Monday, November 28, 2011
Low growth and high debt is the sovereign curse
November 28, 2011
It has become accepted wisdom – as popularised by economists Carmen Reinhart and Kenneth Rogoff – that sovereign debt levels become unsustainable when they rise above 60-90 per cent of a country’s gross domestic product.
But, as government or corporate debt rarely ever gets repaid, the real question is whether that debt can be serviced and investor confidence maintained to allow it to be refinanced. In reality, the level of tolerable sovereign debt depends on a multitude of factors ranging from the currency of the debt to the level of interestrates and the debt maturity profile and structure of the country’s economy.
But perhaps the most important determinant is the level of current and expected economic growth. A dynamic economy capable of high levels of growth, with the attendant ability to generate additional tax revenues and attract investment, can maintain a higher level of debt than one with lower growth prospects.
While not exact, the sustainable level of debt can be approximated by another formulation commonly used by economists and analysts, which links the existing level of public debt, the current budget position, interest rates and growth.
Using this formula, eurozone economies need to achieve strong growth merely to stabilise their debt burdens.
Posted by Yulie Foka-Kavalieraki at 5:02 PM