Fiscal Space

An alternative, economic fundamentals-based measure of the risk of sovereign debt default.

The Great Recession aggravated long-term fiscal pressures in many advanced economies, raising concerns about their solvency. One way to gauge governments’ health in this context is to take a reading of their available fiscal space. Fiscal space is defined as the difference between a nation's sovereign debt-to-GDP ratio and the limit beyond which the nation will default unless policymakers take unprecedented steps.

Fiscal space provides an alternative, fundamentals-based measure of the risk of sovereign debt default. Moody's Analytics calculates fiscal space and related concepts using econometric techniques to identify how nations' fiscal policies have responded historically to increases in their public debt. Each month our researchers update fiscal space estimates based on Moody's Analytics' monthly forecasts of real GDP, inflation and long-term market interest rates. The full set of fiscal space estimates accounts for 30 advanced economies and contains nearly 50 variables (contact us for more information). Learn more about our global forecasts.


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Fiscal Space: Distance to Debt Limit

As measured by the debt-to-GDP ratio, ppts

 
Grave Risk (0-40)
 
Significant Risk (41-69)
 
Caution (70-124)
 
Safe (>124)


Interpreting the Data

Fiscal space is sensitive to economic fundamentals, and sudden shifts in fundamentals can change a country’s fiscal space significantly. Even a modest deterioration—such as a decline in the expected GDP growth rate, or a sustained increase in the government bond yield—can quickly reduce the amount of fiscal space available to the sovereign state. Based on historical experience, it is wise for national governments to maintain at least 125 percentage points of fiscal space.

Since the fiscal space model is a simplified representation of reality, estimates of a country’s debt limit and fiscal space are subject to uncertainty. This uncertainty can be measured and accounted for by deriving probabilities that a country has a given amount of fiscal space.

For example, the probability that the U.S. has more than 125 percentage points of fiscal space is close to 100%. That is, using the Moody’s Analytics economic projections for the U.S. economy and market interest rates, it is highly likely that the U.S. will solve its fiscal problems without policymakers having to take fiscal steps significantly different from what they have taken historically. In the past the U.S. has shown the political will to address its fiscal problems. However, the probability that the U.S. has more than 175 percentage points of fiscal space is closer to 20%, and it is very unlikely that the U.S. has more than 200 percentage points of fiscal space.

More broadly, if the probability that a country has a given level of fiscal space is greater than 97.5%, then it is highly likely that the country does have that level of fiscal space. Probabilities of 84% to 97.5% are considered very likely. The 84% cutoff is consistent with the calculation used by banks to cover their unexpected losses under capital regulations. Banks generally keep enough capital to cover losses that are at least one standard deviation greater than expected. Probabilities of 16% to less than 84% are considered somewhat likely, and those below 16% are considered unlikely.

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Summary Data

Fiscal Space
ppts,
Current month
Fiscal Space,
Change from prior month
Survival Rate: Upper limit on 10-yr bonds, %
Current month
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Key Economic Drivers

Market interest rate
5-yr forecast MA, %
Real GDP growth
5-yr forecast MA, %
GDP deflator growth
5-yr forecast MA, %
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Comparison with Other Estimates

Fiscal space provides an alternative economic fundamentals-based approach to evaluate the risk of sovereign debt default. Other approaches include ratings and implied default probabilities derived from credit default swaps, essentially insurance contracts that pay off if a debtor defaults. Fiscal space is highly correlated with ratings from Moody’s Investors Service. All sovereigns rated Aaa have more than 125 percentage points of fiscal space. Sovereigns rated Baa or less have less than 125 percentage points of space, and in most cases have already run out of space. Fiscal space and Moody's Analytics CDS-Implied EDF™ (Expected Default Frequency) measure are also highly correlated. CDS-Implied EDF measures are the market’s collective assessment of a debtor’s probability of default, extracted from observed credit default swap spreads and adjusted for loss-given default and the market price of risk. As CDS-Implied EDF metric values increase, the probability of various amounts of fiscal space decline.

Fiscal Space>125
(Probability)
MIS
Foreign Currency Rating
MIS
Outlook
CDS-I EDF™
1-yr
CDS-I EDF™
5-yr
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MIS Moody's Investors Service

Global Long-Term Rating Scale
(as specified in Moody's Rating Symbols and Definitions Documentation, Sept.2012)
  • Aaa—Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.
  • Aa—Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
  • A—Obligations rated A are judged to be upper-medium grade and are subject to low credit risk.
  • Baa—Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.
  • Ba—Obligations rated Ba are judged to be speculative and are subject to substantial credit risk.
  • B—Obligations rated B are considered speculative and are subject to high credit risk.
  • Caa—Obligations rated Caa are judged to be speculative of poor standing and are subject to very high credit risk.
  • Ca—Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
  • C—Obligations rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest.

Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aaa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category. Additionally, a "(hyb)" indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.

CDS-I EDF™— Moody's Analytics CDS-Implied EDF™ credit measure

CDS-implied EDF™ (Expected Default Frequency) credit measures are the market’s collective assessment of a debtor’s probability of default, extracted from observed credit default swap spreads and adjusted for loss-given default and the market price of risk.