By Eswar Prasad and Mengjie Ding
As the fifth anniversary of the collapse of Lehman Brothers draws near and the debate about fiscal austerity continues to rage, it is time to take stock of the trajectory of debt levels in the key advanced and emerging market economies (AEs and EMs). The overall picture of government debt around the world is not a pretty one (interactive data here).
Data from the IMF’s latest Fiscal Monitor show that the level of aggregate net government debt in the world is expected to rise from $26tn in 2008 to $42tn in 2013. The ratio of world net debt to world GDP, a more relevant indicator of sustainable debt levels, shows a corresponding increase from 46 per cent in 2008 to 61 per cent in 2013.
Anyone who has read my posts regularly will know that I am not a huge fan of calculations of the structural deficit. I have accused people who put too much weight on the numbers to be suffering from “structural deficits disease“. I have criticised the establishment of the Office for Budget Responsibility on the grounds that it would one day get into a fight with government on the (unknowable) amount of spare capacity in the economy. I have noted how weird the OBR’s initial forecast was once you looked beyond the headlines.
I would prefer to consign calculations of structural deficits to a dustbin. Unfortunately, this cannot be done because the coalition decided to place the current structural budget deficit at the heart of its fiscal policy. It promised to eliminate this deficit during this Parliament. The promise is actually a bit more complicated than that, but as far as the public were told, the deficit that mattered would be gone by the time they next came to vote.
Five interesting things arise from the Financial Times analysis of structural deficits this morning, which show the likely structural deficit to be significantly worse because the OBR’s estimate of spare capacity looks too high. If the OBR were to revise spare capacity down to levels that seem more plausible now, it would have to revise down growth rates into the medium term (and revise up deficits) because the scope for catch-up growth is much lower.
Here are my five new thoughts on the matter.
1. Are the calculations nuts? Read more
Greek debt affordability is set to worsen considerably, according to the IMF’s Global Financial Stability Report. But in a series of charts comparing 11 countries, the striking thing is how exposed indebted economies are to rising interest rates or falling GDP.
These charts (a full set toward the end of this post) are a great way to depict several moving parts to get to the nub of the issue. The basic idea is: black line inside the green area – good; black line inside redder areas – bad. Dotted line (forecast) – likewise. (The black line, incidentally, is the historical interest rate on government debt.)
The country profiles, relative to each other, are much as you’d expect. Greece, Ireland and Portugal have less favourable interest burdens (in that order). The US, incidentally, is forecast to edge into the yellow. Japan is not. Read more
The US lacks a “credible strategy” to stabilise its mounting public debt, posing a small but significant risk of a new global economic crisis, says the International Monetary Fund.
In an unusually stern rebuke to its largest shareholder, the IMF said the US was the only advanced economy to be increasing its underlying budget deficit in 2011, at a time when its economy was growing fast enough to reduce borrowing. The latest warning on the deficit was delivered as Barack Obama, the US president, is becoming increasingly engaged in the debate over ways to curb America’s mounting debt. Read more
Markets are showing signs of stress over Portugal following Moody’s three-notch downgrade of Greece as we approach a significant bond auction on Wednesday.
Yields on the ten-year government bond reached 7.65 per cent today – a euro lifetime high – indicating Lisbon would need to pay these sorts of levels if it tried to issue ten-year debt now. (Or Wednesday.) If it goes ahead, the auction is intended to raise €0.75-1bn. This is optimistic, however. The last two auctions raised just €1.25bn between them.
So, assuming Wednesday’s auction raises €0.75bn (optimistic), the IGCP will have raised about €2bn since the start of the year from the market in bonds. Rumour has it that the agency has about €4bn in cash. So that’s €6bn, excluding bills. So what does Lisbon’s debt management agency, the IGCP, need, and by when? The answers are sobering. Read more
The US is little more than $200bn away – or about 2 months – away from reaching its congressionally mandated national debt limit of $14,300bn.
The need to increase it to avoid a potentially disastrous US default is the next fiscal battleground in Washington, after the lawmakers stop squabbling over a government shutdown.
Republicans want to use the opportunity to push for more spending cuts, while Democrats say this is not the place to negotiate.
On Thursday, Moody’s Investors Service offered its analysis of the likelihood that a major crisis will ensue, threatening America’s triple-A credit rating much earlier than even the most ardent fiscal hawks would imagine. Read more
Talk of a Greek debt restructuring is becoming ever harder to avoid for European policymakers. A paper just published by the respected Bruegel think-tank concludes “that Greece has become insolvent and that further lending without a significant enough debt reduction is not a viable strategy”.
According to Bruegel’s calculations, even on optimistic assumptions the primary surplus required to reduce Greece’s debt ratio to 60 per cent of GDP in 20 years would be 8.4 per cent of GDP, rising to 14.5 per cent under a cautious scenario. As Bruegel’s economists write: “Over the last 50 years, no country in the OECD (except Norway, thanks to oil surpluses) has ever sustained a primary surplus above 6 per cent of GDP.”
Greece’s problems have been exacerbated by deep investor mistrust and its heavy reliance on overseas financing. The good news is that the situation in other eurozone “peripheral” countries is not as acute. As Bruegel also notes, the European Union establishment has also moved away from complete denial about the Greek problem. Read more
Dublin is resisting pressure to accept aid. Discussions have been taking place over the weekend, with European officials making the case for aid, and Irish officials “determined to get out of the financial difficulties [they] are in.”
Little has changed in the fundamentals of the Irish economy. Market pressures were prompted by discussions of the eurozone rescue fund a few weeks ago, in which it seemed bondholders would lose money in the case of default. Debt prices fell, and yields soared. This tempered considerably on Friday, after finance ministers from Europe’s five largest economies suggested the loss on bonds would not be retrospective and the entire thing might be voluntary. Read more
Irish bond yields have dropped back as European officials have dramatically scaled back the impact of a sovereign default on bondholders.
Bondholders had been selling off peripheral eurozone debt – particularly Irish – since Brussels announced they might need to accept a loss – or haircut – in the value of their holdings should a default occur. This effectively reduced the future value of bonds held. The precise nature of who would lose what has remained unclear, as the sell-off sent bond prices down and yields above 9 per cent yesterday for Irish 10-year debt.
Now finance ministers appear to have backtracked, saying Read more
Beware governments sporting 90 per cent public debt-to-GDP ratios: that’s the conclusion of a new research paper from the ECB.
Up to 90-100 per cent, increasing public debt increases GDP growth, finds the research. Beyond this magic range, increasing debt is associated with ever lower growth rates (see chart, right).
More than this, debt-fuelled increases in the growth rate start to slow when public debt reaches 70-80 per cent of GDP. Austerians will be pleased. A handy map from the Economist, left, shows us which countries are likely to feel the heat first. But even German debt may classify.
The paper, by Cristina Checherita and Philipp Rother, looked at the average impact for 12 eurozone countries since 1970:
It finds a non-linear impact of debt on growth with a turning point—beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth—at about 90-100% of GDP.
Die Zeit apparently reports Germany’s debt-to-GDP ratio could rise to 90 per cent when the government includes bad bank debt in its calculations, as recommended by Eurostat in July.
WestLB assets are apparently already included in the calculations, but the additional of Hypo Real Estate might indeed increase the ratio, the ministry apparently confirmed. Read more
Freddie Mac 30-year mortgage rates just fell to a fresh all-time low of 4.54 per cent (see chart, right). But it’s not just homeowners who can borrow more cheaply than ever.
The US government’s cost of debt is at, or approaching, its lowest ever levels in the medium-term (<10 years). Yields on Treasury auctions have been falling gently and consistently as demand has risen.
Rising demand for US debt is usually taken as an indicator of risk aversion in the markets. But should US bonds be seen as a safe haven with so much strength in east Asia and Australasia, and such ‘unusual uncertainty’ facing the West?
Auction results of US government bonds are shown below from 2008, or as far back as the data go, for you to puzzle over: Read more
Foreign holdings of US debt rose during May, but only by $0.6bn, the slowest increase since September 2009. Tic data show the UK remains the major buyer of treasuries, with $142bn additional value since the start of the year, nearly five times the purchases of the next biggest buyer, Canada. The rest of the world, in net terms, bought $100bn in that same time period.
A few noteworthy trends reversed in May. China and Japan, between them holding 42 per cent of US treasuries, sold off after months of net purchases. Russia, which had been selling, bought. Read more
Jürgen Stark, the European Central Bank executive board member, was closely involved in drawing up the European Union’s fiscal rules when he worked in the 1990s at the German finance ministry. In the past year, he has seen how ineffective they proved - largely, he believes, because of the example Germany set in 2005 demanding their loosening after flagrantly breaching them itself (by which time Mr Stark had become a central banker). Now, he is lobbying actively for a revised, tougher rule book.
Earlier this week, Mr Stark told a Frankfurt conference that proposals put forward by the European Commission “are not the quantum leap that is needed”. Speaking in Vienna today, Mr Stark backed a series of changes along the lines set out by the ECB in their recent paper on eurozone governance. As I have written, these focus on imposing sanctions earlier and with more “automaticity”. (Is there such a word in English?) To me, it seemed Mr Stark had been actively involved in compiling the ECB’s recommendations. Read more
The US government can borrow from the market for five years at a rate 2.6 percentage points lower than for Portugal. Bond yields continue to fall for medium-term US debt (they fell yesterday for 2-year bonds too), even though very short-term debt rose (4-week treasuries reverse trend (Jun 22)).
The medium yield was 1.925 per cent, down from 2.07 per cent at the last auction on May 26. Tomorrow is the 7-year auction: on current trend, the rate will be lower than a month ago, when it was 2.75 per cent.
The European Central Bank is obviously uncomfortable at having been forced to intervene in eurozone government bond markets, which has caused such controversy in Germany. Its proposals for the future governance of the eurozone, just released to coincide with the European Union summit in Brussels, include the suggestion that a future European crisis management institution should be given powers to buy sovereign bonds to “address disruptions in markets”. In other words, if it got its way, the ECB would not have to take such steps again.
Among the ECB’s other suggestions are that the possibility of a country being expelled from the eurozone should be ruled out “because the very existence of this option would put the viability of the common currency into question”. Read more
Are eurozone governments insolvent? That is a question the ECB appears to be asking in its latest monthly bulletin. A special section calculates eurozone average net government debt – debt minus governments’ financial assets – has hovered around 50 per cent of gross domestic product in the past decade and increased to 53.4 per cent last year. Those high figures, it concludes, “impl[y] that the financial assets held by governments do not constitute a sufficient buffer, especially as some of these assets are illiquid.” (emphasis ours)
Scary? Possibly, but the ECB does not say whether the position is any worse than elsewhere in the world. More crucially the financial assets of governments are only part of their total assets. “Ideally, it would also be interesting to measure government net worth,” the section says. “However, this is currently not feasible given the unavailability of data on government non-financial assets.” Quite right too – how would Greece ever put a value on the Acropolis?
Attention is focusing on Spain. Dominique Strauss-Kahn – who’s in the region anyway, apparently – will take the opportunity to visit the country on Friday to discuss the economy with the PM.
Agenda items might include Spanish sources of debt, following a disappointing bill auction on Tuesday, highest government bond yield spreads since the mid-90s, and data from RBS showing that Spanish institutions’ net borrowing from the ECB is at an all-time high (see chart). Note that the Spain is bucking the euro area trend, which has seen total euro area net borrowing fall by a sixth since its April 2009 peak of €629bn. The white line shows Spain’s borrowing as a proportion: now at a high of 16.5 per cent. High borrowing from the ECB suggests Spain is struggling to raise debt at reasonable rates elsewhere.
Spain is tackling problems in its economy. A raft of austerity measures Read more