Fitch Ratings expects its portfolio of rated sovereigns to pay around USD2.3 trillion in interest costs in 2023. This represents a steep rise in interest spending since 2020, with a greater increase of 47% in developed markets (DMs) compared with 40% in emerging markets (EMs). The trend reflects an end to the era of low inflation and, at least for DMs, a period of exceptionally low interest rates.
Aggregate annual government interest payments by Fitch-rated DM sovereigns were fairly steady at around USD900 billion to USD1 trillion over 2007-2021, even though their median level of government debt/GDP jumped by around 20pp over the period. This partly reflects the effects of steadily low interest rates in DMs. In contrast, interest payments by EM governments have tended to increase in line with their debt ratios.
We expect the increase in interest rates associated with the rise in global inflationary pressure in 2022 to affect most sovereigns around the world. However, the rise in interest costs will be greater for DMs than for EMs, in part because DMs benefitted more from low borrowing costs previously. It also reflects our base case assumptions, under which DM central banks are projected to raise interest rates further in 2H23 in response to high and persistent levels of core inflation. Differences among EMs may be greater, but we believe many EM central banks will keep rates on hold over 2H23, following significant monetary tightening earlier.
The trend among DMs is heavily influenced by the US, the largest sovereign debt issuer. The rolling 12-month sum of federal government interest payments hit USD616 billion in June 2023, surpassing USD600 billion for the first time. It had exceeded USD500 billion for the first time only eight months earlier, in November 2022. Fitch expects the rising interest burden and growing spending on entitlements to keep budget deficits high and government debt/GDP rising.
The rise in interest costs among DMs has been particularly notable in the UK, where interest payments on a 12-month basis reached GBP117 billion in May 2023, double the level in the period to September 2021. This reflects the high proportion of inflation-linked debt in the UK, which sped up the pass-through from inflation to interest costs despite the long average maturity of government debt. Inflation index-linked debt accounted for almost 25% of UK government debt stock in 2023, while the next largest issuer of inflation-linked debt among the G7, Italy, had just 12%; France was the only other member with a level of over 10%.
A small number of EMs also have high levels of inflation-linked debt, including Uruguay, Chile, Brazil and Israel. However, we expect Brazil’s inflation to average 4.7% in 2023, in line with its historic median over 2017-2022. The other EM sovereigns with a substantial proportion of indexed debt account for a small share of total EM debt.
Fitch’s rating Outlooks tend to be more favourable for EM sovereigns than for DMs, which is partly because we see DMs as facing relatively greater interest-rate stress. Negative Outlooks outnumber Positive Outlooks by five among DMs, while Positive Outlooks outnumber Negative by three among EMs, although EMs also account for all the sovereigns with ratings below ‘B-’, for which Fitch does not assign Outlooks. Twelve-month trailing rating changes may be positive for EMs and negative for DMs in 2H23, based on the current Outlook distribution and year-to-date rating changes. This would mark the first such rating outcome since 2012.
