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Unprecedented borrowing by governments around the world to keep the economic recovery underway amid the COVID-19 pandemic raises the question, how much is too much? Anthony Okolie speaks with Sohaib Shahid, Senior Economist, TD Bank about whether governments are healthy enough to sustain a heavy debt burden.
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- So, Sohaib, you wrote a great report on the scale of borrowing and debt being incurred by governments around the world to battle the pandemic, but first I want to take a look at the big picture. How does spending by governments today compared to the global financial crisis?
- Well, there is no comparison between today and the global financial crisis. Today, we're seeing countries from Germany to South Africa, from Canada to Japan spending left, right, and center to stave off an even deeper crisis.
So if you look at the spending that has been done globally, you see that countries have already spent almost $13 trillion. What is interesting is that this time around, unlike the global financial crisis, we are seeing that the IMF is advising countries to continue spending. And while I do agree with this advice and I think it's sound advice, we always have to keep an eye on debt burdens going forward.
What is also interesting to note here is that, unlike the post global financial crisis time period, we are seeing fiscal policy lead the charge unlike previously when we were seeing monetary policy leading the charge. So this time around, we're seeing fiscal policy lead the way whereas monetary policy is playing second fiddle, and rightly so.
- And you said that it's important to look at debt burden, not just debt itself. Why is that?
- Well, the reason for this is-- let's just take the example of two countries, the UK and Italy. Both the UK and Italy until last year had the same amount of debt levels, almost $2.9 trillion. Was their debt burden the same? Not really because the size of both Italy and UK is very different. Their economies are very different sizes. The UK economy is $2.8 trillion, whereas the Italian economy is $2 trillion. So if you take that into account, you see that the UK's debt burden is almost around 110% of GDP, whereas Italy's debt burden is around 150% of GDP. So whenever we want to assess debt burdens, it's best to look at ratios and not just levels.
- So what do you look for to measure a country's ability to pay off debt?
- There are few things I look at, but I'll share four important things that I really focused on. One is the primary deficit. The primary deficit is simply the fiscal deficit minus the interest rate. So the higher the primary deficit, the more difficult it will be for a country to pay off its debt.
The second thing I look at are GDP growth rates. The lower the growth rate, the more challenging it will be for the country to pay off its debt.
The third thing I look at are interest rates. So the higher the interest rates, the higher the debt-servicing costs and more difficult for a country to pay off its debt.
And the final thing I look at are exchange rates. So for countries that have a lot of foreign exchange, foreign-currency-denominated debt, they are more at risk because if the foreign currency appreciates vis-a-vis the domestic currency, debt burdens rise, making it even more challenging to service the debt. Now, this is not much of an issue for a country like the US which has a reserve currency or what economists call exorbitant privilege.
- And so if a country's trying to reduce their debt, what options do they have?
- Well, countries can do several different things. In the past, we've seen countries resort to financial repression, wealth expropriation, debt restructuring, resort to higher inflation, higher taxes, and even debt monetization. But while all of these things can reduce debt, they all have negative consequences. So in other words, the government can't have its cake and eat it too.
But what I really think will happen, Anthony, going forward are two things. One is that there will be higher taxes. There are no two ways about it. The second thing that will happen is debt monetization. In other words, the central bank will print money with the sole purpose of purchasing government debt.
And so for those who are concerned about the sizable government debt, particularly here in Canada as well, what's the one thing that we should take away from all of this?
- Well, if you look at Canada's debt to GDP ratio, it is just under 50%. But one of the things with measuring debt burdens in Canada is that provinces are allowed to have deficits and debt. So if you take into account provincial debt, that debt burden balloons to around 85% of GDP.
Now even that number is not as high as many other advanced economies. So if you look at the G7 countries, the only country that has a lower debt burden than Canada is Germany.
And the good news is that interest rates are low. And now, in fact, they'll stay even lower for even longer. So if interest rates stay lower than GDP, well and good. But if the GDP growth rate is lower than the interest rate, then servicing the debt will become difficult.
But for a country like Canada, we cannot just rely on growing out of this crisis. So as I said before, there will be higher taxes going forward.
- Sohaib, thank you very much for your insights.
- Thank you.
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- Well, there is no comparison between today and the global financial crisis. Today, we're seeing countries from Germany to South Africa, from Canada to Japan spending left, right, and center to stave off an even deeper crisis.
So if you look at the spending that has been done globally, you see that countries have already spent almost $13 trillion. What is interesting is that this time around, unlike the global financial crisis, we are seeing that the IMF is advising countries to continue spending. And while I do agree with this advice and I think it's sound advice, we always have to keep an eye on debt burdens going forward.
What is also interesting to note here is that, unlike the post global financial crisis time period, we are seeing fiscal policy lead the charge unlike previously when we were seeing monetary policy leading the charge. So this time around, we're seeing fiscal policy lead the way whereas monetary policy is playing second fiddle, and rightly so.
- And you said that it's important to look at debt burden, not just debt itself. Why is that?
- Well, the reason for this is-- let's just take the example of two countries, the UK and Italy. Both the UK and Italy until last year had the same amount of debt levels, almost $2.9 trillion. Was their debt burden the same? Not really because the size of both Italy and UK is very different. Their economies are very different sizes. The UK economy is $2.8 trillion, whereas the Italian economy is $2 trillion. So if you take that into account, you see that the UK's debt burden is almost around 110% of GDP, whereas Italy's debt burden is around 150% of GDP. So whenever we want to assess debt burdens, it's best to look at ratios and not just levels.
- So what do you look for to measure a country's ability to pay off debt?
- There are few things I look at, but I'll share four important things that I really focused on. One is the primary deficit. The primary deficit is simply the fiscal deficit minus the interest rate. So the higher the primary deficit, the more difficult it will be for a country to pay off its debt.
The second thing I look at are GDP growth rates. The lower the growth rate, the more challenging it will be for the country to pay off its debt.
The third thing I look at are interest rates. So the higher the interest rates, the higher the debt-servicing costs and more difficult for a country to pay off its debt.
And the final thing I look at are exchange rates. So for countries that have a lot of foreign exchange, foreign-currency-denominated debt, they are more at risk because if the foreign currency appreciates vis-a-vis the domestic currency, debt burdens rise, making it even more challenging to service the debt. Now, this is not much of an issue for a country like the US which has a reserve currency or what economists call exorbitant privilege.
- And so if a country's trying to reduce their debt, what options do they have?
- Well, countries can do several different things. In the past, we've seen countries resort to financial repression, wealth expropriation, debt restructuring, resort to higher inflation, higher taxes, and even debt monetization. But while all of these things can reduce debt, they all have negative consequences. So in other words, the government can't have its cake and eat it too.
But what I really think will happen, Anthony, going forward are two things. One is that there will be higher taxes. There are no two ways about it. The second thing that will happen is debt monetization. In other words, the central bank will print money with the sole purpose of purchasing government debt.
And so for those who are concerned about the sizable government debt, particularly here in Canada as well, what's the one thing that we should take away from all of this?
- Well, if you look at Canada's debt to GDP ratio, it is just under 50%. But one of the things with measuring debt burdens in Canada is that provinces are allowed to have deficits and debt. So if you take into account provincial debt, that debt burden balloons to around 85% of GDP.
Now even that number is not as high as many other advanced economies. So if you look at the G7 countries, the only country that has a lower debt burden than Canada is Germany.
And the good news is that interest rates are low. And now, in fact, they'll stay even lower for even longer. So if interest rates stay lower than GDP, well and good. But if the GDP growth rate is lower than the interest rate, then servicing the debt will become difficult.
But for a country like Canada, we cannot just rely on growing out of this crisis. So as I said before, there will be higher taxes going forward.
- Sohaib, thank you very much for your insights.
- Thank you.
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