There's no emerging market debt threat

The World Bank warns us of a large wave of debt that has been building up since 2010. (Global Economic Prospects, 2020). It’s driven by a rise in debt in emerging market and developing economies (EMDEs). The build-up has been faster and broader than in the three waves of debt in EMDEs that happened before in the past 50 years. 

Every one of the earlier three waves ended in a financial crisis. The report spells out the impact of these crises. It suggests ways in which EMDEs might reduce the probability of a debt-induced crisis and its impact. 

It’s good to be warned and to be prudent in managing debt. But are EMDEs really going on a debt binge that could hurt the global economy? Should we in the EMDEs be having sleepless nights? Not really, if you look closely at the facts presented in the report. The debt problem, it turns out, lies elsewhere — in the advanced economies. 

Global debt, government and private, was at an all-time high of 230 per cent of gross domestic product (GDP) in 2018.  EMDE debt was 170 per cent of GDP in 2018, an increase of 55 basis points over the level in 2010. But the bulk of the increase happened because of China. Excluding China, EMDE debt is 107 per cent of GDP, by no means a high figure given that it includes both government and private debt. A Chinese debt crash has been forecast for so long that it’s now boring to read about it.

Advanced economy total debt was 264 per cent of GDP in 2018. True, this is the same level as in 2010, there has been no increase. But the fact remains that the high level of debt in the world today is primarily on account of advanced economies.

EMDEs barring China are not central to the problem.

High levels of debt are a precursor to a financial crisis. That’s the lesson from the financial crises of the past, including the global crisis of 2007. However, as the report notes, there are numerous mitigating factors in today’s situation. Persistently low interest rates is one of them. A rise in interest rates is sure to create problems. But a sharp increase in rates doesn’t seem likely in the near future. 

The current build-up of debt in EMDEs is on account of a mix of government and private debt. That’s good news. Government debt has a bigger chance of being spent on consumption, so the rise in debt would have been more of a problem had it been driven overwhelmingly by government debt.

At 50 per cent of GDP, government debt in EMDEs is not a huge problem. Moreover, the domestic component of government debt is relatively manageable — governments can inflate their way out of trouble. External debt is the issue. Total external debt, government and private, in EMDEs was 26 per cent of GDP in 2018, not alarming by any reckoning.

There are other positives in the current situation. The international financial system has become more resilient, thanks to higher capital at banks than in 2007. More global safety nets are available. Many EMDEs have moved towards better macro-economic policies. These include flexible exchange rates, targeting of low levels of inflation and higher foreign exchange reserves. 

Since 1970, there have been 520 episodes of rapid accumulation of debt in 100 EMDEs. About half of these resulted in financial crisis. That gives us a probability of 50 per cent in worse times. In today’s situation, the probability of a financial crisis erupting in EMDEs would be considerably lower. The challenge is not a financial crisis originating in EMDEs but one that might originate independently of them. That is what the World Bank should be highlighting. 

Which brings us back to the nub of the problem today, namely, the high level of advanced economy debt. It was advanced economies that created the 2007 crisis. The Eurozone crisis of 2011 was an extension of that crisis and it dealt a further blow to the global economy. High debt and tardy growth in advanced economies are impacting the world economy adversely. So is the upsetting of the international trade system by the leading advanced economy, the US. For a change, the World Bank might want to read its sermons to the advanced world instead of to EMDEs. 

Political stability and investor confidence

Several commentators have been saying that the protests in recent months pose a threat to political stability and have damaged investor confidence. Political stability, they tell us gravely, is just not a matter of having a parliamentary majority. It is also about the absence of political turmoil. The controversial political initiatives of the present government and the protests they have evoked, the pundits warn, are bound to reflect in investor confidence. 

Well, if investor confidence has been damaged, it certainly doesn’t show up in foreign inflows.  Foreign institutional investor inflows totalled $19 billion in the calendar year up to December 2019, up from minus $11.3 billion in the year up to December 2018. Gross foreign direct investment into India was $40.1 billion in the period April-October 2019 compared to $37.3 billion in April-October 2018. Foreign investor confidence is alive and kicking. The government’s critics need to think up a different spiel. 

The writer is a professor at IIM Ahmedabad; ttr@iima.ac.in