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Source: NCB Capital

Facing a flood of government bonds

The global economic crisis is increasingly testing the confidence of investors because of the heavy reliance of especially the OECD economies on government borrowing. There is mounting concern that unsustainable fiscal trajectories in many countries will undermine the willingness of creditors to buy their debt on anything like the current terms, which will almost certainly push fiscal consolidation up the policy agenda with adverse implications for broader economic activity. Similarly, risks of contagion are mounting due to the similar fiscal positions of many Western economies. These concerns are further heightened by the prospect, however gradual, of monetary tightening as well as growing fears of inflation, even if spare capacity and productivity gains should offer some near-term relief.

The great challenge posed by the unprecedented fiscal relief measures during the current crisis has been the backdrop of fiscal vulnerability in many Western countries already at the outset of the recession. Deficit spending throughout the boom years left them with minimal domestic reserves to draw on when growth stalled. The average budget deficit of the G7 economies was 3.4% of GDP in 2002, a comparable 3.3% at the end of 2008, and a staggering 10.1% in 2009. With the overall public debt-to-GDP ratios of many countries in or close to the triple digits, fiscal sustainability is presenting itself as a serious concern.

While the fiscal outlook for many Western countries is precarious, it is not uniform. The fiscal woes of Greece and the new US budget proposal have highlighted the persistence of negative trends. Euro-zone governments have raised a record EUR110bn this year and strains are beginning to show in the most fiscally vulnerable markets. Greece has already seen its bond yields hit 10-year highs of 7.25%, although it has also so far successfully managed to place its bond issues. The situation is not fundamentally different in Ireland, Portugal, Spain and Italy. Even the UK deficit is well above 10% of GDP.

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