In the afterbath of the Global Financial crisis in 2008, governments all over the world have pumped liquidity in the system supported by the lower interest rates from the central banks. The consumption was supported to come out of the crisis, but the governments all over the world have found a very easy supply of money and resorted to the increase in debt year after year. Let us call this is an addiction to debt.
The global debt increased from 280% of GDP in 2008 to 320% in 2019. This will hunt the world for many more years. We are in a vicious circle now where debt burden cost no longer can be neglected. Now, the Interest component is a major expense in the nations and corporates balance sheet. A doubling of interest rates would severely impact the ability to spend by reducing the available money at hand with the governments, corporates, and households.
Rapid Debt buildup has been experienced over the last 10 years. The current wave, which started in 2008, the increase in debt in these economies has already been larger, faster and broader-based than the previous three waves, which was the first oil shock ( decade of 1970) second oil shock ( late years in the decade of 1980s Asian Crisis ( mid of decade of 1990).
The only solace is that current debt buildup is less risky for creating immediately problems as most increase of the debt is with central banks and governments. But this does not mean, its harmful impact in the long run can be mitigated. Japan since last 40 years and Europe in last 10 years have tried a lot to push growth but instead have only made the problem larger by increasing debt.
Here is the more detailed analysis on the Debt problem being faced by the world.
These are the interest rates for various developed and developing nations:
|Name of the Interest Rate||Country/Region||Current Rate|
|Japanese interest rates BoJ||Japan||-0.1%|
|American interest rate FED||United States||1.75%|
|Germany interest rate EUR||Germany||-0.38%|
|Australian interest rate RBA||Australia||0.75%|
|Bank of Korea interest rate||South Korea||1.25%|
|Chinese interest rates PBC||China||4.15%|
|Indian interest rates RBI||India||5.15%|
|Russian interest rate CBR||Russia||6.25%|
All the rates above have declined without exception. Interest rates in 2007 in USA was 4.75% Germany 4.3% and China was 7.29%. Lower interest rates have both give and take: Record low-interest rates make it extremely easy for corporates and sovereigns to borrow more money. But consumer spending mat get distorted as the hefty borrowing amount is not being put to good use (e.g: capital investments, household asset building etc). With interest rates also being low, there is less urgency for the nations to address their debts and this is affecting the overall condition of the global economy.
“Cheapening money to incentivize economic activity is not working any more e.g. Japan and now Europe”. The near negative and declining interest rates in developed countries around the world has caused the dollar to soar, which is having a knock-on effect on developing countries such as India, Brazil and South Africa, as there is heavy borrowing in dollars and repayment must be done from the earning in local currencies that have steadily devalued. For the Developed world as well, there is no free lunch after all. The banks, eventually recoup the lost interest over time with various fees for loans terming it as Credit Expansion. Cheaper money is not necessarily filtering down to consumers at the retail level. Banks with interest rates shortfalls in the world with low IR generally are charging their customers with higher fees for ANY service, whether overdraft or use of out of network ATMs.
Talking about high debt levels in the global economy:
To pull in the low-interest rates, the need to address debt issue isn’t as dire and is often neglected. But debt shouldn’t be growing faster than economy till the the wall is hit.
The report released by the International Institute of Finance(IIF) showed that global debt has surged by $7.5 trillion in the first half of 2019 alone. China and the US accounted for over 60% of this increase. The Emerging Economies debt also hit a new record of $71.4 Trillion. Surprising, if the pattern continues the global debt will surpass $300 Trillion in next few year.
Looking from a statistical point, If interest payments, for example, is an average 2% currently, the interest burden on all global debt would be around $500b @ $ 250T global debt , at 3% interest rate it’ll be $750B, 4% ill be $1 Trillion. There would be a knock out of $500B from the global disposable income if the interest rates go up (the impact would be actually less as there are some recipients as well who would gain). This reduction has the potential to shock the $65T global economy ( increased interest payments would add to almost 1% of global GDP, which would act like de-stimulating the global economy). Effectively, we are in catch 22 situation at the moment. The cycle would play around in the following manner.
AS GDP goes up, central banks will increase the rates, which will directly impact consumption and that will try to slow GDP down and the Central Banks will be forced to change its stance on interest rates. So considering the interest the burden on the governments, corporates, and households and its impact on the change in the consumption preferences for the consumers and budget shrinkage at the government and corporate level—the interest rates it seems can not go up in the entire decade of 2020.
We would like to sensitize the readers to keep a watch on the possible bubble in the asset classes be it Capital Markets, Real Estate, bullion or auto industry. This will happen due to low interest rates.
This Article is written by Arunima Goel, Business and Financial Analyst at East West New Markets.