The rich country debt problem

The rich country debt problem

A year after governments poured record amounts of public money to prevent economic collapse, a new fear is stalking the financial markets: sovereign debt defaults.

We had earlier commented in these columns on how the Dubai debt tremor had led traders to bid up the spreads of credit default swaps (CDS) of small European countries such as Greece, Hungary, Ireland and Estonia. These CDS spreads are the price of insurance against the possibility of a debt default by either a company or country.

New data in the November 2009 statistical handbook published by credit rating agency Moody’s Investors Service on levels of public debt show how the biggest pressure points are now in the developed countries rather than the developing ones. The ratio of government debt to gross domestic product (GDP), a simple measure of indebtedness, has exploded in many rich countries, nearly doubling in most instances.

Consider some numbers. Japan’s public debt ratio was 139.3% in 2000; it is estimated to touch 216.5% in 2009. The US has seen public debt as a proportion of its national output rise from 55.2% to 87% in the same period, and it is expected to touch 99.3% in 2010. The same trend can be seen in other countries such as the UK. Of course, there are still some developed nations such as Germany and Australia that have kept public debt under control.

The major developing countries have kept public debt under control, partly because of low borrowings and partly because their economies are growing faster than the rich ones. Even India’s public debt ratio has moved in a tight range of 73.6-86.4%, too high compared with China, but not bad by current global standards.

The usual thumb rule is that a nation’s debt is sustainable if its nominal GDP growth rate is higher than the cost of borrowing. As many of the world’s richest countries struggle with the prospect of long-term stagnation, ageing populations and higher interest rates, the big debt problem in the next decade could be in the developed countries rather than the developing countries. That could result in a huge change in the way financial markets price risk.

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