A government debt crisis is the inability of a country’s government to pay the interest on its debt. It has the power to leave the economy crippled. Creditors lose confidence in the government and start demanding a higher rate of interest. The European Sovereign Debt Crisis and the recent case of Puerto Rico are classic examples of debt crisis.
The European crisis erupted around late 2009. It ultimately lead to several states like Greece, Portugal, Ireland, Spain and Cyprus requiring third-party assistance for the repayment of their government debt. The Global Financial Crisis hit Greece in 2007-08. Firstly, various credit rating agencies gave its government debt the “junk” status. Secondly, unemployment rates increased in Greece and Spain, followed by widespread poverty. Government policies of increasing tax and reducing expenditure caused social unrest. For instance on 1 May, 2010 the Greek Government announced a series of austerity measures. It secured a three-year €110 billion loan which was met with anger by some Greeks. It lead to massive protests, riots, and social unrest throughout Greece.
There is an ongoing crisis in Puerto Rico with more than US$70 Bn of outstanding government debt, and a debt-to-GDP ratio of about 68%. Also, being home to only 3.5 Mn people there is an alarming debt burden of $34,000/ person. With few options for generating tax revenue, Puerto Rico is in a state of distress and needs a well-organised budget plan in place for the repayment of its debt.
Collapsed economic development model, the misuse and overuse of debt issuance, and an inefficient tax revenue collection system are some of the factors that have contributed to tripling the public debt in Puerto Rico.
According to an analysis by Forbes, the countries which are most likely to face a debt crisis within the next three years, in order of likely severity are China, Australia, Sweden, Hong Kong, Korea, Canada, and Norway.
China is facing a major debt problem with Moody downgrading its Sovereign debt rating. Its ratio of broad money supply (M2, or cash plus bank deposits) to GDP was running at 208 % at the end of 2016. It was 60-70 % points greater than what international standards prescribe. One can explain this the fact that China has a bank-dominated financial system. Moreover, the economy is also characterized by overall high leverage ratio. It can be attributed to its unusually high savings rate and inherent acceleration mechanism in its monetary policy. This implies that money supply expands during both good and bad times. However, Chinese policymakers have identified these issues soon enough. They are on the right track in addressing the country’s debt problem.
Growing threat of debt crisis, globally, necessitates the incorporation of a bankruptcy code. Also, all governments should follow it just like other smaller entities in a country. International Organisations should appropriately define a code of conduct for such cases. Poor governance, budget planning, and risk management skills of ruling authorities of a country have led to the downfall of many countries. Thus, it’s vital that governments identify the early signs of a crisis and take suitable measures to avoid a debt crisis. Governments should have appropriate internal controls in place to ensure efficiency in the system. It ensures that their economic development model doesn’t collapse, like in the case of Puerto Rico.Add to favorites