Global Public Debt

Governments do not always make the best budget managers. Assuming it avoids an accidental debt default, America will run a bigger budget deficit this year than the last, despite a booming economy. Germany runs a surplus—but is stingy on critical investments and annoys its European neighbors in the process. Japan, hiding under a mammoth public-debt pile, is raising its consumption tax, though the last rise strangled a weak economic recovery. But the role of fiscal policy as a recession-fighting tool is only growing. The next downturn will be a painful and dangerous learning experience for many politicians.

When that comes, at some point in the next few years, the initial policy response is easily foreseeable. Central banks, will again move first. But markets reckon that two years from now the Fed’s benchmark rate will remain below 2%, the Bank of England’s below 1% and the European Central Bank’s close to zero. Rates can only go so low before people abandon the banking system for cash. So cuts to interest rates will be limited. By contrast, in the relatively mild recession of 2001, the Fed cut rates by more than six percentage points. Central-bank asset purchases will follow, assuming they are not already happening, as they might well still be in Europe and Japan. Their effects will be less powerful than in the past, however. When bond yields are low, as they are likely to be for the foreseeable future, bonds do not look much different from cash; giving banks cash for their bonds consequently does little to boost risk-taking.

Nonetheless, big debt piles may heighten politicians’ caution about borrowing (see chart). If a borrower’s ability to repay is in doubt, he is forced to pay higher interest rates. That raises the cost of servicing debt, presenting governments with a difficult choice between growth-hampering austerity and default. For many politicians, the financial crisis reinforced this lesson. In late 2009, bond yields on Greek debt began rising, after revisions to budget data revealed that the fiscal situation was more concerning than thought. Yields on the bonds of other neighboring euro-zone economies followed suit, spiking on several occasions between 2010 and 2012.


Yet that crisis has receded, and not because Europe resolved its indebtedness problem. With the exception of Ireland’s, debt levels in that area are higher now than at the peak of the crisis in 2012. Yields instead fell as it became clear that the ECB would buy the bonds of troubled countries, either because the survival of the euro demanded it, or to battle deflation. In a world of low interest rates, central-bank asset purchases are likely to become a conventional policy tool, so the demand for bonds is less likely to go down. The risk of inflation remains. But in advanced economies higher inflation usually means that firms are operating at capacity; the job of fighting the recession is done. At that point, the government should introduce measures to reduce public expenditure.

To use stimulus effectively, politicians must understand the risks they face and plan accordingly. During the last three decades government debt has increased in most developed countries. During the same period we have also observed a significant liberalization of international financial markets.

During the decade 2002-12, credit uptake and the resultant debt burden among Indians grew at a phenomenal pace, a comparison of National Sample Survey Office (NSSO) data from the two years shows. The growth was especially fast among urban Scheduled Castes (SCs) and Scheduled Tribes (STs), the data shows. The NSSO found the average Amount of Debt (AOD) per household to be Rs 1.03 lakh for rural households and Rs 3.78 lakh for urban households. By comparison, according to the 59th Round report published in 2003, the AOD per household was Rs 7,539 for rural areas and Rs 11,771 for urban areas. Interestingly, an increasing percentage of this growing debt is being used to meet household expenses, rather than for the creation of productive assets.

The surveys bring out some stark facts about the distribution of wealth among the various social groups in the country. The growth in the Average Value of Assets (AVA) has not been proportionate with the growth in credit uptake. The AVA is lowest for a rural SC household, which has total assets worth Rs 6.48 lakh. The highest value of assets is for an open category urban household, which has total assets worth Rs 39.27 lakh on average.

Increased consumption has fuelled increased borrowing. The borrowings are substantially higher in the SC community because of entitlement-driven loans where sops are provided to the community. The figures suggest that the community is catching up with others when it comes to consumption. However, the fact that the bulk of the money is spent in meeting household expenses rather than in wealth generation is a worrying aspect.




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