UK runs highest debt interest bill in developed world

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The UK will have one of the highest debt interest costs in the developed world this year, with an unusually large share of government debt linked to persistently high inflation and rising prices taking a toll on public finances.

According to Fitch’s forecast, the Treasury will spend $110 billion on debt interest in 2023. At 10.4% of total government revenue, it would make the UK the highest among high-income countries to top the list for the first time in a data set dating back to 1995, following improvements from previous leader Iceland.

About a quarter of UK government debt is in the form of so-called index-linked bonds, the payments of which fluctuate with inflation, making the UK a huge outlier internationally. Italy has the next highest share of inflation-related bonds at 12%, while most countries have less than 10%.

“We’ve had very large inflationary shocks that are having a negative impact on public finances, and this is obviously a major driver of sovereign credit ratings,” said Ed Parker, Fitch’s director of national and transnational national studies.

The agency reiterated its negative outlook for the UK’s negative Double-A credit rating in June, citing rising government debt and uncertain prospects for fiscal consolidation.

Parker said a negative outlook signals a likely downgrade if current trends continue, and the agency will typically hope to clarify a negative outlook within two years.

Debt interest expense as a percentage of revenue is a key measure of debt servicing capacity and has surged in the UK over the past few years but declined elsewhere.

Debt interest costs in the UK have increased dramatically over the past two years, averaging 6.2% of earnings between 2017 and 2021. The UK tops the Fitchs ranking as Iceland, which had a debt cost ratio of 11% last year, plans to reduce it to 9.6% in 2023. Fitch attributes the expected improvement to strong economic growth that has boosted the Icelandic government’s tax revenue.

The average for Western European and North American countries is set to fall from 4% in the five years to 2021 to 3.7% this year, as inflation drives up government revenues and in some countries the interest rate on expiring debt is higher than new debt.

The rise in the cost of debt in the UK comes as inflation has proven more difficult to tame than in other developed economies, despite recent signs of improving data. The UK’s retail price index, which guides index-linked gilt interest payments, is up 10.7 per cent in the year to June, while wage inflation shows no signs of abating yet.

Fitch predicts that the UK’s debt interest rates will start to fall next year as inflation continues to moderate, with US and Italian interest burdens expected to overtake the UK’s in 2024.

However, credit rating agencies expect UK interest costs to stabilize at historically high levels. We expect the UK’s debt service capacity to be relatively weak, said Evan Wohlmann, senior credit officer at competitive credit ratings agency Moodys.

Debt servicing is at risk from more sustained inflation and continued erosion of British policy confidence, he added.

Moody’s, which has a negative Aa3 rating, the fourth highest in the UK, also issued a negative outlook, which it has held since October and expects to be clarified within 12 months.

Concerns among rating agencies about the UK’s credit outlook came after the UK’s fiscal watchdog, the Office for Budget Responsibility, warned that public finances were in a very risky position and that government debt could reach 310% of gross domestic product within 50 years.

OBR said in May that the UK was more vulnerable than other developed countries when it comes to public debt, which exceeded 100 per cent of gross domestic product (GDP) for the first time since 1961.

The government plans to sell 241 billion guilds in the current fiscal year, up sharply from the 139.2 billion issued in the previous 12 months, while net issuance of Bank of England bonds bought and sold is expected to be about three times more than the average over the past decade.

This article has been amended to correct Moodys UK ratings.

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