The global debt bubbles – what vaccine is there?

By Zainul Chandoo

Whilst the world is breathing sigh of relief since the good news rolled in on success of Covid-19 trials and eventual rollout of vaccinations globally, the hope, and it remains a hope at this juncture, is that the biggest vaccination in human history will eventually relieve us from a virus that led to the greatest recession the world has experienced. While we are celebrating the C-19 success, the big question on the other side of the coin is on the growing global debt–what is the vaccination if at all we have found one? As the pandemic ravaged economies, leading to lower revenues, increased investment in public health and relief measures, governments had to act. The monetary policy reaction has been unprecedented in different countries, many have cut policy rates and introduced quantitative easing (QE) programmes weighing on currency (depreciation) and a sizable retrenchment in portfolio inflows.

These synchronized policy measures have helped fuel a massive wave of borrowing, particularly by nations and corporates leading to record level debt. The pace of global debt accumulation has been unprecedented since 2016, increasing by over $52 trillion. Amid the Covid-19 pandemic, 2020 recorded a $15 trillion surge, by far surpassing the rise over the previous four years amounting to $6 trillion.

On aggregate basis, the debt hit an all-time record of over $272 trillion by end Q3 2020. The expectation, by end 2020 is, for the debt to hit $277 trillion, which is 365 percent of GDP.

Imagine you owe someone 365 times of the output you are able to generate. Flip it the other way – average debt per global citizen is $35,000 whilst average per capita GDP per global citizen is $11,000.

The clock is ticking, every second, it seems, someone in the world takes on more debt. It gets even more exciting if we seek to understand what was the global growth as a result of debt build-up. It appears to have contributed marginally to global growth-average of 2.8 percent between 2014 to 2016 vs 2.9 percent in 2017 to 2019.

The message is simple, the GDP-generating capacity of global debt is waning in an environment of corporate zombification, subdued investment and weak productivity gains.

Thus far, the world has managed to avoid a systemic debt crisis, mainly for two reasons: First, very low interest rates and massive monetary policy support. Central banks throughout the world lowered interest rates and supplied liquidity, quickly established swap lines helping many emerging countries maintain market access. The IMF estimates these measures injected $7.3 trillion.

Secondly, extraordinary direct financial support, including: IMF emergency financing. Over 75 countries have sought this option; World Bank debt service relief to over 44 most vulnerable economies through the G20 Debt Service Suspension Initiative (DSSI); IMF’s Catastrophe Containment and Relief Trust (CCRT) to over 29 members.

Is a vaccine in sight?

In the words of Dr Dambisa Moyo, Zambian born economist – the global picture has become even more complicated because many of the conventional ways to manage excess debt no longer look like credible options.

She has a case, and her argument takes into account interest rates, which in most developed economies are already historically low and even negative in certain jurisdictions (Euro Zone & Japan), central banks’ balance sheets are stretched from the expansionist policy since Global Financial Crisis in 2008 and the pandemic led expansion is the final nail in the coffin. Piling debt on top of debt seems to have reached a dead end.

Way forward (not exhaustive)

It is quite clear countries will require continuous support. The DSSI will need to be extended, I suspect for additional 12 months or even more given the recovery patterns across different geographies. Resuming debt service will come at the expense of fighting the pandemic and its economic fallout. This would increase the human suffering and make recovery even harder. States with unsustainable debts should not delay restructuring and open negotiations with creditors before the situation worsens. Delaying only increases the costs- economic and human.

Use of the assistance approved by the IMF since late March 2020 under its various lending facilities and debt service relief financed by the Catastrophe Containment and Relief Trust (CCRT). Overall, the IMF is making available $1 trillion over a year.

Primary budget surplus: governments can also attempt to reduce the overall size of their debt by running a primary budget surplus. This will increase revenue through tax hikes or decrease spending through cuts. Policy makers favour this method of reducing debt loads, therefore some governments are likely to explore this option post current debt pile up. Ultimately, tax increase is a question of political will - a fine balance to achieve for elected officials whose tenure is often marked in years rather than decades.

In conclusion, in the height of Africa’s debt crisis in the mid-1980s, Mwalimu Julius Nyerere, asked the country’s creditors a blunt question: “Should we really let our people starve so that we can pay our debts?” It took another 20 years to agree to a comprehensive debt reduction programme, effectively consigning Africa to a lost decade of development.

Mwalimu’s question resonates powerfully today. The economic crisis triggered by Covid-19 has devastated many of the world’s poorest countries. Sub-Saharan Africa is heading for its deepest recession in 50 years. Declining exports, plummeting revenues, and capital flight have left many countries struggling to pay creditors. With poverty rising and budgets for health, education, and safety nets under pressure, will countries be able to put the lives of vulnerable people before their debt obligations?

Sources: IIF, IMF, World Bank

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Zainul Chandoo is Head of Treasury at Stanbic Bank