Public sector debt: a Q&A

A quick look at today’s public sector finances release from the ONS will show that the UK’s public sector net debt stands at over £1.5 trillion.

But other than there being a lot of it, what else is there to say about the debt?

Here we investigate the basics of what public sector debt is, how it is funded and who it is owed to.

What is public sector debt?

When the government has a budget deficit – when it is spending more than it is receiving in taxes – it has to borrow. Broadly speaking the public sector’s debt is the stock of its past borrowing. It includes the debts of the whole public sector but the vast majority is attributable to central government.

Where has the government borrowed all this money from?

Over 85% of the government’s total debt has been raised by selling gilts and bills, mainly to financial institutions (more on this later). Just under 10% is from National Savings and Investments (NS&I) – this being the government-owned savings bank that offers savings products, such as premium bonds, to the public. Other sources, such as currency debt, make up the remainder.

What are gilts and bills?

Gilts and bills are ways of loaning money to the government. They are sold by the Debt Management Office (DMO), the government’s debt management agency, to finance the government’s borrowing.

A buyer of a gilt lends the government money for a specified length of time, known as the gilt’s maturity. In return the holder of the gilt receives an interest payment, known as the coupon payment, every six months for the duration of the loan.

When a gilt matures the government pays the original amount loaned back to the holder of the gilt. The holder at maturity may not be the original buyer; once bought, gilts can be traded on secondary markets.

The DMO also sells Treasury bills, but a much smaller proportion of the government’s borrowing is raised through these. Treasury bills are short term loans of less than a year. The holder of a Treasury bill will not receive any interest payments, however once the bill reaches maturity the holder generally receives more money than they initially loaned to the government.

So the DMO sells gilts and bills just to finance the deficit?

Not quite. During the year the DMO will sell gilts and bills not only to finance the government’s deficit, but also to pay up on gilts and bills that are maturing during the year. This means that the stock of debt changes in two ways: the government’s new borrowing is added, and old maturing debt is rolled over.

Who buys gilts and bill?

Insurance companies and pension funds are the biggest holders of gilts and bills with around 27% of the total value. A further 26% are held overseas by foreign central banks and others.

Since 2009 the Bank of England has become a large holder of debt – by December 2015 it held 24% of the value. The Bank of England has been purchasing gilts as part of its quantitative easing programme which is designed to provide a boost to the economy following the economic recession.

160122 debt chart1

What is the average maturity of UK gilts?

The average maturity of UK public sector debt is 16 years, much longer than in most other developed countries. Close to 40% of UK gilts have maturities of over 15 years. The value of debt held in such long-term gilts has increased in recent years, as has the average maturity which was roughly 12 years in 2004. By selling gilts of longer maturities the government has ensured that it will pay the relatively low interest rates observed in the recent past on this debt.

 There isn’t a specific average maturity that governments should aim for. The important thing is that risks are spread, or diversified, by holding debt in different products of different maturities. By having a longer average maturity the UK faces less of a risk from short term rises in interest rates and risks from refinancing debt.

160122 debt chart 2

When did public sector debt get so big, and when will it come down?

Public sector net debt increased sharply in the aftermath of the financial crisis, rising from around 36-37% of GDP in 2007 to 80% at the end of 2014/15. Over the same period the actual amount of debt more than doubled to roughly
£1.5 trillion.

160122 debt chart3

The Office for Budget Responsibility (OBR), the UK’s fiscal watchdog, forecasts that growth in the public sector’s stock of debt will slow over the forthcoming years. The OBR also forecasts that debt will fall as a % of GDP as they believe that GDP will grow faster than the debt will grow.

Picture Credit: Debt by Christian Schnettelker, Creative Commons Attribution 2.0 Generic (CC by 2.0)