INVESTORS are fretting about the ballooning levels of public debt, after a ratings agency downgrade on the British Government's credit outlook fanned fears the United States could suffer a similar fate.
The ASX 200 index fell by 1.4 per cent yesterday amid similar falls in Asia, after Standard & Poor's rattled markets by cutting Britain's credit outlook to negative on Thursday night.
Investors also sold Australian Government bonds, mirroring a sharp sell-off in US Treasury bonds amid fears the US could lose its AAA rating. Any such cut would test the appetite for the massive public borrowing task facing the US Government, economists say.
This year alone, Deutsche Bank expects the US Treasury to issue $US1.9 trillion ($2.5 trillion) in bonds to foreign buyers to fund its stimulus spending. These fears dragged the US dollar down across the board and sent the Australian currency to a seven-month high above US78c.
In an attempt to calm investors' nerves, the US Treasury Secretary, Timothy Geithner, even told markets that the Obama Administration was committed to cutting its budget deficit.
The interest rate strategist at Westpac, Damien McColough, said the cut to Britain's rating had focused investors' minds on the dependence of the borrowing nations on overseas funds.
While Australia's net debt is forecast to peak at 13.8 per cent of gross domestic product in 2013-14, compared with 80 per cent in Britain, investors in Japan and China are well aware of the British, US and Australian dependence on foreign funds.
"We are all fighting for the same pool of money. These guys can pick and choose which market they're in and they can demand a higher yield," Mr McColough said.
The rise in bond yields further raises the cost of raising money for treasury departments around the world. "Governments' cost of borrowing will rise right at the time when they most need these funds," Mr McColough said.
An analyst at Fat Prophets, Colin Whitehead, said the downgrade might take the wind out of the sails of the recent rally.
He said the state of Britain's finances was especially dire because its economy was in a deeper hole. "They don't have the benefit of printing the world's reserve currency to bail themselves out of it," he said.
However, Mr Whitehead said a bigger shock would be negative news from Asia, as investors had priced in a sharp recovery led by a return to rapid growth in China.
The chief economist at Nomura Australia, Stephen Roberts, said ratings agencies' and lenders' biggest concern was large public sector borrowing requirements and little sign from government on how they would wind it back.
"Ratings agencies are putting out warnings that there's a limit to how far you can put debt up without a reasonable strategy for pulling it back and still maintain a AAA credit rating," he said.
Mr Roberts said concerns over sovereign debt were of less concern to Australia because the state of the economy suggested the Government would be able to control its deficit spending.
