The Financial Express

Global debt surging ahead

Bangladesh: Case for domestic borrowing compelling

Bangladesh: Case for domestic borrowing compelling

Global debt records were smashed in 2019 reaching the highest debt - to GDP ratio to 322 per cent which narrowly surpassed 2016 as the highest on record. Global debt is composed of borrowing by households, governments and corporations and grew by US$9.0 trillion to US$253 trillion. But that is not the end of the story, according to the Institute of International Finance (IIF), the figure could reach US$257 trillion by the end of first quarter in 2020. A snapshot of total global debt tells us now that each inhabitant in our world populated by 7.7 billion people owes US$32,500, accounting for 322 per cent of global GDP (gross domestic product). 

More than half of this massive debt has been accumulated in developed economies such as the US and advanced European countries and Japan. These countries now have achieved their debt to GDP ratio to 383 per cent with total debt standing at US$180 trillion. Among these countries New Zealand, Norway and Switzerland have rising household debt levels, while Australia and the US have recorded all-time high government debt to GDP ratios. At the same time corporate debt in the US has risen to nearly US$10 trillion, equivalent to 47 per cent of GDP.

However, the largest increase in debt is in China where debt to GDP has risen close to 310 per cent, one of the highest in emerging markets. This is the result of measures taken by the Chinese government and financial authorities to sustain economic growth in the face of economic slowdown. The rising corporate debt is also of increasing concern. The Institute of International Finance (IIF) noted that as the economy is slowing down, debt growth is on the rise again, especially in the non-financial corporate sector.

But according to a Reuter report increased levels of debt in China is generating smaller increases in output than in the past. This is reflected in a three-fold increase in the incremental capital output ratio from 2009 to 2017. The report further added "in other words, China's credit-heavy financing spree was not matched by a corresponding  boost in productivity, but by an increasingly inefficient use of credit, which suggests China's corporations may have a deteriorating  capacity to repay their existing debts.''

In emerging market economies, debt levels are lower at US$72 trillion but they have been rising at a faster rate in recent years. The potential risk factor facing these economies that their debt is mostly foreign currencies, especially  the US dollar, which will become increasingly difficult to pay off if the US dollar continue to appreciate. The US dollar-denominated debt reached about US$8.0 trillion by the third quarter of last year.   

In a report published last December the World Bank warned that on several measures developing economies were in a worse situation than before the global financial crisis (GFC). Three quarters had budget deficits, corporate debt denominated in foreign currencies was much higher, and current account deficits were four times larger than in 2007.

Overall these economies are now faced with weaker growth prospects in a fragile global economic environment. In addition to debt build-up, they are now experiencing growing fiscal and current account deficits and a shift towards a riskier composition of debt. The IIF also expressed concern over countries with limited borrowing capacity facing severe challenges in meeting development finance needs to meet the UN's Sustainable Development Goals (SDG) which require US$42 trillion investment in infrastructure by 2030.

Such massive global debt spiral poses a real risk for the global economy. The World Bank Report entitled "Global Waves of Debt: Causes and Consequences'' pointed out that debt accumulation have been a major feature of the global economy over the last 50 years, with four in emerging and developing economies. The first three ended in financial crises. The fourth wave of debt accumulation starting in 2010 taking place in conditions of lower growth than the period preceding the GFC and the exceptional size and speed are cause for concern. The report further said that despite exceptionally low interest rates and the prospect of continued low rates in the near term, the current wave of debt accumulation could follow the historical pattern and culminate in financial crisis.

Why has such a pile-up of debt happened and continues to rise? The post-GFC driver of debt binge is low interest rates. US interest rates were cut three times last year, in the EU (European Union) and Japan zero lower bound on interest rates has long since been broken. Also, the pumping of trillions of dollars into financial markets by the major central banks through quantitative easing (QE) further added to the borrowing binge. Most of this borrowed money went into share buybacks to stimulate the share market rather into productive investment in the real economy. As the central banks are running out of options other than interest rate cuts and printing money, some observers characterise the deployment of these two instruments as an ongoing Hail Mary-type bid to stimulate the economy.

Many observers now fear that the world in fact may be gearing up for another financial crisis, potentially worse than that of 2007-08. Carmen Reinhart and Kenneth Rogoff in their book "This Time Is Different: Eight Centuries of Financial Folly'' demonstrated that large increases in public debt tended to precede bad things happening to the economy. They also indicated that a debt to GDP ratio of 90 per cent or higher brought a period of weaker economic growth. Even if one argues that whether debt is the cause or effect, the correlation is rather very strong in a historical perspective. Historically high levels of debt have been followed by slower economic growth or even recessions.

Central banks generally pursued the cheap money policy primarily to stimulate mortgage lending and other loans with the hope that would stoke investment and jobs. With inflation low, central banks feel comfortable to keep borrowing costs low without risking the health of their economies. But such a massive amount of money that is floating around in the global financial system is flowing into all sorts of speculative and obscure assets including share buybacks. One effect of the policy of cheap money is the rising stock prices as is now seen in the US despite the coronavirus knock-on effect.

Macroprudential policy to contain debt and deflate asset price bubble generally rests outside the realm of central banks but now central banks are increasingly stepping into this area to stabilise the broader economy. Now central banks are combining their traditional mandate to control inflation with the task of maintaining financial stability to avoid a financial crisis to ensure that all debt must be repaid.

However, as Reinhart and Rogoff pointed out, in the past countries often reduced their debt costs by allowing inflation to dilute the value of their bonds. But that is not the case anymore, most central banks are mandated to keep a lid on price increases (inflation), and they take that job very seriously by setting inflation targets. Now the result is debtors will have to pay up their creditor or default, there is no room for playing any tricks this time around.

Increased connectivity to international financial markets poses increased risks to developing countries like Bangladesh. Increasingly economic growth has been becoming reliant on debt. Such inflows of external resources can lead to exchange rate appreciation, loss of competitiveness and a negative impact on export earnings. Over the past decade there has been a rise in the accumulation of private, non-financial corporate debt.

While a country like Bangladesh relying on low-skill manufactures has enjoyed export success, that success has come at the expense of economic diversification, the key to growth in the long run. But as the global economy is slowing down, Bangladesh is likely to experience diminished export earnings and slower growth which in turn will reduce tax revenue leading to fiscal deficits. All these will cause to challenge the debt sustainability.

Public debt in Bangladesh stood at US$91 billion in 2018 accounting for 34 per cent of GDP. This figure is used by investors to measure a country's ability to make future payments on its debt, thus affects the country's costs and government bond yields.

Public debt in Bangladesh is projected to rise to US$121 billion by the end of this year. Most of the public debt is domestic and denominated in the local currency accounting for 56 per cent of total public and publicly guaranteed debt (PPG) in 2018. External debt is mostly owed to multilateral and bi-lateral creditors. In recent years there has been an increase in private external debt accounting for about 15 per cent of total external debt in 2018.

Overall Bangladesh remains at low risk of debt distress as reflected in total debt service as percentage of goods, services and primary income. The figure stood at 6.33 per cent in 2018. But looking at this figure over the last 40 years or so one ought to be careful as it fluctuated between 38.5 per cent in 1986 and 4.7 per cent in 2016. But the trend of the ratio has been mostly in the single digit level since 2001.

For Bangladesh the case for domestic borrowing is rather compelling, even though domestic borrowing quite often can be more costly than external borrowing. Increased reliance on domestic borrowing has its own complications when sovereign debt restructuring becomes necessary. Therefore, it is necessary that domestic debt remains completely under domestic jurisdiction separate from external sovereign debt. This will enable the country to weather through any economic downturn caused by any external debt crisis.

Muhammad Mahmood is an independent economic and political analyst.

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