Governments face a painful reckoning as record debt and higher interest rates mean borrowing costs will double over the next three years, according to the annual Sovereign Debt Index from Janus Henderson. This will put significant strain on taxpayers and public services, but there are opportunities for investors.
2022 and 2023 have seen dramatic changes for government finances around the world. By the end of last year, the total value of global government debt had leapt by 7.6% on a constant currency basis to a record $66.2 trillion, double its 2011 level. The US government accounted for more additional borrowing in 2022 than every other country combined.
Costs are mounting sharply. Government interest bills jumped by almost over a fifth in 2022 (+20.9% constant currency basis) to a record $1.38 trillion. This was the fastest increase since 1984 and reflected both rising rates and the swelling stock of sovereign borrowing. The effective interest rate, which includes older, cheaper borrowing, rose to 2.2% in 2022, up by one seventh, year-on-year.
This cost continues to rise as new bonds are issued at higher interest rates and older, cheaper debt is retired. The effective interest rate in 2025 is set to be 3.8%, almost three quarters more than 2022’s level.
This will prove very expensive for governments. By 2025, the governments around the world will have to spend $2.80 trillion on interest, more than double the 2022 level. This will cost an additional 1.2% of GDP diverting resources from other forms of public spending or requiring tax rises. The US is particularly exposed on this measure.
On top of this come losses on central bank portfolios of QE bonds which must be filled by tax dollars, reversing the pre-2022 flow of profits on these bonds paid by central banks to government finance departments.
Ongoing annual deficits mean debts will continue to rise, reaching $77.2 trillion by 2025. The global debt burden will rise from 78% of GDP today to 79% of GDP in 2025.
Jim Cielinski, Global Head of Fixed Income at Janus Henderson said: “The level of government debt and how much it costs to service really matter to society, affecting decisions on taxation and public spending and raising questions of generational fairness. Since the Global Financial Crisis, governments have borrowed with astonishing freedom. Near-zero interest rates and huge QE programmes by central banks have made such a large expansion in government debt possible, but bondholders are now demanding higher returns to compensate them for inflation and rising risks, and this is creating a significant and rising burden for taxpayers. The transition to more normal financial conditions is proving a painful process.
We expect the global economy to weaken markedly in the months ahead, and for inflation to slow more than most expect. The market expects the world economy to have a relatively soft landing – a slowdown in growth, but no outright contraction, except in a handful of national economies, he added. Cielinski said that believe this is incorrect.
The sheer volume of debt owed by governments, corporates and individuals nevertheless means that rates do not need to climb as far as in the past to have the same effect. The interest rate tightening cycle is nearing its end.
Investors stand to benefit. Bonds of all maturities are likely to see yields fall in the year ahead, meaning prices will rise. Short-dated bonds offer higher yields at present because they are more closely connected to central bank policy rates. This is good for those wanting income and tolerating lower risk, but they will see less capital appreciation. The scope for capital gains is significantly greater for longer-dated bonds which we expect to perform very well in the next year as the economy comes under pressure.”
Por Marcelo Soba