Debt warning signs are hard to read
A World Bank study highlights increasing levels of debt in emerging markets
There was a deafening silence in response to the recent World Bank study on the worsening debt dynamics of many emerging economies. The international institution’s annual report on Global Economic Prospects included a special section arguing that debt levels and fiscal deficits have worsened substantially since 1997.
That is not to suggest the worrying conclusions that could be drawn from the report are necessarily correct. On the contrary, there are reasonable grounds to dispute them (see our report on Emerging market debt in this issue). But such claims need to be examined rather than ignored.
The key analytical weakness of the report was its failure to put rising debt levels in their proper economic context. Fiscal deficits and the scale of debt, when considered in isolation, reveal little about whether a country is facing financial or economic difficulties.
An economy enjoying dynamic economic growth can usually weather high debt levels easily. Rising incomes provide the means through which debt can be repaid. Under such circumstances in can make sense to borrow freely to bolster future growth prospects.
The converse is that even moderate debt levels can be a burden for a stagnant economy. Under such conditions it is tempting for governments to borrow more so that they can stimulate demand. Rising debt levels in such circumstances are generally a symptom rather than a cause of economic weakness.
Of course, the biggest analytical challenge occurs when a country’s economic trajectory looks set to change. The economy is likely to grow significantly faster or slower than its trend rate in the past. Identifying such situations demands careful economic investigation.
To be fair to the World Bank the remainder of the Global Economic Prospects report does discuss economic factors. But the focus tends to be too little on fundamental indicators such as productivity and business investment. In contrast, too much emphasis tends to be placed on secondary factors such as commodity prices, inflation and fiscal policy. It is not that the latter set of factors is unimportant but such elements tend to be an outcome of fundamental developments.
Not that World Bank economists are alone in their analytical one-sidedness. Asset managers too often misconstrue the relationship between the bond market and the real economy. Although they monitor inflation and interest rates closely their economic concerns do not generally go much further. They are too quick to assume high debt levels are a cause, rather than a potential symptom, of economic weakness.
Gauging whether a market crisis is imminent is no easy task. But it should always be remembered that finding a reasonable answer means looking beyond the market itself.
Daniel Ben-Ami, Deputy Editor