Crisis approaching? Morgan Stanley: The United States has only "a few years" to solve the ongoing debt issue

As the debt-to-GDP ratio of developed countries sharply rises during the pandemic, concerns about debt sustainability are gradually emerging.

Morgan Stanley pointed out in its latest report that the global interest expenditure as a percentage of GDP will increase from the current 2.5% to 3.5% by the end of this decade, making debt sustainability a focus for the next decade or even longer.

During the pandemic, the increase in debt due to fiscal expansion, coupled with GDP contraction, has become a reality.

Although the rapid growth of nominal GDP partially offsets the denominator's decline as the economy recovers from the pandemic recession, as inflation falls and economic growth returns to normal, the debt level (numerator) will once again become a focus.

Morgan Stanley provides a framework for analyzing the evolution of the debt-to-GDP ratio in developed market economies, with its forecast indicating:

There are significant unsustainable risks in debt levels, especially in the coming years, as the cost of debt burden converges with market prices, necessitating fiscal consolidation to stabilize the ratio of debt to GDP.

The complexity of the debt issue lies in the fact that there is no simple answer to determine a safe threshold for the debt-to-GDP ratio. Seth Carpenter, Chief Global Economist at Morgan Stanley, pointed out:

Considering that the average maturity of sovereign debt in developed countries is between 5-10 years, government debt is still adjusting to generally higher nominal interest rate levels. This repricing will lead to a turning point, where the cost of debt begins to accelerate. Based on rough estimates from the forward curve, the global interest expenditure as a percentage of GDP will increase from the current 2.5% to 3.5% by the end of this decade.

For most countries, the current primary deficits are far above sustainable levels. This gap is most pronounced in some of the countries with the highest debt levels - the United States, France, and the United Kingdom. To stabilize debt/GDP, these countries need to reduce primary deficits to below pre-pandemic levels in the coming years, making debt sustainability a topic for the next decade or even longer. Additionally, fiscal outcomes are policy choices, not economic outcomes.

Morgan Stanley cited the example of France:

As the second largest economy in the Eurozone, doubts about its fiscal stability could have wide-ranging implications. According to recent data, France's debt/GDP exceeds that of Spain but is still below Italy's nearly 140%.

Markets have been considering Italy's fiscal situation for decades, indicating that there are no simple threshold measures. In other words, Italy needs a primary surplus to stabilize its debt level, with an average primary surplus of 1.5% in the decade after the global financial crisis and before the COVID-19 pandemic In addition, Morgan Stanley reminds that the proportion of US interest to GDP reached its peak in the early 1990s, and during that period and afterwards, the primary balance often showed a surplus. History has shown that even with an overall deficit, a primary balance or surplus is possible, so it is necessary to distinguish between the primary fiscal balance (including interest payments) and the overall fiscal balance (excluding interest payments)