Sovereign debt tops unknown risk factors in world economy 2013

We have seen beautiful days since December 21, 2012, which many people believed would be the world's final day. Subsequently, market participants have had something to cheer.

US lawmakers and the administration of President Barack Obama reached an agreement on New Year's Eve to avert a "fiscal cliff", a situation that would have forced the government to increase taxes and reduce spending to cut the budget deficit. Market participants believed that if that situation came to pass, the world economy would be at risk of falling into recession.

Under the agreement, spending cuts were postponed for two months and tax rates were increased for some wealthy people. However, many people considered that these were just temporary measures. The real problem, a large budget deficit, is still around and there are no concrete solutions to solve the problem.

From now through March, we need to follow developments. Some people believe there will be a proposal to increase the US debt ceiling again to allow the government to borrow more to finance its existing debts. How can more debts solve a debt problem?

On the other side of the Pacific Ocean, Japan has its own sovereign debt problem. Some economists project that Japanese public debt is around 230 per cent of gross domestic product, compared with 165 per cent in Greece. Therefore, Japan will be another concern.

The Japanese economy was hit hard by the 1990 crisis and the collapse of its property sector. Japan has been using a very accommodative monetary policy, sending its interest rate to near zero, for more than two decades, but its economy is still not showing any sign of strong recovery. In recent weeks, we have seen the yen depreciate from around 83 to the US dollar to around 88.

The new Japanese government announced recently that it would launch another massive government spending programme worth US$120 billion (Bt3.65 trillion) to stimulate its economy while maintaining its accommodative monetary policy. It will finance this spending with more debt.

For 2013, the known risk factors are the sovereign debt problem in the euro zone, the US debt ceiling and the measures to cut the budget deficit, and Japanese sovereign debt. We believe policy-makers in those economies will maintain accommodative monetary policies, which mean pushing the rates to near zero by injecting liquidity into the market. The policy aims to lower the cost of borrowing, and they hope their economies will sustain a fragile recovery. In turn if they can achieve a strong recovery, they will be able to create jobs and collect more taxes.

However, this policy has it own side effects. We have seen that cheap money flows to trading in commodities such as oil and gold, equity investment, and interest-rate arbitrage in some high-yield countries. Basically, cheap money has not flowed into the real economy but into speculative activities.

What are the unknown risk factors? First, sovereign debts have their own ceilings. Though the countries that issue debt are large, this does not mean they have no limitations. If the market starts losing confidence in their ability to service their debts, what will happen to interest rates and currency values?

Second, the flows of money to emerging countries, equity and commodity market could reverse at any time. That would create volatility in those markets.

These unknowns do not bring cheer at the beginning of the new year. Let us hope that they do not become reality.

Last, I would like to make the very best wishes to all readers.

PADEJ PIROONSIT is head of global sales at CIMB Thai Bank. The opinions expressed here are his own. Padej.p@cimbthai.com