Though you wouldn't think it from the hysterical warnings we have been hearing of late about the dangers of a credit rating downgrade, the UK has a little time to get its finances in order. And one of the chief reasons for this is that even though our borrowing is high, we have relatively little debt to roll over in the next few years – the average maturity of gilts, at around 13 to 14 years, is significantly higher than for the bonds of most other governments.
The Debt Management Office (DMO) deserves credit for having had the prescience to structure gilts issuance in this way, though it has had no choice but to think more creatively about managing demand than its opposite numbers in less indebted countries. Still, with record gilts issues planned for this year, now is the time to go further: it should accede to the call made yesterday by the National Association of Pension Funds for much greater use of long-dated index-linked gilts.
Pension funds are fond of linkers because they need assets they can match against their liabilities. And since so many final salary pension schemes promise benefits that rise in line with inflation, an asset that offers returns linked to inflation is a valuable weapon in their armoury.
The DMO has issued around £30bn of linkers in the current financial year, up from £20bn in 2008-09. But while there is some nervousness about the total demand for linkers, particularly as investors have mostly been domestic, there is scope for a considerable increase.
Indeed, from pension funds' point of view, the more the better. One downside from investors' perspective is that yields on linkers tend to be low, but the greater the supply the more upwards pressure is applied. Even leaving aside the value of matching assets to liabilities, rising yields improve pension fund deficits, because this is the yardstick schemes use to calculate the discounted future value of their liabilities.
The happy news about linkers is they can be as attractive to issuers as to buyers. The low yield makes servicing the debt affordable – saving around £3.5bn a year over a 25-year issue according to some estimates – and funding this way also sends out a powerful message that the Government is serious about staying on top of inflation, which is what the markets want to hear. With other types of gilt, there is always the danger that the government of the day might be tempted to inflate the debt away.
The time, then, has come for a big increase in the supply of long-dated gilts, because it makes sense from a debt management perspective and because it suits the beleaguered pension fund industry. And should a future government find itself threatened with a credit rating downgrade once more, it might be grateful too for a shift in strategy today.