On top of the debt accumulated on the back of the 2008-2011 global financial crisis, sovereigns in developed markets borrowed heavily between 2020 and 2022 to address a series of global emergencies: first the pandemic, then a spike in energy prices after Russia's invasion of Ukraine. At the start of this borrowing spree, interest rates were unusually low, underpinned by quantitative easing.

Now that the pandemic is over and economies have reinflated, central banks have been raising policy rates and reducing their holdings of government debt. This has pushed up borrowing costs for developed-market sovereigns, but only very gradually, while lingering inflation continues to boost nominal GDP and revenue.

Despite, or perhaps because of, these still benign financing conditions, there has been a lack of urgency among large developed-market sovereigns on public finances, and limited progress on structural budgetary consolidation. G7 countries' debt-to-GDP ratios resemble a step function. They increase more during periods of sluggish growth than they decline during subsequent economic recoveries. S&P Global Ratings' historical ratings data reflects this: Since the global financial crisis in 2008, our ratings on France, the U.K., the U.S., and Spain were all lowered from 'AAA' and have not returned to that level. Further deterioration of debt-to-GDP ratios beyond our current forecasts could lead to downgrades.

Debt To GDP Is Still Rising For The G7's Largest Economies

Six sovereigns--G7 nations Italy, the U.S., and France, as well as Belgium, Finland, and New Zealand--which together account for 60% of developed economies' GDP, will see their debt to GDP rise further over the next three years. Notably, the U.S., Italy, and France would all have to improve their primary budgetary balances (the overall budget position excluding interest) by more than 2% cumulatively just to keep debt at current levels, and between 5 percentage points (ppts) (for Italy) and 8ppts of GDP to return it to 2019 levels by 2027 (see heat map).

At present, we don't expect this magnitude of budgetary consolidation to happen. In our view, at the current stage in their electoral cycles, only a sharp step-up in market pressures could persuade these governments to implement a more resolute budgetary consolidation. That said, a sharp deterioration of borrowing conditions would also increase the size of the required fiscal adjustment, making even more painful.

The exceptions to this trend of rising public debt among advanced economies are smaller ex-program sovereigns in Europe--Cyprus, Greece, Ireland, and Portugal--which display buoyant nominal GDP growth (often linked to tourism) and low borrowing costs. Fiscal prudence, inflation, and growth enabled their debt to GDP to decline from very elevated levels by an average of 16 ppts of GDP between 2019 and 2023, compared to an average increase of 8.5 ppts of GDP for the rest of the developed market sovereigns in our study.

Developed Sovereigns' Creditworthiness Has Deteriorated Since 2005

For developed economies, there has been a steady weakening of creditworthiness over the last two decades. As of June 28, 2024, we rate only 11 out of 137 sovereigns 'AAA'. Only two of these (Canada and Germany) are in the G7 versus five in 2005; compared to 2005, today the average rating on G7 sovereigns is 1.5 notches lower and the average rating on euro area sovereigns (both GDP weighted and the numerical average) is two notches lower. That said, since the global pandemic and oil price shocks, only one G7 sovereign was downgraded: France, on May 31, 2024.

Before the downgrade of France this year, the last downgrade of a developed sovereign was in 2016, when we lowered our rating on the U.K. to 'AA'. Between January 2009 and 2012, Ireland and Spain were downgraded from 'AAA' on significant deterioration of their budgetary positions, including due to systemic banking crises. We lowered our rating on the U.S. to 'AA+' in 2011. And Japan, the world's largest external creditor, has not been rated 'AAA' since 2001, given its extremely high debt and large recurring budgetary deficits.

Why Rating Actions On Developed Sovereigns Have Been Infrequent

Our sovereign ratings reflect the wealth of a country's economy, the depth of its local currency capital markets, its monetary and external flexibility, as well as its institutional effectiveness. Historically, these capacities endure; and if they change, they do so only very slowly. That implies stability of the key factors we assess to determine our ratings.

Large, wealthy developed economies finance themselves in reserve currencies and benefit from a large pool of domestic savings.   This, alongside almost no foreign currency debt, has enabled G7 sovereigns to refinance their rising debt burdens even during policy shifts, albeit the market determines refinancing costs.

Advanced economies also tend to have a track record of managing past political, macroeconomic, and financial sector turmoil, which informs our institutional assessment.   In practice, G7 governments generally respond in a timely fashion to market pressures, not least because any increase in their cost of capital pushes up borrowing costs for companies and households, particularly where mortgage interest rates are mainly floating rather than fixed.

In September 2022, for instance, it took the U.K. government less than three weeks to cancel the proposed abolition of the highest income tax rate and a mooted cut in the corporate income tax rate. This was after volatility in the gilts market passed through rapidly to mortgage interest rates and eroded the financial positions of pension funds. Similarly, the rise in funding costs for Italy's Treasury, in the wake of the June 2018 election of the first Conte government, led that coalition to sharply downscale its fiscal stimulus plans (the basic income program or Reddito di Cittadinanza, and the early retirement scheme under Quota 100). Indeed, in 2019, Italy produced its highest primary budgetary surplus since 2013, although the rise in the government's financing costs dragged on GDP growth, which fell below 1% in both 2018 and 2019.

The EU's Excessive Deficit Procedure Brings A Fiscal Test For France And Italy

Europe differs from the rest of the world in that EU member states are committed by international treaty to abide by a series of fiscal rules. On June 19, 2024, under the recently revised fiscal governance framework, the European Commission recommended to the European Council that it initiate an Excessive Deficit Procedure (EDP) for seven EU member states: Belgium, France, Hungary, Italy, Malta, Poland, and Slovakia. In most cases, this was because these governments are in breach of the 3% of GDP general government deficit threshold.

The enforcement of these rules has historically been only partial. But it is worth flagging that--under the guidelines for deploying the European Central Bank's tool to prevent dislocation of bond spreads across euro area sovereign debt markets, the Transmission Protection Instrument (TPI)--the debt securities of euro area member states subject to EDP are, strictly speaking, ineligible for TPI purchases. Although the TPI is a safety net that is probably more powerful in its current dormant state, TPI ineligibility could have ramifications for a government's cost of debt should budgetary positions at the national level deteriorate further. Of course, monetary policy is discretionary and it will be up to the euro area's central bank to determine when spread widening is warranted based on fiscal fundamentals, and when it is not. But this is a fine line. In any case, as in the past, we would expect governments--regardless of their political affiliation--to respond far more quickly to pressure from the market than pressure from European institutions; but the two are not mutually exclusive.

Italy, France, And The U.S. Are Far From Debt-Stabilizing Budgetary Positions

We estimate that all three countries' underlying fiscal balances are currently more than 2 ppts of GDP away from long-term debt-stabilizing positions (DSPB; see chart 1). Under our current forecasts, Belgium and France converge to a DSPB by 2027, whereas Italy (on a cash basis) and the U.S. do not.

Chart 1

Italy (unsolicited BBB/Stable/A-2)

Italy's fiscal problems are first and foremost a function of low potential growth. Of the 21 advanced-economy sovereigns in our study, Italy is one of the few G7 countries where we project that the cost of total debt will exceed nominal GDP growth by 2027. In the case of Italy, we have calculated the primary budgetary position at which debt stabilizes by using projections for cash rather than accrual-based deficits. This is because the cash data fully captures the government's net borrowing requirement to finance its costly "SuperBonus" scheme, which offers tax incentives for building renovations. This scheme, though accounted for on an accrual basis between 2021 and 2024, is now affecting the sovereign's cash balances and will continue to do so because the government has extended it until 2033.

France (unsolicited AA-/Stable/A-1+)

France has not reported a primary budget surplus since 2001. Under our current projections, we do not forecast that the general government deficit will decline below 4.0% of GDP until 2027. Rather, we anticipate that debt to GDP will keep rising, reaching 112% of GDP in 2026 after 109% of GDP at the end of 2023. We estimate that, to stabilize its debt, France would require 2.2% of additional fiscal consolidation, or an annual incremental yearly adjustment of 0.7% of GDP per year, for three consecutive years. However, ahead of second round parliamentary elections on July 7, France's fiscal policy orientation is even more uncertain than before. The scenario of a hung parliament (where no party or coalition wields a majority) would hinder the country's ability to implement structural reforms. It might, however, have a silver lining. In the absence of passage of a 2025 budget, the fiscal program would default to the 2024 Budget Bill.

United States (unsolicited AA+/Stable/A-1+)

The U.S. is the largest economy in the world, with the world's deepest capital markets. The U.S. dollar is the world's premier reserve currency, and the country has unparalleled private wealth, as measured by its per capita GDP of over $85,000 or 1.8x the average for the rest of the G7. The U.S. economy is now 27% larger in nominal dollar terms than in 2019. Nevertheless, we project general government debt at 95.2% of GDP by year-end 2024, more than 15 ppts above the pre-pandemic level. We don't expect the U.S. debt to GDP to be on a downward path between now and 2027, when we estimate it will end the year at 102% of GDP.

Over the next several years, we expect the general government deficit to average 6.0% of GDP, equivalent to the 2018-2019 levels. In 2023, it rose to 9.2% from 4.3% in 2022 as the aggregate balance at state and local governments shifted to a deficit and one-off accounting for student-loan forgiveness made the figure balloon. We project some narrowing of the U.S. underlying primary general government budgetary deficit to -2.9% of GDP in 2024 from -6.1% of GDP in 2023. Nevertheless, we still forecast the primary balance in 2027 at -2.4% of GDP, a deficit that is an estimated 2.2 ppts of GDP wider than the underlying convergence debt-stabilizing primary balance (DSPB), at which point debt to GDP could stay at the 2024 level.

We don't expect negotiations on the 2025 budget until after the elections. Instead, we assume passage of continuing short-term resolutions to avert a government shutdown during the campaign period after September. In January 2025, the debt-ceiling suspension expires, which will entail congressional action before the Treasury's extraordinary measures end. There is a long-standing track record of raising or suspending the government's statutory debt ceiling to permit timely payment of the U.S.' financial obligations.

We assume this will remain the case, since politicians recognize the severe consequences for financial markets and the economy of not doing so. At the end of 2025, various tax cuts—approved under the previous administration—expire, requiring Congress to revisit the tax code. The outcome of this debate could affect the current fiscal deficit trajectory, which we anticipate would slow down only marginally. The debate presents an opportunity for the Government and Congress to take proactive fiscal measures to stem the rise in debt. To date, in our view, broad, bipartisan support on proactive measures to meaningfully reduce high fiscal deficits and curtail the rise in government debt has been elusive, and this affects creditworthiness.

United Kingdom (unsolicited AA/stable/A-1+)

In our view, the U.K.'s fiscal position remains constrained, and subject to policy risks in the future. We estimate that the general government deficit measured 6% of GDP in 2023, up from 4.7% of GDP in 2022. The widening deficit predominantly reflects the cost of energy support to households and businesses over the first half of 2023, following gas price peaks in 2022.

We estimate that net general government debt amounted to an elevated 98.3% of GDP at year-end 2023. Excluding the temporary spike in 2020, this represents the highest level of U.K. government debt since the 1960s. On March 6, 2024, the U.K.'s Chancellor of the Exchequer delivered the spring budgetary statement, in line with the time frame unveiled earlier, in December 2023. According to the Office for Budget Responsibility's estimates, declining inflation and the prospect of lower interest rates will generate a "windfall" of about £10 billion a year in the fiscal years ending March 31, 2025, and March 31, 2026 (about 0.3% of GDP). The windfall will then gradually decline, reaching zero by 2028-2029.

In response to this slight improvement in the official underlying fiscal forecast before additional measures are taken into account, the government has decided to loosen budgetary policy. The measures it has announced will effectively utilize the entire windfall. At 99% of GDP, the U.K.'s net general government debt is now 70 ppts above the levels seen in the early 1990s. In our base-case scenario, we anticipate that the fiscal deficit will moderate to 4.5% of GDP in 2024 before gradually reducing to 3.2% of GDP by 2027. This implies that net general government debt will peak at 99.4% of GDP in 2025 and reduce only very slowly thereafter. This leaves little room to enable the government to meet its fiscal target of reducing debt as a percentage of GDP in five years' time.

Europe's Total Debt (Private And Public) Is Lower Than Before The Pandemic

Over the past two years, private-sector debt (households and non-financial corporations) has decreased across most major economies, including Australia, Belgium, Greece, the Netherlands, Portugal, Spain, and Italy. This took place because corporates and households rapidly restructured their balance sheets to cope with more expensive refinancing costs. Indeed, in many European jurisdictions, even where public debt increased a lot, total debt (the sum of both public and private obligations, see chart 2) is below pre-pandemic levels. This trend, at least in Europe, may imply that governments could take steps to increase tax pressure on the private sector, given the improvement in private-sector finances since 2019.

Conversely, in non-eurozone countries, where interest rate conditions were more benign, private debt continued to increase, by 36 percentage points of GDP in South Korea for example.

Chart 2

Fiscal Complacency Is A Risk To Ratings

Wealthy, savings-rich developed economies that issue debt in their own reserve currencies have a higher capacity to sustain large debt burdens than emerging market governments. That's because, in emerging markets, sovereigns frequently borrow in foreign currency from non-residents and are far more exposed to shifts in investor sentiment across global financial markets, and all the balance-of-payments risks this implies. Lower wealth in emerging markets generally implies smaller financial systems and less domestic financing opportunities for sovereign borrowers.

Nevertheless, even the wealthiest economies cannot sustain an unlimited amount of debt without becoming vulnerable to potential interest rate shocks, and hence weaker growth. This explains why our average long-term foreign currency rating on G7 governments is 1.5 notches lower than before the global financial crisis.

Looking ahead, we expect G7 policymakers will gradually move to restore fiscal space lost during the pandemic and energy price shocks. However, we recognize that, against a backdrop of political uncertainty and rising geopolitical tensions, G7 governments may not prioritize structural fiscal reforms, despite ageing populations and more turbulent global capital flows. Markets may not hold governments to account. The risk, then, is that fiscal policy complacency could be prolonged, which could eventually weigh on our G7 sovereign ratings in future.

By The Numbers

Chart 3

Chart 4

Chart 5

Chart 6

Table 1

Related Research

• Q3 2024 Global Economic Update: The Policy Rate Descent Begins, June 26, 2024
• Economic Outlook Eurozone Q3 2024: Growth Returns, Rates Fall, June 24, 2024
• Sovereign Ratings History, June 6, 2024
• Sovereign Debt 2024: Borrowing Will Hit New Post-Pandemic Highs, Feb. 27, 2024
• Sovereign Debt 2024: Developed European Governments To Borrow About $1.84 Trillion in 2024, Feb. 27, 2024
• EU Sovereign Debt 2024: Mixed Outlook And New Rules, Feb. 7, 2024