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How Bad Is Debt For A Country?

Austerity and repayments are now national talking points, but what do they mean?

13Aug

Brought in by numerous governments after the financial crisis of 2008, austerity has proven tremendously divisive. In the run-up to the 2010 election, it was proclaimed by politicians, particularly those in the UK, as necessary to save the economy. This line was brought by an electorate, for whom the idea that the crisis had been caused, or at least worsened, by the nation’s vast debt appeared logical. So they voted in the Conservatives, albeit not with a majority.

In the years since, austerity has been largely discredited, with economists discovering that such measures are in fact stifling growth. Those few economists who espoused austerity’s virtues when it became popular among governments looking for an excuse to cut public services and privatize, have been shown to have been wrong in their workings. Alberto Alesina, an economist at Harvard, who claimed to find evidence that spending cuts made between 1970 and 2007 were in fact often ‘associated with economic expansions rather than recessions’, contrary to traditional Keynesian economics, was found to have made a number of substantial errors as to what he had believed to be spending cuts that were, in fact, nothing of the sort. Even the IMF, despite having played a leading role in imposing austerity on Greece as part of its debt repayment plan, has released research showing that the economic damage from aggressive austerity measures may be up to triple previous estimates.

The idea that you cannot make an omelette without breaking a few eggs appears to have taken root, with David Cameron, the UK Prime Minister, proudly proclaiming that he is making ’tough decisions’ so that the economy will thrive later. At the moment, however, we are seeing a lot of broken eggs, but very few omelettes making an appearance.

The leading argument for austerity was investor and lender confidence. A country seen to be paying off its debt, it was argued, will create confidence, and drive money into the economy, as well as causing high interest rates.

Moody's Investors' Service now lists seven countries as having a Caa1 rating or lower, which means that they are approaching, or have just narrowly escaped, bankruptcy. Of the seven, only Jamaica has shown signs of improvement, going from a Caa3 to a Caa2 rating. The outlook for the country has also been labelled as ’positive’ - the only country on the list to have received such an appraisal.

Ukraine tops the list, earning a rating of Ca, the second lowest possible rating. According to Moody's, ‘the likelihood of a distressed exchange, and hence a default on government debt taking place, is virtually 100%.’ Greece is second on the list. In these four countries debt of four of the seven countries was equal to more than 75% of GDP. In Jamaica and Greece, debt was well over 100% of GDP.

What lessons are there to be learned from countries’s experiences with austerity, and how these nations should rise from their predicament? For the Ukraine, the situation is largely dictated by circumstances surrounding the Russian occupation of Crimea. For Greece, austerity has been enforced, despite all evidence suggesting that it will not work. For countries spiralling towards bankruptcy, Jamaica’s example is a strong one to follow, particularly for Greece - both countries have economies dominated by tourism. The Jamaican economy grew by 0.4% in the first quarter of 2015 compared to the first quarter of 2014, led by strong figures within the service industry and Moody’s positive outlook comes despite its high debt levels, suggesting that these are not of primary concern for investors. This is reinforced by their bond sale late last month. The country’s finance minister, Peter Phillips, asked to borrow around $2 billion. The market offered him US$4.5 billion. This is 125% more than he asked for. Of greater significance, perhaps, is the interest rate at which the market was willing to lend: 6.75% on $1.35 billion of 13-year money and 8.785% on US$650 million that would be due in 30 years' time.

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