While the ongoing COVID-19 pandemic has had a severe economic impact on just about every country in the world, there will inevitably be nations that will have to endure significantly more severe economic fallout in the years to come. Measures implemented to deal with the crisis in the short term, such as lowering interest rates, are very likely to cause issues down the road.
This is according to our findings in a recent report titled “Which countries’ finances will suffer the worst long-term scarring from Covid-19?”. In it, we take a closer look at countries’ ability to balance their books over the medium term, as they recover from the fiscal impact of the pandemic.
Most notably, increased borrowing throughout the pandemic and future years will inevitably lead to higher levels of debt as a share of GDP for nearly every country. The International Monetary Fund (IMF) has predicted that borrowing will peak in 2020 for most countries. A handful of advanced markets are expected to borrow at least as much in 2025 as in 2019 – suggesting long-term scarring, or excess borrowing. Canada, Japan, Australia and the US may manage to reduce borrowing back below 2019 levels. In emerging markets, Brazil, South Africa and Chile are expected to be running a deficit smaller than in 2019 by 2025. China and India are expected to still run deficits over 8% of GDP. Only Chile, Thailand and Russia are forecast to have deficits below 2% of GDP, though Russia used to run a surplus before the pandemic.
The sole exception in this regard will be Germany, which is expected to cut its deficit back towards surplus and generate enough growth to allow for its debt levels to stabilise.
It may be surprising to learn that some countries will indeed see the cost of financing their existing debt decrease over the coming years. That is thanks to the actions of central banks that have cut interest rates and reintroduced quantitative easing.
Unfortunately, debt forecasts for the private sector are largely non-existent. However, the latest data available from 2019 could still provide some insights. For example, it shows that Italy, which is well known as one of the most indebted major countries in the world, is actually less indebted than Spain and the UK as a share of GDP. After Japan, France and Canada are the most indebted nations, followed by the US and South Korea. High indebtedness in emerging markets is not well tolerated by financial markets.
This is where the world’s biggest liabilities will lie over the next few years. High private debt is arguably more dangerous than high government debt as companies and households have limited resources and are more prone to arrears and defaults. Governments on the other hand have multiple generations to reduce indebtedness, and the levels are less important than being able to re-finance that debt on an ongoing basis.
With that said, there are some liabilities that governments face which are not captured by public finance statistics. For one, age related spending is a poorly understood future cost for governments. The IMF provides an estimate of these broken down into pension spending and healthcare spending. Ageing populations caused by current demographics are largely to blame for the higher spending on healthcare. Demographics in Germany and Spain are significantly worse than those in the US, but the higher cost of healthcare in the US raises the level of spending dramatically. Brazil is only a little behind the US, with most of the extra cost coming from pensions spending, though the 2019 pension reform is a first step towards tackling this.
A significant number of countries are in danger of being ill prepared for the next cyclical downturn. By 2025, one quarter of major economies may still lack fiscal space to manoeuvre, while simultaneously still suffering a drag on their annual budgets from sub-trend cyclical performance.
As an emerging economy plagued by both private and public debt, South Africa is likely to struggle in coming years to return its finances to a sustainable path. However, the country is expected to re-establish its fiscal space by 2025. Doing so will require tremendous restraint and discipline to enact significant fiscal austerity.
The full Schroders report is available here.
Azad Zangana is a Senior European Economist and Strategist at global asset manager Schroders.