Covid-19 has had a truly global impact, which has resulted in governments across the world utilising every available fiscal tool to address the health emergency and to support vulnerable households and businesses.
The huge sums being spent may have negative implications in the long term but have been necessary in preventing a more serious catastrophe.
On March 20, the European Commission activated the fiscal framework's general escape clause, removing restrictions on government spending set out in the Stability and Growth Pact (SGP). Governments have spent unprecedented amounts in an effort to tackle both the health crisis and economic fallout. The global fiscal spend in response to Covid-19 has been more than $6 trillion*, which represents nearly 6% of global annual GDP. The International Monetary Fund (IMF) has also made available an additional $250 billion to the poorest and most vulnerable countries as part of its Catastrophe Containment and Relief Trust (CCRT).
Despite the nature of the crisis being health related, just 10% of the total spend has been used to support the health sector. The majority has helped to prop up the wider economy as it struggles to cope with economic shutdowns, in the form of keeping people employed, subsidising small and medium-sized enterprises (SMEs) and public investment. Governments have also deferred certain payments, including taxes and social security contributions which will cause deterioration of the budget balance in 2020, but improve it later.
In the UK, the Government has spent approximately £187 billion (around 9% of GDP) which has primarily gone to the Coronavirus Job Retention Scheme (CJRS), or Furlough, with a significant proportion also going towards additional funding for the NHS.
The cost of borrowing
Taking on debt has been sensible in the current environment, preventing mass bankruptcies and unemployment and allowing the public to face the prospect of lockdowns without fear for their personal finances. This is particularly true for advanced economies where the cost of debt it currently very low. But just how much debt has been taken on and what are the potential implications?
The debt-to-GDP levels in developed economies have been driven to over 120%, close to the peaks seen in the Second World War. Debt-to-GDP ratio has spiked for all countries, with the UK set to reach 101% by 2021, the U.S. 146% and Japan 265%. Globally, the debt ratio is set to surpass 100% for the first time ever. Governments may choose to transfer some of the debt burden to future generations by issuing long-term government bonds such as 50-year or 100-year bonds. This was a strategy used by the UK Government during war time, with the WWI debt only being paid off in 2015.
Such high levels of debt may be a cause for concern for investors as the perceived risk of default increases. High debt levels may also lead to inflation expectation increasing, as governments may be tempted to increase the money supply to finance the debt. These factors may encourage investors to sell government bonds due to the increased perceived risk, increasing the cost of borrowing for governments and thereby reducing their ability to deal with similar shocks.
Although government spending figures seem uneasily high, the introduction of a vaccine immunisation programme should result in governments directing their spending towards designing policies to create jobs, boosting economic activity and facilitating the transformation to more resilient, inclusive, and greener economies.
Trustees should be mindful of how significant impacts and trends as a result of the pandemic could impact their schemes in the coming months and years and work with their advisors to ensure their asset allocation remains suitable.
*figures are as at 11 September 2020
Spence & Partners Limited is authorised and regulated by the Financial Conduct Authority in the conduct of investment business.