Governments worldwide face a ticking clock as the global population grows increasingly older. Rising age-related expenditure could become unsustainable for several sovereigns amid declining fertility rates, rising interest levels, and steep government debt. In the seven years since S&P Global Ratings published "Global Aging 2016: 58 Shades of Gray," an assessment of the potential credit implications of aging for sovereign states, governments have borrowed extensively to soften the fallout on households and companies from a series of shocks, including the COVID-19 pandemic and the war in Ukraine. Meanwhile, following the trend of developed sovereigns, fertility rates have continued to decline worldwide, which has worsened most sovereigns' demographic profiles--perhaps most acutely those of middle-income emerging sovereigns.

Frequent electoral cycles and a plethora of global economic emergencies have diminished most governments' capacity to focus on the long term, even as central banks' ability and willingness to use their own balance sheets to soften shocks is elapsing. The resulting pressures on public finances--from high government debt and rising interest rates--are leading many governments to focus on the near term, and to delay contentious pension reforms until the distant future. Unfortunately, this does not diminish the problem of rising age-related spending. Indeed, the scale of the ongoing demographic transition and its likely manifold effects on societies risks becoming unmanageable if left ignored.

One of S&P Global Ratings' core assumptions is that governments will prioritize servicing bonded debt over other fiscal promises, including pension liabilities. In developed economies, this assumption has rarely been tested, particularly not at average debt-to-GDP ratios as elevated as they are now. Broadly speaking, governments have three pathways in the face of rising demographic pressures, each involving their own set of political and economic costs:

• Making pension or other age-related reforms that arrest either the rise in age-related expenditure or the worsening in age-dependency ratios;
• Taking other offsetting fiscal measures, such as raising taxes, reducing spending on non-age-related items, except interest payments; or
• Running consistently higher deficits and effectively kicking the can down the road.

A combination of all three is possible, but procrastinating governments will be drawn to the third option, risking the peril of markets still reeling from quantitative tightening.

For advanced economy sovereigns, there is some good news: namely, that at the beginning of our simulation period (2025 for this report) we expect improved budget balances relative to our 2016 assessment. In a minority of cases, this reflects targeted actions aimed at containing age-related spending, including through raising retirement ages, adjusting calculation or indexation formulas, and increasing contribution rates, although we note that the pace of these structural reforms appears slower than in our last report. Compared with our 2016 results, this implies that for a subset of mostly developed sovereigns with better assumed medium-term fiscal balances due to age or other fiscal reforms, the downward trajectory on sovereign ratings between 2025 and 2060 because of age-related pressures is less steep than in the past. Therefore, a larger number of advanced sovereigns should be able to retain their investment-grade status. By contrast, our simulation (which assumes public finances will be in "autopilot mode", described in more detail in the full report) suggests that the median emerging market sovereign would be less likely to retain investment-grade ratings, despite relatively higher long-term economic growth prospects and lower starting points in most emerging market economies with respect to age-dependency ratios and age-related expenditure. Indeed, higher projected increases in age-related spending over the long-term horizon significantly affect emerging market sovereigns' long-term creditworthiness prospects. For emerging market governments--as in advanced economies--decisive action in stabilizing escalating age-related expenditure would pay a steady dividend over many years to come, in the form of healthier public finances and lower associated amounts spent on debt financing. Alternatively, delaying difficult reforms could push public debt to unsustainable levels in a number of rated sovereigns, or force governments to abruptly cut real spending outlays for households.

While S&P Global Ratings does not expect such a widespread, calamitous outcome, there is a conceivable scenario whereby the costs of this transition, both fiscal and political, increase because they are left unaddressed. Governments may find themselves forced to make large, unpopular spending cuts in age-related expenditure items. And high inflation and rising interest rates are not helping; during 2023, backward indexation of pension expenditure will add to fiscal pressures after a year of multi-decade-high inflation levels across much of the developed and emerging world.

On average, and mostly because of the stronger medium-term fiscal deficits that S&P Global Ratings analysts now expect for advanced economies, our long-term debt simulations for sovereigns are lower than they were in 2016. Despite this, we believe that nearly all countries will face a steep, demographically driven deterioration in public finances in the absence of adjustments in social safety net costs combined with policies that boost growth. Our updated study shows that despite the substantial progress made to date, the projected magnitude of the future fiscal burden will require additional measures.

According to our simulated hypothetical scenario in which nations take no further measures to plan for aging populations, and incorporating the dynamics of aging-dependent public expenditure programs and interest payments, the financial burden on most sovereigns will gradually increase, leading to deteriorating fiscal indicators from about the mid-2020s and an accelerating worsening, particularly from the mid-2030s, with significant differences among sovereigns. These estimates include the following expectations:

• Most governments will be on a path of fiscal consolidation until at least 2025, although in several countries progress will stall, particularly in 2023. Beyond 2025, the impacts of an aging population on government fiscal expenditure will begin to worsen fiscal balances, at first gradually, but then accelerating and becoming more noticeable certainly by the mid-2030s.
• The median government will have consolidated its fiscal balance to 2.4% of GDP by 2025 (advanced sovereigns to 1.3% of GDP; emerging market sovereigns to 2.6% of GDP). This will then worsen to 3.4% of GDP in 2035 (2.7% for advanced sovereigns; 4.3% for emerging markets). Left unchecked, these fiscal imbalances will worsen rapidly, owing to the effects of cumulative interest burdens and further aging pressures. Indeed, by 2060 our simulation suggests that, in the absence of reforms to aging-related fiscal policies, the typical government will be running a deficit of 9.1% of GDP (5.6% in advanced sovereigns; 15.9% in emerging markets).
• This would lead to the median general government net debt burden as a percentage of GDP increasing to 49% for all sovereigns by the mid-2030s--and then likely accelerating to about 142% (102% in advanced sovereigns; 155% in emerging markets) of GDP by 2060.

Taking into account these expected future budgetary imbalances and projected economic growth dynamics, we calculate that about half of the 81 sovereigns we have analyzed would have credit metrics that we currently associate with speculative-grade sovereign ratings, compared with about one-third of this sample in 2025 (see chart 1).

Chart 1

To arrive at this calculation, we introduced a simplified analytical model to simulate the impact on sovereign credit metrics (as explained in detail in the full report's Appendix). The model is based on a very limited number of variables compared with those in our sovereign rating criteria (see "Sovereign Rating Methodology," published Dec. 18, 2017), and as such is not as comprehensive as the methodology underlying our sovereign ratings. The hypothetical ratings that this simplified model generates should not be construed as S&P Global Ratings' view of the likely future ratings trajectory; rather, they illustrate the intensity and profile over time of the challenge demographic change poses for sovereign solvency, assuming no mitigating policy action was undertaken. Since the results of this simulation are not sovereign ratings derived by applying our current criteria, we present them in lower case ('aaa', 'aa', etc.).

We anticipate that our hypothetical future credit ratings for our entire sovereign universe would generally be below their present levels. Under the no-policy-change scenario, which assumes no further policy actions to counter demographic fiscal pressures, we see firstly a drop in the number of sovereigns rated in our highest rating categories 'aaa' and 'aa', with an accompanying increase in those appearing in the 'a' category. Eventually, our simulation predicts that the worsening in overall creditworthiness will see a rise in speculative-grade ratings, with the proportion accelerating particularly from the 2050s.

Our projections show that overall, the median advanced sovereign would hypothetically retain investment-grade ratings throughout the period, due to improved budget balances at the beginning of the simulation period, as well as other changes in model assumptions (including our changed interest rate assumption). In total and on average, these effects have been stronger than offsetting impacts from worsened demographic projections. By contrast, we think the median emerging market sovereign would be less likely to retain investment-grade ratings, despite relatively higher long-term economic growth prospects and a healthier starting position in terms of age-dependency ratios and age-related expenditure. Indeed, higher projected increases in age-related spending over the long term significantly affect their future creditworthiness prospects.

We emphasize that these scenarios do not represent an S&P Global Ratings prediction that the sovereign ratings of many governments will inevitably fall because of demographically related fiscal pressures. In our view, it is unlikely 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 huge debts. Nevertheless, the scenarios do indicate the scale of the task that governments face in pruning benefits granted by unfunded, state-run social security systems and achieving further budgetary consolidation as well as growth-enhancing policies.

The old-age dependency ratio will worsen in all countries

Chart 2

We expect that the old-age dependency ratio (the number of elderly population relative to the working age population) will worsen in every country covered, with no exceptions. For most sovereigns, demographers expect the old-age dependency ratio will go further and double by 2060. In Eastern Asia and most of Europe, demographic dynamics appear to be particularly affected by what has been a steadily rising old-age dependency ratio. For sovereigns in large parts of Latin America and Western Asia (in particular the Gulf), the projected demographic shifts look to be significant. Countries in these two regions are also at a relatively nascent stage in their demographic transition, suggesting that (at least for certain sovereigns) current systems to support the elderly may not be appropriately calibrated and will require potentially politically unpopular adjustments. At the other end of the spectrum, demographic projections suggest that sub-Saharan Africa is young and expected to remain young well into our projection horizon up to 2060, with a plausibly manageable demographic shift over this period.

As our chart above shows, the oldest countries in the world in 2060, as measured by the age-dependency ratio, will predominantly be countries in East Asia. Japan, which currently stands as a clear outlier in the world, will be overtaken by South Korea and Hong Kong, both of which face large shifts in their population profiles. Indeed, when comparing the scale of Japan's demographic shift until 2060 (measured by the vertical distance from the "line of no aging"), Japan no longer looks to be an outlier. Arguably, at such an advanced stage of its transition, Japan is in a more favorable position than peers, given that its society is already making the necessary adjustments. For example, Japan now has by far the highest employment rate in its elderly population. It is for this reason that Gulf countries such as Saudi Arabia, Oman, and Qatar bear close watching, since their significant demographic shifts come from a starting point of limited elderly populations.

For more detailed information on S&P Global Ratings' analysis on the impact of aging societies on sovereign ratings, read the full report "Global Aging 2023: The Clock Ticks" on RatingsDirect.

Dive deeper into our latest research in our Sovereigns Spotlight.

Chart 3