Surge in debt levels could weigh on global economy

An “unprecedented” surge in debt levels could weigh on the prospects for the global economy in 2021, according to the Institute of International Finance.

Global debt levels increased by more than $17 trillion to $275tn in 2020, driven largely by a sharp increase in sovereign debt issuance borrowing that has pushed the global government debt-to-GDP ratio to nearly 105 per cent in 2020, the IIF said.

“The aggressive, synchronised fiscal and monetary policy responses to date have been successful in curtailing financial stress and have played a big role in reviving appetite for risk assets, including emerging markets securities,” said the IIF report.

“However, this much-needed policy support has often come at the cost of a sharp rise in financial and budgetary imbalances.”

Monetary stimulus measures have included the setting of interest rates below zero in many countries, with a record $18tn worth of negative-yielding bonds issued by the end of last year, up from $11tn in 2019. Along with the abundant liquidity provided by central banks to limit the impact of the global financial crisis, this has driven investors to hunt for the higher yield offered in emerging markets, the IIF said.

Despite credit concerns and uncertain earnings prospects, fund flows into high-yield US corporate bonds in 2020 also turned positive for the first time since 2016.

Emerging market sovereigns and corporate debt issuers are likely to continue borrowing in US dollars as central banks show no signs of unwinding balance sheets and investors do not expect the US Federal Reserve to raise interest rates until 2025.

Anticipated weakness in the dollar as the US continues fiscal stimulus measures is also encouraging emerging market borrowers to increase dollar- denominated debt. Currently, about 10 per cent of emerging market debt is denominated in the US currency.

Following a temporary market shutdown in March 2020, eurobond issuance in many emerging and frontier markets has picked up pace significantly. A number of sovereign issuers are also planning to tap international bond markets, including those eligible to benefit from the G20’s Debt Service Suspension Initiative.

However, foreign currency debt may exacerbate debt-related vulnerabilities for emerging market borrowers, as “greater reliance on foreign capital could leave emerging market borrowers more exposed to sudden shifts in global risk sentiment”, the IIF warned.

“Keeping debt on a sustainable trajectory may become a challenge for many,” the IIF said.