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ECONOMY| 12.01.2020

Threats for 2021: global debt warning

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Newly developed vaccines spark high hopes for the end of the coronavirus crisis in many countries in the medium-term. Although this does not mean that 2021 comes without risk — on the contrary, recovery from this unprecedented crisis will unfold against a backdrop of global vulnerabilities and imbalances.

As explained by MAPFRE Economics in their report Global Economic Outlook for 2021, “Although the emergence of vaccines reduces the likelihood of some of these risks materializing early, avoiding the costs of a) the tax bill, b) the accumulated financial imbalances, c) the problems of industry stagnation, d) aging, e) climate change and f) social impairment resulting from structural unemployment and the widening poverty gap, etc. will be a bold aim to say the least.”

Likewise, MAPFRE Economics identifies up to four triggers that could lead to risks materializing prematurely:

(1)         A further prolongation of the current economic stagnation; this would cause the current liquidity problem to evolve into a solvency problem (for example in the mortgage or corporate consumer sector).

2)           The return of high and persistent inflation beyond 2021; this could unravel long-term inflation expectations, but for reasons other than demand.

3)           If the central banks’ asset-purchase mechanism loses its effect on sovereign spreads in countries with poor fiscal positions, there could be increasingly high (and, in many cases, unsustainable) financing costs leading to a correction of aggregate demand.

4)           Incorrect monetary policy transmission or interpretation and expectations of the relevant monetary authorities resulting in a sudden economic collapse (credit, asset prices, exchange rate, financial flows, etc.)

In particular, MAPFRE has identified the following global risks:

Increased global debt

The COVID-19 recession has propelled the global debt-to-GDP ratio to a new all-time high of 356 percent in the third quarter of 2020, compared to 322 percent in the fourth quarter of 2019. The greatest risk for emerging economies remains the continued rise in dollar debt levels, owing to a weaker dollar and generally very favorable financial conditions.

For developed economies, the higher debt concentration under exceptionally flexible monetary policies continues to be public-sector oriented. As falling incomes undermine the perception of debt servicing and sustainability, the need to rebalance policies toward fiscal sustainability could ultimately occur early and abruptly.

Economic policy

Monetary easing remains the main focus of the global response to the pandemic shock. Meanwhile, the fiscal response involves additional efforts, as a consequence of expansionary policy, that could continue to grow in the coming months and extend beyond 2021.

In the fiscal framework, budgetary discipline continues to be defined by a temporary relaxation, the prolongation of which could, in time, result in structural imbalances that compromise stability in the medium- and long-term, and lead to sustainability adjustments.

Climate change

Amid the widespread recession caused by the pandemic and social distancing measures, the trend toward sustainability and greater environmental awareness is accelerating. The European Union’s proposal, with recovery-fund investments focused on energy transition and technological development, complements the aspirations proposed at the recent WEF Sustainable Development Impact Summit with ambitions focused on building the pillars of recovery and productivity gains in what they call the Fourth Industrial Revolution.

Geopolitics

The events that unfolded at the Washington Capitol on January 6 serve as a reminder that adverse geopolitical events are continuing at extremely intense levels, as global uncertainty is consolidated, and exacerbated by institutional deterioration.

In Latin America, inflamed social tensions are on the rise in a climate of social protest that sustains the climate of instability in growing decline. In the Middle East, regional instability is evident and accelerating. The frequency and reverberation of conflicts is increasing and spreading to a growing number of countries experiencing conflict dynamics in which spheres of interest gravitate around strategic competition.

The European continent’s relationship with the United Kingdom will continue to shape the near future while arrangements based on equality for both sides are sought. Furthermore, the change in German leadership is approaching amid a fragile populist landscape across Europe that is putting the stability of the union at risk.

Global

At least the question of the US presidential election seems to have been definitively answered with the victory of the Democratic Party led by Joe Biden. However, inherited conflicts—such as the trade tension with China—linger.

In terms of governance in emerging regions, confrontation and instability persist, with increasingly frequent protests and a climate of growing political turmoil both in Latin American countries and in Asia-Pacific regions whose institutions continue to show signs of fragility.

China

The country finds itself with a more positive scenario than that of the global average due to pre-shock levels of growth gradually being recovered, in addition to a progressive recovery in domestic consumption, the strength of exports as a competitive advantage and the accompanying expansionary economic policy.

But the country’s debt overhang remains latent as a vulnerability in which credit discipline showed signs of stress following the recent corporate debt defaults in the state-owned sector.

Vaccines

Science’s answer to our problems also poses a risk in itself. At a time when forecasts are heavily leveraged upward, unforeseen difficulties could negatively impact the more imminent economic outlook amid the uncertainty that defined 2020.