Economy

A double recession? Economies risk debt crises after stimulus spending

Key Points
  • The debt incurred over time from coronavirus stimulus spending could mean a deeper crisis and default risks for some countries, according to a recent economic reports.
  • The current wave of debt accumulation — which started in 2010 — is "the largest, fastest and most broad-based increase" in global borrowing since the 1970s.  
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The economic meltdown brought on by the coronavirus pandemic has governments deploying historically vast fiscal spending packages to support millions of their citizens and businesses.  

This spending is necessary to support economies — officials agree on that much. But the debt incurred over time could mean a deeper crisis and a doubled-down recession for some countries, according to recent reports. 

"Debt crises may be coming," the Economist Intelligence Unit (EIU) wrote in late March. "For now, governments are ramping up fiscal spending to fight the epidemic, maintain basic economic architecture and keep workers in their jobs. As a result, fiscal deficits will rise sharply in the coming years."

Already in early January, before any country imposed coronavirus lockdowns, the World Bank warned of the risk of a fresh global debt crisis. It described the current wave of debt accumulation — which started in 2010 — as "the largest, fastest and most broad-based increase" in global borrowing since the 1970s. 

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In the first half of 2019, global debt surged by $7.5 trillion, hitting a new record of more than $250 trillion, according to the Institute for International Finance. "With no sign of a slowdown, we expect the global debt load to exceed $255 trillion in 2019, largely driven by the U.S. and China," the IIF wrote in late 2019 — before the year was over and well before anyone was talking about a global pandemic.

Now, the International Monetary Fund projects that the global economy this year will "very likely" suffer the worst financial crisis since the Great Depression, as governments around the world extend lockdowns and economic shutdowns to fight the spread of Covid-19. The Washington-based fund now expects the global economy to contract by 3% in 2020. In January, by contrast, it had forecast a global GDP expansion of 3.3% for this year.

Half the world has now asked the IMF for a bailout, the organization's chief Kristalina Georgieva told CNBC on Wednesday, highlighting the severety of the economic crisis.

Southern European countries could be hit first

The EIU report warned that under such unprecedented pressure and with no certainty as to how long the current crisis will last, states' options for pulling themselves out of debt holes after the crisis subsides are becoming increasingly slim.  

While austerity has been used to curb high fiscal deficits in the past, this is unlikely to prove viable during any post-crisis recovery, given the level of trauma and economic pain most of the world will have experienced.  

With no realistic measures in place to prevent sovereign debt crises, a second and potentially deeper blow could hit economies — particularly heavily indebted developed countries like Italy and Spain, threatening contagion to more markets, the EIU warned. Raising fiscal revenue through higher taxes will be unpalatable for some time and may not even be sufficient, the report authors wrote. On top of that, we could see investor appetite for ever more sovereign debt weaken. 

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"Many developed countries may, in the medium term, find themselves on the brink of a debt crisis," Agathe Demarais, global forecasting director for the EIU, wrote in the report.

"This is compounded by the fact that many of the European countries that are among the worst affected by the epidemic, such as Italy and Spain, already had weak fiscal positions before the coronavirus outbreak."

Spain and Italy are the world's second and worst-hit countries in terms of coronavirus cases after the U.S., with  182,816 and 165,155 cases of the coronavirus as of Thursday, respectively, according to the Johns Hopkins Coronavirus Resource Center. Italy has registered more than 21,600 deaths from the disease, and Spain's death toll is at more than 19,100.

Much of Southern Europe is still getting over years of austerity, Demarais added, and is weighed down by high debt, fiscal deficits and ageing populations. "A debt crisis in any of these countries would quickly spread to other developed countries and emerging markets, sending the global economy into another, possibly much deeper, economic crisis." 

Steve Brice, chief investment strategist at Standard Chartered Private Bank, told CNBC he does not in fact see a debt default cycle ahead. 

"We will avoid a massive debt default cycle, but in the short term we might get some worse news," he said, referencing the $349 billion U.S. small business rescue loan program that ran out of money on Thursday. "Clearly we'll need some more funding. And that seems to be less easy today than it was two, three weeks ago," Brice said.

"We still think it'll come through, but in the near term, if you don't get very positive data on the reopening of the economy, then markets are going to be a bit vulnerable short term."

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— CNBC's Sam Meredith contributed to this report