Marcus Svedberg, chief economist, East Capital -
Governments, people and companies in the west have been living beyond their means for a long time. The result was a credit bubble of staggering proportions. And now these loans have been in effect called in, much of this debt has ended up on the balance sheets of European governments.
The EU's growing sovereign debt crisis has been filling the headlines recently. We are flooded with various spreads, yields and sentiment indicators trying to illustrate exactly how worried the market is about the situation. But the underlying problem is a rather basic one and it is not confined to Greece or even the Eurozone but to the entire rich world. In contrast, the emerging Europe's debt is half the Maastricht criteria's limit and Russia's is amongst the lowest in the world.
The most troubling part is that it is not a temporary issue that is possible to repair with a quick fix. Rather the sovereign debt burden for the developed economies in the world is expected to grow -- from the current 98% of GDP to 110% by 2015 before slowly starting to come down. And most troubling part is it will only fall if the governments have the political guts to implement all the budget cuts and raise all taxes they have said (or are about to say) are necessary.
The IMF has calculated that the advanced economies need to implement a fiscal adjustment of over 9% of GDP in the next ten years. This is an incredibly painful programme. Will governments follow through on their commitments? The public protests already seen in the Eurozone in the last few weeks give grounds for scepticism.
The problem is not universal though. Emerging economies are substantially less indebted than their peers in the developed world. The fact that the former normally has to pay higher interest for its debt makes the burden larger but there is still a huge difference and the gap is expected to widen.
The IMF expects the sovereign debt burden of emerging economies to fall from 38% of GDP today to 34% by 2015. Most of these economies need to streamline their budgets as well, but the extent of the problem is significantly smaller as they did not built up such huge excesses in the first place or started to cut back significantly already last year.
In the light of these basic facts, it is rather curious that the rating institutes continue to put such a high-risk premium on emerging economies. These very same emerging economies also tend to run current account surpluses and have accumulated large foreign exchange reserves. Put more bluntly: the rich world is not as rich as commonly believed, as they owe huge amounts to future generations and to emerging economies. It is well known that China holds a lot of US treasury bills but the Russians reminded the EU last week that 40% of its foreign exchange reserves - the third largest in the world - are in Euros.
It is true that emerging markets tend to be more volatile, but that is arguably part of the same old thinking. In times of crisis, investors tend to buy assets that are regarded safe, but the question is if 110% debt to GDP should be safer than 34% for an investor with a 5-year horizon. The question becomes even more pronounced if we on top of this add the expected growth rates in the emerging and developed world. IMF expects the former to grow almost three times (!) faster than the latter in both real and nominal terms over the next five years.
Both the debt and growth scenarios hold across emerging regions even though there are notable differences. Eastern Europe was clearly out of favour last year due to poor growth rates and refinancing problems. The sentiment turned more positive during the begging of this year as growth forecasts were revised up significantly and the market started to realize that Eastern Europe is, after all, not very indebted.
Russia has by far the lowest sovereign debt among the Brics at only 8% of GDP (compared to 20% in China, 67% in Brazil and 79% in India). The most leveraged economies in Eastern Europe were either bailed out by the IMF or took on draconian budget cuts on their own, which has earned them a reputation for not only being fiscally responsible but actually also implementing things. It may therefore be a good idea for Western governments and investors alike to look east for inspiration and good returns.
Marcus Svedberg is the chief economist at Sweden-based East Capital that specialises in investing in New Europe and was the best performing regulated onshore fund in the world of any class in the last decade.
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