Public deficits are exploding due to the recession triggered by the Covid-19 pandemic. The UK is a prime example: Government borrowing is expected to have reached GBP 400 billion in 2020 – a record level in peacetime – as it seeks to combat its worst recession in centuries. A similar picture is emerging around the globe, as months of lockdown cause tax revenues to implode and governments resort to unprecedented measures to stimulate ailing economies and restore them to growth.
Many countries already had significant levels of public debt pre-corona. If we look at the data for 2019, the UK’s public debt – expressed in relation to the size of its GDP – was already 85.2%. If we consider other economies in Europe, the figures are even higher at 98.8% for France, 136.0% for Italy and a staggering 176.9% for Greece. Meanwhile, the average public debt of the Euro area 17 had last year already reached 86.7% of GDP – and let’s not forget that the sustainability of public debt is a real concern in the Eurozone, since the European Central Bank is not a lender of last resort to European governments. Against this backdrop, the obvious question is: Should we be worried about the long-term outlook for public debt?
Some commentators are quick to point out that with interest rates at historic lows and even negative, there is little reason for governments to worry about the cost of borrowing at present. With the yields on 10-year government bonds below 1% in many countries, you could argue that governments could safely run large deficits and lock in these ultra-low yields by selling long bonds. Other observers question the credibility of this argument – emphasizing that since governments tend to roll over borrowing rather than repaying it, they have no way of knowing what level of interest rates that will prevail when the bonds mature. In short: There is no guarantee that the attractive borrowing conditions that exist at present will continue in the future.
In a special issue of Infocus, EFG Chief Economist Stefan Gerlach provides a detailed insight into this topic and explains the fiscal dynamics that are key to answering the conundrum of debt sustainability. In particular, he outlines the key factors driving debt-to-GDP ratios – interest costs of public debt, GDP growth, and the primary fiscal deficit – and shows how changes in these variables influence the ability of governments to stabilize and repay public debt. You can find out more about the debt quandary facing governments now and in the future in ‘The fiscal dilemma: Interest rates versus growth’.