Why a global debt crisis looks very hard to avoid
Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 -- to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black -- pitch black.
Moody’s rates the creditworthiness of 142 countries, which represent about 62.2 trillion of debt. It sees a disruptive political environment both within various countries and at the international level.
This, it says, is aggravating the slow-motion stagnation of global GDP growth that has been a problem since the financial crisis of 2008-09. Together, these difficulties have the potential to worsen the effects of unresolved structural issues in different countries, such as fast-ageing populations, income inequality, poor competitiveness, low currency reserves, and poor policies for managing sovereign debt. The net result could be sovereign debt defaults that could trigger new economic and financial shocks and lead to serious instability in the months ahead.
As a professor of banking and finance law, I broadly agree with this prognosis. So where are the most serious flashpoints, and what can politicians and civil servants do to minimise the risks?
Welcome to the cauldron
Unfortunately, the world is sitting on a sovereign debt timebomb that could be triggered at any time by the smallest event. This is confirmed by the IMF’s data, which identifies 32 countries as being at high risk of unsustainable debt. Their borrowings have more than tripled in just two years. We have to remember how serious the consequences can be when a country’s finances spiral out of control: take Venezuela, which is facing a humanitarian crisis with projected inflation of 10,000,000% by the end of this year.
Moody’s argues convincingly that the main drivers of the problems threatening to tip these high debt levels into crisis are twofold: The recent disruption to world trade and the weakening of global and national institutions. World trade in goods is heading for its worst year since 2009, mainly driven by the geo-political tensions resulting from the trade war between the US and China, and to a lesser extent the Brexit uncertainty in Europe.
The US-China standoff has affected trade volumes between the two superpowers. It has also meant that countries which play an important role in the global supply chain, such as Belgium, the Czech Republic, Ireland, Malaysia, Singapore and Vietnam, will face a slowdown in their economic activity.
Beyond this are indirect consequences that could kick off a crisis: confidence is reducing across the board, and short and medium-term growth is projected to slow down. This threatens to reduce foreign direct investment and capital flows into many countries – Moody’s argues this is already evident in the Asia-Pacific region.
The same thing looks likely to happen to those countries with large account deficits who are more reliant on overseas capital, such as Argentina, Lebanon, Mongolia, Pakistan, Sri Lanka, Tunisia, Turkey and to a lesser extent Indonesia. Capital flight will send their currencies plummeting and make their dollar-denominated debts even more unsustainable, raising the prospect of political strife and contagion.
The division bell
Nationalism and populism are ascendant across the world, undermining the effectiveness of domestic, regional and global policy now that the era of centrist political consensus has ended. As Moody’s notes, this lack of international cohesion has made it harder for institutions, such as the World Trade Organization and G20, to help coordinate policy responses to economic difficulties.
It doesn’t help that there is also a large amount of bilateral antagonism at present -- not only US/China and UK/EU, but also Japan and Korea, China and Japan, North Korea and the US, India and Pakistan, Russia and Ukraine, and the ever-present tensions in the Gulf.
In this climate, populist movements are turning the growing anger over rising income inequality to their advantage, as we have seen in the likes of Argentina, Ecuador, Mexico, and particularly Chile. Other countries facing similar issues include Ethiopia, Iraq, Lebanon, and Tunisia.
In response, governments are being forced to shift their policies. For example, Argentina’s government had to reinstate price controls, which was one of its most criticised policies. Any quick populist fix may quiet discontent, but it doesn’t address structural challenges and only serves to highlight weak governments.
This is not just restricted to emerging markets: Moody’s also recently changed the outlook of the UK to negative, amid the uncertainty surrounding Brexit and the log-jammed parliament. Similarly in the US, the ongoing impeachment process against President Trump and political polarisation are distracting policy-makers from more essential and pressing matters -- not least the sluggish economy. A ratings downgrade cannot be ruled out entirely.
This should all serve as a wake-up call to other countries with long-standing unresolved structural challenges. Sri Lanka, for example, has large account deficits that cannot be reduced, while India’s credit outlook has also been downgraded to negative because its government’s economic policies have been ineffective at producing growth. Many countries, meanwhile, need to do more to address other challenges, such as robotisation and the emergence of AI, or simply reform fatigue.
Put this all together and it looks like a very toxic mix. Countries need to recognise their mutual interest in avoiding a full-blown debt crisis. They need to try to overcome their differences and embrace a cohesive approach towards development and tackling the debt problem.
It may even be too late. There are some parts of the world, such as Africa, where debt is already getting very close to a regional crisis. Latin America and the Caribbean are also at risk, although some countries are already restructuring their debts.
At any rate, the international community must do what it can before time runs out. For the future, there are two vital lessons: Countries need to tackle their structural issues early, and borrowing must be used for investment and not simply to finance budget deficits. If the world can make genuine progress on these fronts, situations like this can hopefully be avoided in the future.
Rodrigo Olivares-Caminal is Professor of Banking and Finance Law, Queen Mary University of London. This article originally appeared in The Conversation UK and has been reprinted under special arrangement.