sovereign debt

…And PIIGS might fly

The following is an interesting chart that shows the projected debt positions of the various PIIGS economies (PIIGS stands for Portugal, Ireland, Italy, Greece and Spain), the US and other economies with triple AAA credit ratings or near investment grade ratings.

It demonstrates why these economies are in such dire straits at the moment. The debts of Greece are the highest at 1.5 times the economy (Greek tragedy). Ireland is next at 1.2 times (the luck of the Irish) and Italy is third at 1.15 times (Italian job).

The US which has been downgraded for the first time in eighty years is projected to breach the 100% debt to GDP ratio after this year given the tepid pace of its economy and expanding entitlement system. Spain has debts at a mere 64% of its economy but is expecting to see them rise on an upward trajectory to 75% by 2016.

Other triple A rated economies either have low debt to GDP levels (Austria, Australia, Denmark and Finland) or are on a downward path to sustainability (France, Germany, Singapore and the UK).

The Philippines and Indonesia which are both one notch below investment grade do not seem to share the problems of the PIIGS with moderate (Philippines) to low (Indonesia) levels of debt and they are both expected to decline over the next few years. The yield of their bonds are trading lower than the Portugal, Ireland or Greece (translation: creditors have greater faith in their ability to repay their debts than the P-I-G economies).

The Philippines stood at the precipice of a sovereign debt crisis back in the last decade with debts rising from 60% to above-70% between 2000 and 2003, but pulled itself back with a combination of increased taxes, fiscal consolidation and a currency appreciation with debts returning to a more manageable level of below-50% in 2007 right before the Global Financial Crisis broke.

The structural adjustment that occurred after 2004 allowed the country to weather the GFC from 2008 to 2010 relatively unscathed. Now that the new government has continued the cautious fiscal consolidation of its predecessor, the question is whether growth will be as robust as it was from 2007 to 2010.

Some might say the fiscal contraction that took place in Q4 of 2010 and Q1 of 2011 will provide the necessary cushion for the government now. The problem is with the slowdown of GDP that the country has experienced this year and into the next few, revenues might not scale up as they were originally projected leaving it with limited options now that fiscal stimulus has gone out of fashion.

Indeed, fiscal contraction has its merits, but it also has its drawbacks when used excessively. Can a country engage in it indefinitely and expect an economic takeoff? Yes, sure it can…and pigs might fly.