Are the US and UK heading towards debt crises?

With massive amounts of fiscal stimulus and financial bailouts, as well as costly healthcare reform programmes, US public sector debt is projected to rise by at least 40% in the next five years (to over 100% of GDP from the current 70%). This has raised fears that the US may soon hit a "debt wall", when no one would want to buy its Treasury debt. In such a case, US interest rates would soar and the loss of confidence in the US would lead to a US dollar crash. Similar concerns have arisen in the UK, where the HM Treasury estimates that its public debt, after rising from 30% of GDP in 2000 to 65% now, will continue to rise towards 80% of GDP by 2014. Like in the US, UK politicians are rushing out plans to pare the fiscal deficit and public debt burden by cutting public spending and raising taxes.

As far as a debt crisis is concerned, though, it is the debt-service cost that counts, not only the level of indebtedness. If total interest payments exceed a certain threshold of a debtor's income, default becomes inevitable. Thus, the debt-service cost-to-income ratio is the critical indicator of a borrower's financial stress and default risk. On this count, the public sectors in both the US and the UK are far from any debt crisis levels, even though total public debt has been rising swiftly since the subprime crisis.

No imminent public debt crisis

Official data show that the US government's debt-service cost-to-income ratio has actually fallen sharply and steadily since the mid-1990s, and the current ratio is the lowest since the late 1970s (Chart 1). This is remarkable, since the fall in the debt-servicing ratio has come on the back of a rapid run-up in the public sector debt burden. The absolute level of public sector indebtedness was higher in the 1990s than in the 1970s and 1980s. The key reason for the fall in the US debt-service cost is the persistent decline in interest rates since the 1980s (Chart 2).