SOVEREIGN DEBT RISK—IMF’s NEW GLOBAL CHALLENGE
By Shan Saeed, Presented on 11th February 2010
The challenge for IMF today is even more severe than it was 40 years ago. Sovereign risk has become every day’s nightmare for IMF with countries confronting mountains of debt including internal and external debt, swollen fiscal deficits, currency depreciation, abysmally low GDP growth and above all poor risk management by financial institutions.
As we navigate through turbulent times, governments in advanced economies and emerging markets are getting wary of countries with huge debt, mismanagement economies and poor ideology of the bad governments in the global economy.
Let’s start by analyzing different countries which were rated according to their sovereign risk and what those countries have achieved in terms of limelight in international papers. So who has got the media attention both press and electronic. CMA-UK based group published a report on 14th Dec 2009 about possibility of countries going bust or down with huge debt.
List of countries with High Sovereign Risk
1. Venezuela 60% Devaluation done and banks nationalized
2. Ukraine 55%
3. Argentina 49% CB Governor resigned. Govt utilizing funds
4. Pakistan 36%
5. Latvia 30%
6. Dubai 29% Already defaulted. Sovereign is not safe.
7. Iceland 23%
8. Lithuania 19%
9. California 18% In a bad shape.
10. Lebanon 17%
CMA, UK Report published 14th Dec-2009
How can you tell which countries are really in trouble? You might look to the country’s ratio of government debt to gross domestic product. Government’s public debt, poor fiscal management, depreciating currency, higher inflation rate, lower GDP growth and weak purchasing power are all indicators of country’s heading towards default. In Latvia, government debt is touching 49% of gross domestic product next year. Vietnam and Venezuela devalued their currencies in December 2009 and January 2010.
2010 would have many governments in trouble in terms of corporate going towards bankruptcy and debt default. . Advanced economies like United States, UK and Japan, which are increasing government spending to shore up slack economies, mounting budget deficits are raising concern about governments’ ability to shoulder their debts, especially once interest rates start to rise again. The important indicators of country heading to default include Increase Public Debt, Increase budget deficit, higher inflation, depreciating currencies, lower productivity and GDP growth rate, low credit growth and money supply in the economy, lower Foreign Direct Investment, banking system under stress , higher discount rate and above all jittery investors who are bearish about the country.
Let’s analyze the advance economies DEBT as % of GDP. In Germany, long the bastion of fiscal rectitude in Europe, government debt is on the rise. All these countries including France, Iceland, Ireland, Bulgaria and Hungary as well as western economies and Baltic republics are massively under debt. They[govt] carrying foreign debt that exceeds 100% of their G.D.P External debt is often held in foreign currency, which means governments. The acceptable level is 25-35% of GDP.
Germany 77% of GDP
UK 80% of GDP
Ireland 83% of GDP
Estonia 100% of GDP
Latvia 100% of GDP
Lithuania 100% of GDP
Many factors are working negatively for Euro single currency as Greece problem mounts further. The ECB welcomed Greece's plan to tackle its debt crisis but warned all euro zone countries to get their finances in order, with a danger of similar problems appearing next in Spain, Portugal and Italy. ECB and IMF have showed willingness to help the Greek economy. Against a backdrop of heightened risk aversion and equity market weakness, investors once again sought out the relative 'safe-haven' of the dollar and the yen. However, according to investors who are fretting that social reason may prevent necessary budgetary adjustments. If this was to occur, governments might be unable to fund their deficits and continue to stimulate their economies, especially if the double-dip risk materializes. The situation looks very ideal with current problems in PIGS. Recovery figures are bad and horrible employment data.
I think right now every vulnerable country has one or two symptoms of going in default. There might be many countries in a wave of defaults about two year from now, when the countries now serving as implicit guarantors turn their focus to economic problems at home, thus sending ripples in the financial markets and jittery investors. Sovereign risk will not be safe any more. One feature of the financial crisis is that some governments have taken on increasingly short-term debt. In USA, it’s the Treasury debt that is under microscope examination from many angles. Maturing debt within one year has risen from 33% of total debt two years ago to 44 %.
In the next few years, many industrialized countries’ own debts – in places like Germany, Japan and the United States – get worse, they will become more reluctant to open up their wallets to spendthrift emerging markets, or at least countries they view strategically. Protectionism will emerge from these developed economies.
But while government debt may be a problem, corporate debt may set off a crisis that, in some ways, is already unfolding. Corporate borrowing surged over the last five years. $200 billion of corporate debt is coming due this year or next year. It is estimated that companies in Russia and the United Arab Emirates account for about half of that borrowing. Companies in several countries face immediate tests. Companies in China are estimated to borrow $8.8 billion in 2010; companies in Mexico $11 billion and in Brazil its $17 billion
What’s more, the packages have not really dealt with the problem of excessive debt, but merely transferred it from the private to the public sector. The pain is spread out over a longer period. But pain will be there, in the form of higher taxes, higher bond yields, slower growth or a combination of all three. The economic managers and decision makers face a dilemma. Reduce the stimulus now and they risk plunging the economy back into recession, as happened in America in 1937 and Japan in 1997. But leave the stimulus in place for too long, and they risk damaging long-term growth prospects.
The bulls hope that the economy can escape from this trap by the simple expedient of private-sector growth. That is why they welcomed the rise in manufacturing activity signalled in last week purchasing managers’ indices report. If the private sector rebounds
of its own accord, unemployment will fall and budget deficits will decline.
But hopes for a strong private-sector recovery are undermined by the data on credit growth. In the year to December, the broad measure of money supply fell by 0.2% in the euro zone and grew by just 3.4% in America. In Britain the annual growth rate is higher [6.4% in December-2009]. However, the quantitative easing (QE)**, whereby central banks create money to buy assets, has been boosting the figure by an annualized rate of 10%. If the Bank of England stops QE entirely, the credit-growth rate could collapse. For the stock market rally to resume properly in 2010, economies in the developed world need to show they can stand on their own two feet. S&P500 Index may retreat 20% from a 15-month high because stock are expensive given prospects of economic and profit growth.
Wall Street Journal,
The market has become overbought globally. I don’t see any significant improvement in the world economy. In the new few months would be quite challenging and threatening for the global market place and for decision makers. Global markets might have stabilized but they are not really expanding. With unemployment relatively staying at a high levels and revenue side pretty weak, I don’t think corporate profits would be higher in 2010. Profits would be coming from massive cost cutting and higher unemployment as we move forward in Q-2 or Q-3, 2010.
Countries will be questioned for their monetary manipulations that threaten trade for many countries, giving rise to imbalances. If this will continue, we might witness financial system not tolerating monetary dumping and protectionist policies amid global crisis. Countries that have history of structural fiscal problem, high debt and monetized fiscal deficit would again create havoc for the fragile global recovery.
So how IMF can intervene to provide confidence and sustain level of trust to global investors with its policies? One key lesson to be learned from this global crisis is that good risk management is necessary in banking system. This was said by Emilion Botin, CEO Satander, The Spanish Banker. I cant emphasis enough at this point which ic very relevant to the current financial mess. Make banking good and boring. Vatican advocated to adopt Islamic banking system to end exploitation and speculation in the current system. Robust and solid control systems need to be in place to counter any crisis going forward.
Capital base of big and small banks need to beef up to provide confidence and to investors and markets that banks balance sheet is strong enough to confront any crisis. 140 banks went down in 2009 up from 7 and 25 in 2007 and 2008 respectively. 15 banks have gone bankrupt in 1 month in USA. I foresee 250 banks will go bankrupt in 2010 as most small banks would be wiped out and they would be fewer banks operating in the financial industry. This is the New Game plan in place for the financial markets. Consolidation is necessary for banks to weather the storm and to improve its capital adequacy and asset ratios. Paul Volcker recently said, the root cause of the problem is too big to fail …..
The question is how IMF can control these crises and how to send confidence to global investors and markets as we move strategically to navigate through financial turmoil of the modern era. Thank you