Many governments around the world are managing their public finances like a spendthrift teenager with their first credit card — regularly raising their credit limit with little regard for the mounting debt pile. Unlike adolescents, nations do not have the bank of mum and dad to bail them out. They are instead disciplined by financial markets, and central banks cannot endlessly keep buying their debt without stoking inflation. Indeed, as interest rates and demands for spending have risen, governments across the world can no longer ignore their elevated levels of debt.
Although inflation and the economic recovery from Covid-19 have shrunk public debt from its peak, it is still well above pre-2020 records at about 96 per cent of global gross domestic product — or $86tn. Expensive lockdown support packages in rich nations are largely to blame. In Europe, energy subsidies since Russia’s invasion of Ukraine have added to the load. Pandemics and wars require a robust response, but with significant spending pressures ahead advanced economies will struggle to restrain borrowing.
The US finally reached a political settlement to suspend its $31.4tn debt ceiling for two years this week, but its deficits remain on course to rise over the next decade. The EU is wrangling over fiscal rules that have been suspended since March 2020. The UK is projected to meet its target to have its debt ratio falling within five years, but only if the government sticks to tight post-election spending plans.
High debts were less of a problem after the financial crisis, when interest rates were at record lows. Now that rates have shot up rapidly alongside total debt, interest spending as a share of GDP is set to remain elevated in many countries over the coming decade. Governments have been caught off guard by the shift in monetary policy. Japan could be next. With national debt standing at more than twice its GDP, if its central bank starts to normalise rates its interest spending will push even higher.
High interest burdens come just as spending pressures are also rising. This includes the costs of acting on climate change, defence commitments prompted by rising geopolitical tensions, and rising health and pension outlays as populations age. Inequality has also raised demands on benefits, and national industrial policies are back in vogue.
These pressures come before the fiscal space necessary to battle the next crisis is even factored in. With the growth outlook uncertain and the potential for rates to stay higher for longer, caution is warranted. As Britain’s gilt crisis last year showed, imprudent fiscal plans will lead investors to demand higher yields — and financial market instability is a real risk.
With poorer nations already paying a premium to borrow, higher debts and rates risk arresting their development. A record number of developing nations are at risk of a debt crisis — Zambia, Sri Lanka and Ghana are among recent defaulters. Opaque borrowing from China has complicated matters. China’s borrowing has also surged, with “hidden debt” owed by local governments looking ominous.
Caught between political and budgetary constraints, governments will need to get smarter about how they manage their finances. Structural reforms and investments in skills and infrastructure will take on greater importance. Patient capital could also be better deployed to help deliver on growth and the green transition. Taxes will also need to be more effective — for example more comprehensive carbon pricing would help shift the onus on decarbonisation away from public subsidies. Developing countries will need to get better at collecting taxes, while global efforts on debt restructuring and raising the firepower of international financial institutions remain vital.
Borrowing cannot keep rising forever without consequence. It is time for governments everywhere to stop ducking the hard choices.