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Update on the great public debt issue

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.

IMF Fiscal Monitor: “Capitalizing on Good Times”, April 2018

The post ties in with SRSV’s summary lecture the systemic risk of highly indebted governments,
The below are quotes from the IMF monitor. Emphasis and cursive text have been added.

The debt problem

“For advanced economies, debt-to-GDP ratios have plateaued since 2012 above 105 percent of GDP—levels not seen since World War II—and are expected to fall only marginally over the medium term…A large number of countries currently have a high debt-to-GDP ratio, as suggested by critical thresholds identified in the IMF’s debt sustainability analysis. In 2017, more than one-third of advanced economies had debt above 85% of GDP, three times more countries than in 2000.”

“In emerging market and middle-income economies, debt-to-GDP ratios in 2017 reached almost 50 percent—a level seen only during the 1980s’ debt crisis—and are expected to continue on an upward trend. ..One-fifth of emerging market and middle-income economies had debt above 70 percent of GDP in 2017, similar to levels in the early 2000s in the aftermath of the Asian financial crisis.”

“The rise in government debt reflects the economic collapse during the global financial crisis and the policy response, as well as the effects of the 2014 fall in commodity prices and rapid spending growth in the case of emerging market and low-income developing countries.”

Debt ratios are considerably higher when including implicit liabilities linked to pension and health care spending. In this case, the average debt-to-GDP ratio doubles to 204 percent among advanced economies, 112 percent among emerging market and middle-income economies, and 80 percent among low-income developing countries. “

“Past experiences with debt reduction have shown that robust GDP growth and sustained primary balances are necessary to bring down debt-to-GDP ratios.”

Public debt plays an important role in the surge in [overall] global debt, with little improvement expected over the medium term. .. At USD164 trillion—equivalent to 225% of global GDP—global debt continues to hit new record highs almost a decade after the collapse of Lehman Brothers. Compared with the previous peak in 2009, the world is now 12 percent of GDP deeper in debt, reflecting a pickup in both public and nonfinancial private sector debt after a short hiatus. All income groups have experienced increases in total debt but, by far, emerging market economies are in the lead… Developments since the onset of the global financial crisis are, however, almost a mirror image of just one country: China alone explains almost three-quarters of the increase in global private debt.”

“Underpinning debt dynamics are large primary deficits [deficits excluding interest spending], which are at their highest in decades in the case of emerging market and developing economies. In the case of advanced economies, there has been little improvement in primary balances since 2015.”

The risks

“There are several reasons why high government debt and deficits are a cause for concern…

  • First, high government debt can make countries vulnerable to rollover risk because of large gross financing needs, particularly when maturities are short…Even with favourable global financing conditions, higher debt ratios are pushing up the interest burden, especially among low-income developing countries. Some countries (Ghana, Nigeria) have seen the interest-to-tax revenue ratio climb to more than 30 percent in 2017.…A high debt-to-GDP ratio could cause a spike in risk premiums if investors become sceptical about a country’s ability or willingness to pay—including because of concerns with the political feasibility of fiscal policies… [The figure below] illustrates that in a number of countries debt is above levels at which fiscal crises occurred in the past.

  • Second, countries can be subject to large unexpected shocks to public debt-to-GDP levels, which would exacerbate rollover risk. Indeed, based on a sample of 179 episodes of debt spikes in 90 advanced, emerging market, and low-income developing countries… the biggest driver of public debt spikes is not primary deficits, output contractions, or higher interest payments, but rather a sudden increase in the stock of debt—arising from the realization of contingent liabilities, quasi-fiscal spending, or the correction of previous underreporting of deficits, among others.
  • Third, high government debt levels make it difficult to conduct countercyclical policies, especially in the event of a financial crisis. The combination of excessive public and private debt levels can be dangerous in the event of a downturn because it would prolong the ensuing recession. Empirical estimates… suggest that entering a financial crisis with a weak fiscal position worsens the depth and duration of the ensuing recession, particularly in emerging market economies. This is because fiscal policy tends to be pro-cyclical in these cases…Countries with low debt-to-GDP ratios typically engage in aggressively expansionary fiscal policy after a crisis, while those without such space usually pursue highly contractionary policy.”

For a summary of systemic risk arising from high public debt also view post here.

The case of the United States

“The fiscal outlook for the United States is driving the average [deficit dynamics] for advanced economies. Following two years of fiscal expansion in the United States in 2016–17, the revised tax code and the two-year budget agreement provide an additional expansionary fiscal impulse until 2019. The increase in spending authority by US$150 billion (0.7% of GDP) per year for the next two years, and lower corporate and personal income tax rates will give rise to overall deficits in excess of US$1 trillion over the next three years (above 5% of GDP). This adds to the rising trend in government debt, bringing it to 117 percent of GDP by 2023.”

The case of China

“General government debt in China is projected to rise over the medium term, driven largely by sizable off-budget borrowing by local governments. The official debt concept points to a stable debt profile over the medium term at about 40% of GDP. However, a broader concept that includes borrowing by local governments and their financing vehicles (LGFVs) shows debt rising to more than 90% of GDP by 2023 primarily driven by rising off-budget borrowing.”

“The Chinese authorities are aware of the fiscal risks implied by rapidly rising off-budget borrowing and undertook reforms to constrain these risks. In 2014, the government recognized as government obligations two-thirds of legacy debt incurred by LGFVs (22% of GDP). In 2015, the budget law was revised to officially allow provincial governments to borrow only in the bond market, subject to an annual threshold. Since then, the government has reiterated the ban on off-budget borrowing by local governments… The authorities do not consider the LGFV off-budget borrowing as a government obligation under applicable laws… However, there have been no LGFV defaults so far, despite weak and deteriorating interest rate coverage ratios and return on equity for LGFVs, which suggests that there continues to be implicit local government support.”


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