Global leaders, business executives, and economic experts will gather at the Davos resort in the Swiss Alps this week for the annual events organized by the World Economic Forum (WEF). The discussions in Davos will revolve around the most pressing issues currently confronting the planet.
Topics on the agenda include two wars, a crisis in maritime transport, cyberattacks targeting state agencies, and the rising global temperatures. However, the two issues expected to generate the most attention at Davos this year are the mounting public debt crisis and an unprecedented wave of elections in countries worldwide.
WEF convenes at a time when governments globally are burdened with a record $88.1 trillion debt, equivalent to about half of the world’s annual economic output. Finding viable solutions to address this overwhelming debt challenge will pose a considerable challenge.
THE GLOBAL STRUGGLE CAUSED BY EXCESSIVE PUBLIC DEBT
During the pandemic, public debt has experienced an unprecedented surge, and projections indicate that governments in some major economies will continue to set new borrowing records this year. This trend will diminish the ability of governments to effectively manage crises, be they financial downturns, health emergencies, or conflicts. Additionally, even in the absence of a new crisis, the escalating interest costs will hinder endeavors to address pressing issues like climate change and elderly care. Many countries are witnessing substantial strain on public services due to consecutive budget reductions, according to CNN.
What’s more concerning is that as the debt burden intensifies, governments are finding it increasingly challenging to secure additional loans to meet current debt obligations and deliver essential services.
Governments that struggle to fulfill debt obligations may be compelled to implement sudden spending cuts or raise taxes abruptly, causing significant economic “distress”, as noted by Michael Saunders, a former member of the Monetary Policy Committee at the Bank of England (BOE). Saunders told CNN that such governments may lack the financial flexibility to respond to potential future shocks and provide crucial economic support when it is most needed.
The former official, now serving as a senior economic advisor at Oxford Economics, contends that the current public debt levels in developed economies haven’t reached a point akin to an individual nearing their personal credit limit. Furthermore, there remains substantial global demand for government bonds. Nevertheless, this doesn’t mean that challenges won’t emerge in the “next 10, 20, or 30 years”.
The case of the United Kingdom, the sixth-largest global economy, exemplifies how public debt concerns can lead to crises when investors reject a government’s borrowing proposals.
In September 2022, both the British pound and UK government bonds experienced a sell-off, partially attributed to market reactions following the then-Prime Minister Liz Truss’s plan to issue additional debt to compensate for tax reductions. Interest rates on mortgages and other loans surged as investors demanded higher risk premiums for holding UK government debt.
Consequently, the Bank of England (BOE) had to step in to stabilize the market, committing to buying government bonds “to whatever extent necessary”.
“If that crisis continues or worsens, it will pose a significant risk to the financial stability of the UK. Such a situation would lead to a reduction in credit flow into the real economy”, remarked Dave Ramsden, a senior BOE official, at that time.
RISKS FROM ELECTION WAVES
While central banks can offer immediate emergency assistance, as witnessed in the aforementioned case of the UK, they cannot act as a substitute for bond investors in supplying funds for governmental expenditures. The instance of Argentina provides insight into this, as the nation in South America has grappled with a prolonged public debt crisis. The Central Bank of Argentina has resorted to printing pesos over several years to assist the government in meeting interest obligations and avoiding default. This strategy has led to a rapid depreciation of the peso exchange rate and an alarming surge in prices, with Argentina experiencing an inflation rate exceeding 211% in December, marking the highest in three decades.
Government budget concerns have become a focal point for investors this year, particularly due to elections occurring across various countries and territories. Political figures have made pledges to increase spending to gain favor with voters. This year is unprecedented as half of the global population is expected to participate in elections, indicating that incumbent governments may have less motivation to curtail spending. Additionally, incoming leaders are more likely to focus on implementing tax cuts and introducing new spending plans to garner support.
In reality, public debt is anticipated to be a crucial theme in the upcoming U.S. Presidential election scheduled for early November this year. The record-high U.S. public debt has become a source of contention between the Democratic and Republican parties, resulting in political gridlock surrounding the national budget. This has led to instances where the U.S. government faced the potential of shutdown due to budget depletion for regular operations.
As a consequence, the United States experienced a downgrade in its credit rating by the credit rating agency Fitch, dropping from the highest AAA to AA+ in August of the preceding year. Subsequently, in November, Moody’s, another credit rating agency, issued a warning that the U.S. might lose its last remaining perfect credit rating from the three major credit rating agencies.
Raghuram Rajan, a former Governor of the Reserve Bank of India (RBI), emphasized that one of the critical factors in upholding a country’s creditworthiness in debt repayment lies in political consensus. Rajan expressed concern that if a sense of political turmoil emerges in the U.S., the value of U.S. Treasury bonds would decline, and interest rates on U.S. government debt would sharply rise.
WHO WILL RESCUE THE WORLD FROM DEBT?
Even if the worst-case scenarios do not materialize, the escalating interest costs due to recent increases in interest rates will compel governments to reduce budgets for essential public services. The battle against climate change may also face heightened challenges. Reports from the UK indicate that the opposition Labour Party has scaled back substantial investment plans for green energy due to concerns about the nation’s debt.
In the fiscal year ending on April 5, 2024, the projected amount of interest on the UK’s public debt that the government expects to pay is slated to surpass £94 billion (USD 120 billion), exceeding allocations for education or defense, according to the Office for Budget Responsibility (OBR).
In the U.S., interest on public debt for the fiscal year ending on September 30, 2023, reached USD 659 billion, marking a 39% increase from the previous fiscal year and nearly double the figure from 2020. The Committee for a Responsible Federal Budget (CRFB) indicates that the U.S. public debt interest in 2023 surpasses the budget expenditure for various sectors, including housing, transportation, and higher education.
Another troubling aspect is the substantial increase in public debt and interest on public debt in developed economies, reflecting economic growth deceleration and a rising proportion of elderly individuals compared to the working-age population. In such a scenario, the global path to overcoming the deep debt predicament remains unclear.
Rajan suggested that achieving a significant improvement in labor productivity without causing job loss or harm could be a solution with minimal pain. He believes that artificial intelligence (AI) might hold the key to addressing this issue. Many experts concur, contending that the productivity surge facilitated by AI could significantly reshape the trajectory of the global economy. This is anticipated to be a prominent topic of discussion at Davos in the forthcoming days.
By. Pham Thanh Bien
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