Scope’s new reports – available for download here – examine these underrated long-term risks on EU sovereigns and the channels through which EU demographic trends are likely to affect sovereign credit risk longer term.

Demographics are a crucial element among the environmental, social and governance (ESG) factors in sovereign credit risk analysis, as population trends affect multiple drivers of government debt sustainability in the long term – from productivity to welfare spending and capacity for long-term investment.

“Given the importance of demographics, it is of more than academic interest to find large differences in projections among official institutions and major question marks over their underlying assumptions,” says Alvise Lennkh, deputy head of sovereign and public sector ratings at Scope.

“Underestimating the demographic impact on EU sovereigns could be compounded by policy inertia, undermining the ability of governments to prepare economies accordingly,” says Lennkh.

Scope’s analysis of long-term population projections from the UN, EC, OECD on the EU-4 – Germany (AAA/Stable), France (AA/Stable), Italy (BBB+/Stable), Spain (A-/Stable) – raises questions over forecasts related to ageing dynamics and migration, albeit more relevant for some countries than others.

All institutions agree that EU economies will face shrinking working age populations and rapidly ageing dynamics over the coming years. “However, we find wide discrepancies in forecasts, as well as rather optimistic assumptions over fertility rates and migration trends, presenting, in our view, meaningful downside risks to their projected baseline scenarios,” says Lennkh.

Without 1m people net migration each year until 2060, which is the European Commission’s baseline, the EU working-age population would decrease by 30% (80m people) and the old-age dependency ratio would rise to 70% for the EU. Including such migration, the working-age population will fall 16% and the old-age dependency ratio will be 60%.

“Germany, Italy and Spain are more exposed to adverse dynamics compared with the US, the UK and France,” says Giulia Branz, analyst at Scope. Scope’s study also shows that other large economies such as Japan (A/Stable) and China (A+/Stable) are also exposed to adverse demographic trends.

“Most advanced economies face meaningful challenges related to ageing in the years ahead, and the impact will be more pronounced depending on migration patterns,” Branz says.

The case of Spain is the most illustrative in comparing the forecasts of the European Commission, OECD and UN, with differences across the institutions less marked for Germany and France while still sizeable for Italy.

For Spain, the working age population will shrink by about 10-15pp from today by 2060 in the baseline scenarios of the EC and OECD, but by more than twice this size according to the UN baseline (“medium-variant”) scenario. This leads also to large discrepancies in old-age dependency ratio estimates. Specifically, while the EC and OECD forecast an old-age dependency ratio of around 60% by 2060, the UN’s baseline forecast is almost 80%.

“These differences are exceptionally large with critical implications for sovereign credit risk,” says Branz.