S &P Global Ratings' analysis of aging in the U.K. is part of a global study conducted to analyze the cost of aging. We presented our findings in "Global Aging 2016: 58 Shades Of Gray," published April 28, 2016. The comparative study explores various scenarios--including a no-policy-change scenario--and the implications that we currently believe these different scenarios could have on sovereign ratings over the next several decades. We included an additional eight sovereigns in this year's report, which expanded the scope of the study's coverage to a total of 58 sovereigns, representing 70% of the world's population. For the 50 sovereigns that we included in the previous edition of our Global Aging series, our findings this year provide an update of our analyses--including information on long-term demographic, macroeconomic, and budgetary trends--all in the context of the countries' current fiscal positions.
It should be noted that since we published our comparative findings in April 2016 we have re-run our simulation on the U.K. specifically for this article, factoring in our June 2016 two-notch downgrade (upon Brexit) and lower fiscal and growth outlooks for the U.K.
- The U.K.'s overall population is expected to increase by 19.5% between 2015 and 2050, reaching 77.3 million by 2050. According to European Commission forecasts, the U.K. will become the most populated country in Europe by 2050, but the share of working-age population is expected to decline from 65.1% to 58.8% leading to higher age-related expenditure.
- Under current policy, the government's annual age-related spending is projected to increase by about 2% of GDP. Absent any further reforms or compensating expenditure cuts in other areas, this could lead to a deterioration of the U.K.'s fiscal position, and a possible increase in net general government debt to 189% of GDP by 2050.
- Since our last Global Aging report in 2013, the U.K. has extended the state pension age and put in place a policy framework for regular review of the retirement age, in an attempt to lower costs.
- However, state pensions in the U.K. continue to be subject to a generous and costly rule, the "triple-lock", ensuring payments consistently rise in both real and nominal terms presenting a significant cost to the exchequer.
Results For The U.K.
Our analysis suggests that in the U.K., the old-age dependency ratio will rise to 40.7% in 2050 from 26.6% in 2015 (see table 1; the old-age dependency ratio is the number of people aged 65 and older divided by the number of those aged 15-64). Overall, we expect the U.K.'s population will continue to grow and exceed 77 million by 2050. The share of the working age population, however, is projected to fall to 58.8% by 2050 from the current 65.1%.
In our view, an aging population will likely place substantial pressure on economic growth and public finances. Demand for publicly provided health care and long-term care services and state pensions could increase. Without further government reforms, total age-related public expenditures in the U.K. are projected to rise to 18.9% of GDP in 2050 from 16.9% in 2015. Nevertheless, this forecast increase of 2% of GDP is less than the projected 3.7 percentage-point increase for the median of our 58-sovereign sample. We expect that the bulk of the U.K.'s age-related spending will go toward health-care outlays, followed by pension expenditures (see table 1).
State pensions are currently subject to a "triple-lock" guarantee, which requires that they rise each year by the highest of either CPI inflation, wage inflation, or 2.5%. This legislative constraint will contribute to long-term pressures on public spending. We anticipate that although the increase in age-related spending in the U.K. will be moderate until around 2020, spending will likely increase after this period, as more people enter retirement age.
Such a development could suggest a significant deterioration in the U.K's budgetary position in the long term. If unmanaged, the weight of general government spending--including social security--could rise significantly as age-related spending increases, coupled with a rising interest bill as deficits and debt mount. Our analysis suggests that without fiscal or structural policy reforms, net debt could rise to 189% of GDP by 2050 in the U.K., higher than the sample median of 134% of GDP.
Expected Impact Of A No-Policy-Change Scenario On The Ratings
Such macroeconomic and fiscal dynamics, if unaddressed, could lead to a change to the current 'AA' long-term foreign currency sovereign rating on the U.K. Based on the fiscal projections of our study, we derived hypothetical sovereign credit ratings for the U.K. (see table 1). In practice, S&P Global Ratings takes a large number of factors into consideration when determining sovereign credit ratings (see "Sovereign Ratings Methodology" published Dec. 23, 2014). In the very long term, prolonged fiscal imbalances and wealth (as measured by GDP per capita) tend to become the more dominant factors. Using this approach, and no mitigating policy response, our 'AA' rating on the U.K. could come under increasing pressure over the coming decades. By 2035, the U.K.'s fiscal indicators could have weakened such that they would be more in line with sovereigns currently rated in the 'bbb' category. And, in our view, the projected improvement in GDP per capita would not be able to offset the potential fiscal deterioration.
When comparing our new post-Brexit results for the U.K. with what we found in our April 2016 pre-Brexit simulation, it seems that future budgetary challenges now appear to be more significant. This is a result of several factors, the main reason being our write-down of key fiscal and economic indicators for the sovereign.
When we compare our post-Brexit 2016 simulation with our 2013 report, we are now projecting specific age-related spending to be lower, mostly on the back of reduced specific health-care expenditures.
Alternative Scenarios Could Result In Drastically Different Economic And Fiscal Prospects
In addition to our no-policy-change scenario, we have considered several other long-term scenarios (see table 1). Two of these scenarios are: the U.K. undertaking radical structural reforms to its social security system, freezing all age-related spending at the current level (as a percentage of GDP); or the U.K. balancing its budget by 2019. Based on these scenarios, fiscal indicators in the U.K. appear to hold up much better--especially if the government were to undertake structural reforms to prevent age-related spending from rising or move to consolidate its budget for a sustained period.
The Effects Of Age-Related Spending On Sovereigns' Future Creditworthiness
The base-case scenario is not a prediction. Rather, it is a simulation that highlights the importance of age-related spending trends as a factor in the evolution of sovereign creditworthiness. In our view, it is unlikely that governments would, as a general matter, allow debt and deficit burdens to spiral out of control or that creditors would be willing to subscribe to such high levels of debt. In fact, as we have observed in many sovereigns in our 2016 Global Aging report, governments are often able to confront the prospects of unsustainably rising debt burdens by implementing budgetary consolidation or reforms of their social security systems.
|Aging Population Data And Scenario Results: United Kingdom|
|Demographic and economic assumptions|
|Working-age population (% of total)||65.1||63.0||61.9||60.8||60.0||59.6||59.4||58.8|
|Elderly population (aged over 65; % of total)||17.3||18.7||19.8||21.4||22.7||23.3||23.5||23.9|
|Old-age dependency ratio (%)||26.6||29.6||31.9||35.2||37.9||39.1||39.6||40.7|
|Real GDP (% change)||2.3||1.1||1.3||1.7||2.0||2.1||2.0||1.8|
|Age-related government expenditure (% of GDP)|
|Scenario 1: No policy change (% of GDP)|
|Net general government debt||83.5||87.7||98.4||112.7||128.5||146.8||166.7||189.0|
|General government balance||(4.4)||(3.6)||(5.8)||(6.9)||(8.2)||(9.5)||(10.3)||(11.5)|
|General government expenditure||43.2||42.3||44.5||45.6||46.9||48.2||49.0||50.2|
|Hypothetical long-term sovereign rating||AA||a||aa||a||bbb||bbb||bbb||bbb|
|Scenario 2: Balanced budget in 2019 (% of GDP)|
|Net general government debt||83.5||81.2||74.0||69.1||65.0||62.6||60.6||58.9|
|General government balance||(4.4)||(0.2)||(1.4)||(1.5)||(1.9)||(2.1)||(1.9)||(1.9)|
|Hypothetical long-term sovereign rating||AA||aa||aaa||aaa||aaa||aaa||aaa||aaa|
|Scenario 3: No additional age-related spending (% of GDP)|
|Net general government debt||83.5||87.6||95.7||104.4||111.7||118.6||126.2||134.9|
|General government balance||(4.4)||(3.5)||(4.9)||(5.3)||(5.7)||(6.0)||(6.4)||(6.8)|
|Hypothetical long-term sovereign rating||AA||a||aa||a||a||a||a||a|
|Scenario 4: Lower interest rate (% of GDP)|
|Net general government debt||83.5||86.2||90.0||95.0||100.9||108.2||116.2||125.0|
|General government balance||(4.4)||(3.0)||(3.8)||(4.4)||(5.2)||(5.8)||(6.0)||(6.4)|
|Hypothetical long-term sovereign rating||AA||aa||aa||aa||a||a||a||a|
|Scenario 5: Higher growth (% GDP)|
|Net general government debt||83.5||84.9||90.3||98.3||107.2||117.6||128.6||140.4|
|General government balance||(4.4)||(3.4)||(5.3)||(6.0)||(7.0)||(7.8)||(8.2)||(8.9)|
|Hypothetical long-term sovereign rating||AA||aaa||aa||aa||a||a||a||a|