Drowning in pandemic debt?

Is this the correct perspective? Looking at debt as a share of GDP exaggerates the increases, because economies’ revenues have fallen as the pandemic shut sectors. The global figures also obscure important regional differences. Debt in developed countries increased by USD 12.7 trillion to USD 196.3 trillion since the end of 2019, equivalent to 432% of their GDP.

However, the US accounted for almost half of the overall increase, and will record a rise in total debt from USD 71 trillion at the end of 2019 to USD 80 trillion this year, according to forecasts by the Institute of International Finance. US lawmakers, as we publish, are still negotiating a new USD 908 billion economic support package. Eurozone total debt has increased through September to USD 53.4 trillion equivalent. Historically, the eurozone’s record level of total debt reached more than USD 55 trillion in the second quarter of 2014.

Emerging markets also registered an increase in their overall debt-to-GDP ratios from 222% to 248% at the end of September. In absolute terms, this is a rise of USD 2.4 trillion, and entirely the result of non-financial corporate debt in China. Removing China from the data reverses this trend, thanks to a weaker dollar, with overall emerging market debt falling to USD29.3 trillion from USD 31 trillion at the end of 2019. 

However, the IIF says that the growth in debt levels this year is already slowing and should stabilise in 2021 as economic recoveries kick-in. Much of 2020’s increase is in general government and non-financial corporate sectors, as fiscal authorities responded to the pandemic.

Servicing the burden

These debt levels may be entirely justifiable, even unavoidable, as governments try to compensate firms and citizens for the challenges of the pandemic. Thankfully, the debt is mostly currently affordable because of the exceptionally loose monetary policy and the associated rock-bottom interest rates. However, this unprecedented debt accumulation is still fundamentally unsustainable. Clearly, governments will want to slow their borrowing as soon as the crisis is past, and may be forced to raise taxes.

Despite low interest rates in emerging markets, the debt service burden has increased due to falling revenues. But as a whole, emerging markets should cope, even as they manage slowing economic growth.

Indeed, USD 7 trillion of global debt falls due over the next 12 months and around USD 1 trillion of that total is US dollar-denominated. China, which accounts for one-third of this total, is able to service this debt, as can the next four most-exposed countries to dollar-denominated debt: the United Arab Emirates, Hong Kong, Singapore and Saudi Arabia. Countries facing challenging debt repayments in the near term include Turkey and South Africa, and we are monitoring Latin American nations such as Colombia and Brazil.

Debt in the world’s very poorest economies may prove more damaging. In October, the Group of 20 agreed to suspend debt repayments for another six months. The agreement includes China, which accounted for 63% of the poorest nations’ USD 178 bn debt owed to G20 countries in 2019.

Absolute debt levels of course also miss the issue of financing conditions. Much of the debt held is public and so subject to central banks’ control of interest rates, who are widely committed to keeping them low.

More debt, smarter investments?

The great financial crisis of a decade ago was the result of weaknesses in the financial system. That is not the case for the current Covid-triggered crisis. The pandemic has underlined the fragility of sectors from health care to logistics, communications to education, sparking a widespread determination to rethink spending priorities.  Countries recognise that they need better infrastructure and narrow inequalities. This can be partially achieved through investments in innovation.

Many economies, including China and the US, are now committing themselves to climate change targets that imply fundamental overhauls to their post-Covid economic models.

In a world of low interest rates, the crucial question is not whether debt is affordable, but how the money will be spent.

As the world’s economies recover from the pandemic, in line with mass vaccination programmes, focus will turn to the spending incurred over 2020. Investors will inevitably begin to pay more attention to which governments can afford these long-term investments, and their implications for the global financial system.

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