In finance, the concepts of debt and risk are inextricably intertwined. The more debt– the more chance of bankruptcy and default. It is almost a certainty that the current situation will finish badly, the big question: when?
Central Europe is not alone in its high debt levels. In 2020, global average national debt surpassed 100% of GDP (with some countries like Japan and Greece having spectacularly high national debts—at 230% and 168% respectively—although Japan has an incredibly strong economic engine).
Total global debt in 2020 increased from 300% to 360% of global GDP, an eye popping increase. The numerator of this ratio increased due to massive pandemic spending; GDP, the denominator, decreased in many countries, also due to the pandemic.
If we see the storm clouds approaching, we should batten down the hatches. In this article, we look at how vulnerable Central Europe might be to a potential economic downturn. We do this by providing the highlights of an analysis by Rabobank on Poland, Czech Republic and Hungary: Exhibit 1: Vulnerability of Central European Economies
|Current Acct Deficit (as a % of GDP)||3,8||0,4||4,1|
|Inflation (% yoy)||2,8||3||2,9|
|Economic growth (%)||4||-3,6||-2|
|Budget balance (as % of GDP)||-5||-7,5||-4,9|
|Political risk (scale 0-100)||67,9||71,5||56|
|Security risk (scale 0-100)||93,6||87,3||88,6|
|FX reserves (import cover months)||10,3||3,3||5,6|
|Debt vulnerability indicators||2,4||-4,4||1,3|
|Total external debt (as a % of GDP)||77,5||148,6||53,8|
|Government debt (as a % of GDP)||43,4||85,7||60,6|
|Household debt (as a % of GDP)||34,4||21,1||34,9|
|NFC debt (as a % of GDP)||56,2||70,4||44,6|
|NFC debt in foreign currency (as a % of GDP)||26,6||31,5||14,5|
|Government debt in foreign currency (% GDP)||3,3||17,7||15,9|
|Financial markets index||-1,1||-1,5||0,4|
|Hot money indicator||0,1||-0,2||-1,4|
When the scores are aggregated, they provide the following scores:
As American financier Howard Marks said: “Financial [stability] doesn’t come from making or having a lot of money…You know what it comes from? Spending less than you make. Living within your means. It’s important to know that your antifragility comes from the extent to which you are not at the limit.” This may be applicable not just for individuals, but also for companies and nations. Most of the world seems close to the limit, some closer than others.
The world economy is integrated as never before– the contagion risk is enormous. This is why antifragility measures—e.g. reducing indebtedness, denominating debt in local currency as much as possible, lengthening the tenor of debt—would be so important.
Over the past few years, in most countries we have had the lowest interest rates in the history of the world. This is the only reason high debt levels have not led to default and crisis. Interest rates are so low—they are lower than inflation rates in most countries.
If interest rates were to suddenly rise (e.g. a reversion to the historical mean of real interest rates), it would simultaneously
- knock the wind out of asset prices (e.g. possible collapse of financial markets), and
- create failures in debt service—defaults and bankruptcies of individuals, corporations and government.