Editorial
Market and funding conditions have shifted considerably since the last edition of the Sovereign Borrowing Outlook in 2022. In the year since the pace of monetary policy tightening has accelerated, global financial risk appetite has shifted, and investor confidence has declined. This marks the end of a long period of benign funding conditions for sovereign issuers as they adjust to new realities and a rapidly evolving market environment. The 2023 Outlook analyses recent trends in sovereign debt markets, presents new data and forecasts, and discusses considerations for sovereign issuers navigating the immediate challenges presented by this new landscape, and the longer-term issues facing public debt management.
OECD countries’ borrowing needs continued to decline in 2022, down over 20% from the record peaks seen at the height of the COVID-19 pandemic in 2020, while outstanding debt has as also tapered off, from 90% of GDP in 2020 to 83% in 2022. However, this normalisation has been disrupted by the financial and economic spillovers of Russia’s war of aggression against Ukraine, with borrowing forecasted to rise in 2023 as many OECD countries seek to cushion households and businesses from rising prices. Driven in part by geopolitical developments, the outlook for government funding needs is uncertain.
Despite the general downward trend in the last two years, borrowing and debt levels remain substantially elevated against pre-pandemic levels. In 2022 borrowing needs were 43% above the 2011-19 average, with total outstanding debt at 10 percentage points of GDP above the average over the same period. This substantial volume of government debt will need to be repaid or refinanced, and much of it soon. Almost half of the debt – some USD 23 trillion – will fall due over the next three years.
During the pandemic, many OECD countries could count on accommodative monetary policy to soften both the cost of financing higher debt levels and refinancing risks, but this is no longer the case. Borrowing costs have more than doubled for OECD sovereigns since 2021, and look set to rise further still in the near term. As a result, countries face elevated refinancing risk, and many governments will spend a higher proportion of their budgets servicing debt – and facing greater fiscal constraints as a result – in the years ahead.
Sovereign issuers face further challenges beyond higher rates. The end of quantitative easing has seen central bank demand for bonds largely evaporate, leaving the private sector to absorb high volumes of new issuance and refinancings. Liquidity in markets has also deteriorated in a confluence of macroeconomic uncertainty, geopolitical risks, declining investor sentiment and shifting trading dynamics, potentially increasing borrowing costs further and giving less flexibility to Debt Management Offices (DMOs) to adapt to shifting borrowing needs.
Emerging Market and Developing Economies (EMDEs) also face historically high levels of outstanding debt and a similarly challenging market environment, further exacerbated by systemic dynamics common in some EMDE sovereign debt markets. EMDEs generally face higher yields, less certain investor demand, and are more exposed to exchange rate risk. Reflecting these vulnerabilities, EMDE sovereign debt quality further declined between 2021 and 2022, with 40 rating downgrades centred most in Europe and Latin America.
Taken together, these developments mean that debt sustainability is a heightened concern going forward, with significant implications for governments broadly and debt managers specifically. The confidence that OECD sovereign issuers enjoy from markets is a major advantage in the face of such risks, challenges and uncertainties. This confidence is earned each day through good governance, responsible economic management and a credible framework for debt management, and markets showed us in 2022 that this cannot be taken for granted. Such principles apply equally to EMDEs, which could also benefit from building up domestic bond markets, and where debt transparency can be particularly important. These must be key priorities for the financial and technical support coming from the international community.
At a more technical level, public debt managers are already adapting their operations. Maintaining predictable and regular issuance is an important goal even through uncertain times, which DMOs have achieved by modifying the composition of issuances, building contingency funding tools for flexibility as well as strong co-ordination with monetary and fiscal authorities. They have supported liquidity in markets through enhanced communication, conducting buyback and switch operations, providing security lending facilities, and taking measures to support key market makers. Above all, DMOs must continue their vigilant monitoring of market conditions and stay abreast of the strategies and tools available to respond, which the Outlook helps equip them to do.
The Outlook also tracks the contribution of sovereign issuers in catalysing sustainable investment more broadly. The total stock of sustainable bonds now exceeds USD 325 billion, 75% of which are focused on climate and environmental projects. While the total value of sustainable bond issuance declined between 2021 and 2022, the number of countries issuing such instruments is expanding, with ten new countries in 2022 and a further five in the first four months of 2023. Investor demand appears strong, and this momentum is expected to continue in the coming years.
These are welcome developments, but more can be done to strengthen the efficiency and impact of sustainability instruments and the functioning of wider sustainable bond markets. Simplification and standardisation across the issuance process will be key, from criteria for projects to metrics for reporting. Sovereign issuers can help deliver on this by providing benchmark levels of compliance and disclosures within sustainable investing frameworks, as well as quality, comparable and relevant data so that investors are more fully equipped to direct capital toward key priorities, including the climate transition.
