• MARCH 1, 2017

The Balance Sheets of Nations

Many economic discussions focus on the 'flow' variables of a country - GDP, GNP, deficits, etc. These are important and useful; they're like the income statement of a company.

Then there is another set of variables, called 'stock' variables, which is more like a balance sheet. These variables include public debt, foreign exchange reserves, and foreign assets. Though often overlooked, they can provide useful insights.

What Is the Balance Sheet of a Country?

This is an abstract concept. In fact, 'countries' do not have reported balance sheets. This data is very difficult to collect and report. But conceptually, what would it look like?

We can divide the assets of a country into the physical and the intangible. Physical assets include things that are produced like buildings, roads, and machinery. They also include endowments like land and natural resources. Intangible assets include financial assets like foreign exchange reserves and ownership of foreign equity/debt. Intellectual property is also an intangible asset.

This approach to thinking about the balance sheet of countries is problematic. What is the value of physical assets like roads and bridges? How do you value forests and other geological resources? This helps explain why we don't hear about a country's assets...even though there is a lot of discussion about its liabilities!

By some estimates, on average, a country's assets are 67% of its GDP (will vary significantly by country). Many will argue that public assets are best managed by a single entity separate from the influence of political leaders. A sovereign wealth fund, for example. This can drive better financial returns from these public assets. The income stream from the fund can be used to service public debt. Another benefit is improved transparency, as the fund would be required to use standard accounting practices and report its performance.

Detractors of the sovereign wealth fund model believe that the national balance statement omits 'human capital'. The citizens of a country can be viewed as a productive resource with a legitimate income stream.

In my view, a more useful way to view the national balance sheet is the sum of government, corporate, and household balance sheets. This does not give us accurate numbers, but it's easier to conceptualise. There are significant cross-holdings in this view. For example, a corporation reports shares of a company as equity, but this is an asset from the citizen's point of view. Still, this is a very useful model.

Travelling Risks

The balance sheet is a combination of government, corporate, and household finances. A risk in any one of them can result in a countrywide crisis. Large debt loads are toxic - understanding where the debt load is un-sustainable can be vital.

The 2009 debt crisis in Greece was a case of high government debt. The debt reached a point where creditors no longer believed the debt was recoverable. The solvency of public sector finances was in question.

The 1980 'Latin American debt crisis' was another an example of public sector saddled with a large foreign debt on its balance sheet. This lead to currency-related risks; A sudden stop of external inflows lead to currency depreciation, forex depletion, and finally a crisis.

The Daewoo bankruptcy in South Korea during the 1990s was a case of excessive corporate debt. The episode was catastrophic economically and politically, leaving a cloud over the South Korean economy.

The 2008 Global Financial Crisis was a case of highly leverage household balance sheets. Consumers levered to speculate in real estate. The resultant correction created a debt hangover.

The IMF working paper, A Balance Sheet Approach to Financial Crisis, highlights the importance of collecting data to evaluate risks. Even Industry and sector-specific risks can quickly spread to infect the whole country.

Raghuram Rajan argued against relaxing norms on higher leverage and external borrowings in 'nationally important' sectors, rightly pointing out the possibility of systemic risks to the national balance sheet.

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.


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