Tai Hui

How bailout debt is painting governments and central banks into a corner

Central banks, under pressure to buy assets and keep rates down to support government debt, have promised to keep it temporary to avoid the risks of inflation and capital flight. But unwinding the policy will prove very difficult

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The US Federal Reserve Board building. The global status of the US dollar gives the Fed more leeway in funding the US government but, for others, painful austerity measures could be hard to avoid. Photo: Reuters

Tai Hui

Published: 9:00pm, 10 Jul 2020Updated: 10:31pm, 10 Jul 2020

Regardless of who wins the US presidential election, the next leader will start his term with record government debt. The pandemic has dealt a significant blow to government finances around the world. For some countries, such as the US and Japan, their central banks can help buy time before a debt reckoning. For others, painful austerity measures could be hard to avoid.

With business revenues wiped out by lockdowns, public sector grants and loans are a lifeline for companies. Job protection payments also support low-income families by putting food on the table. Without such measures, many companies could be forced out of business, and families could see their living standards decline dramatically, even if they are spared illness from Covid-19.

As important as they are, these policies are very costly for governments. The International Monetary Fund estimates that US$11 trillion in fiscal spending has been announced. Half is additional spending or taxes and fees that will not be collected, and the remaining half takes the form of liquidity support, such as loans to businesses, equity injections and guarantees.

The IMF has estimated that the US government debt-to-gross-domestic-product ratio could jump from 109 per cent last year to 141 per cent this year. The rest of the developed world may face similarly sizeable fiscal shortfalls.

Borrowers deep in the red are less likely to repay what they owe. Lenders charge higher interest rates for higher-risk loans. The good news is that many highly indebted governments have central banks on their side to keep interest rates low, at least for now, making their debt loads more affordable.

In the years following the global financial crisis, from 2009 to 2014, the Federal Reserve bought about US$2 trillion worth of US government bonds. More recently, it bought US$1.7 trillion worth of these debts in just four months, from late February. The European Central Bank, Bank of Japan and Bank of England have all stepped up their bond buying to keep government bond yields low.

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