Debt levels highest since World War II

WASHINGTON — Public debt has soared in advanced economies to the highest levels since World War II as governments struggle against slow growth and deflation, the International Monetary Fund (IMF) warned Wednesday.

Levels of government borrowing have picked up since the financial crisis and continue to rise as economic powers like Japan and Europe remain mired in very slow growth, and many emerging and poorer economies struggle with the plunge in income from commodities like oil and metals.

The higher borrowing makes it harder for governments to spend any more to support growth, as the fund has urged.

On average for advanced economies, the IMF said in its new Fiscal Monitor report, "public debt now exceeds the level observed during the Great Depression and is approaching the level immediately after World War II”.

For advanced economies, debt has risen to over 107 per cent of gross domestic product (GDP), with Japan at almost 250 per cent.

Emerging market economies are better off at just under 50 per cent of GDP, but their needs are rising and many face greater challenges, including sharply higher fiscal deficits, than the advanced economies.

The strain between higher debt and the need to keep spending is contributing to the slow pace of growth. 

The IMF lowered its global growth forecast for 2016 on Tuesday to 3.2 per cent and warned of the risk that growth could stall worldwide if action was not taken.

"Advanced economies are facing the triple threat of low growth, low inflation, and high public debt. This combination of factors could create self-reinforcing downward spirals," it said.

Slow growth means that the financing needs of many countries are rising just as the availability of funds is tightening. The US central bank in particular has begun to raise interest rates, hiking the costs of borrowing for most countries.

As a result, more countries are approaching the World Bank and IMF for support. 

The World Bank says loan requests have surged to levels only seen during financial crises. The IMF has also seen a rise in requests for support programmes, the most recent from Angola, whose financial position has been devastated by the crash in oil prices.

 The IMF urges countries with some fiscal space to spend more while others need to focus spending on anything that will accelerate growth: infrastructure, education, business creation and research and development.

"A lasting solution to the debt overhang problem is not possible without higher medium-term growth," the IMF indicated.

In its latest Global Financial Stability Report, the IMF warned that although world financial markets have calmed after turmoil earlier this year, more needs to be done to ensure global financial stability amid slowing growth, weak commodity prices and worries about China's economy.

The IMF said the financial system risks have risen since the last report in October and market turmoil could easily recur and intensify if no action is taken to clean up bank balance sheets, particularly in China and Europe.

"If the growth and inflation outlooks degrade further, the risk of a loss of confidence would rise. In such circumstances, recurrent bouts of financial volatility could interact with balance sheet vulnerabilities," the IMF added in the report.

"Risk premiums could rise and financial conditions could tighten, creating a pernicious feedback loop of weak growth, low inflation and rising debt burdens," it continued.

Worries about China's growth slowdown and transition to a more consumer-driven economy helped spark the most recent financial turmoil, and the IMF said China's struggling state enterprise sector is straining bank balance sheets. 

The report estimates that bank loans to companies potentially at risk in China could translate into potential bank losses of approximately seven per cent of the country's GDP.

"This may seem like a large number, but it is manageable given China's bank and policy buffers and continued strong growth in the economy," said Jose Vinals, head of the IMF's Monetary and Capital Markets Department.

The report complements the IMF's gloomy World Economic Outlook publication released on Tuesday, in which the crisis lending institution cut its growth forecasts for the fourth time in the past year.

The report comes as finance ministers and central bankers from around the world convene in Washington this week for the spring meetings of the IMF, the World Bank and Group of 20 finance ministers and central bank governors. The formal meetings begin on Friday and continue through Sunday.

Negative interest rates crucial to growth

The IMF stability report said negative interest rate policies, along with bond purchases, were "crucial" to boosting economic growth, marking a sharp contrast with German Finance Minister Wolfgang Schaeuble's criticism of the European Central Bank's negative rates as causing problems for German banks and depositors alike.

Although they have reduced bank profit margins, the report said banks would ultimately benefit from stronger growth and the ability to cut non-deposit funding costs.

However, should the IMF's worst-case market disruption scenario occur, its modeling suggests that potential global output growth could be reduced by 3.7 percentage points over five years, effectively the loss of nearly a year's worth of growth at current levels.

Conversely, the fund argues in the report that actions to reduce liquidity risks, clean up non-performing loan problems left over from the last financial crisis in advanced economies  and reduce vulnerabilities in emerging market banks could add 1.7 percentage points to annual baseline growth by 2018, roughly half of this year's estimated growth.

The report also made a case for bank consolidation, particularly in Europe. It argued that banks whose business models are no longer viable following the financial crisis hold some 15 per cent of bank assets in advanced economies.