Now, as economic activity reemerges even as daily new confirmed cases of the virus top 100,000, we can start to address how governments can pay back their debts.1 For developed markets, at least, the situation may be less dire than some fear.
It first may make sense to touch upon just how rational policymakers' moves have been. The more than $9 trillion in spending, loans, and loan guarantees that the world's largest economies have committed to countering the negative effects of the pandemic, while extraordinary, speak to the uniquely consequential nature of the challenge.2
A multitrillion-dollar global fiscal commitment
Note: The bars show announced fiscal measures in selected G20 countries as a percentage of GDP.
Source: International Monetary Fund, as of May 13, 2020.
Few have disputed the potential for serious, long-lasting economic harm in the absence of such programs. That, alongside recognition that such outlays are unlikely to recur and the structuring of much of the fiscal response as loans rather than grants, makes such bold moves more palatable.
Loans and equity stakes can be thought of as government investment in those assets. Thus, any increase in debt from those disbursements could be reversed as those equities are sold or as the loans mature, except for a small percentage of possible bankruptcy losses. According to the International Monetary Fund, more than half the total fiscal response in the largest developed and emerging economies belongs to these categories.
To be sure, instituting such policy in the face of blaring headlines about triple-digit debt-to-GDP ratios requires steely conviction. For the group of major developed economies, the debt-to-GDP ratio jumped 24 percentage points in about two months. In comparison, a similar increase in global debt in response to the 2008 global financial crisis took two years to play out. The average debt level for this group of countries sits at 154% of GDP.
The fiscal math behind debt sustainability
Notes: Countries included in the calculation are Australia, Canada, France, Germany, Italy, Japan, Spain, the United Kingdom, and the United States.
Scenario 1 represents 4% nominal GDP growth, an average 10-year yield of 1.2%, and a 2% budget deficit.
Scenario 2 represents 3% nominal GDP growth, an average 10-year yield of 1.2%, and a 2% budget deficit.
Scenario 3 represents 3% nominal GDP growth, an average 10-year yield of 1.2%, and a 5% budget deficit.
Source: Vanguard calculations based on data from Thomson Reuters Datastream.
As striking as those figures sound, most policymakers and market participants understand that debt sustainability—the cost of servicing debt compared with economic growth—is far more important than the cold, hard headline number. In that respect, although the health shock led to unprecedented emergency spending, our low-interest-rate environment is a favorable backdrop. It's more than conceivable that developed-market economies can grow out of their newfound debt.
With solid yet realistic growth rates in coming years as economies bounce back from pandemic-induced contractions, we could see debt in these economies returning to pre-COVID levels by the end of the decade (Scenario 1 in the figure above). Moreover, even more muted growth assumptions are enough to put debt on a sustainable downward trajectory, thanks to the sub-1% 10-year yields at which governments are issuing their debt (Scenario 2).
Although fiscal consolidation—raising taxes, cutting spending, or both—is the tried and true method for tackling debt challenges, these scenarios don't depend on draconian assumptions. Only modest fiscal austerity, in the form of budget deficits not larger than 2% or 3% of GDP, is required alongside modest growth to reduce debt-to-GDP levels. But some fiscal discipline is needed; runaway deficits won't work. Not even sub-1% yields would be sufficient for a grow-out-of-debt strategy if fiscal deficits remained systematically above 3% (Scenario 3).
Central bank actions over the coming months and years will also have important implications for developed markets' debt arithmetic. In fact, everything central banks are doing to help their economies right now increases the odds of a sustainable debt scenario going forward. Although explicit coordination between monetary and fiscal policy would violate the sacrosanct principle of central bank independence, the reality is that the massive monetary accommodations in most developed markets in response to the pandemic will help significantly from a debt perspective.
Beyond policies of zero or negative interest rates, central banks will need to adopt forward-guidance frameworks. Global financial markets no doubt will respond better if they know what's coming. The U.S. Federal Reserve, for example, will need to put a forward-guidance framework in place as soon as the U.S. economy starts to move from contraction to expansion, which Vanguard's base case foresees occurring in the second half of 2020. Guidance could be timeline-driven, or it could depend on data outcomes such as when unemployment falls back toward more typical levels or when inflation rises toward targets around 2% in most developed markets.
Higher inflation could be beneficial, if central banks can finally achieve it. In normal conditions, higher inflation doesn't help with debt reduction because bond markets eventually catch up through higher interest rates. But in rare circumstances like wartime spending or disaster responses, such as in this COVID-19 crisis, higher inflation can erode the value of one-off debt.
Of course, the greatest condition of all is the pandemic's progression. A second wave of infection that requires another round of national lockdowns is a worst-case scenario—from both health and economic standpoints—that we unfortunately can't rule out. On the other hand, a sooner-than-expected development of a vaccine or indications that we've achieved herd immunity would accelerate recoveries.
I don't mean to suggest that everything is rosy. Recovery will take time and be uneven, coming later to sectors that depend on face-to-face interaction. And while our view on developed markets is sanguine, our outlook for emerging markets—which we don't foresee being able to simply grow themselves out of debt—is far more challenging. But considering where we've been in recent months, just being able to discuss recovery in present terms offers promise.
1 World Health Organization COVID-19 Situation Report 146, June 14, 2020.
2 International Monetary Fund data as of May 13, 2020.
Chief Economist for the Americas
23 June 2020
BEc (Acc), MBA, CPA, FFin
David has been in the Financial Services Industry for nearly 30 years. He was one of the founding Directors of the successful Financial Planning and Stockbroking Practice, Henderson Gregory Forrest, for a decade. Prior to that, he held senior roles in companies such as ING, KPMG Accountants and AMP. David was previously Chairman of OAMPS Superannuation Trustee Board and currently serves as an independent Board Director for several companies.
David’s extensive experience in all forms of superannuation, including Self Managed Super Funds (SMSF), Defined Benefit Funds, retirement funding through Account Based Pensions, stockbroking with a focus on Direct Share Investment, Taxation/Remuneration Planning, Centrelink, Aged Care and business management, equip him to advise expertly on all aspects of Financial Advice.
Those with a particular interest in superannuation/SMSFs, direct share investment, salary packaging or applying for the Centrelink Pension will find his knowledge and ability in formulating and implementing creative, logical and simple wealth creation strategies a valuable asset.
David maintains a strong personalised client service focus, providing tailored solutions for clients.
David Forrest is an Authorised Representative of Integrity Financial (SA) Pty Ltd ABN 16 133 921 187 — AFSL No 334846
Business Finance Manager
B Bus (Acc), CPA
Michelle’s career has spanned across the Financial Services, Retirement Living and Aged Care industries working in the private sector, not for profit and more recently with the state government for over 20 years. Her experience extends to many facets of the financial services industry, having worked in superannuation administration, technical support and financial planning practice administration.
Commencing with AMP and subsequently working in commerce and accounting roles with companies such as Brambles, Adelaide Bank Retirement Services, ECH Inc and SA Health and Wellbeing, Michelle returns to financial services after working in practice financial management at Henderson Gregory Forrest. This wide range of experience from senior accounting and management roles has provided Michelle with a strong background in business administration.
With an astute financial acumen and keen interest in business improvement strategies, Michelle ensures the smooth running of the Integrity Financial Advisory practice providing valued management support to our personalised client service focus.
B Com, Dip FP
Darren joins the Integrity team as a strong technical specialist with almost 20 years’ in the Financial Services industry. He has extensive experience advising clients on how to build and protect wealth, prepare for retirement and retire comfortably.
Commencing with advising clients on direct equities for over 10 years at Baker Young, Tolhurst Noall, and ABN AMRO Morgans, his career expanded to providing holistic client advice, having operated his own financial services licence and company. Most recently having worked for a 'Big 4' bank, he has welcomed the more personalised ‘client first’ approach that is evident at Integrity Financial Advisory.
With a deep understanding of investment markets, he is appropriately qualified and authorised to provide direct share advice, as well as superannuation/SMSF advice, encompassing both investments and insurance.
Meticulous in his approach, he aims to deliver quality outcomes for clients by understanding their financial situation and needs before providing advice which is central to our advice process. Darren supports David in tailoring solutions for all client financial advice needs.
Darren Chalk is an Authorised Representative of Integrity Financial (SA) Pty Ltd ABN 16 133 921 187 — AFSL No 334846
Client Service Manager
Natasha commenced working in the financial services industry in June 2008 and is a new addition to the Integrity team. During the past 11 years, she worked closely with advisers providing administration support in a share broking and financial advice business.
Having successfully completed her RG146 accreditation in securities and managed investments and continued her studies to complete her competency in Superannuation, Natasha can ably assist with all aspects of fixed interest, cash management, portfolio administration, direct shares and client advice implementation.
Natasha takes time to ensure she understands our client’s financial goals and needs and believes in creating, preserving and utilising wealth through effective financial management as a key objective in helping clients.
Client Service Manager
Kelly has worked in the Financial Services Industry for over 10 years and has supported David since 2013. Kelly’s primary background is in customer service and administration.
On starting in the industry, Kelly initially focused on direct shares, stockbroking administration and client liaison. Since moving to the Client Service Manager role, Kelly has developed skills encompassing all aspects of financial planning including client advice implementation and term deposit management.
Kelly’s experience in the direct share environment, especially management of estates, provides a key part of the direct equity expertise in Integrity’s Client Service Team.
Returning from Parental Leave following the arrival of her second child, Kelly has developed further honed multi-tasking skills after juggling the demands of a growing family.
Client Service Manager
Jasmine has worked in the financial services industry for over 12 years in all areas of client administration, working with David since 2013.
Jasmine has extensive knowledge and experience in client service including implementation of advice, portfolio reporting, assisting with the establishment of Self Managed Super Funds (SMSFs), term deposit management and a long history of helping clients with their enquiries.
Jasmine’s attention to detail, yet gentle approach, means she is able to solve the trickiest of questions for our client community.
Jasmine has gained her Certificate III in Financial Services qualification.
Client Service Manager
Merrilyn has worked in the financial services industry for over 11 years in all areas of client administration, and is a new addition to our client services team, returning from Melbourne to join the team in June 2019.
Merrilyn has extensive knowledge and experience in client service including implementation of advice, managed fund administration, assisting with the establishment of Self Managed Super Funds (SMSFs) and process improvement for the previous practices she has worked with. Merrilyn’s experience with direct shares constitutes the other part of our administrative support for direct equity investments.
Merrilyn’s warm and caring nature continues to endear her to our clients and she has already established herself as a valued member of our team.