Wednesday, 25 April 2018

GROWING THE ECONOMY AND STABILIZING THE DEBT








When it comes to planning a budget for the country the act is not very dissimilar to planning the budget for a family. The size certainly is very different but the intent and the purpose however are very similar. Just like a family, a country too has its wish list, a set of realistic goals for the year, it too has to identify all possible sources of income, list the expenditures according to its priorities and importance, and allocate funds for each of them, and save something for a rainy day.

The 7 Steps to a Budget are
·         Step 1: Set Realistic Goals. Goals for our money will help us make smart spending choices…
·         Step 2: Identify our Income and Expenses. ...
·         Step 3: Separate Needs and Wants. ...
·         Step 4: Design our Budget. ...
·         Step 5: Put our Plan into Action. ...
·         Step 6: Seasonal Expenses. ...
·         Step 7: Look Ahead.

While families manage to strike a balance between their income and expenditure on most occasions, governments are often not so smart. They end up spending more than they earn, thus adding to their Credit Card debt. A "government deficit" refers to the difference between government receipts and spending in a single year. And how does the government meet this deficit? Naturally by borrowing and this is “government debt”. So the government debt is the debt owed by a government.

This government debt can be categorized as internal debt (owed to lenders within the country) and external debt (owed to foreign lenders). Another common division of government debt is by duration until repayment is due. Short term debt is generally considered to be for one year or less, long term debt is for more than ten years. Medium term debt falls between these two boundaries. A broader definition of government debt may consider all government liabilities, including future pension payments and payments for goods and services which the government has contracted but not yet paid.

Governments create debt by issuing securities, government bonds and bills. Less creditworthy countries sometimes borrow directly from a supranational organization (e.g. the World Bank) or international financial institutions like IMF and Asian Development Bank. So government debt is effectively an account of all the money that has been spent but not yet taxed back. The ability of a government to repay this debt is dependent on how much it earns annually and this is its ‘Gross Domestic Product’ or GDP.

GDP is an aggregate measure of production equal to the sum of the gross values added of all resident and institutional units engaged in production (plus any taxes, and minus any subsidies, on products not included in the value of their outputs). GDP thus measures the monetary value of final goods and services—that are bought by the final user—produced in a country in a given period of time. 

The debt-to-GDP ratio is the ratio of a country's public debt to its gross domestic product (GDP). By comparing what a country owes to what it produces, the debt-to-GDP ratio indicates the country's ability to pay back its debt. Often expressed as a percentage, the ratio can be interpreted as the number of years needed to pay back debt if GDP is dedicated entirely to debt repayment. Generally, Government debt as a percent of GDP is used by investors to measure a country ability to make future payments on its debt, thus affecting the country borrowing costs and government bond yields. So countries with modest debt-to-GDP ratio can borrow money to meet their deficit at a lower rate and those which have alarmingly high debt-to GDP ratio end up borrowing at a much higher rate thus compounding their already fragile fiscal situation. If a country is unable to pay its debt, it defaults, which causes panic both in its domestic and international markets, as it has both internal and external debts. The higher the debt-to-GDP ratio, the less likely the country will pay back its debt and the higher its risk of default!

Governments have the unenviable task of achieving two goals at once:
1.      Faster economic growth that will create more jobs and bring the unemployment rate steadily down.
2.      A sustainable long-run budget plan that will halt the rise in the debt/GDP ratio or better still, put it on a downward trajectory.

The two goals reinforce each other and neither can be achieved without the other. Weak economic growth—or worse, sliding back into recession—will reduce revenues and make it much harder to reduce or even stabilize the ratio of debt to GDP. But the prospect of debt growing faster than the economy for the foreseeable future reduces consumer and investor confidence, raises a serious threat of high future interest rates.

Stabilizing and reducing future debt does not require immediate austerity; on the contrary, excessive budgetary austerity in a still-slow recovery undermines both goals. But it does require a firm plan enacted soon to halt the rising debt/GDP ratio and reduce it over coming decades.

What is ideal debt-to-GDP ratio?
Economists have not identified a specific debt-to-GDP ratio as being ideal, and instead focus on the sustainability of certain debt levels. If a country can continue to pay interest on its debt without refinancing or harming economic growth, it is generally considered to be stable. A high debt-to-GDP ratio may make it more difficult for a country to pay external debts, and may lead creditors to seek higher interest rates when lending. Then again while governments may strive to have low debt-to-GDP ratios, government borrowing may increase in times of war or recession and government earnings may be depleted by poor harvest and mindless subsidies.

Some World Figures
Global debt reached a record high in 2016 at $164 trillion, or almost 225 per cent of global GDP. China alone has contributed to 43 per cent increase to global debt since 2007. Public debt is currently at historic highs in advanced and emerging market economies. Average debt-to-GDP ratios, at more than 105 per cent of GDP in advanced economies, are at levels not seen since World War II. The average debt-to-GDP ratio among Organisation for Economic Co-operation and Development (OECD) countries in 2015 was 111.2%. A number of countries had a debt-to-GDP ratio in 2015 that was over 100% including Belgium at 105.4%, France at 116.1%, Greece at 188.2%, Ireland at 132%, Italy at 147.4%, Japan at 232.5%, Portugal at 142.2%, Spain at 111.5% and the United Kingdom at 103.1%.

The United States had a debt-to-GDP ratio of 104.17% in 2015 according to the U.S. Bureau of Public Debt. The United States experienced its highest debt-to-GDP ratio in 1946 at 121.70%, and its lowest in 1974 at 31.70%. Debt levels gradually fell from their post-World War II peak before plateauing between 31 and 40% in the 1970s. They have been rising steadily since 1980, jumping sharply following the subprime housing crisis of 2007 and subsequent financial meltdown.

The U.S. government finances its debt by issuing U.S. Treasury bonds, which are considered the safest bonds on the market. The countries with the 10 largest holdings of U.S. Treasury bonds are Taiwan at $182.3 billion, Hong Kong at $200.3 billion, Luxembourg at $221.3 billion, the United Kingdom at $227.6 billion, Switzerland at $230 billion, Brazil at $246.4 billion, Ireland at $264.30 billion, the Cayman Islands at $265 billion, Japan at $1.147 trillion and Mainland China at $1.244 trillion.

Where is India?
India's general government debt remained relatively high, at 70 per cent of its GDP in 2017, but authorities are planning to bring it down over the medium term with the right policies. For economies that are growing rapidly, a higher debt to GDP ratio is acceptable. This is because its future earnings will be able to pay off the debt much more easily than a country with a slow growth rate. India on date is the world's fastest growing major economy. Another factor that determines the health of an economy and its debt to GDP ratio is its demographics. The older the average age of the country’s population, greater the cause of concern. For example, an ageing population like China's is a cause of concern as there will be more pensioners than earners. India on the other hand has the world's youngest population. India's external debt witnessed a decline of 2.7 per cent over its level at end-March 2016. The decline in the magnitude of external debt was partly due to valuation loss resulting from the depreciation of the US dollar with respect to the Indian rupee, but the role played by correct policy decisions cannot be under-played.

Avoiding Disaster, Growing the Economy and Stabilizing the Debt should be our mantra for future. Indeed, higher investment in science, education, and modern infrastructure is needed to foster future productivity and job creation. While savings in defence can be made over time, they should result from serious planning, not mindless cut, regardless of priorities as integrity of the Nation is non-negotiable.