Who Does the Government borrow from?

How does the government borrow money and who does it borrow from?

Essentially, the government borrow money by selling bonds, which are usually bought by the private sector (pension funds and investment trusts). These investment trust may be oversees, but, in the UK most are held by domestic banks.

Debt Management Office

• The Bank of England used to be responsible for selling UK government debt. But, now that responsibility is undertaken by the Debt Management Office DMO (part of the UK Treasury)
• Nearly every week the DMO is having a gilt auction, where they sell gilts and bonds
• The Debt Management Office sell a range of financial securities. These are basically loans or IOUs. These bonds have a fixed interest payment. e.g. a £1,000 bond may have an interest payment of £50, giving an interest rate of 5%.
• The most common type of debt is a long dated gilt. These have a maturity of say 30 years. They are often bought by pension funds and investment trusts looking for a guaranteed return over a long time. These pension funds are typically UK based funds, but, also include foreign buyers.
• Foreign buyers are often more attracted by short term gilts which reach maturity in a short time - 3 months, 1 year e.t.c.

UK debt held by Oversees investors

• In the UK about 25-30% of government debt is held by foreigners. (see: UK debt held by foreigners)
  
• This % can vary between different countries. For example, in Italy, the % of debt held by foreigners is over 60%
• In the US, about 32% of total US debt is held by foreigners. The biggest foreign holder of US debt is China, Japan and UK.

Central Bank and Bond Holdings

Usually government borrowing is financed by selling bonds to the private sector. But, in some circumstances, bonds can be bought by Central Banks. For example, in the UK, the Bank of England pursued quantitative easing. This involved creating money electronically, and using this to buy government bonds. Therefore, in 2011, the Bank held a substantial % of UK government debt. However, the bank are committed to selling these bonds when the economy recovers and they end quantitative easing. (see: amount of bond purchases at Bank of England)

In the Eurozone, the ECB is not willing to act as this lender of last resort.

Rating Downgrade

A Rating Downgrade would make it more difficult to sell government debt - especially to oversees investors. A rating downgrade or genuine concerns over the UK's ability to repay would lead to investors requiring higher interest payments to compensate for risk.

Factors Which Make it Easier to Borrow

• Low interest rates mean the interest rate on government bonds is relatively low. This means the cost of servicing debt is relatively low. If interest rates rose, the cost of servicing national debt could in itself increase the borrowing requirement.
  
• Recession makes commercial bonds unattractive, therefore, investors are keener to go for the perceived security of government bonds.
• A policy of quantitative easing - buying a range of bonds, increases demand for government bonds and this increased demand makes it more attractive to buy bonds in an auction.
• The UK's fiscal position, although bad, is comparatively not as bad as many competitors, therefore there is still foreign demand for government bonds - despite threats of rating downgrades.

What Could make selling debt more difficult in Future?

• If the economy didn't recover leading to a worse fiscal position than expected.
• More bank losses which government need to absorb.
• An end in quantitative easing would reduce demand for bonds
• Rising interest rates would make it more expensive to buy.
• Threat of inflation and devaluation of pound would make foreign investors want to leave UK

Related

• National debt from a historical perspective
• Government borrowing in recessions
• UK National Debt