Pouring $8 Trillion to Prevent Economic Damage from COVID-19... Behind It, the Fear of Fiscal Deficit

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Jeong Hyunjin] "The novel coronavirus disease (COVID-19) crisis will leave behind a legacy of a mountain of debt." - The Wall Street Journal (WSJ)

There is a growing argument that the fiscal support policies hastily implemented worldwide to mitigate the economic impact of COVID-19 will trigger another crisis in the future. The larger the scale of fiscal injections, the more the fiscal deficits swell, potentially becoming another time bomb for the global economy. Accordingly, some countries are facing a resurgence of past fiscal crises, with even 'L'-shaped scenarios emerging where they cannot escape the COVID-19-induced economic recession. Analysts suggest that measures such as tax increases and fiscal tightening will be necessary going forward, while others argue that since it is realistically difficult to reduce fiscal deficits, debt should be accepted as a kind of 'new normal.'

◆ US Government Debt Ratio Soars to World War II Levels= According to the International Monetary Fund (IMF) on the 20th (local time), the scale of fiscal stimulus packages mobilized by countries worldwide in response to the COVID-19 crisis reached about $8 trillion (approximately 9,746 trillion KRW) by early this month. Of this, more than $2 trillion was used in the United States, with active stimulus measures also emerging in Europe and Asian countries such as South Korea, China, and Japan. Consequently, the IMF projected the global fiscal deficit ratio relative to GDP at 9.9% this year, more than double last year's 3.7%. This is because tax revenues have decreased due to reduced economic activity caused by COVID-19, while fiscal spending has surged sharply.

By country, the US had the largest fiscal deficit ratio relative to GDP at 15.4% among major countries. China’s general government fiscal deficit ratio relative to GDP was also estimated at 11.2%, significantly exceeding last year's 6.4%. The UK, European countries, and Japan are also expected to see large increases in fiscal deficits compared to the previous year. Governments have covered funding shortfalls by issuing government bonds, causing a rapid increase in debt levels.

In particular, the US total government debt ratio relative to GDP is likely to surpass 106%, the level seen immediately after World War II in 1946. The total government debt ratio is an indicator that reflects the overall government finances. The US non-profit think tank, the Committee for a Responsible Federal Budget (CRFB), forecast that the US total public debt ratio will reach 100% of GDP this year and rise to between 102% and 117% by 2025 depending on economic recovery. The IMF also projected the US total government debt ratio at 131.1% this year.

◆ The 'New Normal' of Debt Management= The ballooning fiscal deficits in various countries are generally viewed as an unavoidable choice to respond to the worst economic crisis caused by COVID-19. Without sufficient support, economic agents could collapse, making it difficult to recover from the recession. The problem arises after the COVID-19 crisis. Once the current crisis is overcome, excessive fiscal deficits become a stark reality. Experts point to the Southern European crisis triggered by fiscal deficits in 2010-2011 as a warning, emphasizing the need to prepare for large-scale debt.

Agathe Demarez, Global Economic Outlook Manager at the Economist Intelligence Unit (EIU), cited Southern European countries as examples, saying, "They have endured years of hardship due to high debt levels, fiscal deficits, and aging populations," and added, "The debt crisis in these countries could quickly spread to other advanced and emerging markets, causing another global economic crisis."

The situation in Southern European countries such as Italy is serious. The IMF expects Italy’s total government debt ratio to GDP to reach 155.5% this year. The total government debt ratio in the Eurozone (19 countries using the euro) rose from 65% in 2007 to 90% in 2012, then fell to 84% at the end of last year. Moritz Kramer, head of S&P, wrote in a media article that "the Eurozone’s debt ratio is expected to rise to 112% in 2022," and analyzed that "Italy’s lower-rated government bonds will raise questions about fiscal sustainability."

However, resolving fiscal deficits is not as easy as it sounds. Tax increases or fiscal tightening are proposed solutions, but these measures pressure economic agents, forcing countries to approach them cautiously. Moreover, with the US presidential election coming in November, such options are even less likely to be considered. Ray Dalio, CEO of Bridgewater Associates, the world’s largest hedge fund, predicted, "Once the dust settles, there will be political debates in the US about who will pay for all this spending and bear the debt burden."

There is also an opinion that, given prolonged low interest rates, large-scale debt should be accepted as a kind of 'new normal.' Mario Draghi, former President of the European Central Bank (ECB), wrote in an article published by a foreign media outlet at the end of last month, "Public debt levels will increase, but choosing alternatives would cause much greater damage to the economy and ultimately affect government credit ratings," and argued, "A change in mindset is needed in such crisis situations." He emphasized, "Much higher levels of public debt will become a permanent feature of our economy."

Gita Gopinath, IMF Chief Economist, also mentioned, "If interest rates remain very low and the economy recovers as expected, debt levels will gradually decline over time." She also said that central banks should keep interest rates low if inflation remains well below target. This approach places more emphasis on managing debt rather than tightening.

This content was produced with the assistance of AI translation services.