The fiscal response to Covid will raise average government debt levels to an unprecedented 90% of GDP in 2021 from 75% in 2019. But in our view, most economies will be able to stabilise their debt with very limited fiscal adjustment over the next decade.
Rock-bottom interest rates mean that interest payments – which will be under 2% of world GDP in 2021 – remain significantly lower than 20 years ago, alleviating the need for strong fiscal restraint that could prove unpalatable.
Our global debt sustainability analysis will be comforting to governments and sovereign investors alike. Based on neutral macro assumptions for the 2020s, we find governments can on average stabilise debt to-GDP at 2021 ratios and yet still run sizable primary fiscal deficits of 4.3% of GDP.
A global stagflation scenario – in which nominal yields rise by 200bps – is the main threat to this benign diagnosis. It would require governments to reduce primary deficits by 0.9% of GDP relative to the baseline (Figure 1) to stabilise debt. AEs have much higher debt than EMs, so their adjustment is correspondingly bigger at 1.6% of GDP – painful in the context of weak growth.
The 200bp yield shock is so big that it is only realistic in the context of an historic regime-shift. It represents over 3 standard deviations based on a 10- year window for UST yields. Over a 50-year window, however, its less than one standard deviation. Global fiscal authorities had better hope global central banks maintain this era’s ultra-low and stable yields.
None of this means debt is a free lunch; massive resources spent tackling Covid are no longer available for other things. But major concerns about the public sector are in the tail. It’s the private sector we should worry about more.