Sustained high debt levels and prolonged low-interest rates will constrain the ability of policymakers in developed markets (DMs) to stimulate their economies in the event of a new shock, Fitch Solutions reveals.
The high spending triggered in response to the Covid-19 pandemic in 2020 has significantly strained the finances of developed markets. Policy buffers available are eroded and that will limit the ability of policy makers to normalize their economies in the event of another shock.
After inflating to about 80% of GDP in 2013, the developed market public debt ratio fell steadily through to 2019. However, this changed abruptly in 2020, as governments of developed markets dwelt extensively on fiscal policy to support their economies throughout the Covid-19 crisis.
Fitch Solutions expect that the aggregate debt ratio of developed markets will rise to 88.1% of GDP in 2021. Afterward, it will start declining from 2022 and beyond as fiscal balances improve. Expectations are that the aggregate debt ratio will fall to about 81% of GDP by the end of a 10-year forecast.
More so, macroeconomic theory posits that a high government debt level reduces GDP growth. Thus, in this case, countries that experienced the highest increase in public debt over the past 20 years have also recorded the lowest growth rates over the same period, Fitch Solutions noted.
On the back of this, economies with low policy rates, but at the same time have high public debts simply limit policymakers to implement counter measures in the event of another shock, Fitch Solutions indicated.
Policy flexibility in developed markets
That notwithstanding, economists at Fitch Solutions believe that some countries are well-placed than others to tackle such future occurrences or challenges. By identifying countries that have slightly more or less room to use policy measures at their disposal, Fitch Solutions divided a set of nine developed economies in three groups.
These categories are based on the degree of fiscal and monetary policy flexibility; Australia and Canada have higher policy flexibility; the US, UK and Germany have medium policy flexibility; Italy, France, Spain and Japan have lower policy flexibility.
According to Fitch Solutions’ assessment, countries that fall into ‘higher policy flexibility’ category have relatively lower public sector debt stock and relatively have more room to either cut interest rates or expand their balance sheet than their peers in the other categories.
Fitch Solutions’ Analysis
InAustralia and Canada, public finances are among the robust in the developed world, with government debt at around 35.6% of GDP and 51.3% respectively, as of the end of 2020.
Fitch Solutions believe that this will allow their governments to start consolidating fiscal accounts more easily than their highly indebted peers such as Italy, France and Spain. Although, debt profiles of these two economies are forecast to rise in the next five years, these will not be so much elevated as compared to their peers.
Moreover, the Central Banks of these two countries have more room to implement unconventional monetary policies such as quantitative easing (QE) in the event of a future shock. QE was largely employed by many developed economies in 2020, to reduce the pandemic- induced effect on their economies.
Yet, unlike their peers, in the event of a future shock, their Central Banks would have limited space to replicate quantitative easing mechanism as a suitable monetary policy.
If only a few developed economies, per Fitch Solutions assessment are in good standing, then it indicates that the global economy cannot afford to risk another global pandemic within this short while. That will be a devastating blow to developed markets, and developing markets the more.
