A $32 billion increase in global debt during 2020 is one legacy of the pandemic.
MON 28 JUNE, 2021-theGBJournal- Uncertain growth prospects and policymakers’ support for an inclusive recovery will likely delay fiscal consolidation, leaving elevated government debt burdens in place. For advanced and emerging economies with high debt burdens, particularly those in Africa, frontier Asia and the Caribbean, credit quality will reflect a government’s ability to reverse debt trajectories ahead of potential shocks. Debt affordability, access to international capital markets and the depth of domestic funding bases will differentiate sovereign credits.
For advanced economies, the current low interest rate environment has so far supported debt sustainability, but future debt affordability will depend on interest rate paths and economic growth. Advanced economies have more room to undertake discretionary fiscal policy without endangering debt sustainability in the short term, but face medium-term debt sustainability challenges tied to low productivity growth and aging populations.
The decline in productivity growth in advanced economies is a long-term phenomenon that predates the 2008 global financial crisis and the COVID-19 pandemic. Productivity is a key driver of economic growth, living standards, private-sector profitability and the public-sector tax base. Low productivity growth will likely put pressure on sovereign balance sheets and debt dynamics through lower tax revenue and higher government expenditure compared with a counterfactual scenario of higher productivity growth. Many factors have caused slowing productivity growth, including weak investment, slower technology diffusion, lower firm dynamism and sectoral reallocation. Adapting to the COVID-19 pandemic accelerated digitization, but whether this and progress on advanced technologies will catalyze the next productivity boom is uncertain.
In addition to slow productivity growth, accelerating population aging during the next two decades implies significantly slower economic growth than in the past. In advanced economies, immigration has been a major driver of workforce growth and boosted innovation and productivity. However, current immigration rates will not compensate for the expected slower growth of the workingage population, especially in Europe. Immigration has declined in a number of countries over the past few years, including the US, and political polarization poses future risks for immigration policy.
Emerging market governments with weak external positions and dependence on foreign-currency debt are vulnerable.
Deepening local-currency debt markets after 2000 reduced emerging market currency mismatches and susceptibility to shocks, and increased monetary and fiscal policy effectiveness. But after the share of local-currency debt rose to 71% in 2013 (from 53% in 2002), it stayed relatively flat until 2017. Since then, the share of local-currency debt has been falling and we expect it to decline to 66% in 2022. External funding risks will remain the overriding concern for some liquidity-strained sovereigns, including in Sub-Saharan Africa and frontier Asia, where domestic markets are less developed. Tackling debt vulnerabilities is critical to prevent divergent recoveries.
Africa and the Caribbean are most vulnerable among emerging markets. Exposure to natural disasters contributes to credit risk in the Caribbean, one of the world’s most disaster-prone regions. Natural disasters caused damage equivalent to more than 3.5% of GDP on average each year from 1980 to 2015 and contributed to the rise in debt levels over many years. Tourism-dependent Caribbean countries have been disproportionately affected by the pandemic and will continue to struggle until people feel safe to travel en masse again.
Recent debt buildup in Sub-Saharan Africa has reversed prior debt reduction following the Heavily Indebted Poor Countries (HIPC) initiative. Many African countries face a difficult recovery from the pandemic given lagging regional access to vaccines and limited policy options to support the recovery and health systems. The pandemic will reverse progress on social goals and add to existing challenges in many countries, such as slow growth, low investment, dependence on volatile commodity prices and vulnerability to climate shocks.
International initiatives will likely support the most vulnerable countries. The G20 Debt Service Suspension Initiative (DSSI) supports liquidity for the most vulnerable countries this year, as it did last year. Debt relief under the Common Framework for Debt Treatments beyond the DSSI will likely involve losses for private-sector creditors. Country-specific differences necessitate tailored approaches to debt restructuring because debt sustainability positions, debt structures and creditor universes vary greatly between countries. We expect the focus on frameworks for sovereign debt restructurings to intensify.
This article is originally written and published by Moody’s in their Credit Outlook-Moody’s Macro Monday.
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