Record debt and soaring interest costs mean governments face a reckoning – but investors stand to benefit
- Global government debt rose 7.6% to a record $66.2 trillion in 2022
- Higher interest rates meant government interest bills soared 20.9%, the fastest rate of increase since 1984; interest paid on sovereign debt reached a record $1.38 trillion in 2022 and will double in the next three years
- By 2025, global debt is set to rise by one sixth from 2022’s record levels to $77.2 trillion
- The US accounted for more than half the global increase and more additional borrowing than every other country combined
- The UK now owes a record £2.57 trillion ($3.1 trillion), up 6.9% year-on-year
- With the global economy expected to weaken in the coming months, Janus Henderson is bullish on bonds and opportunities for bond investors; bonds of all maturities are likely to see yields fall in the year ahead and long-dated bonds are expected to perform well as economy comes under pressure
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, putting significant strain on taxpayers and public services. However, there are opportunities for investors despite these challenging market conditions.
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.
Government interest bills jumped by more than a fifth (+20.9% constant currency basis) in 2022 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.
Deep-dive across regions
In the UK, government finances have substantially deteriorated in the last twelve months, due to the effect of inflation on interest payments, the Bank of England’s holding of government debt from quantitative easing, and increased daily spending in the form of energy subsidies. The country now owes a record £2.57 trillion ($3.1 trillion), up 6.9% year-on-year. The UK’s debt per person has risen by £9,417 since the end of 2019 and now stands at £38,017 ($46,002). With so many pressures, the UK’s budget deficit is going to rise again in 2023 and will only begin to fall when big tax rises begin to kick in and when the economic downturn passes.
Public debt in the United States rose to $24.86 trillion in 2022, up 11.5% year-on-year. Its total borrowings are almost as large as Japan, China, France, the UK, Italy and Germany combined. The 2022 increase funded a range of spending commitments by the Biden administration and accounted for over half the increase in global government debt last year, well ahead of the United States’ two-fifths share of global GDP.
In Emerging Markets, India saw record debt levels – an increase of one eighth to a record $1.9 trillion. Colombia’s sovereign debt reached COP956 trillion ($199bn) in 2022, up 11.8% year-on-year, a faster increase than the global average. Brazil’s BRL7.29 trillion ($1.40 trillion) public debt rose 4.7% in 2022, slower than the global increase but its interest costs jumped by a third owing to higher interest rates. The Mexican government had outstanding debts of MXP14.3 trillion ($736bn) in 2022, up 6.3% year-on-year. Its 51% debt-to-GDP ratio is lower than the global average but middle of the pack among its emerging market peers.
Three-year global outlook
By 2025, the effective interest rate paid on government borrowing will rise from 2.2% in 2022 to 3.8% as bonds are refinanced or new ones are issued. This will prove very expensive for governments around the world, who 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 – half of US debt must be refinanced by October 2025.
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% in 2025. Over the next three years, the global average debt per person will rise by another $2,025 to $15,550.
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 quantitative easing (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 i.e. a slowdown in growth, but no outright contraction, except in a handful of national economies.
We believe this is incorrect, although 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.”
