The monetary and fiscal policies pursued since the Great Financial Crisis and greatly expanded during the COVID pandemic have repressed interest rates and flooded the global economy with liquidity. Low interest rates have promoted debt accumulation and stimulated a global yield chase. This environment has supported the widespread complacency of policy makers and investors who assume that these conditions are here to stay.
The fundamental argument of those who argue that the current mix of policies is sustainable is that low nominal interest rates and negative real rates make the burden of debt low by historical standards. The data series published quarterly by the Bank for International Settlements (BIS) allow us to evaluate this claim. What the BIS data shows is that some important qualifications are in order. Though low debt servicing costs may persist in the U.S., it seems stretched for many other countries to believe they will be so fortunate.
The chart below shows the latest non-financial private sector debt service ratios for emerging markets as well as for several key developed markets. Private sector ratios are important as they are very sensitive to credit cycles and the private sector in all these countries is the driver of productivity and growth. The data for China may be less meaningful because of the dominant role of the state in the economy and the difficulty in distinguishing between public and private companies.
What we see is that these ratios vary tremendously across the world and within regions. The United States is in the middle of the pack, a comfortable position for the issuer of the global reserve currency and also the deepest market for “safe” assets. The countries on the left of the chart appear in good shape. On the other hand, on the right side of the chart there are obvious vulnerabilities. France is probably the weakest link among developed countries (twice the level of Germany though below Canada). In emerging markets, Brazil, Turkey and Korea are around the critical 20% level.
These debt service coverage ratios must be seen in the context of the recent wave of Central Bank tightening cycles that have been initiated to confront rising inflation and capital flight. The chart below from Charlie Billelo details the recent wave of tightening measures. Both Brazil and South Korea are now in tightening mode but still have negative real central bank rates.
We should also be aware of the historical context. We can see the historical trends for each individual country in the three regional charts below. First, in Asia it is noteworthy that Korea may soon be back to the record-high debt service ratios experienced after the Asian financial crisis.
In EMEA (Europe, Middle East and Africa), the very high and persistently rising ratios of France and Turkey are noteworthy.
Finally, in the Americas the contrast is striking. Both the United States and Mexico have relatively low ratios which are very consistent over time. The U.S. is in a privileged situation as the recipient of global capital flight, and the Federal Reserve may be in a position to maintain negative real interest rates for the foreseeable future. Mexico’s private sector is underleveraged and poised to take advantage of growth opportunities. The situation is very different in Brazil. Brazil has a history of high and volatile debt ratios. Corporate debt is at record-high levels at a time when the Central Bank may have to tighten sharply, the economy is slowing to a crawl and capital flight is high.
The BIS data is a warning to not make global generalizations about debt sustainability. Arguments for Modern Monetary Theory, unrestrained fiscal expansion and financial repression may be justified for the U.S., but inapplicable for most countries.