium to the world’s poorest countries. They have encouraged private lenders to follow suit – albeit with little success.

So far, the pandemic shock has been limited to the poorest countries and has not morphed into a full blown middle income emerging market debt crisis. Thanks in part to favorable global liquidity conditions confirmed by massive central bank support in advanced economies, private capital outflows have moderated and many middle income countries have been able to continue to borrow in global capital markets. According to the IMF, emerging market governments issued 124 billion dollars in hard currency debt during the first six months of 2020, with 2/3 of the borrowing coming in the second quarter.

But now comes the inequality effects. Inequality reduces growth!

Yet, there are still reasons for concern about sustained emerging market access to capital markets. The riskiest period may still lie ahead. The first wave of the pandemic is not over. Experience from the 1918 influenza pandemic suggests the possibility of an even more severe second wave, especially if it takes until mid-2021 [or later] for an effective vaccine to become widely available.

Even in the best-case scenario, international travel will face roadblocks, and uncertainty among consumers and businesses is likely to remain high. Will poverty has risen sharply, and many people will not be returning to work when the crisis losses. The political ramifications of the crisis in advanced economies I still am falling. The backlash against globalization, already rising before COVID-19, may intensify.

Rising budget pressures have been accompanied by a new wave of sovereign debt downgrades, surpassing peaks during prior crises. They have persisted even as major advanced economy central banks have eased credit conditions. Central bank purchases of corporate bonds to provide support for local firms in emerging market and developing economies have also handicap their debt ratings.

History shows that it is not unusual that countries can keep borrowing even when default risk is high. A review of 89 default episodes from 1827 to 2003 shows the typical experience to be a sharp rise in borrowing, both external and domestic, in the run-up to default. Ideally, this time will be different, but the record is not encouraging.

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