Impact of Covid-19 on Global Debt: A Study of Countries in the G-20 Group

This paper highlights the prospect of a Covid-19 led 
upsurge in the government debt-GDP ratio of 19 countries in the G-20 group. 
Many of these countries have Fiscal Responsibility Legislations (FRLs) where 
government debt-GDP ratios have been targeted. A key policy implication of our 
findings is that most countries will find that the post-Covid slippage in their 
government debt-GDP ratio is so large as to call for major changes in their 
fiscal policy framework. In some cases, even a modification of their FRL may be 
warranted. The evolution of debt of these countries over the period 1996 to 
2019 indicates that major economic crises have led to one-time upsurges in 
their debt-GDP ratios covering both government and private debt. These ratios 
tend to remain at high levels well after the crises are over, showing downward 
rigidity. We estimate that Covid-19 induced increase in government debt-GDP 
ratio for the selected countries, would amount to 14.9% points on average which 
is more than 141% higher than the increase of 6.2% points resulting from the 
2008 crisis. We propose a methodology to project the government debt-GDP ratio 
as a function of incremental borrowing relative to GDP, real GDP growth and GDP 
deflator-based inflation. We also estimate the relative contribution to the 
increase in government debt-GDP ratio, individually of these factors. We find 
that the upsurge in the Covid led government debt-GDP ratio is large because of 
the reversal of the role of the growth factor in explaining the change in the 
debt-GDP ratio between two successive years. In particular, instead of 
appearing with a negative sign, which is the case in a normal year, it appears 
with a positive sign in a crisis year. Further, the fiscal deficit-GDP ratio 
also increases due to large stimulus packages in a crisis year.


Impact of Covid-19 on global debt: a study of countries in the G-20 group D.K. Srivastava, Tarrung Kapur, Muralikrishna Bharadwaj and Ragini Trehan
Well after the deleterious health and economic effects of Covid-19 are resolved, it is likely to leave the global economy with one long lasting effect, namely, an upsurge in the debt-GDP ratios of individual countries. For analysing this, we have selected 19 individual countries of the G-20 group 5 . The evolution of country-wise debt indicates that major economic crises have led to one-time upsurges in the debt-GDP ratios. These tend to remain at high levels well after the crises are over, showing downward rigidity. Further, each major crisis has resulted in an increase in both government and private debt relative to GDP on average. After 2010, the government debt-GDP ratio rose at a rate faster than the increase in the private debt-GDP ratio.
This resulted in a change in the composition of debt where the share of government debt in total debt increased. In this paper, we estimate that Covid-19 induced increase in government debt-GDP ratio for the selected countries, would amount to 14.9% points on average, which is more than 141% higher than the increase of 6.2% points resulting from the 2008 global economic and financial crisis. This is because the Covid-19 induced contraction in GDP is estimated to be much sharper and the fiscal stimulus has also been quite larger than the 2008 crisis. Both of these factors are expected to lead to an increase in the country-wise debt-GDP ratios, particularly government debt to GDP ratios in 2020. The private sector entities have also attempted to cope with the pandemic by increasing their indebtedness.
In the related literature, a country's indebtedness has been indicated by the sum of private nonfinancial debt and government debt (Mbaye, Badia, & Chae, 2018), where government debt pertains to the general government covering central and subnational governments.
In this paper, we propose a methodology for projecting the increase in the debt-GDP ratio as a function of (a) incremental borrowing relative to GDP, (b) real GDP growth and (c) GDP 5  . The EU has been excluded from the group, since its data was not available in the IMF Global debt database. Collectively, G20 members represent around 80% of the world's economic output, two-thirds of global population and three-quarters of international trade (https://g20.org/en/about/Pages/whatis.aspx) deflator-based inflation. We also estimate the relative contribution to the increase in government debt-GDP ratio, individually of these factors.

Evolution of country-wise total debt-GDP ratio: 1996 to 2019
In this section, we undertake a review of the evolution of country-specific total debt-GDP ratios over the period 1996-2019. This analysis is in terms of debt-GDP ratios where both debt and GDP are in local currency units (LCU). Data for this analysis has been drawn from the International Monetary Fund (IMF) 6 which is presently available up to 2019. For two years, that is, 2020 and 2021, government debt levels have been projected by using real GDP growth and inflation rate forecasts as sourced from the IMF World Economic Outlook (October 2020).
Further, the fiscal deficit to GDP ratio for 2020 and 2021 has been derived by using government debt to GDP ratio and the nominal GDP for these two years as projected by the IMF in its WEO (October 2020).
In terms of the underlying economic conditions during 1996 to 2019, the 2008 global economic and financial crisis was preceded by other economic crises affecting different groups of countries from time to time. Thus, in the late 90's, there was the Latin American economic crisis as also the Southeast Asian crisis. The latter had continued up to the early 2000's. From 2010 to 2013, there was the European sovereign debt crisis. Also, global crude prices had been strongly cyclical during this period, affecting the fortunes of the oil-rich economies on the one hand and oil-import dependent economies on the other (Baffes et. al, 2001). We find that the evolution of the debt-GDP ratio has generally been episodic, rising sharply during crisis years, and then remaining stable at an elevated level until the next crisis is encountered. The downward adjustments in the indebtedness of a country has been very limited and exceptional. Table 1 indicates the total debt-GDP ratio comprising private and government debt of the selected G-19 countries.

Composition of debt: relative share of government debt in total debt
In this section, we examine the changing profile of the composition of total debt as divided between government debt and private debt for individual countries with respect to four benchmark years namely, 1996, 2005, 2010, and 2019.

Chart 1: Share of government debt in total debt: 1996
Source (basic data): IMF Chart 1 shows that in the selected countries, in 1996, the share of government debt in total debt was the highest for Russia at 85.6%, followed by Saudi Arabia at 74.4% and India at 71.6%.
At the lower end, the lowest share of government debt in total debt was for South Korea at 5.3%. The next two countries were Australia at 20.3% and China at 20.5%. The average share of government debt in total debt for the selected countries was 43.5% in 1996. Thus, over the period from 1996 to 2010, there was an increase in the overall debt-GDP ratio of countries in general, but this increase was relatively more for private debt whereas the share of government debt in total debt had shown some decline. Between 2010 and 2019, the overall debt-GDP ratio continued to surge, but in this period, the share of government debt in total debt increased on average.

Government debt-GDP ratio
In this section, we look at the comparative position of countries with respect to the evolution of their government debt to GDP ratio. In 1996 (Chart 5), three countries, namely Italy, Japan and Canada already had a government debt to GDP ratio which was higher than 100%. Other countries like Saudi Arabia, the US, India, and France had a government debt-GDP ratio in the range of 60% to 75.2%. As economies went through different phases of economic crises and responded to these crises through fiscal stimulus based on an increase in their fiscal deficits, their government debt to GDP ratio kept increasing. The average government debt to GDP ratio for the selected countries was 53.9% in 1996.

Projecting government debt-GDP ratio for the pandemic years
In this section, we consider decomposing the change in the government debt-GDP ratio in a country into three factors namely, (1) increased borrowing, (2) real growth rate and (3) inflation rate. Change in government debt amounts to a country's fiscal deficit which is one of the main instruments through which a stimulus is injected in order to overcome an economic crisis.
Change in the government debt-GDP ratio in any year t may be defined as: Here, and − denote the debt-GDP ratio in the year t and t-1 respectively. is the fiscal deficit to GDP ratio in year t which is defined as change in the level of debt relative to the level of nominal GDP, that is, refers to the nominal growth rate which can be expanded as the sum of real growth rate and the inflation rate, that is, = + + Equations (1)  Utilizing equation (4), we project the government debt-GDP levels for 2020 and 2021, using independent projections of fiscal deficit to GDP ratio, real GDP growth and inflation rate in these years. Real GDP growth and inflation forecasts are taken from the October 2020 issue of IMF's World Economic Outlook (WEO). The fiscal deficit to GDP ratio has been derived by using government debt to GDP ratio and the nominal GDP for these two years as projected by the IMF in its WEO (October 2020). The relevant values are given in Appendix 2.  Table 2 shows the sharp increase in the government debt-GDP ratio in 2020 over 2019. The largest increase is for Japan at 28.1% points, followed by Italy at 26.7% points, Canada at 25.9% points, and the UK and the USA at 22.4% points each. The average increase in the government debt-GDP ratio for selected countries in 2020 is estimated at 14.9% points.

Relative contributions of fiscal deficit, growth and inflation factors
With a view to estimating the relative contribution of different factors, we may rewrite equation (4), after ignoring the product terms, as follows (see Appendix 1): Equation (5) indicates that in order to derive the current level of debt-GDP ratio, only a proportion of previous year's debt to GDP ratio should be added to the current fiscal deficit relative to GDP. This fraction applied to previous year's debt to GDP ratio depends on current real growth and inflation levels. Higher the levels of current growth and inflation, the lower would be the increase in the current level of debt to GDP ratio.
Following from Equation (5), we can also write: The relative contribution of the two terms on the righthand side in explaining the increase in the debt-GDP ratio between two successive years namely t and t-1 can be written as: In a normal year, and are positive and the entire second term enters with a negative sign.
However, in a crisis year, when the growth rate contracts, would be negative while may continue to be positive. The contribution of the second term in equation (7) can be divided into two terms with associated signs as indicated below: in the 1980s and 1990s. Using a VAR model with debt feedback, Cherif and Hasanov (2012) conclude that when the economy is weak, the safest policy for reducing high level of public debt is to stimulate growth as compared to the option of introducing fiscal austerity and/or high inflation.
In Tables 3 and 4 India, however, was able to show a contraction in its debt-GDP ratio of (-)1.7% points while Indonesia showed a contraction of (-)3.8% points. In these cases, the contribution of the growth factor to the increase in government debt-GDP ratio was negative.  Table 4 shows the impact of Covid-19 on the government debt-GDP ratio of selected countries and the relative role of its determinants. A major reason for a sharp increase in the government debt-GDP ratio in the Covid-19 period is because of the expected contraction in the growth rates of both developed and developing countries. The average percentage contribution of the growth factor to the increase in government debt-GDP ratio is expected to rise to 37.5% in 2020 as compared to 23.6% in 2009. Clearly, Covid-19 is turning out to be a far more serious crisis, having its impact on countries' economic and fiscal parameters.  Germany, there was no slippage. In 2020 however, the projected slippage in government debt levels for these three European economies is expected to increase significantly to 58.5% points, 101.5% points and 13.2% points respectively. Similarly, in India, the deviation of general government debt from the limit of 60% is forecasted to rise to 28.9% points in 2020 (FY21) as against 12.3% points in 2019 (FY20). In South Korea, the slippage from the public debt limit of 40% is forecasted at 8.4% points in 2020. Table 5 shows the slippage in the government debt-GDP levels of the selected counties with respect to a common benchmark value of 60%. Except for some of the oil and mineral rich countries, the slippage has been building up even before the onset of Covid-19. On average, it was 14.9% points in 2019. Within a short span of two years, the Covid-induced spurt in slippage is likely to amount to 16.4% points. Experience of previous crises has indicated that the private debt levels may also rise in tandem. Further, once countries become used to a higher debt-GDP level, due to downward rigidity, there may be considerable difficulty in reducing this slippage. Thus, both the fiscal and financial systems of the global economy are likely to become much weaker even after the health and growth situation becomes normal. These effects are expected to last much longer. We have indicated that the substantive upsurge in the government debt-GDP ratio is because two of its three determinants namely, fiscal deficit and growth supplement each other in a pandemic year leading to an increase in the government debt-GDP ratio. This is because growth rate becomes negative. There is thus a policy trade-off in dealing with the pandemic. A higher fiscal deficit within a country could be justified if it can minimize the contraction in its growth rate. Furthermore, there is a case for coordination amongst major economies of the world in implementing their fiscal stimuli. A joint and well-coordinated effort to stimulate major global economies may help minimize the contractionary export effect of the pandemic. In 2008 crisis, such a coordination was consciously attempted within the G-20 framework. But in the Covid-19 crisis, such a global coordination of stimulus efforts is notably missing.

Concluding observations
An overview of evolution of government debt relative to GDP over the period 1996 to 2019 for a set of 19 countries of the G-20 group indicates the following trends:

Appendix-1: Decomposing change in government debt-GDP ratio: methodology
Change in the government debt-GDP ratios in any year t may be defined as: Here, and − denote the debt-GDP ratio in the year t and t-1 respectively. is the fiscal deficit to GDP ratio in year t which is defined as change in the level of debt relative to the level of nominal GDP, that is, refers to the nominal growth rate which can be expanded as the sum of real growth rate and the inflation rate, that is, = + + Equation (1) can be written as follows after ignoring the interaction term ( ): We can write equation (3)  Ignoring the third order terms again, this may give us a close approximation of the evolution of debt relative to GDP.
The above equation can also be written as: Ignoring the product term, contributions of real growth and inflation to the evolution of debt can be separated by re-writing this equation as: 8 The expansion of Taylor series using binomial theorem can be given as: Thus, a negative growth rate will contribute positively to the increase in the debt-GDP ratio in addition to the contribution of the current year's fiscal deficit relative to GDP. In fact, if a country experiences a price deflation in a crisis year, even the third term would contribute positively to the increase in the debt-GDP ratio. However, as long as inflation remains positive, there would be some counterbalancing effect of the inflation factor on the increment in the debt-GDP ratio between two successive years. i In Saudi Arabia, the medium-term public strategy statement within the Budget specifies the government debt target. The target was set at 30% of GDP in 2016 and has been subsequently revised to 50% of GDP in 2020. Both the government debt levels in Saudi Arabia in 2019 and the projected level in 2020 are much lower than the respective debt targets of 30% and 50%. In Indonesia government debt level at 30.5% of GDP in 2019 is well below the 60% debt ceiling. Debt-GDP ratio is projected to increase to 38.5% in 2020.