Many commentators are highly critical of the Government given the high debt held at present, particularly so, as the Minister of Finance has told us that the Government is short of money and had to revert to both the Heritage and Stabilisation Fund (HSF) and borrowing to continue to run the economy and support those disadvantaged by the pandemic and the continuing recession.
The concern is that even though interest rates are relatively low, such a debt burden is much above the recommended rate of some 60 per cent of debt/GDP — approaching 90 per cent. Some even talk of the impending collapse of the economy.
Indeed, the conventional wisdom is that there is an absolute limit to the amount of debt a government can hold; the penalty is default and hence governments should observe fiscal discipline and avoid this like the plague. Further, the cost of debt service must be affordable even for future generations. Hence in such a situation a government should maintain debt at affordable levels even if it means austerity and that certain investments may not be made that could develop the economy that would be worthwhile to the population.
However, an article by Oliver Blanchard of the Peterson Institute of Economics, “Public Debt, Finance and Welfare Costs in a Time of Low Interest Rates”, casts serious doubts on this entire basis of austerity for which the IMF was renowned. Indeed, the conclusion of this article is that for economies in good standing a government’s debt limit appears to be infinite!
The idea behind this is that government debt is usually measured as debt/GDP and traditionally sustainable debt models assume governments will run a primary surplus sufficient to pay back the debt over a defined time horizon. But governments in good standing generally do not repay debt, they refinance it. So what really matters in debt affordability is the debt service cost. Thus “sustainable” here means that the interest on the debt must be comfortably payable from current income.
It is easy to see algebraically that a government can increase its debt without an increase in its nominal debt/GDP measure if this increase in debt as a fraction of the existing debt is at most equal to the growth rate of its GDP—in fact if this fraction is less than the GDP growth rate then the debt/GDP decreases—the traditional debt burden reduces. Hence, as long as the government can comfortably repay the interest, debt can be continuously increased with no increase in debt/GDP if the growth rate in GDP is adequate. Indeed, governments can include the yearly interest as an increase in debt without increasing debt/GDP if the interest rate is less than or equal to the GDP growth rate. Hence the real limit on debt held by a government is what it can afford as interest, subject to GDP growth.
The situation T&T will find itself in at the end of the pandemic is one in which it has to reconstruct the economy, both in building a new onshore export sector to replace the decreasing export earnings of the energy and petrochemical sectors and restart its current mainly non-tradable onshore sectors.
However if the new debt can also be deployed so as to increase GDP as opposed to simply funding the current account such that the growth rate of the GDP is greater than the long term average of the proportion of the existing debt being incurred, with the plan to refinance long term debt, a high debt/GDP is of little concern.
The existing financial environment with low interest rates and T&T’s good credit rating is indeed well suited to increasing government debt to help diversify the economy so as to maintain an adequate GDP growth rate.
In a previous article, “Post-pandemic economic threat”, I considered Ewart Williams’ idea that the HSF becomes a fiscal asset; using debt in conjunction with this asset presents an interesting opportunity to fund both the diversification of the economy and its restart after Covid-19.
However, at the recent presentation of the Report of the Finance Standing Committee by the Minister of Finance, he told us that the Government had to increase its expenditure for 2021 by $2.9 billion to meet “inescapable obligations”. These included salaries/wages, goods and services particularly for the health sector, vaccines and salary relief grants.
Further, there was a revenue shortfall of $2.5 billion—reduction in taxes on income and profits from oil companies, significant reduction in royalty payments. Though oil production was as expected and the price a bit higher, natural gas production (as the main income earner) was below projection and on average its netback price was lower than expected.
Without a resurgence of the natural gas sector the economy in the short term is in a critical state. Still, there is hope that in this period of transition to a low carbon economy worldwide T&T’s energy sector, with its proven gas reserves of 10.7tcf, could again be buoyant via the use of gas.
Some tell us that we should have used debt to build GDP when debt/GDP was 60 per cent. However, we now have a political and economic system with different initial conditions, e.g. debt/GDP approaching 90 per cent and an underperforming energy sector.
As to the question of what we do with debt, the Minister of Finance appears to have chosen no social austerity, continued support for the pandemic disadvantaged with an increase in non-productive debt in the short term to meet his current account shortfall given his good credit rating now.
Note though, that the IMF has an emergency low interest Covid-19 relief fund that does not carry the normal conditionalities, which the Minister must be aware of – he admitted that he is talking to the IMF.
— Mary K King is an economist