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Economy Lab

The price of debt: Higher borrowing costs Add to ...

Ranga Chand is president of Chand Carmichael & Company. He has held senior positions with the Department of Finance and the Conference Board of Canada





Public debt levels have shot up dramatically since the Great Recession and are still rising, especially in the developed economies. Debt ratios have increased in all the G7 countries, and this year the United States is expected to join the ranks of the super-debtors -- Japan and Italy -- as its debt hits 100 per cent of GDP. But, in terms of sheer speed, the United Kingdom grabs the title of plunging into debt at the fastest rate among this group.

The country’s debt-to-GDP ratio is forecast to reach 83 per cent this year, up from 44 per cent in 2007 (see table below). In Canada’s case the debt-ratio is projected to climb from 67 per cent to 84 per cent. In the BRIC nations, debt ratios are expected to range from 9 per cent in Russia to 68 per cent in India and, interestingly, will be lower than that of all the G7 countries.



Credit rating agencies, worried that governments will increasingly find it difficult to meet growing debt obligations in a low-growth environment, have been particularly busy in recent weeks.

Among the G7, Standard & Poor’s downgraded its outlook on America’s debt in April for the first-time from ‘stable’ to ‘negative’ and in June it put Italy’s A+ debt rating on negative watch.



It is worth noting that Dagong Global Credit Rating, China’s main ratings agency, has already downgraded U.S. debt. While the debt of all the G7 countries are rated in the top A category, among the BRIC economies only China makes it into S&P’s top stratum, receiving an AA– rating. Remarkably, although Japan’s debt-to-GDP ratio (229 per cent) is expected to be more than 13 times larger than China’s (17 per cent) this year, both countries have the same credit rating (AA–).



When we look at the PIGS (Portugal, Ireland, Greece and Spain), S&P signalled that a default was likely by downgrading Greece’s credit rating to junk status in June and the country now has the lowest credit rating in the world. Moreover, Greece’s on-going debt crisis is spreading and the cost of borrowing is zooming in the debt-laden PIGS. In Spain, despite having an AA rating and a debt ratio that is well below its peer group, the yield on 10-year Spanish government bonds has climbed well above 5 per cent -- a record high since the launch of the euro.



Ultra-low interest rates have kept the cost of servicing government debt in the major advanced economies artificially low, but this can’t last forever. As government debt starts to get either downgraded or put on watch by rating agencies, borrowing costs are set to increase.



This combined with pension and health care costs that are set to soar as the population ages will profoundly challenge governments and is likely to lead to considerable political uncertainty and social unrest. Moreover, climbing out of debt will be a major drag on growth and with unemployment rates expected to remain stubbornly high, the adjustment will be painful. The upshot is that standards of living will continue to be squeezed in the advanced economies.

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