Global debt has reached unprecedented levels. While interest rates stay low, the problem is perhaps not that worrying. But if – or, rather, when – rates rise, high debt levels increase risks that could derail the global economic recovery.
The latest Fiscal Monitor report by the International Monetary Fund highlights that global debt of the nonfinancial sector, at 225 percent of world GDP, is at an all-time high. The findings of the report underscore the fragile situation that many economies find themselves in – growth is tepid yet leverage has continued to march upwards. The high levels of debt, currently manageable in a world of record-low interest rates, could set the stage for a global deleveraging that is likely to hinder the already patchy global economic recovery.
As can be seen from the graph below, global debt has reached unprecedented levels, driven in part by an era of ultralow interest rates as well as weak global economic growth.
Furthermore, credit growth has been tracking materially above its long-term growth rate.
These high debt levels increase risks that could derail the current global economic recovery; this is particularly so if interest rates rise, where this debt will require a greater share of income to be serviced, as well as potentially leading to an increased amount of non-performing loans. A deleveraging is necessary but the report warns that “[t]he current low-nominal-growth environment, however, is making the adjustment very difficult, setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown”.
It’s possible to reduce global debt levels through: (i) macroeconomic deleveraging, which is primarily through economic growth and inflation; and (ii) balance sheet deleveraging, which involves debt repayments, restructuring and debt write-downs. However, unwinding the buildup of global debt, particularly private sector debt, is something that continually poses a risk to global economic growth.