Executive summary
Bond financing has grown alongside expansionary monetary policies, in particular quantitative easing, since the 2008 global financial crisis. This trend is broad-based, from sovereign issuers responding to increased public spending needs in both advanced and emerging economies, to financial and non-financial corporations across the world. A favourable funding environment post-2008 has opened bond markets to a wider range of issuers, including lower-rated governments and companies, expanding into riskier market segments. It has also contributed to the emergence of the sustainable bond market. The total volume of sovereign and corporate bond debt globally at the end of 2023 was almost USD 100 trillion, similar in size to global GDP.
At the end of 2023, OECD governments’ total bond debt stood at USD 54 trillion, an increase of USD 30 trillion since 2008. This is projected to increase further to USD 56 trillion in 2024. The United States will represent roughly half of this debt, twice its share in 2008. The share of People’s Republic of China’s (China) debt in Emerging Markets and Developing Economies has also doubled, reaching nearly 30% of the total outstanding amount.
The total global outstanding corporate bond debt has increased from USD 21 trillion to USD 34 trillion over the same period. Over 60% of this increase came from non-financial corporations. Structurally low yields have enabled lower-rated corporates to access the market, with an expansion of the non-investment grade market and a sharp decrease in the value-weighted average corporate credit rating globally. The outstanding debt of the non-investment grade segment totalled USD 3.4 trillion at the end of 2023, almost twice the 2008 figure.
The post-2008 environment has also seen the emergence of sustainable bond markets. This is still a nascent market segment but one that has been growing rapidly. At the end of 2023, the outstanding amount of sustainable corporate and official sector bonds totalled USD 2.3 trillion and USD 2.0 trillion respectively.
Bond markets play a critical role in allowing both governments and corporations to respond to periods of financial distress. During the COVID-19 crisis, sovereign and corporate bond issuance reached record levels. However, in some segments of bond markets this rapid growth has halted and even reversed from 2022 as monetary policy began tightening sharply in response to elevated levels of inflation.
The economic and financial disruption which resulted from the onset of the COVID-19 pandemic prompted a further easing of already accommodative monetary policies, with the substantial expansion of asset purchase programmes. During the period 2020-21, sovereign bond issuance in the OECD area peaked at USD 15.4 trillion in 2020, and sovereign issuance in Emerging Market and Developing Economies reached a then-record of USD 3.2 trillion in 2021, as governments provided large, mostly blanket fiscal support to businesses and households. Similarly, corporate issuance peaked in 2020 at USD 6.9 trillion, almost 50% above the 2008-19 average.
However, the sharp reversal in monetary policy starting in 2021-22 to tackle higher inflation has halted, and even reversed, this trend for certain market segments. Significantly tighter financial conditions have caused corporate issuance in particular to contract. While sovereign issuance by OECD countries fell somewhat in 2022, down approximately 16% from 2021, it remained substantially higher than pre-pandemic levels, and is projected to reach a new record high in 2024. Corporate issuance, however, fell by 25% in 2022, bringing it close to the pre-pandemic average. Non-investment grade corporate issuance contracted by as much as 74%. Both total and non-investment grade issuance remained around 2022 levels in 2023.
Central banks have purchased large amounts of sovereign debt from markets. While corporate debt purchases have been much smaller, sovereign debt purchase programmes have also had a significant indirect effect on corporate bond markets by lowering borrowing costs. However, as central banks have begun withdrawing from bond markets through quantitative tightening, a more price sensitive investor base is emerging.
At the end of 2023, the aggregate central government debt-to-GDP ratio in the OECD was approximately 83%, an increase of 30 percentage points compared to 2008, even though higher inflation, which boosted nominal GDP growth, has contributed to a decrease in this ratio of more than 10 percentage points over the past two years. Central bank holdings of sovereign bonds in the OECD area is currently equivalent to nearly 30% of GDP. The gradual withdrawal of central banks from bond markets globally will therefore not simply result in a return to the pre-quantitative easing market structure. Despite the surge in borrowing since 2008, the level of sovereign bonds held by the market as a percentage of GDP has remained largely unchanged. As central banks begin to shrink their balance sheets through quantitative tightening, the net supply of bonds to be absorbed by the broader market will increase to record levels. This will result in a growing share of bonds being held by more price sensitive investors, such as the non-bank financial sector and households.
The withdrawal of central banks from global sovereign bond markets will also affect corporate markets. Quantitative easing has had a strong effect on corporate bond markets, driving down yields and making issuance cheaper. Quantitative tightening will have the opposite effect, further contributing to the tightening of financial conditions. In addition, while much smaller than their sovereign holdings, certain central banks, notably the ECB and the Bank of Japan, hold considerable amounts of corporate bonds as well.
The expansion of the non-bank financial sector is particularly visible in the corporate bond market, where investment funds have substantially increased their activity. In the United States, investment funds quadrupled their ownership share of outstanding non-financial corporate bonds from 8% in 2008 to 34% in 2021, before falling sharply to 23% in 2022, illustrative of the price sensitivity of this investor category. Globally, open-ended funds invested in corporate bonds have an aggregate size of USD 8.9 trillion. They have increased their average net holdings of corporate bonds from 38% in 2005 to 51% in 2023.
Many governments and companies have locked in the benefits of the favourable funding conditions post-2008, by extending debt maturities and increasing the share of fixed-rate issuance. This has mitigated the immediate impact of the steep increases in policy rates since early 2022.
OECD area sovereigns have increased the average maturity of their borrowing from around 6 years in 2008 to approximately 8 years in 2023. As a result, more than half of the total outstanding stock will mature after 2027, reducing the near-term impact of the current tightening cycle on interest payments. For example, average sovereign yields in the OECD area rose from 1% in 2021 to 4% in 2023, whilst interest expenses only rose from 2.3% to 2.9% of GDP in the same period. The average maturity of investment grade corporate bonds has also been extended in most regions. In the United States, for example, maturities have more than doubled since 2000, and stood at above 10 years in 2023.
In addition, the vast majority of both sovereign and corporate bonds have fixed rate coupon structures, further reducing immediate exposure to interest rate fluctuations. On aggregate, both financial and non-financial companies in advanced as well as emerging economies have increased the fixed rate share of their borrowing over time.
The partial insulation from increasing interest rates is only transitory. Even if inflation is brought down to target and remains low, yields will likely remain higher than when most of the debt was originally issued. As the amount of debt maturing in the next three years remains considerable, this will add significantly to financing pressures, especially in emerging economies.
Around 40% of sovereign bonds will mature by 2026 globally. While this will entail further borrowing from the markets, the impact on interest payments is limited due to short-term, floating rates, and inflation-linked instruments already having been re-fixed at higher rates. Pressure on future interest payments will largely arise from new borrowings and the refinancing of fixed-rate debt, projected to lead to an increase in interest payments amounting to 0.5% of GDP in the OECD area by 2026. That is equivalent, for example, to OECD government's average annual expenditure on environmental protection.
Owing to the extension of maturities, the corporate refinancing profile in advanced economies has improved over time. The share of debt due in the following three years is equivalent to 32% of the total outstanding amount in 2023, compared to 37% in 2008. However, considering the increase in borrowing, this still represents a substantial amount totalling USD 8 trillion.
In emerging economies, the situation for corporates is more challenging. Debt coming due in the next three years has grown significantly in both absolute terms and as a share of total outstanding debt, representing 51% in 2023 (USD 4.4 trillion). This increase is driven to a large extent by the growth of the Chinese market, where maturities have been shortening. When looking at emerging markets excluding China, the share of debt maturing in the next three years is more stable, but was still 48% at the end of 2023.
Market risks are especially present in certain advanced economies with higher debt-to-GDP ratios, low-income countries experiencing credit downgrades and very high spreads, and low-quality corporate issuers in particular sectors, notably real estate.
Inflation has reduced debt-to-GDP ratios, but it does not improve the fundamentals of debt sustainability. It may have the initial effect of lowering debt-to-GDP ratios, but the medium-term impact of elevated inflation is to put upward pressure on debt-to-GDP ratios, due to high inflation premiums. This leaves several highly indebted OECD countries facing the potential negative feedback loop of rising rates, slow growth and expanding deficits unless they take steps to enhance fiscal resilience.
Rapid monetary tightening in major economies has also affected the credit ratings of low-income and lower middle-income countries, which together have seen a total of 24 downgrades compared to 6 upgrades in 2023. This figure is almost twice the annual average of downgrades and about half the average number of upgrades observed from 2010 to 2019 for countries in these income groups. In sub-Saharan Africa, the average 10-year sovereign yield spread over the US Treasury benchmark is above 10%, which is a key threshold for considering whether a country is in debt distress.
Amongst corporates, sector-specific risks are particularly visible among real estate companies. The aggregate leverage in the sector has more than tripled since 2005, with the debt to EBITDA ratio reaching 13.5 in 2022. Globally, real estate companies have increased their use of bond markets; their share of total issuance is around three times what it was in 2000.
Indications of decreased credit quality for non-financial corporate bonds merit attention. An increasingly large share of non-financial investment grade bonds is just above the non-investment grade threshold. At the same time, the characteristics of these issuers have changed over time. The average leverage of companies issuing BBB rated bonds is substantially higher today than it was 15 years ago. The potential for fire sale dynamics in the event of widespread downgrades is a key aspect to consider.
The decrease in corporate credit quality is not just an effect of the expansion of the non-investment grade market, but also of an increasing concentration of lower-rated issuance within the investment grade segment. At the end of 2023, 53% of all investment grade issuance by non-financial companies was rated BBB, the lowest investment grade rating, more than twice the share in 2000. In addition, bonds rated BBB-minus have grown as a share of total BBB issuance over time.
Another component adds further complexity to this deterioration in investment grade credit quality: the average leverage of a BBB rated bond issuer was 44% higher in 2023 than in 2008 in advanced economies, and 162% higher in emerging economies. Globally, 42% of BBB rated bonds were issued by non-financial companies with debt-to-EBITDA ratios over 4 in 2023, compared to 11% in 2008.
Historically, BBB-minus bonds have had the lowest probability of being downgraded. In addition to companies paying particular attention to their credit quality metrics, it is possible that rating agencies exercise particular caution when it comes to downgrading these bonds to non-investment grade. Given the increase in within-rating leverage, the implications of this possibility should be considered.
Owing to the sheer size of the non-financial BBB market – USD 4.3 trillion at the end of 2023 – even a relatively small transition rate to non-investment grade of 5% would be equivalent to 58% of 5-year average non-investment grade issuance globally. The non-investment grade market’s capacity to absorb these quantities needs to be considered.
The risk of widespread downgrades is especially relevant given the changing investor structure of corporate bond markets. Open-ended funds categorised specifically as investment grade funds hold USD 651 billion worth of BBB rated securities. In a scenario where there are a higher number of downgrades from investment grade to non-investment grade, the potential for fire sale dynamics in illiquid secondary markets by price sensitive investors such as these, and others with rating-based mandates, is a key risk.
Despite the rapid growth of the sustainable bond market, there is no clear evidence that companies systematically benefit from a premium for issuing sustainable bonds.
At the end of 2023, the outstanding amount of sustainable bonds globally reached USD 4.3 trillion, up from USD 641 billion just five years prior. Europe has been the most active region in the sustainable bond market in both the corporate and official sectors. From 2014 to 2023, 45% of the global amount issued through corporate non-financial sustainable bonds was raised by European companies.
In terms of pricing, investors may not be willing to pay a premium for sustainable bonds either because they do not value the potential sustainability impacts of their investments or, while investors may value such impacts, sustainable bond contracts might not create credible commitments by the issuer. It may also be the case that investors would be willing to pay a small premium for sustainability impacts, but that liquidity-related discounts and the transaction costs involved in the investment process may offset this.
An analysis of a sample of green, social and sustainability (GSS) bonds prospectuses shows that two-thirds mention that refinancing existing eligible projects with the proceeds is allowed, and no prospectus explicitly mentions that proceeds would not be used for refinancing. This effectively means that proceeds of many GSS bonds may not be used to finance a new green or social project. Additionally, no GSS bond prospectus in the sample refers to a contractual penalty in case the issuer does not use all proceeds to finance or refinance eligible projects, which may undermine investor confidence in issuers’ compliance with the sustainability-related commitments.
The share of sustainable bonds being assured by second party opinion providers has grown from less than half in 2019 to three-quarters in 2023. These service providers verify whether the bond contract is aligned with a specific sustainable bond standard, and these verifications may help assure sustainability-conscious investors that their investment will have a positive impact on the environment and society.
A new macroeconomic landscape of higher inflation and more restrictive monetary policies is transforming global bond markets at a pace not seen in decades. This has profound implications for debt markets and financial stability at a time of renewed financing needs. Vigilant monitoring and appropriate policy responses are needed to ensure that sovereign and corporate bond markets continue to function effectively.
Public debt managers face a range of challenges, including a continued growth in borrowing needs in the context of a changing investor base and shifts in demand for securities across different maturities. Strategic debt management decisions are needed to ensure the long-term sustainability of government debt. These should be implemented with great care and by adhering to the key principles of debt management, including providing transparency and predictability while maintaining flexibility in market operations. Monitoring and, where possible, actively supporting market liquidity will also be vital.
Market supervisors should closely monitor the evolution of corporate debt sustainability indicators. The exposure of investment funds to corporate bonds at the lower end of the investment grade category warrants particular attention. Given the sharp growth in the outstanding amount of BBB rated bonds, even a relatively small transition rate to non-investment grade would represent a large share of average non-investment grade issuance. A limited market capacity to absorb significant new quantities of non-investment grade bonds could lead to fire sale dynamics with implications for market stability.
Meanwhile, further improvements are needed to the sustainable bond market to enhance its efficiency, safeguard investor interests, and ensure that these bonds can be an effective tool in combatting climate change. Market regulators can support these goals by adopting sustainable bond standards that effectively commit issuers to investing in new sustainable projects that help drive additionality (new funding for the climate, not repackaged existing funding); and by requiring external reviews of such standards to ensure that sustainable bonds deliver the intended positive impacts for society and the environment.