Friday, December 4, 2009

Growing global public debt ratios

The Dubai government's decision to postpone the repayment of the debt obligations of its investment arm, Dubai World, has set off intense speculation about similar prospects elsewhere. Going beyond private sector debt defaults, there is mounting concern about the prospect of sovereign defaults among economies.

In the wake of the Dubai crisis, William Buiter has argued that the contraction of credit "makes it all but inevitable that the final chapter of the crisis and its aftermath will involve sovereign default, perhaps dressed up as sovereign debt restructuring or even debt deferral".

After decades of living beyond its means, the leading economy of the world faces payback time. The Times points to a trifecta of headaches being faced by the US government - a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.

With 36% of the $12 trillion and growing national debt due for repayment within a year, there is a real danger of the US government facing the same payment shock that sent homeowners to default on their mortgages. As the Times reports, the White House estimates that the government will have to borrow about $3.5 trillion more over the next three years, besides refinance, or roll over, the huge amount of short-term debt that was issued during the financial crisis.

The biggest worry is not so much immediate, but prospects for the future, given the inevitability of continuing and growing deficits (and resultant debts) and higher debt servicing rates. In an indication of the ultra-low levels of interest rates prevailing, the US government paid less interest on its debt this year than in 2008, even though it added almost $2 trillion in debt. The government’s average interest rate on new borrowing last year fell below 1% and for short-term IOUs like one-month Treasury bills, its average rate was only sixteen-hundredths of a percent. The Times refers to Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates lower deficits, who summed it up most appropriately,

"The government is on teaser rates. We’re taking out a huge mortgage right now, but we won’t feel the pain until later."

Exacerbating this is the massive anticipated explosion in spending on benefits under Medicare and Social Security as the nations babyboomers arrive to collect their old age benefits. Further, as the foreign lenders diversify away to other investment avenues and domestic investors return to their regular invesmtents as the economy and credit markets return to normal, there will be an upward pressure on interest rates to keep investors interested. And this in turn will drive the debts further up.

Echoing these concerns, Bill Gross, MD of Pimco bond management firm had this to say about America's burgeoning deficits and debts, "What a good country or a good squirrel should be doing is stashing away nuts for the winter. The United States is not only not saving nuts, it’s eating the ones left over from the last winter."

The White House itself estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. The Times writes,

"Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode."

The fiscal strains imposed by the financial market bailouts and fiscal stimuluses coupled with the continuing economic weakness (with its attendant drop in tax and other revenues), has dramatically raised the debt burdens of all major economies. Germany's government debt outstanding is expected to increase to the equivalent of 77% of GDP in 2010, up from 60% in 2002, and in Britain that figure is expected to more than double over the same period, to more than 80%.

Eastern Europe is the worst affected by the burgeoning debt disease as its governments gorged on domestic and, more damagingly, foreign debt. Public debt in Ireland is expected to soar to 83% of GDP next year, from just 25% in 2007. Latvia's borrowings are set to reach the equivalent of nearly half the economy next year, up from 9% a mere two years ago. The debt situation is worse with the two other Baltic states of Lithuania and Estonia, and others like Bulgaria and Hungary, all of whom carry foreign debt that exceeds 100% of their GDPs.

Encouragingly, India has been among the few countries which have managed to keep their debt shares stabilized, despite the fiscal stimulus spending. Interesingly, it is among the few major countries expected to show a slight decline in debt share over the next year. Further, unlike the vulnerable East European and Latin American economies, external liabilities form a very small share of the debt burden. Short-term debt coming due is also a small share. However, of great concern is the fact that India's debt burden as a share of GDP is the highest among all the major emerging economies, almost double that of their average.

In this context, Catherine Rampell has an interesting post in Economix, which seeks to put in perspective the burgeoning public debt burdens across the world and find out what level of public debt marks the Rubicon. It compares the trends and projections of government debt across countries from Moody's Investors Service and feels that the debt thresholds vary across nations.

Though many emerging economies, especially from East Europe have debt levels much lower (as share of their GDP's) than Japan and the US, they face greater threats and are more vulnerable to economic shocks. Japan and Italy ahve been sustaining more than 100% debt burdens for more than a decade without much trouble, whereas similar figures for any developing economy would have spelt certain disaster. The Moody's estimates predict debt ratios of 223.4% of GDP for Japan, 99.3% for US, 79.5% for India, and just 15.7% for China for 2010.

In their magisterial examination of 800 years of financial crises, Carmen Reinhart and Kenneth Rogoff had found evidence that the thresholds for default are much lower for many emerging markets. They also argue that developing countries have lower market credibility of their institutions and governments and therefore have low levels of debt intolerance, especially those who have had a history of debt defaults. Further, since they have large share of foreign borrowings, they cannot use inflation to deflate away their debts.

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