The mounting debt burden of the world’s most developed nations, set for a post-World War II record this year, is unsustainable and risks a future fiscal crisis, the International Monetary Fund’s John Lipsky said.
The average public debt ratio of advanced countries will exceed 100 percent of their gross domestic product this year for the first time since the war, Lipsky, the IMF’s first deputy managing director, said in a speech at a forum in Beijing today.
“The fiscal fallout of the recent crisis must be addressed before it begins to impede the recovery and create new risks,” said Lipsky. “The central challenge is to avert a potential future fiscal crisis, while at the same time creating jobs and supporting social cohesion.”
Lipsky’s view clashes with Nobel laureate Joseph Stiglitz, who told the same forum yesterday that further fiscal stimulus is needed to aid growth, and that European nations focused on austerity have a “fairly pessimistic” outlook. At stake is sustaining the developed world’s rebound without a deepening in the debt crisis that’s engulfed nations from Greece to Ireland.
Long-term bond yields could climb 100 to 150 basis points, driven by the 25 percentage point rise in sovereign debt ratios since the global financial crisis and projected increases in borrowing in coming years, according to Lipsky. A basis point is 0.01 percentage point. Yields on benchmark 10-year Treasury notes closed at 3.27 percent last week, with comparable-maturity German debt at 3.19 percent and Japanese bonds at 1.21 percent.
Bank of England Governor Mervyn King reiterated his view at a conference four days ago in Beijing that “long-term real interest rates are unsustainably low” in the aftermath of policy makers’ unprecedented monetary stimulus during the 2008 financial crisis.
Total U.S. public debt was more than $14 trillion at the end of 2010, a 72 percent increase during five years, while Japan’s debt is about double the size of its $5 trillion economy. The European turmoil has forced policy makers to create rescue packages for Ireland and Greece.
While interest payments on debt have remained stable at about 2.75 percentage points of GDP over the last three years, “higher deficits and debts together with normalizing economic growth sooner or later will lead to higher interest rates,” Lipsky said. The IMF estimates fiscal deficits for developed nations will average about 7 percent of GDP this year.
The cost of repaying debt would increase by 1.5 percentage points of GDP by 2014 even if interest rates rise only about 100 basis points, Lipsky said.
IMF studies show that each 10-percentage-point increase in the debt ratio slows annual real economic growth by around 0.15 percentage point because of the adverse effect on investment and lower productivity growth, according to Lipsky, a former chief economist at JPMorgan Chase & Co.