WHEN IT COMES TO NATION STATES SPENDING BEYOND THEIR MEANS, GREECE IS ONCE AGAIN DOMINATING HEADLINES. BUT THE BIRTHPLACE OF WESTERN DEMOCRACY HAS PLENTY OF COMPANY — AND WE’RE NOT JUST TALKING ABOUT OTHER MEMBERS OF THE CLUB KNOWN AS EUROPE’S PIIGS (PORT
Countries are racking up bigger and bigger debts even while trumpeting the Age of Austerity.
Remember all the talk about deleveraging that came after the credit bubble burst and subjected the world economy to the worst financial crisis since the Great Depression? The talk was cheap because nobody bought into it. Indeed, all major economies today have higher debt levels relative to GDP than before the so-called Age of Austerity started.
What kinds of dollars are we talking about? According to the McKinsey Global Institute, total world liabilities have increased by a whopping US$57 trillion since 2007 . Governments are the worst offenders, increasing their collective debt by US$25 trillion at a 9.7% compound annual growth rate over the past seven years.
Corporations have done a better job of managing the impulse to borrow, increasing liabilities by only US$18 trillion since 2007 . But here is the really bad news. The best of the bunch still appear destined to be hammered by credit rating downgrades thanks to out-of-control public spending, say an international group of debt market analysts.
“Our research has uncovered a disturbing issue,” says Colombian risk management expert Felipe Restrepo, who recently signed on to teach finance at Western University’s Ivey Business School. He points out that when a downgrade on sovereign debt is issued, the system deployed by credit rating firms will trigger related privatesector downgrades that are not based upon company fundamentals. This results from the so-called sovereign ceiling rule, which was designed to limit the credit ratings of companies to levels no higher than those warranted by their nation state.
Although this rule is not strictly applied, it has created a significant link between the ratings of sovereign debt and the debt of public corporations, but only for firms with the same or better rating as a government. In other words, following a sovereign downgrade, a country’s healthier firms tend to be arbitrarily penalized with a lower credit rating, which increases their cost of capital. And this does not happen as often or as quickly to higher-risk firms.
As a result, sovereign debt downgrades actually encourage capital to flow away from a nation’s best businesses at a time when the economy most needs the private sector to help stimulate stable growth.