Public finances in several developed markets (DMs) look exposed when the next recession eventually strikes, with potential negative consequences for some sovereign ratings, according to a report by a leading rating agency.
In a recent report for its clients, Fitch Rating said its analysis of major recessions since 1980 underlines their severe impact on budget deficits and public debt/GDP, which remains elevated in many countries in Western Europe and North America, even with the global economy in its ninth year of expansion.
Of course, Fitch is not forecasting a global or DM recession. In its latest Global Economic Outlook, the agency projects DM GDP to grow by 2.3% in 2018, 2% in 2019 and 1.7% in 2020. “Nevertheless, there will be another recession at some point. And it is becoming more likely as the already long expansion matures. Rising US interest rates, trade wars, higher oil prices, China deleveraging and stress in some emerging markets pose risks,” the agency said.
Fitch also analysed 58 major recessions (involving a decline in GDP of at least 2% and duration of at least two quarters) across 22 of its rated DMs in Western Europe and North America since 1980, and noted: “The median fall in GDP was 4.4% and there were seven recessions involving a drop in GDP of at least 10%. The median duration was five quarters and DMs were in major recessionary periods around 10% of the time on average.
“The median deterioration in the general government budget balance in these major recessions was 4.3pp of GDP (measured from the year before the start of the recession to its peak during the recession or in the following two years).”
For general government debt, Fitch found that the median increase in these major recessions was 16% of GDP (measured from the year preceding the start of the recession to its peak in the recession or the following two years). Eleven recessions saw a jump of over 30% of GDP.
Fitch projects the US will have the highest general government deficit, at 5.0% of GDP in 2018, rising to 6.0% in 2019. This is almost double the next highest: Spain at 2.6%. If the US deficit were to widen by the median amount seen in the previous four US recessions (3.1pp of GDP) it could exceed 9% of GDP.
The countries with the highest projected general government debt/GDP at end-2018 are Greece at 183%, Italy at 131%, Portugal at 122%, Cyprus at 110%, Belgium at 102% and the US at 101%. “If it were to increase in line with the median deterioration in a major recession across the 22 DMs since 1980 of 16%, then public debt would increase sharply to levels incompatible with current ratings in many countries,” Fitch said.
Several countries have allowed a long-term upward trend in public debt, with it typically plateauing during economic recoveries before ratcheting up in recessions. Others have track records of debt reduction to build fiscal space in good economic times.
Fitch sees “limited tolerance” to absorb significant deterioration in public finances at current rating levels for those sovereigns with relatively high public debt or weak track records of fiscal consolidation.
Austerity fatigue, demographic trends and the rising support for populist political parties will likely make it even more difficult to reduce budget deficits and stabilise government debt/GDP in the aftermath of the next recession, the agency concluded.
