The story so far: Global debt rose to an all-time high of $307 trillion in the second quarter, by the end of June 2023, the Institute of International Finance (IIF) said in a report released last week. Quite notably, global debt has risen by about $100 trillion over the last decade. Further, global debt as a share of gross domestic product (GDP) has started to increase once again to hit 336% after dropping quite steeply for seven consecutive quarters.
What is global debt?
Global debt refers to the borrowings of governments as well as private businesses and individuals. Governments borrow to meet various expenditures that they are unable to meet through tax and other revenues. Governments may also borrow to pay interest on the money that they have already borrowed to fund past expenditures. The private sector borrows predominantly to make investments.
Why is it rising?
Both global debt in nominal terms and global debt as a share of GDP have been rising steadily over the decades. The rise came to a halt during the pandemic as economic activity turned sluggish and lending slowed down. But global debt levels, it seems, have started to rise again in the last few quarters. Most (over 80%) of the rise in global debt in the first half of the year has come from advanced economies such as the U.S., the U.K., Japan, and France. Among emerging market economies, China, India and Brazil have seen the most growth in debt. During the first half of 2023, total global debt rose by $10 trillion. This has happened amid rising interest rates, which was expected to adversely affect demand for loans. But a rise in debt levels over time is to be expected since the total money supply usually steadily rises each year in countries across the globe. In other words, the rise in global debt levels witnessed during the first half of the year is nothing out of the ordinary and does not per se have to mean trouble for the global economy. In fact, even a simple rise in the total amount of savings in an economy can cause a rise in debt levels as these increased savings are channelled into investments.
What is more interesting than rising debt levels is the drop in global debt as a share of GDP over seven consecutive quarters prior to 2023. The IIF attributes the decline in global debt as a share of GDP to the rise in price inflation, which it claims has helped governments to inflate away the debts denominated in their local currencies. Inflating away of debt refers to the phenomenon wherein the central bank of a country either directly or indirectly uses freshly created currency to effectively pay off outstanding government debt by, for example, purchasing government bonds in the market. But the creation of fresh money causes prices to rise, thus imposing an indirect tax on the wider economy to pay the government’s debt.
Is it a cause for worry?
Rising global debt levels usually leads to concerns about the sustainability of such debt. This is particularly so in the case of government debt which is prone to rise rapidly due to reckless borrowing by politicians to fund populist programmes. And when central banks raise interest rates, servicing outstanding debt becomes a challenge for governments with a heavy debt burden.
It should be noted that despite rising debt levels over the last decade, the interest that governments had to pay lenders largely remained manageable due to extremely low interest rates, particularly in western economies. This is set to change now as central banks have let interest rates rise in order to fight high price inflation since the pandemic. Rising interest rates can increase pressure on governments and force them to either default outright or inflate away their debt. Many analysts, in fact, believe that several governments will never be able to pay their debt in full and that inflating away debt is the only way for such governments to avoid an outright default on their debt. In its report, the IIF has also warned that the international financial infrastructure is not equipped to handle unsustainable domestic debt levels. Generally, rapidly rising private debt levels also lead to worries among analysts about their sustainability. This is because such a rise is linked to unsustainable booms that end in economic crises when such lending is not backed by genuine savings.
The most recent example of the same was the 2008 global financial crisis. The crisis was immediately preceded by an economic boom fuelled by the U.S. Federal Reserve’s easy credit policy.