Standard & Poor's: Global Aging 2010 - An Irreversible Truth.
No other force is likely to shape the future of national economic health, public finances, and policymaking as the irreversible rate at which the world's population is aging. The problem has been long observed and is well understood: U.N. figures show the proportion of the world's population aged over 65 is set to more than double by 2050, to 16.2% from 7.6% currently. By the middle of the century, about 1 billion over 65s will join the ranks of those classed as of non-working age. Standard & Poor's Ratings Services believes that the cost of caring for these people will profoundly affect growth prospects and dominate public finance policy debates worldwide.
Since September 2007, when we published our last update on what we view to be the potential implications of this shift in demographics on sovereign ratings, the onset of the financial crisis has interrupted government efforts to manage the burden of aging-related spending. Before the crisis, many governments' structural primary deficits were improving, albeit not as quickly as our projections had indicated would be needed. However, the rapid build-up of government debt over the past three years has, in our view, heightened the need to do more to frontload reforms aimed at containing the risks to sovereign budgets, especially in countries with high expected future increases in age-related spending. Currently, relatively high general government deficits are complicating efforts to rapidly improve public finances, particularly among advanced economies. This will, in our view, likely lead to further debt accumulation over the medium term.
The 2010s had been considered by previous Standard & Poor's reports the window of opportunity to address the challenges posed by aging to the sustainability of public finances. Through the next decade, governments likely have some breathing space as we expect pressure from age-related spending will remain relatively moderate over this period. Nevertheless, while this window to implement fiscal sustainability strategies remains open, it will not be for long with the expected acceleration in spending starting in 2020. Against the backdrop of large deficits in some countries, we expect undertaking budgetary consolidation and pension or health-care system reforms simultaneously will prove politically challenging, and could lead to delays in policy implementation. In our view, the maneuvering room has shrunk and delays in policy implementations may generate additional political, economic, and budgetary costs.
A Long-Observed Phenomenon
Standard & Poor's commenced its regular analysis of the implications of the shifting demographics for sovereign ratings across the advanced world in 2002. In May 2006, we published simulations that projected an almost universal deterioration of sovereign creditworthiness in a sample of 32 advanced economies (see "Global Graying: Aging Societies And Sovereign Ratings," published June 27, 2006). This study was updated in 2007 (see "What A Change A Year Makes: Standard & Poor's 2007 Global Graying Progress Report," published Sept. 19, 2007).
This year's report includes the 32 EU and the non-EU OECD sovereigns covered previously and introduces analysis for a further 17--mainly emerging market--sovereigns across the world. This significant expansion in scope means our study now covers more than two-thirds of the world's population, incorporating Argentina, Brazil, Bulgaria, China, Iceland, India, Indonesia, Malaysia, Mexico, Philippines, Romania, Russia, South Africa, Saudi Arabia, Switzerland, Turkey, and Ukraine (for credit ratings on these sovereigns see table 1 below).
Over the coming weeks, Standard & Poor's will also publish individual country reports for the sovereigns covered in this study, containing more detailed data as well as country-specific results for the various scenarios described below. Information on our data sources and methodology used, and extensive data for demographic and economic assumptions and results of scenario analysis, can be found in a separate supplement: "Global Aging 2010: An Irreversible Truth--Methodological and Data Supplement," published Oct. 7, 2010.
Key Findings: A Heavy Burden, Unequally Shared
In our view, population aging will lead to profound changes in economic growth prospects for countries around the world, alongside heightened budgetary pressures from greater age-related spending needs. In the absence of appropriate budgetary adjustment, additional reforms to pension and health-care systems, or structural measures to improve sovereigns' growth potential, our projections show the future fiscal burden will increase significantly across the board.
We do not expect this burden to fall equally, though. The projected deterioration in public finances over the period 2010-2050 is particularly significant in advanced economies and emerging market economies in Europe. The relevant characteristics of this group of countries, in our view, are a relatively high level of existing social security coverage and a rapid worsening in demographic profile. In other emerging market sovereigns, the projected change in demographics is likely to be similar, although the proportion of elderly in the population will be lower. As these sovereigns also tend to have relatively smaller welfare networks, we expect the projected fiscal burden will be lower than in advanced economies. Nevertheless, as these economies develop, the likely demand for better and expanded social security systems will put pressure on their budgets.
An increasing number of sovereigns, particularly in the advanced and European emerging economies, has been undertaking reforms of pension or health-care systems to contain related budgetary risks. However, we believe the results of our study show the projected magnitude of the future fiscal burden will require additional measures.
Under our hypothetical base-case scenario of unchanged policies, incorporating the dynamics of aging-dependent public expenditure programs and interest payments, the financial burden is projected to gradually increase, leading to deteriorating fiscal indicators from the middle of this decade. These estimates include:
Standard & Poor's utilizes sustainability gap indicators that translate these debt ratios into projections of the permanent budgetary adjustment that we believe is likely to ensure the sustainability of public finances. The gap represents the difference between the constant revenue ratio as a share of GDP, which equals the actualized flow of revenues and expenses over an infinite horizon, and the current revenue ratio. The median sustainability gap for the whole sample is 6.8% of GDP. However, the difference between the advanced and emerging market economies is significant--8.5% of GDP for the former and 5.2% of GDP for the latter. Within the whole sample, the disparities are large, with Russia, Luxembourg, Japan, and Ukraine posting sustainability gaps of more than 14% of GDP. On the other side of the spectrum China, Switzerland, Indonesia, Saudi Arabia, Philippines, and India have gaps of between 0.5%-3.5% of GDP. We have concluded that the main driver of the gaps is the long-term increase in age-related spending, as the component related to the adjustment required due to long-term changes in government structural primary balances is higher than that required due to the government's initial budgetary position. This underlines the importance of addressing the projected increases in aging costs. If the sovereigns balance their budget by 2016, the sustainability gap of the entire sample, by our calculations, is suggested to be brought down to 4% of GDP, that of the advanced countries would halve to 4.4% of GDP and of emerging economies to 1.9% of GDP. Budgetary consolidation can, in our view, thus contribute significantly to reducing the overall future budgetary burden.
Taking into account expected future budgetary imbalances and projected economic growth dynamics, the derived hypothetical future ratings for the whole sample are generally expected to be below their present rating levels. Under our first scenario, which assumes no policy actions to counter demographic fiscal pressures, a general downward slide in sovereign ratings is expected to start in 2020, accelerating through 2030 and thereafter. On the whole, the median emerging market sovereign would hypothetically retain investment-grade ratings throughout the projection period, due to relatively high potential economic growth, moderate projected increase in age-related costs, and consequently relatively smaller current budgetary imbalances. In contrast, the median advanced sovereign is projected to be less likely to retain investment-grade ratings as we expect growth prospects will be relatively lower, while age-related spending will be comparably much higher on the back of relatively wider budget imbalances.
We emphasize that this hypothetical scenario does not represent a Standard & Poor's prediction that the sovereign ratings of many governments will inevitably fall because of demographically related fiscal pressures. In our view, it is inconceivable that governments will allow debt and deficit burdens to spiral out of control in the manner outlined above, even if creditors would be willing to underwrite such a huge amount of debt. Nevertheless, the scenario does reveal the dimension of the task that governments face in pruning benefits granted by unfunded state-run social security systems and achieving further fiscal belt-tightening. In fact, most European governments have embarked on the path of budgetary consolidation or have initiated structural reforms to social security. Recent examples include France and Greece, likely to be followed by Slovenia and Spain. Nevertheless, the magnitude of the challenge, as indicated by our sustainability gap indicators, will in our view require further decisive steps by almost all governments in the sample.
Future Trends In Age-Related Public Spending
In the absence of further policy measures, we generally expect population aging will lead to increases in overall budgetary expenditures that are sensitive to demographic change, although according to our estimates the impact will differ significantly among the countries in our sample. The categories considered in this study are old-age pensions, health care, and, where data is available, long-term care for the frail and unemployment benefits. Education was not included as an age-related spending category. Although the number of pupils and students likely will decline in most countries, it is also likely that spending per student will rise to help ensure satisfactory productivity growth, given that the countries in this sample tend to be knowledge-based societies and economies. Child benefits were also excluded due to the lack of data. Although shrinking child-age cohorts could have a dampening effect on public spending through lower benefit outlays, comparable data is unavailable. Moreover, the cohort effect may be offset by more generous benefits to encourage the dual objectives of boosting labor market participation and fertility, as witnessed in several countries already. Overall, pensions remain the biggest spending item, followed by health-care and long-term care. The expected decline in unemployment benefits is typically very small and, we believe, will not produce significant relief for government spending.
Pensions (including early retirement, surviving relative, and disability pensions) are expected to remain the largest expenditure item in the future, rising on average by around 3% of GDP by 2050 from current levels. However, this average does not fully illustrate the expected large differences among the countries.
For most sovereigns, the old-age dependency ratio (the number of over 65s relative to the population aged 15-64) is expected to double. In Eastern Europe, Asia, and Latin America, the demographic dynamics appear to be particularly affected in terms of changes in the old-age dependency ratio. However, the overall projected dynamics do not fully illustrate the variations in the level of the ratio, which for Eastern European sovereigns by 2050 is projected to be substantially higher than in other regions. In general, the strongest pressure on government budgets is expected in those sovereigns where reforms to pay-as-you-go (PAYG) pension systems are still pending. In Luxembourg, pensions are expected to rise by more than 13% of GDP by 2050 as the country's old-age dependency ratio doubles. For Greece, the projected increase in pensions as shown here does not take into account the expected savings due to the implementation of recent pension reforms, which, according to the IMF/EU program, are expected to lead to savings of around 10% of GDP by 2060, likely bringing the Greek pension spending profile below the current median for advanced economies. In the face of rapid shifts to their demographic profiles, governments in Spain and Slovenia are currently preparing reforms to their PAYG pension systems, which are likely to include raising the statutory retirement age, changes to pension indexation formulas, and other measures. In the case of Korea and Slovakia, where demographic profiles appear to be the most unfavorable, future increases in pensions have been cushioned by systemic reforms in the past
Please visit Standard & Poor's website for more information.
Please visit NEWS & EVENTS to view a listing of all articles.