In 2020, the world focussed on health.
A once-in-a-century pandemic had hit the globe.
Everyone was worried about vaccines, hospital beds, doctors & nurses, supply of essentials, and so on.
Lurking underneath all of this commotion was a less-widely discussed problem: money.
Or in broader words, economy.
We can talk about many countries, but it’s easier to analyse one country at a time so let’s focus on the UK this week.
Like many other major countries, they understood that a massive problem was lurking immediately over them – healthcare.
But the other problem was the economy.
Most major countries’ governments earn by two sources: taxes and borrowing money.
Taxes – are paid by the citizens, companies, etc.
Loans – are paid by lenders/investors.
This dual source of money is the root of some of the biggest headaches for governments.
You need money. If you raise the taxes too much, people are left with less money in their hands. When that happens, people spend less.
And when people spend less, the economy suffers. Which in turn reduces taxes even more.
So, governments are scared of increasing taxes suddenly and by too much.
But then, think about it.
A pandemic has hit the country. You need (a lot more) money to spend on healthcare. What do you do?
One thing you can do is reduce spending from other sectors to finance the one that needs it the most. But that is not always possible.
So you borrow money. You take loans. Debt.
The UK government decided to do just that during the 2020-21 period.
In years before that, they were borrowing money equal to roughly 2-3% of the GDP. This shot to nearly 18% in the 2020-21 period.
Government Debt
On a personal level, some of us borrow money for what we need.
Some of us stay away from loans altogether. “I will buy only what I can afford”.
Both these approaches are fine.
However, in the case of most major governments, a no-loans policy is not possible.
We saw above that the UK government could not have raised taxes. But it still had to take care of its citizens. So they borrowed money.
This is a more extreme example.
Governments actually borrow money quite regularly – to continue developing the nation.
They borrow money and pay it back to the lenders.
The assumption is that money used will lead to economic growth. That economic growth will lead to more taxes.
Those taxes can then be used to pay back the loans with interest.
This entire cycle — borrow, grow the economy, pay back the loan — is a continuous process.
The governments are always borrowing money and paying back older loans.
Lenders
Who are these lenders?
The government takes on debt in the form of bonds. It issues bonds.
The bond mentions the principal amount, the interest rate, and the maturity date.
In the US, these bonds are called Treasury Bonds or just Treasuries. In India, they’re called Government Securities or G-Secs.
Investment in government bonds is considered extremely low risk.
So anyone who invests in these bonds is effectively lending money to the government.
It can be anyone.
In the case of the US, the biggest investors in government bonds are government agencies, mutual funds, insurance companies, individual investors, and even other countries.
In India, the lenders would be anyone who buys G-Secs.
Now, you might struggle to think about anyone you know who buys G-Secs.
But chances are you know them.
Around 40% of all G-Secs are owned by banks. Mutual funds, insurance companies and several other institutions like this invest in G-Secs..
Banks are actually required by law to invest a certain part of their deposits in G-Secs.
So when you invest in FD, a part of the money is automatically getting invested in G-Secs. When you even store your money in a bank, a part of your money is getting invested in G-Secs.
G-Secs are considered the safest investment in India. Nothing is more safe than a G-Sec.
The minimum amount of money that a bank has to invest in G-Secs is called Statutory Liquidity Ratio (SLR).
In India, the SLR is 18% right now. Although banks actually invest a lot more than that in G-Secs.
The rest of the money is given out as loans by the bank.
This is how banks across the world work.
Too Much
All good. Until too much.
A country’s debt is often measured with the help of debt-to-GDP ratio.
(Total debt a country owes ÷ GDP) x 100.
Japan’s is one of the highest in the world at around 250%.
The US is at ~120% which is also considered too high.
The UK is at 100% — again, not good.
China is at 84%. India is at 83%. Considered healthy. Under 90% is considered fine by many.
Another important metric when discussing government debt is debt servicing ratio. It tells us how much a government is spending on paying back its loans.
A government’s bonds may be bought by investors outside the country too.
When the percentage of foreign lenders to a country is high, the currency fluctuation is also high. Governments aim to keep foreign investments low. Under 15-20% is considered fine.
As you might already be thinking, this debt is good only to a certain limit.
After that, it becomes a liability.
As a country’s debt goes up, more of its income goes towards paying off older loans. This means less money is left over for spending on public infrastructure, healthcare, education, defense, etc.
As it further goes up, investors become cautious. They worry that the country might not be able to pay back.
In such a case, they demand a higher interest rate to offset the risk.
That in turn leads to even higher interest payments for the country.
As this happens, the economy starts slowing down. Companies make less revenue and therefore pay less taxes.
It also results in lower income of citizens.
All of these lead to slower economic growth and even lower taxes collected by the government — making it even harder to pay back its existing loans.
Eventually, if things go bad enough, the country defaults on its loans.
Government Spending
Government spending is a crucial pillar of economic activity.
If the government cannot spend, the economy starts slowing down.
This was one of the main reasons why the UK borrowed more money in the 2020-21 period.
They passed laws to prevent the laying off of many employees by partly paying for their salaries for some time.
They offered lower interest rates to allow businesses to recover. They lowered taxes and provided tax reliefs in many cases.
They increased their spending towards infrastructure and other public goods.
All of this was done to fight the ill effects of lockdowns.
Most countries took such steps. India too introduced massive spending and tax-cuts.
Despite that, India managed to keep its borrowing within limits. Many other countries are struggling even now.
One debt that many are fearing is that of the US.
When a country borrows money, it aims to repay it later. And that later payment comes from higher taxes collected.
For that to happen, the GDP must grow.
So, if the GDP grows slower, the debt problem becomes big.
If the US GDP growth slows too much, the debt will become an even bigger problem.
And once a government starts paying more interest, it has less money to spend on itself.
That problem is a vicious cycle — it keeps going down and down from there.
For now, the problem is being handled. It is hard to comment on it long term.
Quick Takes
+ India’s manufacturing PMI rose to 59.2 in Oct (vs 57.7 in Sept). This means manufacturing activity increased more in Oct than in Sept.
+ India’s composite PMI (manufacturing + services) fell to 60.4 in Oct (vs 61 in Sept). Services PMI fell to 58.9 (vs 60.9 in Sept). This means that business activity grew less in Oct than in Sept.
+ India’s gross GST collection rose 4.6% year-on-year to Rs 1.96 lakh crore in Oct.
+ Foreign portfolio investors (FPIs) recorded a net inflow of Rs 14,610 crore into equities in Oct, ending a 3-month streak of outflows.
+ India and the EU advanced the negotiations about the India-EU Free Trade Agreement (FTA).
+ NSE set aside around Rs 1,300 crore to settle pending regulatory cases related to co-location and dark-fibre matters with SEBI. This will also possibly help the exchange move forward with its long-awaited IPO.
+ The Maharashtra government signed a Letter of Intent with Starlink to deploy satellite-based internet services across rural and remote regions.
+ SEBI increased the quota for anchor investors in IPOs from 33% to 40%. Of this, 33% will be reserved for mutual funds and 7% for insurers and pension funds. SEBI also raised the limit for the number of anchor investors for IPOs with an anchor portion above Rs 250 crore: up from 10 to 15 per Rs 250 crore.
+ India’s forex reserves fell $5.6 billion to $689.73 billion in the week that ended on 31 Oct.
+ China’s exports fell 1.1% year-on-year in Oct (vs a growth of 8.3% in Sept) while imports rose 1% (vs 7.4% in Sept). The trade surplus narrowed by $38 million in Oct.
+ Orkla IPO was listed on the stock exchanges at a premium of 2.75% over the issue price and closed 2.24% down at the end of the day
+ Note: we will not be covering any news related to the Groww IPO till the listing date (12 Nov) due to legal/conflict-of-interest reasons#
The information contained in this Groww Digest is purely for knowledge. This Groww Digest does not contain any recommendations or advice.
Team Groww Digest