Higher debt leaves sovereigns tough choices as recession risks rise

Few countries have managed to reverse the damage that the Covid-19 pandemic did to public finances yet, says Fitch Ratings.

As global growth slows in 2022-2023, higher levels of government debt/GDP could leave many sovereigns with less fiscal flexibility to support economic growth and vulnerable sections of the population than during other recent external shocks.

Fitch forecasts that government debt/GDP ratios will be at 2019 levels or lower in just 20 of the 119 sovereigns in our rated portfolio by end-2022.

This is despite unexpectedly strong fiscal outcomes and nominal GDP growth in 2021 that helped move Outlooks to Stable from Negative for some sovereign ratings, such as in Latin America and the US. Africa and the Middle East have the highest proportion of sovereigns with lower debt/GDP in 2022 than in 2019. Most are oil exporters that have benefited from the surge in oil prices.

The proportion of sovereigns that have restored debt/GDP to pre-pandemic levels is smaller in Eastern Europe and Latin America. In Eastern Europe, this partly reflects fiscal slippage in 2022 linked to the fallout from the Russia-Ukraine war. However, debt/GDP ratios are still lower than they were on average in 2015-2019 for almost a third of the region’s sovereigns. In Latin America, only Jamaica has achieved the same improvement compared with 2015-2019.

The recent acceleration of inflation in many countries may initially lower debt/GDP by boosting nominal GDP levels and lifting fiscal revenues more quickly than spending, especially for commodity exporters.

However, structural fiscal-consolidation efforts that require increasing taxes or reducing public spending will likely generate social and political frictions where households and businesses face inflation-related income pressures. In fact, most sovereigns have already eased fiscal policy to offset some of the impact of price rises on households and businesses.

Meanwhile, high inflation is also driving up nominal interest rates, raising sovereign borrowing costs, as well as driving exchange-rate weakness in some emerging markets that is increasing repayment burdens associated with foreign currency-denominated debt.

The impact of higher rates on borrowing costs will feed through at different speeds in different parts of the world, reflecting variations in factors such as the speed and scale of rate hikes, debt duration, and the proportion of debt that is inflation-indexed, on floating rates or foreign-currency denominated.

In Western Europe, where debt durations are generally high and policy interest rates have been comparatively slow to rise, almost three-quarters of sovereigns will pay less in interest as a share of GDP in 2022 than in 2019, prior to the pandemic.

The UK, where rates have risen faster and instruments linked to the retail price index account for 31% of the debt stock, is a marked exception, with interest/GDP increasing by 1.3pp over the period. By contrast, median interest payments in Sub-Saharan Africa in 2022, at 2.7% of GDP, will already be almost 0.4pp greater than in 2019, and more than 1pp higher in countries like Ghana, Namibia and Uganda.

The series of major shocks to the global economy leave public finances in many sovereigns more exposed. The trajectory of debt/GDP is a key rating sensitivity for several sovereigns currently on Negative Outlook, including the Czech Republic, France, Kenya, North Macedonia, the Philippines, Romania and Rwanda.

“We expect debt/GDP in 2022 to remain well above 2019 levels in all these sovereigns, though it is significantly below its pandemic peak in France”.

Elsewhere, ratings and Outlooks will remain sensitive to public finance pressures associated with slower growth or potentially recessions, which may be exacerbated by rising debt service costs and fiscal efforts to address inflation.