Enormous doses of stimulus spending are offering relief from coronavirus damage but their lifelong legacy of debt could seed future crises by hobbling economic growth and worsening poverty, especially in developing countries.
Central banks and governments worldwide have unleashed at least $15 trillion of stimulus via bond-buying and budget spending to cushion the blow of a global recession tipped to be the worst since the 1930s.
But the steps will pile even more debt on countries already struggling with the aftermath of the 2008-9 financial crisis — total global debt has risen $87 trillion since 2007, and governments, with $70 trillion, accounted for the lion’s share of that increase, the Institute of International Finance estimates (IIF).
This year alone may see the global debt-GDP ratio rise by 20 percentage points to 342%, the group said, based on 3% economic contraction and a doubling in government borrowing from 2019.
Taking on that kind of debt doesn’t go unpunished: the most pain will be in highly indebted states, whether relatively wealthy ones such as Italy or those such as Zambia which were already under strain before the virus hit and are now careering towards default.
But not even the richest will be spared. The rising debt could lose Germany and the United States their triple-A credit ratings, while governments will increasingly rely on central banks to keep borrowing costs in check or even directly finance spending for years to come.
“Historically, whenever countries step up debt levels, things change,” said Mike Kelly, global head of multi-asset at PineBridge Investments. “This crisis…has taken us back to the slow-growth trap that we had just started to shake off in 2016-2019.”
The challenge for policymakers in the coming years will be to find a way to “grow into this massive debt-GDP structure we’ve found ourselves in almost overnight,” he predicted.
For now, with the world economy staring at a 5-6% contraction this year, the additional borrowing and spending is a lifeline. The International Monetary Fund estimates public deficits as a percentage of national income will jump to almost 10% this year from just under 4% in 2019.
Even European powerhouse Germany is taking on new debt for the first time since 2013, while the U.S. Treasury’s second-quarter borrowing will amount to almost $3 trillion — more than five times the previous record.
U.S. federal debt held by the public, a gauge tracked by the Congressional Budget Office, will rise to 100% of GDP this year – levels last seen in the 1940s – and approach 125% by 2030, Deutsch Bank calculates. It was 79% in the 2019 fiscal year.
Eventually, though, debt can drag on economic growth if countries start to spend more and more of their annual income on paying creditors, a position developing countries have endured time and again.
Accelerating economic growth in those circumstances is like “trying to fly when we were already carrying a lot of debt and now we are adding more,” OECD Secretary-General Angel Gurría told an FT online conference this week.
QE NOT ALWAYS PANACEA
Low-interest rates will allow some countries to live with higher debt. Japan’s debt, for instance, exceeds 200% of GDP but it prints money to issue debt which the central bank then buys.
“The ability to control interest rates and keep rates low is a key parameter for keeping debt servicing costs low and we expect that to continue,” said Eric Brard, head of fixed income at Amundi.
The trend will gather pace in the United States and Europe too, with central banks soaking up much of the excess debt.
But in some countries, average GDP growth has crawled along well below interest rates for years, meaning debt ratios were rising relentlessly even before coronavirus hit.
Italy, for instance, has not benefited from five years of low-interest rates, noted Kevin Thozet, a member of the investment committee at Carmignac.
“Italy’s debt, at around 135% of GDP, is likely to rise to around 170% — those levels are not sustainable so it either needs rapid growth or debt mutualization,” he said.
He was referring to the idea of pooling European risk across all member states, something wealthier countries are resisting.
According to Pictet Asset Management, Greece had the worst debt sustainability at the end of 2019 among developed countries, followed by Italy, Japan, Belgium, and Britain.
However, Italy and other southern European states have the might of the European Central Bank backstopping their borrowing, a luxury most developing countries lack.
Central banks in about a dozen emerging economies have started their own quantitative easing programs. Yet without big domestic savings pools, most rely on foreign investors to cover the balance of payment deficits and underpin currencies.
That, along with inflation risks, constrains how much money they can print to support growth. Bond buying programs in Brazil or South Africa could see real interest rates at the back end of the yield curve push up sharply, said Manik Narain, head of EM strategy at UBS.
“How can South Africa service debt at 10%? This debt becomes unsustainable and creates a crisis – at best it will pull GDP growth down,” he said.
The dynamics could put some developing economies on track for another devaluation and inflation cycle, said analysts.
“Worryingly some large developing economies – Turkey, Brazil, South Africa – are heading in this direction,” said Andres Sanchez Balcazar, Head of Global Bonds at Pictet Asset Management.
Some countries such as Brazil and South Africa have for years grappled with annual growth below 2%, while interest rates were as high as 14.25% and 7% respectively.
BofA calculates public debt could hit 77.2% of GDP by year-end in Brazil and 64.9% in South Africa. A decade ago, they were around 61% and 35% respectively, IMF data showed.
Rising debt levels in turn raise borrowing costs for such issuers, noted Edith Siermann, head of fixed income solutions at NN Investment Partners.
“The long-term worry is – who is going to pay for this?”
British Prime Minister Boris Johnson said on Sunday the coronavirus lockdown will not end yet, urging people to “stay alert” to the risks as he outlined plans to begin slowly easing measures that have closed down much of the economy for nearly seven weeks.
While his government was giving directions for England, it wants the United Kingdom’s other constituent nations – Wales, Scotland and Northern Ireland – to take the same approach. But there were immediate divisions, with Scottish First Minister Nicola Sturgeon saying she was sticking with the existing “stay at home” message.
Johnson announced a limited easing of restrictions, including allowing people to exercise outside more often and encouraging those who cannot work from home to return to their jobs.
“This is not the time simply to end the lockdown this week,” he said in a televised address. “Instead we are taking the first careful steps to modify our measures.”
Johnson’s government has faced criticism from opposition parties and others over its handling of the pandemic and the prime minister is wary of taking the brakes off too soon. Britain’s coronavirus death toll – 31,855 – is the second-highest in the world, behind only the United States. The bulk of the cases and deaths have been in England.
The government’s decision to replace its “stay at home” slogan, drummed into the public for weeks, was criticized by opposition parties who called the new “stay alert” message too ambiguous.
Johnson earlier tweeted a new government poster with rules including “stay at home as much as possible”, “limit contact with other people” and “keep your distance if you go out”.
In his address, Johnson said people should continue to work from home if they could, but from Monday those who cannot, such people working in construction and manufacturing, should be “actively encouraged to go to work”.
From Wednesday, people will be allowed to take unlimited amounts of outdoor exercise, he said and can sit in the sun in their local park, drive to other destinations, and play sports with members of their own household.
Until now, people have been expected to exercise outdoors once a day, do so locally, and – despite recent spells of warm weather – told not to go to parks to sit in the sun.
Social distancing rules must still be obeyed, Johnson said, adding that fines would be increased for those who break them.
He detailed an alert system ranging from level 1, where the virus is no longer present, to level 5, the most critical, that will allow the government to flag risks in different parts of England and to decrease or increase restrictions where necessary.
Scotland’s Sturgeon said the only modification she was making to lockdown measures was to allow people to exercise more than once a day.
“(That) is the only change that the Scottish government judges that it is safe to make right now without risking a rapid resurgence of the virus,” she told a news conference.
Sturgeon also said she had asked the UK government not to use its “stay alert” advertising campaign in Scotland.
Labour health spokesman Jonathan Ashworth also criticized the “stay alert” slogan. “Many people will be puzzled by it,” he told BBC TV. “This virus really does exploit ambivalence and thrive on ambiguity, we need clarity at all times.”
SLOW AND CAUTIOUS
Britain’s economy – the world’s fifth-largest – has been hammered by the pandemic and the lockdown measures.
The government has faced steady questions from Labour and others on why the country was not locked down earlier, why it has struggled to administer mass testing, and why there have been shortages of protective equipment for medics and care workers.
Johnson himself is recovering after falling critically ill with COVID-19, the respiratory illness caused by the coronavirus, last month.
The Sunday Times reported that scientific advisers had told the government that deaths could exceed 100,000 by the end of the year if lockdown measures are relaxed too fast. As of Sunday, Britain had reported some 219,183 confirmed infections.
Johnson said that by the earliest by June 1, the government might be in a position to begin the phased reopening of shops and to get primary pupils back into schools, in stages.
At the earliest by July, and if the infection rates support it, there could be the re-opening of at least some of the hospitality industry and other public places, provided they are safe and enforce social distancing, he added.
With both the death rate and hospital admissions falling, Johnson said it would be “madness” to allow a second spike in infections.
Changes will be closely monitored at a local, regional and national level and the government would “not hesitate to put on the brakes” if there are outbreaks, he said.
The White House has started informal talks with Republicans and Democrats in Congress about the next steps on coronavirus relief legislation, officials said on Sunday, but they stressed any new federal money would come with conditions.
Treasury Secretary Steven Mnuchin told Fox News Sunday he was having discussions with lawmakers from both parties to understand their concerns about state budgets. But he said the White House is in no hurry to pass another fiscal relief bill.
“Let’s take the next few weeks,” Mnuchin said.
Since early March, Congress has passed bills allocating $3 trillion to combat the coronavirus pandemic, including taxpayer money for individuals and companies to blunt an economic impact that includes an unemployment rate to 14.7% in April.
“We just want to make sure that before we jump back in and spend another few trillion of taxpayers’ money that we do it carefully,” Mnuchin said. “We’ve been very clear that we’re not going to do things just to bail out states that were poorly managed.”
President Donald Trump has previously threatened to withhold more coronavirus relief funds from states that limit cooperation with federal immigration enforcement, and advisers said last week that the White House would not consider new stimulus legislation in May.
Democrats, who control the House, are pushing for a vote as soon as this week on another massive relief bill that would include more money for state and local governments, coronavirus testing, and the U.S. Postal Service.
“It’s not that we’re not talking. We are. It’s just informal at this stage,” White House economic adviser Larry Kudlow told ABC’s “This Week” program on Sunday, referring to discussions between the White House and Congress.
“We’re collecting ideas for next steps, which will undoubtedly be data-driven,” he said.
Kudlow said he took part in a Friday conference call with House lawmakers from both parties, and that he planned to do the same on Monday with members of the Senate.
“If we go to a Phase 4 deal, I think that President Trump has signaled that, while he doesn’t want to bail out the states, he’s willing to help cover some of the unexpected COVID expenses that might have come their way,” White House senior economic adviser Kevin Hassett said on CNN’s “State of the Union.”
The White House is “absolutely” pushing for a payroll tax cut, Mnuchin said. Trump has been calling for a cut to the tax, which is paid by employers and workers and funds Social Security and Medicare. The idea has little support in Congress, however.
White House predictions on the economy, and how quickly a coronavirus vaccine could be rolled out were questioned on Sunday by both Democrats and Republicans.
The United States will need more tests before schools can reopen later in the year, said Senator Lamar Alexander, chairman of the Senate Health, Education, Labor, and Pensions Committee.
In an interview with NBC’s “Meet the Press,” he appeared to question the White House’s aim of having 100 million vaccines by the autumn and 300 million by the end of the year, calling it “an amazingly ambitious goal” and adding, “I have no idea if we can reach that.” There is currently no coronavirus vaccine.
The president and CEO of the Federal Reserve Bank of Minneapolis, Neal Kashkari, told ABC’s “This Week” that he would love to see a robust recovery.
“But that would require a breakthrough in vaccines, a breakthrough in widespread testing, a breakthrough in therapies, to give all of us confidence that it’s safe to go back,” he said. “I don’t know when we’re going to have that confidence.”
Ultimately, Kashkari said, “the American people are going to decide how long the shutdown is.”
The outbreak of the novel coronavirus and plummeting oil prices and global demand were having a devastating effect on Ecuador, one of the largest oil exporters in Latin America said IMF Managing Director Kristalina Georgieva.
The IMF said the emergency aid would help Ecuador finance much-needed health and social assistance spending, while helping to catalyze additional resources from other multilateral financial institutions such as the World Bank.
Ecuador has been among the hardest-hit countries in Latin America by the coronavirus, with 24,934 confirmed cases and 900 deaths, plus a further 1,357 deaths that were likely caused by the virus.
Ecuadorean authorities have taken decisive action to contain the virus and mitigate the socio-economic impact of the health crisis on households and firms while prioritizing efforts to protect the poor and vulnerable, the IMF said.
Austerity measures imposed on April 16 by President Lenin Moreno have sparked fears of further social instability following a wave of street protests that erupted last October after Moreno decided to end a fuel subsidy.