Take credit or not? Your choice may affect EU's economy
The EU’s growing sovereign debt crisis has been filling the headlines recently. We are flooded with various spreads, yields and sentiment indicators trying to illustrate exactly how worried the market is about the situation. But the underlying problem is a rather basic one and it is not confined to Greece or even the eurozone, but to the entire rich world. In contrast, the debt in emerging Europe is half the Maastricht criteria’s limit and Russia’s is among the lowest in the world.
The most troubling part is that this debt is not a temporary issue that is possible to repair with a quick fix. Rather, the sovereign debt burden for the developed economies in the world is expected to grow—from the current 98 percent of GDP to 110 percent by 2015 before slowly starting to come down. And the most troubling part is that it will only fall if governments have the political guts to implement all the budget cuts and raise all taxes they have said are necessary.
The IMF has calculated that the advanced economies need to implement a fiscal adjustment of over 9 percent of GDP in the next 10 years. This is an incredibly painful program. Will governments follow through on their commitments? The public protests already seen in the eurozone in the last few weeks give grounds for scepticism.
The problem is not universal though. Emerging economies are substantially less indebted than their peers in the developed world. The fact that the former normally has to pay higher interest for its debt makes the burden larger, but there is still a huge difference and the gap is expected to widen.
The IMF expects the sovereign debt burden of emerging economies to fall from 38 percent of GDP today to 34 percent by 2015. Most of these economies need to streamline their budgets as well, but the extent of the problem is significantly smaller as they did not built up such huge excesses in the first place or started to cut back significantly already last year.
In the light of these basic facts, it is rather curious that the rating institutes continue to put such a high-risk premium on emerging economies. These very same emerging economies also tend to run current account surpluses and have accumulated large foreign exchange reserves. Put more bluntly: The rich world is not as rich as commonly believed, as it owes huge amounts to future generations and to emerging economies. It is well known that China holds a lot of US treasury bills, but the Russians reminded the EU last week that 40 percent of its foreign exchange reserves – the third largest in the world – are in euros.
It is true that emerging markets tend to be more volatile, but that is arguably part of the same old thinking. In times of crisis, investors tend to buy assets that are regarded safe, but the question is if 110 percent debt to GDP should be safer than 34 percent for an investor with a five-year horizon. The question becomes even more pronounced if we on top of this add the expected growth rates in the emerging and developed world. IMF expects the former to grow almost three times faster than the latter in both real and nominal terms over the next five years.
Both the debt and growth scenarios hold across emerging regions even though there are notable differences. Eastern Europe was clearly out of favor last year due to poor growth rates and refinancing problems. The sentiment turned more positive during the begging of this year as growth forecasts were revised up significantly and the market started to realize that Eastern Europe is, after all, not very indebted.
Russia has by far the lowest sovereign debt among the BRICs at only 8 percent of GDP (compared with 20 percent in China, 67 percent in Brazil and 79 percent in India). The most leveraged economies in Eastern Europe were either bailed out by the IMF or took on draconian budget cuts on their own, which has earned them a reputation for not only being fiscally responsible but actually also implementing things. It may therefore be a good idea for Western governments and investors alike to look east for inspiration and good returns.
Marcus Svedberg is the chief economist at Sweden-based East Capital that specializes in investing in New Europe and was the best performing regulated onshore fund in the world of any class in the last decade.
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