What Fitch got right – the case for slower adjustment
On Friday Fitch joined Moody’s in downgrading the UK from AAA to AA. My thoughts on this are much the same as I thought at the last downgrade – this is of no economic importance even if it is politically embarrassing for the Chancellor. The wider point is that retaining the AAA should never have been a target for fiscal policy makers.
Whilst my views of the calibre of rating agencies analysis throughout the crisis has been pretty much in line with that of Jonathan Portes, I thought one nugget of information in Fitch’s statement was worth highlighting.
The long average maturity of public debt (15 years) – the longest of any high-grade sovereign -exclusively denominated in local currency and low interest service burden implies a higher level of debt tolerance than many high-grade peers.
This is an important point. Much as there is a tendency to look at deficit/GDP ratios without taking account of interest rates, too often economists look at debt/GDP ratios without looking at the maturity of that debt. This is nonsensical. As any individual can grasp, there is a world of difference between owing someone £100,000 repayable in twenty years time and owing someone £100,000 due tomorrow.
The UK, as Fitch note, has the longest average debt maturity of any high-grade country. Last week’s IMF Fiscal Monitor makes this very clear:
Whereas most countries’ debt is due in 5-7 years time the UK’s average debt to maturity is 14.4 years.
This has two important impacts on the UK’s fiscal position. First, the UK is less exposed to rising interest rates than other sovereign borrowers. As it has less debt maturing each year than would be the case with shorter maturities it has to refinance less debt each year than comparable countries. This gives a degree of insulation against rising borrowing costs.
Second, the fact that less existing debt matures each year means that gross debt issuance is much lower than would be expected given the large deficit.
Again, IMF data shows this clearly:
Despite having a larger deficit than, say Canada or France, the UK needs to issue less gross debt each year than either. Whilst the UK may come towards the top of the table for size of deficit, it is very much in the middle of the pack when it comes to gross issuance. This is directly down to the long maturity profile of its debt.
As Fitch note (this really is worth quoting twice!), together with low interest rates this “implies a higher level of debt tolerance than many high-grade peers”. To simplify, the UK economy is better able to handle periods of higher debt/GDP than other countries.
All of which suggests that the UK has room for a much slower fiscal adjustment than it is currently pursuing. This yet another reason to seriously question the UK’s current (failed) fiscal framework.