Can negative yields save the countries?

Recently, some countries have been investing in negative-yielding bonds. Such strange preference of investment in terms of yield is obviously a brand new type of analysis to experts. The only reason there’s been so many peculiarities these days is because of the global amount debt, which is huge indeed.

The abundance of debt securities has led to negative-yielding I might say, to the advantage of investors that engage in trading in secondary markets. While the recent decline in interest rates proves that people show higher interest in bonds, it concurrently results in a rise in coupon rate, which means the opportunity to make a profit out of dealing transactions is still out there. The end of this journey, however, may not end well. Here’s why:

According to IMF’s 2010 report on the “Long-Term Trends in the Public Finances of the G-7 Economies”, under the current and future pressures on public finances, public debt would spiral out of control in the absence of fiscal adjustment. Under unchanged policies, the net debt-to-GDP ratio of the G-7 economies would exceed %440 percent by 2050’.

Very frightening indeed… Let me make something clear. It is just not possible to pay off such enormous stock of debt. This report suggests a miracle as well, according to which, if potential growth was raised by 1 percentage point compared to the baseline debt projections, and even assuming that half of the increased revenues is spent, the debt path would dramatically change by 2050, reaching 185 percent of GDP. These calculations will obviously get revised periodically but for now, the situation seems to become more hopeless with each passing day.

First of all, I’m not saying that it is easy for the G-7 Countries to increase GDP rate by additional 1 pts than expected, because it’s simply almost possible. But, say that these projections became a reality; will it make this amount of debt payable anyway? I think we need to take a look at some countries’ current debt in order to have a better understanding of this concept.

“A bottomless pit of debt…”

Japan’s current debt-to-GDP ratio is around 239 percent, followed by Greece with a ratio of 181 percent. Lebanon, Italy and Portugal rank among the top five with ratios respectively 149 percent, 132 percent and 130 percent. According to some experts, on the other hand, total-debt-to-total-assets ratio is as important as debt-to-GDP ratio. When looked from this perspective, all of the countries mentioned above, except Japan, are in a massive debt spiral, because countries with a debt-to-GDP ratio above 100 percent must keep its GDP rate constantly high, which can inevitably lead to various side effects and complications, especially including high inflation and financial crises.

You might ask, “Turkey’s debt-to-GDP ratio is quite low when compared to these countries. Why would we ever have to face a financial crisis?” That’s because Turkey has short-term external debt obligations and has to pay off high interest rate debts. Although Turkey’s public debt-to-GDP ratio remains around 40% when compared to total GDP, which seems comforting at first, the fact that Turkey still doesn’t have a strong narrative to offer to the world, and the fact that it offers very high interest rates for short-term loans increases its “country risk”.

Obviously, in some cases, accessing funds can become more important than the cost of funding. Even if the positive scenario in the IMF Reports sees the light of day, a debt of around 185% is simply not payable.

So, although the debt securities investors keep buying in spite of negative-yielding seems like a safe haven for now, it may also bring big risks for the future.