The combined supply and demand shock could not have come at a worse time
Hung Tran
A firefighter in protective clothing sprays disinfectant on a pedestrian bridge in Tehran, Iran © Bloomberg
The spread of the coronavirus is likely to tilt 2020 global economic growth below the OECD’s base-case estimate of 2.4 per cent (already below the 2.5 per cent threshold marking a global recession) towards its worst-case estimate of 1.5 per cent.
This disease-induced shock to supply and demand could not have come at a worse time for a world economy awash in debt: $72.7tn (92.5 per cent of global gross domestic product) for sovereign borrowers and $69.3tn (88.3 per cent of GDP) for non-financial corporate borrowers, according to the Institute of International Finance. Many highly indebted sovereign and corporate borrowers will be in distress.
The obvious casualties are countries already in debt crises before Covid-19 hit. Besides Venezuela and Argentina, Lebanon has just defaulted on its maturing $1.2bn eurobond and is looking to restructure all of its $31.3bn eurobonds. With about $90bn of public debt, equal to 155 per cent of GDP, the crisis-stricken country has been going through its own version of the sovereign/bank doom loop — domestic banks hold most of its public debt.
Also hard hit are the sub-Saharan African countries, almost half of which have been in debt distress according to the IMF and the World Bank.
Zimbabwe is in an economic and humanitarian crisis, with a painful economic contraction last year. Half of its population reportedly experience food insecurity, while the newly introduced Zimbabwe dollar has lost most of its value due to triple-digit inflation. Arrears to external creditors add up to more than 30 per cent of GDP.
Zambia is also struggling, with record external debt of $11.2bn at the end of 2019. The country continues to run a fiscal deficit of minus 9 per cent of GDP on a commitment basis, making it difficult to engage with the IMF to restore debt sustainability.
Having posted a record debt-to-GDP ratio of 118 per cent in 2017, the Republic of Congo secured an IMF package of $449m last July after it was able to extend maturity (with no principal haircuts) on its $2.5bn debt to China — showing a way for China’s loans to sub-Saharan African countries to be tackled.
Mozambique’s restructuring agreement with 60 per cent of its eurobond holders remains mired in litigation. Angola’s public debt has reached 102 per cent of GDP. South Africa was in recession during the second half of 2019 — serious fiscal deterioration will soon raise government debt to 70 per cent of GDP.
At present, only Somalia, Sudan and Eritrea remain in the pre-decision point phase of the Highly Indebted Poor Countries (HIPC) debt relief programme; perhaps more should be added.
The elephant in the room in terms of sovereign debt risk, however, is Italy. The parts of the country in lockdown account for 40 per cent of its GDP; the economic disruption will probably push Italy into its fourth recession since the global financial crisis, lifting the 2020 fiscal deficit above the budgeted 2.2 per cent of GDP and government debt beyond $2.5tn, or 135 per cent of GDP.
Low interest rates can help for now but zero growth combined with high and rising debt is not sustainable. While the probability of an Italian sovereign debt crisis is still low, it is not negligible and is rising, representing a high-impact risk to the global economy and an existential threat to the eurozone.
With expected corporate profit growth this year being slashed to zero or negative for many mature and emerging market economies, corporate borrowers with low interest coverage ratios (ICR) will increasingly come under pressure.
A recent study by the US Federal Reserve Board estimates that for US corporations, the average ICR is a rather low 3.7 and the percentage of debt at risk (with ICR<2) is a non-negligible 31.7 per cent.
South Korea merits particular attention: aside from being hard hit by Covid-19, it has a high corporate debt-to-GDP ratio at 101.6 per cent — and high household debt ratio of 95 per cent.
China posts the world’s highest ratio of corporate debt to GDP at 156.7 per cent. Most of the debt is domestic. However, it has plenty of state-owned assets, including forex reserves of $3.1tn and a relatively low level of government debt, at 54 per cent of GDP. China can use its sovereign balance sheet to absorb corporate debt losses if necessary.
Beijing will probably continue to direct state-owned banks to evergreen loans to state-owned enterprises, and state-owned asset management companies to conduct debt-for-equity swaps, allowing a controllable number of bankruptcies for demonstrative purposes. In other words, while China’s corporate debt problem is serious, its potential losses and impact will be stretched far out into the future — debt resolution with Chinese characteristics!
In short, expect to see more cases of sovereign and corporate debt distress in the months ahead. While many distressed borrowers are individually small and non-systemic, if a sufficient number of them default at the same time, it would cause a shock to global financial stability.
That is, until Italy falls into debt distress!
Hung Tran is a non-resident senior fellow at the Atlantic Council, and former executive managing director at the Institute of International Finance.
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