The amount of debt alone says little about its affordability. What is relevant is whether it can be serviced. That is why economists analyze the amount of interest being spent as a percentage of economic output. Consequently, the looming shift in interest rates could be a problem.
That will not happen overnight, however. Depending on the average residual term in the debt portfolio and the resulting risk to refinancing, governments have time to prepare themselves for the change in financing conditions.
Upon closer examination, it becomes clear that there are major differences between the debt held by Switzerland, its most important trading partners – Germany, France, Italy, Spain, the UK – and the US and Japan.
The short-term perspective reveals that the debt burden at the end of 2023 will still be far removed from the level seen during the debt crisis of 2012. Yet, temporarily avoiding the problem does not mean it will go away. Even if the interest rate hikes do not immediately trigger a debt crisis, the government will not have carte blanche to continue running deficits.
In the medium term, the growing interest burden can become a problem even if the primary balance evens out. The primary balance is the fiscal balance – excluding all interest income and expenses – that is used to evaluate the government budget independently of its debt level and financing activities. Specifically, this is the case if the real interest rate on bonds is higher than the growth rate of the economy, i.e. when what is called the interest-growth differential is positive. That is because then, the amount spent on debt servicing exceeds the growth in GDP, and the debt-to-GDP ratio increases, even if the government budget is balanced.
In Switzerland and Germany, the interest-growth differential could remain negative until the end of the decade, even if the central banks raise their prime rates in increments of 25 basis points each quarter until the end of 2025. Thus, the two countries will at least be able to continue stabilizing their debt levels in spite of their primary deficits.
Even balanced primary budgets will not be enough to accomplish that in the US as of 2027 or in Spain and France as of 2028. As for Italy, it will need to generate primary surpluses starting as early as mid-2025 in order to prevent its debt-to-GDP ratio from climbing higher due to its debt servicing.
With investments in the energy transition, higher defense spending on weapons and cybersecurity, or the unsecured financing of pension systems, it has become less likely that large-scale consolidation of government budgets will take place in the next few years.
The IMF's budget forecasts do not suggest that will be accomplished in any country – with the exception of the United Kingdom and Switzerland. In other words, Italy, France, Spain, and the US could be faced with an affordability problem sometime between the middle and the end of this decade. If they do not have a credible fiscal strategy on the table by then, markets could lose confidence in those countries, thereby increasing the probability of a debt crisis.
The level of debt in many countries has reached historic highs, but other numbers allow people to breathe a sigh of relief, at least for the time being. For example, the shift in interest rates will only have an impact on government budgets with a delay, in particular because of the long residual maturities on existing debt.
Switzerland stands out with its especially robust fiscal policy. Without a doubt, the country owes that to the debt brake. However, the expensive problems of the future could, under certain conditions, also result in tax increases or spending cuts elsewhere in this country.