Posted in Finance Articles, Total Reads: 2817
, Published on 21 October 2011
Today, the puzzle ‘Global debt’ has unveiled into a monstrous crisis, posing a huge challenge to the world. Global debt, as the name suggests arises when a country faces a daunting task of repaying the debts, while the revenue is sufficiently low. What follows is a vicious circle of recursive debt, to manage the country and pay off the old debts. Soon, the bubble of recursive debts bursts and the nation is left with no money to spend. The policy of taking more debts to pay off the older ones is a dangerous proposition, as it results in accumulation of debts, which ultimately leads to a point where it becomes difficult to pay off the debt anymore. Taking debt is no problem, until the borrower has the potential to pay it off. Recursive debts incur the risk of replenishing the potential of debt borrowing and tag a higher risk to the borrower. The world is conspicuously on stranger tides, as the situation turns out of control.
The origin of the crisis spans back to late 1940s1, during the world war, when the colonial countries were getting liberated from the ruler countries. Lack of financial independence, obligations of repaying the debts which their rulers owed and need for sustenance after independence left the countries with no choice but to accept debts from International Monetary Fund(IMF). Civil unrest, autocracy and other emergency situations worsened the debt status of the third world countries, leading to massive lending followed by major defaults. A complacency of taking fresh debts to pay off the older ones and periodic glitches of crisis worsened the debt status of developed countries. This ultimately led to the rising aspirations(of earning money) turn into rising apprehensions(of losing money).
All nations are interdependent (in terms of investment, outsourcing, trade, partnership, etc). Thus, a slide in a nation causes a cascading effect and thus accelerates other nations towards a slide, causing international crisis. As an instance, the recent downgrading of US credit ratings(a proxy of country’s ability of returning a debt) caused a panic in the market, leading the foreign investors to take out their fingers(i.e. investments) from the burning fire(i.e. US market). The attempt of Greece to curtail its rhetoric deficit, met with a harsh consequence when the actual deficit value was found out. Unfortunately, Greece ran out of options and had to take austerity measures in order to accept relief package from IMF to avoid crisis2.
The world has sensed the potential of crisis occurring in nations, and applied measures to quell the escalating debt crisis. One of the measures was austerity in which the borrower acted in compliance (i.e. follow stabilization measures, etc) with the specified measures by the lender. Programs such as HIPC(heavily indebted poor countries)3intended in providing debt at lower interest rates in order to cancel or reduce external debt payments to sustainable levels, were introduced to solve the debt crisis of poor nations in Africa.
Imposing austerity measures limits the spending power of a country, resulting in halting the scope for growth. Disinvestments, imposing higher tax rates, lower allowances and limited spending4 are the direct consequences which might give rise to indirect consequences like public dissatisfaction5, low motivation and limit on research(due to limited funds). The program HIPC was criticised for its long tenure, lack of action by IMF and World Bank to cancel any debt until the completion point, undermining poverty reduction efforts, debt sustainability and excluding countries with unsustainable debt burdens even upon reaching the point to abolish debts till the point6.
Unfortunately for the world, the problems such as escalating debts, lack of funds, inflation(supply too low to be matched by demand) and many others continue to appear today. Countries continue to risk taking debts to pay off the old debts. The debts have reached/exceeded the stage of Gross Domestic Product (the income earned). Efforts to raise more currencies by devaluating money(where the price of one unit of money depreciates) has lead to inflation, as the price of commodities stand the same as before(it is the value of money that weakens this time). Thus, we head to a point where there is lack of money to buy goods(i.e. inflation). To make the matter worse, the government has the only option of borrowing money to rescue the nation. The potential scope of investments by foreign countries is jeopardised as a result of the events.
While it can be understood that there cannot be a one-stop shop solution to the problem, efforts can be made to control it. Educating citizens about the scenario is the first and foremost step that is needed for combating the flame of debt crisis. People across the globe have to realise that they are the primary stakeholders of the problem, and problems like these pose a strong likelihood of snatching away their last piece of bread. External auditing, banking agencies and watch dog institutions have to be assessed over their rationale of any ratings, statements and comments issued which has direct/indirect impact on world economy. And ultimately, governments need to be questioned over their motives of any financial decision/policies made.
Educating citizens is vital step towards solving the problem. Initiatives like the education section introduced by RBI, India7, have to be made mandatory in all financial, audit and rating institutes. Media can prove pivotal element in making people aware. Partnerships with NGOs, educational institutes and popular icons(willing to serve for national interest) can serve useful in spreading the awareness and educating the citizens. The role of foreign countries would also be an important element in having the step implemented.
Each and every decision of financial, auditing, rating institutes and recommendations of financial experts have to be reviewed by foreign nations followed by questions and recommendations if any. Collective interest of countries would pose as one of the aids in achieving consensus amongst countries over judging the credibility of a review or comments issued by financial experts and institutions. Debates and essay on these topics must be encouraged by educational institutes to learn the reaction of students on the decisions.
Finally, the government needs to be consistently questioned and policies to be reviewed constantly in order to check the complacency or hastening that can occur and lead to major economic disaster. Gauging the reactions of financial experts in educational institutes and researchers would also help in understanding the credibility of government decision and also draw suggestions which would help us in solving the problem.
A change is definite to pose some risks and downturn due to correction of errors, although the change for betterment always yields positive growth in long term. In the context of consequences after implementing the solution, we can certainly expect economies of countries to dip(as there would be arrest over the government act of recurring debts, prudent approach by financial institutes and experts while posing any opinion), which is good for short term as per conservative principle of accounting which states ‘to note the anticipated expense and ignore the expected revenues’. Caution should be maintained so as to minimize the period of economic dip, which might arise after implementing the solutions. The only hope we have now, however, is that the timer of the “bomb of debt’ should continue ticking for some more time.