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The Sovereign Debt Debacle – Phase 2 of the GFC ?
- By Martin Fowler
- Published 18/03/2010
- Investment Insights
- Unrated
Sovereign Debt - Australia
So far we have focussed on private sector debt. Much has been reported about the huge amount of borrowing undertaken by the government to spend our way out of the GFC. While public debt in Australia has increased, it is unlikely to exceed 10% of GDP at its peak which means that the actual cost of servicing the debt is unlikely to exceed 1% of GDP. This is not only relatively low in a historical context but also very low in a global context.
So far we have focussed on private sector debt. Much has been reported about the huge amount of borrowing undertaken by the government to spend our way out of the GFC. While public debt in Australia has increased, it is unlikely to exceed 10% of GDP at its peak which means that the actual cost of servicing the debt is unlikely to exceed 1% of GDP. This is not only relatively low in a historical context but also very low in a global context.
This
means that the Australian Government is on a strong position to be able
to fund further initiatives should they be required in the event of
another crisis.
Sovereign Debt – Global
Contrast this with the position in the United States and Europe where public debt levels are significant.
Sovereign Debt – Global
Contrast this with the position in the United States and Europe where public debt levels are significant.
Public
debt in the United States and Europe has exploded since the onset of
the GFC due to massive stimulus packages and plummeting tax receipts.
By bailing out the banking system and selected corporates, governments
have simply shuffled the debt from the private sector to the public
sector, creating new and arguably more hazardous policy challenges.
As of early 2010, US public debt to GDP has been estimated at 63% of GDP. If we assume an average interest cost on this debt (over the longer run) of roughly 4% per annum, then the annual cost of servicing this debt equates to 2.5% of GDP. On the face of it this does not sound too high. However, tax receipts only equate to around 15% of GDP which means that 17% of all tax receipts are effectively applied towards debt servicing. Compare this against the actual 2009 budget data where interest repayments on government debt equated to only 9% of all tax receipts due to the very low interest rate environment.
Sovereign debt problems are not a new phenomena. There have been some 87 defaults over the past 200 years. However, the number of countries experiencing financial difficulties (including Portugal, Italy, Ireland, Iceland, Greece, Spain and much of Eastern Europe; not to mention the United States and Japan) would suggest that a tipping point has been reached. The situation becomes much worse if we take into account unfunded liabilities (assets required to fund existing retirement, health care and education liabilities into the future) as shown below:
As of early 2010, US public debt to GDP has been estimated at 63% of GDP. If we assume an average interest cost on this debt (over the longer run) of roughly 4% per annum, then the annual cost of servicing this debt equates to 2.5% of GDP. On the face of it this does not sound too high. However, tax receipts only equate to around 15% of GDP which means that 17% of all tax receipts are effectively applied towards debt servicing. Compare this against the actual 2009 budget data where interest repayments on government debt equated to only 9% of all tax receipts due to the very low interest rate environment.
Sovereign debt problems are not a new phenomena. There have been some 87 defaults over the past 200 years. However, the number of countries experiencing financial difficulties (including Portugal, Italy, Ireland, Iceland, Greece, Spain and much of Eastern Europe; not to mention the United States and Japan) would suggest that a tipping point has been reached. The situation becomes much worse if we take into account unfunded liabilities (assets required to fund existing retirement, health care and education liabilities into the future) as shown below:
The
only sustainable way forward is for the public sector in much of the
developed world to start to deleverage. Deleveraging will require a
combination of the following:
What is going to be the likely impact on financial markets?
It is clear that the much of the economic growth since the 1960’s has been fuelled by the global debt boom. It also clear that the necessary deleveraging that needs to take place to provide sustainable future growth is, outside the corporate sector, not very advanced. Individuals and government alike have much work to do.
The risks for governments over this period are large and the prospect for enhanced social instability over these times is likely to be elevated. Further, the necessary reductions in government and consumer spending are likely to lead to below trend growth prospects over the coming decade. On balance, enhanced uncertainty as countries work their way through their financial problems is likely to generate greater volatility and the prospect of sub par growth is likely to result in more subdued returns. Under such circumstances the need for prudent stock selection (stocks with comparative advantages, high earnings certainty, strong cashflows and reasonable dividends) and asset allocation has perhaps never been so important.
Conclusions
To conclude:
Charlie Viola, Director
Phone +61 2 8236 7798
Martin Fowler, Director
+61 2 8236 7776
Haris Argeetes, Manager
+61 2 8236 7851
Disclaimer
The information provided is not personal advice. It does not take into account the investment objectives, financial situations or needs of any particular investor and should not be relied upon as advice. While the information is provided in good faith and believed to be accurate and reliable at the date of preparation, we will not be held liable for any losses arising from reliance thereon. We recommend investors consult their personal financial adviser to discuss suitability and application to their individual circumstances.
- reducing expenditure
- increasing taxes
- initiating reforms (such as user pays systems that transfer costs from the public sector to the private sector)
What is going to be the likely impact on financial markets?
It is clear that the much of the economic growth since the 1960’s has been fuelled by the global debt boom. It also clear that the necessary deleveraging that needs to take place to provide sustainable future growth is, outside the corporate sector, not very advanced. Individuals and government alike have much work to do.
The risks for governments over this period are large and the prospect for enhanced social instability over these times is likely to be elevated. Further, the necessary reductions in government and consumer spending are likely to lead to below trend growth prospects over the coming decade. On balance, enhanced uncertainty as countries work their way through their financial problems is likely to generate greater volatility and the prospect of sub par growth is likely to result in more subdued returns. Under such circumstances the need for prudent stock selection (stocks with comparative advantages, high earnings certainty, strong cashflows and reasonable dividends) and asset allocation has perhaps never been so important.
Conclusions
To conclude:
- Australian household debt levels are at unprecedented levels (not dissimilar to US household debt levels). While the US consumer has started to repair its balance sheet, the Australian consumer has not.
- Having survived the GFC, the Australian and United States corporate sector (excluding the finance sector) balance sheets are in reasonable shape.
- Public debt in Australia is low by global standards.
- Public debt in the United States and much of Europe remains high. The policy challenges for these countries in coming years are immense.
- Necessary reductions in government and consumer spending are likely to lead to below trend growth prospects over the coming decade. In turn, we would expect increased sharemarket volatility and more subdued shareholder returns.
Charlie Viola, Director
Phone +61 2 8236 7798
Martin Fowler, Director
+61 2 8236 7776
Haris Argeetes, Manager
+61 2 8236 7851
Disclaimer
The information provided is not personal advice. It does not take into account the investment objectives, financial situations or needs of any particular investor and should not be relied upon as advice. While the information is provided in good faith and believed to be accurate and reliable at the date of preparation, we will not be held liable for any losses arising from reliance thereon. We recommend investors consult their personal financial adviser to discuss suitability and application to their individual circumstances.
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