From Fed Minutes to Global Debt…

Released just yesterday, the Fed Minutes was a real shot in the arm for developing markets. Now, everyone expects a rate cut, including people in Turkey.

I’ve explained in my previous reports the reason why a rate cut is super important. As opposed to decreasing expectational inflation, the fact that real interest rate remains at high levels causes concerns. The cause and effect relationship gets even more complicated, leading these concerns to grow bigger.

We should also admit that higher interest rates are the nightmare of over-indebted countries. For instance, the United States is the most indebted country in the world. With a debt of 31%, the US also generates international revenues of almost 25%. Obviously, the United States is not only country with huge debt. According to the IMF’s “Long-Term Trends in Public Finances in the G-7 Economies” 2010 report issued in September 1, 2010; ‘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. No one can pay off such huge amount of debt. A rate cut will sadly not sooth this wound. But, if a series of miracles happens, then maybe, we might still have hope.

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 pps 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.

“Turkey has low debt-to-GDP ratio, but….”

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, it seems like the world will have to go through some struggles over the next periods, where we might witness lenders, not borrowers, to suffer due to the abovementioned reasons.