Need to brace for high cost of public debt

Global public debt has shot up sharply post the pandemic. Per IMF, for advanced economies, the public debt to GDP is estimated to have risen to 112 per cent and for emerging and developing economies (EMDEs) to 67 per cent by 2023. While debt levels persist at elevated levels, global growth has slowed down over the past few years, due to disruptions in the supply chain and escalating geopolitical conflicts. Rising interest rates have further dampened the global growth outlook. This backdrop of high public debt, high interest rates and low growth is making debt sustainability challenging for advanced and emerging economies. For advanced economies, public debt to GDP is projected to rise further to 116 per cent and for EMDEs to 75 per cent by 2028 (IMF).

The high public debt scenario has resulted in increased concerns around sovereign defaults. The total sovereign debt in default as a per cent of world GDP was 0.6 per cent in 2022, the highest since 2014 (Bank of Canada-Bank of England database on sovereign defaults). While it is critical to assess the threat of sovereign defaults by smaller developing economies, it is also important to be watchful of the vulnerabilities of the advanced economies.

Low interest rates

Many of advanced economies like the US, Japan, Italy, France and the UK have very high general government debt levels at more than 100 per cent of GDP. Advanced economies have the benefit of lower interest rates compared to emerging economies. This, coupled with better government revenue collection, enables advanced economies to enjoy healthy debt affordability (interest/revenue), even with high debt.

For instance, for UK, while the general government debt is at a high of 104 per cent, interest to revenue is at a low of 11 per cent. In contrast, some of the emerging economies, even with relatively lower debt levels have very high interest to revenue ratio. For instance, for India, the general government debt to GDP ratio is at 81 per cent but the interest to revenue is much higher at 27 per cent. Similarly, for Brazil with a general government debt of 88 per cent, it has interest to revenue of 26 per cent.

In most advanced economies, the implementation of ultra loose monetary policy post the 2008 global financial crisis resulted in very low interest rates for a long period of time. However, in the post Covid period interest rates have risen sharply in a bid to tame inflation. Even though a policy easing cycle is anticipated in the second half of the year, interest rates are likely to remain above pre-pandemic levels, specifically in advanced economies. Higher interest costs coupled with very high debt levels, will have a bearing on the debt affordability of the advanced economies. For instance, for US Federal Government, the net interest payment is projected to cross 20 per cent of revenue by 2032 from 9.7 per cent in 2022, as per US Congressional Budget Office. Similarly, for UK, the government’s interest expenses (per cent of revenue) has already doubled from 5.4 per cent in 2020 to 11 per cent in 2022.

Many of the advanced economies have the advantage of reserve currency status, hence external funding of debt is not a serious challenge for them. Moreover, they enjoy better sovereign risk ratings enabling them easier access to external funding. Nevertheless, we cannot ignore the fact that high government debt and resultant diversion of high portion of revenue into interest payment will result in less of resource availability for more productive expenditure for these economies.

Debt in India

If we look specifically at India, the general government debt to GDP has risen sharply to 81 per cent in FY23 from 70 per cent in FY19 (pre-pandemic). However, this ratio is projected to reduce gradually in the coming years, touching a marginally lower 78 per cent in FY31, according to the IMF. While India has high government debt, it is mainly financed from domestic borrowing, this reduces vulnerability of the economy to external parameters. However, as discussed earlier, the country has high interest expenses (at 27 per cent of revenue), that eats into more productive expenditure. This makes it critical for the economy to move swiftly towards fiscal consolidation and reduce the government debt more meaningfully.

This post-pandemic period of low economic growth and high interest rates will make it difficult for both advanced and emerging economies to move towards debt sustainability. In fact, each debt cycle comes with its own challenges. In the current cycle, it is critical to remain vigilant of the vulnerabilities of not just emerging economies, but also of the advanced economies.

The writer is Chief Economist, CareEdge Ratings

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