One area that has caught my interest throughout the current crisis has been the Economic response of countries across the world and the potential strains on debt sustainability as a result. Looking at Europe, The US and Emerging Markets (EM), we’ve seen government budgets completely overhauled and replaced by massive, blank cheque spending that only 2 months ago would have been very hard to imagine.
The Current Narrative
Emerging Markets and many other developing countries have seen a surge in stimulus packages from the IMF, with the multilateral institution dispersing out over $500 Million in Grants to IDA countries (the lowest developed nations). These have been provided in order to assist such countries in covering their debt obligations over the next six months and will also enable them to channel their scarce financial resources to emergency health services that desperately need them. Additionally, The G20 group have been discussing plans to push-back on debt payments as they attempt to provide some form of relief for EM nations.
In the US we’ve seen congress pass the Coronavirus Aid, Relief and Economic Security (CARES) Act. This has granted the US government $2 trillion(about 10% of their annual GDP!) worth of funding to combat the virus, with the package aimed at sustaining jobs, boosting consumer spending and keeping companies afloat, ensuring the virus doesn’t completely decimate their economy. More recently, the decision to roll out a further $25 billion to help bailout the Airline Industry with the likes of Delta, Southwest Airlines and United all signing up, is likely to become the norm in this environment with further bailouts expected globally. The narrative has been the need to protect vital industries, fundamental to the US economy and the same can be said for most nations.
Europe has seen major selloffs in their sovereign debt market as yields on the Italian 10-year rose to a four-week high of 1.8% in March, rising further to 2.1% in April. Greece, Spain and Portugal saw major selloffs with yields between the German 10 Year and the PIIGS(Portugal, Italy, Ireland Greece and Spain) widening further. It’s projected that Debt-to-GDP in these jurisdictions will rise to an average of 130% of GDP while Germany will hold up at 63%, indicating the contrast in the amount of debt being taken on within Europe and showing those in the most weakened positions. The fears round debt sustainability in Southern Europe was further raised due to the failure of the European region to conclude on a joint issue ‘Corona Bond’ as part of a joint crisis package last week.
In the UK, the government has pumped over £350 billion worth of stimulus into the UK economy, dwarfing some of the levels seen during the 2008 Financial Crisis and war periods gone by. All with the purpose of ensuring economic activity, through loan facilities and furlough schemes being made available to people and businesses likely to be hit the hardest from the pandemic. A recent decision to provide 1.25 Billion worth of financing for UK tech startups being one of the latest proposed bailouts from the Chancellor. We are likely to see even further packages going forward as the rhetoric from global leaders has been ‘To do whatever it takes’.
Implications and My Point of View
Looking at the amount of money being thrown around, I can’t help but wonder what the future holds for Debt Sustainability as a lot of this spending has been facilitated through Borrowing, NOT Tax Revenues or Reserves. The IMF has claimed that the Net Debt-to-GDP ratios of all countries globally will rise significantly as a result, leaving a number of sovereign states highly leveraged and running the risk of future financial distress, evidenced through talks of potential defaults on bonds within EM and Credit Rating downgrades for all. Globally, there have already been cases where a number of nations such as Argentina, Ecuador and Zambia looking to restructure their debt during this crisis by calling in external advisers to aid in discussions.
So far, a lot of the pressure, although global, is likely to be felt most in Emerging Markets with talk of restructurings likely to trigger a Domino Effect. With about $11 Trillion in external debt and $3 Trillion in servicing all due in 2020, Developing markets are the regions most exposed to any short to medium term debt obligations. There have been calls for debt moratoriums (debt payment holidays) to be put in place which could go some way in easing the burden. However, these will be dependent on whether private bondholders will accept countries temporarily suspending debt payments and this discussion remains an area of debate as G20 nations push private investors to cooperate.
My view is that EMs are likely to feel this for the foreseeable future, long after the virus due to the relatively high levels of debt, prior to this pandemic and interest rates that are significantly higher than those in Europe. This has mainly been due to continued Quantitative Easing across Europe which has seen interest rates fall closer to/below the zero bound. Whereas, most EM markets have attempted to curb inflation by Monetary tightening which has propped up the cost of borrowing domestically, with the increased risk of default being priced into markets as EM bond yields rise and prices fall significantly.
Internationally, the strengthening Dollar due to the flight to safer assets or Hard currency has seen a number of EM currencies fall sharply and makes the cost of servicing any debt obligations very high as paying back Dollar denominated debt is even more costly. This suggests a long road ahead for a level of sustainable debt to be reached in these jurisdictions and thus the long-term effects of the pandemic are likely to leave deep scars in these markets.
Ultimately, It is important to note that every government is vulnerable during this crisis. Although some have more exposure than others, each nation will ultimately face debt pressure in some form due to the significant amount of fiscal action we continue to see globally. This paints a very grim outlook and looking forward, assessing how countries restructure and manage their debt in the coming months will be crucial in avoiding a repeat of the debt crisis in Greece and other parts of Europe in 2008-2009, with a lot of these nations just only beginning to recover 12 years on.
Disclaimer: Do not take any of the personal views shared here as Investment advice. Whenever you want to start investing make sure you do your own research and seek professional advice for any investment decisions you make in the future.