Public finances: A world of debt
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Jorge Grave’s future looked bright when he in 2006 graduated with a degree in physical education from the Technical University of Lisbon. But then the eurozone crisis erupted, and sucked Portugal’s economy down the drain.
To save money in the resulting austerity drive, school classes were swelled and Mr Grave’s hours as a gym teacher in his native Setúbal were cut to just one a day. Unable to survive on such a pittance, he was forced to quit and set up a personal training business, while many of his former colleagues continue to eke out a living from teaching — or have had to leave education altogether.
“I can’t complain, but I have friends who I’ve worked with who have nothing,” he says. “Most of them only work five to 10 hours a week, that’s not enough to start a family, or even leave their parents’ place.”
Portugal limped out of its bailout programme last year, but the economic scars of the crisis are still raw. The widely-watched debt to gross domestic product ratio remains at almost 130 per cent, one of the highest rates in the world. Although borrowing costs have fallen the country now spends more money on simply servicing its debts than on its entire education budget, taking a heavy toll on teachers like Mr Grave.
The government has fought hard to restore its credibility with investors, but some economists fret that the country’s debts remain unsustainably high. Portugal’s predicament is a vivid example of a longstanding conundrum of economics: when is a country bankrupt? At what point are a government’s debts simply too great to bear?
Unlike for companies, there is no clean answer for countries. Yet rarely before has the question been more pressing, in states from Ukraine to Venezuela, from Jamaica to Ghana and not least in Europe, where a clutch of countries still labour under staggeringly high debt burdens even as the crisis recedes.
Despite the biggest restructuring in history in 2012, Greece’s debts are still at about 174 per cent of GDP, a fact that has helped the radical left Syriza party ride high in the polls on a platform of “debt forgiveness” from the country’s lenders ahead of elections later this month.
“Clearly a lot of euro countries are at or close to danger thresholds,” says Peter Doyle, a former IMF official who left in disgust over the handling of the crisis in 2012. “There is a major, unresolved debt problem.”
Together with the IMF, the Financial Times has designed an online, interactive tool based on the fund’s economic model that calculates a country’s debt trajectory and how it is affected by an array of factors such as economic growth, borrowing costs and public belt-tightening. Assumptions can be tweaked to see how debts can be tamed, or increased. But it cannot determine exactly when a country is bankrupt.
Walter Wriston, the former chairman of Citigroup, once said “countries don’t go bust”. In some respects the banker was right, countries do not go out of business and disappear like companies do. Yet history is littered with examples of governments directly or indirectly reneging on their debts.
Economists Michael Tomz and Mark Wright have examined the history of 176 countries from 1820 to 2013, and counted 248 defaults on foreign debts by 107 countries. Although some were repeat state bankruptcies, few countries have an unblemished history. As Adam Smith wrote in the Wealth of Nations in 1776: “When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid.”
There are reasons to fear that Smith’s observation might still hold true. The gross government debts of developed countries now stand at an average of 108 per cent of GDP, according to the latest Geneva Report written by a panel of senior economists.
Hardly anyone spends more time squinting at the financial ledgers of governments and calculating their sustainability than the staff of the IMF. But even its experts admit it is, at best, a rough science. They operate with a rule of thumb that developed countries should try to keep their debts below 85 per cent of GDP, while emerging economies should aim to stay below 70 per cent.
This is corroborated by a considerable body of academic research. In This Time Is Different, the account of humankind’s lamentable confidence in thinking that financial crises are a thing of the past, professors Carmen Reinhart and Kenneth Rogoff calculated that the average external debt-to-GDP ratio of countries that defaulted in 1970-2008 was just 69.3 per cent.
This ratio does not include local debts. These have proven less problematic as governments can simply print the money they need to service these liabilities, often leading to inflation but not a direct, “hard” default.
Even without debasing the currency, local debts are usually less susceptible to crises, as domestic savers and investors are more willing to fund their government than foreign investors in times of distress. In extreme situations, local savers and investors can be cajoled or forced to do so through regulation, a phenomenon known as “financial repression”. The large pool of local savings is one of the reasons why developed countries such as Japan can typically carry bigger debt burdens than emerging economies without buckling.
The FT-IMF interactive model for debt sustainability therefore allows users to tweak the mix of local and foreign debts to see how it can affect a country’s vulnerability, as well as growth, interest rates, currency shocks, the primary budget balance (before interest payments) and borrowing costs. Yet these numbers are only a guide to determining when countries are flirting with disaster, says Reza Baqir, head of the IMF’s debt division.
“A key element in assessing sustainability is not just the level of debt but also the structure of debt,” he says. “You could have a situation where the debt level per se doesn’t look too high, but most of it is short-term and has to be rolled over at a difficult time, which could be a significant risk.”
Moreover, history has shown that looking purely at government debts can be misleading. Nominally private debts have a nasty way of becoming public liabilities in severe crises — especially when bloated banking sectors implode and governments feel compelled to bail them out, as happened in Ireland and Spain in the eurozone crisis.
Some economists fear the next noxious examples of this phenomenon could crop up in the developing world. While the recent Geneva Report estimated that emerging economies only have an average gross government debt-to-GDP ratio of 48 per cent, add in the private sector and the total climbs to 151 per cent — even excluding the debts of their banks — and rising fast.
Spectre of default
Defaulting is almost always a political decision. Some countries are able and willing to credibly impose draconian spending cuts and tax rises to repay their debts no matter what the impact on the economy, while others would rather default as soon as a crisis bites.
The decision may make little conventional sense. Nicolae Ceausescu’s determination to repay in full and on time $9bn owed by Bucharest to foreign banks in the 1980s forced many Romanians to go through winters with little or no heat, and factories to partly shut down to conserve electricity. On the other side of the spectrum, Ecuador controversially decided that some of its foreign debts were “illegitimate” and defaulted in 2008, despite the absence of any severe stresses.
Prof Rogoff says there are likely to be “multiple equilibria” points for dangerous debt levels. “In the canonical model, if a country’s fundamentals are sufficiently strong, it is at no risk of debt crisis, and if the fundamentals are sufficiently weak, it is certain to happen,” he says. “But there is a large grey area in the middle where a country is vulnerable to crises, but they need never happen.”
Growth — the simplest solution to excessive debts — cannot be conjured up by magic, and often proves stubbornly elusive when it is needed most. But some countries have pulled off improbable escapes.
Turkey, for example, looked doomed to default in the early 2000s. Every IMF warning light was flashing red, and at one point in 2001 a debt auction resulted in an annual interest cost of 130 per cent, recalls Kemal Dervis, then the economy minister. “You’re not very happy on days like that,” he says.
Thanks to some nimble footwork by Mr Dervis, a massive bailout from the IMF and a flurry of previously stalled reforms, Ankara managed to pull back from the brink. Within a few years the economy regained its vim and embarked on a long period of expansion. But the former minister, now at the Brookings Institution, admits that the buoyant global economy of the early noughties was a big boon for Turkey’s recovery, a fillip few countries can count on today, especially in the eurozone.
Despite falling borrowing costs, the debts of countries such as Greece, Portugal, Spain and Italy continue to mount, with the burden eating into ever more revenues at the cost of public services.
For now, investors have faith in eurozone bonds again, but voters may eventually rebel at seeing creditors claim an increasing share of the public purse. Greek voters will have a chance to do so in elections later this month.
No one has worked with as many countries in distress as Lee Buchheit, the lawyer virtually every government turns to for advice on restructuring debt when the money runs out. He says the one common factor in every country he has worked for is initial denial.
“They all realised far too late the extent of their problems,” he says. “And when they did it was too late to arrange an orderly readjustment of the debts.”
Europe: Periphery’s burdens stretch into ‘soft core’
Sovereign debt sustainability has typically been an issue for emerging markets, but economists are training their eyes on the heavily-indebted countries on Europe’s periphery.
Borrowing costs have slumped to multiyear or record lows after Mario Draghi, the European Central Bank governor, promised to do “whatever it takes” to keep the currency bloc intact. Yet with inflation extremely subdued and growth anaemic at best, there are mounting concerns that the periphery’s debts are simply unsustainable. Almost 10 cents in every euro of revenues raised by Portugal, Ireland, Italy, Greece and Spain now goes to simply servicing debts, let alone repaying them.
Without a growth and inflation spurt, economists Barry Eichengreen and Ugo Panizza have pointed out that for their debt-to-gross domestic product ratios to stabilise, and eventually fall towards the 60 per cent targeted by the EU by 2030, the countries would have to run primary budget surpluses — before interest payments — of between 4 per cent, for Spain, and 7.2 per cent, for Greece.
“These are large primary surpluses,” the two economists wrote. “There are both political and economic reasons for questioning whether they are plausible.”
Economists at Barclays fear that the problem is not contained along Europe’s rim. In a report last year they pointed out that the eurozone’s “soft core” — countries such as France, Belgium and even the Netherlands — also confront challenging debt burdens.
“Public debt sustainability is still far from guaranteed in several periphery and perhaps also some soft-core euro area countries, despite record-low yields and unprecedented fiscal austerity in the recent past,” the report said. “Public debt ratios are still rising in all euro area countries, except Germany and probably Ireland.”
Policy makers face a dilemma on how to tackle the problem. Deeper austerity would undermine growth and exacerbate debts. Boosting spending may help growth but could also lift debt levels and intensify market concerns. Restructuring debt is tricky when the biggest holders are domestic banks that could be bankrupted by a haircut severe enough to make a difference.
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