Debt problem is no stranger to the global economy. What is new now is that the global debt problem that rose incrementally, except in the wake of the financial crisis of 2007-2008, has now shot up to record high levels after 2020, the year pandemic struck economies like lightning and spread like wildfire. Both the public and private sectors, including individuals, were dragged deeper into borrowing to cope with the economic crisis engendered by the pandemic. A complex nexus among virus attacks (turned interminable through mutations), debt and rising inflation has resulted in confounding policy makers in countries of different economic status and in global institutions (IMF, G-20).
As pointed out, debt was on the rise for quite some time but in the aftermath of the pandemic it has assumed crisis proportions, recording the longest one-year surge since second world war. The global debt level has now risen to US$ 226 trillion, which was estimated by IMF (Global Debt Data base) to be equivalent to 256 per cent increase in global Gross Domestic Product (GDP) in 2020. Governments across the world borrowed a total that is slightly more than half of the increase turning the global public debt ratio of 99 per cent of global GDP. Private debt of non-financial institutions and households also reached new highs during the same period. Increase in debt levels have been particularly high in advanced economies where public debt rose from about 70 per cent of GDP in 2007 to 124 per cent in 2020. During this period, private debt rose at a more moderate rate, from 164 per cent to 178 per cent of GDP. Public debt now accounts for almost 40 per cent of global debt, the highest share since the mid-1960s.The rise and accumulation of public debt since 2007 are mainly due to the two major economic crises that governments have faced– first, the global financial crisis of 2007-2008, and the second one that coincided with the pandemic since 2020.
Debt levels, however, vary among countries. Advanced countries and China accounted for more than 90 per cent of 28 billion US dollar in debt surge in 2020.Public and private debt in these countries rose during pandemic, supported by low interest rates, easy money policy of central banks (purchase of treasury bonds) and well developed financial markets that facilitated borrowing. Faced with limited financial resources and higher interest rates, emerging and developing economies were forced to borrow less than their requirement. The developments in financial and money markets led fiscal deficits to soar in developed countries to record levels which fed into the need for borrowing by governments of these countries. While public debt rose by 19 per cent in 2020, private debt jumped by 14 per cent of GDP the same year, almost twice as much as in the financial crisis of 2007. After the breakout of pandemic in 2020, governments and central banks were supportive of borrowing by private sector through stimulus packages and easy money policy respectively. The objectives of these interventions were to protect lives and livelihoods. During the financial crisis of 2007, on the other hand, the challenge was to protect the overly leveraged financial institutions.
With elevated debt levels that were aggravated by fall in GDP rates, the emerging and developing economies also faced fiscal crisis as the developed countries, but the magnitude of the problem was not the same. The convergence of both monetary and fiscal crisis across all economies has been unprecedented. With the developed countries burdened with growing debt, scope of help from them to mitigate the economic pains of emerging and developing economies has become limited. Despite some relief measures from external sources (multilateral institutions) during the pandemic, 60 per cent of low income countries have been flagged as being at high risk of default in repayment of sovereign debt at present. Pandemic- related initiatives such as the G-20 Debt Service Suspension Initiatives(DSSI) will expire at the end of 2022. Many of the countries that benefitted from these initiatives now face arrears in repayment or reductions in both public and private expenditures. Unless G-20 countries agree to accelerate debt restructuring for these countries and suspend debt servicing, many of these countries face economic collapse. It is also critical that financial markets also undertake debt relief measures. The multilateral institutions have very prudently scaled up their financial support for debt-strapped countries, with IMF giving emergency lending and a 650 billion US dollar allocation of Special Drawing Rights (SDR) to all member countries. The low income countries have been allocated US$21 billion directly while developed countries have committed to support low income countries with on- lending 100 billion out of their special allocation of SDR.
The DSSI undertaken by G-20 countries that will expire later this year was followed by a Common Framework (CF) to help vulnerable developing and low income countries to restructure their debt and to deal with insolvency and protracted liquidity problems. It is also designed to deal with insolvency for debt servicing and help support the implementation of a IMF supported reform programme. Due to lack of coordination among G-20 official creditors, both traditional Paris Club creditors and new creditors (China and India), very little has been achieved so far. If CF is to contribute to the solution of the debt problem of the developing and low income countries, it has to be implemented with a sense of urgency.
Debt problem being both external and domestic, the problem related to the latter has also to be addressed in earnest. Over the last two decades the share of domestic debt in emerging and developing countries (EMDEs) has risen from 31 to 46 per cent of their total sovereign debt. The resolution of debt crisis for EMDEs also requires restructuring of domestic debt. As most of domestic debt is held by domestic creditors (banks, pension funds) the cost of restructuring can add to the economic malaise that makes restructuring necessary in the first place. The key here is to know the cost and benefits of restructuring domestic debt. The net benefit calculations will determine whether or not domestic debt should be a part of restructuring together with external debt.
From global point of view, the debt problem at present has become almost intractable because almost all countries are now entangled in what may be called a ‘debt trap’. While the developed countries are expected to provide as much help to EMDEs as they can, they have to stabilise their own economies first. What are the tools available to them for this? The answer is: a balanced and prudent use of fiscal and monetary policies. The crucial challenge for governments of all stripes of economies is to strike the right balance between the two policies in the prevailing environment of high debt and rising inflation. Fortunately, fiscal and monetary policies complemented each other during the worst phase of the current pandemic. Central banks’ actions in advanced economies pushed interest rates down and made it easier for governments to borrow while their easy money policy through purchase of treasury bonds injected money in the financial market. While the Quantative Easing (QE) is going to be wind down soon in view of inflationary pressure, central banks of advanced economies should be circumspect about raising interest rates lest it impedes the economic recovery.
As for fiscal policy, developed countries should go for higher public expenditures with the help of higher corporate tax and tax on the wealth of those in the top income bracket. The Biden administration has adopted that policy, though the original proposal has been somewhat watered down. There is no doubt that this is the right strategy at this juncture when the need to sustain the recovery momentum and to rein in inflation have to be met simultaneously. For the EMDEs, which depended more on monetary policy to cope with the economic crisis engendered by the pandemic, resetting the policy regime is now called for. In view of rising inflation they should go for greater use of fiscal policy to sustain recovery with the same strategy of higher corporate tax and wealth tax on the rich. It is payback time for those who have been battened with government support so long. Neither debt level nor inflation can be allowed to cross the red line. It is as much imperative for developed countries as for EMDEs.
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