Dr Keen Mhlanga
Global debt has increased substantially over the last two decades, and it is a major source of concern for the global economy since it poses serious challenges to macroeconomic, financial, and fiscal stability, which can magnify uncertainty among economic actors.
High debt may stifle economic growth, particularly in debt-burdened nations, and it may also magnify the volatility of GDP growth rates.
Concerns about debt sustainability are raised by high amounts of national debt. When interest rates rise, the state finances are put under strain.
There may be further reasons to be worried about public indebtedness.
While debt-financed government expenditure might increase economic activity in the short run, consistently high and rising debt ratios may have a long-term negative impact on economic growth.
The debt-growth connection is complicated, differing per country and influenced by global variables.
While there is no single universal threshold at which debt-to-GDP becomes a substantial economic constraint, evidence from the previous four decades suggest that large and growing public debt burdens hinder growth in the long run.
The link between public debt expansion and economic development has received a lot of attention in recent years, owing to the high increase in government borrowing in industrialised countries following the global financial crisis and the ensuing eurozone sovereign debt crisis.
Economists generally agree that an increase in public debt due to fiscal expansion stimulates aggregate demand, which should help the economy grow in the short run; the longer term economic impact of public debt accumulation.
As the stock of government debt continues to rise, growing government borrowing competes for money in the capital markets.
Because public debt substitutes physical capital in investment portfolios, it can crowd out private investment by lowering capital available for productive private investment or raising borrowing costs for private investment.
When public debt reaches high levels, investors want more compensation for the increased risk, which raises sovereign debt rates.
As the economy’s benchmark interest rates, these are subsequently communicated to the rest of the economy, boosting borrowing costs for the private sector.
In today’s context, a clearer understanding of the potential negative repercussions of public debt is especially important. The proportion of general government debt to GDP has risen since 2009. It will hit an all-time high in 2022 and is anticipated to climb throughout time.
Current public conversations mostly address the issue of debt sustainability as interest rates rise, disregarding other critical challenges.
While the EU’s unified fiscal rules limit borrowing, debt sustainability will continue to be a priority.
In the near future, the national debt will be assessed.
The primary issues will be how much debt governments should have for what purposes, as well as whether heavily indebted countries should tolerate a slower rate of debt reduction. This would require accepting greater debt ratios for a prolonged period of time.
According to the risk-management perspective on public debt, by decreasing debt today, the government prepares for unforeseen occurrences that would need considerable future public borrowing.
The government can limit the distortionary effect of debt service taxation by decreasing the debt load.
Reducing debt during an economic expansion, when private demand is high and monetary policy is accommodating, leads in fiscal policy that is optimum both in the short and long run, avoiding the potentially damaging effect of fiscal consolidation on economic growth.
Policies and structural changes that promote economic growth allow the debt ratio to fall as the economy expands, lowering the need for fiscal consolidation.
The Domar condition is one of the most widely used conditions for analysing fiscal stability.
It compares the interest rate to the economic growth rate under balanced budget (excluding interest payments), and if the former is more than the latter, public finances will become unstable, and the outstanding government debt would increase.
The numerical simulations exemplify the critical importance of the ECB’s extraordinary monetary policies, the Next Generation European Union (NGEU), and, to a lesser extent, national expansionary fiscal policies implemented during a pandemic shock; both European-wide monetary and fiscal policies actually increase the sustainability area, avoiding the high risk of a sovereign debt crisis in Italy (and other peripheral Eurozone countries).
Tax-based adjustments, according to descriptive analysis, are not contractionary, despite the fact that they may fail to lower the debt-to-GDP ratio when compared to spending-based consolidation. As a result, the twin goals of sustainable public finance and economic growth cannot be met at the same time, indicating a trade-off.
If the aim is to get the economy going in the direction of economic growth, tax-based adjustments will assist, but spending-based consolidation will help achieve the long-term fiscal sustainability goal.
For the United Kingdom, econometric estimations of the Debt-to-GDP ratio’s influence on interest rates reveal that the predicted change in indebtedness has a bigger and statistically significant effect on government long-term bond yields.
If all consumer savings are not spent, demand is insufficient, and a greater budget deficit is required to maintain full employment in a developing economy.
Even if not all savings are utilised for consumption and the interest rate exceeds the growth rate, fiscal instability or un-sustainability do not develop.
The Covid-19 problem in 2020 has further weakened the Italian economy and harmed the national budget.
Despite a resurgence in 2021, Italy’s economy and government debt remain unstable. The Italian government debt is unlikely to reach a sustainable level in the next years. While the Next Generation EU and other fiscal and monetary measures are assisting the Italian economy’s recovery, a greater effort on the part of European authorities including an intervention by the ECB in yield curve control seems necessary in the coming years to stabilise Italy’s debt to GDP ratio.
The GDP Indicator used to analyse the trajectory of the debt-to-GDP ratio in 45 Sub-Saharan African countries during the Covid-19 Pandemic and to establish whether there is a threshold at which public debt becomes harmful to the region’s economy.
Revealed that as long as Sub-Saharan African economies continue to thrive, a high debt-to-GDP ratio is not always a bad thing; in fact, the majority of states with debt-to-GDP ratios larger than the 77 percent threshold had increasing economic growth.
Countries in the region may suffer a high debt-to-GDP ratio as a result of excessive expenditure caused by the Covid-19 outbreak, as well as an unforeseen halt in economic activity as a result of sectorial governments’ movement restriction laws. The average debt-to-GDP ratio in Sub-Saharan Africa in 2020 is 56,6 percent, which is significantly lower than the advised limit of 77 percent.
It is highly recommendable that governments cut wasteful spending without jeopardizing the region’s economic development rate.
Fiscal policies should be accompanied by monetary policies in order to promote efficient public investment, simplified tax expenditures, improved public financial management, and improved debt management and transparency.
It indicates that private and public debt are adversely related to economic growth, but favourably related to growth volatility. In particular, family debt causes the highest changes in GDP growth for both Advanced Economies and Emerging Market Economies, whereas non-financial corporate debt provides the largest changes in growth volatility.
An increase in public debt dampens economic development in Emerging Market Economies while increasing volatility in Advanced Economies.
Dr Keen Mhlanga is a global financial expect, key note speaker, investment advisor with high skills in digital banking, corporate and development finance. A dedicated, hardworking financial genius and business magnate. He is the executive chairman of FinKing Financial Advisory. Send your feedback to [email protected], contact him on 0777597526.