20 October 2011

ECB published occasional paper: ‘The Size and Composition of Government Debt in the Euro Area’

The paper is structured as follows:

• Section 1 - introduction
• Section 2 gives an overview of the  concepts used for the measurement of government debt
• Section 3 shows the possible extended measurements of government debt, with a particular focus on the implications of the size of government debt in the assessment of fiscal risks
• Section 4 deals with the ‘hidden debt’ implied by off balance-sheet government liabilities
• Section 5 focuses on the composition of debt, including the implications for debt portfolio management strategies
• Section 6 outlines a set of conclusions.

Conclusions

Sound and sustainable public finances are crucial for the optimal functioning of EMU. The strengthening of EMU’s fiscal surveillance framework concentrates, inter alia, on giving greater prominence to government debt and the sustainability of public finances. Governments in particular need to address the fact that euro area government debt, irrespective of the definition used, has been growing in net and gross terms in the aftermath of the financial and economic crisis and increased by 10 per cent to 15 per cent of GDP respectively between 2007 and 2010, an upward trend which is projected to continue. The gross debt concept remains the cornerstone of fiscal surveillance in the EU. At the same time, the financial assets held by governments constitute a buffer that can be used in order to reduce financial market concerns about government solvency.

As well as the debt measurements derived from the government’s balance sheet data, there are off-balance-sheet positions, such as the contingent and implicit liabilities (and assets) which must be accounted for in the future and whose adequate estimation, monitoring and analysis are essential. There are contingent liabilities within the euro area originating from government guarantees, which may increase government debt if called, and from the bilateral and multilateral support arrangements for euro area countries in distress. In terms of implicit liabilities, assorted attempts are being made to tackle this rather complex issue which potentially has a high impact on government accounts when the costs of ageing are accounted for. The available long-term estimates are still subject to considerable uncertainty in terms of macro-economic, demographic and behavioural scenarios. Hence, efforts to improve further the existing estimates of implicit and contingent liabilities (and assets) are of the utmost importance.

Fiscal vulnerabilities are high in the euro area on average and stem from both higher levels of explicit and off-balance-sheet debt and from the composition of debt reliant on short-term financing and foreign holders. The elevated alertness of investors and their higher risk aversion are accompanied by tighter scrutiny of government accounts and statistics. Market developments have shown that high deficits combined with rapidly growing gross government debt-to-GDP ratios – in some cases far above 60 per cent of GDP for an extended period of time – need to be avoided in the future. Hence, several euro area governments have had to reduce their existing vulnerabilities and exposure to rollover risks by implementing consolidation strategies, structural reforms and adequate debt management policies. These measures should be aimed, inter alia, at reducing governments’ explicit and implicit liabilities and, in the latter instance, at improving the credibility of the long-term sustainability of public finances in the euro area.

Overall, the growing government debt ratios call for an implementation of credible fiscal consolidation strategies to keep government debt on a sustainable path. Lessons need to be drawn and future surveillance analysis should focus more on various government debt indicators. At the same time, analysts need to be aware of various statistical concepts used in government debt measurement, especially the differences between the net and gross concepts and their different implications for government liquidity, solvency and debt sustainability. This also requires better monitoring of governments’ implicit and other off-balance-sheet items. As regards the management of government debt and its composition, predictable strategies which are orientated towards limiting refinancing and other risks would contribute to increasing market confidence.

Full paper

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