by Andreas Charalambous and Omiros Pissarides
The financial crisis that unfolded in 2008 is inextricably linked to the disproportionate levels of private debt that have contributed to vast problems in the banking sector. In parallel, even economies with relatively low public debt, such as Ireland and Spain, faced sustainability challenges. Two lessons learned by governments relate to the importance of sound long-term oriented fiscal policies as well as forward looking public debt management, as the main determinants of the ability to raise funds through international bond markets. Countries that did not act accordingly were penalised by excessive borrowing rates, which in turn limited their potential to implement expansionary fiscal policies at times of recession, thus negatively affecting economic growth.
Today, compared to 2008, the prevailing conditions are very different due to two, largely interconnected, factors. The first concerns the global coronavirus pandemic, which has led to unprecedented actions by both governments and central banks and to increased public spending and extensive borrowing to support economies. The second factor relates to the prolonged period of low interest rates which, in conjunction with subdued inflationary pressures in the foreseeable future, creates conducive conditions for further borrowing. As a case in point, just a few weeks ago, China managed to borrow at a negative interest rate €4bn in five-year bonds for the first time in its history. Simultaneously, in Europe, a number of countries, with Germany at the forefront, have been borrowing for some time now at negative rates, while public debt yields continue to depict a declining trend.
Most analysts agree that the adopted fiscal approach was fully justified, taking into consideration the unprecedented magnitude of the crisis and its particularly adverse effects on vulnerable groups of the society.
However, the first worrying signs relating to high debt levels are beginning to make their presence felt. Recently, the Institute of International Finance has warned that global debt will reach $277tr within the year or a whopping 365 per cent of global GDP. Already, a small number of developing countries have stalled payments, although in the case of countries, such as Zambia, default is primarily the result of long-standing and mostly endogenous factors.
In Europe, debt levels do not inspire long-term optimism for a number of nations, including Cyprus, whose sovereign debt exceeds 110 per cent of GDP. The Italian cabinet undersecretary Riccardo Fraccaro recently expressed the view that the ECB should cancel, or perpetually extend the maturity of, government bonds bought on the secondary market during the pandemic. Although unequivocal criticism, including that of the ECB president, did not take long, Italy, with a historically high sovereign debt of 135 per cent to GDP, unofficially but most likely effectively dared to put forward a parameter that would serve well many highly indebted countries.
In conclusion, it is obvious that the current crisis warranted swift and determined actions in order to avoid disastrous outcomes. Furthermore, in the midst of the second wave of the pandemic, it would be a particularly negative development to contemplate an early suspension of the extraordinary fiscal and monetary measures pursued. At the same time, however, it is also evident that, if debt accumulation is not reversed over a medium-term horizon, it will inevitably create severe shocks. To this end, vigorous efforts will be required to reduce the existing level of borrowing without causing substantial side effects on economic activity. Consequently, every nation, Cyprus included, must prepare and implement a strategic plan which, while acknowledging the continuing adverse effects of the pandemic, will put forward a framework for long-term sustainable growth.
Andreas Charalambous is an economist and former director of the Ministry of Finance. Omiros Pissarides is the Managing Director of PricewaterhouseCoopers Investment Services