Global Debt Is Currently At An All-Time High via IMF
At 225 percent of world GDP, the global debt of the nonfinancial sector–comprising the general government, households, and nonfinancial firms–is currently at an all-time high. Two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which, as documented in an extensive literature, can carry great risks when they reach excessive levels. However, there is considerable heterogeneity, as not all countries are in the same phase of the debt cycle, nor do they face the same risks. Nevertheless, there are concerns that the sheer size of debt could set the stage for an unprecedented private deleveraging process that could thwart the fragile economic recovery. Resolving this “private debt overhang” problem is, however, not easy in the current global environment of low nominal output growth.
In light of these developments, this issue of the Fiscal Monitor examines the extent and makeup of global debt and asks what role fiscal policy can play in facilitating the adjustment. It goes beyond previous studies by drawing on an expanded data set covering emerging markets and low-income countries as well as advanced economies. Another novelty is the use of an analytical framework that explicitly models the interlinkages between private and public debt in analyzing the role of fiscal policy in the deleveraging process. Finally, country case studies provide useful insights on what fiscal policy should and should not do to facilitate deleveraging while minimizing the drag on the economy.
The chapter finds that private debt is high not only in advanced but also in a few systemically important emerging market economies. Although some advanced economies have made inroads in reducing household indebtedness–the original source of the problem–these debt ratios are still going up in some cases. In addition, easier financial conditions have led to a sharp increase in nonfinancial corporate sector debt in a few emerging markets. Historical precedents and alternative indicators of debt overhang indicate that the private deleveraging process may still take some time to play out, even more so in light of low nominal growth. The incomplete repair of banks’ balance sheets creates additional headwinds to the deleveraging process by hampering the efficient flow of credit, hence contributing to lackluster growth.
Weak macroeconomic conditions are also taking a toll on general government balance sheets, particularly in advanced economies, where they explain close to 50 percent of the increase in public debt since the start of the global financial crisis. Financial deepening and improved market access over the last few years have led to higher private and public debt ratios in low-income countries, although debt levels remain generally low. Advances in microfinance lending and mobile banking have also helped improve financial inclusion in many of these countries.
New empirical evidence confirms that financial crises tend to be associated with excessive private debt levels in both advanced and emerging market economies, but high public debt is not without its risks. In particular, entering a financial crisis with a weak fiscal position exacerbates the depth and duration of the ensuing recession. The reason is that the absence of fiscal buffers prior to the crisis significantly curtails the ability to conduct countercyclical fiscal policy, especially in emerging market economies. These results argue for strengthening the government balance sheet in upturns, while adequately accounting for financial cycles when assessing a country’s fiscal position, and ensuring the close monitoring of private debt through adequate regulatory and supervisory frameworks.
This is particularly relevant in emerging markets where private sector leverage has increased significantly over the past few years.
It is clear that meaningful deleveraging will be very difficult without robust growth and a return to normal inflation, but what can fiscal policy do to facilitate the deleveraging process? The path toward strong growth in those countries mired in a debt overhang may require decisive and prompt action to repair the balance sheets of banks–a clear priority in some European countries–and the private sector, notably nonfinancial corporations in China. The specific policy package will depend of course on country circumstances and the available fiscal buffers. Generally, where the financial system is under severe stress, resolving the underlying problem quickly is critical. When the problems in the nonfinancial sector have not yet migrated to the banking sector, well-designed and well-targeted fiscal interventions in the form of government- sponsored programs to restructure private debt–which can include measures such as subsidies for creditors to lengthen maturities, guarantees, direct lending, and asset management companies–can create incentives for the cleanup to take place. These measures should be supported by strong insolvency and bankruptcy procedures. As past experience shows, the design of fiscal interventions to facilitate the deleveraging process is critical for minimizing their cost, mitigating moral hazard, and ultimately ensuring their success. In particular, these measures should be targeted to specific sectors or individuals and involve burden sharing. If bank recapitalization is necessary, it should be carried out swiftly, with the private sector taking the lead. Strong governance principles should be applied in the decision-making process to safeguard public funds.
While trade-offs are difficult at the current juncture of limited fiscal room, inaction is likely to be costlier, even from a public debt sustainability perspective. However, fiscal policy cannot do it alone; it has to be supported by complementary policies within credible frameworks. More specifically, monetary policy should remain accommodative in those countries where inflation is still well below target, while financial policies should provide incentives for banks to recognize losses and facilitate balance sheet repair. Structural policies can also improve intertemporal budget constraints by increasing potential growth. If well designed and credible, these policies can in fact increase the policy space to support growth and bring inflation to target while facilitating the deleveraging process.
Debt: Use It Wisely
The global gross debt of the nonfinancial sector has more than doubled in nominal terms since the turn of the century, reaching $152 trillion in 2015.1 About two-thirds of this debt consists of liabilities of the private sector. Although there is no consensus about how much is too much, current debt levels, at 225 percent of world GDP (Figure 1.1), are at an all-time high. The negative implications of excessive private debt (or what is often termed a “debt overhang”) for growth and financial stability are well documented in the literature, underscoring the need for private sector deleveraging in some countries. The current low-nominal- growth environment, however, is making the adjustment very difficult, setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown (Buttiglione and others 2014; McKinsey Global Institute 2015; Gaspar, Obstfeld, and Sahay 2016). The dynamics at play resemble that of a debt deflation episode in which falling prices increase the real burden of debt, leading to further deflation. Weak bank balance sheets in some countries have further contributed to dampening economic activity, as private credit has been curtailed beyond what would be desirable.
A key priority in those countries currently facing a private debt overhang is to identify policies that can help with the repair process while minimizing the drag on the economy. This task is particularly challenging because the room for policy maneuver has narrowed since the start of the global financial crisis and the effectiveness of some policies (notably monetary) may be more limited. These constraints put a premium on how to use the fiscal space that may still be available, including leveraging complementarities across different policy tools to get more mileage out of any fiscal intervention. Against this backdrop, this issue of the Fiscal Monitor addresses the following questions:
- How high is global private and public debt, and how far are we in the deleveraging process?
- Can fiscal policy help with private sector deleveraging and, if so, how?
This issue of the Fiscal Monitor goes beyond the existing literature, significantly expanding the country coverage of previous studies by including emerging market economies and low-income countries as well as advanced economies. It also looks at the sectoral composition of leverage by analyzing both public and private nonfinancial debt (for households and nonfinancial corporations). The analysis attempts to cover the asset side as well to arrive at broader measures of the health of private and public balance sheets. A key contribution is the use of a novel analytical framework developed by Batini, Melina, and Villa (2016), which explicitly models the interactions between private and public debt in analyzing the role of fiscal policy during the deleveraging process.
The chapter starts by giving an overview of debt trends around the world and taking stock of the deleveraging process. Next, it explains why debt levels matter for growth as well as macroeconomic and financial stability. It then examines empirically and through model simulations how fiscal policy can help a country get out of a debt overhang while drawing on country case studies to illustrate the types of measures–and key design features to enhance their effectiveness–that would support a smooth deleveraging process.
The main findings can be summarized as follows:
- Private debt is high not only among advanced economies, but also in a few systemically important emerging market economies. High private debt not only increases the likelihood of a financial crisis but can also hamper growth even in its absence, as highly indebted borrowers eventually decrease their consumption and investment.
- The chapter’s analysis also suggests that the current process of private sector deleveraging in highly indebted countries will likely take some time to play out. General government balance sheets have also weakened, particularly in advanced economies, although low interest rates have temporarily eased budget constraints.
- Empirical analysis shows that fiscal policy can significantly reduce the depth and duration of a financial recession associated with a private sector debt overhang. However, a government’s ability to play such a stabilizing role depends on the health of its fiscal position prior to the crisis, especially in emerging market economies. This underscores the importance of building fiscal buffers and properly accounting for financial cycles in assessing the strength of the fiscal position in periods of expansion while ensuring the close monitoring of private debt to limit fiscal risks (IMF 2016a).
- At the current juncture, the array of growth-friendly fiscal policies should include measures that facilitate the repair of balance sheets in those countries facing a private debt overhang or where the financial system is impaired. This is particularly important in some European countries, where the weak banking system is retarding the recovery, and in China, where high corporate debt levels raise the risk of a disorderly deleveraging. Such targeted fiscal interventions may include government-sponsored programs to help restructure private debt–such as subsidies for creditors to lengthen maturities, guarantees, direct lending, and asset management companies–that can facilitate the deleveraging process. To the extent that weaknesses in a country’s financial system threaten financial stability, impair the credit channel, and hamper growth, addressing the underlying problems swiftly is essential.
- The design of such fiscal interventions is critical for minimizing their cost, mitigating moral hazard, and ultimately ensuring their success. The limited policy room calls for exploiting the synergies among fiscal, monetary, and financial, as well as structural, policies to facilitate the deleveraging process, reinvigorate growth, and bring inflation to target.
How High Is Debt?
This section provides a broad perspective on global debt, expanding the country coverage of previous studies and looking at recent developments in advanced economies, emerging market economies, and low-income countries. It also explores the drivers behind recent trends and how far we are in the deleveraging process.
The Global Picture
The genesis of the global debt overhang problem resides squarely within advanced economies’ private sector.2 Enabled by the globalization of banking and a period of easy access to credit, nonfinancial private debt increased by 35 percent of GDP in advanced economies in the six years leading up to the global financial crisis (Figure 1.2). The credit boom was not limited to the U.S. mortgage sector but was broad based within this country group, with more than half of the debt coming from households (Figure 1.3). In emerging market economies, the increase in nonfinancial private debt during this period was also driven by the household sector but was generally less pronounced. Low-income countries, on the other hand, were largely shielded, as many were (and still are) in the process of financial deepening (IMF 2015a). Interestingly, public debt declined across all country groups up to 2007, particularly among low-income countries–mainly as a result of debt relief under the Heavily Indebted Poor Countries and Multilateral Debt Relief Initiatives. Nevertheless, there is evidence that the financial cycle may have overstated the strength of government balance sheets in some advanced economies that experienced a real estate boom (Budina and others 2015).
After the start of the global financial crisis, public debt in advanced economies rose rapidly, while progress in private sector deleveraging was mixed (Figure 1.4). On average, private debt ratios in advanced economies reached a turning point in 2012, with the largest reductions since then registered in those countries that entered the crisis with high debt levels. In some cases, however, private debt has continued to accumulate at a fast pace–notably, Australia, Canada, and Singapore. As private debt started to retrench, public debt picked up, increasing by 25 percent of GDP over 2008–15. The realization of contingent liabilities with respect to the private sector played an important role (Bova and others 2016), accounting for about a quarter of the change. General government financial balance sheets also deteriorated, in some cases significantly, in part reflecting the assumption of private sector liabilities as a result of bank bailouts (Figure 1.4, panel 3). Only about one-third of advanced economies have made inroads in improving general government net financial worth since 2012 and, on average, these inroads have been small.
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