Key World Economies Facing Towering Debt Accumulation: Looking at the Bigger Picture

Debt is the most easily available source of financing and it is time-bound in the sense that the borrower has to pay back the loan plus the interest at the end of the pre-defined period.

In the first half of the calendar year 2019 (H1 2019), the global debt has crossed over a new record of $ 250 trillion (~ 320% of the GDP), surging by $ 7.5 trillion. The worlds? two largest economies- China and the United States (US) are leading the way, together accounting for over 60% of the new borrowing, according to the latest figures released by the Institute of International Finance (IIF),which is a global association of the financial industry with close to 450 members from 70 countries.

Ironically, the most indebted nations across the globe are also the wealthier ones.

As per IIF, governments of developed countries constituted the maximum portion of borrowing for H1 2019 and rightly so they can enable higher spending without having to increase taxes.

Emerging economies, on the other hand, have companies taking the lead as far as borrowing is concerned with over half of the corporate debt being largely held by state-owned businesses, a change that transpired since the global financial crisis. Particularly, private sector debt has nearly tripled since 1950, being the driving force behind global debt. At the other end of the spectrum, low-income developing countries have witnessed very low levels of private debt and continue to do so.

With no signs of easing, IIF has also estimated that the global debt load would exceed $ 255 trillion by 2019 end, largely driven by the US and China. In addition, high-debt countries like Japan, Singapore, Korea and the US may also struggle in tackling climate change with the rapid increase in funding that the fight against climate change will require.

Lower interest rates translating into lower borrowing costs as Central Banks continue to execute monetary easing around the world has primarily encouraged countries to take on new debt. Later, it becomes tricky for countries to pay off debt without diverting attention from other goals.

Developed Economies ? Japan and US in Focus

According to the World Population Review, Japan?s Debt-to-GDP ratio is ticking around 253% as of June 2019, followed by Greece with the next highest ratio of 181.1%, lagging significantly behind Japan.

How has the national debt grown so big for Japan? The story of Japan has been a popular topic of interest amongst different economists. The country emerged out strongly after its severe financial crisis of 1980s that served as an example for other economies around the world during the sub-prime crisis of 2009. It used fiscal stimulus to jump start its economy over the last two decades.

So, what was the classic government strategy that increased inflation and eroded Japan?s national debt away?

• Amidst Crippling debt, more bonds were pushed into the market by government.
• Correct estimation around the impact of post-war currency devaluation and increased inflation in combatting debt.
• Meanwhile, the government also adopted a mercantilist trade policy that improved the country?s foreign currency income, which did not decrease in value as fast as the Yen.

Despite its high debt levels, the Japanese government has certain advantages over other highly indebted nations. The most important one is that most of the debt is held within the country and so the government is less likely to face any blocks in financing the debt, that is denominated in Yen. Japan has the edge of just printing away out of financial difficulty as it owns the country?s central bank, the Bank of Japan, unlike in the US, Germany, France, Greece, or Italy.

Overseas in the US, the rising debt levels have been ringing alarm bells especially against heightened borrowing by the Federal Reserve from foreign investors during the last ten years, standing at around $ 16 trillion in 2018 and forecasted to accelerate even further over the time to come.

The starting point for the US debt was unprecedented Defense spending during the World War II when debt skyrocketed to over 100% of the GDP in 1946. Over time, although sustained economic growth did reduce the debt, again 1980?s onwards, ballooning Defense spending and sweeping tax cuts increased the debt followed by four consecutive years of budget surpluses, beginning 1998, on the back of tax increases, Defense cuts, and an economic boom.

Despite the alarming levels of debt, the latest budget legislation signed by President Donald J. Trump, consistent increase in entitlement spending and higher interest rates is expected to double the debt by 2029, nearly to the size of the country?s economy.

The key drivers of future debt for the US may be mandatory spending programs, namely Social Security (the largest US government program), Medicare and Medicaid. Plus, interest payments on the debt are also sloping upward.

Emerging Economies ? China

Emerging economies around the world are also facing high debt conditions, that is further straining the global economy, declining in strength under the weight of escalated trade protectionism and shifting supply chains.

China is at a tipping point as far its debt levels are concerned amidst slowing economic growth. In the first quarter of 2019, China?s total debt has climbed up over 300% of its GDP, according to IIF.

Economists are of conflicting view over the seriousness of the Chinese economic debt. Yes, China did have this big stimulus and turned on the credit taps that drove huge global demand; however, there was going to be a cost for such a debt led growth that they are suffering from. The US-China trade war has worsened the scenario and there are companies leaving China with different headwinds being faced by its slowing economy.

But there are reasons as to why there are no such fears regarding China?s debt. Around 90% of China?s borrowing is in local currency, which mitigates the risk of a crisis due to devaluation. D?j? vu? Lessons learnt from the aforementioned Japanese example!!

GDP Generating Capacity of Debt

From 2017 to the first quarter of 2019, it has been observed that each dollar of global debt produced only $ 0.42 of GDP growth in key economies around the world.

Read More: GDP Generating Capacity of Global Debt Dips; Look at other macro indicators

Debt led economic growth- Boon or Bane?

Are Loans really useful from an economic standpoint? Yes. In theory, based on the concept of Division of Labour, lending is one of the cornerstones of a successful economy. First, loans enable borrowers to have future income at their disposal now. And second, loans allow creditors to make optimal use of their available capital. The possibility of lending enables available capital to be invested as profitably as possible and enhances the diversification of investment risk. For society as a whole, it means that accrued savings are made widely available and thus put to better use.

Now, under what circumstances is lending detrimental to an economy? If a country fails to address its long-term fiscal challenges, the economic environment weakens leading to reduced consumer confidence, capital accessibility reduces, interest costs crowd out key future investments and the conditions for growth deteriorate, then the economy is steered onto a path of future crisis.

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