Rich Western governments are running out of time to confront budget challenges posed by aging populations, Moody’s said.
The rating agency said in its quarterly Aaa Sovereign Monitor that big sovereign bond issuers such as the United States, the United Kingdom, France and Germany are “well positioned” to retain their gold-plated triple-A credit ratings, even amid questions about the strength of the global economic recovery.
But Moody’s added that paying for the cost of quelling the financial crisis has left Western governments “much more vulnerable” to a potential rise in funding costs.
It added that the price of containing the financial meltdown of 2008-2009 has been to accelerate longer-term challenges such as making good on pension and healthcare promises for an expanding group of retirees, at a time when workforces are shrinking.
“The crisis has effectively ‘fast-forwarded’ history by 15 to 20 years, eroding all the time that was previously available for governments to adjust,” Moody’s wrote.
The biggest governments’ borrowing costs have actually fallen sharply over the course of this year, as investors have scooped up government bonds in a bid to lock in valuable income streams with deflation knocking at the door. Benchmark bond yields have dropped by a percentage point in the United States and by lesser but still sizable amounts in the U.K., Germany and Japan.
But Moody’s notes that policymakers must continually win the bond market’s confidence by showing they are taking their longer-term fiscal challenges seriously. It points out that a failure to retain that confidence could be destabilizing.
“A potential interest rate shock is the biggest single threat to the debt affordability of Aaa governments,” Moody’s wrote.
What’s more, the biggest problem isn’t the enormous debt we have now, the rating agency writes. The real issue are the promises we’re going to have to make in coming years to pay off the costs we have yet to incur.
The magnitude of the fiscal challenges faced by Aaa-rated governments is not appropriately captured by current levels of indebtedness as these reflect the accumulation of past deficits. Debt levels are already high in most countries, but the main challenges facing governments actually stem from future deficits, arising from the permanent effects of the crisis and compounded by the consequences of ageing.
The ratings firm writes that while high debt levels in the United States “are among the most challenged of the major Aaa countries, it possesses very high finance-ability and a significant adjustment capacity to reverse debt dynamics over time.”
But addressing those dynamics, Moody’s reminds, won’t be painless. No nation will be able to handle its surging debt loads and unhappy demographics without explicitly addressing who will bear the costs, and how, via reduced benefits, higher taxes, etc.
The size of the fiscal challenge is such that, in many cases, this implies a reversal of the secular trend towards a rise in the size of government in the economy (captured by the size of government expenditure as a percentage of GDP) and ever broader mutualization of society’s risks through the balance sheet of the public sector. This requires, in other terms, a renewal of the social contract.