Chart: Debt-to-GDP Continues to Rise Around the World
With vaccines slowly obtaining approval in various countries, the world may finally be on the path to overcoming the COVID-19 pandemic.
The economic situation, on the other hand, is unlikely to improve anytime soon. Falling revenues combined with costly pandemic relief measures have increased global debt by $20 trillion since the third quarter of 2019. By the end of 2020, economists expect global debt to reach $277 trillion, or 365% of world GDP.
Today’s chart uses data from the Institute of International Finance (IIF) to provide an overview of where debt, relative to GDP, has increased the most.
Comparing Developed and Emerging Markets
Developed economies represent four of the five countries seeing the largest increases in debt-to-GDP, but looking from a more macro angle reveals that debt levels are rising at a similar pace around the world.
|Q3 2019 ($ trillions)||Q3 2020 ($ trillions)||% Increase|
Source: IIF, BIS, IMF, Haver, National Sources
To put these figures into perspective, economists often use the debt-to-GDP metric, which compares a country’s debt to its economic output. As the name implies, it’s calculated by taking a country’s total debts and dividing them by its annual GDP. Having a low debt-to-GDP ratio suggests that a country will have little issues paying off its debts, while a high ratio can be interpreted as a sign of higher default risk.
The actual definition of a “low” or “high” ratio is quite loose, though the World Bank believes there is a threshold for government debt at 77% of GDP. Every percentage point beyond this threshold has been found to detract 0.017 percentage points from annual growth.
Comparing Debt-to-GDP by Sector
To see how COVID-19 has affected the global economy since Q3 2019, let’s take a look at each sector’s debt as a percentage of GDP.
|Households (Q3 '19)||Households (Q3 '20)||Non-financials* (Q3 '19)||Non-financials* (Q3 '20)||Government (Q3 '19)||Government (Q3 '20)|
|Developed markets average||72%||78%||91%||102%||110%||131%|
|Emerging markets average||40%||44%||93%||104%||53%||60%|
*Corporations that are not in the financial industry.
Source: IIF, BIS, Haver, National Sources
Within developed markets, government debt-to-GDP grew by 21 percentage points compared to 11 for non-financial corporates, and 6 for households. This is unsurprising as governments have supplied billions (or in some cases, trillions) of economic stimulus while also pulling in less tax revenue.
The story in emerging markets is slightly different, with non-financial corporates experiencing the largest increase at 11 percentage points. The sector’s debt is now at 104% of GDP, making it the most highly-leveraged in the region.
Highlights from Today’s Chart
Today’s chart boils this data down to the individual country level, allowing us to identify two outliers: Canada and Australia.
Excluding the financial sector, Canada’s debt-to-GDP ratio increased by nearly 80%, the highest of any developed country. Government borrowing surged as the Canada Emergency Response Benefit (CERB), which provided struggling Canadians with roughly $1,500 a month, rang up a bill of $60 billion over 7 months.
An increase in debt wasn’t the only reason for the country’s worsening debt-to-GDP ratios. In Q2 2020, Canada’s GDP declined at an annualized rate of 38%, its worst three-month performance on record.
Australia was another outlier, but for a different reason; the country’s household debt decreased by almost 5% relative to GDP. This was likely due to an early-access scheme that allowed millions of Australians to make withdrawals from their superannuation, a social security fund similar to America’s 401(k).
We know that almost 60 per cent of those accessing their [superannuation] early have used it…to meet essential day-to-day expenses, including paying down debts.
—Josh Frydenberg, Treasurer of the Commonwealth of Australia
Officials have exercised caution around the prolonged use of these programs, as superannuation funds are meant to support people through retirement. Of the 2.6 million Australians that accessed their superannuations early, 500,000 are believed to have completely emptied their accounts.
Debt-to-GDP is Set to Fall…Or is it?
A global roll out of COVID-19 vaccines is likely to end the ongoing health crisis and allow the economy to return to pre-pandemic levels, though delays are to be expected.
Regardless, this spells good news for governments and financial institutions around the world—economic output will recover, shrinking debt-to-GDP ratios. Whether or not borrowing will also slow down, however, is much harder to predict.
Government borrowing has been relied on to stimulate growth since 2008, and with 75% of Americans in favor of a second COVID-19 relief bill, public debt is likely to accumulate further. Private sector debt is following a similar trend, with non-financial U.S. corporations owing $10.9 trillion as of Q2 2020, up from $6.4 trillion at the start of 2008.
These growing debts have been manageable thanks to an extended period of low interest rates and loose monetary policy, but whether or not this is sustainable remains to be seen.
Visualizing $65 Trillion in Hidden Dollar Debt
Since 2008, the value of unrecorded dollar debt has doubled. Here’s why this is increasing risk in global financial markets.
Visualizing $65 Trillion in Hidden Dollar Debt
The scale of hidden dollar debt around the world is huge.
No less than $65 trillion in unrecorded dollar debt circulates across the global financial system in non-U.S. banks and shadow banks. To put in perspective, global GDP sits at $104 trillion.
This dollar debt is in the form of foreign-exchange swaps, which have exploded over the last decade due to years of monetary easing and ultra-low interest rates, as investors searched for higher yields. Today, unrecorded debt from these foreign-exchange swaps is worth more than double the dollar debt officially recorded on balance sheets across these institutions.
Based on analysis from the Bank of International Settlements (BIS), the above infographic charts the rise in hidden dollar debt across non-U.S. financial institutions and examines the wider implications of its growth.
Dollar Debt: A Beginners Guide
To start, we will briefly look at the role of foreign-exchange (forex) swaps in the global economy. The forex market is the largest in the world by a long stretch, with trillions traded daily.
Some of the key players that use foreign-exchange swaps are:
- Financial institutions
- Central banks
To understand forex swaps is to look at the role of currency risk. As we have seen in 2022, the U.S. dollar has been on a tear. When this happens, it hurts company earnings that generate revenue across borders. That’s because they earn revenue in foreign currencies (which have likely declined in value against the dollar) but end up converting earnings to U.S. dollars.
In order to reduce currency risk, market participants will buy forex swaps. Here, two parties agree to exchange one currency for another. In short, this helps protect the company from unfavorable foreign exchange rates.
What’s more, due to accounting rules, forex swaps are often unrecorded on balance sheets, and as a result are quite opaque.
A Mountain of Debt
Since 2008, the value of this opaque, unrecorded dollar debt has nearly doubled.
|Non-U.S. Shadow Bank
*As of June 30, 2022
Driving its rise in part was an era of rock-bottom interest rates globally. As investors sought out higher returns, they took on greater leverage—and forex swaps are one example of this.
Now, as interest rates have been rising, forex swaps have increased amid higher market volatility as investors look to hedge currency risk. This appears in both non-U.S. banks and non-U.S. shadow banks, which are unregulated financial intermediaries.
Overall, the value of unrecorded debt is staggering. An estimated $39 trillion is held by non-U.S. banks along with $26 trillion in overseas shadow banks around the world.
Past Case Studies
Why does the massive growth in dollar debt present risks?
During the market crashes of 2008 and 2020, forex swaps faced a funding squeeze. To borrow U.S. dollars, market participants had to pay high rates. A lot of this hinged on the impact of extreme volatility on these swaps, putting pressure on funding rates.
Here are two examples of how volatility can heighten risk in the forex market:
- Exchange-rate volatility: Sharp swings in USD can spur a liquidity crunch
- U.S. interest-rate volatility: Sudden rate fluctuations can mean much higher costs for these trades
In both cases, the U.S. central bank had to step in to provide liquidity in the market and prevent dollar shortages. This was done through pumping cash into the system and creating swap lines with other non-U.S. banks such as the Bank of Canada or the Bank of Japan. These were designed to protect from declining currency values and a liquidity crunch.
Dollar Debt: The Wider Implications
The risk from growing dollar debt and these swap lines arises when a non-U.S. bank or shadow bank may not be able to hold up their end of the agreement. In fact, on a daily basis, there is an estimated $2.2 trillion in forex swaps exposed to settlement risk.
Given its vast scale, this dollar debt could have greater systemic spillover effects. If participants fail to pay it could undermine financial market stability. Because demand for U.S. dollars increases during market uncertainty, a worsening economic climate could potentially expose the forex market to more vulnerabilities.
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