March 2nd, 2016

Growing Public Sector Debt

Posted at 1:00 AM ET

Many governments today are straining under public debt and many of the most catastrophically exposed governments are in the worst financial position. This is particularly true for countries exposed to the perils of flood, tropical cyclone and earthquake. Compounding this situation are demographic and economic trends that are adding additional pressure on already stressed balance sheets, both in emerging and developed economies.

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Between 2007 and early 2014, global debt grew by USD 57 trillion with almost 45 percent of the expansion coming from government spending (USD 19 trillion in advanced economies and another USD 6 trillion from developing economies) (1). Governments in advanced economies borrowed heavily to offset the effects of the global financial crisis (GFC) of 2008. Eight years following the GFC, economies have not yet deleveraged.

For example, according to the US Congressional Budget Office (CBO), spending on Medicare, Medicaid and Social Security already accounts for 60 percent of the US federal budget and is poised to drive federal debt to unsustainable levels unless fundamental changes are introduced. The CBO projects public debt (2) growth of more than 100 percent over the next two decades (3). Furthermore, at the state level, many governments are also challenged by high levels of debt while carrying significant exposure to catastrophic perils such as hurricane, winter weather and earthquake risk.

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Today, most public sector budgets globally do not account for the potential impact of large catastrophic loss. While these losses could materially impact the gross domestic product (GDP) of emerging economies, they also have the potential to impact developed economies as well. Looking ahead, demographic shifts and aging populations, emerging markets and their exposures and an interconnected global economy with increasing political risks will all bring increased pressure to bear on public sector finances. This pertains to both unfunded sources of risk exposure that rely on post-event risk financing and to publicly sponsored insurance programs that are demonstrably under-funded.

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Note:

1. McKinsey Global Institute Report: Debt and (Not Much) Deleveraging, February, 2015.

2. Defined as debt borrowed from credit markets and intra-government debt.

3. US Congressional Budget Office, 2015.

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