Last year, the world went down. It could be an ugly hangover

by

Boosted by lower rates, governments have issued $ 16.3 trillion in debt in 2020 and are expected to borrow another $ 12.6 trillion this year, according to S&P Global Ratings. But fears point to an explosive economic recovery starting this summer could generate inflation, potentially forcing central banks to raise rates sooner than expected.

If this happens, the cost of servicing the mountains of sovereign debt will increase, consuming government funds that might otherwise be spent on essential services or rebuilding weakened economies. U.S. lawmakers on Wednesday approved a $ 1.9 trillion stimulus package on Wednesday that could raise prices and put pressure on the Federal Reserve.

Many economists believe that the threat of inflation can overlap. But political leaders, worried that they will have to make difficult compromises in the coming years, are watching the situation closely.

Waiting for inflation

Concerns about rising interest rates have been concentrated as investors discharge government bonds. The 10-year US Treasury yield has recently risen by more than 1.6% to its highest level in more than a year. Meanwhile, the 10-year British bond yield rose more than 0.8% at the end of last month, a sharp rise from less than 0.2% at the beginning of the year.

The moves were triggered in part by growing confidence in the next phase of the pandemic. Because vaccination campaigns allow governments to lift some restrictions, consumers are expected to rush to restaurants and board planes. This could increase prices, which central banks have pledged to keep under control.

Political factors have minimized the threat. Federal Reserve Chairman Jerome Powell, who spoke last week, said he expects inflation to rise as the economy reopens, but stressed that the Fed will try to differentiate between “single price increases and ongoing inflation.” that he is in no hurry to change course. European Central Bank President Christine Lagarde is expected to send a similar message later on Thursday, speaking to reporters.

However, S&P Global Ratings said inflation was a potential concern in a sovereign debt report this month, noting that “it could push central banks to raise interest rates, partially reversing the benefits of low debt service costs”.

“A large increase in interest rates would be very costly,” said Ugo Panizza, a professor of international economics at the Graduate Institute in Geneva. “Central banks will face very, very complicated trade-offs if inflation rises.”

Britain is sounding the alarm

The Congressional Budget Office projects that government debt publicly held in the United States will rise to nearly $ 22.5 trillion by the end of fiscal year 2021. This equates to 102% of annual gross domestic product. In Italy, the ratio stood at 154% at the end of September, while Greece was close to 200%.

High debt levels leave government finances more exposed to rising interest rates. Take the UK, where public sector debt has also risen to a level almost equal to the size of the economy.

The UK says the biggest companies have to pay more taxes

The Office of Budgetary Responsibility estimates that if short- and long-term interest rates increase by just 1 percentage point, debt interest spending would increase by £ 20.8 billion ($ 29 billion) in fiscal year 2025-26.

While this may not necessarily be unsustainable, it is certainly not desirable, according to Isabel Stockton, an economist at the Institute for Tax Studies in the UK.

“Everyone would prefer to give £ 21 billion [National Health Service] or [to] improve the welfare system or infrastructure, “she said.

Interest costs are even more sensitive to inflation and rising interest rates due to the response to the pandemic.

The British government borrowed £ 270.6 billion ($ 377 billion) between April 2020 and January 2021, and higher interest rates mean increased payments for that debt.

About a quarter of the British government’s debt is related to inflation, according to the Institute for Fiscal Studies, which means payments will rise automatically if prices rise. In addition, the Bank of England has purchased huge amounts of government debt as part of its quantitative easing program. The central bank pays interest on the reserves it creates to make those purchases.

If interest payments rise while economic growth lags behind, politicians are left with difficult choices: raising taxes to cover the budget deficit or reducing spending.

Sunak made the country’s debt burden a central issue when it unveiled its spending proposals last week, which included plans for a higher tax increase. British companies in 2023.

“It simply came to our notice then [economic] support too soon, it would also be irresponsible to allow future loans and debts to be left uncontrolled, ”he said.

A global problem

Similar dynamics could be played around the world.

The Organization for Economic Co-operation and Development said in a report last month that while interest rates are currently low, high levels of existing debt, combined with continuing lending needs, have raised refinancing risks. About a quarter of market-based debt in member countries – or $ 14.1 trillion – will mature within a year, according to the agency.

“It’s a real concern,” said Randall Kroszner, who served as governor of the Federal Reserve from 2006 to 2009. If U.S. debt payments suddenly go “from being quite low to being quite significant,” this could influence the recovery and slowdown in the economy activity, he added.

Countries that do not control their own currencies could be in particularly tight positions, Panizza said. Italy, which uses the euro, is an example.

Panizza said Italy needs to refinance or extend the maturity of about seven of its debt each year. If interest rates rose by 2%, this would add about half a point of GDP, or about $ 9.9 billion, to annual debt service costs. This is a “substantial” amount, he stressed.

Emerging market economies, such as Turkey or Brazil, could also be vulnerable. Higher interest rates tend to strengthen the dollar, a move that has already begun. This can increase maintenance costs. Meanwhile, government revenues in such countries may be affected by the continuing weakness in the tourism sector.

An increase in inflation can never materialize; for decades, global inflation has remained stubborn. And a booming economy would also increase how much money governments bring in taxes, helping to alleviate deficit anxieties.

But there is no denying that central banks could face a difficult set of choices as the global economy emerges from an unprecedented shock and a wide range of results remains on the table.

“It’s not something we have a lot of experience with,” Kroszner said.

.Source