Governments across the world are taking on debt burdens in an effort to deal with the impact of the Covid-19 crisis, and it’s the right thing to do, according to an analyst.
Speaking during a webinar hosted by Ninety One on Tuesday, investment strategist Russell Silberston noted that government debt had been rising rapidly since the 2008 global financial crisis.
As the world faces another crisis, governments will likely take on more debts, which is normal, he posited. "Government must protect working capital and it must protect labour markets," Silberston said. Referencing statistics from the Bank for International Settlements, debts of the US as at September 2019 stood around $53 trillion. China's debt stood at $35 trillion and that of the Eurozone and UK was $33 trillion and $7 trillion, respectively. By comparison, SA's debt is under half a trillion dollars.
Moody's, which was the last rating agency to have SA's debt ranked at investment grade, recently downgraded it to junk status. S&P also dealt the country another blow when it downgraded its debt further into junk status. These ratings actions saw SA fall out of the world government bond index.
SA's debt levels were heading towards 70% of GDP by 2022/23 ahead of the crisis, but S&P sees further borrowings to fund Covid-19 to push this towards 90% of GDP.
The SA government is seeking R95 billion in funds from the International Monetary Fund, the World Bank and the New Development Bank, Bloomberg previously reported. These funds will purely be used for Covid-19 interventions, Finance Minister Tito Mboweni has said.
Government has also implemented a raft of measures to cushion the blow of Covid-19 on the economy, relying on a fiscal stimulus package of R500 billion, combined with monetary policy measures taking the stimulus package to R800 billion.
During the last financial crisis, households and corporates in western countries largely shifted their behaviour towards paying off debt and increasing savings. The problem is that saving too much and not spending at all could result in lower growth levels, leaving it to government to pick up the economic slack by borrowing more, said Silberston.
He noted seven options to deal with accumulating government debt.
1. Financial repression
This is a method in which policy or regulations are used to steer funds towards government through purchases of government bonds and treasury bills. Historically this has been successful at reducing debt levels, when accompanied by inflation, Silberston said. For example, following World War II, governments kept interest rates low coupled with other capital controls, leaving investors with little choice but to lend to government. This method was also widely practised after the global financial crisis.
In SA we have seen the Reserve Bank purchase government bonds in order to stabilise dysfunction in the market. Although not the bank's intent, it had the effect of easing bond yields, that along with a low inflation outlook, made the asset class quite attractive to investors.
Inflation can be used to erode the value of debt. But practically, this is difficult to achieve, said Silberston. Increasing inflation to decrease the value of debt will be difficult, especially with Covid-19 expected to decrease inflation, Silberston explained.
The SA Reserve Bank expects inflation to decline towards the lower end of the 3% to 6% target band for April, Fin24 previously reported.
Governments could also opt to default on debt, but this is a politically driven choice, Silberston explained. Economic history shows default is common, for example, modern Greece has been in default for 53% of the time, Silberston said.
Inclusive and sustainable growth is another way to ease the debt burden. The problem is Covid-19 is expected to undermine economic growth, globally. With the IMF projecting a contraction of 3%.
"Unless the virus releases a surge in productivity and business investment, strong growth looks like an unlikely solution to the growing debt burden," he said.
The SA economy was already in a recession ahead of a nationwide lockdown instituted to slow the spread of Covid-19. The country is slowly reopening sectors of the economy, but Treasury projects a contraction of 16.1% based on a protracted lockdown and an even longer recovery in economic activity.
Government could also increase its income by raising taxes. "Widespread tax rises seem unlikely for now," said Silberston. If governments do opt to raise taxes, they may target corporates or consider wealth taxes, he added.
In SA, government has introduced a set of tax relief measures amounting to R70 billion have been implemented. They include deferrals on excise duties, carbon tax, and employees' tax, including the postponement on corporate tax proposals.
6. Reduce spending
Another option is to reduce spending, but Silberston said this unlikely. In the medium-term spending could be reined in, but not at this point.
7. Funny money
Silberston said governments could be pushed to drastic measures – such as merging monetary and fiscal policy. For example, having no constraints on government spending apart from inflation. Or would involve central banks printing more money, and using it to buy government debt directly from Treasury.
SA's deputy finance minister David Masondo has called for the Reserve Bank to do more to help bolster the country's efforts to fight Covid-19, by potentially buying government bonds directly from Treasury. However, Reserve Bank Governor Lesetja Kganyago has warned against the idea of central banks being drawn into the fiscal policy space.
Kganyago has stressed the importance of the bank maintaining independence, and the separation of fiscal and monetary authorities has been outlined in the Constitution. Legislation also limits the amount of government debt the Reserve Bank can purchase from the primary market. As a member of the Southern African Development Community, the bank is limited from providing more than 10% of funding to government, Kganyago previously said.