Rising debt, falling growth: the developed world considers its options
17 Jul 2020
Governments around the world have taken stringent measures to contain the spread of COVID-19, which have been crucial to save lives but have come at a huge economic cost. Our Research analysts expect the global economy to shrink 3.5% in 2020. It is likely that advanced economies will bear the brunt of this slowdown, contracting an anticipated 7%, compared with a pre-COVID growth estimate of 1.5%.
To support businesses and individuals through the COVID-19 crisis, governments have also provided unprecedented fiscal support. Trillions of dollars have been spent on loans, grants, unemployment benefits, healthcare and a raft of other measures.
In the latest ‘3 Point Perspective’, our Research team examines the longer-term consequences for some of the leading G20 countries and considers the fiscal measures governments can take to alleviate their growing debt burdens.
Not all debt burdens will be equal
The fiscal profiles of advanced economies are set to worsen quite dramatically, although the deterioration is uneven across economies:
Debt-growth ratios of developed markets set to worsen dramatically
Source: CBO, OBR, Eurostat, Barclays Research
The US, which provided the most direct financial support during the pandemic, is likely to increase its already shaky debt-to-GDP ratio by nearly 30 percentage points in the next two years, to 110% - a level not reached even during World War Two.
We expect the ratio in the euro area as a whole to grow from about 85% in 2019 to 100% in 2020, but the outlook is even worse for individual European countries. Italy’s debt as a proportion of GDP could rise to as high as 165%, while Portugal (135%) and Spain and France (both 120%) also face uncertain times. Northern European countries, including Germany, the Netherlands, Austria and Finland, are likely to see their deficits increase to a more ‘modest’ 60-80%.
The UK is also likely to grow its debt/GDP ratio to 100%, a peace-time record.
Policy-makers will not be able to ignore these worsening fiscal profiles for long, as rising debt would ultimately be detrimental to growth. With the US dollar as the reserve currency and US Treasury debt as the preferred 'safe asset', policymakers in the US have the luxury of being more patient. However, without a fiscal union, the euro area remains vulnerable, as does the UK, with Brexit-related uncertainties
Governments have choices to address the problem
Broadly, there are four options to address the rising debt burden. The preferred policy options and their success will depend on each country’s specific situation.
Boost economic growth: Governments can enact pro-growth policies to lower the debt burden through greater tax revenues and higher GDP levels.
Cut budget deficits: Increasing taxation and reducing spending both work to reduce the gap between government revenues and spending.
Inflate away debt: By relying on higher inflation, governments can reduce the real value of outstanding debt.
Engage in financial repression: With central banks buying or promising to buy debt, governments can issue debt at low rates, thus keeping the cost of servicing debt low.
A fifth possibility - debt restructuring - is not a feasible policy for major developed markets.
No easy way out: A comprehensive approach is required
Given the limitations of each of these options, governments would need to take a comprehensive approach to address the rising debt burden.
Financial repression policies will probably be the path of least resistance. However, they are not without costs. Central bank involvement beyond that justified by the economic backdrop would call into question their independence. Hence, while these policies are likely to be used to buy time for vulnerable countries, they cannot be relied upon forever.
Achieving fiscal consolidation has limits, as well. Following the austerity measures after the global financial crisis, there is little public appetite for further cuts in services. There is, in fact, demand for more spending, such as on healthcare, education and infrastructure. Policymakers are better served by enacting policies that boost growth via encouraging more people to work, as well as via greater private and public investments. Increased taxation is likely to be part of the solution.
Finally, inflating away debt is easier said than done. Inflation has been quite sticky at low levels and if it does rise sharply, investors would also demand higher interest rates, offsetting the benefit of higher nominal growth. Still, a post-COVID world of modestly higher medium-term inflation, if it occurs, could be welcomed by policymakers.
Central Banks have failed to get inflation up to their targets
Source: Haver Analytics, Barclays Research
Overall, while there is no easy way out, developed economies are in a strong position to put their fiscal houses in order and are likely to consider their options carefully in the coming years.
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Anshul Pradhan is Head of US Rates Strategy. Based in New York, Anshul is responsible for interest rates research across cash and derivative products in the US. Prior to his current role, he was responsible for the firm’s US Treasuries research and prior to joining Barclays in 2008, he was part of the Fixed Income Research Group at Lehman Brothers, where he focused on inflation-linked government securities. Anshul holds a MBA from the Indian Institute of Management and a Bachelor’s degree in Engineering from the Indian Institute of Technology.
Cagdas Aksu is a Managing Director and Head of European Rates Research, based in London. He joined the firm in 2004 and is responsible for interest rate research and market views in cash and swap products in Europe. In close cooperation with Research, Sales and Trading colleagues, he delivers a high level of service to clients globally. Cagdas holds an MSc degree from the London School of Economics and a BSc degree in Engineering from Bogazici University in Istanbul.
Moyeen Islam is a Director in European Fixed Income Strategy, based in London. Mr. Islam joined the European Fixed Income Research Group of Barclays Investment Bank (then known as Barclays Capital) in 2004.
Between 2000-04, he was a senior economist in the Macroeconomic Policy and International Finance Directorate in HM Treasury covering debt management policy and government borrowing strategy as well as policy issues surrounding the wider management of the liability side of central government’s balance sheet. In the earlier part of his public sector career, he worked for six years within the Government Economic Service in three different government departments.
This experience covered a variety of issues including Latin America economies and sovereign credit issues, analysis of global oil and oil product markets and reform of European downstream power markets. He had represented the UK government at a variety of international meetings including the OECD/IMF committees and workshops and had extensive experience of negotiation European directives. Mr. Islam studied economics at University College, London and Manchester University.