How deep can countries safely go into debt? The answer may be harder than we thought
The continued improvement in global economic conditions has lately been a source of justified optimism, but rising government debt levels in countries of all income categories are starting to cast a shadow on these positive forecasts.
A broad-based increase in public sector debt comes at a critical moment when closing the global infrastructure gap is a major priority for the international community.
Rising public debt limits the capacity of governments to invest in key development areas that are instrumental in driving progress towards the Sustainable Development Goals (SDGs). Public investment in education, health, environmental management and infrastructure can help raise output, attract private investment and reduce unemployment. This in turn can support growth and development today and in the future.
Balancing the needs to invest in SDGs and to contain debt risks naturally prompts the important question of how much room for manoeuvre a government actually has. Or in economics jargon, how much fiscal space does a government have?
Central government debt-to-GDP ratio, 2008 versus 2016 – based on IMF Global Debt Database. Each dot represents a country. A dot above the 45-degree line means the country has seen an increase in the central government debt-to-GDP ratio during 2008-2016.
While it is generally understood that fiscal space is related to the concept of debt sustainability, there is no agreement on how fiscal space should be measured. In a recent working paper, Hoi Wai Jackie Cheng and Ingo Pitterle – economists at UN DESA–argue for a more comprehensive approach to assess fiscal space.
The paper shows that the different measures stress different aspects of the fiscal space concept. Some rely heavily on historical data related to previous debt crisis episodes or fiscal balance adjustment.. However, historical policy responses may not be the best guide to future challenges. Other measures depend on future projections of fiscal and macroeconomic variables and are thus less suitable for countries that display large fluctuations in these variables.
The paper also illustrates that using different measures could paint considerably different pictures of the global fiscal landscape. This suggests that relying on any single measure leads to an incomplete and potentially biased assessment of fiscal resources available to governments.
In this light, the paper calls for using a dashboard of indicators and paying more attention to factors that are not adequately captured in standard fiscal space assessments. These include the ability of a country to issue debt in its own currency and the effectiveness of fiscal policy in boosting growth and prospects for fiscal space expansion.
The authors also warn of the inherent uncertainty linked to measuring fiscal space, noting that at least one of three assumptions needs to be fulfilled for any of the available measurements to be useful for fiscal policymaking. The measurements should either accurately predict the future trajectory of a country’s fiscal and macroeconomic variables, assume historical consistency of fiscal and market behaviours or ensure that enough benchmark countries have a similar fiscal behaviour to the country in question.
Since none of these conditions can be completely fulfilled, fiscal space cannot be exactly determined. Therefore, even with a variety of fiscal space measures at their disposal, policymakers must complement their fiscal space assessment with careful judgement that considers such uncertainty.