Update on the great public debt issue

May 5, 2018

The latest IMF fiscal monitor is a stark reminder of the public finance risks in the world. Public debt ratios have remained stuck near record highs of 105% of GDP for the developed world and a 3-decade high of 50% for EM countries. If one includes contingent liabilities public debt would average over 200% of GDP in advanced economies and 112% in emerging economies. Deficits remain sizeable in the developed and emerging world, notwithstanding the mature stage of the business cycle. Overall the financial position of governments today is a lot more precarious than during past recoveries, leaving them ill prepared for future adverse shocks. The U.S. is even easing fiscal policy, expanding its deficit and an already high debt ratio. Also, China’s public debt stock is expected to rise rapidly in future years.

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The global debt overhang

October 15, 2016

A new IMF report illustrates that a large share of both advanced and emerging economies struggle with private debt overhangs. Excessive debt is a drag on growth and a risk for financial stability. Low nominal growth has hampered deleveraging and aggravates these dangers. Moreover, high public sector debt has reduced governments’ capacity to support private balance sheets and stabilize economic growth in future crises. Therefore, the lingering debt overhang provides a strong incentive for fiscal and monetary policies to work towards higher nominal GDP growth now.

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Corporate bond market momentum: a model

September 3, 2016

An increase in expected default ratios naturally reduces prices for corporate bonds. However, it also triggers feedback loops. First, it reduces funds’ wealth and demand for corporate credit in terms of notional, resulting in selling for rebalancing purposes. Second, negative performance of funds typically triggers investor outflows, resulting in selling for redemption purposes. Flow-sensitive market-making and momentum trading can aggravate these price dynamics. A larger market share of passive funds can increase tail risks.

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The threat from China’s shadow finance

August 27, 2016

In past years China witnessed a boom in shadow finance, particularly in form of entrusted loans. Banks apparently used shadow credit products in large size to circumvent policy restrictions and bank loan regulations. Regulatory tightening has reined in the proliferation of shadow finance since 2014, but outstanding contracts pose serious systemic risk due to the combination of high default risk and dependence on fragile wholesale funding.

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The China credit risk

May 18, 2016

The rapid rise of China’s internal debt stock is a global concern. Oxford Economics research shows that non-financial sector debt has soared to 250% of GDP in 2015, due mainly to a very high investment ratio alongside falling corporate profitability. Debt-to-asset ratios look worrisome in problem industries and real estate. Problem loans could be 10-15% of GDP now and might rise to systemically critical levels if the credit boom continues.

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Tracking the history of sovereign defaults

March 8, 2014

Bank of Canada has assembled a new broad database on global public debt default. It shows that after sovereign delinquency had exceeded 5% of outstanding debt in the 1980s, it declined alongside falling interest rates to below 1% in the 2000s and has remained low despite the global financial and euro sovereign crises. In a longer (200 year) context sovereign default ratios have moved in long cycles, each stretching over several decades.

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The rise of counter-cyclical fiscal policy

September 21, 2013

A new IMF paper illustrates the changed realities of public macro policy. In times of negative shocks at the zero bound for interest rates, fiscal policy is best suited for stabilizing economies. Monetary policy takes on a support role, securing funding conditions and financial stability. As a side effect of this policy mix, sovereign risk has emerged as a major concern in advanced economies. This suggests that in times of recovery it will also be fiscal rather than monetary tightening that dampens economic growth and overheating.

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Asia’s systemic credit risks

July 8, 2013

A new Standard Chartered Research Report investigates pockets of potential credit risk in Asia, by using a new comprehensive set of metrics. China’s overleveraged corporates are at the forefront of concerns, as mentioned in other posts (view here). Japan’s massive 400% debt-to-GDP ratio is a potentially large risk if real interest rates in the country ever increase. India is burdened with a high government debt ratio and an apparently deteriorating profile of corporate debt.

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Monetary financing does not preclude sovereign default

June 27, 2013

Most investors take for granted that a government with access to monetary financing cannot be driven to default. However, a new paper by Corsetti and Dedola challenges this belief. Monetary financing incurs costs and, hence, preference for default and self-fulfilling confidence crises are possible. Necessary conditions to rule out self-fulfilling crises include credible caps on government borrowing rates, the ability of the central bank to issue default-free, interest-bearing, and non-inflationary “reserves” (rather than cash), and full coverage of central bank losses by the state budget.

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China’s highly leveraged state-owned corporates

May 3, 2013

Morgan Stanley’s Viktor Hjort, Nishant Sood, and Gaurav Singhal show that financial leverage of China’s corporates has reached record highs, particularly for state-owned enterprises (SOEs). Increased debt financing reflects easy credit conditions and has partly served to cover funding gaps. In case of an economic downturn, consequences for credit quality would probably be more severe now than back in 2009.

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