Debt/GDP - Compass Group

Fundamentos macro y riesgo
soberano: ¿qué hemos
aprendido?
March 2013
Roger Aliaga-Diaz, PhD
Senior Economist
Vanguard Investment Strategy Group
For institutional use only. Not for public distribution.
Developed markets government debt:
Reaching record highs … during peace time
Public debt in advanced economies, 1880–2012
130
120
110
100
% of GDP
(weighted avg)
90
80
70
60
50
40
30
20
10
0
1880
1900
1920
1940
1960
1980
2000
Source: International Monetary Fund, World Economic Outlook, October 2012.
For institutional use only. Not for public distribution.
2
Which countries are above average?
Government debt-to-GDP ratios for selected economies in 2012
250
237
200
% of GDP
171
150
126
100
83
90
119
118
107
91
89
94
UK
Iceland
50
0
Japan
Germany France
Spain
Greece
Italy
Portugal
Ireland
US
Four numbers for U.S. government debt
Gross
Net
General
107.2
83.8
Central
103.2
72.5
Sources: US Bureau of Public Debt, U.S. Board of Governors of the Federal Reserve System, U.S.
Bureau of Economic Analysis , International Monetary Fund (IMF): World Economic Outlook ©2012
For institutional use only. Not for public distribution.
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Assessing government debt overhangs
General questions
• What is wrong with the current paradigm for evaluating sovereign debt risk?
• What are the ways out of debt? What works and what doesn’t?
Specific questions
• Is debt-to-GDP a good indicator of debt sustainability?
• Does harsh austerity pay off?
• Should central banks stay out of the problem?
For institutional use only. Not for public distribution.
4
Macro fundamentals and sovereign debt math:
Debt limits, fiscal space and the primary balance
Accounting formula
Interest service (r x debt) – Primary balance = Growth in outstanding debt
For Debt/GDP ratios:
(r – g) x Debt/GDP ratio – Primary balance/GDP = Debt/GDP ratio growth
(r-g)d
Current paradigm
1. Higher the Debt/GDP ratio requires
higher government savings
2. “Debt limit” is the max Debt/GDP
ratio beyond which markets loose
credibility on the government’s
fiscal adjustment plans
3. “Fiscal space” indicates how
close the debt/GDP ratio is to
the “debt limit”
Primary
Balance
Int. rate schedule with
endogenous risk
premium and default
probability, p
(r(p)-g)d
(r(0)-g)d
Primary Balance
Risk free int. rate,
r(0)-output growth
rate g
Debt limit
Debt/GDP
Sources: “Fiscal Space”, by Jonathan D. Ostry et al, IMF Position Notes, September 2010.
For institutional use only. Not for public distribution.
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Fiscal space framework:
Too much focus on debt/GDP and deficits/GDP
Moody’s estimates of Fiscal Space, 2012
For Debt/GDP ratios:
250
South Korea
(r – g) x Debt/GDP ratio
229
Norway
223
Australia
– Primary balance/GDP
203
Sweden
197
Switzerland
= Debt/GDP ratio growth
182
Finland
174
United States
162
Canada
158
Germany
1. Is (r-g) > or < 0 or ~0
154
Austria
137
United Kingdom
2. What determines “r”? What determines
risk premia embedded in “r”?
129
France
Belgium
118
Ireland
Grave Risk (0-40)
93
Greece 0
3. What can be done about “g”?
Significant Risk (41-69)
Italy 0
4. How does “g” impacts the primary
balance?
Caution (70-124)
Japan 0
Spain 0
Safe (>124)
Cyprus 0
Portugal 0
0
50
100
150
200
250
300
Sources: Moody’s economy.com, Update as of December 2012.
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6
Fiscal space framework:
“Panic” austerity has real effects
Fiscal multipliers during 2010–11
8
Austerity and changes in debt-GDP ratio
50
y = -1.16x + 0.67
R² = 0.51
45
Increase Debt ratio (% of GDP)
GDP growth impact 2011 (ppts)
6
4
Multiplier ~ 1.2
2
0
-2
-4
-6
40
35
Greece
30
Portugal
25
Ireland
20
15
Spain
10
Italy
5
0
Germany
-5
-8
-4
-2
0
2
4
Unexpected fiscal consolidation 2010–2011
(% of potential GDP)
6
0
5
10
15
Austerity
Source: International Monetary Fund, World Economic Outlook, October 2013 and “Panic-driven austerity in the Eurozone and its implications”,
Paul De Grauwe and Yuemei Ji, February 2013.
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7
High debt-to-GDP ratio for developed markets:
We have been here before … multiple times
Debt-to-GDP dynamics after public debt reaches 100 percent of GDP
300
ISR 1977
FRA 1916
250
GRC 1888
GBR 1918
JPN 1997
NLD 1932
200
150
NZL 1884
ITA
BEL 1921
NZL 1909
CAN 1932
ITA 1992
BEL 1983
100
GRC 1993
FRA 1884
NLD 1887
ESP
ITA 1919
GRC 1931
50
USA 1946
IRL 1986
BEL 1940
CAN 1995
ITA 1942
GER 1918
0
1875
1890
1905
JPN 1942
1920
1935
1950
1965
1980
1995
2010
Source: International Monetary Fund (IMF): World Economic Outlook, October 2012.
For institutional use only. Not for public distribution.
8
Learning from history: what is next after reaching 100% debt/GDP?
Debt-to-GDP dynamics after crossing the 100% threshold
(% of GDP of advanced economies)
240
10th/90th percentile
25th/75th percentile
220
Japan 1997
UK 1918
200
Median
180
160
140
120
Italy 1992
100
80
USA 1946
60
40
20
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Source: International Monetary Fund (IMF): World Economic Outlook, October 2012.
For institutional use only. Not for public distribution.
9
Learning from history
1. UK in the 20s and 30s - the orthodox way
United Kingdom’s debt-to-GDP dynamics after crossing the 100% threshold
(% of GDP of advanced economies)
240
10th/90th percentile
25th/75th percentile
Median
220
200
15
Decomposition of annual
change in debt
10
180
160
5
140
120
100
0
80
60
-5
40
20
-10
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Nominal interest rate
GDP growth
Residual
Inflation
Primary balance
Source: International Monetary Fund (IMF): World Economic Outlook, October 2012.
For institutional use only. Not for public distribution.
10
Learning from history
2. US in the 50s and 60s- financial repression and surprise inflation
United States’ debt-to-GDP dynamics after crossing the 100% threshold
(% of GDP of advanced economies)
240
10th/90th percentile
25th/75th percentile
Median
220
200
4
Decomposition of annual
change in debt
2
180
160
0
140
-2
120
100
-4
80
60
-6
40
20
-8
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Nominal interest rate
Inflation
GDP growth
Primary balance
Residual
Source: International Monetary Fund (IMF): World Economic Outlook, October 2012.
For institutional use only. Not for public distribution.
11
Learning from history
3. Japan in the 90s - Deflation
Japan’s debt-to-GDP dynamics after crossing the 100% threshold
(% of GDP of advanced economies)
240
240
10th/90th percentile
25th/75th percentile
Median
220
200
220
200
180
180
160
160
140
140
120
120
100
100
80
80
60
60
40
40
20
20
0
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14 15 16
12
Decomposition of annual
change in debt
10
8
6
4
2
0
-2
Nominal interest rate
Inflation
GDP growth
Primary balance
Residual
Source: International Monetary Fund (IMF): World Economic Outlook, October 2012.
For institutional use only. Not for public distribution.
12
Learning from history: Summary
1. Supportive monetary environment is necessary condition for fiscal adjustment
2. Commitment to an external currency anchor (i.e. gold standard) worsen the
outcomes
3. Fiscal adjustment requires the economy to be strong
4. Deflation and low growth worsen the debt dynamics
5. Financial repression with inflation surprises worked in the past, but it may not be
possible today
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13
ECB balance sheet is the only effective tool
against short-term break-up risk
Yields of Eurozone sovereign bonds
Market weighted average yield
LTROs
€1 trn
8%
OMT
Unlimited
7%
SMP
€200 bn
Yield to maturity
6%
5%
4%
3%
2%
1%
0%
2008
2009
Germany
France
2010
Spain
2011
2012
Italy
Notes: Reflects the yield to maturity for each country’s index within the Barclays Capital Euro Aggregate Treasury All Market Index. Data through 15 October 2012.
Source: Barclays Capital.
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14
Central banks’ lender-of-last-resort role may be more important
than debt-to-GDP ratios
Debt-to-GDP and interest rates, 2013
Change in spreads vs initial spreads for
selected countries
(June 2012–January 2013)
25
2
0
Euro
20
Change in spread (%)
15
10
5
France
Ireland
-2
Non-Euro
Interest rates
UK
Portugal
-4
-6
Italy
Spain
-8
-10
-12
-14
-16
0
Greece
-18
0
50
100
150
Gross ebt-to-GDP
200
250
0
10
20
Initial spread (%)
30
Source: International Monetary Fund, World Economic Outlook Database, Thomson Reuters Datastream and “Panic-driven austerity in the Eurozone and its
implications”, Paul De Grauwe and Yuemei Ji, February 2013.
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15
Central banks’ quantitative easing policies:
Are they already acting as lenders of last resort?
Central bank total assets
30
ECB
Lehman Brothers
collapse
Total assets (% of 2008 GDP)
Fed
25
BoE
BoJ
20
15
10
5
0
2007
2008
2009
2010
2011
2012
Source: Vanguard Investment Strategy Group calculations based on IMF, Federal Reserve and Bank of England and Bank of Japan.
For institutional use only. Not for public distribution.
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“Fiscal dominance” and inflation are the key risks
Central banks stance and real policy rates
10%
ZLB policy
8%
Interest rate rule
6%
4%
2%
0%
-2%
-4%
US
UK
Core inflation
Eurozone
Canada
Japan
Mexico
Australia
Brazil
China
India
Real policy rate
Notes: Core inflation measured as the year/year change in that countries CPI ex food and energy index, except for India which displays the headline inflation number.
Real policy rate is defined as the country's primary monetary policy target interest rate, adjusted by core inflation . Data as of 10 July 2012.
Sources: Various international statistical agencies, compiled from Thomson Reuters and Moody's Analytics.
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What have we learned?
1) Too much focus on debt-to-GDP and “panic” fiscal adjustments.
The macro accounting arithmetic should also include GDP growth rates, their
impact on fiscal balances and the determinants of interest rates.
(Japan vs Greece)
2) The monetary regime is a critical component of sovereign debt risk
assesments.
For currency unions, currency boards, gold standard or fixed-exchange rates
settings, “breakup” risk amounts to default risk. (Spain vs UK)
3) Fiscal and monetary policy coordination is necessary.
Credible fiscal consolidation plans must be accompanied by ample monetary
support. Avoiding a deflationary trap is critical.
QE policies seem to be appropriate here.
(No country is doing this right now).
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18
Appendix
For institutional use only. Not for public distribution.
19
A look back at post-WWII debt reduction:
Mostly growth, but also inflation and belt-tightening
Cumulative contribution to post-WWII reduction of U.S. gross debt/GDP
250.0
Financial Repression
Belt tightening
200.0
Inflation
8%
Real GDP growth
Debt/GDP
150.0
22%
9%
21%
20%
30%
100.0
50%
40%
50.0
For institutional use only. Not for public distribution.
1970
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
1959
1958
1957
1956
1955
1954
1953
1952
1951
1950
1949
1948
1947
1946
0.0
20
A look back at post-WWII debt reduction
Would inflating our way out work?
Composition of U.S. federal spending
100%
80%
Defense
60%
Other Non Interest
Net Int
Medicare
40%
Social Security
20%
0%
1946
2010
110% Net Debt/GDP
65% Net Debt/GDP
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21
Learning from history: what is next after 100% debt/GDP?
Italy’s Debt to GDP Dynamics after Crossing the 100% Threshold
(% of GDP of advanced economies)
240
Decomposition of debt
10th/90th percentile
25th/75th percentile
Median
220
200
10
8
180
6
160
4
140
2
120
0
100
-2
80
-4
60
40
-6
20
-8
0
-10
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Nominal interest rate
Inflation
GDP growth
Primary balance
Residual
Source: International Monetary Fund (IMF): World Economic Outlook ©2012.
For institutional use only. Not for public distribution.
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