Without concerted policy and fiscal reforms, aging populations will lead to intense pressure on the public finances and sovereign ratings of many developed countries in the coming years, but Canada appears to be in fairly good shape, says Standard & Poor’s in a new report.

The report, to be released Tuesday, warns that, assuming no change in their current fiscal stance and policies governing age-related spending, sovereign ratings could begin to fall from their current levels early in the next decade. By the 2020s, the downward pressure on ratings would greatly accelerate, and by the 2040s, all but Canada, Austria, and Denmark would display fiscal deficits that are currently associated with speculative grade sovereigns.

“Without further adjustment either to the current fiscal stance or to pension and health-care costs, the median general government net debt-to-GDP ratio for the sample will reach an overpowering 180% of GDP by the middle of the current century, from 33% in 2005,” says Standard & Poor’s credit analyst Moritz Kraemer. “Higher debt-service costs and age-related spending will significantly increase the economic weight of the state, with government spending rising to 56% of GDP in 2050, from 44% today.”

“This scenario is not a prediction by Standard & Poor’s,” the report stresses. “It is a simulation that highlights the importance of age-related spending trends as a factor in the evolution of sovereign creditworthiness. In reality, it is highly unlikely that governments will allow debt and deficit burdens to spiral out of control.”

S&P says that the example of Belgium in the past decade is instructive, “Once governments are confronted with unsustainably rising debt burdens they do react, however reluctantly, by tightening the fiscal stance.”

The rating agency notes that aging is only one force jeopardizing long-term fiscal solvency. The weak fiscal starting position is a factor of similar importance, it notes: “Several countries, especially France and Germany, have implemented important structural reforms since the turn of the current decade, which have helped to alleviate future fiscal pressures building up toward mid-century. Even so, much more remains to be done to effectively prevent the debt ratio from mushrooming.

“Compared with the estimates we conducted in early 2002, the fiscal readiness of sovereigns has not improved, and indeed, has deteriorated markedly in certain countries, most prominently the U.K. and the U.S.,” S&P observes. “This is partly due to weaker fiscal starting positions than we assumed back in 2002, but also due to higher health-care and pension spending estimates, in the U.S. dominated by ballooning Medicare outlays.”

The report also considers the effects if investors were to begin demanding compensation for lending to riskier (more leveraged) borrowers. It assumes that investors would charge one basis point extra for every percentage point that the net debt ratio exceeds 60% of GDP, which is broadly in line with the spreads currently observed among Eurozone sovereigns. “If investors became discerning in this way, it would drive Japan’s debt to more than 1,100% of GDP and even the U.S.’s general government debt would reach 500% of GDP in 2050,” it says.

“This illustrates how highly leveraged governments become extraordinarily vulnerable to sentiment shifts among investors,” said Kraemer. “In these circumstances, what looks sustainable one day may be a slippery slope the following morning.”