A global debt crisis looms?

“We’re not necessarily at a crisis level, but increasingly higher debt leverage increases the risk of a crisis,” says Chan.

THE problem of excess debt is not just a domestic issue. Globally, debt levels have soared to unprecedented levels. A number of market commentators have long been predicting stock market crashes because of the inflated debt levels.

Global debt has hit a record US$300 trillion (RM1.32 quadrillion) or equivalent to 349% of global gross domestic product (GDP), notes S&P Global Ratings in a recent report.

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This figure – monies owed by governments, households, financial and non-financial corporates – is higher than pre-global financial crisis (GFC) peaks. It works out to US$37,500 (RM165,563) of average debt for each person in the world versus a GDP per capita of just US$12,000 (RM52,980).

So is the world facing a debt crisis?

S&P Global Ratings managing director and senior research fellow, credit research and insights Terry Chan says this is not the case.

“We’re not necessarily at a crisis level, but increasingly higher debt leverage increases the risk of a crisis,” he tells StarBizWeek. According to him, a crisis may be triggered if there is a shock of sufficient magnitude.

“For example, a sudden collapse of a major borrower or segment of a financial sector, or from commodities shock or geopolitical tension due to a war,” says Chan, who in his report projects that the global debt-to-GDP ratio could reach 366% in 2030 under a base-case scenario.

The Centre for Market Education chief executive officer Dr Carmelo Ferlito says the continued rise in global debt is a source of concern. He points out that government sector debt has grown aggressively, rising to 102% of GDP in 2022 from 58% in 2007.

“This means that governments are recurring more often to spur their spending via debt, therefore shifting the burden of their expenditures on future generations,” Ferlito explains.

The second biggest jump was recorded by non-financial firms, which meant that businesses have been relying more and more on loans to sustain their economic activities – making them more fragile to resist shocks, he adds.

Notably, global debt had surged in the wake of Covid-19 with governments adding to spending needs on healthcare and social programmes to cushion the economic effects.

However, the blame cannot be pinned solely on the pandemic, say economists. One of the main factors that contributed to the current debt leverage challenge was the low cost of borrowings due to a prolonged period of low interest rates post the 2008 to 2009 GFC.

S&P Global’s Chan explains that interest rates were originally set low to mitigate the impact of the GFC, which was triggered by the United States’ subprime mortgages.

However, he adds that no explicit plan to “normalise” interest rates was clearly articulated by any central bank. Back to the current circumstances, Chan says the US subprime is unlikely to be a trigger factor.

Rising interest rates and slowing economies

One of the ways to escape a debt trap is to grow out of it. But with the world economy poised to slow in 2023 amid rising interest rates, this could make it harder for debt to be serviced, particularly for highly-leveraged borrowers at the lower end of the credit scale.

The strong US dollar will increase the debt burden for countries who have borrowed in dollars but whose receipts are in another currency. However, economists say that the strong greenback is not the main root of the problem.

“Globally, it’s a situation of swings-and-roundabouts. If the strong dollar increases the burden for some borrowers, like those who have unhedged dollar borrowing), it decreases those of others who easily earn in that currency,” says Chan.

For middle-income countries, Chan says the question is whether there are pockets of highly-leveraged borrowers.

“Such pockets could be a threat. For example, in the GFC it was the US housing subprime ‘pocket’ that proved vulnerable,” he adds.

Furthermore, some advanced countries, such as the United States and Japan are also mired in debt, begging the question of what they can do to help others?

The United States has hit its US$31.4 trillion (RM138.2 trillion) debt ceiling, kicking off extraordinary measures to keep paying the nation’s bills. If the cap on the amount of money it can borrow isn’t lifted, the world’s biggest economy, which is battling to tame inflation while avoiding a recession, could face a fiscal crisis in the next few months. Data from the United States on Thursday showed that household debt in the country had soared by the biggest amount in two decades, bringing the total amount to a record US$16.9 trillion (RM74.8 trillion) in the fourth quarter of 2022.

In Japan, a flurry of big spending packages and ballooning social welfare costs for a rapidly ageing population have left the country with a debt pile 263% the size of its economy – a percentage which is double the ratio for the United States and the highest among major economies, according to a recent report.

‘Great reset’

Unfortunately, there is no easy way out to keep global leverage down and it will require a “great reset” of policymaker mindset and community acceptance.

“This would involve societies and policymakers (at national level) having to accept that they can’t keep borrowing their way to prosperity forever,” says Chan, who notes debt has become less productive since 2007.

For this, societies may have to be more prudent and selective about borrowing and spending. He contends this may not be easy as different societies have different pain tolerances. He foresees more pain ahead because some debt that have to be written off.

But from a creditor perspective, the “moral hazard” has to be addressed too.

“If debt is forgiven for a poor country, what’s to prevent the country from over-borrowing again?” he asks.

To support the additional debt governments, Chan says governments, either through spending or policies, must be able to improve medium-to-long term productivity.

UOB Malaysia senior economist Julia Goh believes tackling the global debt issue requires a country specific approach.

“It is not something that can be generalised as there are important distinctions between countries’ ability to sustain the debt. Countries with lower incomes, weak growth prospects, and wide fiscal deficits are more vulnerable. Nevertheless, during times of heightened caution and risk-off sentiment, there can be market contagion that reverberates through emerging markets especially if one country defaults on its debt payments,” she says. Goh notes that Asean countries are in a stronger position today.

“The region’s growth prospects and macro fundamentals, such as low and stable inflation and higher domestic savings, particularly among the middle-to higher-income, will provide the buffers for Asean countries to carry higher debt levels,” she says.

She adds that the bulk of Asean countries’ local currency debt is government debt, which has helped drive the region’s growth.

“As they are issued in the local currency, there is lesser external-related risk and foreign exchange exposure when their currencies depreciate. However, if the foreign holdings of the local currency debt is high, this could weigh on local currencies during times of steep sell-offs,” Goh explains.

Commenting on Malaysia, she says the country is included in global bond market indices, has a stable sovereign ratings outlook and liquidity in the bond market , alongside a wider investor base.

“These provide comfort that Malaysia is able to fund its debt financing needs. But the government will need to strengthen its public finances, improve transparency and ensure that credibility is not lost ... else the cost of funding the debt will be much higher,” Goh says.

According to her, the country’s debt payments as a share of revenue is projected to hit a 30-year high of 16.9% in 2023 based on Budget 2023 presented last year.

“This comes on the back of Malaysia’s high public debt levels of 60.4% of GDP or 78.1% of GDP if the government-guaranteed debt for 2022 is included. Hence, ensuring sustainable debt and debt servicing levels will require strong commitment to reduce debt and cap the debt-to-GDP levels to ensure that Malaysia has sufficient fiscal space during downturns and is less vulnerable to future economic shocks,” says Goh.

Coming back to the big picture, Group of 20 (G20) finance and central bank chiefs are slated to meet in India next week to discuss the rising debt troubles among developing countries, among other things. Reuters reported that a proposal is being drafted for G20 countries to help debtor nations badly hit by the economic impact from the pandemic and the Russia-Ukraine war, by asking big lenders, including China, to take a large haircut on loans.

This is positive, but economists say it will take a lot of discipline and coordination between countries to successfully bring down global debt.