Current Issues
Public debt in 2020:
International topics
July 6, 2011
Monitoring fiscal risks in developed markets
The global crisis has caused a massive fiscal deterioration and
resulted in a sharp increase in developed market (DM) economies’
public indebtedness. On a GDP-weighted average, the DM public-debt-to-GDP
ratio climbed to around 104% in 2010 from roughly 77% in 2007. While the
troubled EMU peripheral countries have been pressured by markets to start
consolidating drastically, other DMs such as the US or Japan have continued to
run highly expansionary fiscal policies despite rapidly growing debt.
In our baseline scenario, which assumes a gradual tightening of fiscal
policies, the DM public debt stock is projected to rise to around 126%
of GDP in 2020 from roughly 104% in 2010. However, should fiscal
consolidation fail, public indebtedness could soar to more than 150% of GDP by
2020, according to our “no-policy-change” scenario. But also in the event of lower
growth, weaker fiscal accounts and/or higher market interest rates, the DM public
debt ratio could rise more sharply than sketched in our baseline scenario.
Fiscal policies have become unsustainable not only in a couple of
smaller EMU countries but also in some major DM economies. Many
DM economies are at the moment nowhere near short-term debt stabilisation.
Therefore, lowering debt ratios to pre-crisis or prudential levels will require a
prolonged consolidation process and thus strong political support and stamina.
Apart from the EMU peripheral countries the debt outlook for the US
is particularly worrying. If US policymakers fail to agree on a more drastic
Authors
Sebastian Becker
+49 69 910-30664
sebastian.becker@db.com
Wolf von Rotberg
+49 69 910-31886
wolf-von.rotberg@db.com
consolidation programme than presumed in our baseline scenario, the US debt
stock may climb to around 134% of GDP by 2020. As a result, the debt interest
burden could rise considerably over time and thus increasingly weigh on sovereign
creditworthiness. S&P‟s recent move to attach a negative outlook to the US
sovereign AAA long-term credit rating was a warning shot which deserves to be
taken seriously.
DM public indebtedness still rising
Gross public debt, % of GDP (DM PPP GDP-weighted average)
160
140
120
100
80
60
40
20
0
Editor
María Laura Lanzeni
Technical Assistant
Bettina Giesel
Deutsche Bank Research
Frankfurt am Main
Germany
Internet: www.dbresearch.com
E-mail: marketing.dbr@db.com
Fax: +49 69 910-31877
Managing Director
Thomas Mayer
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
Baseline scenario
No-policy-change scenario*
* The no-policy-change scenario assumes no active fiscal consolidation over the outlook period. In other words, the
structural (i.e. cyclically adjusted) primary balances of the DM sample economies are assumed to remain unchanged at their
2010 levels.
Sources: DB Research, OECD, IMF, IHS Global Insight
Current Issues
Contents
Page
1. Introduction .................................................................................................................................................... 3
2. Why the public debt structure matters ........................................................................................................ 4
2.1. A look at the public debt structure ......................................................................................................... 4
Public debt by currency denomination .................................................................................................. 4
Average maturity of public debt ............................................................................................................. 5
Public debt by type of interest-rate contract .......................................................................................... 6
Public debt by residency of holder ........................................................................................................ 7
2.2. Public debt risk matrix ........................................................................................................................... 8
Box 1: Our new public debt scenario framework ......................................................................................... 11
3. Public debt scenario analysis ..................................................................................................................... 13
3.1. Scenario framework and methodology ................................................................................................ 13
3.2. Baseline scenario ................................................................................................................................ 15
Macroeconomic and financial market assumptions ............................................................................ 15
Public-debt-to-GDP projections ........................................................................................................... 20
3.3. Shock scenarios .................................................................................................................................. 22
Shock scenario methodology .............................................................................................................. 22
Public-debt-to-GDP projections in a shock scenario ........................................................................... 23
(a) Single real GDP growth shock scenario .................................................................................... 23
(b) Single primary balance shock scenario ..................................................................................... 23
(c) Single market interest rate shock scenario ................................................................................ 24
(d) Contingent liability shock scenario ............................................................................................. 25
(e/f) First and second combined shock scenarios ........................................................................... 26
Summary of pessimistic shock scenarios ............................................................................................ 26
Optimistic shock scenarios .................................................................................................................. 27
Box 2: Calculating fiscal consolidation needs .............................................................................................. 28
4. Fiscal consolidation needs ......................................................................................................................... 29
4.1. Stabilising debt ratios at 2010 levels ................................................................................................... 29
4.2. Lowering debt ratios to pre-crisis levels .............................................................................................. 31
4.3. Lowering debt ratios to prudential benchmarks................................................................................... 32
5. Summary and conclusions ......................................................................................................................... 33
Literature ........................................................................................................................................................... 35
2
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
1. Introduction
Global crisis has caused
sharp fiscal deterioration
This study is a follow-up to our research paper “Public debt in 2020:
A sustainability analysis for DM and EM economies” (see Becker et
al. (2010)), which was published just before the EMU sovereign debt
crisis escalated in spring 2010 and which projected public debt
dynamics until the year 2020 for a sample of 38 economies,
consisting of 17 developed market (DM) and 21 emerging market
(EM) economies. The main finding was that public debt sustainability
had become a serious challenge to the advanced world. Equipped
with updated figures, the main aim of this paper is to re-estimate our
debt projections for the DM sample (see all 17 DM country names in
chart 1).
Fiscal deficit, % of GDP
IE
GR
US
GB
PT
ES
JP
FR
SK
IT
BE
AU
CA
DE
DK
SE
CH
DM*
-5
0
5
2000-06 (average)
10
15
2007-10 (average)
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
1
DM public debt up sharply
DM gross public debt, % of GDP
110
100
90
80
70
60
94 96 98 00 02 04 06 08 10
PPP GDP-weighted average
Simple average
Sources: DB Research, OECD, IMF, IHS Global
Insight
2
Sovereign risk repriced
since 2008!
5-year sovereign CDS, bp
The paper is structured as follows. In Chapter 2 we take an in-depth
look at the composition of public debt, as the current crisis has
demonstrated that not only the debt level or the fiscal balance but
also a government‟s debt structure determine a country‟s
vulnerability to crisis. We construct a public debt risk matrix that
ranks countries with respect to the risks stemming from debt levels
as well as from debt structures. In Chapter 3 we use our new
scenario framework, which explicitly takes a government‟s debt
structure into account, to project public debt dynamics over the next
ten years. In the baseline scenario we assume a policy of fiscal
consolidation, with the consolidation pace varying across countries.
In the “no-policy-change” scenario we project the debt levels that
could be reached by 2020 in the absence of consolidation.
Moreover, we calculate “shock” scenarios which are characterised
by a more challenging economic and financial environment, as e.g.
by lower GDP growth or higher market interest rates. In Chapter 4
we estimate how much consolidation is needed to (a) stabilise debt
stocks at current levels and (b) lower debt ratios to pre-crisis levels,
or levels considered “prudent”. Chapter 5 concludes.
GR
IE
PT
ES
IT
FR
JP
DE
GB
US
2,250
2,000
1,750
1,500
1,250
1,000
750
500
250
0
Indeed, the global crisis has caused a massive fiscal deterioration in
many DM economies (see chart 1) and led to a drastic increase in
public indebtedness. On a GDP-weighted average, the DM publicdebt-to-GDP ratio climbed sharply to around 104% in 2010 from
around 77% of GDP in 2007, a jump of more than 25% of GDP in
just three years (see chart 2). Against the backdrop of growing debt
sustainability concerns, financial markets have sharply repriced
sovereign credit risks in many DM economies, as reflected by
widening sovereign CDS spreads (see chart 3). Especially in the
troubled EMU peripherals Greece, Ireland and Portugal, all of which
had to seek EU/IMF aid, sovereign CDS spreads have remained
close to or even at all-time highs (see chart 3), indicating that
financial markets attach a high probability to a debt restructuring
scenario. However, public finances have become unsustainable not
only in these smaller EMU peripheral countries but also in some
major advanced economies. In the US and Japan, for instance,
governments have continued to post large fiscal deficits despite
already large and growing debt stocks. By contrast, other major
DMs, such as the UK, have already begun consolidating to prevent
public debt spinning out of control.
January 2008 (eop)
Peak (since January 2008)
June 2011
Sources: Bloomberg, Markit, DB Research
July 6, 2011
3
3
Current Issues
2. Why the public debt structure matters
Sovereign CDS: Blown
out in EMU peripherals,
up modestly in Japan
5-year sovereign CDS, bp
2,500
2,000
1,500
1,000
500
0
07
08
09
GR
10
11
IE
PT
JP
4
Source: Bloomberg
It's not only the government
debt level that matters for
sovereign risk perception
Gross public debt, % of GDP
225
200
175
150
125
100
75
PT
The foreign currency exposure is paramount among risks inherent in
the debt structure because of the material debt reset effects local
currency devaluations could have on the public-debt-to-GDP ratio.
Rapid and unexpected devaluations repeatedly caused severe
distress or default in EMs, as for instance in the Argentinian crisis of
2001/2002 (see “The Argentinian crisis of 2001/02” in the box on
page 5). As most DMs are home to internationally accepted reserve
currencies they enjoy a major advantage over most EMs. They
neither need to peg their currencies to a stronger foreign currency
nor do they have to issue foreign currency (FCY) debt. Thus, the
potentially most severe single market risk factor to a country‟s public
debt stock, a rapid and unexpected exchange-rate movement, is
only of minor concern for most DMs.
JP
5
Public debt vs. sovereign
CDS spreads
X: Gross public debt, % of GDP (2010),
Y: Sovereign CDS spread, bp (June 2011)
2,500
GR
2,000
1,500
1,000
IE
500
ES
IT
AU
JP
50
100
150
200
This analysis is based on our DM sample, which
consists of 17 DM economies.
Sources: OECD, Bloomberg, Markit, DB Research
In our DM sample only Sweden, Denmark and Canada have issued
significant shares of public debt in foreign currencies (see chart 7 on
page 5). Unlike other countries in our sample, their currencies are
not considered international reserve currencies. Higher market
liquidity in reserve currency markets may be one of the reasons to
1
search for funding in major currencies.
In Sweden, where a foreign currency share of 15% is targeted, FCY
government debt accounted for around 14% of total public debt in
2010. Since the onset of the global financial crisis, the Danish
government increased its amount of outstanding FCY debt to 11.8%
0
0
6
1
4
A look at the public debt structure
25
Sources: OECD, IHS Global Insight
PT
2.1
Public debt by currency denomination
90 92 94 96 98 00 02 04 06 08 10
IE
Even in a sample of developed markets with relatively similar
macroeconomic characteristics, sovereign CDS do not always trade
in line with public debt levels (see chart 6). A likely explanation for
this apparent disconnect is that, when assessing default risks,
markets consider not only the level of public debt but also its
structure. In this chapter we take a closer look at the debt stocks of
DM economies. We analyse the debt structure and show debt
composition by currency denomination (local vs. foreign), by
maturity (short vs. long term), by type of interest-rate contracts
(fixed, floating, inflation-linked) and by residency of creditors
(internal vs. external). In a second step, we develop a public-debt
risk matrix, which ranks countries according to their solvency and
debt structure indicators.
50
0
GR
Even though higher indebtedness tends to make countries more
vulnerable to economic and financial turmoil, CDS and bond
spreads suggest that the debt level is far from being the only
determinant of a country‟s implied probability of default. Sovereign
credit ratings or CDS spreads, which signal the implied probability of
default on public debt, are only loosely correlated with the publicdebt-to-GDP ratio. Structural indicators for potential market demand
and the debt stock‟s shock resilience also play a role. Contrary to
highly indebted Japan for example, Greece, Ireland and Portugal
have been confronted with severe market pressures despite much
lower (albeit still large) debt ratios (see chart 4 and 5).
The larger number of market participants minimises bid-ask spreads and
correspondingly the interest rate or bond yield a government issuer has to offer.
Besides budget financing, governments may want to signal their commitment to an
existing currency peg. By tying the debt burden to the stability of the local
exchange rate they can increase the credibility of an existing currency peg.
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
The Argentinian crisis of 2001/02
In the case of Argentina‟s sovereign default in
the early 2000s, the government‟s high share
of FCY debt made the government debt
burden unbearable as soon as markets
started to doubt the credibility of the peso‟s
peg to the US dollar. The peg was abandoned
straight after sovereign default. One reason
for the loss of credibility was Argentina‟s weak
export performance (against the backdrop of
high import growth) and its related current
account deficits throughout the 1990s, which
led to rising external debt. Generally, a large
and competitive export sector is vital for a net
external (FCY) debtor country because it
generates hard-currency revenues and hence
secures the government‟s ability to honour its
FCY obligations. Overall, a country should
borrow only as much in foreign currencies as
its economy is able to generate and hence to
repay. In other words, currency mismatches
between the government‟s liablities and
revenues should be limited.
Public debt by currency
FCY debt, % of total public debt (2010)
SE
DK
CA
GR
ES
PT
CH
SK
BE
IT
14.0
11.8
3.5
1.9
1.5
1.3
0.6
0.3
0.2
0.1
0
5
10
15
Sources: National sources, OECD, Bloomberg,
DB Research
7
US short-term rates still
way below long-term rates
%
6
5
4
3
2
1
0
07
08
09
10
11
Fed funds target rate
3-month US T-Bill yield
10-year US Treasury yield
Sources: IHS Global Insight, DB Research
8
of total general government debt in 2010. Besides direct euro
purchases, FCY debt issuance was used as an instrument to
enlarge the central bank‟s foreign currency reserve holdings,
material to the stability of the krona‟s narrow peg to the euro. In
Canada, FCY debt accounted for 3.5% of general government debt
in 2010. Most of Canada‟s foreign currency funding is met through
foreign currency swaps. In 2009, however, for the first time in a
decade the Canadian DMO issued two foreign currency bonds. The
proceeds of the USD 3 bn and EUR 2 bn issues were exclusively
used to increase Canada‟s foreign exchange reserves. Given that
Sweden, Denmark and Canada are home to large and competitive
export industries, a gradual depreciation of their currencies would be
unlikely to lead to a large increase in their public-debt-to-GDP
2
ratios. This is a major difference to the risks found in some EM
economies (for a detailed discussion on currency mismatches in EM
countries see for instance Becker (2011) page 8).
Average maturity of public debt
The nominal interest rate which a government effectively pays on its
public debt is not only determined by prevailing market interest rates
but also by the pace at which changing market conditions affect
coupon payments on outstanding government securities. The
market interest rate is determined by the official policy rate, which is
set by the central bank, inflation expectations as well as the default
risk premium demanded by investors. The share of debt that adjusts
to new market conditions depends on the amount of variableinterest-rate and inflation-linked debt as well as on the amount of
maturing fixed-interest-rate debt that needs to be rolled over at
market interest rates. Increased short-term debt issuance can
significantly reduce a government‟s effective interest rate. However,
over-reliance on short-term debt poses significant roll-over risks and
leaves a sovereign exposed to rising market interest rates.
A shift towards short-term debt is generally observed at times of
crisis. The reason is twofold. First, short-term borrowing becomes
relatively cheaper than long-term borrowing thanks to crisis-induced
monetary policy easing (see chart 8). Second, short-term debt
markets become much easier to tap for most debtors during periods
of stress than longer-term markets, especially for those borrowers
with relatively poor credit standings. Long-term yields react less
sensitively to interest rate cuts by central banks due to a variety of
factors. Future growth and inflation expectations tend to be higher
and the default risk premium usually rises with the length of a debt
instrument‟s maturity. Furthermore, if a country faces severe market
pressure, increased short-term borrowing itself may cause long-term
yields to rise because short-term debt holders are more likely to be
repaid than long-term debt holders. The combined effect is a
considerable steepening of the yield curve, making short-term debt
even more attractive to long-term debt.
De Broeck and Guscina (2011) find that the share of short-term debt
issuance in total debt issuance from the second half of 2008 to the
end of 2009 increased in 11 out of 16 EMU sovereigns compared to
the 1 ½-year pre-crisis period. In Belgium, for example, the share of
T-bills in total debt issuance increased to 50.7% from 21.3%. Ireland
did not issue T-bills at all in the 1 ½ years before the crisis.
2
July 6, 2011
In Sweden, for instance, where the local currency depreciated by 15% in 2009 as
a result of the financial crisis, the rise in the public-debt-to-GDP ratio remained
manageable and the country became one of the fastest growing DM economies in
2010, partly thanks to local currency depreciation and strong export performance.
5
Current Issues
Public debt by maturity
Average maturity, years (2010)
16
13.4
14
12
10
7.8
8
7.2
7.2
7.1
6.9
6.8
6.7
6.5
6.3
6.3
6.2
5.9
5.8
5.7
PT
JP
6
4.9
4.7
AU
US
4
2
0
GB
DK
IT
FR
GR
CH
IE
ES
BE
DE
SK
SE
CA
Sources: National sources, OECD, Bloomberg, DB Research
Public debt by type of
interest-rate contract
However, from the second half of 2008 to the end of 2009 the share
of short-term to total debt issues stood at 47.4%. At the end of 2010
the US (4.7 years), Australia (4.9 years) and Japan (5.7 years) had
the shortest average maturities among our sample economies, while
the UK (13.4 years), Denmark (7.8 years) and Italy (7.2 years) had
the longest average maturities (see chart 9). In Greece, the average
maturity shortened over recent years, from 8.5 years in 2007 to
around 7.1 years at the end of 2010. Over the course of 2010 more
than ¾ of Greek issues were T-bills with maturities of below one
year.
% of total public debt (2010)
GR
GB
SE
IT
FR
SK
AU
Public debt by type of interest-rate contract
US
JP
CA
IE
DE
DK
BE
ES
PT
CH
0
20
40
60
80
100
Fixed-interest-rate debt
Floating-interest-rate debt
Inflation-linked debt
10
Sources: National sources, OECD, DB Research
UST inflation-linked debt
share has shrunk
UST inflation-indexed notes and bonds
12
700
600
10
500
8
400
6
300
4
200
2
100
0
0
00 01 02 03 04 05 06 07 08 09 10 11
USD bn (right)
% of total* (left)
* gross marketable, interest-bearing UST debt.
Sources: IHS Global Insight, US Treasury
6
9
11
Investor preferences can have a major effect on a country‟s debt
structure. For example, in the UK Gilt market, domestic pension
funds and insurance companies play an important role, as reflected
by the 28% share they hold in the outstanding Gilt market. In order
to match their liability structure they demand long-term, inflationlinked assets. The British debt management office (DMO) is meeting
those demands. It was the first DMO that issued inflation-linked
securities. The purchase of the first linkers in the early 1980s was
restricted to domestic pension funds. It was not a coincidence that
they were issued after a prolonged period of high inflation. Tying the
interest expenditure to inflation was designed to make inflationary
policies less desirable for a government and hence dispel inflation
worries of long-term investors. In 2010 around 22% of outstanding
UK Gilts were linked to the domestic inflation rate, with maturities of
10 years and more (see chart 10). The largest inflation-linked market
worldwide, however, is the US Treasury Inflation Protected
Securities (TIPS) market. With a volume of more than USD 600 bn,
TIPS account for a significant share of total US Treasury (UST) debt
(see chart 11).
Elsewhere in Europe, Sweden was the first country to issue
inflation-linked bonds in 1994. The Swedish DMO targets a constant
inflation-linked debt share of 25% of total debt. Right now 20% of
outstanding debt is linked to domestic inflation, according to the
Swedish DMO. Insurance companies and pension funds, as in the
UK, are the dominant investor groups in the Swedish inflation-linked
government bond market. They hold more than two-thirds of
Swedish inflation-protected debt. France issued its first inflationindexed bonds in 1998. Driven by low inflation rates, the share of
French inflation-protected debt issuance fell to 7.5% of total
issuance in 2009, the lowest level since 2001. For 2010 the French
DMO set a target of 10% of total issuance, reflecting the increasing
demand for inflation-hedged instruments after the crisis. A similar
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
observation could be made in several DMs. In the US, for instance,
the inflation-linked debt share shrank to around 7% of gross
marketable interest-bearing UST debt from more than 10% in
2007/08 (see chart 11 and 12), presumably driven by subdued US
inflation expectations in the aftermath of the crisis, evidenced by an
almost closed spread of 10-year UST yields over 10-year US TIPS
yields in late 2008/early 2009 (see chart 13). However, rising
inflation expectations are likely to boost demand for DM inflationprotected government debt again (see Blommestein, 2011). This
development can be regarded as favourable with respect to
governments‟ incentives to decrease their debt stocks by accepting
higher inflation rates.
Inflation-linked public debt
of selected DM countries
% of total public debt
30
25
20
15
10
5
0
00 01 02 03 04 05 06 07 08 09 10
US
FR
GB
GR
AU
SE
Sources: National sources, OECD, DB Research
Public debt by residency of holder
To minimise risks, a DMO should preferably issue domesticcurrency-denominated, fixed-interest-rate government securities
with long maturities to a strongly committed creditor group. A strong
and affluent domestic funding base proved valuable for several
highly-indebted sovereigns in the past. In this regard, the Japanese
creditor structure is outstanding. Even though the gross government
debt level currently stands at around 200% of GDP, the annual fiscal
deficit is forecast to remain above 7% of GDP until 2013 and real
GDP growth has averaged only 0.7% p.a. since 1997 (which makes
future fiscal consolidation very challenging), 10-year Japanese
government bonds (JGB) yielded less than 1.2% in June 2011. The
Japanese government enjoys the advantage that it can resort to a
cash-rich domestic population which gladly finances its fiscal
deficits. At 376% of disposable income in 2009, Japanese
households‟ net financial wealth was higher than in any other large
DM country. The deep pool of domestic savings and the large
publicly-owned financial sector provide a very strong and reliant
funding base. More than 90% of general government debt is held by
Japanese domestic investors and more than 50% was held by the
3
broader public sector in 2009.
12
US bond yields point to
mild inflation expectations
%
6
5
4
3
2
1
0
-1
07
08
09
10
11
10-year US Treasury yield
10-year US TIPS yield
10-year UST yield minus TIPS yield, pp.
Sources: IHS Global Insight, DB Research
13
The resilience of Japanese debt has repeatedly been demonstrated.
Neither the March earthquake and its economic impact, nor
repeated rating downgrades by major rating agencies put upward
pressure on JGB yields. Although an internationally diversified
creditor structure minimises direct domestic spill-over effects from
one sector to another and presence in international markets
increases liquidity, close ties with a rich and only moderately
leveraged domestic financial sector may be crucial to fund the
government in times of distress.
Public debt by holder
External debt, % of total public debt (2010)
70
67
54
60
50
39
40
30
25
26
28
28
29
GB
SK
AU
SE
DK
32
US
43
59
59
61
BE
PT
IE
47
18
20
7
8
JP
CH
10
0
CA
IT
ES
DE
FR
Sources: National sources, JEDH, DB Research
3
July 6, 2011
GR
14
See Fitch (2010), p. 1.
7
Current Issues
External UST debt has risen
over the past decade ...
UST securities held at the Federal
Reserve Banks by foreigners
35
3.0
30
2.5
25
2.0
20
1.5
15
1.0
10
0.5
5
0
0.0
00 01 02 03 04 05 06 07 08 09 10 11
USD tr (right)
% of gross marketable debt (left)
% of gross total debt (left)
Sources: IHS Global Insight, US Treasury, Fed
15
Large UST purchases by
foreigners, lower US yields
10
10
8
15
6
20
4
25
2
30
90 92 94 96 98 00 02 04 06 08 10
10-year US Treasury yield, % (left)
US Treasury securities held by
foreigners, %* (inverted scale, right)
* of total UST gross marketable debt.
Sources: IHS Global Insight, Fed, DB Research
16
The European countries with notorious current account deficits,
Greece and Portugal, as well as Ireland, mostly relied on financing
from foreign creditors in the past. As shown in chart 14 on page 7,
public-external debt accounted for 67%, 61% and 59% of total debt
4
in Greece, Ireland and Portugal, respectively, by the end of 2010. In
the above three countries external funding ran dry in 2010/11 and
could not be offset by the respective domestic financial sectors.
These governments ultimately required external help in the form of
EU/IMF-led bail-out programmes.
The US is a special case in terms of foreign debt holdings and
vulnerability. Different to Japan, a large share of US government
debt is held by foreign creditors and different to peripheral European
countries, it is unlikely that the US will experience a sudden stop of
external funding due to its systemic importance for the global
economy. The amount of UST debt held by non-residents has risen
noticeably over the past decade to around 18% of total (or 29% of
marketable) UST debt in April 2011, from just 11% (20%) in early
2000 (see chart 15), mainly as a result of large UST purchases by
Asian countries, especially Japan and China. Rising foreign
participation in the US government bond market seems to have
contributed to the gradual fall in UST yields over recent decades and
years (see chart 16). Moreover, liquidity or roll-over risks arising
from the large Asian holdings of UST are probably contained, given
that an abrupt sale of these holdings would lead to significant losses
for Asian investors.
Other economies with relatively high public-external debt shares are
Belgium (59%) and France (54%) (see chart 14 on page 7). Highly
indebted Italy can be found together with Spain and the US in the
mid-range of our sample economies with external debt shares of
between 30% and 45% of total public debt in 2010. Overall, the
ongoing EMU sovereign debt crisis suggests that a well-funded
domestic investor base provides a strong backstop if liquidity and/or
solvency concerns about a government arise. However, stretching
the capacity of this backstop too far could result in even higher
losses if distress eventually occurs at a later point in time.
2.2
Public debt risk matrix
As explained in the previous sections, not only solvency indicators
but also the structure of public debt determine a country‟s
vulnerability to sovereign debt crisis. In order to gauge which of the
17 economies of our DM sample are the most/least vulnerable to
sovereign debt crisis we construct a public debt risk matrix which is
based on two different kinds of risk indicators.
The first indicator, the debt-structure indicator, captures the risks
inherent in a country‟s public debt structure, i.e. it indicates how
vulnerable a country is with respect to market and liquidity risks. It
reflects reliance on external creditors, the average maturity of public
debt outstanding, as well as the shares of floating-interest-rate and
inflation-linked debt in total debt. A country with relatively large
public external debt, a short average maturity as well as a high
share of variable-interest-rate and inflation-protected debt would
obtain a relatively poor score. On the contrary, a country with low
reliance on external debt, a long average maturity as well as no or
little floating-interest-rate and inflation-linked debt would receive a
4
8
External debt statistics record debt liabilities at market values. Due to significant
changes in the market value of Greek, Portuguese and Irish outstanding debt in
2010, we adjusted their respective nominal external debt values accordingly. See
Anderson, Jeffrey and Jared Bebee (2011).
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Japan had by far the largest
public debt stock in 2010
% of GDP (2010)
AU
SK
relatively good score. The debt-structure indicator has a scale
between 1 and 17, with 1 being the best and 17 being the worst
score. The largest weight was given to the external debt share,
followed by the average maturity and the share of variable-interestrate and inflation-protected debt.
The second indicator, the debt level and dynamics indicator,
captures standard solvency indicators such as a government‟s debt
level and contingent liabilities from the banking sector (see chart 17)
as well as the primary balance and net debt interest payments (see
chart 18). Again, the indicator has a scale from 1 (best) to 17
(worst).
CH
SE
DK
CA
ES
DE
According to our public debt risk matrix (see chart 19), Greece
appears to be the most vulnerable country as it scores poorly with
respect to both indicators. At the other end of the spectrum,
Switzerland and Denmark are the least vulnerable countries. Other
relatively risky countries are Portugal, Ireland and the US. For the
US there are a couple of important risk mitigants, however, which
are not quantifiable and thus not captured in our simple indicatorbased approach. For instance, the US dollar‟s reserve currency
status or the generally high flexiblity of the US economy somewhat
reduce its vulnerability to a public debt crisis.
US
FR
BE
GB
PT
IT
GR
IE
JP
0
50
100
150
200
250
Gross public debt
Contingent liabilities
* Contingent liabilities from the banking sector are
DBR estimates based on IFS data and gross
problematic assets (GPA) estimates by S&P's.
Sources: DB Research, OECD, S&P's, IFS
17
Ireland had the widest
fiscal deficit in 2010
Fiscal deficit (2010) by sub-components,
% of GDP
IE
Japan appears to be less vulnerable than any of the three EMU
peripheral countries thanks to a relatively safe debt structure as e.g.
characterised by a very low external debt share. But also based on
the debt level and dynamics indicator, Japan is doing better than
Greece, Portugal and Ireland (see chart 19). Although Japan had by
far the largest gross public debt stock at almost 200% of GDP in
2010, its contingent liabilites from the banking sector appear to be
much lower than in, for instance, Greece, Ireland and Portugal (see
chart 17). Moreover, against the backdrop of large government
assets, such as the BoJ‟s sizable foreign exchange reserves,
Japan‟s net government debt stood at around 116% of GDP in 2010
and hence was much lower than gross government debt (see chart
20 on page 10).
US
GR
Public debt risk matrix
GB
Average ranking of countries: From 1 (best) to 17 (worst)
ES
16
PT
JP
JP IT
SK
FR
GR
14
IE
12
USA
GB
FR
AU
BE
10
ES
CA
CA
DE
IT
8
BE
6
DK
DE
SK
4
DK
AU
CH
SE
SE
2
CH
-5
0
5
Source: OECD
July 6, 2011
0
10 15 20 25 30 35
0
Net debt interest payments
Primary deficit
Debt level and dynamics indicator
PT
2
4
6
8
10
12
14
Debt-structure indicator
18
Source: DB Research
19
9
Current Issues
Furthermore, despite its extremely large gross public debt stock the
Japanese government still has one of the lowest net debt interest
expenses thanks to a combination of very low nominal effective
interest rates it has to pay on gross debt as well as significant
interest income it receives on public assets. While Japan‟s gross
government interest expenses stood at around 2.8% of GDP in
2010, its net debt interest payments accounted for a much lower
1.4% of GDP and hence was just half of gross interest expenditures
in 2010 (see chart 21).
Japan has the largest
public debt stock ...
Public debt, % of GDP (2010)
SE
DK
CH
AU
SK
Although our public debt risk matrix is able to indicate which of our
17 sample economies are the countries most/least prone to
imminent debt crisis, it does not say anything about a country‟s
absolute risk level to run into sovereign debt problems over the
medium to long term. In the next two chapters we will therefore
address the question of which countries are doing well in terms of
medium to long-term public debt sustainability and which countries
could run into debt problems at a later point if they failed to
consolidate.
CA
ES
DE
GB
FR
IE
US
PT
BE
IT
GR
JP
-50
0
50
100
Gross
150
200
Net
Source: OECD
20
... but one of the lowest
levels of net debt interest
payments
Debt interest payments (2010), % of GDP
SE
CH
DK
CA
SK
AU
JP
ES
US
DE
FR
IE
GB
PT
BE
IT
GR
0
1
2
Gross
3
4
5
Sources: OECD, IHS Global Insight
10
6
Net
21
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Box 1: Our new public debt scenario framework
In Becker et al. (2010), “Public debt in 2020: A sustainability analysis for DM and EM economies”, we based
our public debt sustainability framework on the basic concept of public debt arithmetics, which required
assumptions on real GDP growth, the primary balance and the real interest rate. The average real interest rate
paid on public debt is difficult to calculate because of a heterogeneous debt structure. Usually a government
has outstanding debt and also continuously issues new debt at different maturities (short/medium vs. long-term
debt), in different currencies (domestic vs. foreign debt) and/or at different types of interest-rate contracts
(fixed, floating vs. inflation-linked debt). As a result, there is no single interest rate that represents a
government‟s ultimate borrowing costs. While Becker et al. (2010) approximated a government‟s relevant real
interest rate via the prevailing CPI-deflated benchmark government bond yield, we now introduce a new
framework which explicitly models a sovereign‟s average real interest rates paid on public debt, taking into
account the structure of that debt.
Our new debt sustainability framework is derived from Ley (2005) and based on Becker (2011), who describes
public debt dynamics in a two currency (domestic vs. foreign)/two sector (non-tradable vs. tradable GDP)
framework that explicitly differentiates between the contractual type of interest rates (fixed vs. floating) and the
structure of local-currency-denominated debt (straight vs. inflation-protected debt) and considers the average
maturity of a country‟s public debt stock. Most DM economies issue the bulk of their public debt in domestic
currency, so DM public debt stocks are generally unaffected by debt reset effects stemming from currency
fluctuations. Therefore, we simplify Becker‟s two currency/two sector framework into a single currency/single
sector public debt sustainability model.
1.
Public debt dynamics
The starting point of our analysis is the ex-post period budget constraint of the government:
dt 
1  i 
eff ,t
1  gt   1   t 
 d t 1  pbt  mt
(1)
where d denotes the public-debt-to-GDP ratio, ieff captures the nominal effective interest rate paid on public
debt outstanding, g and π stand for the real GDP growth rate and the change in the GDP deflator (which is in
the following approximated by domestic inflation) and pb and Δm represent the primary balance (i.e. the fiscal
balance before net debt interest payments) and seigniorage (i.e. the change in the base-money-supply-to-GDP
ratio), respectively. Finally, t denotes the respective year of each variable.
As apparent from equation (1), the current public-debt-to-GDP ratio depends on the debt stock of the previous
year as well as on the current macroeconomic and financial environment and public finances. Generally, strong
real GDP growth and a positive change in the GDP deflator (i.e. positive inflation), a low nominal effective
interest rate and sound fiscal policies (as reflected by primary surpluses) are prerequisites to keep public debt
dynamics in check.
2.
Nominal effective interest rates
The nominal effective interest rate paid on public debt is determined by a host of factors such as the prevailing
market interest rates, the average maturity of the debt stock (which determines how quickly changes in market
interest rates affect the nominal effective interest rate) as well as the domestic inflation rate. As the
composition of debt plays a crucial role in the determination of the nominal effective interest rate, one needs to
differentiate between the contractual type of interest payments (floating, fixed, inflation-linked), and also needs
to consider the average maturity of outstanding debt.
July 6, 2011
11
Current Issues
The nominal effective interest rate (ieff) can be expressed as:


ieff ,t  iˆeff ,t   t    1  ieffh,,t
 

Weighted nominal
effective interest
rate before inflation
compensation

where
(2)
Inflation
compensation
costs on CPIlinked debt
h,x
is the share of inflation-protected debt to total debt,  is the domestic inflation rate and ieff
is the
effective base (i.e. “real”) interest rate component paid on inflation-linked debt. As apparent from equation (2),
the higher the share of inflation-protected debt to total debt (Х) the higher the inflation-related compensation
costs on inflation-protected debt (in the case of a positive inflation rate).
The weighted nominal effective interest rate before inflation compensation costs is given by:
iˆeff ,t  1     ieffh,1,t     ieffh,,t
 
Interest rate
component on noninflation-linked debt
(3)
Base (i.e. “real“) interest
rate component on
inflation-linked debt
As shown in equation (3), the weighted nominal effective interest rate before inflation compensation costs
h, x
hinges on (a) the effective base interest rate component on inflation-protected debt ( ieff
) and the nominal
h ,1 x
effective interest rate on non-inflation-protected debt ( ieff
) debt and, on (b) the shares of inflation-protected
(Х) and straight debt (1-Х) to total debt.
h, x
h ,1 x
Finally, let us show how the above-mentioned effective interest rates ( ieff
, ieff
) are determined, i.e. how
quickly they adjust to changes in market interest rates.
The individual effective interest rate that is paid on the different slices of debt (i.e. on non-inflation-linked as
well as inflation-linked debt) is given by:
ieffj ,t  p  it  (1  p)  ieffj ,t 1
j
(4)
where:
j  h,1   ; h, 
p       
(5)
As shown in equation (4), the effective interest rate on the different slices of debt is the weighted average of
j
j
the prevailing market interest rate ( it ) and the effective interest rate of the previous year ( i eff ,t 1 ). As also
apparent from equation (4), the higher the share of debt that is (on average per year) subject to new financial
market conditions (p) the more sensitively the effective interest rate reacts to changing financial market
1
conditions. Moreover, as shown in equation (5) , the share of debt that adjusts on average per year to new
market conditions (p) depends on both the share of floating-rate-debt in total debt (ω) and the share of debt
that has to be rolled-over per year (μ), which is given by the reciprocal value of the average maturity of
outstanding debt. As part of floating-interest-rate-debt has to be rolled over each year anyway, we have to
subtract the cross-product of μ and ω in order to avoid double-counting.
____________________
1
Equation (5) applies to non-inflation-protected debt only. In the case of inflation-linked debt, the share of debt that adjusts to new market
interest rates is solely given by μ as there is generally no floating-interest rate component on inflation-protected debt.
12
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
3.
Debt scenario analysis
By plugging equation (2) into equation (1), we obtain the following expression:
Weighted nominal effective
interest rate before inflation
compensation
Inflation
compensation
costs on CPIlinked debt
  

1  iˆ      1  i h , x 
eff ,t
t
eff ,t
  d t 1  pbt  mt
dt  
(
1

g
)

(
1


)


t
t



Inflation benefits/


(6)
costs
As apparent from the right-hand side of equation (6) the current year‟s public-debt-to-GDP ratio depends on
the previous year‟s public-debt-to-GDP ratio, the current nominal effective interest rate, the current real GDP
growth rate, the current inflation rate, the current primary balance and current seigniorage. From equation (6)
we can now see that, ceteris paribus, there would be an increase (decrease) in the public-debt-to-GDP ratio by
the end of this period if (a) the real GDP growth rate decreases (increases), (b) the inflation rate decelerates
(accelerates), (c) the primary balance deteriorates (strenghtens) and/or (d) seigniorage decreases (increases).
As regards the direct effects of inflation on the public-debt-to-GDP ratio, the lower (higher) the share of
inflation-linked debt to total debt the more (less) a country‟s public-debt-to-GDP ratio falls, ceteris paribus,
when domestic inflation accelerates. On the one hand, a country which has 100% of its public debt outstanding
linked to the domestic inflation rate will not be able to lower the public-debt-to-GDP ratio via higher inflation. On
the other hand, a country which has no inflation-linked debt at all will benefit most significantly from a falling
public-debt-to-GDP ratio in the case of accelerating inflation. However, one should also bear in mind that
higher domestic inflation will most likely lead (either immediately or with a time lag) to “second-round” effects
such as a general rise in market interest rates as investors demand a larger inflation and/or risk premium. As
seen in (4) and (5) the shorter (longer) the average maturity of public debt outstanding, the stronger (weaker)
the adverse interest-rate effect. Moreover, in the event of an active inflationary monetary policy (that aims to
produce higher inflation rates to decrease the real value of public debt) one would also need to take the central
bank‟s seigniorage from printing more money into account when carrying out a cost-benefit analysis of higher
inflation.
Note: As regards our public debt sustainability scenario analysis presented in this chapter, we omitted
the seigniorage term (Δm) of equation (6) for simplicity.
3. Public debt scenario analysis
In this chapter we analyse public debt dynamics in the 17 DM
sample economies over the outlook period 2011-20. This analysis
gives an update to our public debt projections presented in previous
research (see “Public debt in 2020: A sustainability analysis for DM
and EM economies”).
3.1
Scenario framework and methodology
As discussed in the previous chapter, a favourable public debt
structure can be an important mitigant for sovereign debt risks. Vice
versa, a precarious debt structure can expose a country to high
market and roll-over risks. The following debt sustainability analysis
is based on our new scenario framework that explicitly models a
country‟s debt structure. For instance, our new framework considers
the average maturity of government debt as well as the proportion of
floating-interest-rate debt in total debt outstanding, and thus
implicitly accounts for the speed at which a sovereign‟s nominal
effective interest rate adjusts upwards to higher market interest
rates. Furthermore, our model takes the share of inflation-protected
debt to total debt into account, and hence is able to gauge the
July 6, 2011
13
Current Issues
ultimate effects of higher or lower inflation on the debt-to-GDP ratio.
For readers who are interested in the underlying framework, a
technical description is given in Box 1 on page 11-13.
Monetary expansion has
kept bond yields low
%
8
7
6
5
4
3
2
1
0
00 01 02 03 04 05 06 07 08 09 10 11
Fed funds target rate
10-year US Treasury yield
ECB refi rate
10-year Bund yield
Sources: IHS Global Insight, DB Research
22
Large credit stocks
increase contingent
liabilities for the sovereign
Private-sector credit, % of GDP (2010)
SK
US
JP
BE
GR
DE
AU
CA
IT
FR
SE
CH
GB
PT
ES
DK
IE
DM*
0
50
100 150 200 250 300
* DM PPP GDP-weighted average.
Sources: DB Research, S&P's, IFS, IMF,
IHS Global Insight
14
23
In our baseline scenario we calculate possible outcomes for our DM
sample economies‟ public-debt-to-GDP ratios over the the next ten
years in the absence of major financial as well as real economic
shocks. In the baseline scenario fiscal consolidation is presumed to
advance gradually over the next ten years, with the pace of
consolidation varying across countries. We also assess DM public
debt dynamics in four adverse single-variable shock scenarios as
well as in two adverse combined shock scenarios.The aim of the
adverse shock scenario analysis is to obtain an idea of the levels
which public-debt-to-GDP ratios could reach in a more challenging
economic and financial market environment. In the single-shock
scenarios we consider (a) a real GDP growth shock, (b) a primary
balance shock, (c) a market interest rate shock, and (d) a contingent
liability shock in which the government is forced to provide financial
assistance to the banking sector. How should our adverse shock
scenarios be interpreted?
The single-shock scenarios serve as a sort of sensitivity analysis to
a country‟s public debt dynamics with regard to isolated deviations in
the underlying macroeconomic and financial variables from their
baseline numbers. In the growth shock scenario, for example, we
calculate a country‟s possible future debt path using lower real GDP
growth forecasts than in the baseline scenario but leaving the
forecasts for the remaining variables (i.e. inflation, market interest
rates, primary balance) unchanged.
Scenario (a) can be understood as a low-growth scenario in which
the economic activity is restricted by domestic and/or global factors
such as renewed global recession. Scenario (b) captures weakerthan-expected public finances which could arise from slumping
public revenue and/or rising primary expenditure, for instance,
driven by weaker-than-expected tax collection and/or higher social
government expenditures. In shock scenario (c) sovereign bond
yields, which have been relatively low over the past few years
thanks to weak growth, monetary expansion and subdued inflation
expectations (see chart 22), are assumed to rise sharply over the
outlook period. For instance, investors could become increasingly
concerned about long-term fiscal solvency and hence demand much
higher default risk premia on government securities. Furthermore,
bondholders could demand a much higher inflation risk premium as
they fear governments could opt to fight large public indebtedness
with higher inflation. Finally, in scenario (d) governments face
financial-sector bail-out costs as part of the banking sector assets
become problematic (see chart 23). Although the single-variable
shock scenarios are useful in revealing country-specific weaknesses
to certain shocks, it is more appropriate to assume that any shock
will affect most macroeconomic or financial variables at the same
time. To take account of such a scenario we conclude by running
two combined shock scenarios. In (e) the first combined shock
scenario we project public debt dynamics using lower real GDP
growth, a weaker primary balance, higher market interest rates as
well as higher consumer price inflation. While consumer price
inflation is assumed to decelerate in the first combined shock
scenario (deflationary world) due to large output gaps, it is assumed
to accelerate in (f) our second combined shock scenario because of
the lagged effects of abundant monetary liquidity and rising public
indebtedness.
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
3.2
Subdued growth prospects
Real GDP, % yoy
(DM PPP GDP-weighted average)
Macroeconomic and financial market assumptions
Before we turn to our updated public debt projections for the 17 DM
sample economies, we describe our baseline scenario assumptions
with respect to the key variables that are relevant for the future
evolution of a country‟s public-debt-to-GDP ratio. As apparent from
the right-hand side of equation (6) in Box 1 on page 13 we need to
make dynamic assumptions on a wide set of macroeconomic,
financial market and fiscal indicators in order to gauge future public
debt dynamics. In what follows, we briefly present our baseline
assumptions for real GDP growth, consumer price inflation, market
interest rates and the primary balance. Moreover, we explain how
we arrive at our nominal and real effective interest rate assumptions.
4
2
0
-2
-4
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline
2000-09 average
Sources: DB Research, IMF
24
Real GDP growth (% p.a.)
For 2011-16 we take the IMF‟s real GDP growth forecasts (World
Economic Outlook Database, April 2011). For 2017-20 we assume
that our sample economies will grow at their potential, which is
approximated by the IMF‟s 2016 growth forecasts. Thus, the DM
GDP-weighted real GDP growth rate is assumed to average 2.3%
p.a. over the period 2011-20, somewhat higher than the 2000-09
ten-year historical average (see chart 24). Average DM growth over
the next ten years is expected to be only marginally higher than
projected in our study “Public debt in 2020: A sustainability analysis
for DM and EM economies”, published in March 2010. However, on
a single country basis, 2011-20 average growth rates deviate by a
couple of basis points, either positively or negatively, from previous
baseline projections (see chart 25).
Real economic growth
assumptions reviewed
Real GDP, % yoy (2011-20 average)
PT
IT
JP
GR
DE
ES
CH
BE
DK
FR
CA
GB
US
IE
AU
SE
SK
DM*
0
1
2
3
Baseline scenario
4
At the country level, Slovakia, Sweden and Australia are expected to
post the highest average growth over the next ten years at more
than 3% per year, while Portugal and Italy are forecast to grow
below 1.5% per year, the lowest rates in our country sample. Among
the three largest sample economies, the US economy is expected to
advance over the next ten years at a relatively robust average
growth rate of 2.7% per year, while real GDP growth is forecast to
be on average much weaker in Japan (+1.4% p.a.) and Germany
(+1.6% p.a.) (see chart 26).
5
Baseline assumptions ("Public debt in
2020", March 2010)
New baseline assumptions
* DM PPP GDP-weighted average.
Sources: DB Research, IMF
25
Real GDP
% yoy
6
4
2
0
-2
-4
-6
PT
IT
JP
GR
DE
ES
Avg. 2000-09
CH
BE
DK
FR
CA
Avg. 2011-20
GB
US
IE
AU
SE
SK
DM*
2010
* DM PPP GDP-weighted series.
Sources: DB Research, IMF
July 6, 2011
26
15
Current Issues
Inflation
CPI (aop), % yoy
6
5
4
3
2
1
0
-1
-2
JP
CH
GR
IE
PT
ES
US
FR
DE
Avg. 2000-09
DK
SE
IT
CA
BE
Avg. 2011-20
GB
AU
SK
DM*
2010
* DM PPP GDP-weighted average.
Sources: DB Research, IMF
27
Market interest rates
10-year government bond yields, %
14
12
10
8
6
4
2
0
JP
DE
DK
SE
FR
US
SK
BE
Avg. 2000-09
CH
CA
IT
GB
ES
Avg. 2011-20
AU
IE
PT
GR
DM*
2010
* DM PPP GDP-weighted average.
Sources: DB Research, IMF
28
Consumer price inflation (% p.a.)
Moderate inflation outlook
Inflation, % (DM PPP GDP-weighted avg.)
4
3
2
1
0
-1
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline
2000-09 average
Sources: DB Research, IMF
29
Gov't bond yields to rise
10-year government bond yields, %
(DM PPP GDP-weighted average)
6
5
4
3
2
In line with our real economic growth assumptions we employ the
latest IMF consumer price inflation forecasts (World Economic
Outlook Database, April 2011) for the period 2011-16. Again, for
2017-20 a country‟s inflation rate is assumed to remain constant at
the IMF‟s 2016 forecast rate. Because of a moderate growth outlook
the DM GDP-weighted inflation rate is expected to average 1.8%
p.a. over the next ten years (see chart 27 and 29). Inflation is
projected to be the highest in Slovakia (2.9% p.a.) and Australia
(2.7% p.a.) and the lowest in Japan (0.7% p.a.).
Market interest rates (% p.a.)
We gauge a government‟s nominal market interest rate on non5
inflation-linked public debt , i.e. its prevailing borrowing costs in
financial markets, by 10-year government bond yields. Against the
backdrop of a moderate growth and inflation outlook as well as a
gradual normalisation of monetary policies, the DM GDP-weighted
government bond yield is projected to rise modestly over the next
few years, to 4.6% from 3.4% in 2010 (see chart 30). Greece (7%
p.a.), Portugal (6.5%) and Ireland (6.2%) will face the highest
government bond yields over the next ten years due to high default
risk premia. Japan (below 1.5% p.a.) and Germany (around 4% p.a.)
are expected to pay the lowest market interest rates on new
government debt issues, as a result of comparably low inflation and
their status of “safe havens” (see chart 28).
96 98 00 02 04 06 08 10 12 14 16 18 20
5
Baseline
2000-09 average
Sources: DB Research, IMF
16
30
Our nominal interest rate projection for inflation-linked debt is determined by our
underlying projections for the base (i.e. “real”) interest rate component on inflationlinked debt as well as the inflation rate.
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Nominal effective interest
rate to rise gradually
Nominal effective interest rates (% p.a.)
A government not only has outstanding debt but also continuously
issues new debt at different maturities (short/medium vs. long-term
debt), in different currencies (domestic vs. foreign debt) and/or at
different types of interest-rate contracts (fixed, floating vs. inflationlinked debt). Hence, there is no single market interest rate that
represents a sovereign‟s ultimate borrowing costs. While sovereign
bond yields reflect the current conditions at which governments are
able to borrow in financial markets, the financial costs of public debt
(i.e. the average nominal interest rate paid on total government debt
outstanding) is given by the nominal effective interest rate. As
explained in Box 1 on page 11, a country‟s current nominal effective
interest rate depends on a host of factors. In short, it depends on the
debt structure, the prevailing market interest rates (at which a
government is currently able to issue new debt), the inflation rate as
well as the nominal effective interest rate(s) of the previous year.
The lower the average maturity of outstanding government debt and
the higher the share of floating-rate and inflation-linked debt in total
debt, the more quickly the nominal effective interest rate adjusts
upwards to rising market interest rates or higher inflation.
Nominal interest rate, %
(DM PPP GDP-weighted average)
7
6
5
4
3
2
96 98 00 02 04 06 08 10 12 14 16 18 20
Effective rate** (baseline)
Market rate* (baseline)
Effective rate** (2000-09 average)
Market rate* (2000-09 average)
* Gauged by 10-year government bond yields. ** Past
nominal effective interest rates on total public debt
outstanding were approximated by the ratio of annual
gross public debt interest payments to the previous
year's gross public debt stock.
Sources: DB Research, OECD, IMF, IHS Global
Insight, Australian Bureau of Statistics
31
Nominal effective interest rate
%
8
6
4
2
0
JP
SE
CH
DE
FR
DK
US
ES
Avg. 2000-09**
BE
GB
SK
Avg. 2011-20
IT
CA
AU
PT
IE
GR
DM*
2010**
* DM PPP GDP-weighted average. **Past nominal effective interest rates on total public debt outstanding were approximated by the ratio of annual gross public debt interest
payments to the previous year's gross public debt stock.
Sources: DB Research, OECD, IMF, IHS Global Insight, Australian Bureau of Statistics
Real interest rate to
converge to long-term avg.
Real effective interest rate, %
(DM PPP GDP-weighted average)
5
4
3
2
1
0
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline
2000-09 average
Sources: DB Research, OECD, IMF, IHS Global
Insight, Australian Bureau of Statistics
33
We approximate the sample economies‟ past nominal effective
interest rates by the ratio of gross government debt interest
payments to the previous year‟s gross government debt stock. The
data employed for the calculation of nominal effective interest rates
comes from the OECD‟s Economic Outlook database and refers to
6
the general government level. Nominal effective interest rate
projections for 2011-20 depend on the initial effective interest rate
level and our market interest rate and inflation projections, as well
as a government‟s interest-cost sensivity to changing financial
market conditions. The DM GDP-weighted nominal effective interest
rate is projected to rise gradually to around 4.2% by 2020 owing to
higher market interest rates (see chart 31). While Greece, Ireland
and Portugal are projected to face the highest nominal effective
interest rates, at 6.1%, 5.5% and 5.4% per year over the outlook
period due to high default risk premia, respectively, Japan is
estimated to effectively pay only 1.4% p.a. on its outstanding gross
government debt stock thanks to subdued inflation and very low
government bond market yields (see chart 32).
6
July 6, 2011
32
The only exception is Australia where gross general government interest payments
(“interest expenses other than nominal superannuation”) come from the Australian
Bureau of Statistics.
17
Current Issues
Real effective interest rate
%
8
6
4
2
0
-2
JP
SE
SK
DE
FR
DK
GB
BE
US
Avg. 2000-09
IT
ES
AU
CH
CA
Avg. 2011-20
PT
IE
GR
DM*
2010
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF, IHS Global Insight, Australian Bureau of Statistics
34
Real effective interest rate (% p.a.)
In our March 2010 paper, we approximated real effective interest
rates by the prevailing CPI-deflated benchmark government bond
yield. We now gauge real effective interest rates by the CPI-deflated
nominal effective interest rates. These are the final outcome of (a)
7
the countries‟ underlying public debt structures and hence their
sensivities to changing market conditions, (b) the countries‟ initial
nominal effective interest rates approximated by the OECD‟s public
debt and fiscal data, and (c) our baseline scenario projections for
market interest rates and inflation. The DM GDP-weighted real
effective interest rate, which temporarily spiked to around 3.4% in
2009 because of slumping inflation rates, is projected to rise again,
though only moderately, to 2.3% p.a. by 2020, from 1.2% p.a. this
year (see chart 33 on page 17). Although the real effective interest
rate is seen to converge to its 2000-09 annual average of around
2.4%, it is still projected to remain far below levels observed during
the late 1990s. Going forward, a continuation of expansionary
monetary policies in major DMs as well as abundant global liquidity
may prevent a more pronounced increase in the DM average real
effective interest rate. At the country level, there are large
differences as regards to real effective interest rates (see chart 34).
While the 2011-20 average real effective interest rates are expected
to be highest in Greece (4.9% p.a.), Ireland (4.0% p.a.) and Portugal
(3.6% p.a.), they are projected to be lowest in Japan (0.7% p.a.).
Interest-rate/growth
differential to remain fairly
balanced
Interest-rate/growth differential, pp
(DM PPP GDP-weighted average)
8
6
4
2
0
-2
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline
2000-09 average
Sources: DB Research, OECD, IMF, IHS Global
Insight, Australian Bureau of Statistics
35
Interest-rate/growth differential
Percentage points
8
6
4
2
0
-2
-4
SK
SE
JP
AU
US
GB
FR
DK
Avg. 2000-09
DE
BE
CA
Avg. 2011-20
ES
CH
IT
IE
PT
GR
DM*
2010
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF, IHS Global Insight, Australian Bureau of Statistics
7
18
36
As in Becker (2011), we make the simplifying assumption that a country‟s public
debt structure remains constant over the outlook period.
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Interest-rate/growth differential (percentage points)
Consolidation at different
speeds in major DMs ...
Generally, the interest-rate/growth differential determines the
underlying trend of a country‟s public-debt-to-GDP ratio in the event
of a balanced primary account. The primary balance is the fiscal
balance before net debt interest payments. In case of a positive
differential (interest rates exceed growth) the public debt ratio will
trend upwards unless the government achieves sufficiently large
primary surpluses. Likewise, a negative differential (interest rates
are lower than economic growth) the debt ratio will remain on a
falling trend if the government does not run large primary deficits. As
a result of our real growth and effective interest rate assumptions,
the DM GDP-weighted interest-rate/growth differential is projected to
be fairly balanced in our baseline scenario (see chart 35). At the
country level, Greece, Portugal and Ireland are projected to face the
widest interest-rate/growth differentials of 3.3, 2.9 and 1.1 pp,
respectively, while Slovakia or Sweden, for instance, will benefit
from comparably large negative interest-rate/growth differentials
(see chart 36). On the one hand, Greece, Ireland and Portugal have
to run relatively large primary surpluses to keep public debt in check
because of unfavourable interest-rate/growth differentials. On the
other hand, Slovakia or Sweden could stabilise or lower current
public debt levels even when running mild primary deficits.
Primary balance, % of GDP
4
2
0
-2
-4
-6
-8
-10
06
08
10
12
14
16
FR
GB
JP
US
18
20
DE
37
Sources: DB Research, OECD
... but abrupt consolidation
in most EMU peripherals
Primary balance, % of GDP
10
0
-10
-20
Primary balance (% of GDP)
-30
06
08
10
12
ES
PT
14
16
18
GR
IT
The only economic variable that can be directly influenced by the
government, either via changes in the tax rate/base or adjustments
in public expenditures, is the primary balance. Historical primary
balance data is taken from the OECD‟s Economic Outlook database
(No. 89, May 2011) and refers to the general government level.
While most of the EMU peripheral countries are projected to
consolidate sharply over the forecast period due to persistent
financial market pressures (see chart 38), consolidation is expected
to take place at very different speeds in major DM economies. While
the UK has already launched a consolidation programme and is
seen to close its primary deficit by 2016, the US and Japan still lack
clear consolidation plans and are expected to adjust only gradually
over time (see chart 37). As a result, the DM GDP-weighted primary
deficit will narrow from 6.6% of GDP in 2010 to 1.5% by 2016 (see
chart 39). As population ageing will increasingly weigh on fiscal
accounts and make further improvements in the primary balance
harder to achieve, we assume that the DM primary balance will
continue to post a mild deficit of 1.5% of GDP for the remainder of
the outlook period.
20
IE
Sources: DB Research, OECD
38
Fiscal consolidation to
advance gradually
Primary balance, % of GDP
(DM PPP GDP-weighted average)
4
2
0
-2
-4
-6
-8
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline
2000-09 average
Sources: DB Research, OECD, IMF, IHS Global
Insight
39
Primary balance
% of GDP
4
2
0
-2
-4
-6
2010:
- 30
-8
-10
JP
US
SK
GB
ES
IE
Avg. 2000-09
CA
FR
AU
BE
DE
Avg. 2011-20
PT
CH
DK
IT
SE
GR
DM*
2010
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
July 6, 2011
40
19
Current Issues
Change in DM primary balances: 2020 vs. 2010 level
Percentage points of GDP
35
30
25
20
15
10
5
0
CH
JP
IT
BE
SE
DE
AU
FR
SK
CA
US
DK
ES
PT
GB
GR
IE
DM*
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
Public debt remains on a
rising trend
Gross public debt, % of GDP
(DM PPP GDP-weighted average)
140
120
100
80
60
40
20
0
41
The projected improvement in the DM GDP-weighted primary
balance is driven by a combination of active fiscal consolidation, as
reflected by a reduction in the structural (i.e. cyclically-adjusted)
primary balances, and cyclical improvements in fiscal revenues and
expenditures due to economic recovery. At the country level, Greece
(2.8% of GDP), Sweden (2.2% of GDP) and Italy (1.8% of GDP) are
expected to achieve the largest average primary surpluses over the
next ten years, while Japan (-5.4% of GDP) and the US (-4.6% of
GDP) are expected to post the largest primary deficits (see chart 40
on page 19). While Ireland and Greece are projected to achieve the
largest adjustments in their primary balances, Japan is expected to
cut its primary deficit only marginally (see chart 41).
96 98 00 02 04 06 08 10 12 14 16 18 20
Public-debt-to-GDP projections
Baseline
Baseline (March 2010)
Sources: DB Research, OECD, IMF, IHS Global
Insight
42
Primary balance
assumptions reviewed
Primary balance, % of GDP
(2011-20 average)
JP
US
SK
GB
ES
IE
CA
FR
AU
BE
DE
PT
CH
DK
IT
SE
GR
DM*
-6
-4
-2
0
2
4
Baseline assumptions ("Public debt in
2020", March 2010)
In our March 2010 paper (which was published just before the
escalation of the EMU sovereign debt crisis) we found that the DM
GDP-weighted public-debt-to-GDP ratio could soar to more than
130% of GDP by 2020 if policymakers failed to implement sizeable
and durable near-term fiscal consolidation. Since then much has
happened. In particular, the EMU peripheral countries are facing
much tougher economic and financial market conditions today than
one year ago and hence are forced to press ahead with fiscal
consolidation. Feeding our updated baseline assumptions into our
new debt model, we find that the DM average public-debt-to-GDP
ratio will continue to climb over the next ten years, to around 126%
by 2020 from 103.7% in 2010. However, the increase in debt levels
over the next ten years is projected to be somewhat lower than
envisaged in our March 2010 study (see chart 42).
This downward revision is mainly driven by three factors. First, 2010
DM average growth surprised to the upside and, furthermore, the
medium-term growth outlook has slightly improved compared to last
year. Second, real effective interest rates are projected to be
somewhat lower on average than assumed in our March 2010
paper. Third, and most important, the fiscal outlook has brightened
in many DM economies thanks to consolidation efforts as well as
stronger-than-expected economic recovery (see chart 43).
Moreover, some major DM economies such as the UK, Germany,
France, Japan or Italy posted lower-than-expected primary deficits
in 2010 as their economies grew more strongly than initially
expected. Thus, many governments can embark on fiscal
consolidation from a better starting position.
New baseline assumptions
* DM PPP GDP-weighted average.
Sources: DB Research, OECD
20
43
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Public debt in 2020: Updated baseline scenario projections
Gross public debt, % of GDP (baseline)
250
200
150
100
50
0
-50
SE
AU
CH
DK
SK
DE
ES
2007 debt stock
GB
BE
CA
FR
IT
Change in debt stock 2008-10
IE
PT
US
GR
JP
DM*
Change in debt stock 2011-20
*DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
Public debt is still projected to remain on a rising trend in just over
half of our sample economies (9 out of 17), including the US, Japan,
the UK as well as most of the crisis-hit EMU countries such as
Spain, Ireland, Portugal and Greece. As regards the remaining DM
sample economies, the public-debt-to-GDP ratio is expected to
remain broadly unchanged in France and to decrease in Australia,
Belgium, Denmark, Germany, Italy, Switzerland and Sweden (see
chart 44). What are the conclusions from our updated baseline
scenario analysis? Although the DM public-debt-to-GDP ratio is now
predicted to rise at a somewhat slower pace than sketched one year
ago, it is still projected to climb by more than 20% of GDP until 2020
(from 2010 levels) despite the launch and implementation of
consolidation programmes in some economies. In particular, the
sharply rising US debt stock could have severe repercussions if
financial markets lost confidence in the US dollar. The recent move
by S&P‟s to attach a negative outlook to the US government‟s AAA
long-term credit rating may serve as a warning shot to the US to
tackle its large budget problems. Because of further rising debt
levels and higher interest rates, the DM average net debt interest
burden could more than double to almost 4% of GDP in 2020 from
around 1.8% in 2010, according to our calculations (see chart 45).
Overall, DM governments will have to press ahead with even more
stringent consolidation steps than assumed in our baseline scenario
to avoid an increasing debt burden.To stress the importance of nearterm consolidation we project debt dynamics in a so-called nopolicy-change scenario in which no active fiscal consolidation takes
place over the outlook period.
Debt burden to rise sharply
in baseline scenario
% of GDP, baseline scenario
(DM PPP GDP-weighted average)
4
2
0
-2
-4
-6
-8
-10
96 98 00 02 04 06 08 10 12 14 16 18 20
Net debt interest payments*
Fiscal balance
Primary balance
* Gross debt interest payments minus interest receipts.
Gross debt interest payments were calculated from
our model. Interest receipts were assumed to remain
constant over time at the 2010 level of around 1% of
GDP.
Sources: DB Research, OECD, IMF
44
45
Public debt in 2020: Baseline vs. no-policy-change scenario projections
Gross public debt, % of GDP
250
200
150
100
50
0
SE
AU
CH
DK
Current (2010)
SK
DE
ES
GB
BE
CA
Baseline scenario (2020)
FR
IT
IE
PT
US
GR
JP
DM*
No-policy-change scenario (2020)
*DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
July 6, 2011
46
21
Current Issues
If fiscal consolidation
fails ...
Primary balance, % of GDP
(DM PPP GDP-weighted average)
4
2
0
-2
-4
-6
-8
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline scenario
No-policy-change scenario
47
Sources: DB Research, OECD, IMF
175
150
125
100
75
50
25
0
96 98 00 02 04 06 08 10 12 14 16 18 20
Baseline scenario
No-policy-change scenario
48
Market interest rate in
standard-deviation shock
approach
JP
DE
DK
SE
FR
US
SK
BE
CH
CA
IT
GB
ES
AU
IE
PT
GR
DM*
10-year gov't bond yields in single market
interest rate shock, % (2011-20 avg.)
8
7
6
5
4
3
2
1
0
Negative shock**
* DM PPP GDP-weighted average. **Calculated as the
baseline market interest rate plus 0.5 times the 5-year
(2005-09) standard deviation.
Source: DB Research
22
Shock scenarios
Shock scenario methodology
Gross public debt, % of GDP
(DM PPP GDP-weighted average)
Baseline
The message of the “no-policy-change” scenario is alarming. If
consolidation failed, the DM GDP-weighted public-debt-to-GDP ratio
would increase by an additional 26.9% of GDP compared with the
baseline scenario, reaching more than 150% of GDP in 2020 (see
chart 48). While the public debt level would reach around 165% of
GDP in the US, it would increase to around 244% in Japan, around
143% in the UK, around 123% in France and around 121% in Spain
(see chart 46 on page 21).
3.3
... public debt could exceed
150% of GDP by 2020
Sources: DB Research, OECD, IMF, IHS Global
Insight
In the no-policy-change scenario we employ the same assumptions
for growth, inflation and interest rates as in the baseline scenario.
However, no further active fiscal consolidation is presumed to take
place over the coming years. In other words, a country‟s structural
(i.e. cyclically-adjusted) primary balance is assumed to remain at its
2010 level. In the absence of active fiscal consolidation the DM
GDP-weighted primary deficit is estimated to shrink only slightly
over the outlook period. The estimated reduction in the DM GDPweighted primary deficit to slightly less than 5% of GDP by 2016
from 6.6% of GDP in 2010 would be driven solely by cyclical factors
(i.e. driven by an economic recovery) (see chart 47).
49
In addition to our baseline scenario we perform four adverse singlevariable as well as two combined shock scenarios for the outlook
period 2011-20 to account for renewed economic and financial
turmoil. In (a) the single real economic growth shock scenario, a
country‟s real GDP growth rate is given by the baseline growth
number minus 0.5 times the historical standard deviation. As
regards (b) the single primary balance shock scenario, a
government‟s primary balance is given by the baseline level minus
0.5 times the historical standard deviation. For both variables we
use five-year (2005-09) historical standard deviations. Contrary to
Becker et al. (2010) we do not apply the standard-deviation-shock
framework to market interest rates. Given that historical standard
deviations of the past couple of years were relatively low for most
DM economies, the application of the standard-deviation-shock
approach produced an interest-rate-shock scenario that would most
probably be too benign (see chart 49). In (c) the single market
interest rate shock scenario we therefore assume a country‟s market
interest rates to be 50% (instead of the 0.5 standard deviation)
higher than in the baseline scenario.
In (d) the contingent-liability-shock scenario the underlying
macroeconomic and financial market assumptions are the same as
in the baseline scenario, but we assume contingent liabilities from
the banking sector to materialise in 2011, thereby causing an
immediate one-off increase in public debt levels. In our combined
shock scenarios the real GDP growth rate as well as the primary
balance are calculated as their baseline numbers minus 0.25 times
the historical standard deviation, while the market interest rate is
assumed to be 25% higher than in the baseline scenario. With
respect to inflation, the medium/long-term outlook is highly
uncertain. Some economists are more concerned about mediumterm deflation risks as renewed turmoil could lead to large output
gaps and deflationary tendencies, while other market observers are
more worried about the upside risks to the medium to long-term
inflation outlook because of highly expansionary monetary policies
in major DM economies and rapidly rising public debt levels.
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
To account for both inflation scenarios, lower and higher inflation, we
finally perform two combined shock scenarios. In (e) the first
combined shock scenario we assume inflation to accelerate globally.
In this scenario, a country‟s inflation rate is assumed be 25% higher
than in the baseline case. In (f) the second combined shock
scenario, inflation is projected to decelerate worldwide. In this
scenario, a country‟s inflation rate is presumed to be 25% lower than
8
in the baseline scenario . All shocks, apart from the contingent
liability shock (which is a “one-off” shock), are assumed to persist
9
throughout the whole period 2011-20, i.e. are permanent shocks.
Public-debt-to-GDP projections in a shock scenario
Single real GDP shock debt
projections
Gross public debt, % of GDP (2020)
DM*
17
IE
46
JP
42
GR
30
IT
21
GB
16
SK
15
DE
15
ES
14
US
14
PT
(a) Single real GDP growth shock scenario. In the single
economic growth shock scenario the DM GDP-weighted real GDP
growth rate is assumed to fall permanently short of baseline growth
by 1.4 percentage points over the outlook period 2011-20, to 0.9%
yoy from 2.3% yoy; see chart 51). On the one hand, real GDP
growth will be most affected in absolute terms in Ireland, Slovakia
and Sweden, according to our shock scenario framework, where
growth is assumed to be 3.1, 3.0 and 2.0 percentage points,
respectively, below baseline numbers. On the other hand, economic
growth will be least affected in absolute terms in Australia, Portugal
and France, where growth is assumed to fall short of baseline
growth by 0.6, 0.9 and 1.0 percentage points, respectively, (see
chart 51). As regards debt projections in the single growth shock,
the DM-GDP-weighted public-debt-to-GDP ratio will be around 17
percentage points of GDP higher than in the baseline scenario. At
the country level, Ireland (+46% of GDP), Japan (+42% of GDP) and
Greece (+30% of GDP) will face the steepest increases in their debt
ratios relative to their baseline debt ratio projections. (see chart 50).
13
Real GDP growth shock assumptions
BE
12
CA
11
5
FR
11
4
Real GDP, % yoy (2011-20 average)
DK
3
10
SE
2
7
1
CH
4
AU
0
1
Baseline
Real GDP shock
DM*
SK
SE
AU
IE
US
GB
CA
FR
DK
BE
ES
CH
DE
GR
Baseline
Negative shock
* DM PPP GDP-weighted average.
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
JP
100 150 200 250 300
IT
-1
50
PT
0
50
Sources: DB Research, IMF
51
(b) Single primary balance shock scenario. In this shock
scenario, the DM GDP-weighted primary balance is assumed to fall
(on a 2011-20 average) by 1.7 percentage points below baseline
levels, to -4.2% of GDP from -2.6% of GDP. As regards individual
8
9
July 6, 2011
In line with our market interest rate shock scenario assumptions, we also refrain
from applying the the standard-deviation-shock framework to the inflation rate.
With the exception of the market interest rate as well as the inflation rate shock
assumptions, our shock scenario framework is broadly in line with the IMF‟s Article
IV public debt sustainability framework. The IMF assumes all variables to deviate
persistently from the baseline numbers by half a standard deviation in a singlevariable-shock and by one-quarter of a standard deviation in a combined-variableshock scenario.
23
Current Issues
countries, primary balances would be most affected in absolute
terms in Ireland (-3.5 pp of GDP below baseline), Spain (-2.8 pp)
and Greece (-2 pp) and least affected in Switzerland (-0.5 pp), Italy
(-0.8 pp) and Germany (-0.9 pp) (see chart 53). As regards debt
projections, the DM GDP-weighted debt ratio will be around 17
percentage points of GDP higher than in the baseline scenario. At
the country level, Ireland (+36% of GDP), Spain (+30% of GDP) and
Greece (+23% of GDP) will see the steepest increases in their debt
ratios relative to their baseline debt ratio projections (see chart 52).
Single primary balance
shock debt projections
Gross public debt, % of GDP (2020)
DM*
17
IE
36
ES
30
GR
23
US
19
DK
18
GB
Primary balance shock assumptions
17
PT
Primary balance, % of GDP (2011-20 average)
16
CA
4
16
JP
2
15
AU
0
13
BE
13
FR
11
SK
-2
-4
-6
11
9
CH
DM*
GR
SE
IT
DK
CH
PT
DE
BE
AU
IE
CA
FR
Negative shock
* DM PPP GDP-weighted average.
50
Sources: DB Research, OECD, IMF
100 150 200 250 300
Baseline
Sources: DB Research, OECD, IMF
52
Single market interest rate
shock debt projections
Gross public debt, % of GDP (2020)
14
53
27
24
21
17
13
13
11
11
10
9
(c) Single market interest rate shock scenario. The nominal
effective interest rate of a government with a long average maturity
and/or a high share of fixed-interest-rate debt reacts more sluggishly
to rising market interest rates than that of a sovereign with short
debt maturities and a high share of floating-interest-rate debt. This
relationship is now explicitly considered in our new scenario tool. In
the market interest rate shock scenario, the DM GDP-weighted
government bond yield is assumed to increase (on a 2011-20
average) by 2.2 percentage points above baseline levels, to 6.5%
from 4.3%. At the country level, government bond yields would rise
most significantly in absolute terms in Greece (3.5 pp above
baseline levels), Portugal (3.2 pp) and Ireland (3.1 pp) and the least
Japan (0.7 pp), Germany (2.0 pp) and Denmark (2.1 pp) (see chart
55). As regards debt projections, the DM GDP-weighted debt ratio
will be around 14 percentage points of GDP higher than in the
baseline scenario. At the country level, Greece (+53% of GDP),
Portugal (+27% of GDP) and Ireland (+24% of GDP) will see the
Market interest rate shock assumptions
8
10-year government bond yields**, % (2011-20 average)
6
12
6
10
5
4
3
8
6
2
Market interest rate shock**
Baseline
DM*
PT
GR
IE
AU
ES
IT
GB
CA
CH
BE
SK
FR
US
0
SE
* DM PPP GDP-weighted average. **In the single
market interest rate shock both the nominal market
interest rate on non-inflation-linked debt (which is
gauged by the 10-year government bond yield) and the
base rate (i.e. the real interest rate component) on
inflation-linked debt are assumed to be higher than in
the baseline scenario.
Sources: DB Research, OECD, IMF 54
DK
Baseline
4
100 150 200 250 300
DE
50
JP
0
53
Primary balance shock
* DM PPP GDP-weighted average.
DM*
GR
PT
IE
IT
US
BE
CA
ES
FR
JP
DE
SK
GB
DK
CH
AU
SE
ES
Baseline
5
0
24
GB
JP
9
SE
SK
-8
9
US
IT
DE
Negative shock
* DM PPP GDP-weighted average. **In this chart we show our nominal market interest rate assumptions
for non-inflation-linked debt only.
Sources: DB Research, IMF
55
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Contingent liabilities
largest in Ireland
steepest increases in their debt ratios relative to their baseline debt
ratio projections (see chart 54 on page 24).
% of GDP (2010)
US
9.5
Gross problematic asset estimates by S&P's
JP
10.2
Gross problematic assets, % of total banking sector assets (2010)
SK
10.8
IT
19.2
DK
Lower bound
GB
30.7
PT
32.3
ES
32.6
IE
81.9
14.0
0 10 20 30 40 50 60 70 80 90
* DM PPP GDP-weighted average.
Sources: DB Research, S&P's, IFS, IMF,
IHS Global Insight
56
Gross public debt, % of GDP (2020)
14
IE
89
PT
42
ES
35
GR
34
GB
30
DK
23
IT
21
CH
19
CA
13
FR
13
DE
12
AU
12
SE
12
JP
10
US
10
9
SK
9
11
0
50
Baseline
100 150 200 250 300
Contingent liability shock
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF, S&P's, IFS,
IHS Global Insight
July 6, 2011
IE
SK
GR
PT
US
IT
ES
(d) Contingent liability shock scenario. Contingent liabilities from
the banking sector can be an important risk factor for public debt
sustainability. In the event of a severe banking crisis, the
government may have to come to the aid of its domestic financial
institutions and cover most of the banks‟ financial losses. This could
push the public-debt-to-GDP ratio sharply upwards, thereby causing
concerns about public debt sustainability. The Irish sovereign debt
crisis, which was to a large extent caused by the country‟s ailing
banking sector, is only the most recent example.
As a result, the DM GDP-weighted public-debt-to-GDP ratio could
rise to around 140% of GDP by 2020 and hence could be 14% of
GDP higher than predicted in our baseline scenario. However, we
would like to stress that the above contingent liability shock scenario
is based on relatively rough estimates for sovereign contingent
12
BE
57
In line with Becker (2011), our contingent liability calculations are
based on a country‟s 2010 year-end private-sector-credit-to-GDP
10
ratio (see chart 23 on page 14) and S&P‟s latest estimates for a
country‟s gross problematic assets (GPA) as a percentage of total
assets from the banking sector (see chart 57). S&P‟s estimates a
GPA range, i.e. a lower and an upper limit for the banking sector‟s
11
GPA in percent of total assets. Our calculations are based on the
average of S&P‟s lower and upper limit estimates for the share of
gross problematic assets. According to our estimates, contingent
liabilities from the banking sector could be largest in Ireland (81.9%
of GDP), Spain (32.6% of GDP) and Portugal (32.3% of GDP) (see
chart 56). As regards a shock scenario in which governments face
immediate financial-sector bailout costs in 2011, public-debt-to-GDP
ratios in 2020 could climb most significantly (relative to the baseline
scenario) in Ireland (+89% of GDP), Portugal (+42% of GDP) and
Spain (+35% of GDP) (see chart 58).
Contingent liability shock
debt projections
DM*
GB
Sources: DB Research, S&P's, IMF
26.3
DM*
Upper bound
* DM PPP GDP-weighted average.
22.4
GR
Mid bound
DM*
17.6
CA
14.1
SE
SE
CH
CH
12.9
JP
12.7
FR
DE
12.5
CA
FR
AU
DK
11.8
BE
11.6
AU
BE
DE
45
40
35
30
25
20
15
10
5
0
58
For some sample economies no IFS data is available on the private-sector credit
stock. For these economies we used the stock of “Other sectors“, which is
domestic credit minus credit to the general government level.
See S&P‟s (2011), pp. 2-6. S&P‟s GPA range is an estimate of a country's potential
proportion of credit to the private sector and non-financial public enterprises that
could become problematic during a severe economic downturn. According to
S&P‟s, problematic assets include overdue loans, restructured assets (where the
original terms have been altered), foreclosed real estate and other assets
recovered in loan workouts, and non-performing assets sold to special-purpose
vehicles.
25
Current Issues
liabilities from the banking sector (which are based on IFS credit
stock data and S&P‟s GPA range estimates as of April 8, 2011) and
hence could either over- or underestimate contingent claims on the
government.
First combined shock debt
projections
Gross public debt, % of GDP (2020)
DM*
19
IE
(e/f) First and second combined shock scenarios. As our
combined shock scenarios permanently affect all variables at the
same time, we assume that the real GDP growth rate and the
primary balance deviate “only” by the 0.25 standard deviation from
their baseline levels as higher standard deviations would most likely
produce a too extreme shock scenario. Furthermore, we assume
that market interest rates climb “only” by 25% above baseline
numbers. In the first combined shock scenario, where consumer
price inflation is presumed to edge higher (i.e. is assumed to be
25% higher than in the baseline scenario), public-debt-to-GDP ratios
will see the steepest increases relative to the baseline 2020 debt
projections in Ireland (+49% of GDP), Greece (+48% of GDP) and
Japan (+29% of GDP) (see chart 59).
49
GR
48
JP
29
ES
24
PT
22
US
20
IT
19
GB
16
CA
15
DK
14
BE
14
SK
13
FR
12
DE
12
SE
8
AU
8
CH
6
0
50
100 150 200 250 300
Baseline
First combined shock
Our second combined shock scenario, where inflation is presumed
to fall below baseline numbers (i.e. is assumed to fall 25% below
baseline numbers), produces higher debt stock projections than our
first combined shock scenario as higher inflation generally helps
governments to lower debt-to-GDP ratios – irrespective of whether a
country has a high or a low share of inflation-linked debt (see chart
60). Of course, if inflation exceeds a certain threshold and spins out
of control, market interest rates may increase more than
proportionally in response, thereby strongly limiting or even inverting
the “debt-lowering” effects of inflation.
* DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
59
As explained in the shock scenario analysis (and depicted in charts
62 and 63 on page 27), the DM GDP-weighted public-debt-to-GDP
ratio could climb even more sharply in the event of renewed
economic and/or financial market turmoil than sketched in our
baseline scenario. Precisely, the DM GDP-weighted public-debt-toGDP ratio could spike to more than 155% of GDP in our second
combined shock scenario (see charts 62 and 63), which is
characterised by permanently weaker real GDP growth (annual
average growth of 1.6% during the outlook period 2011-20 vs. 2.3%
in the baseline scenario), lower consumer price inflation (1.3% yoy
vs. 1.8% yoy), higher market interest rates (5.4% vs. 4.3%) and a
wider primary deficit (-3.4% of GDP vs. -2.6% of GDP). The
Second combined shock
debt projections
Gross public debt, % of GDP (2020)
DM*
30
IE
61
GR
61
JP
38
PT
36
IT
33
ES
33
US
Summary of pessimistic shock scenarios
32
CA
26
BE
26
GB
25
Baseline vs. shock scenario assumptions
Pessimistic shocks, 2011-20 average (DM PPP GDP-weighted average)
6.5
5.4
4.3
SK
21
FR
2.3
0.9
21
DE
1.8
1.6
1.8
1.3
21
DK
21
-2.6
-4.2
AU
11
SE
11
CH
8
0
Real GDP,
% yoy
50
Baseline
-3.4
Primary
balance,
% of GDP
Market
Inflation rate, Inflation rate,
interest rate*,
% yoy
% yoy
%
(First comb. (Second comb.
shock)
shock)
100 150 200 250 300
Baseline
Second combined shock
Sources: DB Research, OECD, IMF
Single shock
Combined shocks
* on non-inflation-linked debt. The market interest rate on non-inflation-linked debt is gauged
by the 10-year government bond yield.
* DM PPP GDP-weighted average.
26
2.2
8
6
4
2
0
-2
-4
-6
60
Sources: DB Research, OECD, IMF
61
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Pessimistic shock scenario
debt projections (2020)
Gross public debt, % of GDP
(DM PPP GDP-weighted average)
160
140
120
100
80
Second comb.
Growth
First comb.
Primary balance
Interest rate
Cont. liability
2010
Baseline
2007
60
Sources: DB Research, OECD, IMF, IFS, S&P's,
IHS Global Insight
62
Pessimistic shock
scenarios in comparison
Gross public debt, % of GDP
(DM PPP GDP-weighted average)
160
150
140
130
120
110
100
90
10 11 12 13 14 15 16 17 18 19 20
Baseline
Real GDP shock
Primary balance shock
Interest rate shock
First combined shock
Second combined shock
Contingent liability shock
Sources: DB Research, OECD, IMF, IFS, S&P's,
IHS Global Insight
63
underlying assumptions for all single and combined shock scenarios
are summarised in chart 61 on page 26. However, in our first
combined shock scenario, in which the inflation rate is assumed to
stay above its baseline figures (2.2% yoy vs. 1.8% yoy in the
baseline scenario), the public-debt-to-GDP ratio would climb less
sharply to around 145% of GDP. As regards the single shock
scenarios, the DM GDP-weighted public-debt-to-GDP ratio would
reach the highest levels in the growth shock by the year 2020 (see
chart 62).
Optimistic shock scenarios
Finally, we are interested in what could happen to debt dynamics in
the event of more favourable financial and economic conditions than
assumed in the baseline scenario. When running our single and
combined shocks with opposite signs (i.e. assuming higher instead
of lower growth, stronger instead of weaker primary balances, lower
instead of higher market interest rates, and so forth), the DM GDPweighted public-debt-to-GDP ratio would only come back over time
on a moderate downward trend in the optimistic second combined
shock scenario. In the remaining optimistic shock scenarios, such as
the first combined shock scenario or the single growth shock, the
DM GDP-weighted public-debt-to-GDP ratio would only stabilise
over time at very high debt levels of around 110% of GDP (see chart
64).
As regards the optimistic second combined shock scenario, the
public-debt-to-GDP ratio would still remain at very high levels of
more than 90% of GDP in a couple of smaller as well as major DM
economies, including the US, Italy, Portugal, Greece and Japan (see
the blue bars in chart 65). Interestingly, only in the US and Japan
public-debt-to-GDP ratios would continue to climb from current
(2010) debt levels in the optimistic second combined shock scenario
(compare the blue bars with the dark lines in chart 65), showing that
current fiscal policies would still produce higher debt stocks in the
event of more favourable marcoeconomic and financial market
conditions. Overall, the optimistic shock scenario exercise
underlines that many DM countries have to do more than just return
to “business as usual” in order to restore/ensure long-term public
debt sustainability.
Optimistic shock scenarios
in comparison
Gross public debt, % of GDP
(DM PPP GDP-weighted average)
160
150
140
DM public debt would remain broadly unchanged in
an optimistic scenario
Second combined shock scenario: Gross public debt, % of GDP (2020)
130
300
120
250
110
200
100
150
90
100
10 11 12 13 14 15 16 17 18 19 20
50
Baseline
Real GDP shock
Primary balance shock
Interest rate shock
First combined shock
Second combined shock
Sources: DB Research, OECD, IMF, IFS, S&P's,
IHS Global Insight
July 6, 2011
Positive shock
Baseline
Negative shock
DM*
JP
GR
US
PT
IT
IE
FR
CA
BE
GB
ES
DE
SK
DK
CH
AU
SE
0
Current (2010)
* DM PPP GDP-weighted average.
64
Sources: DB Research, OECD, IMF
65
27
Current Issues
Box 2: Calculating fiscal consolidation needs
For both investors and governments it is important to know the magnitude of future fiscal consolidation needs
in order to stabilise or reduce the public-debt-to-GDP ratio to certain target debt levels. The following
calculation of fiscal consolidation needs is borrowed from Sturzenegger (2002) and Ley (2005).
Stabilising the public-debt-to-GDP ratio at the current (2010) level
The required primary balance to stabilise the public-debt-to-GDP ratio, denoted as pb , is given by:
r  g 
pb  
  d0
1  g 
(7)
where r denotes a government„s real effective interest rate,
prevailing public-debt-to-GDP ratio.
g the real GDP growth rate and d 0 the
As can be seen from the right-hand side of equation (7), the required primary balance to stabilise the current
public-debt-to-GDP ratio is determined by the real-interest-rate/real-GDP-growth differential as well as the
prevailing debt level. While governments which are confronted with a positive real-interest-rate/real-GDPgrowth differential (i.e. with a real interest rate that exceeds the real GDP growth rate) need to achieve a
primary surplus to stabilise the prevailing public-debt-to-GDP ratio, governments facing a negative realinterest-rate/real-GDP-growth differential (i.e. with a real interest rate that falls short of the real GDP growth
rate) could run primary deficits to stabilise the current public-debt-to-GDP ratio. Generally, the wider a country‟s
positive (negative) real-interest-rate/real-GDP-growth differential, the larger the government‟s required primary
surplus (primary deficit) to stabilise the current public-debt-to-GDP ratio.
Lowering the public-debt-to-GDP ratio to target debt levels
The required primary balance to lower the current public-debt-to-GDP ratio to a target debt level is given by:
T
 1 r 
  d *
d 0  
1

g


pb * 
j
T 1
 1 r 



j 0  1  g 
(8)
*
where pb denotes the primary balance that needs to be achieved by the government to lower the current
*
public-debt-to-GDP ratio to a target debt level of d over the next T years.
As can be seen from the right-hand side of equation (8), the required primary balance is determined by the
real-interest-rate/real-GDP-growth differential, the prevailing and target debt levels as well as the time horizon
for debt reduction. Generally, the lower the target debt level and the shorter the time horizon during which debt
reduction should take place, the larger the required primary balance to lower the public-debt-to-GDP ratio.
Countries with a high public-debt-to-GDP ratio and wide (positive) real-interest-rate/real-GDP-growth
differentials need to run large primary surpluses to lower their debt levels.
28
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
4. Fiscal consolidation needs
It is essential to know how much fiscal adjustment is needed to bring
public finances back on a sound(er) footing. Obviously, the
dimension of and the time frame for fiscal consolidation differ widely
across countries and depend on the economic and financial
conditions which governments face (i.e. economic growth and
effective interest rates on outstanding government debt), the current
stance of fiscal policy (i.e. large, medium or small
deficits/surpluses), the prevailing debt level (i.e. low, medium or high
government debt) as well as the desired target debt level. While
highly indebted sovereigns will be forced to lower their debt ratios
significantly, governments with already low or only moderate debt
levels may only have to stabilise their debt ratios to ensure longterm debt sustainability.
Ireland & Southern Europe
need the largest primary
surpluses to stabilise debt
RPB to stabilise the gross debt ratio at
the 2010 level*, % of GDP
JP
SK
SE
US
GB
In this chapter we want to answer three questions:
FR
First, how much fiscal adjustment is needed to stabilise the publicdebt-to-GDP ratio at the current (2010) level.
AU
Second, given that the recent rise in public debt was mainly driven
by the global financial crisis, how large is the fiscal adjustment to
bring the debt ratio back to its pre-crisis (2007) level.
DK
DE
Third, how much fiscal adjustment is needed to lower the debt stock
to so-called “prudent” benchmark debt levels such as the 60%-ofGDP Maastricht criterion.
BE
CH
CA
The methodology to calculate fiscal consolidation needs is explained
in Box 2 on page 28.
ES
4.1
IE
IT
PT
GR
DM**
-2
-1
0
1
2
3
4
5
* Calculations are based on 2011-20 average
projections for real GDP growth and the real effective
interest rate. ** DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
66
Stabilising debt ratios at 2010 levels
Some sample economies (such as Japan, Sweden or Slovakia) can
run mild primary deficits to stabilise their public-debt-to-GDP ratios
at current levels thanks to favourable interest-rate-/growth
differentials (see chart 66). At the same time, Greece, Portugal, Italy
and Ireland need to run comparatively large primary surpluses of
between 1.2% of GDP (in the case of Italy and Ireland) and around
4.9% of GDP (in the case of Greece) because of relatively high debt
levels and unfavourable interest-rate/growth differentials (see chart
66). However, in order to see how close a government‟s current
fiscal policy stance is to debt stabilisation, we compare a country‟s
required debt-stabilising primary balance (in the following
abbreviated by RPB) with its current primary balance and
alternatively with the achieved average primary balance during the
last business cycle.
Greece, Portugal and Ireland have to achieve large primary surpluses to stabilise debt
% of GDP
6
4
2
0
-2
-4
-6
-8
-10
JP
SK
SE
US
GB
FR
Primary balance (avg. 2005-09)
AU
DK
DE
BE
CH
Primary balance (2011)
CA
ES
IE
IT
PT
GR
DM**
Required primary balance* (baseline)
*Required primary balance to stabilise the gross public-debt-to-GDP ratio at 2010 level. Calculations are based on 2011-20 average projections for real GDP growth and the real
effective interest rate. ** DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
July 6, 2011
67
29
Current Issues
Ireland, the US and Greece face the largest consolidation needs to stabilise debt
Primary gap vs. 2011 primary balance*, percentage points of GDP
12
10
8
6
4
2
0
-2
-4
SE
CH
DE
BE
IT
Baseline scenario
AU
FR
DK
SK
CA
PT
Pessimistic second combined shock scenario
ES
GB
JP
GR
US
IE
DM**
Optimistic second combined shock scenario
* The primary gap indicator is defined as the required primary balance to stabilise the gross public-debt-to-GDP ratio at 2010 level minus the projected primary balance
for 2011. ** DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
Widest primary gaps in
Ireland, the US and Greece
In the following we compare a country‟s estimated primary balance
for this year (i.e. 2011) with its RPB as well as with its historical
(2005-09) average primary balance. Three out of the four sample
economies with the largest RPB are currently nowhere near debt
stabilisation, according to our calculations (see chart 69). While, for
instance, the Greek primary balance is estimated to post a deficit of
around 2% of GDP in 2011 (vs. an estimated RPB of 4.9%), the Irish
primary balance is expected to record a deficit of 7.1% of GDP this
year (vs. a RPB of 1.2%). In Italy, where the government is expected
to achieve a primary surplus of around 0.5% of GDP this year (vs. a
RPB of 1.2% of GDP), near-term debt stabilisation is not out of
sight. As regards the whole DM country sample, the current primary
12
gap to reach near-term debt stabilisation (as measured by the gap
between a country‟s RPB and its 2011 primary balance estimate) is
currently the largest in Ireland (~8.3% of GDP) and in the US
(~7.7%) followed by Greece (~6.8%), Japan (~5.9%), the UK
(~5.8%) and Spain (~5.1%) (see charts 67 and 69).
Primary gap vs. 2011 primary balance*,
percentage points of GDP
SE
CH
DE
BE
IT
AU
FR
DK
SK
CA
PT
ES
GB
JP
GR
US
IE
DM**
-4
-2
0
2
4
6
8
Moreover, even when assuming more favourable economic and
financial market conditions (i.e. higher growth, lower interest rates,
etc.) most of the above countries would still record large primary
gaps and thus would be nowhere near short-term debt stabilisation
(see the black lines in chart 68). Not surprisingly, many more sample
countries would post large primary gaps in the event of more
adverse economic and financial market conditions (i.e. lower growth,
higher interest rates, etc.) (see the grey lines in chart 68). Overall,
10
* The primary gap indicator is defined as the required
primary balance to stabilise the gross public-debt-toGDP ratio at 2010 level minus the projected primary
balance for 2011. ** DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
68
69
Return to "business as usual" will not suffice for debt stabilisation in many countries
Primary gap vs. 2005-09 avg. primary balance*, percentage points of GDP
10
8
6
4
2
0
-2
-4
DK
SE
BE
CH
DE
AU
CA
IT
FR
ES
SK
JP
GB
US
IE
PT
GR
DM**
* The primary gap indicator is defined as the required primary balance to stabilise the gross public-debt-to-GDP ratio at 2010 level minus the average primary balance during
2005-09. ** DM PPP GDP-weighted average.
Sources: DB Research, OECD, IMF
12
30
70
The primary gap indicator is based on the ideas of Blanchard (1990).
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
the above analysis shows that most DM sample economies, apart
from a few exceptions like Sweden, Switzerland, Germany, Belgium,
Italy or Australia, are still far away from near-term debt stabilisation.
Moreover, in many economies (such as Greece, Portugal, Ireland,
the US, the UK, Japan, Slovakia, Spain and France) fiscal
policymakers will have to do more than just return to “business as
usual” in order to stabilise debt ratios.
In other words, fiscal policymakers in those countries will have to do
more than merely adjust the primary balance back to historical
averages (such as the five-year 2005-09 average) in order to
achieve near-term debt stabilisation. On the other hand, there are
some countries (such as Denmark, Sweden, Belgium, Switzerland,
Germany, Australia, Canada and Italy) where “business as usual”
could suffice for debt stabilisation (or in some cases, even suffice for
debt reduction) (see chart 70 on page 30). As the rapid increase in
public indebtedness over the past few years has been driven mainly
by the global financial crisis, we now estimate a country‟s fiscal
consolidation requirements to lower debt ratios to pre-crisis levels.
4.2
Public debt ratios have
climbed sharply since 2007
Change in the gross public-debt-to-GDP
ratio (2010 vs. 2007 level), pp of GDP
CH
SE
-7
0
AU
11
SK
12
BE
13
IT
14
CA
18
DK
21
DE
22
FR
22
ES
24
PT
28
US
32
JP
33
GR
34
GB
35
IE
74
-10 0
10 20 30 40 50 60 70 80
Sources: DB Research, OECD
July 6, 2011
71
Lowering debt ratios to pre-crisis levels
In most DM economies the financial crisis has caused a large
increase in the public-debt-to-GDP ratio. The increase in the debt
stock was driven either by the materialisation of contingent liablities
from the banking sector (direct costs of the financial crisis for the
sovereign) and/or slumping tax revenue as well as rising
expenditure (indirect costs) because of large output losses. While
public debt ratios have climbed noticeably since 2007 in Ireland
(+74% of GDP), the UK (+35% of GDP), Greece (+34% of GDP),
Japan (+33% of GDP) or the US (+32% of GDP), they have risen
less strongly in Australia (+11% of GDP) or Slovakia (+12% of GDP).
There is only one country in our DM sample, namely Switzerland,
where the public debt ratio has decreased over the past three years
by almost 7 percentage points of GDP, to just above 40% of GDP in
2010 from around 47% of GDP in 2007. Moreover, there is only one
sample economy (Sweden), where the public-debt-to-GDP ratio has
remained broadly unchanged (see chart 71).
In order to undo the damage caused by the global crisis over a
reasonably short period of time, let‟s say the next five (ten) years,
i.e. in order to lower the public-debt-to-GDP ratio to pre-crisis (2007)
levels by the year 2015 (2020), Ireland, Greece and Portugal would
have to achieve extremely large primary surpluses of an estimated
16.3% (8.5%) of GDP, 12.2% (8.8%) of GDP, and 8.8% (6.0%) of
GDP, respectively (see the blue and grey bars in chart 72 on page
32). Against the backdrop of still wide primary deficits, these three
EMU peripheral countries will most likely not be able to lower their
debt-to-GDP ratios to pre-crisis levels over a reasonably short
period of time. Hence, debt reduction to pre-crisis levels would
realistically take relatively long in these economies and will most
likely not be achieved within one decade. Hence, debt reduction to
pre-crisis levels would be a challenging process which requires
strong political support for drastic and ongoing fiscal consolidation
over more than one decade. However, debt reduction to pre-crisis
levels over the next five or ten years also appears to be very
demanding, if not impossible, in most other sample economies (see
chart 72).
31
Current Issues
Debt reduction to pre-crisis levels looks extremely demanding for most economies
Permanently required primary balance to reach 2007 gross public debt level, % of GDP
20
The blue bar shows the required primary balance to
lower the debt level over the 10-year period. The sum
of the blue and grey bars shows the required primary
balance to lower the debt level over the 5-year period.
15
10
5
0
-5
-10
SE
CH
SK
AU
BE
JP
FR
in ten years (by 2020)
DK
CA
DE
IT
US
in five years (by 2015)
ES
GB
PT
IE
GR
Primary balance (2011)
72
Sources: DB Research, OECD, IMF
Public debt is significantly
higher than 60% of GDP
in most economies
4.3
Even before the global financial crisis there were only eight out of 17
sample economies with public-debt-to-GDP ratios of below 60% of
GDP, which is often considered to be a prudent benchmark debt
level for DM economies. In 2010, only five sample economies
(Australia, Switzerland, Slovakia, Sweden, Denmark) had publicdebt-to-GDP ratios of below 60% (see chart 73). Moreover, public
debt ratios are significantly above the 60% threshold in many
economies, including many EMU countries (e.g. Greece, Italy,
Portugal, Ireland, Belgium, France and Germany) and other major
DM economies (e.g. Japan, the US, Canada and the UK). At the
moment, Slovakia is the only EMU country in our DM sample which
has a public-debt-to-GDP ratio of below the 60% and thus in
compliance with the Maastricht debt criterion (see chart 73).
Gross public debt, % of GDP
JP
GR
IT
PT
IE
BE
FR
US
DE
CA
GB
ES
DK
SE
SK
CH
AU
0
30
60
90 120 150 180 210
2010
2007
Sources: DB Research, OECD
Lowering debt ratios to prudential benchmarks
Most of those sample economies with government debt ratios above
60% of GDP would have to implement harsh and prolonged fiscal
consolidation programmes to reduce their (2010) debt ratios to 60%
of GDP over the next ten years (see the blue bars in chart 74). On
the one hand, for instance, Greece (14.0% of GDP), Japan (12.7%),
Italy (7.9%) and Portugal (7.5%) would have to run extremely large
permanent primary surpluses to lower the gross public debt level to
60% of GDP by the year 2020 because of very high current debt
ratios and/or unfavourable interest-rate/growth differentials. On the
other hand, Spain (1.1% of GDP), the UK (2.0%), Germany (2.7%)
or Canada (2.8%) would have to achieve the lowest permanent
annual primary surpluses to bring their public debt stocks to 60% of
GDP over the next ten years.
73
Debt reduction to prudent benchmarks is currently not within reach for most countries
Permanently required primary balance to reach 60% of GDP target (for the gross public debt stock), % of GDP
30
25
20
15
10
5
0
-5
-10
The blue bar shows the required primary balance to
lower the debt level over the 10-year period. The sum
of the blue and grey bars shows the required primary
balance to lower the debt level over the 5-year period.
AU
SK
SE
CH
DK
in ten years (by 2020)
ES
GB
DE
CA
US
in five years (by 2015)
FR
BE
IE
PT
IT
JP
GR
Primary balance (2011)
Sources: DB Research, OECD, IMF
32
74
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Debt reduction to 60% of
GDP would be a long-term
task for most countries
However, to obtain an idea how challenging debt reduction to
prudential benchmarks would be over the next ten years, we
calculate the current gap between a country‟s permanently required
primary balance to lower the debt level to 60% of GDP and its
estimated primary balance for this year. Our calculations show that
such a goal would be extremely demanding, if not impossible, for
many countries (see chart 75). Japan, for example, would have to
achieve a permanent adjustment in its primary balance of around
20% of GDP in order to lower its debt level to 60% of GDP by 2020.
But also many other sample economies (Greece, Ireland, the US,
Portugal, the UK, Italy, Canada, France, Spain and Belgium) would
have to achieve large permanent adjustments in their primary
balances to reach debt reduction to prudent benchmarks by 2020,
ranging from around 4.5% to more than 15% of GDP. Among major
DM countries with debt levels above 60% of GDP, Germany would
have to achieve the smallest adjustment in its primary balance (of
around 2.7% of GDP) to reach debt reduction to prudent
benchmarks over the next ten years. Overall, the above analysis
suggests that debt reduction to prudent benchmark levels would
take a very long time and require strong political will.
Permanent fiscal adjustment*, % of GDP
SE
CH
AU
SK
DK
DE
BE
ES
FR
CA
IT
GB
PT
US
IE
GR
JP
-5
0
5
10
15
20
Difference between required primary balance to
reach the 60% of GDP target (for the gross public debt
stock) over the next ten years and the estimated
primary balance for 2011.
75
Sources: DB Research, OECD, IMF
Public debt dynamics in
EMU peripheral countries
Gross public debt, % of GDP
180
160
140
120
100
80
60
40
20
0
96 98 00 02 04 06 08 10 12 14 16 18 20
PT
GR
IT
ES
IE
Sources: DB Research, OECD, IMF, IHS Global
Insight
76
Public debt dynamics in
major advanced economies
Gross public debt, % of GDP
250
200
150
100
50
0
96 98 00 02 04 06 08 10 12 14 16 18 20
US
FR
JP
GB
DE
Sources: DB Research, OECD, IMF
July 6, 2011
77
5. Summary and conclusions
The global crisis has caused massive fiscal deterioration and
resulted in a sharp increase in public indebtedness. On a GDPweighted average, the DM public-debt-to-GDP ratio climbed
drastically from around 77% in 2007 to roughly 104% in 2010,
marking an increase of more than 25% in just three years. Public
finances have not only become unsustainable in EMU peripheral
countries but also in some major DM economies like the US. In
2010, for instance, the US fiscal balance posted an extremely large
deficit of more than 10% of GDP for the second consecutive year
and the public debt stock is estimated to reach 100% of GDP by the
end of this year. Because of a still fragile economic and financial
system, many DM policymakers face the balancing act of
significantly consolidating fiscal accounts without stalling economic
growth. While the crisis-troubled EMU peripheral countries have
been tremendously pressured by markets to consolidate drastically,
other major DM economies with larger fiscal scope, including the US
and Japan, have remained on a highly expansionary fiscal policy
path to bolster economic growth despite rapidly rising debt levels.
According to our baseline scenario projections in chapter 3, which
are on average based on a gradual tightening of fiscal policies in the
advanced world, the DM GDP-weighted public-debt-to-GDP ratio
could continue to rise over the next ten years, to around 126% of
GDP in 2020 from around 104% today. However, should fiscal
consolidation fail, the DM GDP-weighted public debt stock could
even soar to more than 150% of GDP by 2020, according to our nopolicy-change scenario projections. Also in the event of lower-thanexpected growth or higher-than-expected interest rates, public debt
ratios could rise much more sharply than projected in our baseline
scenario. In our second combined shock scenario, for instance, the
DM GDP-weighted public-debt-to-GDP ratio could surge to more
than 155% of GDP by 2020, even when assuming a gradual
withdrawal of expansionary fiscal policies. Moreover, even in an
optimistic scenario – driven by higher growth, stronger-thanexpected public finances, lower interest rates and higher inflation –
the DM average public-debt-to-GDP ratio would only fall very
33
Current Issues
Debt burden could rise
sharply until 2020 ...
gradually over time and still stand at around 100% of GDP by the
end of 2020. All in all, our public debt sustainability scenario analysis
confirms that current fiscal policies are unsustainable in many DM
economies. At the country level, most EMU peripherals (Ireland,
Portugal, Spain and Greece) are likely to see their debt levels climb
further despite harsh austerity measures. In the case of Greece, the
debt stock could continue to climb to around 174% of GDP by 2020
and then stabilise. (see chart 76 on page 33). While the public-debtto-GDP ratio could rise further in some major DMs like the US,
Japan, Canada or the UK, it is projected to remain broadly
unchanged in France (see charts 76, 77 and 79). Last but not least,
public debt levels could fall in Germany and Italy as well as in some
other countries (Sweden, Denmark, Switzerland, Belgium and
Australia), according to our baseline projections (see chart 79).
Net debt interest payments*, % of GDP
(baseline scenario)
SE
DK
CH
CA
AU
SK
JP
DE
ES
FR
GB
BE
US
IT
IE
PT
GR
DM**
Public debt dynamics
0
2
4
6
Avg. 2005-09
8
2010
10
12
2020***
* Gross debt interest payments minus interest
receipts. ** DM PPP GDP-weighted average.
*** Gross debt interest payments in 2020 were
calculated from our model. Interest receipts were
assumed to remain constant over time at the 2010
level.
Sources: DB Research, OECD, IMF
78
Gross public debt: 2020 vs. 2010, percentage points of GDP
50
40
30
20
10
0
-10
-20
-30
-40
US JP GR IE PT ES CA GB SK FR AU IT BE DE CH DK SE
Sources: DB Research, OECD, IMF
... and consume a larger
share of public revenue
Net debt interest payments*, % total
revenue (baseline scenario)
SE
DK
CH
CA
AU
SK
DE
JP
FR
BE
GB
ES
IT
IE
US
PT
GR
DM**
0
5
Avg. 2005-09
10
15
2010
20
25
2020***
* Gross debt interest payments minus interest
receipts. ** DM PPP GDP-weighted average.
*** Gross debt interest payments in 2020 were
calculated from our model. Interest receipts were
assumed to remain constant over time at the 2010
level. Moreover, we implicitly assumed that the
projected change in a country's primary balance over
the outlook period 2011-20 will be equally driven by
adjustments in primary expenditures and total
revenues.
Sources: DB Research, OECD, IMF
34
79
In light of rapidly rising debt levels and a challenging fiscal outlook
due to population ageing, many DM governments have to continue
(or start, if not yet done) consolidating their government budgets to
regain/ensure fiscal credibility and long-term debt sustainability. On
average, DM fiscal policies are at the moment far away from nearterm debt stabilisation, according to our analysis in chapter 4.
Lowering debt ratios to pre-crisis (2007) or prudent benchmark
levels will require a long consolidation process and thus strong
political support and stamina to ultimately reach this goal. Apart from
the EMU peripheral countries, where public debt ratios could
continue to rise due to unfavourable interest-rate/growth
differentials, the US debt outlook remains particularily worrying. If
US fiscal policymakers fail to agree on a more drastic consolidation
programme over the next few years than presumed in our baseline
scenario, the US government debt stock could soar to around 134%
of GDP by 2020, sharply up from 93.6% in 2010 and 62% in 2007.
As a result, the US net debt interest burden – an important indicator
eyed by external rating agencies – could rise considerably over time
and hence increasingly weigh on sovereign creditworthiness (see
charts 78 and 80). S&P‟s recent move to attach a negative outlook
to the US government‟s AAA long-term credit rating could serve as a
warning shot to fiscal policymakers to prevent this scenario from
materialising.
Sebastian Becker (+49 69 910-30664, sebastian.becker@db.com)
Wolf von Rotberg (+49 69 910-31886, wolf-von.rotberg@db.com)
80
July 6, 2011
Public debt in 2020: Monitoring fiscal risks in developed markets
Literature
Anderson, Jeffrey and Jared Bebee (2011). Government Debt By
Creditor: Greece, Ireland and Portugal. IIF Research Note.
Institute Of International Finance.
Becker, Sebastian, Gunter Deuber and Sandra Stankiewicz (2010).
Public debt in 2020: A sustainability analysis for DM and EM
economies. Current Issues. Deutsche Bank Research.
Becker, Sebastian (2011). Public debt in 2020: Structure matters! A
new scenario tool applied to Latin America. Current Issues.
Deutsche Bank Research.
Blanchard, O. J. (1990). Suggestions for a New Set of Fiscal
Indicators. OECD Economics Department Working Papers, No.
79, OECD Publishing. http://dx.doi.org/10.1787/435618162862
Blommestein, Hans J. (2011). Public Debt Management and
Sovereign Risk during the Worst Financial Crisis on Record:
Experiences and Lessons from the OECD Area. Sovereign Debt
and the Financial Crisis. The World Bank.
De Broeck, Mark and Anastasia Guscina (2011). Government Debt
Issuance in the Euro Area: The Impact of the Financial Crisis.
IMF Working Paper WP/11/21.
Fitch (2010). Just How Indebted Is the Japanese
Government?
Ley, Eduardo (2005). Fiscal (and external) sustainability. Fiscal
Affairs Department, IMF.
Standard & Poor‟s, (2011). Banking Industry Country Risk
Assessments.
Sturzenegger, Federico (2002). Toolkit for the Analysis of Debt
Problems. Universidad Torcuato Di Tella.
July 6, 2011
35
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