Summer 2023

Demographic forces bound to affect sovereign ratings and development

Ageing populations are set to slow global growth and weigh on credit ratings, writes Ed Parker, global head of research for sovereigns and supranationals at Fitch Ratings. 

Demographic trends may be slow-moving and predictable, but they are already adversely affecting countries’ economic performance, public finances and credit profiles. Without urgent policy action, the impact will ratchet up over the coming years.

In most developed economies and emerging markets, such as China, eastern Europe and much of Latin America, there is slowing population growth or outright decline in working-age populations. Conversely, in the Middle East, Africa and parts of Asia, there is rapid population growth with bulging youth cohorts. Such trends can adversely affect sovereign creditworthiness by lowering potential gross domestic product growth, contributing to unsustainable pension systems, rising public debt burdens and increasing risks to social and political instability.

A reduced supply of labour will mean weaker GDP growth in countries facing slower growth or falling working-age populations, particularly in the absence of an offsetting increase in the participation rate or output per worker. Shrinking or ageing populations will also tend to weigh on growth by reducing the demand for physical capital, innovation and dynamism.

‘The longer governments defer action, the more economically painful that action will have to be.’

What is known as the ‘demographic dividend’ – when the working-age population rises relative to the young and old – still lies ahead in sub-Saharan Africa. This is provided that a sufficiently flexible labour market and conducive business climate allows the wave of young people to find gainful employment. Broadly speaking, strong population growth in poorer, less productive countries will not offset the drag from weaker population dynamics in richer, high-productivity countries.

The combination of adverse demographics and generous pension systems can render public finances unsustainable. According to United Nations projections, southern Europe and eastern Asia face the most acute ageing profiles and will have the oldest populations in 2050. A rapidly ageing population profile increases pressure on health, social care and pension spending, while the tax burden to fund it is spread over fewer workers. In its 2021 Ageing Report, the European Commission estimated that age-related budgetary costs will increase by 2.4% of GDP between 2019 and 2045 in the European Union as a whole, but by more than 4% in nine member states.

Budget deficits and debt burdens will rise unless there is reform to pensions systems or other offsetting tax rises or spending cuts. And reform is possible. In the 2009 version of its report, the Commission projected that Greece’s ageing costs would increase by 15% of GDP by 2050, while it now projects them to decline. However, the longer governments defer action, the more economically painful that action will have to be. Reform will become more politically challenging as pensioners or those nearing retirement age make up a larger share of the population.

Figure 1. Tracking pension pressures across China, Japan, Korea and more

Old age dependency rates: Age 65+/(15-64), UN medium variant

Source: UN and Fitch Ratings

Figure 2. Tracking pension pressures across the US, UK, France and more

Old age dependency ratios: Age 65+/(15-64), UN medium variant

Source: UN and Fitch Ratings

In a 2021 report, Fitch Ratings projected that the ageing costs of the median sovereign of 33 European Union and developed economies included in its study would rise by 2.4% of GDP annually by 2045 and 3.6% by 2070, without reform. Based on stylised assumptions, median government debt-to-GDP would rise by 46% of GDP by 2045 and 140% of GDP by 2070. Plugging these illustrative projections into Fitch’s Sovereign Rating Model would predict a 1.1-notch downgrade for the median sovereign rating by 2045 and a 3.8-notch downgrade by 2070. While these are not forecasts, they highlight the potential impact of the ageing pressures without offsetting policy action.

Demographic risks are not confined to countries with shrinking populations. Unstable demographic profiles, such as rapid youth population growth, can foment unstable social and political environments, with adverse implications for sovereign ratings. If large numbers of young people are unable to find jobs, see little prospect of having a family or having status in society, then social unrest is likely to follow. This is more likely if there is high unemployment and poor governance.

Other sources of political risks are heightened pressures on environmental resources – aggravated by climate change – or shifts in ethnic, sectarian or gender balances. The countries most exposed to such risks are predominantly in Africa and the Middle East, which are experiencing social conflict or political violence as a result.

Demographic forces are already affecting some sovereign ratings and Fitch believes they are likely to become a more important catalyst in the coming years. This depends on their proximity and severity, as well as the likelihood of reforms to mitigate the impact.

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