Governments around the world have close to $80 trillion in debt. As interest rates begin to rise globally we explore if governments around the world can really afford higher interest rates. We will write about the impact of rising interest rates on individuals/households and corporates/businesses later.
We recently wrote about Greece (Moody’s Credit Rating: Caa2) paying lower interest on bonds than the US (Moody’s Credit Rating: Aaa) here. Many governments have not run a surplus for years, they have simply been borrowing additional money every single year increasing their total debt. We will talk about several countries here but will specifically provide some numbers for the US and the UK. Both the US and the UK last ran a surplus in 2001.
The US and the UK
The US government has around $20.5 trillion in debt and pays around $320 billion in interest payments a year (an effective interest rate of 1.56%). The US tax revenues are around $4 trillion (Federal revenue only – state revenues not included) a year, which would mean 8% of all tax revenues are paid as interest.
The UK government has around £1.7 trillion in debt and pays around £40 billion in interest payments a year (an effective interest rate of 2.35%). The UK tax revenues are around £750 billion a year, which would mean 5.33% of all tax revenues are paid as interest. The UK has paid £540 billion in interest since it last ran a surplus in 2001.
Both the UK and US are unlikely to run surpluses any time soon. The UK government has projected to balance its books and generate a surplus in 2025. That surplus target year has changed several times and going by past precedence it should be taken with a pinch of salt.
Now, on the impact of rising interest rates and bond yields. A lot of government borrowing is long term (10 and 30 year bonds being the most popular) so the impact of rising bond yields won’t be felt immediately. On an average, around 7% of the total debt is rolled over for both the US and UK every year plus new borrowing is made. A 1% (100 basis points) rise in yields would increase the total interest cost on existing borrowings by 4.8% for the US and by 5.1% for the UK in the first year. Those numbers would be compounded in subsequent years.
The impact would be much lesser on emerging economies like Brazil and India because they already have a high effective interest rate. A 1% (100 basis points) increase is unlikely to make much of an impact. The impact on countries with zero or negative interest rates (we covered here) would be very significant.
We do not expect Japan to increase interest rates nor do we think bond yields for Japan are likely to rise mainly because most debt is held within Japan rather than overseas. Japan already spends a large proportion of its tax revenues as interest. Japan also has the largest government debt to GDP ratio in excess of 250%.
The Eurozone is a different story. The weaker Eurozone economies (Greece, Italy and Portugal) simply have a high debt to GDP ratio and higher interest payments as part of tax revenues. These countries have experienced ultra low bond yields recently with Greece bond yields hitting a 12 year low. Any increase in interest rates will have a major impact on these countries.
“Credit is a system whereby a person who can’t pay, gets another person who can’t pay, to guarantee that he can pay.” – Charles Dickens, Little Dorrit