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The powder keg of public debt: why the world is addicted to living on borrowed money


States raised their commitments during the covid and already owe 85 billion euros. Rising interest rates are a stress test for global financial sustainability

The public debt balloon continues to swell.

It has been doing so for more than half a century, taking advantage of the great crises: it has grown with the winds of Buenos Aires, Bangkok or Athens.

And the pandemic was another spectacular breath of air.

The obligations of governments around the world amount to almost 85 trillion euros, which is practically equivalent to the size of the entire global economy.

During the past decade, that of ultra-low or negative interest rates, that huge amount was not a problem.

But the lever of the increase in the price of money, used massively by central banks to curb inflation, can now light the fuse that raises the balloon.

International institutions point to the most impoverished countries as the first victims.

“A debt crisis is intensifying in the world's poorest countries,” warns the World Bank.

Even so, the red dots extend into the northern hemisphere as well, from Tokyo to Rome.

Governments came to the rescue of their economies in 2020, when the world suffered an unprecedented shock.

Sectors of activity were completely stopped for months and the State responded to the health emergency and laid out an enormous network to prevent the fall of companies and workers.

Given the economic paralysis, he had to finance this expense by resorting to debt.

According to the IMF, that year saw "the largest increase in debt since World War II", going from accounting for 84% of world GDP in 2019 to 100% in 2020. "Public debt now represents almost 40% of the total world debt (equivalent to 247% of GDP), the highest ratio since the mid-1960s," says an IMF report.

The arrival at that peak —which in 2021 fell slightly to 96% due to the effect of inflation and the economic rebound— is also explained by the open wounds during the 2008 financial crisis. The legacy of that recession was a mountain of debt: a significant part of the private sector's liabilities went to the public through the rescue of strategic companies and banks.

The McKinsey report,

A decade after the global financial crisis,

points out how in advanced economies alone public debt made a huge jump in 10 years: from 69% of GDP in 2007 to 105% in 2017.

It was not the only legacy left by that crisis.

In those years, the large economies experienced weak growth and very low inflation, even with deflation.

The central banks fought against this dynamic with an ultra-expansionary policy, based on a combination of cheap money and massive purchases of public debt.

“For more than 15 years, and until recently, interest rates have been very low, sometimes even negative, and the general perception was that this would last for many more years,” explains Charles Wyplosz, a professor at the Graduate Institute of Geneva. .

The purpose of Mario Draghi, former ECB president, was to get the euro zone out of penury, encourage credit and raise inflation.

It was the time when investors had to pay to lend and savers to have their money in the bank.

“It is not clear if it worked as expected, but it had a noticeable effect: financial institutions bought public debt, which seemed safe because everyone was buying it.

In addition, the ECB took initiatives to buy a large amount of national public debt, precisely to thwart any risk of crisis”, adds Wyplosz.

The pandemic did nothing but prolong that unprecedented ultra-expansive era.

The quick and flexible reaction of governments allowed the economies to recover with unusually strong markets.

But of that gale there is also a trace.

And, again, in the form of a huge amount of debt.

Just look at the IMF data.

In advanced economies, public debt exceeded 120% of GDP.

“These countries were able to expand public and private debt during the pandemic thanks to low interest rates, the actions of central banks, and their well-developed financial markets,” the IMF notes.

The emerging and impoverished countries, on the other hand, had to face much stricter financing conditions that prevented them from borrowing on a large scale, so that their combined debt barely exceeds 60% of GDP.


think tank

Atlantic Council estimates that the four major monetary authorities on the planet (the Federal Reserve, the ECB, the Bank of England and the Bank of Japan) launched debt purchase programs totaling eight trillion euros during the pandemic.

Governments took advantage of the financial costs that this action provided them to launch stimulus programs.

Only the countries of the European Union allocated 1.7 billion to measures to alleviate the crisis derived from the covid.

And that was the trend of all Western economies.

However, there are not two without three.

And just when the world was beginning to leave the pandemic behind, what the historian Adam Tooze has dubbed the polycrisis arrived, and in what refers to the result of the materialization of two or more of the countless risks that exist in the world today: the war in Ukraine, bottlenecks in supply chains or the late opening of China, among other factors.

Governments are once again trying to protect their populations from this new crisis, but some have already exhausted their fiscal cushion.

Japan's Finance Minister, Shunichi Suzuki, warned last month of the "unprecedented" precariousness of his country's finances, whose debt in 2021 reached 262.5% of GDP.

For now, the Bank of Japan maintains ultra-low rates of -0.1%, which allows it to continue carrying that burden.

The European Snowball

Japan is, for now, the great exception.

Europe dragged its feet, but it has also jumped into the race to aggressively raise rates to deal with runaway inflation.

And not only that.

In just two weeks, the ECB will join most of the world's monetary authorities in pulling back the candlesticks to reduce balance sheet.

"I don't find it worrying.

At the planned rate of 15 billion a year, they would need 22 years to get rid of their entire debt portfolio,” says Paul De Grauwe, a professor at the London School of Economics.

The maneuver, in any case, has aroused misgivings among the most heterodox members of the Governing Council, who fear that any slippage could end in a sovereign debt crisis like the one of the past decade.

The ECB, in fact,

This same week it has already launched a warning about the illusory effect that inflation can have on budgets.

The Eurobank has warned that the rise in prices now makes it possible to release ballast and trigger tax revenues, which offset the items earmarked for aid or increases in public wages and pensions.

In the future, however, these extra revenues may vanish and those expenses remain, putting the sustainability of the public debt at risk.

After the slap of tax aid from the pandemic, EU governments have so far exhausted 681,000 million euros in aid to companies and consumers, of which 40% correspond to German subsidies.

As a result of all these crises, the debt of the euro area rose from 84.1% of GDP in 2019 to 93% in the third quarter of 2022, with Greece (178.2%), Italy (147.3%), Portugal, (120.1%), Spain (115.6%) and France (113.4%) in the lead.

Europe trembled when, upon announcing the first rate hike in 2022, risk premiums skyrocketed.

The ECB then approved the creation of an instrument to contain the debt of a euro country in the face of market attacks.

“Those tools often work better when they are announced than when they are implemented.

It is a safety net and, as such,

It has worked well because, for now, you don't have to use it”, says Giancarlo Corsetti, professor of Economics at the European University Institute.

The markets have accepted this and, although the cost of the debt has been growing due to the rise in interest rates, the spreads with the German bond have remained stable.

“Today the dynamic is still that of a drop in debt in relation to GDP in the euro zone and also in Spain.

Of course, you have to be careful with budget management, but I don't think that debt is now a problem”, says De Grauwe.

spreads with the German bond have remained stable.

“Today the dynamic is still that of a drop in debt in relation to GDP in the euro zone and also in Spain.

Of course, you have to be careful with budget management, but I don't think that debt is now a problem”, says De Grauwe.

spreads with the German bond have remained stable.

“Today the dynamic is still that of a drop in debt in relation to GDP in the euro zone and also in Spain.

Of course, you have to be careful with budget management, but I don't think that debt is now a problem”, says De Grauwe.

The EU is at the gates of what seems to be an intense debate on the reform of fiscal rules.

And the focus is on debt.

Brussels puts individualized medium-term plans on the table, with the aim of countries releasing ballast.

It does so with the carrot and stick strategy: more reasonable but more frequent and automatic sanctions and funds in exchange for reforms with the recovery plan.

Among other legal modifications, the European Commission wants countries to adapt their pension systems to the demographic reality, in which the population continues to age.

The protests in Paris are the most visible expression of these reforms, which are also being considered in Madrid, Berlin or Brussels.

Mabrouk Chetouane, director of global market strategy at the manager Natixis IM Solutions,

emphasizes the role of the Next Generation EU plan in reducing fiscal policy vulnerabilities in the Eurozone.

“The amount of money to support investment is very substantial, which will ultimately support potential growth.

And we know that the best way to address the fiscal deficit is to increase the potential of the economy”, she maintains.

Electronic panel with the price of the markets in Tokyo.

Japan is one of the most indebted countries in the world.

Seong Joon Cho (Bloomberg) (Bloomberg)

On the other side of the Atlantic, the debate is more political in nature.

With the Federal Reserve easing the foot of the accelerator, Washington is dependent almost exclusively on its Congress once the Government has already reached the ceiling to borrow.

With the House of Representatives in the hands of the Republicans, the agreement seems complex and indicates that cuts will be demanded.

More information

The world lives on borrowed

alarm in pop-ups

The red light has come on, however, in emerging markets and impoverished countries.

“There have been symptoms and even red flags in emerging markets, which have been a source of serious concern.

We already saw some worrisome cases last year in these countries, which are very much affected by the rise in energy and food prices," says Nicolas Véron, a researcher at the Peterson Institute for International Economics and Bruegel.

Their financial obligations are lower, but they are more pressing.

They even drown.

According to the latest International Debt Report of the World Bank, the external debt of the 75 countries with a per capita income of less than 1,255 dollars tripled, reaching nine trillion dollars.

“The focus now is on emerging countries, but also on several countries in Africa and Asia, as we have seen with Sri Lanka”, explains Giancarlo Corsetti.

According to the World Bank, these nations are spending more than a tenth of their export earnings on long-term debt payments, the highest proportion since 2000.

The risk paper prepared for the World Economic Forum in Davos identified the rising cost of debt as one of the most immediate threats to the global economy.

And he stopped at the emerging countries and the most vulnerable countries, which suffer more than the rest from the consequences of the rise in interest rates, especially the high financing costs and the strength of the dollar.

All this occurs at a time of economic weakness and the rise in the cost of raw materials due to the war in Ukraine.

Just this week, Zambia's Finance Minister, Situmbeko Musokotwane, has criticized the delay in closing an agreement with his creditors -among them, the World Bank- to restructure a debt of 13,000 million dollars.

Before, in December,

Ghana had closed an agreement with the IMF to restructure a debt of 3,000 million dollars.

The list does not end there.

The report gave names and surnames to countries with a high risk of


: Argentina, Egypt, Ghana, Kenya, Tunisia, Pakistan and Turkey.

In May of last year, in fact, Sri Lanka became the first Asian country to declare itself in suspension of payments after failing to make a payment of 51,000 million dollars with various creditors, including China and India.

Its financial difficulties coincided with a moment of economic, social and political crisis that ended with a popular revolt in July.

Almost automatically, a dozen countries saw investors punish their bonds harshly in the debt markets, once again exposing the contagion risks that exist.

Obligations from Argentina, El Salvador or Ghana gave returns of over 20%, while Egypt, Ecuador and Nigeria were above 15%.

The crisis in Sri Lanka revealed, in turn, the power that China has accumulated as the world's great bilateral creditor.

Under the umbrella of its new Silk Road, Beijing has financed everything from Lusaka airport (Zambia) to the port city of Colombo (Sri Lanka).

The covid-19 crisis exposed the extent to which the Xi Jinping regime has tried to rival the World Bank and the IMF to become a major global lender.

According to the Rhodium Group consultancy, Beijing had to restructure loans for 52,000 million euros in 2020 and 2021, which triples the volume renegotiated in the previous two years.

Western institutions are suspicious of China, whom they criticize for its bad arts and its opacity when lending to other countries.

The members of the G-7 urged Beijing in May of last year to "contribute constructively" in these debt renegotiation processes.

So has the managing director of the IMF, Kristalina Georgieva, who has extended that demand to private capital.

According to estimates by multilateral institutions, 61% of these countries' liabilities are already in the hands of investors, which is 15 points more than in 2010 and complicates renegotiations.

In the other 39% of the pie, the countries that do not belong to the so-called Paris Club, which includes most of the Western States, including Spain, are gaining ground.

And according to World Bank calculations, by the end of 2021 China was the largest bilateral lender,

India has set itself the challenge of addressing the external debt of these countries under its current G-20 presidency.

As reported by Reuters this week, its authorities are drafting a proposal to alleviate the debt of the most distressed governments that involves asking lenders, including China, to cut their loans.

Finance ministers will address that issue later this month at their Bangalore summit.

The chief Asia-Pacific economist for Natixis, Alicia García Herrero, believes the deal is too complex.

“China is dragging its feet to restructure Sri Lanka's debt.

It does not agree to the terms of the Paris Club or private ones.

And now it begins to raise problems with Zambia.

The problem is that he sees a mountain of distressed debt coming because Pakistan's situation is problematic.

And that country supposes 40.

billion dollars, according to some reports.

That is why it is reluctant to accept reductions in the nominal value of the debt and is more open to payment extensions, ”he explains.


Economies with high volumes of debt remain relatively comfortable, while others with more modest leverage look rough.

That puts on the table the eternal question of what level of indebtedness is sustainable.

Olivier Blanchard, a former IMF chief economist, has published several articles in the past year.

And his conclusion is that there is no universal formula.

“Take two countries with the same level of debt distress, but with two different types of government or with debt denominated in different currencies.

One of these debts could be safe, while the other could not be ”, he summarizes in an article published by the IMF.

International institutions, however, want to heal in health.

Central bankers are suspicious of the fiscal packages launched by their governments and ask them to be careful, fearing that they will hinder their task by fueling inflation or putting their finances at risk.

The World Bank asks to address the debt of the most disadvantaged countries, the IMF continues to urge governments to implement fiscal plans to return to budgetary balance in the medium term and the OECD insists on guaranteeing the sustainability of pensions.

The Bank for International Settlements also raises the rugs and warns of a shadow debt of 75 trillion euros only in opaque instruments.

There is a good wick.

The challenge is not to activate a detonator.

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Source: elparis

All business articles on 2023-02-20

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