Sovereign vulnerabilities

One of the ongoing debates amongst economists is whether there is a level of sovereign debt-to-GDP which would hamper a nation’s economic growth prospects. It appears that in the not-too-distant future, we may find out.

According to the International Monetary Fund (IMF), the COVID-19 crisis is expected to push global debt above 100 percent of GDP in 2020. The move to ease fiscal policy around the world has coincided with a rapid decline in tax receipts for most governments, leading to debt-to-GDP ratios that are at their highest levels over the last 30 years. In 2020, headline fiscal deficits in advanced economies are expected to be five times higher in 2020, whilst in emerging market economies the increase has been at a more modest pace reflecting greater financing constraints.

Arguably, what is more important for governments is their ability to repay the debt that is being accumulated due to the current crisis. Unconventional monetary policies, like yield curve control and quantitative easing, is assisting governments by keeping bond yields low. The hope is that these policies will assist in reducing the debt-to-GDP ratio over time, as nominal interest rates are kept constantly below nominal rates of growth in GDP. Whilst this appears the most likely scenario in the immediate future, the key question for central bankers will come should inflation begin to materially rise, testing the willingness of central banks to maintain ultra-easy monetary policy. If central banks around the world fail to act in while inflation moves higher - which would also assist in alleviating debt loads - it may be the formal end of the central bank independence era.