The Covid-19 pandemic has led to unprecedented government spending around the world to ward off grave economic consequences. But this spending to fund economic stimulus measures has made countries, both developed and developing, more indebted than anytime in modern history. Many countries entered the pandemic with already elevated debt levels. But high public debt did not restrict developed economies to borrow to deal with the crisis, but developing countries have found it more difficult to borrow, especially the highly indebted ones to support the response to the pandemic. At the same time corporations encouraged by government support measures and rock-bottom interest rates have also got into a borrowing binge.
It is estimated that the pandemic has added US$24 trillion to the global debt burden in 2020. This pandemic-triggered government debt has been piled on top of the money created in the immediate aftermath of the great financial crisis (GFC) of 2008. Now the global debt stands at a record US$281 trillion. This is the largest peace time borrowing in history-- increasing public debt by 15 per cent globally.
According to the Institute of International Finance (IIF), government support programmes had accounted for half of this rise in debt level, while global firms, banks, households added US$5.4 trillion, 3.9 trillion and 2.6 trillion respectively. Now the rise in global debt levels has caused a surge in the debt to global GDP ratio by 35 percentage points to over 355 per cent. This rise is quite well beyond the rise seen during the GFC. The IIF also expects global government debt to rise by another US$10 trillion this year.
The very low interest rates in some countries have even moved to negative rates and made borrowing very affordable and costs of debt servicing manageable. Also, government borrowing supported by central banks slashing interest rates and buying an estimated US$ 5 trillion assets -- largely made up of longer dated second-hand government bonds -- has now started to buy corporate bond for the first time with created money which further added to the accumulation of debt.
As a result, balance sheets of central banks, especially in the developed countries swelled significantly exposing themselves to the risk of rising interest rates. Like the latest rush of printed money, central banks' greatly bloated balance sheets were ostensibly designed to preserve financial stability, but more particularly to prop up big banks. Central banks thus have enabled countries to borrow at a breakneck speed. Big banks and corporations are now heavily cashed up with borrowed money and are on a buy back spree of their shares. Thus, money is moving into buying and selling financial assets rather than stimulating the real economy.
Many weak firms also joined in the borrowing binge to take advantage of low interest rates. The IIF pointed out that "premature withdrawal of supportive government measures could mean a surge in bankruptcies and a new wave of non-performing loans". As such it further added that sustained reliance on government support could pose a "systemic risk". Corporate debt already reached alarming levels when the pandemic hit in many emerging market economies and the situation has now further worsened.
The World Bank (WB) also pointed out that corporate debt in economically weaker countries had shot up from 56 per cent of GDP to a sky high 96 per cent. High and rising corporate and private debt may also cause problems as countries try to transit to achieve solid economic growth.
According to Bloomberg Economics, debt for the G-7 countries rose from 85 per cent of GDP in 2005 to 140 per cent now, but servicing debt has fallen from close to 2 per cent to 1.5 per cent during the same period. It is projected that debt servicing costs are expected to remain manageable until 2030. In fact, such a low interest cost burden relative to GDP is further bolstering the case for even more borrowing to further stimulate the economy.
But as the economic recovery gather momentum with increased public spending, the balance of risk will shift. Central banks will have to juggle between rising inflation and continued public spending with the consequent rise in interest rates.
Meanwhile, the International Monetary Fund (IMF) has issued a warning that lower income countries face a debt sustainability crisis as interest rates on bonds start to rise. In fact, interest rates on bonds are already showing an upward trend. According to a Brooking Institute report "the developing world is currently facing twin crises -a balance of payments and a debt crises that may upend development progress, and a development crisis that could erupt into a debt crisis as the state of the economy deteriorates".
The unprecedented government spending helped to ward off the severe economic consequences of the pandemic but the debt burden to fund stimulus measures could prove a daunting challenge to propel the economy to a growth trajectory. UN Secretary General Antonio Guterres in an interview with the Financial Times said that in failing to address the problems associated with debt sustainability which had not been properly understood, we risk to compromise the recovery of developing economies with catastrophic consequences for people's lives with increased hunger, poverty and dramatic problems with health and education systems, thus "in many cases leading to instability, social unrest, at the limit, conflict. Everything is now interlinked".
Half of all developing countries are either already in debt distress or at high risk, the other half is considered as low risk of debt distress. Now very low interest rates could conceal problems that many countries will face with paying back their debt in future when interest rates start to rise. As such debt surges can prove costly and restrictive to developing countries to promote a robust economic recovery.
According to the IMF also, about half of developing countries are considered as already in or at high risk of a debt crisis and any further rise in their debt levels could be very destabilising. These countries face default, capital flight and fiscal austerity. One of the major cause contributing to the economic distress could be the decline in remittances received by these countries from their overseas workers. The WB expects the amount of remittances to fall in 2021 due to a collapse in demand for workers in travel and tourism, construction and manufacturing industries abroad.
Despite the Federal Reserve's assurance that it will keep the interest rates low until inflation tops its 2 per cent target, there has been continuing sell off of government bonds, thus lowering their prices leading to a significant rise in their yield, i.e., interest rate. It is to be noted that the yield on US-10 year Treasury bonds is the benchmark for global interest rates. Such a rise in interest rates could jeopardise the current phase of the road to economic recovery out of Covid-19 induced economic slowdown and also add to higher debt servicing costs.
To counteract rises in interest rates, most central banks in advanced economies have intervened in the market by further accelerating asset purchases. But there are now growing concerns that asset purchases may not be able to stem the rise in the inflation rate as asset prices are increasingly becoming unsustainable.
Now the fear is when market correction comes which essentially means asset prices will fall leading to rise in interest rates. According to the Financial Times an inflation overshoot could trigger a deflationary response from central banks leading to much higher interest rates and its effect could go far beyond lower income countries. That will make the present debt crisis far more wide encompassing than ever before, because there is so much more debt now than ever before.
IMF Chief Kristalina Georgieva believes that the global economic situation is so grim that the world now faces a turning point in economic management similar to that which preceded the Bretton-Woods agreement of 1944. She then further adds the world now faces two "massive tasks": one is to fight the crisis and the other to build a better tomorrow. "Today we face a new Bretton-Wood moment", she said and then felt comforted by her own assessment that while we have a sea of debt, at least so far, no debt crisis. But what the IMF is now geared to do is the reform of the international debt architecture. Just do more of the same as before.
It may be pointed out that to describe the current pandemic induced economic crisis as " a new Bretton-Wood moment" is rather very misleading. In fact, there is no parallel between the pre-Bretton-Wood global economic situation and the current crisis. The 1929-1945 period experienced a very prolonged period of economic crisis including a depression and a devastating world war negatively impacting on consumption and investment expenditures. There is nothing like that now remotely comparable to the 1929-45 period. Also, levels of public and private debt are much higher than in 1945. So, a significant proportion of household income will go to service the debt and likely interest rates rise will make that even more costly.
What is surprising is that nowhere the IMF or the WB agenda for post-pandemic economic recovery includes increased levels of corporate and wealth tax to raise revenue rather than borrowing. In fact, the IMF has been striving to introduce a global minimum corporate tax where if implemented the effective corporate tax will even be lower than the corporate minimum tax. For fiscal management, the choice between borrowing and taxing does not require deep intellectual inquiry. The choice is very clear, tax the rich and their wealth. Even during the pandemic, billionaires and corporations in the US accumulated an extra US$ 1.1 trillion wealth. This is similar in most other developed and developing countries.
There is a profound crisis within current global economic system with grotesque inequality not only between countries but also within countries. The US, a country generally considered as the indicator for the global economic health created a fear of rising interest rates which could wreck havoc on the global economy, especially least developed countries. This is so because the "market" continues to expect endless supply of created cheap money bolstering financial institutions to carry on business as usual.
In the US and other countries around the world now, it is estimated that the richest 1 per cent own half of the world's wealth. According to Oxfam, world's 26 richest people own as much as the poorest 50 per cent in the world. It is to be noted that global population now stands at 7.9 billion. These figures clearly indicate the extent of wealth concentration in countries around the world. The GFC and the pandemic are triggers that exacerbate the deeply embedded systemic problems. By throwing money at them will only work as a palliative but not address the basic systemic problems.