Sovereign debt

Nearly two hundred countries across the globe are spending borrowed money. Internal and external debt as a percentage of GDP is alarming. Consider that in the United Kingdom external debt alone stands at over 365 percent of GDP. With a snail speed annual GDP growth of less than a percentage point and a euro zone external trade deficit of 32.1 billion euros, it is not difficult to comprehend the debt trap that is building up on this front. The current economic global crisis appears small compared to what sovereign defaults could do. To put it in broader perspective, Iceland, Ireland, Germany and France have an external debt to GDP ratio of 998, 960, 185 and 237 percent respectively.


Add to that other debts like consumer debt. Grant Thornton research shows that the total outstanding UK consumer debt amassed through mortgages, loans and credit cards has increased by 7.3% to 1,444 billion pounds over the past year, up from 1,346 billion pounds in June 2007

Personal debt has forged ahead of UK GDP.

United States external debt stands at 95 percent of GDP and consumer debt is nearly 2 trillion. Additionally total household mortgage debt is nearly 7.8 trillion.

This does not include other debts like Implicit debt which in many countries is not even earmarked in government coffers.

One would expect structural changes to be enforced on these economies. Yet the IMF and rating agencies like Moody’s and Standard and Poor’s remain silent. Why then the double standards? Do we need new institutions with more objectivity and lesser association with the developed world? If the sovereign rating of these countries is downgraded who would lend them money and more importantly what rate of interest would they end up paying? What would be the impact on their top notch companies? High interest pay outs alone could have negative impacts on these governments and organisations.

Consider the recent example of Greece that issued a 5 billion euro bond. The Greek ten year bond yield is 6.6 percent compared with 3.2 per cent for the German bond. As more and more governments tap the open market to borrow, money will become even more expensive. In Europe alone, the Greek will be tapping the market soon for another 70 billion and the Spanish treasury needs to raise 76.8 billion Euros through debt issuance this year. Britain may follow soon and who knows who else. Yet instead of talking about the pressure this will put on borrowers, the higher cost of borrowing which is only going to get worse, Ms Angela Merkel of Germany spoke of oversubscription of the Greek bond as good news and a sign of confidence in the Greek nation. Perhaps the German and French banks who scooped up the issue will make a killing on it.

The increasing risk of Greece defaulting on its debt has pushed up the price to insure $10 million of Greek bonds 42% - from $282,000 in early January to more than 400,000 in February —there will be institutions that will profit from a default. Trading credit default swaps has already begun

Germany and France have called for a crackdown on what they see as speculators amplifying Greece's problem by short-selling CDS contracts based on the country's sovereign debt.

So what happened to the new financial framework that the G-8 was talking about?

Meanwhile the social uprising in Greece is an example of how difficult it will be to introduce economic reform and austerity measures in the developed world.

What happens if at some point in time future, governments cannot pay up? Will they be forced to sell off assets. There has been mention (by a prominent German at least) that Greece should sell its islands instead of tapping the debt market. That is telling !

Iceland referendum rejecting plans to repay Britain and Netherlands is an example of what could be yet another outcome.

Perhaps we need new caps on government borrowing. For instance a country debt to reserve ratio or a cap on borrowing.

Remember the mean restructuring of Latin American economies as also the Asian economies – tens of thousands were rendered jobless, tens of thousands more were thrust below the poverty line and governments in these countries were forced to hammer down much of the public sector to its last nails. Not to mention across the board structural changes before even a penny was handed out.

No such reform in the Euro zone economies or the United States!. The trend seems to be borrowing more and spending more and when it comes to job creation, a top U.S economist said the other day on CNN that she was certain that the next big employment wave was not sitting atop the Green economy. ” We do not know where the next set of jobs will come from”, she added. Scary that no one is actually in charge out there. Everything is chance and market dynamics. There is no thought process in determining future economies and yet we are funnelling billions into the economy to create jobs. Hope at least some jobs will outlast the recession.

So if no one is directing economic growth towards a particular path why spend money within and outside of the government in forecasting, risk management, project assessment etc. Let us just wait for things to happen themselves and in the process save public money.

The interview was an eye opener and a reminder that the world’s economic health needs better doctors. Needs diagnosis and cure and not just waiting for chance to get us ashore. Something has failed in a complete Laissez fare and perhaps its human morality.

Thank God the Yuan is undervalued. Imagine the repercussions on purchasing power of common people if the Yuan were to become stronger overnight! Who cares China has an artificial advantage. Thanks God their economy is doing well –giving us someone to do business with !