A record surge in private debt triggered by the Covid-19 pandemic could slow the global economic recovery, with the biggest drag on future expansion in countries where low-income households and vulnerable firms are highly indebted.
The recent spike in debt levels could slow economic recovery by a cumulative 0.9 per cent of gross domestic product in advanced economies and 1.3 per cent in emerging markets on average over the next three years, the International Monetary Fund said on Monday.
"The recent surge in indebtedness of households and firms poses risks to the pace of recovery," the Washington-based lender said in a report.
"Yet this risk is not equally distributed. Careful, real-time monitoring of the balance sheets of low-income households and vulnerable firms is key to calibrating the unwinding of support measures. This could prevent sudden distress when financial conditions tighten."
Governments worldwide have provided economic stimulus packages to help individuals and businesses ride out the Covid-19 pandemic. These have helped to provide liquidity for affected individuals and businesses through credit guarantees, concessional lending and extensions on interest payments. While these policies helped prop balance sheets, they also led to a spike in private debt, extending a steady increase in leverage since the global financial crisis of 2008.
Global private debt surged by 13 per cent of the world’s GDP in 2020 — faster than the rise seen during the global financial crisis and almost as fast as public debt, the IMF said.
The impact of the pandemic on households’ and firms’ balance sheets has been unequal across and within countries, depending on policy responses and the types of sectors in those economies, the IMF added.
High-contact-services such as entertainment shrank as people stayed at home, but production and exports of computers, software and other goods expanded as consumers spent more on appliances.
For example, the situation of workers in tourism services, restaurants, hospitality and entertainment has in many cases "remained precarious" two years after the start of the pandemic. Meanwhile, labour shortages and fast wage increases have become the norm in construction and logistics, the fund said.
The war in Ukraine has further disrupted global supply chains, leading to shortages and higher costs of basic commodities.
"Large increases in the prices of energy and food products are likely to affect low-income households — especially in emerging markets and developing economies — and could spill over to many industries via higher input prices if the conflict is prolonged," the IMF said.
The worsening situation in Ukraine, with Russia bombarding several cities and peace talks between Kyiv and Moscow at a dead end, have also raised the prospects of tougher sanctions on Russian energy exports in an already tight market.
The impact of the pandemic on consumer and business balance sheets, especially those most exposed to the crisis, differed greatly depending on the support provided by governments.
"The post-pandemic drag on growth could be much larger in countries where (1) indebtedness is more concentrated among financially stretched households and vulnerable firms, (2) fiscal space is limited, (3) the insolvency regime is inefficient and (4) monetary policy needs to be tightened rapidly," IMF analysis shows.
Low-income households and highly-indebted or unprofitable firms are typically less able to cope with a high level of debt, becoming more likely to make sharper cuts to consumption and investment spending in the future.
"The drag on future growth is therefore expected to be greatest in countries that experienced the largest increases in indebtedness among low-income households and vulnerable firms during the pandemic," the IMF warned.
Consumers in China and South Africa suffered the biggest increases in household debt ratios among the countries for which detailed data are available, according to the report.
Within advanced economies, low-income households in the US, Germany, and the UK recorded comparatively larger increases in debt than those in France and Italy, where debt actually declined for poorer households.
Vulnerable businesses — which are highly concentrated in contact-intensive services — often borrowed to survive the drop in revenues caused by the pandemic.
Future investment is therefore likely to be lower in countries with a higher share of contact-intensive sectors, the IMF said.
"As economies recover and inflation accelerates, governments should take account of the impact of fiscal and monetary policy tightening on the most financially stretched consumers and businesses when pacing the exit from extraordinary support policies," the IMF said in its policy recommendations.
It estimates that a surprise tightening of 100 basis points would slow investment by the most leveraged firms by a cumulative 6.5 percentage points over two years — four percentage points more than for the least leveraged.
In countries where the economic recovery is well underway and balance sheets are in good shape, governments can reduce fiscal support faster, therefore facilitating the work of central banks, the IMF said.
In other economies, governments should target fiscal support to the most vulnerable in the transition to recovery but within "within credible medium-term fiscal framework", it said.
Government support to firms could be limited to circumstances in which there is clear market failure, it added.
"To prevent rapid tightening of monetary policy from causing large and potentially long-lasting disruptions, policymakers should pay close attention to adverse developments in the financial sector," the IMF said.
This is especially important in countries where a wave of bankruptcies in sectors heavily hit by the pandemic could spill over to the rest of the economy. In this case, governments could provide incentives for restructuring over liquidation and solvency support could be considered where necessary, the fund said.
"As countries prepare to normalise monetary policy, assessing how leverage is distributed is key to forecasting the pace of the recovery and calibrating the unwinding of pandemic-time support."
