Paris: The debt dilemma confronting Dubai has thrown into sharp relief a new threat to the financial health of rich countries that have borrowed and spent heavily to escape recession and must now pay up.
Dubai, a once-thriving Gulf emirate, has sent world markets into a tailspin with an acknowledgement that it will need a six-month moratorium on around $59 billion dollars’ (Rs2.76 trillion today) worth of debt owed by its sprawling conglomerate Dubai World.
But Dubai is hardly alone in having come to the uncomfortable conclusion that its Biblical seven fat years are over.
The Organisation for Economic Co-operation and Development (OECD) has warned that the world’s 30 leading industrialized economies will see their indebtedness grow to 100% of output in 2010, a near doubling from the percentage 20 years ago.
Japan’s public debt is forecast to hit 200% of output next year. Comparable projections are 127.3% in Italy and 111.8% in Greece.
Borrowed riches: Currency exchange rates displayed at a shopping mall in Dubai on Friday. OECD has warned that the debt of the world’s 30 leading industrialized economies will grow to 100% of output in 2010. Steve Crisp / Reuters
The debt weighing on national budgets will have soared by up to 45% worldwide in the period from 2007 to 2010, leading ratings agency Moody’s estimated on Wednesday.
“Preliminary estimates suggest that the total stock of sovereign debt will have risen by as much as 45% or $15.3 trillion from 2007 to 2010,” Moody’s analyst Jaime Reusche said in a statement.
This is “over 100 times the inflation-adjusted cost of the Marshall Plan”, the huge US investment programme launched to revive Europe after World War II, he added.
Moody’s estimated in a report that the total global debt in 2010 would reach at least $49 trillion.
The members of the Group of Seven grouping of rich countries will account for at least three-fourths of the increase, “as their fiscal accounts have been hit hardest by the crisis”, Reusche said.
“As growth turns negative in 2009 for most countries, the relative debt load becomes harder to bear.”
At the Centre for European Policy Studies in Brussels, economist Cinzia Alcidi said: “A debt equivalent to 100% of gross domestic product means that everything produced in the course of a year will have to go towards reimbursement.
“Are governments in a position to do that?”
The fear is that if financial markets begin to doubt the ability of countries to pay what they owe, they could steer clear of official debt instruments—such as treasury bonds—and thereby deprive countries of fresh cash.
“If the debt continues to grow, it’s not hard to imagine a country having trouble securing finance,” said Jean Pisani-Ferry of the Bruegel think tank in Brussels.
Other analysts have warned that heavily indebted governments could see their credit ratings lowered, raising the cost of critical borrowing.
Under such a scenario, governments would be tempted to raise interest rates offered to national creditors, thus intensifying the debt burden.
“That’s what makes debt explosive,” noted Michel Aglietta of the research group Cepii.
Economist Daniel Fermon of the bank Societe Generale has warned that in an “extreme case”, a debt explosion could trigger a new wave of recession.
In principle a return to robust economic growth should reduce the need for public borrowing, although economists caution that that may not happen in the current climate where a weak recovery is forecast.
The weight of debt can also be eased if inflation rises faster than interest rates. But Aglietta of France’s Cepii institute said higher inflation can erode consumer spending, triggering “a flight of private capital towards countries with lower inflation”.
The alternative, according to Bruegel’s Jean-Pisani Ferry, is to “raise taxes or cut public spending”.
But both OECD and the International Monetary Fund have stressed that too abrupt a clamp-down on spending could snuff out recovery.
Aglietta said governments should try to reassure credit markets by “signalling in advance their spending cuts or tax increases”.
For the moment, however, the message to the markets from Europe is mixed. Germany plans to cut taxes, Spain is preparing to raise them, the Netherlands sees spending cuts in 2011 while France has ruled out any tax hike.