By Rodrigo Campos

NEW YORK, (Reuters) – The two world’s largest economies borrowed most during the first quarter. Global debt reached a new record high of $305 trillion while overall output fell, according to data released Wednesday by the Institute of International Finance.

China’s first quarter debt increased by $2.5 Trillion, while the United States added $1.5 Trillion, according to data. The total eurozone debt declined for the third consecutive quarter.

Many countries both developed and emerging are now entering a cycle of tightening monetary conditions, led by U.S. Federal Reserve. This is accompanied with high dollar debt.

(GRAPHIC- Global debt totals: https://fingfx.thomsonreuters.com/gfx/mkt/zgvomebnxvd/GlobalDebt.png)

The IIF report stated that “as central banks continue to tighten policy in order to reduce inflationary pressures,” higher borrowing costs would exacerbate debt vulnerability.

The impact on emerging market borrower could be greater for those with fewer diversified investors.

The benchmark 10-year Treasury Note yield has increased by 150 basis points this year, and was at its highest level since 2018 earlier in the month.

BEWARE OF SOVEREIGNS

Bank and government debt were the main sources of borrowing growth. The total debt outside the financial system rose above $236 trillion. That’s $40 trillion more than the level two years prior to the COVID-19 pandemic.

Although government debt has been rising more slowly during the same period as before, borrowing costs have risen and sovereign balance sheets are still under strain.

(GRAPHIC- Government financing needs: https://fingfx.thomsonreuters.com/gfx/mkt/movanzkwdpa/GovernmentFinancingNeeds.png)

According to the IIF, “With the government’s financing needs remaining well above their pre-pandemic levels,” some countries may have to raise public spending to combat social unrest.

Emerging markets may find it particularly challenging to have more fiscal flexibility.

In emerging markets where debt has risen to $100 trillion, it is also a problem. It was $89 trillion in 2008 and now there are more than 100 trillion.

According to the IIF report “Lack of timely disclosure of public obligations, limited coverage of contingent liabilities (including SOE), and extensive use confidentiality clauses are major obstacles causing information asymmetries among creditors and debtors,” noting that these factors push borrowing costs up and limit access to the private capital markets for EM borrowers.

(GRAPHIC- Government interest expense: https://fingfx.thomsonreuters.com/gfx/mkt/zdvxowdqjpx/GovernmentInterestExpenses.png)

Global debt-to GDP ratio dropped to 348 percent, which is about 15 percentage point less than the previous record. Major improvements were made in countries of European Union. According to the IIF, Korea, Thailand, and Vietnam saw the highest increases in this measure.

The IIF report stated that “Growth is likely to slow significantly this Year, which could have adverse effects on debt dynamics.”

“The anticipated slowdown of the global financial market and China’s tighter funding policies will probably limit or reverse the decline in the debt ratios.”