Ageing populations hit government credit ratings

This is an audio transcript of the FT News Briefing podcast episode: ‘Ageing populations hit government credit ratings’

Marc Filippino
Good morning from the Financial Times. Today is Tuesday, May 30th, and this is your FT News Briefing.

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The US has reached a deal to raise the debt ceiling. Democrats and Republicans plan to dot the I’s and cross the T’s this week. And the outcome of Turkey’s presidential election has caused the lira to slide. Plus, we’ll take a look at how ageing populations are causing government credit ratings to take a hit. I’m Marc Filippino, and here’s the news you need to start your day.

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All the drama over raising the debt ceiling in the US is nearly over. Democrats and Republicans reached a deal over the weekend that once signed will prevent the United States from defaulting on its debt and avoid an economic catastrophe in the process. I’m joined now by the FT’s Lauren Fedor. She’s based in Washington and has been following the debt ceiling story. Hi, Lauren.

Lauren Fedor
Hi, Marc.

Marc Filippino
OK, so we have a deal. What exactly is the status?

Lauren Fedor
That is right, we have a deal. After a lot of hand-wringing and many days of back and forth. Speaker of the House Kevin McCarthy, Joe Biden came out over the weekend and they said, we’ve got a deal. A lot of people in Washington breathed a sigh of relief when they heard that, but that’s only the first step. Unfortunately, there’s still a lot more hand-wringing to go this week, particularly on Capitol Hill. This deal needs to, have been turned into a bill, and now it needs to be approved by both the House and Senate in order to go into effect.

Marc Filippino
What’s some of the nitty-gritty? Do we know any of the details of this deal yet?

Lauren Fedor
We do. We do. So originally over the weekend, we heard that it was just a deal in principle. Then later on Sunday, a full legislative text came out. And there are a couple of top lines I can give you. One is that it’s going to raise the debt ceiling, that’s the limit on government borrowing until after the next presidential election. Remember, that’s in November of 2024. It’s gonna cap spending at current levels for the 2024 fiscal year. And then it’s only going to allow spending to rise by 1 per cent in 2025. And there are some changes as well to some of the social safety net programmes in the US, particularly when it comes to eligibility for nutritional assistance or what is commonly referred to as food stamps. There’s also been a change to something called permitting reform. It’s basically speeding up the ability for big energy projects to get going.

Marc Filippino
So Democratic President Joe Biden and Republican Speaker of the House Kevin McCarthy both came out after the deal was announced over the weekend. They both said good things about the deal, more or less. Do we know how other Democrats and Republicans are reacting to this?

Lauren Fedor
Yeah, so, I mean, the big task for both McCarthy and Biden now is selling the deal to the members of their own party. And we’ve already seen members from both parties be very critical of this deal. When it comes to the Republicans on the right, some of the biggest fiscal hawks, members of the so-called Freedom Caucus, they’ve already hit out at the deal saying the cuts are far too modest, do not go far enough. And then on the other end of the political spectrum on the left, the progressives in the Democratic party are pretty disappointed with Biden for compromising at all. And we’re expecting both Republicans and Democrats to sign on to this. But we need a critical mass in order for a majority of the House in particular to pass this deal.

Marc Filippino
Lauren Fedor is the FT’s deputy Washington bureau chief. Thanks, Lauren.

Lauren Fedor
Thanks, Marc.

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Marc Filippino
Recep Tayyip Erdoğan comfortably won re-election in Turkey’s presidential election this weekend. Sunday’s run-off vote showed Erdoğan’s main rival, Kemal Kılıçdaroğlu, only received about 48 per cent of the vote. But the real loser here is the Turkish lira. The currency hovered around record lows on Monday after the election. You see, Erdoğan doesn’t believe in raising interest rates. A few years ago, he called high interest rates the mother of all evil. And after Sunday’s run-off vote, Erdoğan insisted he would keep interest rates low, even though inflation in the country is above 40 per cent. But many economists think that Erdoğan won’t be able to keep up his low interest rate environment and his measures to prop up the lira. Turkey’s reserves have dropped by about $27bn this year as Ankara tries to prop up the currency.

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High inflation is raising the cost of borrowing for governments. But inflation isn’t the only culprit here. The cost of looking after ageing populations is also becoming a growing headache. And agencies are already beginning to warn that credit downgrades are likely. Mary McDougall covers the government debt market for the FT, and she joins me now. Hi, Mary.

Mary McDougall
Hi, Marc. Thanks for having me on.

Marc Filippino
Good to have you. So you talked to Moody’s, which is one of the biggest credit agencies in the world, and they said that demographics are already hitting the credit ratings of some countries. What does that mean? What’s the correlation between an ageing population and a lower credit rating?

Mary McDougall
Yeah, it was super interesting. I spoke to Moody’s and then I spoke to the other ones because it’s something that they’re really getting more worried about. So the correlation, ageing populations hit government finances in two ways. You have on one side, you have shrinking workforces, which hinders economic growth, and then on the other side, on the government spending side, pension and healthcare policies, the two big ones that become more expensive. So it really becomes more difficult for the government finances. And the reason that they’re talking about it now is inflation globally has pushed up interest rates, and that pushes up debt servicing costs, which makes borrowing much more expensive for governments to spend on these policies.

Marc Filippino
And as I understand it, it’s kind of taken governments off guard. They weren’t expecting these rate hikes and inflation to be as bad as it was. So they’re caught a little flat-footed.

Mary McDougall
Yeah, absolutely. I mean, it’s interesting because ageing populations generally is one of the few things in economics that really is pretty predictable. But what wasn’t predictable is the interest rates. So S&P took some quite interesting analysis where they forecast that under a stress test, adding one percentage point to borrowing costs would increase debt- to-GDP ratios for Japan, Italy, the UK and the US by around 40 to 60 percentage points by 2060. So it’s a huge increase.

Marc Filippino
Are those the most vulnerable countries? And if they are, how come?

Mary McDougall
Yes, they are among the most vulnerable just because they have the oldest workforces at the moment. I mean, Japan in particular stands out and Europe as well. And then looking into the future, rating agencies say that Asia is gonna be under the most pressure by the middle of the century. So you’ve got countries like China, for example, which had a one-child policy.

Marc Filippino
I want to talk about France, though, for a second, because Fitch downgraded France’s credit rating recently, despite President Emmanuel Macron’s move to raise the retirement age. How come?

Mary McDougall
Well, they downgraded France for a host of reasons. I think part of it was that they’re worried that Macron’s reform agenda could stall. It’s not quite through yet. And what they said was that France doesn’t have a great record in managing its public finances.

Marc Filippino
Would raising the retirement age even do anything?

Mary McDougall
Yeah, it definitely helps. That keeps costs down. Some countries link the retirement age to life expectancy, and that is one way that analysts say is something that countries can do to try and make these ballooning pension costs more affordable.

Marc Filippino
So there are a few other things that governments can do to help here based on what I read in your story. For example, they can look at their immigration policies to make sure that they have a skilled and growing workforce that could help economies. But what happens, hypothetically, if governments just fail to take action?

Mary McDougall
So if they don’t take any action, we’re gonna see ballooning debt-to-GDP ratios. We’ve already seen debt-to-GDP grow a lot since the pandemic, and it started to come down a bit. But projections are that this will start to increase again by the end of this decade. And having this ballooning debt to GDP makes it more likely that they’ll then have their credit ratings downgraded. So S&P said in January that roughly half of the world’s economies will have been downgraded to junk by 2060, up from a level of around a third today if measures aren’t taken to ease ageing populations. And being downgraded to junk makes borrowing much more expensive for governments because there are lots of investors that will only own investment-grade bonds, which are deemed less risky. And so with fewer owners, that puts borrowing costs up as well. So then potentially puts it into a bit of a downward spiral.

Marc Filippino
So Mary, it sounds like it’s pretty serious. Is it something that governments are prioritising?

Mary McDougall
Well, it’s, it is very important. But actually, if you think about it, you’ve had a pandemic and the lockdowns sparked by that. And then you had Russia’s invasion of Ukraine and the energy crisis that came out from that. So it’s really not been the top priority for governments, I wouldn’t say. But the important thing is they do need to make the reforms now or the earlier the better, because the earlier you start putting in reforms, the easier it is for them to start feeding through and the less damage that’s done in the long term.

Marc Filippino
Mary McDougall is the FT’s bonds and currencies reporter. Thanks, Mary.

Mary McDougall
Thank you.

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Marc Filippino
You can read more on all of these stories at FT.com. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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