Sovereign Debt Crisis
The Roots of the Sovereign Debt Crisis
This time, emerging market economies are not the epicenter of the financial crisis. Having entered the crisis with a relatively strong fiscal position, they emerge from it relatively unscathed. Hence, their aggre-gate public debt ratio, at around 35% of GDP at the end of 2009, remains low compared with that of the advanced economies and seems unlikely to rise sharply. By contrast, the combination of large-scale fiscal stimulus plans, financial rescue packages and falling tax revenues has led to historically large government budget deficits and record levels of actual and projected public debt in most industrial countries. The aggregate public debt of the advanced economies is projected by the BIS to rise from 76% of GDP in 2007 to more than 100% in 2011 – a record high in recent decades. Moreover, the full cost of cleaning up the balance sheets of financial institutions – parti-cularly against the backdrop of their continued high vulnerability to adverse shocks – is not yet known. And beyond 2011, many industrial countries face the large, rising pension and health costs associated with their ageing populations.
Following the quasi-collapse and public rescue of the private financial sphere and given this extraordinary convergence of factors, the sustainability of fiscal policy could only turn out to be a major financial concern. Public debt/GDP ratios are rapidly increasing in every industrial country, this increase being particularly high for coun-tries particularly hard hit by the financial crisis. According to the most recent BIS data, the debt/GDP ratio is expected to rise between 2007 and 2011 by one third for Germany (reaching 84% in 2011), by less than half for France (99%), by more than half in the United States (95%), by four fifths in Spain (only 78%) and to almost double in the United Kingdom (99%) and triple in Ireland (91%). These levels, except for in Germany, Spain and a few others, are extremely close but what is even more striking is the size of the deterioration. The cumulative public deficit between 2007 and 2011 is less than 30% for all Eurozone countries, except Greece, but above 40% for the US, the UK, Ireland; the rescue of the private financial sphere in the winter 2008-09 in those three countries clearly remains a prominent – and durable – factor in the damage caused to public finance.
Sovereign risk concerns first arose following the large financial rescue packages and substantial fiscal stimulus programs announced in late 2008 and early 2009. Those worries then remained relatively subdued for much of 2009, overshadowed by concerns about the slowdown in global economic activity and the associated rise in unemployment. Nonetheless, warnings about fiscal responsibility began to appear in the spring of 2009, the most significant being the Chinese call addressed to American authorities to wisely manage their finance and their currency. At the same time, ratings agencies started publishing more negative ratings for Ireland, Greece, Spain, Portugal and the UK. Bond yields and credit default swap (CDS) spreads on the government debt of several countries also started to rise in 2009; sovereign CDS spreads on Dubai rose sharply after Dubai World unexpectedly announced that it was seeking a mora-torium on its debt payments. Henceforward, the specter of sovereign default reappeared. It first coagulated on Greece because Greece was clearly the worst offender.
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