How will a long financial Covid and a global experiment in massive debt affect you?
Post Covid debt restructuring by treasuries, countless businesses, and individuals in the 90% of countries now struggling to recover from Covid-19’s economic disruption is likely to be messy and protracted. Current debt exceeds that of two world wars, the Great Depression, and the global financial crisis (GFC).
It’s no wonder Australians wonder how the consequent global experiment in massive, unprecedented debt is likely to affect them.
The latest World Development Report (WDR) entitled Finance for an Equitable Recovery, says the pandemic bequeaths the spectre of a lost decade to vulnerable nations. And wealthier ones won’t escape the virus’s bequests of ill health, social and economic disruption.
According to the Report the average total debt burden of low to middle-income countries has increased during the pandemic by about nine percentage points of gross domestic product, compared to an average annual increase of only 1.9 percentage points during previous decades.
The huge experiment in debt
How this global experiment in massive debt will affect you – and it will (to be explained later) -- depends significantly on your personal financial situation and the strength of the economy where you live.
Living in Australia is clearly advantageous, for it’s not one of the 51 countries (44 of them with emerging economies) that the Report says have experienced downgrades in their sovereign debt credit rating -- as the number of people living in extreme poverty worldwide has been increasing by 80m in the past two years.
While 53% of low-income nations are seen to be at risk of debt distress – and that’s only debt that can be seen -- Australians benefit from an economy that has survived the pandemic as well, if not better, than any other. So, what then have Australians to fear?
With so much in their favour they nonetheless live in the shadow of big question marks – how will they fare individually when the Reserve Bank of Australia (RBA) increases interest rates, perhaps, according to some analysts, as soon as August? And how will Australian taxpayers be expected to contribute to repaying an unprecedented national debt?
Rapid and huge rises in countries’ indebtedness were necessary for economic stimulus to counter destructive forces of the pandemic, but the problem for most emerging and developing countries is they couldn’t afford what they needed to borrow to stop the havoc.
It gets much, much worse
Worse, according to the World Development Report (WDR) many seem unlikely to be able to repay what they’ve borrowed. Some 46% of developing countries are, according to the Report at risk of defaulting on loans to the World Bank, and 65% of SMEs in these countries are at risk of defaulting on $157b in loans to ordinary commercial banks.
Why should this be of any particular concern to us in the Land of Oz?
It’s because this default risk has tended to widen inequality within countries and between them, and accordingly, to heighten danger internally and internationally from political activists and terrorists who thrive by exploiting tensions inherent in inequality. To what extent do you think such people, one way or another, domestically or internationally, could threaten Australians’ post pandemic recovery – and your future?
The World Bank, established in 1944, provides loans to low and middle-income nations which are backed by bonds, the worth of which it sustains by way of interest payments on its loans and a variety of investments (often major infrastructure) in the borrowing countries.
But if borrowers default on World Bank loans, the Bank’s bonds will lose value – and these are bonds in which the superannuation and pension funds in high-income nations invest. In short, Australians’ superannuation and pensions could be adversely affected if the WDR is right when it says the current level of global debt, the prospects of inflation and rising interest rates, could precipitate a financial crisis, the like of which has not been seen for generations.
The report says greatest dangers lie in the possible collapse of the economies of Turkey and China where huge companies, that either in effect work directly for governments, or exist under government patronage, have been granted loans at close to 0% interest. Even so, they are still on the verge of financial collapse – while it’s estimated China, Australia’s most important trading partner, is holding up to 11% of the debts of the world’s low and lower-middle-income countries.
In Turkey and China where many big companies have affiliations with governments, public servants tend, at their nations’ cost, to be less concerned about the financial management of such companies, as distinct from their tight monitoring of companies that lack government connections.
As if China hasn’t enough internal financial worries without also having to worry about carrying so much of the debt of the world’s lower and lower-to-middle income countries.
Prolonging the recovery
The rise in global poverty referred to earlier, by far the biggest increase in a generation, seems likely to continue, and the gap between haves and have-nots may well widen in the immediate future, even as Covid’s disruption recedes.
The global availability of vaccines and treatment for the ill, are unequal across the world, and education has been seriously disrupted. These inequalities will take a long time to reach a reasonable balance, and international tourism can’t be expected to flourish soon.
SMEs worldwide, forced by the pandemic to close, will not be rejuvenated overnight. Financial stress of countries, businesses and individuals is the most likely cause of a prolonged recovery from the pandemic, exacerbated in Australia by unprecedented floods.
The WDR advises governments to tackle debt head on: “The early detection and swift resolution of economic and financial fragilities can make all the difference between an economic recovery that is robust and one that falters -- or worse, one that delays recovery altogether”.
Governments’ history of ridding themselves of sovereign debt is not good. On average it takes about eight years, largely because politicians can’t summon the will to do what needs to be done to balance the books -- and it’s arguable whether Australia has ever had more sovereign debt than it has now.
Leading finance analysts are saying there should be in place something like the sovereign debt restructuring mechanism proposed by the International Monetary Fund (IMF) two decades ago, but meanwhile a growing number of economists claim debt contracts can, in the medium term, be made more flexible than they are now -- otherwise debt restructurings will be prolonged and messy.
