The Covid-19 debt deluge

[Celerity]

The Covid-19 crisis may have set the stage for a debt meltdown long in the making, starting in the Asian economies on the front lines.

https://www.socialeurope.eu/the-covid-19-debt-deluge

Pandemics like Covid-19, alarming and destructive as they are, can serve a useful purpose if they remind everyone of the critical importance of public health. When a contagious disease strikes, even a society’s most protected elites must worry about the health of neglected populations. Those who have advocated privatisation and cost-cutting measures that deny health care to the most vulnerable now know that they did so at their own peril. A society’s overall health depends on the health of its poorest people.

More immediately, though, the Covid-19 crisis could have many severe economic effects, possibly pushing the global economy into recession. Supply chains are being disrupted, factories are being closed, entire regions are being locked down and a growing number of workers are struggling to secure their livelihoods. These developments will all lead to mounting economic losses. A world economy already suffering from insufficient demand—owing to rising wealth and income inequality—is now vulnerable to a massive supply-side shock. Another potential consequence of the pandemic is less recognised but potentially more important: increased financial fragility, implying the potential for a debt crisis and even a broader financial collapse. After Covid-19 is contained and policies are implemented to ease the situation, supply chains will be restored and people will return to work with the hopes of recovering at least some of their lost incomes. But that real economic recovery could be derailed by unresolved financial and debt crises.

Financial fragility

Today’s financial fragility far predates the Covid-19 ‘black swan’. Given the massive accumulation of debt in both developed and developing countries since the 2008 financial crisis, it has long been clear that even a minor event—some ‘known unknown’—could have far-reaching destabilising effects. Yet, until recently, rising asset prices—owing to a long period of extraordinarily loose monetary policies in advanced economies—disguised mounting debt levels. As the recent scare in global equity markets indicates, asset bubbles cannot last forever. By contrast, in the absence of active public pressure or state intervention to facilitate their resolution, debts do not deflate on their own.

A recent analysis by the United Nations Conference on Trade and Development shows how sustained debts could pose a larger problem for the global economy and financial system. In 2018, total debt (private, public, domestic and external) across developing countries was equal to almost twice their combined gross domestic product—the highest it has ever been. Particularly concerning is the build-up of private debt by non-financial corporations, which now amounts to nearly three-quarters of total debt in developing countries (a much higher ratio than in advanced economies). According to UNCTAD, inherently volatile ‘foreign shadow financial institutions’ have played a major role in fuelling this accumulation, such that around one-third of private non-financial corporate debt in developing countries (with the exception of China) is denominated in foreign currency and held by external creditors.

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