The Risky Rich

NEW YORK – Today’s swollen fiscal deficits and public debt are fueling concerns about sovereign risk in many advanced economies. Traditionally, sovereign risk has been concentrated in emerging-market economies. After all, in the last decade or so, Russia, Argentina, and Ecuador defaulted on their public debts, while Pakistan, Ukraine, and Uruguay coercively restructured their public debt under the threat of default.

But, in large part – and with a few exceptions in Central and Eastern Europe – emerging-market economies improved their fiscal performance by reducing overall deficits, running large primary surpluses, lowering their stock of public debt-to-GDP ratios, and reducing the currency and maturity mismatches in their public debt. As a result, sovereign risk today is a greater problem in advanced economies than in most emerging-market economies.

Indeed, rating-agency downgrades, a widening of sovereign spreads, and failed public-debt auctions in countries like the United Kingdom, Greece, Ireland, and Spain provided a stark reminder last year that unless advanced economies begin to put their fiscal houses in order, investors, bond-market vigilantes, and rating agencies may turn from friend to foe. The severe recession, combined with the financial crisis during 2008-2009, worsened developed countries’ fiscal positions, owing to stimulus spending, lower tax revenues, and backstopping and ring-fencing of their financial sectors.

The impact was greater in countries that had a history of structural fiscal problems, maintained loose fiscal policies, and ignored fiscal reforms during the boom years. In the future, a weak economic recovery and an aging population are likely to increase the debt burden of many advanced economies, including the United States, the UK, Japan, and several euro-zone countries.