Page 41 - Nuvama | IC Report 2023

INDIA: THE 5D ADVANTAGE

At such elevated debt levels, even US treasuries – supposed to be the ultimate safe haven – are
not spared. Global central banks’ fight against inflation has pushed global bonds into their worst
year in more than two decades. This is despite a sharp slowdown in growth (global PMI is already in
contraction)—a dynamics that usually tends to benefit sovereign bonds.
Not only that, volatility in these ‘safe’ asset classes has been unusually high. In the UK, risk showed up High debt
in an unlikely place— UK pension funds ran into trouble as UK gilts yields spiked, so much so that the beyond a point,
Bank of England had to step in to prevent financial instability. Very recently, even US treasury secretary even among
Janet Yellen noted illiquidity issues in the US treasury market. safest borrowers,
could breed
In short, high debt beyond a point, even among safest borrowers, breeds instability. This can have instability
repercussions across asset classes and economies.
How to break the vicious debt cycle?

Escaping the debt trap requires making tough political decisions and moving away from inertia—a
process that can be broken down into three parts:
• Recognising unserviceable debt and restructuring it. There is a tendency in the policymaking
corridors to kick the can down the road. Recognition of bad debt and resolving it could be a Escaping the
painful and winding process that can blight near-term growth prospects. It requires great political debt trap calls
will and an approprite and transparent institutional framework to tackle bad debt. Japan, after its for tough political
growth bubble burst, delayed the resolution of debt, which left its financial system saddled with decisions and
bad debt. The fallout: long-term stagnation. That said, while Chinese policymakers are believed to shrugging off
be more decisive and quick in addressing problems, their resolve shall be tested this time. inertia, which
could take time
• Maintaining negative real rates for a sustained period. When it comes to sovereign debt
problems, particularly for reserve currency sovereigns such as the US and Europe, debt deleveraging
happens not through restructuring or default, but through high inflation and negative real rates
over a sustained period of time. It was this dynamic that facilitated deleveraging of indebted
western sovereigns post-WW2. In 1940s, inflation averaged 5–6%, reaching as high as double-
digits for a few years in-between, but the Fed stood aside and kept real rates deeply negative
to facilitate relatively smooth deleveraging. The political system too allowed for high inflation
as population was young, and reconstruction and expansion of educational and employment Central banks
have been fighting
opprtunities were the key political goals. Besides, voting rights were relatively restricted then.
inflation tooth and
But can the western world pull it off when it is ageing? (Old suffer much more from inflation.) So far, nail, but political
central banks have been fighting inflation tooth and nail, but we would not be surprised if political consesnsus
consesnsus shifts. might shift
• Ensuring better capital allocation. A key reason for deterioration in global ICOR has been poor
capital allocation. Consider the two biggest economies: the US and China. China invested far too
much in building infrastructure over the last two–three decades such that it is left with ‘ghost
towns’ and ‘bridges to nowhere’— a signficant loss of capital productivity. It hardly built mechsims
of income transfers, social safety nets, employment insurance and so on. The US, in contrast, has
gone too far in running only a consumption economy while neglecting public infrastructure.
If the world is to see more balanced growth that’s less depenedent on debt, then re-allocation of
capital is called for. China must boost its income transfers and social safety nets, while the West
must shore up its infrastructure. This requires overcoming political inertia, which could take time.

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