The McKinsey Global Institute (MGI) has issued two updates to its January 2010 report “Debt and Deleveraging: The Global Credit Bubble and Its Economic Consequences.” Its first and brief update, issued last July, found that the total debt-to-gross domestic product (GDP) ratios in most major economies stabilized and in some cases had started to decrease only slightly. But in many countries the decline in private sector debt was offset by a significant rise in public sector debt due to the Great Recession that resulted in higher government expenditures and lower tax revenues. It concluded that deleveraging had just begun, with the speed and pattern varying across the major economies. Last month the MGI issued its second and full 64-page update “Debt and Deleveraging: Uneven Progress on the Path to Growth.”
This latest report covers the same sample of the 10 largest advanced economies (the US, Japan, Germany, France, the UK, Italy, Canada, Spain, Australia and South Korea) in the January 2010 report. The composition of total debt, in terms of the shares of households, nonfinancial corporations, financial institutions and government, varies widely among these countries. The report pays special attention to the US, the UK and Spain, which are facing different challenges in easing their debt burdens. For relevant lessons from history it examines the banking crises and the deleveraging episodes of Sweden and Finland in the 1990s. It discusses six indicators, derived from the experience of those two Nordic countries, which can help business and government leaders monitor progress in deleveraging.
Here is a summary of the major findings: (1) Deleveraging is in its early stages in most countries. Total absolute debt has actually risen in the world's 10 largest advanced economies since the 2008-09 global financial crisis, with the total debt-to-GDP ratio declining in only the US, South Korea and Australia. (2) The experiences of Sweden and Finland in the 1990s show two distinct, yet overlapping, phases of deleveraging. In the first phase, the private sector (households, corporations and financial institutions) debt decreases substantially over several years, the economy either contracts or grows slowly and the public sector debt increases. In the second phase, as economic growth accelerates, the public sector debt decreases gradually. (3) The US is now progressing in the first phase and could complete it in two years. But the UK and Spain are yet to enter the first phase and they could spend up to a decade in it. Spain has fewer options in deleveraging because as a eurozone member it lacks its own monetary and foreign exchange policies. (4) The six indicators posed as questions that can help business and government leaders monitor the progress in deleveraging are: (i) Is the banking system stable? (ii) Is there a credible plan for long-term fiscal sustainability? (iii) Are structural reforms in place? (iv) Are exports rising? (v) Is private investment rising? (vi) Has the housing market stabilized?
Deleveraging has important implications for business executives in planning investment as well as setting geographic and strategic priorities. They should: (1) Use a granular approach in their planning and strategizing, as their markets in different countries and regions experience deleveraging unevenly. (2) Expect constrained consumer demand, as consumers reduce debt and rely more on current income than credit to fund purchases. (3) Emphasize value, as consumers eliminate impulse purchases and put lower prices before brand loyalty. (4) Accelerate productivity improvements, as profit margins are pressured by reluctant consumer buying during slow economic growth. (5) Think long-term and invest ahead of demand recovery, as success in capturing market share from rivals requires increasing productive capacity preemptively. (6) Consider new opportunities in public-sector projects, as many governments are unable by themselves to fund urgently needed infrastructure improvements and other critical public investments.
The relevance of the MGI report for Turkey, with its 2010 public sector debt-to-GDP ratio of 42.2 percent, compared to the European Union's average of 80.1 percent, and with its total external debt-to-GDP ratio of 39.5 percent, is more indirect than direct. Despite the rising private sector leverage associated with the record current account deficit (CAD), estimated at 10 percent of GDP in 2011, Turkey does not suffer from an overall debt overhang on the scale and of the type similar to those of advanced countries, especially several EU countries. Although the procyclical leverage of the strongly capitalized and well regulated Turkish banking sector has risen in tandem with credit expansion in the last two years, it is relatively low by global standards. Besides, it should start falling readily this year as economic growth decelerates. But Turkey is quite vulnerable to the slow and painful deleveraging in those EU countries on which it is highly dependent for its exports and capital inflows.
