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“I’m bored,” I said as I sat sipping soup in a small restaurant.

“So what’s new?” she asked. “You are a perpetually bored person.”

“Well, I am still not bored of this soup, though.”

“Are you suggesting you are bored of me?” she asked.

“You can assume so if you want to.”

“Whatever. But one thing I am sure of is that you are not bored of all the discussions we have on the financial crisis”

“I can see where this is going. So what’s the question?”

“You know we keep talking about all the debt that countries around the world have accumulated. Where do you see that going?”

“I happened to read an interesting paper recently titled
“Reflections on the Sovereign Debt Crisis”, by Edward Chancellor. It tries to answer the question you just asked. So why don’t you
read the paper and find out for yourself?”

“Because I like to hear it come from you, V. You may be bored of me, but I am not bored of you.”

“Okay, okay, let’s focus on this debt question.”

“Sounds good to me.”

“Great. As Chancellor points out in his paper, “Topping the list of debtor deadbeats in the order of magnitude are Japan (with a gross debt of 227% of GDP), Greece (133%), Italy (120%), Belgium (100%), the US (93%), France (84%), Portugal (87%), the UK (78%), and Ireland (78%).” Now, over and above this, these countries also run huge fiscal deficits. Fiscal deficit is the difference between what a country earns and what is spends.

Data from the Bank for International Settlements (BIS) points out that fiscal deficit in the UK and the US is at 10% of GDP. In Ireland and Japan it is at 9% and at 7%. Typically, if a country’s fiscal deficit gets over 3-5%, it is a dangerous situation.”

“So will these indebted countries continue to borrow more?”

“Yes. What also does not help them are their unfunded pension liabilities.”

“Now what’s that?” she asked.

“Say someone hopes to retire 10 years from now, and hopes to earn an income of `6 lakh per year. Obviously, he will need a certain amount of money to generate that income. Taking a return of 8%, he would need a corpus of `75 lakh, to generate an income of `6 lakh per year. But before investing the `75 lakh, this person needs to first earn that amount to invest it.

To do that, he will need to invest `5.20 lakh every year at the rate of 8% for the next 10 years. If he does not do that, he cannot generate a regular income after he retires.”

“What’s that got to do with unfunded pension liabilities?”

“Well, the same logic works for governments too. If they have to give pensions to a certain number of citizens who are retiring 10 years from now, they need to start investing from now.

This will ensure that in 10 years, they have the required money that can be invested to generate regular monthly pensions for its citizens. If governments don’t invest now, they will have to pay these citizens by borrowing money. And if pensions cannot be funded through the investments already made, they are said to be ‘unfunded’.

Now, this is the case with most of the bigger countries with huge debt. As Chancellor writes, “Unfunded British pension liabilities have been estimated at some 78% of GDP. One estimate of US healthcare and pension liabilities runs to 7 times the country’s GDP.

According to the Organisation for Economic Co-operation and Development, unfunded government liabilities are at around 330% of GDP in France, 190% in Germany, 150% in Japan, and 130% in Italy.”

“So what’s the moral of the story?”

“It’s that these countries’ debt will continue to grow. “A recent paper from the BIS suggests that without a substantial change in fiscal policy and age-related spending, the debt-to-GDP ratio will soon exceed 300% in Japan, 200% in the UK, and 150% in Belgium, France, Ireland, Greece, Italy, and the US,” points out Chancellor.

That’s not all. During the financial crisis, several governments felt obliged to guarantee the liabilities of their stricken banking systems, which, in several cases, were larger than their national income. Ireland, for example, guaranteed bank liabilities equivalent to a staggering 200% of its GDP. The UK’s financial guarantees amounted to more than 50% of GDP.”

“So will these countries default on their debt?”

“There are two answers to that question. Yes and no.”

“Yes and no?”

“It depends whether your debt is in a foreign currency or your own currency. Of the heavily indebted PIIGS (Portugal, Italy, Ireland, Spain and Greece), other than Italy, the others have a major portion of their borrowings in foreign currencies. Then there are the US, the UK and Japan, which have a major portion of their borrowings in their own currency.

Countries which owe money in foreign currency cannot print the money to repay the debt, so their chances of default are high if the situation turns really bad. The US has almost all of its government debt — even though more than half of it is owned by foreigners — in dollars. Same is the case with the UK, where almost one-third of government debt is owed by foreigners. So these countries can simply print money and repay their debtors. Of course, that will create a new set of problems, but that’s a risk the governments may be willing to take.”

“But what about Japan?”

“Japan is a little more complicated than that. Let’s leave it for another day,” I replied.

“So are you still bored of me?” she asked again.

“Here we go again,” I muttered. “As the poet Nida Fazli once wrote “Jo har ik baar wo har bar ho, aisa nahi hota, hamesha ek hi se pyar ho, aisa nahi hota.”
(The example is hypothetical)
References:
Reflections on the Sovereign Debt Crisis — Edward Chancellor