Risks not being tackled in a leaderless world

When former UK Prime Minister Gordon Brown said about a month back that risks were not being tackled now in a leaderless world and consequently the global economy was “sleepwalking into a future crisis”, many would have thought that he was talking of some distant future, which may or may not come to pass.

In the days that followed, several men who matter in the financial world have come forward to voice their concern, leading to strengthening of the belief that we are face-to-face with an economic crisis looming at us, unless corrective measures are taken soon. But with the world’s only supposed leader opting out of international agreements one after another and regulators still looking complacent, efforts to prepare for another downturn in economy seem undermined.

The warning voices are increasing in numbers and intensity. Only recently, the IMF’s head – Christine Lagarde – said she was concerned that the total value of global debt, in both the public and private sectors, has rocketed by 60% in the decade since the financial crisis of 2008 to reach an all-time high $182 tn. Warning that this should serve as a wake-up call, she said the build-up has made developing world governments and companies more vulnerable to higher US interest rates, which could trigger a flight of funds and destabilize their economies.

The IMF said: “The sequence of aftershocks and policy responses that followed the Lehman bankruptcy has led to a world economy in which the median general government debt-GDP ratio stands at 52%, up from 36% before the crisis; central bank balance sheets, particularly in advanced economies, are several multiples of the size they were before the crisis; and emerging market and developing economies now account for 60% of global GDP in purchasing-power-parity terms – which compares with 44% in the decade before the crisis – reflecting, in part, a weak recovery in advanced economies.”

IMF has given a warning that the global economy today is more deeply indebted than before the 2008 financial crisis and has asked the countries to take immediate action to improve their finances before the next downturn. The prolonged period of low interest rates had stipulated a build-up of debt worth 225% of world GDP in 2016, which was 12 points above the previous record level reached in 2009.

IMF is not the only institution that has warned that rising levels of inequality have a negative impact on investment and productivity as wealthier groups hoard funds rather than re-invest them in productive parts of the economy. Without a rise in investment, economies remain vulnerable to financial stress.

Growth in the global economy is expected to be 3.9% in both 2018 and 2019, but experts feel this might not meet the predictions every time and that countries which reduce budget deficits now will be best placed when tougher times arrive.

However, past experiments of Europe have shown that even the austerity measures have not shown the desired results unless other timely actions are taken simultaneously. A case in point is the austerity measures announced by George Osborne, erstwhile head of exchequer in Britain. A variety of spending cuts including cutting welfare funds were announced and taxes were increased with hope that this would liquidate the budget deficit from 11% to 1%. Yet the economy didn’t grow at expected pace, potential output shrank considerably due to sharp austerity measures, all together leading to Osborne’s calculations going awry, the impact of which is still felt in the form of lost output and earnings.

China, the biggest emerging market economy, is being touted by IMF as responsible for more than 40% of the increase in global debt since 2007. Despite the fact that consequent to Gleneagles Agreement of 2005, the debt of world’s poorest countries was written off, the dept-to-GDP ratios, says IMF, are still on the rise and were now above 40% of GDP. Nearly half of the debt is on non-concessional terms, which has resulted in a doubling of the interest burden as a share of tax revenues in the past 10 years.

Many poor countries who borrowed heavily when commodity prices were high are now facing immense difficulties when the market for their exports crashed. The debt service has also been rising rapidly, particularly in countries with high inflation rates, says Vitor Gaspar – Director of the Fiscal Affairs at IMF – adding that the interest burden has doubled in the past 10 years to 20 percent of taxes.

Both the developed, emerging markets, as well as low-income countries look more  vulnerable now than any time in history. Decisive measures aimed at fiscal multiplication are needed, taking full advantage of the cyclical upswing in economic activity. But with no strong leadership and the supposed world leaders themselves acting in an arbitrary manner, concerned more about short term gains than larger interests, and with inequity levels rising within the countries as well as between countries and the consumption base of the economies becoming weaker, government and companies today should open their ears to hear the wake-up call. Will we listen to the emerging scenario now or wait for another Lehman moment? This time, however, it might be too late to act!