A recent Reuter’s article (see here) drew attention towards some ominous signs emanating from the bond pricing of emerging markets that are more vulnerable to default on their sovereign obligations. Noting the signals like weakening currencies, bond spread widening beyond 1000bps, and dwindling Fx reserves, it concludes that a record number of developing economies might be “in trouble” now.
More than US$400bn worth
of sovereign debt could be facing default. While the countries like Russia, Sri
Lanka, Lebanon, Zambia etc. have already defaulted on their obligation, the
usual suspects like Argentina and Pakistan etc. appear on the precipice of a
default. The serial defaulter Argentina (US$150bn); Ecuador 9US$40bn); and
Egypt (US$45bn) may actually default much sooner. If the war drags on for a couple
of more months, Ukraine may also default on US$20bn debt payments.
Of course, the sovereign
defaults are not new and the US$400bn default might not look massive in the
context of trillions of dollars of new money created in the past one decade.
Nonetheless, so many countries defaulting in a short span of time could have
serious consequences for the global financial system. For one, it could trigger
a contagion if some large global institution like Lehman Brothers collapses
under the weight of such default. The worst however would be if the ‘default’ loses
the moral stigma attached to it, and many profligate nations find it convenient
to default and start afresh.
It is pertinent to note
that the Bank of Japan (BoJ) owns more than 50% of the debt taken by the
Government of Japan. This effectively means that Japan has borrowed about USD
one trillion from the JPY printing press in the three years 2020-2022. Considering
the deteriorating demographics and anaemic growth over the past three decades,
it is obvious that Japan is ‘riding a tiger’. Many developed countries like
Italy and Greece are also trapped in a vicious low growth high debt cycle.
Obviously, getting out of this trap is not feasible in the normal course of
business.
The most relevant question
at this point in time therefore ought to be “how the global economy gets out of
this extortionate high debt-low growth trap?”
Historically, the following methods have been
used by the governments to break out of the low growth high debt trap:
1. Currency
debasement by stimulating high inflation for long or devaluing the
currency.
2. Financial
suppression by keeping the real rates negative for long.
3. Fiscal
tightening by increasing taxes disproportionately and/or reducing
public spending.
4. Incremental
improvement by gradually tightening the monetary policy.
5. Defaulting
on debt obligation and negotiating waivers with the lenders.
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