Deleveraging Government Balance Sheets

In many countries in the world today , the government borrowing has reached a level whereby more borrowings would put a strain on the economy and growth. In some countries, the borrowings had exceeded the acceptable limits and threatening the viability of the Economic systems. The accumulation of debt in many countries was accompanied by good growth. But when the growth slowed down and witnessed a flattening trend, the servicing of Government loans alone had consumed lot of resources generated by the government.

Reduction in interest rates as a part of the stimulus in the recent years, enabled governments to borrow funds at cheaper rates thereby reducing the pressure on account of high interest rates. But this trend cannot continue for a very long time and interest rates have to move up.

The countries which have high foreign debt have very high economic risks and the ones having high domestic debt are protected from high forex volatility. The ones having high domestic debt have high adaptability and flexibility and hence there is a need for countries to be careful when the foreign debt is being accumulated in the form of sovereign bonds and corporate debt.

Going forward, Governments across the world have to develop focussed debt management strategies and maintain the debt within the manageable levels and ensure orderly economic growth. There is a need to deleverage the balance sheets of the governments.

1. Achieve higher GDP growth through improved productivity of funds / resources. Since economic systems across the world had grown large and complex , there are many inefficiencies in the system. By focussing on productivity of resources, the need for capex by governments could be reduced, the surplus from deployment of assets would increase thereby reducing the need for large incremental debt funds for growth and service. The countries which have good economic growth rates will have an advantage in achieving this objective and reduce the need for borrowed funds and also the ratio of borrowed funds to the GDP could be held at healthy levels.

2. Maintain an inflation level of 3 – 4% p.a. Though inflation is a market determined variable in many countries , this is being controlled in many countries through government intervention and policies. The countries which are growing would be in a position to reduce the debt burden through inflation but there are many countries in the world which are having very low economic growth and low inflation and they would find it difficult to manage the debt and debt servicing.

3. Reduce the interest rates. This is the strategy being followed in the recent past whereby the governments  resort to very high borrowings, which did not result in high burden on interest servicing. Low interest rates make the loans affordable and repayment capacity is being enhanced.

4. Privatise the Government owned organisations. The role of government in initial phases of industrialisation was to establish the essential industries for Economic growth and in the present context , the government has to play a major role in orderly and stable economic growth. Since in many countries the level of industrialisation is very high, the need for government to invest in major industries is limited. The private sector in many countries are well developed and they will be in a better position to take over the so called essential industries. The governments can even look at disinvestment to the extent of 100% in the sectors where they are present and to reduce the forex loans, they could even invite foreign companies to take over the assets. This will generate funds .

5. Fund mobilisation. While raising funds, the governments could look at raising funds through the equity structure or equity type instruments, wherever the vehicles for raising resources are available. Only in case, the options for raising equity based funds are exhausted, the government could borrow through debt instruments.

6. Sources of funds. The emergence of capital markets offers many options for governments to raise funds through various sources. The options for raising funds could be based on the tenor of the funds available and the interest rates. The preference could be for sources from which concessional funding is available for long periods of time. The prioritisation of the sources based on similar criteria would enable orderly raising of debt.

7. Dividend. In many countries, still the government companies are one of the largest in their sectors and they continue to make good profits. The companies which make a very high surplus can pay generous dividends to the shareholders thereby, the governments also benefit through receipt of higher dividends.

8. Negotiate with Creditors for reduction of debt. In many instances, the countries had accumulated very high level of debt, which is not justified considering the size of the economy and repayment capacity. If the lenders and investors had made careful decisions , then the countries could have not accumulated large level of debt beyond their capacity to repay. The lenders , investors should have taken precautions and done the due diligence in investing in such instruments. Partly lenders are responsible for big debt accumulation. Hence, when it comes to debt restructuring, the lenders have to take a cut in valuation of their investments. Based on the future ability to repay, the country in distress would be able to extract a discount on the outstanding loans from the lenders.

9. Government Expenditure. In well developed and advanced countries where the growth potential is very low, the need for higher government expenditure is limited. In fact, the countries which have low potential need to look at improving the productivity of the resources and in line with the technological developments increase the productivity of the manpower and other resources. The non essential items and the ones with high cost implications in relation to the productivity could be considered for cost reduction. Manpower is one area which offers a very big scope for improvement in productivity. Subsidies is another area which offers lot of scope for reduction. Instead of providing subsidies, loans through directed lending by banks could support the targeted beneficiaries which will also help in creating enduring employment and sustainable businesses. The expenses on aid to other countries, defence and supporting new industries like renewable energy , offers scope for reduction of government expenditure.

10. Taxation. In many countries , when the tax rates were slashed, the revenue collection witnessed a multifold increase. The countries where the tax rates are very high, the tax compliance levels are very low. Some countries are in a very bad shape and there is a scope to  raise resources from those who are earning very high income . The countries where the residents had parked their income abroad without declaration, tax amnesties could be given and voluntary disclosure schemes could be introduced. Depending on the circumstance, the increase / reduction of tax could be looked at and voluntary disclosure schemes could be introduced.

11. In an initiative to create competitiveness, the countries allow currencies to depreciate. In the short term, it creates competitiveness but when the country relies on borrowed funds for growth especially through external borrowings, the depreciation of the currency leads to undesirable efforts in the long run . The value of external debt in relation to the borrowing country’s currency goes up. The strategy of achieving competitiveness should be approached with big caution to ensure that it is not going to  be a burden in terms of higher debt going forward.

12. Land. In high growth countries, the land in growing regions are in great demand and since Governments in many parts of the world were the early ones to set up industries, they own prime land in cities and growing regions. Governments also develop new centres of manufacturing and services. Sale of land can be a big source of funding for government which can reduce the need for debt. Many of the government companies which are in old industries, not doing well, own prime land and these companies can capitalise on the land to generate funds which could be given to the government in the form of dividends.

13. Looking at many countries balance sheets today, it appears that they would not be in a position to service even the existing debts. Adding more debts would worsen the situation making the economic viability of the country in jeopardy. In such cases, the scope for printing money without creating debt could be looked at. In the earlier post, I had discussed the criteria which could be looked at for creation of money without debt.

14. In many instances, governments have huge outstandings to be collected from other countries, corporates and individuals. The delay occurs due to many reasons including legal proceedings. The governments can identify action plans to collect the outstandings. Especially, the legal proceedings with Government departments and Government enterprises could be concluded through a separate mechanism to be created by governments. On the debt to be collected from corporates and individuals , action plans could be identified to collect the same.

15. There is a lot of cross border , mutual debt existing between countries. At the country level, an institution could be created for consolidating all the debt from within the country and from outside the country ( this could include even individual and corporate debt ) on country wide basis. The pooled debt through a process or through an international institution could be extinguished through a mutual process of consent. The foreign debt extinguished in the case of Individuals and Corporates could be substituted through local /domestic debt. This would help the Country to maintain good credit rating at the country level and help the borrowers from the country to obtain low rate of interests for foreign loans.

R.Kannan

Eurozone Exit – Cost Effective Solutions

The Eurozone was created with a view to achieve higher growth, leverage synergies , reduce the cost of trade and transactions. During the course of existence of Eurozone , many of the benefits accrued to member countries. But it also enabled countries with less financial resources to raise funds from the markets at very attractive rates. This has resulted in huge borrowing by member states without looking into the feasibility of  accumulating a large debt relative to the size of the economies.

After the global crisis and reduced Economic growth rates in these countries, the huge debt started threatening the viability of well established Economic systems. Creation of Euro zone did not result in consensus of political views or harmonisation of the Fiscal systems  across the countries in the Union. The flexibility of countries to adapt the monetary policy was lost. The interdependence on other countries and banks from other countries in the zone had increased. There is an immediate need for the member countries to stick to a common code for managing the finances and follow the austerity measures as required. Despite an urgent need for such measures, there is no support for following these measures in toto by Political parties and members from the society in the member countries.

The immediate economic growth prospects for many of the member countries are very bleak and measures were taken by IMF and ECB to provide stimulus to the economies. Whatever the measures being taken, the scope for achieving a positive growth for next two / three years for some of these countries looks very bleak. The countries have to accept the fact that there will be a negative growth for the next  two/ three  years and take measures to kick start the growth in the following years. The austerity measures are required. If they do not want to follow the common code, then it is going to affect the performance and prospects for the entire European Union and make the task of revival more difficult.

To provide flexibility and higher level of adaptability, it would be a  better option to allow the members to exit the zone. There are fears that the local currency would be devalued and it will create a systemic crisis which would be even worse than we had seen so far. The process could be made smooth and painless by  implementing the following action points.

1. Peg the currency to the Euro. ( Initially)  Allow a Exchange  variation of 0.5% against Euro from the previous day for every day. Cap the maximum variation of the currency for the whole year to 5% . At the max, the currency can depreciate or appreciate by 15.7% in three years. This will bring predictability and certainty to the investors.

2. Government / Central bank of the exiting country have to play a major role in controlling the inflation / deflation by closely monitoring the Demand / Supply of products and services.

3. On the day of exiting the Eurozone, convert all the external loans outstanding with lenders from outside to the local currency loans on par with the Euro. For one Euro – one Local currency could be given. The lenders benefit / lose as and when the Currency appreciation / depreciation takes place.

4. Continue the Aid programmes as planned by IMF and  ECB.

5. Reduce the Foreign Debt. Through Restructuring of the debt and debt reduction by negotiations . Extinguishing the cross balances of debt with other countries, banks from other countries and others. This strategy could be adopted for all the countries in the Eurozone by creating a mechanism whereby overall debt reduction could take place.

6. Bank Lending. Provide incentives for banks to lend . Set higher targets for  credit / deposit ratios . Focus on lending should be to create manufacturing industries and Entrepreneurs.

7. Since most of the banks are weak and require additional capital, the government has to induct more capital in to these banks.

8. Considering the poor immediate growth prospects, it would be difficult to achieve a viable economic model with the outstanding loans and the servicing costs of these loans. Hence, the country exiting the zone could be allowed to print money without creating Debt. This limit could be set at 25% of the total currency in circulation.

9. Prepare a comprehensive turn around plan for the country with a defined objective of increasing the competitiveness rank in three years. Identify the items imported which will not help to improve the productivity in the immediate future and reduce the import of these items to improve the trade balance.

10. Continue the free flow of resources with the  other Euro Zone countries.  The free flow of people, resources should be continued without any restrictions.

11. Focus on Manufacturing growth. Revive the old  industries and give incentives for setting up Small scale and Medium Scale industries. Develop county wide vocational training plans and give a big focus on vocational education on the similar lines of the practices adopted in Germany.

12. Develop the Tourism, Education and Services Sector. Create Specialised growth zones for these sectors. This will create lot of  employment.

13. Apart from focussing on creation of additional employment, formulate strategies for developing large number of entrepreneurs. This could be facilitated by National vocational training programmes. For example India has the largest number of entrepreneurs in retailing.

14. Government could guarantee all the deposits made in the banks. Since the currency is pegged to Euro, the flight of deposits to other countries could be reduced to a great extent.

15. Since the growth prospects in the immediate future is very bleak, there is an immediate need to put austerity measures in place. The government can identify all the non essential expenditure and postpone them by three years. The pension to the employees for three years can have a cap. There will be a reduction for those who are getting very high pension. Freeze the recruitment in the government. Freeze the salaries at the present level for two years.

16. Create new manufacturing zones. Announce fiscal incentives for large investments. Liberalise FDI rules. Open Most of the sectors for FDI.

17. Create a National Revival fund. Request the Wealthiest and those who are in high income bracket to liberally contribute to this fund.

18. The member exiting for all practical purposes to be treated as a part of the Euro zone even after exit and Status quo could continue in terms of Political, Economic and Trade relations. The only difference would be the flexibility of the exiting country to decide its monetary policy and the effects of the performance of the exiting country would not have any immediate bearing on the Eurozone as a whole.

R.Kannan