The Group of Twenty (G-20) meeting in Toronto concluded with a declaration that advanced countries will pursue policies that will halve their fiscal deficits by 2013, and stabilize or reduce government debt by 2016.
They really didn’t have much of a choice, having to ensure that growth didn’t suffer, while at the same time signalling to financial markets that they had a plan to reduce the huge government debt built up during the crisis. The details of how exactly these nations will bring their deficits under control, however, are rather fuzzy.
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Interestingly, the International Monetary Fund’s (IMF) estimates of public debt as a proportion of gross domestic product (GDP) in the advanced economies show that debt will rise from 90.1% of GDP in 2009 to 108.1% of GDP by 2015. Is it a coincidence then that the G-20 talked of bringing down the debt only by 2016?
What is also significant is that the public debt to GDP percentage is predicted to fall in emerging countries from 37.5% in 2009 to 33.2% in 2015. For India, IMF predicts that government gross debt will fall from 80.8% of GDP in 2009 to 67.3% of GDP by 2015.
In contrast, government gross debt in the US is projected to increase from 83.2% of GDP in 2009 to 109.7% of GDP in 2015. The biggest fiscal sinner is Japan, whose gross government debt as a percentage of GDP is projected by IMF to rise from 217.7% in 2009 to 250% by 2015.
What will be the impact of these high levels of government debt? IMF, in its recently published Fiscal Monitor, says that public debt in advanced countries is also rising as a ratio of household financial wealth, after decades of stability.
According to IMF, “As a result, public obligations will represent a larger share of private sector portfolios, with possible effects on interest rate differentials between public and private debt.” A key risk is upward pressure on interest rates as a result of “insufficiently credible adjustment plans”—higher interest rates are also a risk for emerging economies.
And then there’s the risk that the debt overhang slows growth. IMF says that a 10 percentage points increase in the initial debt-GDP ratio is associated with a slowdown in annual real per capita GDP growth of around 0.2 percentage point per year, with the impact being smaller (around 0.15) in advanced economies.
Further, a 10 percentage points increase in the debt ratio is likely to lead to an increase in long-term interest rates by 0.5 percentage point over the medium term. Finally, ageing populations will also put pressure on the deficit. IMF estimates that spending increases in health and pensions are projected at 4-5 percentage points of GDP in advanced economies over the next 20 years.
Has the widely differing fiscal positions of the advanced and emerging economies led to a change in bond spreads? It’s true that emerging market bond spreads have come down, but as seen from the chart, we still have some way to go before we reach the low levels of early 2007.
Once the so-called flight to safety effect wears off, it’s likely that emerging market bond spreads will fall even further.
Graphic by Naveen Kumar Saini/Mint
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