What happens to federal debt when interest rates rise

22.04.2022

The Confederation has debt of almost CHF 110 billion, and around CHF 75 billion of this is money and capital market debt. In the last two years, this market debt rose for the first time in more than ten years as a result of the pandemic. Investor interest in Confederation bonds remains strong.

The ongoing COVID-19 pandemic continued to weigh heavily on the federal budget in 2021, and resulted in high funding requirements for the Confederation. To cover these needs, the Confederation significantly increased its issuing activity, as can be read in the Federal Treasury's new activity report. In other words, it raised more funds on the capital market, which caused the Confederation's long-term market debt to rise for the first time in more than a decade.

Money and capital market debt

In 2020, the first year of the pandemic, the Confederation covered its funding requirements in other ways, i.e. it reduced its liquidity and also took on short-term money market debt (maximum maturity of one year). This is a typical approach in crisis situations: government debt managers first increase short-term debt, which can be raised relatively quickly and cheaply. The associated interest rate and refinancing risks are addressed in a later consolidation phase by restructuring the debt portfolio. Although the financial repercussions of the pandemic are not yet over, the Confederation has initiated the consolidation and transition phase and has already partially restructured its debt.

Doubling of demand

Who at the Confederation keeps track of these huge amounts? How much money is raised at what interest rate? The Federal Treasury is responsible for ensuring that the Confederation always has enough liquidity and raises funds on the best possible terms. This division of the Federal Finance Administration has to provide the corresponding funds based on the Federal Administration's reported needs. The Confederation is considered to be a very good borrower in this respect and has no difficulty borrowing. This is reflected in demand, for example. When the Confederation auctioned a bond last year, the average demand was around CHF 403 million, which was noticeably more than in the previous year and almost twice as high as before the pandemic (2019: 214 mn). Both the number of participants and the number of bidders considered per auction also rose significantly last year. This is proof of the undiminished appeal of Confederation bonds among investors, to the extent that investors even pay the Confederation to lend it money – in other words, negative interest.

Confederation bond investor base

The average issue yield in 2021 was negative for the third year in succession at -0.21%. The low interest rate environment also meant that the Confederation's interest expenditure continued to decline overall, despite an increase in bond issuance. Over the past 10 years, this expenditure has fallen steadily from around CHF 2.5 billion to less than CHF 1 billion.

Delayed impact of interest rate reversal

Despite the shorter duration of issues relative to the pre-pandemic period, Switzerland continues to have an above-average duration and a high proportion of issues with terms to maturity exceeding 15 years when compared with other countries. Consequently, Switzerland's exposure to interest rate risks is comparatively low. This means that an interest rate reversal will affect the Confederation's debt service with a greater time lag, thereby protecting the federal budget from higher interest rates in the short and medium term.

Comparison of government bond interest commitment

What lies ahead this year in terms of debt management? Although the COVID-19 pandemic is nearing an end and this is likely to lead to the gradual rollback of many exceptional measures, the pandemic will continue to put a burden on the federal budget in 2022. According to current planning, funds amounting to just under CHF 8 billion will have to be raised on the money and capital market this year. Based on the issuance program published in December, bonds with a nominal value of CHF 6 billion are to be issued in 2022. As a result, the Confederation's capital market debt is likely to increase slightly again by CHF 2.5 billion.

At the same time, interest rates are rising and issuing activity is thus becoming more challenging. Due to accelerating inflation in many Western industrialized countries, the major central banks have announced a more restrictive monetary policy and in some cases already responded with initial interest rate moves. Interest rates have already risen sharply in recent weeks and months. However, the impact on the federal budget is likely to remain limited thanks to the above-average duration.

More information: Federal Treasury activity report for 2021

Last modification 22.04.2022

Top of page