Global Market: IMF urges governments to cut spending, reduce debt as borrowing costs rise

ETMarkets.com

Global public debt was on track to reach 100% of gross domestic product, its highest level since World War Two, leaving governments with limited room to respond to future economic shocks, the IMF said.

Rodrigo Valdes, director of the IMF's Fiscal Affairs Department, told Reuters in an interview ahead of this week's IMF and World Bank meetings in Bangkok that fiscal outcomes had deteriorated compared with expectations six months ago and a year earlier. Most countries were now planning to increase spending rather than tighten their budgets, he said.

Major advanced economies with high debt levels need to build political support for credible medium-term plans to contain borrowing costs and limit the spillover effects of fiscal pressures on the global economy, the IMF said.

In a blog published on Wednesday, the fund warned that postponing fiscal adjustments would increase interest payments, heighten vulnerabilities and further constrain governments' policy options.

Emerging market and developing economies have so far benefited from relatively favourable financing conditions, but these may not last, the IMF said, urging them to reduce fiscal vulnerabilities and strengthen debt management. Low-income countries, facing tighter access to external financing, need to improve tax collection systems and make public spending more efficient.

Rising bond yields add to fiscal pressures

Higher oil prices, persistent inflation, stronger investment demand and unexpectedly robust growth in artificial intelligence-related investment have contributed to a sharp increase in long-term government bond yields in recent months, according to the IMF.

The average 10-year government bond yield across the Group of Seven advanced economies rose by more than 110 basis points between February and September, reaching its highest level in nearly two decades, the fund said.

The effective average cost of government borrowing is projected to rise to 3.7% by 2031, up from 2.3% in 2021, adding to the burden of servicing public debt.

In the United States, interest payments are expected to reach 5.3% of GDP, compared with 2.8% before the COVID-19 pandemic. The projected interest burden is roughly equivalent to the country's expected spending on Social Security, the IMF said.

The pressure is particularly acute in low-income countries, where interest payments currently consume more than 15% of tax revenues, compared with an average of around 9% between 2011 and 2019.

Governments in advanced economies are also refinancing a greater share of their debt at shorter maturities, allowing higher market interest rates to feed through more quickly into borrowing costs. For the G7 economies and Spain, debt due to mature within a year is approaching 30%, the IMF said.

Higher rates limit governments' policy options

Persistent inflation above central bank targets and elevated energy prices could require monetary policymakers to keep interest rates higher for longer, increasing financing costs for governments.

At the same time, governments face mounting pressure to increase spending on defence, energy security and ageing populations, complicating efforts to restore fiscal sustainability.

The IMF also warned that interest rates on government debt now exceeded expected nominal economic growth rates in several countries, making it more difficult for them to stabilise debt levels.

Valdes stressed to Reuters that governments needed to begin fiscal consolidation promptly, warning that the underlying dynamics of public debt left little scope for continued delays.

The IMF's latest warning underscores the growing challenge facing policymakers as higher borrowing costs, rising spending demands and elevated debt levels threaten to reduce governments' ability to support their economies during future downturns.